ACTG445Fall2021Sikes_Test3_AnswerKeyforStudents(2)

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445

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Apr 3, 2024

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1 1. Meaux Inc. sold two assets on March 15, 2021. Asset #1 is machinery with an original basis of $65,000, currently in the fifth year of depreciation, and under the half-year convention. Asset #2 is furniture with an original basis of $20,000 placed in service during the third quarter, currently in the fourth year of depreciation, and under the mid-quarter convention. The recovery period for both assets is 7 years. a. What is Meaux’s depreciation expense for Asset #1 in 2021? (2.5 points) 65,000*8.93%*0.5=$2,902 b. What is Meaux’s depreciation expense for Asset #2 in 2021? (2.5 points) $20,000*13.02%*12.5%=$326 2. Casbon Corp. placed in service on August 1, 2021 equipment (7-year property) with a basis of $1,220,000. This was the only asset that Casbon Corp. purchased this year. Assume that Casbon has sufficient income to avoid any limitations. Calculate the maximum depreciation expense including §179 expensing (but ignoring bonus expensing). (2.5 points) The $1,050,000 §179 expense is not limited. The half-year convention applies. The expense is $1,074,293, which is depreciation of $170,000 × 14.29% = $24,293 plus $1,050,000 of §179 expense. 3. On February 1 of last year, Steve received a painting from Albert as a gift. Albert’s adjusted $326 $2,902 $1,074,293

2 basis was $2,000 and the painting was valued at $3,000 at the time of the gift. Albert acquired the painting two years ago. Albert is still living (i.e., this was a gift and not an inheritance). What is Steve’s adjusted basis if he sells the painting on October 1 of this year for $2,500? (2.5 points) Because the FMV at date of gift > Albert’s adjusted basis, Steve will receive a carryover basis. 4. On February 1 of last year, Anthony received a painting from Michael as a gift. Michael’s adjusted basis was $3,000 and the painting was valued at $2,000 at the time of the gift. Michael acquired the painting two years ago. Michael is still living (i.e., this was a gift and not an inheritance). What is Anthony’s adjusted basis if he sells the painting on October 1 of this year for $2,500? (2.5 points) Anthony’s basis is deemed to be equal to the amount realized since the amount realized falls between the basis for loss and the basis for gain. 5. Missy inherits a house from her grandmother, Katie, on March 9 of the current year. Katie bought the house for $100,000 three years ago. The fair market value of the house in March is $150,000. What is Missy’s adjusted basis in the house? (Assume that the alternative valuation date is not used.) (2 points) The heir’s basis in property passing from a decedent to the heir is the FMV on the date of the decedent’s death. 6. In year 0, Matthew purchased a machine to use in his business for $67,000. In year 3, Matthew sold the machine. Between the date of the purchase and the date of the sale, Matthew depreciated the machine by $38,500. (5 points) a. What amount of ordinary income, if any, must Matthew recognize on the sale if the sale proceeds were $72,000? (2.5 points) $2,000 $2,500 $150,000

3 b. What amount of Section 1231 long-term capital gain, if any, must Matthew recognize on the sale if the sale proceeds were $72,000? (2.5 points) Only the gain caused by depreciation is treated as ordinary income under §1245, the remaining gain is §1231. Description Amount Explanation (1) Amount Realized $72,000 Given (2) Original Basis 67,000 Given (3) Accumulated Depreciation (38,500) Given (4) Adjusted Basis 28,500 (2) + (3) (5) Gain/(Loss) Recognized $43,500 (1) – (4) (6) Ordinary income (§1245 depreciation recapture) $38,500 Lesser of (3) or (5) §1231 gain $5,000 (5) – (6) 7. Why do corporations prefer for a gain to receive long-term capital gain treatment as opposed to ordinary income treatment? (Circle your answer.) (2 points) a. Long-term capital gains are taxed at a lower rate than ordinary income for corporations. b. A corporation can only use its capital losses to the extent it has capital gains. c. Both a and b $38,500 $5,000

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4 d. Neither a nor b Correct answer is b. 8. Baudoin Inc. trades Land A for Land B. The fair Myleset value of Land A is $54,450 and Baudoin trades Land A for Land B valued at $48,400 and $6,050 cash. Land A and Land B are like-kind property. Baudoin originally purchased Land A three years ago for $60,500 and Land A’s adjusted basis was $30,250 at the time of the exchange. a. What is the amount of Baudoin’s realized gain or loss? (Write gain or loss next to your answer in the box.) (2.5 points) Description Amount Explanation (1) Amount realized from Land B $48,400 Given in example (2) Amount realized from boot (cash) $6,050 Given in example (3) Total amount realized $54,450 (1) + (2) (4) Adjusted basis $30,250 Given in example (5) Gain realized $24,200 (3) – (4) b. What is the amount of Baudoin’s recognized gain or loss? (If it is a gain, enter it as a positive number. If it is a loss, enter it as a negative number by putting a minus sign in front of it.) (2.5 points) Lesser of boot received ($6,050) or gain realized ($24,200) c. What is Baudoin’s adjusted basis in Land B? (2.5 points) $24,200 gain $6,050

5 Basis of like-kind property received = Adjusted basis of like-kind property surrendered + Adjusted basis of boot given + Gain recognized - Fair Myleset value of boot received - Loss recognized = 30,250+6,050-6,050=30,250 9. Stacey sold an asset to Valerie. Valerie paid Stacey $99,000 of cash and also relieved Stacey of a $38,500 mortgage on the asset. Stacey paid a broker $7,700 to help find a buyer. What is Stacey’s amount realized on the sale? (2.5 points) Property Received Amount Explanation (1) Cash $99,000 (2) Relief of debt 38,500 (3) Broker fee (7,700) Amount Realized $129,800 (1) + (2) + (3) 10. Catherine is the CEO of publicly traded ABC Corporation and earns a salary of $1,500,000. Assume ABC has a 21 percent marginal tax rate. What is ABC’s after-tax cost of paying Catherine’s salary ignoring FICA taxes? (2.5 points) Description Amount Explanation Before tax cost of salary: (1) Salary $1,500,000 Taxes: (2) Deductible portion $1,000,000 Maximum deduction (3) Marginal tax rate × 21% (4) Tax deduction $210,000 (2) × (3) After tax cost of salary $1,290,000 (1) – (4) $30,250 $129,800

6 $1,290,000

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7 11. Newco granted Jeanne 10,000 nonqualified stock options (NQOs) on January 1, 2018. The options vest on January 1, 2021. The exercise price is $20 per share. On January 1, 2021, Jeanne exercises all 10,000 options when the price is $25 per share. She holds the stock for two years and sells all 10,000 shares for $28 per share. a. What is the amount of Jeanne’s taxable income from the options on the grant date? (2.5 points) b. What is the character of Jeanne’s taxable income from the options on the grant date? (Circle your answer below. Choose Not Applicable if Jeanne does not recognize income from the options on the grant date). (2.5 points) Ordinary Long-term Capital Gain Not Applicable c. What is the amount of Jeanne’s taxable income from the options on the exercise date? (2.5 points) 10,000 x ($25 - $20) d. What is the character of Jeanne’s taxable income from the options on the exercise date? (Circle your answer below. Choose Not Applicable if Jeanne does not recognize income from the options on the exercise date). (2.5 points) Ordinary Long-term Capital Gain Not Applicable e. What is the amount of Jeanne’s taxable income from the options on the date of sale? (2.5 points) 10,000 shares x ($28 - $25) $0 $50,000

8 f. What is the character of Jeanne’s taxable income from the options on the date of sale? Write either Ordinary, Long-term Capital Gain, or Not applicable (if Jeanne does not recognize income from the options on the date of sale). (2.5 points) 12. Dianne received 10,000 shares of restricted stock on June 1, 2020 when the stock was valued at $3 per share. The shares vest on June 1, 2021 when the shares are valued at $9 per share. She continues to hold the shares after the vesting date. a. When must Dianne recognize taxable income from the restricted stock if she does not make a Section 83(b) election? Circle answer your answer below. (2.5 points) Grant Date Vesting Date b. What is the amount of her taxable income from the restricted stock if she does not make a Section 83(b) election? (2.5 points) 10,000 shares x $9/share = $90,000 c. What is the character of Dianne’s taxable income from the restricted stock if she does not make a Section 83(b) election? Circle your answer below. Write either Ordinary or Long- term Capital Gain in the blank. (2.5 points) Ordinary Long-term Capital Gain $30,000 Long-term Capital Gain $90,000

9 d. When must Dianne recognize taxable income from the restricted stock if she does make a Section 83(b) election? Circle your answer below. (2.5 points) Grant Date Vesting Date e. What is the amount of her taxable income from the restricted stock if she does make a Section 83(b) election? (2.5 points) 10,000 shares x $3/share = $30,000 f. What is the character of Dianne’s taxable income from the restricted stock if she does make a Section 83(b) election? Write either Ordinary or Long-term Capital Gain in the blank. (2.5 points) Ordinary Long-term Capital Gain 13. Janice is currently a manager for Best Buy and her current salary is $52,800. Her marginal tax rate is 22 percent and she loves designer winter coats. She purchases a new coat each year. Her friend, knowing of her interest in coats, tells her about a manager position at the local coat store. The new position pays only $51,400 per year, but it allows employees to purchase one new designer coat per year at a discount of $2,300. This discount qualifies as a nontaxable fringe benefit. Assume that Janice will purchase the new coat regardless of whether she switches jobs. a. Which offer is better for Janice on an after-tax basis? Write either Best Buy or Coat Store in the blank. (2.5 points) b. By how much more is the best offer better on an after-tax basis? (2.5 points) If she stays at Best Buy: Salary $52,800 x (1-.22) $30,000 Coat store

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10 After-tax benefit from salary $41,184 If she switches jobs: Salary $51,400 x (1-.22) After-tax benefit $40,092 After-tax benefit of discount 2,300 After-tax value of second package $42,392 So the after-tax value of the coat store ($42,392) is higher than her current employer (Best Buy) ($41,184). The difference is $1,208. $1,208

11 14. Joan has been employed by Red Corp. for the last 2.5 years. Joan participates in Red’s traditional 401(k) plan. During her employment, Joan has contributed $6,000 to her 401(k) account. Red has contributed $3,000 to Joan's 401(k) account (it matched 50 cents of every dollar that Joan contributed). Red uses a 6-year graded vesting schedule. If Joan were to quit her job with Red, what would be her vested benefit in her 401(k) account (assume the account balance is $12,000)? (2.5 points) Answer: $6,600 Joan fully vests in her own contributions. Because she has worked two full years, she is 20% vested in what Red has contributed (20%*$3,000=$600). 15. Grant’s employer offers its employees a Roth 401(k) plan. Grant contributes 10% of his 60,000 salary. What is Grant’s after-tax cost of his contribution? His marginal tax rate is 24%. (2.5 points) Because contributions to Roth 401(k) plans are not deductible, the after-tax cost of the contribution equals the pre-tax cost. 10%*60,000=$6,000 16. Taxpayers generally should prefer which of the following when their current marginal tax rate is higher than their expected future marginal tax rate? (1 point) a. Traditional 401(k) plans b. Roth 401(k) plans Answer: A 17. Myles (single) is an attorney (age 40) who wants to save a lot for retirement so that he can retire young. His 2021 AGI before any IRA contribution deduction is $72,000 (all earned income). a. If he does not participate in an employer-sponsored plan, what is the maximum deductible IRA contribution Myles can make to a traditional IRA in 2021? (2.5 points) $6,600 $6,000

12 $6,000. Because Myles is not covered by an employer provided retirement plan, his deductible contribution is not limited by AGI. Also, because he is under 50 years of age at the end of the year, his maximum deductible IRA contribution for the year is $6,000. b. If he does participate in an employer-sponsored plan, what is the maximum deductible IRA contribution Myles can make to a traditional IRA in 2021? (2.5 points) Because Myles is under 50 years of age at the end of the year, his maximum deductible contribution (before phase-out) is $6,000. However, because he is covered by an employer sponsored plan as a single taxpayer, Myles’s maximum deductible contribution is phased out proportionally for MAGI between $66,000 and $76,000. Myles’s MAGI of $72,000 is 60% of the way through the $10,000 phase-out range [($72,000 – $66,000)/($76,000 – $66,000)] so he is not allowed to deduct 60% of the $6,000 maximum deductible contribution. But he is allowed to deduct 40% of his maximum deductible contribution of $6,000 which is $2,400. 18. Caroline and George (both 43 years old) are married and both want to contribute to a Roth IRA. In 2021, their AGI before any IRA contribution deductions is $65,000. George earned $60,000 and Caroline earned $5,000. a. How much can George contribute to his Roth IRA if they file a joint return? (2.5 points) $6,000. Individuals are allowed to contribute to a Roth IRA as long as their MAGI falls below certain phase-out threshold limits. For married individuals filing jointly, the ability to contribute starts to phase out once the couple’s MAGI hits $198,000 and is fully phased out when MAGI reaches $208,000. Because George and Caroline’s MAGI is below $198,000, George can contribute $6,000, the maximum contribution for taxpayers under age 50 at the end of the year. $6,000 $2,400 $6,000

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13 b. How much can George contribute to his Roth IRA if they file separately? (2.5 points) Zero. The MAGI based phase-out range for married individuals filing separately is between $0 and $10,000. Thus, if George files separately, he would not be allowed to contribute to Roth IRA because his MAGI is $60,000. c. How much can Caroline contribute to her Roth IRA if they file separately? (2.5 points) $2,500 ($5000 × 50%). Since Caroline’s MAGI is 50% of the way between $0 and $10,000 [($5,000 – 0)/(10,000 – 0)], Caroline is only allowed to contribute 50% of the maximum contribution for taxpayers under 50 years of age at year end. The maximum is the lesser of $6,000 or earned income. In this case, it is her earned income of $5,000 19. Alex, who is 38 years of age, opened a Roth IRA three years ago. He has contributed a total of $14,175 to a Roth IRA ($4,725 a year). The current value of the Roth IRA is $17,850. In the current year, Alex withdraws $15,750 of the account balance to purchase a grand piano. Alex’s marginal tax rate is 24 percent. a. What amount of income tax, if any, does Alex owe as a consequence of the $15,750 withdrawal? (2.5 points) b. What amount of penalty tax, if any, does Alex owe as a consequence of the $15,750 withdrawal? (2.5 points) $2,500 $0 $378

14 Because Alex has made a withdrawal from his Roth IRA within five years of opening it, he has received a nonqualified distribution. Nonqualified distributions are non-taxable to the extent they are attributable to contributions; the earnings made on such contributions are taxed as ordinary income. Further, because he is not 59 ½ years of age at the time of the distribution, the distribution of earnings is also subject to a 10% penalty. In this instance, Alex has withdrawn $1,575 of earnings (15,750 withdrawal – 14,175 contributions) and will pay income taxes of $378 (24% × 1,575) and a penalty tax of $158 (10% × 1,575). 20. Madeline (age 40 at year-end) has been contributing to a traditional IRA for years (all deductible contributions) and her IRA is now worth $40,000. Madeline plans to take the $40,000 out of the traditional IRA, pay the taxes due from the traditional IRA distribution, and contribute (roll over) the remaining distribution to a Roth IRA. Madeline’s marginal tax rate is 24 percent. a. What amount of income tax, if any, does Madeline owe as a consequence of the rollover as described? (2.5 points) b. What amount of penalty tax, if any, does Madeline owe as a consequence of the rollover as described? (2.5 points) Madeline will have to pay taxes of $9,600 for taking the $40,000 out of the IRA. After taxes, this leaves $30,400 ($40,000 – 9,600) for Madeline to contribute to the Roth IRA. However, because she doesn’t contribute (rollover) $40,000 (the full amount that was withdrawn from the traditional IRA), she will also have to pay the 10% penalty tax on the $9,600 that she did not contribute or roll over. Therefore, she will have to pay a penalty of $960 ($9,600 × 10%). $158 $960 $9,600

15 21. In 2021, Iva (64 years old) retired and planned on immediately receiving distributions (making withdrawals) from her traditional IRA account. The balance of her IRA account is $165,000 (before reducing it for withdrawals/distributions described). Over the years, Iva has contributed $55,000 to the IRA. Of her $55,000 contributions, $11,000 were nondeductible and $44,000 were deductible. Assume Iva did not make any contributions to the account in 2021. If Iva currently withdraws $27,500 from the IRA, how much tax will she be required to pay on the withdrawal if her marginal tax rate is 24 percent? (2.5 points) Because Iva has made both deductible and nondeductible contributions to her IRA, she needs to allocate the distribution between taxable amounts and amounts that are a return of her nondeductible contribution. To do this, she first has to determine the ratio of nondeductible contributions to the value of the IRA at the time of the distribution. In this case the ratio is $11,000/$165,000 or 6.67%. Consequently, $1,833.33 (27,500 × 6.67%) is not taxable and the remaining $25,666.67 is taxed at Iva’s marginal tax rate of 24%. Thus, Iva must pay $6,160 in taxes. $6,160

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ACTG445Fall2021Sikes_Test3_AnswerKeyforStudents(2)

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