Chapter 13, Problem 47CP

Part 1

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.

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

Part 2

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.

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