Chapter 15, Problem 57CP

Devon Bishop, age 45, is single. He lives at 1507 Rose Lane, Albuquerque, NM 87131. His Social Security number is 111-11-1117. Devon does not want $3 to go to the Presidential Election Campaign Fund.

Devon’s wife, Ariane, passed away in 2014. Devon’s son, Tom, who is age 18, resides with Devon. Tom’s Social Security number is 123-45-6788.

Devon owns a sole proprietorship for which he uses the accrual method of accounting and maintains no inventory; the business operates as Devon’s Copy Shop, 422 E. Main Street, Albuquerque, NM 87131, IRS business activity code: 453990. His revenues and expenses for 2018 are as follows.

Other income received by Devon includes the following.

During the year, Devon and his sole proprietorship were involved in the following property transactions. Stock transactions were reported to Devon on Form 1099–B; basis was not reported to the IRS.

1. a. Sold Blue, Inc. stock for $45,000 on March 12, 2018. He had purchased the stock on September 5, 2015, for $50,000.
2. b. Received an inheritance of $300,000 from his uncle, Henry. Devon used $200,000 to purchase Green, Inc. stock on May 15, 2018, and invested $100,000 in Gold, Inc. stock on May 30, 2018.
3. c. Received Orange, Inc. stock worth $9,500 as a gift from his aunt, Jane, on June 17, 2018. Her adjusted basis for the stock was $5,000. No gift taxes were paid on the transfer. Jane had purchased the stock on April 1, 2012. Devon sold the stock on July 1, 2018, for $22,000.
4. d. On July 15, 2018, Devon sold one-half of the Green, Inc. stock for $40,000.
5. e. Devon was notified on August 1, 2018, that Yellow, Inc. stock he purchased from a colleague on September 1, 2017, for $52,500 had become worthless. Although he understood that investing in Yellow was risky, Devon did not anticipate that the corporation would declare bankruptcy.
6. f. On August 15, 2018, Devon received a parcel of land in Phoenix worth $220,000 in exchange for a parcel of land he owned in Tucson. Because the Tucson parcel was worth $245,000, he also received $25,000 cash. Devon’s adjusted basis for the Tucson parcel was $210,000. He originally purchased it on September 18, 2015.
7. g. On December 1, 2018, Devon sold the condominium in which he had been living for the past 20 years (1844 Lighthouse Lane, Albuquerque, NM 87131) and moved into a rented townhouse. The sales price was $480,000, selling expenses were $28,500, and repair expenses related to the sale were $9,400. Devon purchased the condominium for $180,000.

Devon’s potential itemized deductions, exclusive of the aforementioned information, are as follows.

During the year, Devon makes estimated Federal income tax payments of $35,000.

Compute Devon’s lowest net tax payable or refund due for 2018 assuming that he makes any available elections that will reduce the tax. If you use tax forms for your computations, you will need Form 1040 and its Schedules 1, 4, 5, A, B, C, D, and SE and Forms 4562, 8824, and 8949. Suggested software: ProConnect Tax Online.

To determine

Compute the lowest net tax payable or refund due for 2018.

Explanation of Solution

Compute the lowest net tax payable or refund due for 2018:

Particulars	Amount ($)
Business income (Note 1)	$146,500
Dividend Income $\left(\$10,000+\$2,000\right)$	$12,000
Interest income $\left(\$11,000+\$2,500\right)$ (Note 2)	$13,500
Capital loss (Note 3)	($3,000)
Self employment tax deduction (Note 4)	($9,923)
Self employed health insurance (Note 4)	($8,000)
Adjusted gross income	$151,077
Less: Itemized deductions (Note 6)	($29,900)
Deduction for qualifies business income (Note 7)	($21,835)
Taxable income	$99,342
Income tax computation:
Tax on taxable income of $99,342 (Note 8)	$15,656
Self employment tax (Note 4)	$19,845
Tax liability before prepayments and credits	$35,501
Less: Estimated tax payments	($35,000)
Dependent tax credit (Note 9)	($500)
Net tax payable (or refund) for 2018	$1

Table (1)

Therefore, Net tax payable for the year 2018 is $1

Working note 1: Compute the business income:

Particulars	Amount ($)	Amount ($)
Sales revenue		$740,000
Less: Cost of goods sold		($405,000)
Gross profit		$335,000
Less: Salary expense	$88,000
Rent expense	$30,000
Utilities	$8,000
Telephone	$6,500
Advertising	$4,000
Bad debts	$5,000
Depreciation	$21,000
Health insurance for employees	$18,000
Accounting and legal fees	$7,000
Supplies	$1,000	($188,500)
Net income		$146,500

Table (2)

Note: Out of the health insurance payments, only the $18,000 of health insurance paid for employees is allowed as a deduction while computing the net income of the sole proprietorship. The $8,000 paid for Person D eligible as a deduction for AGI.

Working Note 2: The amount of $17,000 interest on the County of SF, NM bonds is expelled from the gross income.

Working note 3: Compute the capital loss:

Compute the recognized gain or loss for each item:

Item a:

Particulars	Amount ($)
Amount realized	$45,000
Less: Adjusted basis	($50,000)
Realized loss	($5,000)
Recognized loss (long-term capital loss)	($5,000)

Table (3)

Item b: The $300,000 inheritance is barred from Person D’s gross income. His adjusted basis for Incorporation GR’s stock is the cost of $200,000, and his adjusted basis for Incorporation G’s, stock is $100,000.

Item c: Gifts are expelled from Person D’s gross income. His adjusted basis for the Incorporation O’s stock is a postpone basis of $5,000. His holding period also is a postpone holding period (i.e., it comprises Person J’s holding period, which began April 1, 2012).

Item c.
Amount realized	$22,000
Less: Adjusted basis	($5,000)
Realized gain	$17,000
Recognized gain (long-term capital gain)	$17,000

Table (4)

Item d:

Item d.
Amount realized	$40,000
Less: Adjusted basis $\left[\left(1/2\right)\times \$200,000\left(Itemb\right)\right]$	($100,000)
Realized loss	($60,000)
Recognized loss (short-term capital loss)	($60,000)

Table (5)

Item e:

Item e.
Amount realized	$0
Less: Adjusted basis	($52,500)
Realized loss	($52,500)
Recognized loss (long-term capital loss)	($52,500)

Table (6)

Item f:

Item f.
Amount realized $\left(\$220,000+\$25,000\right)$	$245,000
Less: Adjusted basis	($210,000)
Realized gain	$35,000
Recognized gain (long-term capital gain)	$25,000

Table (7)

Item g:

Item g.
Amount realized $\left(\$480,000+\$28,500\right)$	$451,500
Less: Adjusted basis	($180,000)
Realized gain	$271,500
§ 121 exclusion	($250,000)
Recognized gain (long-term capital gain)	$21,500

Table (8)

Person D eligible’s for the § 121 exclusion since he has owned and occupied the residence as his principal residence throughout at least two of the five years prior to the date of sale. Therefore, his realized gain of $271,500 is decreased to $21,500.

Repair expenses of amount $9,400 are neither capitalizable nor allowed as deduction.

Person D’s capital gains and losses are abridged as follows:

Long term capital gains:
Incorporation O’s stock	$17,000
Residence	21,500
T land	25,000	$63,500
Long-term capital losses:
Incorporation B’s stock	($5,000)
Incorporation Y stock	($52,500)	($57,500)
Net long-term capital gain		$6,000
Short-term capital loss:
Incorporation G’s stock		($60,000)
Net capital loss $\left(\$6,000-\$60,000\right)$		($54,000)

Table (9)

Out of $54,000 capital loss, only $3,000 of the net capital loss can be allowed as a deduction in the year 2018. The balance amount of $51,000 is carried forwarded to the following year (2019).

Working note 4: Compute the self-employment tax:

Particulars	Amount ($)
Step 1: Net profit from Schedule C (line 31 of Schedule C)	$146,500
Step 2: Multiply step 1 amount by 92.35%	$135,293
Step 3: If the amount in step 2 is $128,400 or less, multiply the step 2 amount by 15.3%. If the step 2 amount is more than $128,400, multiply the excess of the step 2 amount ($135,293) over $128,400 by 2.9% and add $19,645.20. This is the self-employment tax.	$19,845.10

Table (10)

The deduction for AGI for part of the self-employment tax is $9,923 (50% of $19,845.10).

Working note 5: Out of the amount $8,000 of health insurance premiums paid for Person D 100% is allowed as a deduction for AGI.

Working note 6: Compute the itemized deductions:

Itemized deductions:
Medical expenses $\left[\$9,500-\left(7.5\%\times \$151,077\right)\right]$	$0
Property taxes and sales taxes (greater than $4,000 state income taxes); limited to $10,000	$10,000
Charitable contributions	$10,000
Mortgage interest	$9,900
Total itemized deductions	$29,900

Table (11)

Working note 7: Person D’s taxable income previous to the eligible business income deduction is $121,177$\left(\$151,077-\$29,900\right)$ . As this amount does not exceed $157,500, his deduction for eligible business income is not based on a phase-out. Person D’s eligible business income is $128,577$\left(\$146,500-\$9,923–\$8,000\right)$. Therefore, his deduction for qualified business income is $21,835, the lesser of:

1. (a) 20% of qualified business income $25,175 $\left(\$128,577\times 20\%\right)$ or
2. (b) 20% of taxable income prior to the qualified business income deduction, decreased by any net capital gain (including any qualified dividends) is $21,835$\left[\left(\$121,177-\$12,000\right)\times 20\%\right]$.

Working note 8: Compute the taxable income:

All of Person D’s qualified dividends of $12,000 are taxed at 15% as his taxable income net of the qualified dividends goes above $51,700 and the head-of-household zero percent rate thresholds.

Particulars	Amount ($)
Taxable income	$99,342
Qualified dividends	($12,000)
Portion of taxable income taxed at regular tax rates	$87,342
Tax on qualified dividends $\left(\$12,000\times 15\%\right)$	$1,800
Tax on $87,342 from the 2018 Tax Tables (Head of Household)	13,856
Tax on taxable income	$15,656

Table (12)

Working note 9: Determine the dependent tax credit:

The child tax credit is not available (As Person T is 18, hence he is not eligible as child). But, Person T does qualify for a dependent tax credit of $500.