Chapter 3 - 05.23.24

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School

Salt Lake Community College *

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Course

5310

Subject

Accounting

Date

Jun 1, 2024

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Uploaded by SuperHumanComputerHedgehog24

Taxation 1 - Accounting 5310 Problems Covered in Class Chapter 3 Bill & Federal & 1. Bill and Susan are husband and wife. They have consistently filed a 'married filing joint' income Total Susan State Gov't tax return. Between federal and state income tax, Bill and Susan's marginal tax rate is 35%. For 20X1, Mortage interest expense 46,500 30,225 16,275 Bill and Susan made deductible mortgage interest payments of $46,500. Given that Bill and Susan's charitable contributions alone exceed the standard deduction, how much of the $46,500 interest payment are Bill and Susan effectively paying? Now, how much of the $46,500 interest payment is the government paying? 2. Joshua is the sole owner of an LLC. Such LLC generates income from a business selling water After considering the 50% deduction for the S-E tax, Joshua's marginal tax rate is as follows: skis. Joshua is planning on running an advertising campaign that will cost him $30,000 during the next two months. He asks for your input. Given a combined federal and state income tax Income tax rate before 50% S-E tax deduction 40.00% rate of 40% and a self-employment tax rate of 15.30% where 50% of the self-employment tax S-E tax 15.30% rate is deductible, how much of the advertising cost will Joshua effectively pay and how much Income tax benefit of 50% S-E tax deduction -3.06% will the government pay? Total 52.24% Federal & Total Joshua State Gov't Advertising campaign 30,000 14,328 15,672 3. Ralph is a successful sole proprietor. He creates and sells pottery from a converted two-story garage next to his principal residence. The following are several potential expenses he is considering making in the next 30 days. He seeks your help in determining whether such expenses are (1) ordinary and necessary and (2) assuming they are ordinary and necessary, whether they should be capitalized (i.e., put on his sole proprietorship balance sheet). For each item, determine the answers to these two questions: Ordinary & Necess. Capitalized a. Hiring a part-time student to deliver pottery to his local distributors and customers. Ralph anticipates this will cost him roughly $3,000 per month. By hiring this student, he will be freed up to spend more time developing his pottery inventory. Yes No b. Ralph is considering buying a second kiln to fire his pottery. Such kiln will cost him $42,600. Based on the experience he has had with his first kiln, he expects the new kiln to last at least 30 years. Also, the new kiln is much more energy efficient saving Ralph some on his gas bill. Yes Yes c. Also looking for a way to generate a deduction, Ralph has decided to buy a new Car Maybe Yes car for $65,000. He plans on having a 'skin' wrapped around the car advertising his Wrap Yes Yes pottery business. Is the car an ordinary and necessary expense? What about the advertising wrap? d. His pottery shop (his former garage) has a leaky roof. He needs to either patch the roof or have a new roof put on the garage (the pottery shop). Given the two alternatives ((1) patch and (2) replace) answer the questions regarding 'ordinary and necessary' and 'capitalization.' Patch Yes No Replace Yes Yes e. One of Ralph's customers and her husband have become close friends of Ralph and his spouse. Ralph's customer approached him about the four of them going to Bermuda for 10 days. Ralph loves the idea as does his spouse. Ralph figures he can deduct the trip given he is furthering the success of his business by developing a deeper relationship with his customer and her husband. Ralph and his wife will spend $12,000 on this little jaunt over 10 days. What do you think? No N/A f. Ralph was approached by a friend in California about Ralph purchasing Tsunami insurance for his business here in Salt Lake City. The cost is rather minimal (say $600) and one never knows when Salt Lake will be hit with a Tsunami. He goes for it!! No N/A g. Ralph is considering buying a Traeger grill for personal use. However, he believes firing up the Traeger and slow cooking some brisket, he will attract more customers to his pottery shop. What do you think? No N/A h. Ralph is considering purchasing new accounting software. He has been using Quickbooks for better than a decade and would like a more robust accounting package. He is looking at a package that will cost $1,500. Yes No 4. The following is ABC's balance sheet on a tax and FMV basis. Cash basis Tax Basis FMV Cash 20,000 20,000 Accounts Receivable 0 60,000 Fixed Assets 1,000,000 250,000 Accumulated Depr. (1,000,000) Land 300,000 400,000 Investments 20,000 130,000 Total 340,000 860,000 Accounts Payable 40,000 Bank Loan 300,000 Common Stock 10,000 APIC 170,000 Retained Earnings 340,000 Total 860,000 Is ABC a cash basis or accrual basis taxpayer? 5. The following is XYZ's balance sheet on a tax and FMV basis. Somehow, it looks a lot Accrual basis like ABC's balance sheet! Tax

Basis FMV Cash 20,000 20,000 Accounts Receivable 60,000 60,000 Fixed Assets 1,000,000 250,000 Accumulated Depr. (1,000,000) Land 300,000 400,000 Investments 20,000 130,000 Total 400,000 860,000 Accounts Payable 40,000 Bank Loan 300,000 Common Stock 10,000 APIC 170,000 Retained Earnings 340,000 Total 860,000 Is XYZ a cash basis or accrual basis taxpayer? 6. XYZ sold inventory on May 1, 20X1 for $10,000. The allocated cost of such inventory was $3,000. As such, XYZ generated net income (before considering operating expenses) of $7,000. The buyer, ABC, has recently struggled financially. ABC took months to pay off the account receivable. It was paid off on February 15, 20X2. With this information, please answer the following questions? a. Assuming XYZ is a cash basis taxpayer, how much income will be recognized on the The answer to this question depends on how XYZ accounts for its inventory. Even if XYZ is a cash basis inventory sale and when will such income be recognized? taxpayer, it will likely account for its inventory on an accrual basis creating an asset on the company's balance sheet. If this is the case, the sale will generate $7,000 of income recognized in 20X2. b. Assuming XYZ is an accrual basis taxpayer, how much income will be recognized on the The inventory sale will generate $7,000 of income recognized in 20X1. inventory sale and when will such income be recognized? c. Under an accrual method, what is the balance of the account receivable created by $10,000 the sale mentioned above? 7. Given a choice, which of the two accounting methods should the company choose if it desires Cash method to maximize its ability to engage in appropriate tax planning - cash or accrual? 8. What about this idea? DEF, Inc. ("DEF") reports its taxable income on the cash basis method of NO!!!! accounting. The CEO is very creative. Knowing that expenses paid by year end are deductible in such year, the CEO pulls out of his numerically ordered checks, ten checks right at year end. The purpose in doing so is to reduce his 'prior' year income if necessary by writing checks taken out at the end of the year, written in say April of the subsequent year, and dating such checks as of December 31 of the prior year. His hope is to create a deduction for the prior year to reduce DEF's prior year taxable income. Does this work? 9. In order to more effectively match expenses with income, XYZ, Inc. ("XYZ") books a warranty Given the expense is an estimate, the $30,000 will not be deducted in 20X1. However, reserve at year end. The amount booked is tied to sales made during the current year - the greater it will be deductible at some point. The $30,000 will be deducted as repair work the sales, the greater the warranty reserve. XYZ's thought process is as follows - the product under warranty is actually performed. At that point, the 'all events' and 'economic sold by XYZ comes with a five-year warranty. While XYZ believes it produces extremely well- performance' tests have been met. built, reliable products, it also recognizes that a portion of their sales will return for repairs or replacement because the product didn't survive five years. On December 31, 20X1, XYZ booked an increase to its warranty reserve of $30,000. The debit was expensed as product repairs under warranty. For tax purposes, when will the $30,000 be deductible? 20X1? 10. XYZ, Inc. ("XYZ") is owned by one owner - Joey. Joey is economically very savvy and particularly No. Section 267 disallows the loss given that XYZ and Joey are related. When Joey sells the looks for ways to reduce both his tax liability as well as that of XYZ. Several years ago, XYZ purchased raw land at some point in the future, he will be able to reduce his gain, if any, by the $160,000 raw land for $300,000. For a period of years the property appreciated until the federal government deferred gain disallowed by 267. announced a freeway would be built just west of the property. Joey recognized this would kill his land's value and he was right. Now, a year after the freeway was announced, his raw land is worth only $140,000. Given a built-in loss of $160,000 and recognizing that XYZ has a $400,000 capital gain from the sale of another capital asset, Joey decides it's time to cut his losses and decides to sell the raw land for $140,000. He has virtually no luck. Finally, as December is coming to a close, he decides XYZ will sell the land to him (to Joey) thus permitting XYZ to recognize the loss offsetting the $400,000 gain. Does Joey's plan work? 11. Rachel is passionate about politics. She has been a strong supporter of her political party. The answer is zero. This is a political contribution and such contributions are not deductible. This election year, one of her political friends is running for mayor of Salt Lake. Her friend is In addition, they are not treated as a charitable contribution since the contribution is not a long shot and Rachel wants to help her financially as much as she possible can. Having expressed going to a qualified charity. this desire, she is only willing to contribute to her friend's campaign if she is permitted to deduct the contribution. Fortunately, Rachel itemizes her deductions. Assuming her adjusted gross income amounts to $150,000, what is the maximum cash contribution she can make to her friend's mayoral campaign where such contribution is fully deductible in the current year? 12. John has found himself in a tight financial situation. April 15th is approaching. John's CPA Yes - he should pay the penalties and interest. No - they are not deductible. Neither the has prepared his Form 1040. Such return shows $6,003 due and payable on April 15th. Bottom penalties nor the interest is deductible. line, he doesn't have the money to pay the tax. As such, he decides to ignore the problem and fails to file the return. Doing so subjects John to two penalties - (1) Underpayment of tax and (2) Failure to file. Fortunately, in the following months, John's financial situation improves. On August 10th, John files his Form 1040 and pays the $6,003 due on the return. Problem solved! In October, he receives a notice from the IRS indicating that he owes $1,501 for the two penalties mentioned above plus $97 in interest. John calls his CPA stunned by both the penalties and the interest. John's CPA tells him to pay the penalties and interest indicating that both are deductible so it isn't as expensive as it seems. Is the advice received from the CPA correct? 13. Below is a list containing various expenses. Are the following expenses deductible, partially deductible or not deductible at all? a. Tickets to a mud wrestling contest sponsored by a local charity. The payor This is entertainment. None is deductible invited one of her clients to join her in attending the event. Prior to the event, they had a lengthy business conversation about a new business the client is purchasing. b. Leslie made a contribution to the Utah Symphony. In gratitude for the The donation to the Symphony is deductible but such deduction must be reduced by the contribution, Leslie received four Symphony tickets. She invited one of her clients and value of the four tickets given to Leslie. As such, Leslie does have basis in those tickets. her client's spouse (along with Leslie's spouse) to the concert. Regardless, this event is treated as an entertainment expense such that the basis in the

tickets is not deductible even though it appears to be a business expense. c. Martha takes an important client to a nice lunch to discuss next year's It appears the lunch qualifies as a business expense given the purpose and topic discussed. audit budget. The lunch, though very nice, is not lavish or extravagant. However, such lunch is only 50% deductible. d. William, a CPA, has been asked to meet with the CEO and CFO of Big Deal, Doesn't work. This is a business meal which is only 50% deductible. Inc. - a large business here in Salt Lake City. William suggests they go to lunch on his nickel. All three agree on a date, time and place for lunch. William is delighted to meet the CEO and CFO to explore picking up Big Deal as a client. Even if he doesn't pick up Big Deal as a client, he believes the lunch can be categorized as 'advertising expense' and therefore be fully deductible. Fortunately, William is successful in picking up Big Deal as a client. He feels good about deducting the full cost as a business development expense. Is the lunch cost 100% deductible as advertising expense?

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