Chapter 13, Problem 44CP

Beth R. Jordan lives at 2322 Skyview Road, Mesa, AZ 85201. She is a tax accountant with Mesa Manufacturing Company, 1203 Western Avenue, Mesa, AZ 85201 (employer identification number 11-1111111). She also writes computer software programs for tax practitioners and has a part-time tax practice. Beth is single and has no dependents. Beth’s birthday is July 4, 1972, and her Social Security number is 123-45-6785. She wants to contribute $3 to the Presidential Election Campaign Fund. The following information is shown on Beth’s Wage and Tax Statement (Form W–2) for 2018.

The following information is shown on Beth’s Wage and Tax Statement (Form W–2) for 2018.

During the year, Beth received interest of $1,300 from Arizona Federal Savings and Loan and $400 from Arizona State Bank. Each financial institution reported the interest income on a Form 1099–INT. She received qualified dividends of $800 from Blue Corporation, $750 from Green Corporation, and $650 from Orange Corporation. Each corporation reported Beth’s dividend payments on a Form 1099–DIV.

Beth received a $1,100 income tax refund from the state of Arizona on April 29, 2018. On her 2017 Federal income tax return, she reported total itemized deductions of $8,200, which included $2,200 of state income tax withheld by her employer.

Fees earned from her part-time tax practice in 2018 totaled $3,800. She paid $600 to have the tax returns processed by a computerized tax return service.

On February 8, 2018, Beth bought 500 shares of Gray Corporation common stock for $17.60 a share. On September 12, 2018, Beth sold the stock for $14 a share.

On January 2, 2018, Beth acquired 100 shares of Blue Corporation common stock for $30 a share. She sold the stock on December 19, 2018, for $55 a share. Both stock transactions were reported to Beth on Form 1099–B; basis was not reported to the IRS.

Beth bought a used sport utility vehicle for $6,000 on June 5, 2018. She purchased the vehicle from her brother-in-law, who was unemployed and was in need of cash. On November 2, 2018, she sold the vehicle to a friend for $6,500.

During the year, Beth records revenues of $16,000 from the sale of a software program she developed. Beth incurred the following expenses in connection with her software development business.

Beth elected to expense the maximum portion of the cost of the computer, printer, and furniture allowed under the provisions of § 179. These items were placed in service on January 15, 2018, and used 100% in her business.

Although her employer suggested that Beth attend a convention on current developments in corporate taxation, Beth was not reimbursed for the travel expenses of $1,420 she incurred in attending the convention. The $1,420 included $200 for the cost of meals.

During the year, Beth paid $300 for prescription medicines and $2,875 for doctor bills and hospital bills. Medical insurance premiums were paid for her by her employer. Beth paid real property taxes of $1,766 on her home. Interest on her home mortgage (Valley National Bank) was $3,845, and interest to credit card companies was $320. Beth contributed $2,080 to various qualifying charities during the year. Professional dues and subscriptions totaled $350.

Beth paid estimated taxes of $1,000.

Part 1—Tax Computation

Compute the net tax payable or refund due for Beth R. Jordan for 2018. If you use tax forms for your solution, you will need Form 1040 (and its Schedules 1, 4, 5, B, C, D, and SE) and Forms 4562 and 8949. Suggested software: ProConnect Tax Online

Part 2—Tax Planning

Beth is anticipating significant changes in her life in 2019, and she has asked you to estimate her taxable income and tax liability for 2019.

Beth just received word that she has been qualified to adopt a two-year-old daughter. Beth expects that the adoption will be finalized in 2019 and that she will incur approximately $2,000 of adoption expenses. In addition, she expects to incur approximately $3,500 of child and dependent care expenses relating to the care of her new daughter, which will enable her to keep her job at Mesa Manufacturing Company. However, with the additional demands on her time because of her daughter, she has decided to discontinue her two part-time jobs (i.e., the part-time tax practice and her software business), and she will cease making estimated income tax payments. Beth expects her interest income to increase from $1,700 to $2,050.

In your computations, assume that all other 2019 income and expenses will be the same as 2018 amounts.

To determine

Determine the net income tax payable or refund due for Ms B for 2018.

Explanation of Solution

Determine the net income tax payable or refund due for Ms B for 2018.

Calculation of Income Tax Payable (or Refund Due)
Description	Amount ($)	Amount ($)
Gross Income:
Salary		$65,000
Interest and Dividend Income
Interest on Savings	$1,300
Interest from AS Bank	400
Dividends on B Stock	800
Dividends on G Stock	750
Dividends on O Stock	650	3,900
State income tax refund		1,100
Business Income		19,800	Refer Note 1
Net Short-Term Capital Gain		1,200	Refer Note 2
Gross Income		91,000
Less: ‘For AGI Deduction’
Business expenses		(16,750)	Refer Note 3
Self-employment tax deduction		(216)	Refer Note 4
Adjusted Gross Income (AGI)		74,034
Less: ‘From AGI Deduction’
Itemized deductions ($9,645) or standard deduction ($12,000), whichever is greater		(12,000)	Refer Note 5
Deductions for qualified business income		(567)	Refer Note 6
Taxable Income		$61,467
Tax Liability		$9,308	Refer Note 7
Self-employment Tax		431	Refer Note 4
Total Tax Liability		$9,739
Less: Tax withholdings by employer		(10,500)
Estimated taxes		(1,000)
Net tax payable (or refund due) for 2018		$(1,761)

Note (1): Compute business income amount.

Details	Amount ($)
Revenue from part-time tax practice	$3,800
Royalties received for software program	16,000
Total business income	$19,800

Note (2): Compute short-term capital gain (STCG).

Step 1: Compute cost of short-term capital investment as at purchase date.

Security	Number of Shares	$\times$	Cost Price	=	Cost of Investment
Corporation G	500 shares	$\times$	$17.60	=	$8,800
Sports Utility Vehicle					6,000
Corporation B	100 shares	$\times$	30	=	3,000
Total					$17,800

Step 2: Compute the sale proceeds from short-term capital investment.

Security	Number of Shares	$\times$	Sale Price	=	Sale Proceeds
Corporation G	500 shares	$\times$	$14	=	$7,000
Sports Utility Vehicle					6,500
Corporation B	100 shares	$\times$	55	=	5,500
Total					$19,000

Step 3: Prepare the schedule of cost and market of the investment portfolio.

Security	Sale Proceeds	–	Cost of Investment	=	Gain (Loss)
Corporation G	$7,000	–	$8,800	=	$(1,800)
Sports Utility Vehicle	6,500	–	6,000	=	500)
Corporation B	5,500	–	3,000	=	2,500
Total	$19,000	–	$17,800	=	$1,200

Note (3): Compute business expenses amount.

Details	Amount ($)
Processing fee for part-time tax practice	$600
Cost of personal computer	7,000
Cost of printer	2,000
Furniture  cost	3,000
Supplies cost	650
Fee paid to computer consultant	3,500
Total business expenses	$16,750

Note (4): Compute self-employment deduction amount.

Step 1: Compute B’s earnings from self-employment.

Details	Amount ($)
Business income	$19,800
Business expenses	16,750
B’s earnings	$3,050

Step 2: Compute net self-employment income not subject to FICA tax.

$\begin{array}{c}\text{Net self-employment income = B’s earnings }\times \left(\text{100\%–FICA Tax rate}\right)\\ \text{= \$3,050×}\left(\text{100\%–7}\text{.65\%}\right)\\ \text{= \$3,050×92}\text{.35\%}\\ \text{= \$2,817}\end{array}$

Step 3: Compute excess of Social Security portion over FICA (Federal Insurance Contributions Act Taxes) wages.

Details	Amount ($)
Social Security ceiling	$128,400
Less: FICA wages	(65,000)
Net ceiling	$63,400

Step 4: Compute Social Security tax on lesser of Step 2 and Step 3.

Since value of Step 2 is lesser than value of Step 3, compute Social Security Tax on value of Step 2.

$\begin{array}{c}\begin{array}{l}\text{Social Security self-}\\ \text{employment tax }\end{array}\}\text{= }\left(\begin{array}{l}\text{Net self-employment income}\\ \times \text{ Social Security tax rate}\end{array}\right)\\ \text{= \$2,817 × 12}\text{.4\%}\\ \text{= \$349}\end{array}$

Step 5: Compute Medicare tax on lesser of Step 2 and Step 3.

Since value of Step 2 is lesser than value of Step 3, compute Medicare Tax on value of Step 2.

$\begin{array}{c}\begin{array}{l}\text{Mediacare self-}\\ \text{employment tax }\end{array}\}\text{= }\left(\begin{array}{l}\text{Net self-employment income}\\ \times \text{Medicare tax rate}\end{array}\right)\\ \text{= \$2,817 × 2}\text{.9\%}\\ \text{= \$82}\end{array}$

Step 6: Compute total self-employment tax.

Details	Amount ($)
Social Security tax	$349
Medicare tax	82
Self-employment tax	$431

Step 7: Compute self-employment tax deduction amount.

$\begin{array}{c}\begin{array}{l}\text{Self-employment }\\ \text{deduction amount }\end{array}\}\text{= }\left(\begin{array}{l}\text{Self-employment tax}\\ \times 50\%\end{array}\right)\\ \text{= \$431 × 50\%}\\ \text{= \$216}\end{array}$

Note (5): Compute the itemized deductions.

Description	Amount ($)
Medical expenses	$0
Home mortgage interest	3,845
Real property taxes on home	1,766
Charitable contributions to church	1,560
Charitable contributions to U Way	520
Sales tax	1,954
Total itemized deductions	$9,645

Working Notes:

Compute medical expenses amount.

$\begin{array}{c}\begin{array}{l}\text{Medical expenses }\\ \text{amount}\end{array}\}\text{ = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Precription medicines + }\\ \text{Physician fees}\end{array}\right)\text{ – }\\ \left(\text{Limitation percentage }\times \text{ AGI}\right)\end{array}\right\}\\ \text{= }\left(\text{\$300+\$2,875}\right)\text{–}\left(\text{7}\text{.4\%×\$74,034}\right)\\ \text{= \$3,175–\$5,479}\\ \text{= \$}\left(2,304\right)\end{array}$

Note: Since the medical expenses do not exceed the 2% limit, they are not subject to deduction.

Compute charitable contributions to church amount.

$\begin{array}{c}\text{Contributions to church = }\left(\begin{array}{l}\text{Amount contributed per week}\\ \times \text{ Number of weeks in a year}\end{array}\right)\\ \text{= \$30×52weeks}\\ \text{= \$1,560}\end{array}$

Compute charitable contributions to U Way.

$\begin{array}{c}\text{Contributions to U Way = }\left(\begin{array}{l}\text{Amount contributed per week × }\\ \text{Number of weeks in a year}\end{array}\right)\\ \text{= \$10×52weeks}\\ \text{= \$520}\end{array}$

Note (6): Calculate deduction for qualified business income.

$\begin{array}{c}\begin{array}{l}\text{Deduction for qualified}\\ \text{ business income}\end{array})\text{ =}\left\{\begin{array}{l}\left(\begin{array}{l}\text{Business income }-\text{ Business expense}\\ -\text{ Self-employment tax deduction}\end{array}\right)\\ \times \text{20\%}\end{array}\right\}\\ \text{= }\left(\$19,800-\$16,750-\$216\right)\times 20\%\\ \text{=}\text{\$567}\end{array}$

Note (7): Compute tax liability.

Step 1: Compute tax liability of qualified dividends.

$\begin{array}{c}\text{Tax on qualified dividends =}\left\{\begin{array}{l}\text{Qualified dividends on B Stock +}\\ \text{Qualified dividends on G Stock +}\\ \text{Qualified dividends on O Stock ×}\\ \text{ 15\%}\end{array}\right\}\\ \text{= }\left(\text{\$800+\$750+\$650}\right)\text{ × 15\%}\\ \text{= \$2,200× 15\%}\\ \text{= \$330}\end{array}$

Step 2: Compute tax liability on the remaining taxable income of $59,267 ($61,467 − $2,200).

$\begin{array}{c}\text{Tax liability = \$4,453}\text{.50 + 22\% × }\left(\left(\text{Taxable income–\$2,200 }\right)\text{– \$38,700}\right)\\ \text{= \$4,453}\text{.50 + 22\%× }\left(\left(\text{\$61,467–\$2,200}\right)\text{ – \$38,700}\right)\\ =\text{\$4,453}\text{.50 + 22\%× }\left(\text{\$59,267 – \$38,700}\right)\\ \text{= \$4,453}\text{.50 + 22\% × \$20,567}\\ \text{=\$4,453}\text{.50 +\$4,524}\text{.74}\\ \text{=}\text{\$8,978}\text{.24}\end{array}$

Note: Refer to the Schedule X of 2018 Federal Tax Rate Schedule.

Step 3: Compute total tax liability.

$\begin{array}{c}\text{Total tax liability = }\left\{\begin{array}{l}\text{Tax on qualified dividends + }\\ \text{Tax liability on remaining taxable income}\end{array}\right\}\\ \text{= \$330+\$8,978}\\ \text{= \$9,308}\end{array}$

To determine

Determine the net income tax payable or refund due for Ms B for 2019, after the changes.

Explanation of Solution

Determine the net income tax payable or refund due for Ms B for 2019, after the changes.

Calculation of Federal Income Tax Payable (or Refund Due)
Description	Amount ($)	Amount ($)
Gross Income:
Salary		$65,000
Interest and Dividend Income
Interest income	$2,050
Dividends on B Stock	800
Dividends on G Stock	750
Dividends on O Stock	650	4,250
State income tax refund		1,100
Net Short-Term Capital Gain		1,200	Refer Note 2 of Part 1
Gross Income		71,550
Less: ‘For AGI Deduction’		(0)
Adjusted Gross Income (AGI)		71,550
Less: ‘From AGI Deduction’
Itemized deductions (9,645) or standard deduction ($18,350) , whichever is greater		(18,350)	Refer Note 5 of Part 1
Taxable Income		$53,200
Tax Liability		$5,908	Refer Note 1 of Part 2
Less: Tax withholdings by employer		(10,500)
Child tax credit		(2,000)
Credit for child and dependent care           expenses($3,000 × 20%)		(600)
Adoption expenses credit		(2,000)
Net tax payable (or refund due) for 2019		$(9,192)

Note (1): Compute tax liability.

Step 1: Compute tax liability of qualified dividends.

$\begin{array}{c}\text{Tax on qualified dividends =}\left[\left(\$1,750\times 0\%\right)+\left(\$100\times 12\%\right)+\left(\$350\times 15\%\right)\right]\\ =\$65\end{array}$

Step 2: Compute tax liability on the remaining taxable income of $51,000 ($53,200 − $2,200).

$\begin{array}{c}\text{Tax liability = \$1,385 + 12\% × }\left(\left(\text{Taxable income–\$2,200 }\right)\text{– \$13,850}\right)\\ \text{= \$1,385 + 12\%× }\left(\left(\text{\$53,200–\$2,200}\right)\text{ – \$13,850}\right)\\ =\text{\$1,385 + 12\%× }\left(\text{\$51,000 – \$13,850}\right)\\ \text{= \$1,385 + 12\% × \$37,150}\\ \text{=\$1,385 +\$4,458}\\ \text{=}\text{\$5,843}\end{array}$

Step 3: Compute total tax liability.

$\begin{array}{c}\text{Total tax liability = }\left\{\begin{array}{l}\text{Tax on qualified dividends + }\\ \text{Tax liability on remaining taxable income}\end{array}\right\}\\ \text{= \$65+\$5,843}\\ \text{= \$5,908}\end{array}$