South Western Federal Taxation 2013 Individual Income Taxes 36th Edition by Hoffman Smith Solutions Manual Test Bank
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* Solutions to Research Problems
* Solution Transparency Masters
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* Instructor's Guide
* Solutions to Appendix E
Contents of Appendix E
Problem 1 – Karl F. and Jeanne S. Wheat – Individual Income Tax Return
Problem 2 – Robert (Bob) S. and Sally D. Grove – Individual Income Tax Return
Problem 3 – Pet Kingdom – Form 1120 Corporate Tax Return
Problem 4 – By the Numbers – Form 1120 Corporate Tax Return
Problem 5 – Rock the Ages – Form 1065 tax return
Problem 6 – Chocolat, Inc – Form 1120S
Problem 7 – Daniel and Lisa Ward – Form 709 Tax Returns
Problem 8 – Pam Butler – Form 706 Tax Return
Problem 9 – Green – Form 1041 Tax Return
DISCUSSION QUESTIONS OF CHAPTER 3
1. LO.1 Rearrange the following items to show the correct formula for arriving at taxable
income of individuals under the Federal income tax:
a. Deductions for AGI.
b. Income (broadly conceived).
c. Taxable income.
d. Adjusted gross income.
e. Personal and dependency exemptions.
f. Gross income.
h. The greater of the standard deduction or itemized deductions.
2. LO.1, 5, 8, 9 During the year, Addison is involved in the following transactions:
• Lost money gambling on a recent trip to a casino.
• Helped pay for her neighbor’s dental bills. The neighbor is a good friend who is
• Received from the IRS a tax refund due to Addison’s overpayment of last year’s Federal
• Paid a traffic ticket received while double parking to attend a business meeting.
• Contributed to the mayor’s reelection campaign. The mayor had promised Addison to
have some of her land rezoned. The mayor was reelected and got Addison’s land rezoned.
• Borrowed money from a bank to make a down payment on an automobile.
• Sold a houseboat and a camper on eBay. Both were personal use items, and the gain
from one offset the loss from the other.
• Her dependent grandfather died on June 3 of the year.
• Paid for dependent grandfather’s funeral expenses.
• Paid premiums on her dependent son’s life insurance policy.
What are the possible income tax ramifications of these transactions?
3. LO.1 Which of the following items are inclusions in gross income?
a. During the year, stock the taxpayer purchased as an investment tripled in value.
b. Amount an off-duty motorcycle police officer received for escorting a funeral
c. While his mother was in the hospital, the taxpayer sold her jewelry and gave the
money to his girlfriend.
d. Alimony payments received.
e. A damage deposit the taxpayer recovered when he vacated the apartment he had
f. Interest received by the taxpayer on an investment in general purpose bonds issued
by the City of Memphis.
g. Amounts received by the taxpayer, a baseball “Hall of Famer,” for autographing
sports equipment (e.g., balls and gloves).
h. Tips received by a bartender from patrons. (Taxpayer is paid a regular salary by the
cocktail lounge that employs him.)
i. Taxpayer sells his Super Bowl tickets for five times what he paid for them.
j. Taxpayer receives a new BMW from his grandmother when he passes the CPA exam.
4. LO.1 Which of the following items are exclusions from gross income?
a. Child support payments received.
b. Damages award received by the taxpayer for personal physical injury—none were for
c. A new golf cart won in a church raffle.
d. Amount collected on a loan previously made to a college friend.
e. Insurance proceeds paid to the taxpayer on the death of her uncle—she was the designated
beneficiary under the policy.
f. Interest income on IBM bonds.
g. Jury duty fees.
h. Stolen funds the taxpayer had collected for a local food bank drive.
i. Reward paid by the IRS for information provided that led to the conviction of the
taxpayer’s former employer for tax evasion.
j. An envelope containing $8,000 found (and unclaimed) by the taxpayer in a bus
5. LO.1 To save on U.S. income taxes, Lucas (a U.S. citizen and resident of Vermont)
invests in foreign stocks and bonds. Is Lucas correct in his approach? Explain.
6. LO.1 One class of deductions is variously described as deductions for AGI, above-the-line
deductions, and page 1 deductions. Explain the meaning of the various designations.
7. LO.1, 8, 9 In late 2012, the Polks come to you for tax advice. They are considering
selling some stock investments for a loss and making a contribution to a traditional IRA.
In reviewing their situation, you note that they have large medical expenses and a casualty
loss, neither of which is covered by insurance. What advice would you give the
8. LO.2 In choosing between the standard deduction and itemizing deductions from AGI,
what effect, if any, does each of the following have?
a. The age of the taxpayer(s).
b. The health (i.e., physical condition) of the taxpayer.
c. Whether taxpayers rent or own their residence.
d. Taxpayer’s filing status (e.g., single, married, filing jointly).
e. Whether married taxpayers decide to file separate returns.
f. The taxpayer’s uninsured personal residence was recently destroyed by fire.
g. The number of personal and dependency exemptions the taxpayer can claim.
9. LO.2 In connection with the standard deduction alternative, comment on the following:
a. Percentage of taxpayers who chose the standard deduction rather than itemize.
b. Status of a taxpayer who dies before year-end.
c. Types of standard deductions available.
d. Special limitations on standard deduction for dependents.
e. When not available.
10. LO.2, 3, 5 Abigail is a widow who is age 80 and blind. She is claimed as a dependent
by her grandson. As to this situation, comment on the following issues:
a. Whether Abigail needs to file an income tax return.
b. If Abigail files a return, the personal exemption and standard deduction she can
11. LO.2 Bernice and Drew are dependents of their parents, and each has income of
$2,000 for the year. Bernice’s standard deduction for the year is $950, while Drew’s is
$2,300. As their income is the same, what causes the difference in the amount of the
12. LO.4 Kirby, age 18, lives with her parents in a household maintained by them. As an actress,
she earns $600,000 during the year, which, after taxes, is placed in a trust for her.
Can Kirby be claimed as a dependent by her parents?
13. LO.4 Patsy maintains a household that includes a son (age 30) and a cousin (age 28).
She can claim the cousin as a dependent but not her son. Explain.
14. LO.4 Heather, age 12, lives in the same household with her mother, grandmother, and
a. Who can qualify for the dependency exemption?
b. Who takes preference?
15. LO.4 Caden and Lily are divorced on March 3, 2011. For financial reasons, however,
Lily continues to live in Caden’s apartment and receives her support from him. Caden
does not claim Lily as a dependent on his 2011 Federal income tax return but does so
on his 2012 return. Explain.
16. LO.4 Isabella, Emma, and Jacob share equally in the support of their parents. Jacob
tells his sisters to split the dependency exemptions between the two of them. Explain
what Jacob means.
17. LO.4 Jerry and Arlene were divorced in 2011. In 2012, Arlene has custody of their children,
but Jerry provides nearly all of their support. Who is entitled to claim the children
18. LO.4 Marcus maintains a household in which his 18-year-old married daughter and
her husband live. Although Marcus provides most of their support, he does not claim
them as dependents because they file a joint return. Is Marcus correct? Explain.
19. LO.4 Mario, who is single, is a U.S. citizen and resident. He provides almost all of the
support of his parents and two aunts, who are citizens and residents of Guatemala. Mario’s
parents and aunts are seriously considering moving to and becoming residents of
Mexico. Would such a move have any impact on Mario? Why or why not?
20. LO.5, 9 Jack and Joyce, who are married, had itemized deductions of $7,500 and $500,
respectively, during 2012. Jack suggests that they file separately—he will itemize his
deductions from AGI, and she will claim the standard deduction.
a. Evaluate Jack’s suggestion.
b. What should they do?
21. LO.5 Oliver is a U.S. citizen employed by a multinational corporation at its London
office. Oliver is married to Regina, a British citizen, and they reside in England. Regina
receives substantial rent income from real estate she owns in western Europe.
a. Must Oliver file a U.S. income tax return?
b. Under what circumstances might Regina be considered a resident of the United
States? Would such a classification be advantageous? Disadvantageous? Explain.
22. LO.4, 5 Comment on the availability of head-of-household filing status for 2012 in
each of the following independent situations:
a. Taxpayer lives alone but maintains the household of his parents. In July 2012, the
parents use their savings to purchase a Lexus automobile for $62,000.
b. Taxpayer maintains a home in which she and her father live. The father enters a
nursing facility for treatment for a mental disorder.
c. Taxpayer, a single parent, maintains a home in which she and her unmarried son
live. The son, age 18, earns $5,000 from a part-time job.
d. Assume the same facts as in (c) except that the son is age 19, not 18.
e. Taxpayer is married and maintains a household in which he and his dependent stepson
f. Taxpayer lives alone but maintains the household where her dependent daughter
g. Taxpayer maintains a household that includes an unrelated friend who qualifies as
23. LO.5 In many cases, a surviving spouse ultimately becomes a head of household for filing
status purposes. Explain this statement.
24. LO.6 Jayden calculates his 2012 income tax by using both the Tax Tables and the Tax
Rate Schedules. Because the Tax Rate Schedules yield a slightly lower tax liability, he
plans to pay this amount.
a. Why is there a difference?
b. Is Jayden’s approach permissible?
25. LO.7 In connection with the application of the kiddie tax, comment on the following:
a. The child has only earned income.
b. The child has a modest amount of unearned income.
c. The child is age 20, not a student, and not disabled.
d. The child is married.
e. Effect of the parental election.
f. The result when the parental election is made and the married parents file separate
26. LO.8 During the year, Hernando has the following transactions:
• Gain on the sale of stock held as an investment for 10 months.
• Gain on the sale of land held as an investment for 4 years.
• Gain on the sale of a houseboat owned for 2 years and used for family vacations.
• Loss on the sale of a reconditioned motorcycle owned for 3 years and used for recreational
How should Hernando treat these transactions for income tax purposes?
27. LO.8 Several years ago, Milton and Arlene inherited equal shares of their father’s coin
collection. When they sold the collection this year, Milton paid a tax of 28% on his
profit, while Arlene’s tax rate was only 25%. Presuming that each had the same amount
of gain, explain the difference in result.
28. LO.8 During the year, Brandi had the following transactions: a long-term capital gain
from the sale of land, a short-term capital loss from the sale of stock, and a long-term
capital gain from the sale of a gun collection.
a. How are these transactions treated for income tax purposes?
b. Does this treatment favor the taxpayer or the IRS? Explain.
29. LO.1 Compute the taxable income for 2012 in each of the following independent
a. Drew and Meg, ages 40 and 41, respectively, are married and file a joint return. In
addition to four dependent children, they have AGI of $65,000 and itemized deductions
b. Sybil, age 40, is single and supports her dependent parents who live with her as well
as her grandfather who is in a nursing home. She has AGI of $80,000 and itemized
deductions of $8,000.
c. Scott, age 49, is a surviving spouse. His household includes two unmarried stepsons
who qualify as his dependents. He has AGI of $75,000 and itemized deductions of
d. Amelia, age 33, is an abandoned spouse who maintains a household for her three dependent
children. She has AGI of $58,000 and itemized deductions of $9,100.
e. Dale, age 42, is divorced but maintains the home in which he and his daughter, Jill,
live. Jill is single and qualifies as Dale’s dependent. Dale has AGI of $64,000 and itemized
deductions of $9,900.
Note: Problems 30 and 31 can be solved by referring to Figure 3.1, Exhibits 3.1 through 3.3, Tables
3.1 and 3.2, and the discussion under Deductions for Adjusted Gross Income in this chapter.
30. LO.1, 8 Compute the taxable income for 2012 for Andrea on the basis of the following
information. Her filing status is single.
Interest income from bonds issued by IBM 3,000
Alimony payments received 3,600
Contribution to traditional IRA 5,000
Gift from grandparents 30,000
Short-term capital gain from stock investment 3,000
Amount lost in football office pool (sports gambling is against the law
where Andrea lives) 1,500
Number of potential dependents (two cousins, who live in Canada) ?
31. LO.1 Compute the taxable income for 2012 for Aiden on the basis of the following information.
Aiden is married but has not seen or heard from his wife since 2010.
Salary $ 80,000
Interest on bonds issued by City of Boston 3,000
Interest on CD issued by Wells Fargo Bank 2,000
Cash dividend received on Chevron common stock 2,200
Life insurance proceeds paid on death of aunt (Aiden was
the designated beneficiary of the policy) 200,000
Inheritance received upon death of aunt $100,000
Jackson (a cousin) repaid a loan Aiden made to him in 2008
(no interest was provided for) 5,000
Itemized deductions (state income tax, property taxes on
residence, interest on home mortgage, and charitable
Number of dependents (children, ages 17 and 18 and
mother-in-law, age 70) 3
32. LO.2 Determine the amount of the standard deduction allowed for 2012 in the following
independent situations. In each case, assume that the taxpayer is claimed as another
a. Curtis, age 18, has income as follows: $700 interest from a certificate of deposit and
$6,000 from repairing cars.
b. Mattie, age 18, has income as follows: $600 cash dividends from a stock investment
and $4,700 from handling a paper route.
c. Mel, age 16, has income as follows: $800 interest on a bank savings account and $700
for painting a neighbor’s fence.
d. Lucy, age 15, has income as follows: $400 cash dividends from a stock investment and
$500 from grooming pets.
e. Sarah, age 67 and a widow, has income as follows: $500 from a bank savings account
and $3,200 from babysitting.
33. LO.4 Using the legend provided below, classify each statement as to the taxpayer for
dependency exemption purposes.
QC = Could be a qualifying child
QR = Could be a qualifying relative
B = Could satisfy the definition of both a qualifying child and a qualifying
N = Could not satisfy the definition of either a qualifying child or a
a. Taxpayer’s son has gross income of $7,000.
b. Taxpayer’s niece has gross income of $3,000.
c. Taxpayer’s uncle lives with him.
d. Taxpayer’s daughter is age 25 and disabled.
e. Taxpayer’s daughter is age 18, has gross income of $8,000, and does not live with him.
f. Taxpayer’s cousin does not live with her.
g. Taxpayer’s brother does not live with her.
h. Taxpayer’s sister, has dropped out of school, is age 17, and lives with him.
i. Taxpayer’s older nephew is age 23 and a full-time student.
j. Taxpayer’s grandson lives with her and has gross income of $7,000.
34. LO.3, 4 For tax year 2012, determine the number of personal and dependency exemptions
in each of the following independent situations:
a. Leo and Amanda (ages 48 and 46, respectively) are husband and wife and furnish
more than 50% of the support of their two children, Elton (age 18) and Trista (age
24). During the year, Elton earns $4,500 providing transportation for elderly persons
with disabilities, and Trista receives a $5,000 scholarship for tuition at the law school
b. Audry (age 45) was divorced this year. She maintains a household in which she, her
ex-husband, Clint, and his mother, Olive, live and furnishes more than 50% of their
support. Olive is age 91 and blind.
c. Crystal, age 45, furnishes more than 50% of the support of her married son, Andy
(age 18), and his wife, Paige (age 19), who live with her. During the year, Andy
earned $8,000 from a part-time jo
b. All parties live in Iowa (a common law state).
b. All parties live in Iowa (a common law state).
d. Assume the same facts as in (c), except that all parties live in Washington (a community
35. LO.3, 4 Compute the number of personal and dependency exemptions in each of the
following independent situations:
a. Reginald, a U.S. citizen and resident, contributes 100% of the support of his parents
who are citizens of Canada and live there.
b. Pablo, a U.S. citizen and resident, contributes 100% of the support of his parents
who are citizens of Panama. Pablo’s father is a resident of Panama, and his mother is
a legal resident of the United States.
c. Gretchen, a U.S. citizen and resident, contributes 100% of the support of her
parents, who are U.S. citizens but residents of Germany.
d. Elena is a U.S. citizen and a resident of Italy. Her household includes Carlos, a fouryear-
old adopted son who is a citizen of Spain.
36. LO.3, 4 Determine how many personal and dependency exemptions would be available
in each of the following independent situations. Specify whether any such exemptions
would come under the qualifying child or the qualifying relative category.
a. Andy maintains a household that includes a cousin (age 12), a niece (age 18), and a
son (age 26). All are full-time students. Andy furnishes all of their support.
b. Minerva provides all of the support of a family friend’s son (age 20) who lives with
her. She also furnishes most of the support of her stepmother, who does not live with
c. Raul, a U.S. citizen, lives in Costa Rica. Raul’s household includes a friend, Helena,
who is age 19 and a citizen of Costa Rica. Raul provides all of Helena’s support.
d. Karen maintains a household that includes her ex-husband, her mother-in-law, and
her brother-in-law (age 23 and not a full-time student). Karen provides more than
half of all of their support. Karen is single and was divorced last year.
37. LO.4 During 2012, Jenny, age 14, lives in a household with her father, uncle, and
grandmother. The household is maintained by the uncle. The parties, all of whom file
separate returns, have AGI as follows: father ($30,000), uncle ($50,000), and grandmother
a. Who is eligible to claim Jenny as a dependent?
b. Who has preference as to the exemption?
38. LO.3, 4 Determine the number of personal and dependency exemptions for 2012 in
each of the following independent situations:
a. Marcus (age 68) and Alice (age 65 and blind) file a joint return. They furnish more
than 50% of the support of a cousin, Ida, who lives with them. Ida (age 20) is a fulltime
student and earns $3,500 during the year tutoring special needs children.
b. Penny (age 45) is single and maintains a household in which she and her nephew,
Clint, live. Clint (age 18) earns $4,900 from doing yard work, but receives more than
50% of his support from Penny.
c. Trent (age 38) is single and lives alone. He provides more than 50% of the support
of his parents (ages 69 and 70), who are in a nursing home.
d. Jack and Carol were divorced in 2007, and Carol has custody of their two children
(ages 5 and 9). Jack furnishes more than half of their support, but the divorce decree
is silent as to the dependency exemptions. Carol does not sign a Form 8332.
39. LO.4, 9 Wesley and Myrtle (ages 90 and 88, respectively) live in an assisted care facility
and for 2011 and 2012 received their support from the following sources:
Percentage of Support
Social Security benefits 16%
Family friend (not related) 12
a. Which persons are eligible to claim the dependency exemptions under a multiple
b. Must Wesley and Myrtle be claimed by the same person(s) for both 2011 and 2012?
c. Who, if anyone, can claim their medical expenses?
40. LO.3, 7 Taylor, age 18, is claimed as a dependent by her parents. For 2012, she has
the following income: $4,000 wages from a summer job, $1,800 interest from a money
market account, and $2,000 interest from City of Boston bonds.
a. What is Taylor’s taxable income for 2012?
b. What is Taylor’s tax for 2012? (Her parents file a joint return and have taxable
income of $130,000 [no dividends or capital gains].)
41. LO.4, 9 Walter and Nancy provide 60% of the support of their daughter (age 18) and
son-in-law (age 22). The son-in-law (John) is a full-time student at a local university,
while the daughter (Irene) holds various part-time jobs from which she earns $11,000.
Walter and Nancy engage you to prepare their tax return for 2012. During a meeting
with them in late March 2013, you learn that John and Irene have filed a joint return.
What tax advice would you give based on the following assumptions:
a. All parties live in Louisiana (a community property state).
b. All parties live in New Jersey (a common law state).
42. LO.1, 2, 3, 4, 5, 6 Charlotte (age 40) is a surviving spouse and provides all of the
support of her four minor children who live with her. She also maintains the household
in which her parents live and furnished 60% of their support. Besides interest on City of
Miami bonds in the amount of $5,500, Charlotte’s father received $2,400 from a part time job. Charlotte has a salary of $80,000, a short-term capital loss of $2,000, a cash
prize of $4,000 from a church raffle, and itemized deductions of $10,500. Using the Tax
Rate Schedules, compute the 2012 tax liability for Charlotte.
43. LO.1, 2, 3, 4, 5, 6 Morgan (age 45) is single and provides more than 50% of the support
of Rosalyn (a family friend), Flo (a niece, age 18), and Jerold (a nephew, age 18).
Both Rosalyn and Flo live with Morgan, but Jerold (a French citizen) lives in Canada.
Morgan earns a salary of $95,000, contributes $5,000 to a traditional IRA, and receives
sales proceeds of $15,000 for an RV that cost $60,000 and was used for vacations. She
has $8,200 in itemized deductions. Using the Tax Rate Schedules, compute the 2012 tax
liability for Morgan.
44. LO.5 Which of the following individuals are required to file a tax return for 2012?
Should any of these individuals file a return even if filing is not required? Why or why
a. Patricia, age 19, is a self-employed single individual with gross income of $4,500 from
an unincorporated business. Business expenses amounted to $4,300.
b. Mike is single and is 67 years old. His gross income from wages was $11,000.
c. Ronald is a dependent child under age 19 who received $6,000 in wages from a parttime
d. Sam is married and files a joint return with his spouse, Lana. Both Sam and Lana are
67 years old. Their combined gross income was $21,900.
e. Quinn, age 20, is a full-time college student who is claimed as a dependent by his
parents. For 2012, Quinn has taxable interest and dividends of $2,500.
45. LO.5, 6, 9 Roy and Brandi are engaged and plan to get married. During 2012, Roy is
a full-time student and earns $9,000 from a part-time jo
b. With this income, student
loans, savings, and nontaxable scholarships, he is self-supporting. For the year, Brandi is
employed and has wages of $61,000. How much income tax, if any, can Brandi save if
she and Roy marry in 2012 and file a joint return?
46. LO.5 In each of the following independent situations, determine Winston’s filing status
for 2012. Winston is not married.
a. Winston lives alone, but he maintains a household in which his parents live. The
mother qualifies as Winston’s dependent, but the father does not.
b. Winston lives alone but maintains a household in which his married daughter, Karin,
lives. Both Karin and her husband (Winston’s son-in-law) qualify as Winston’s
c. Winston maintains a household in which he and a family friend, Ward, live. Ward
qualifies as Winston’s dependent.
d. Winston maintains a household in which he and his mother-in-law live. Winston’s
wife died in 2011.
e. Same as (d), except that Winston’s wife disappeared (i.e., she did not die) in 2010.
47. LO.4, 5 Christopher died in 2010 and is survived by his wife, Chloe, and their 18-yearold
son, Dylan. Chloe is the executor of Christopher’s estate and maintains the household
in which she and Dylan live. All of their support is furnished by Chloe while Dylan
saves his earnings. Dylan’s status for 2010–2011 is as follows:
Year Earnings Student Status
2010 $5,000 Yes
2011 7,000 No
2012 6,000 Yes
What is Chloe’s filing status for:
48. LO.3, 4, 5 Nadia died in 2011 and is survived by her husband, Jerold (age 44); her
married son, Travis (age 22); and her daughter-in-law, Macy (age 18). Jerold is the executor
of his wife’s estate. He maintains the household where he, Travis, and Macy live
and furnished all of their support. During 2011 and 2012, Travis is a full-time student,
while Macy earns $7,000 each year from a part-time job. Travis and Macy do not file
jointly during either year. What is Jerold’s filing status for 2011 and 2012 if all parties reside
a. Idaho (a community property state)?
b. Kansas (a common law state)?
49. LO.1, 3, 7 Paige, age 17, is claimed as a dependent on her parents’ 2012 return, on
which they report taxable income of $120,000 (no qualified dividends or capital gains).
Paige earned $3,900 pet sitting and $4,000 in interest on a savings account. What are
Paige’s taxable income and tax liability for 2012?
50. LO.1, 3, 7 Terri, age 16, is claimed as a dependent on her parents’ 2012 return. During
the year, Terri earned $5,000 in interest income and $3,000 from part-time jobs.
a. What is Terri’s taxable income?
b. How much of Terri’s income is taxed at her rate? At her parents’ rate?
c. Can the parental election be made? Why or why not?
51. LO.8 During the year, Inez had the following transactions involving capital assets:
Gain on the sale of unimproved land (held as an investment for 3 years) $ 3,000
Loss on the sale of a camper (purchased 2 years ago and used for family
Gain on the sale of ADM stock (purchased 9 months ago as an investment) 4,000
Gain on the sale of a fishing boat and trailer (acquired 18 months ago at
an auction and used for recreational purposes) 1,000
a. If Inez is in the 35% bracket, how much income tax results?
b. If Inez is in the 15% bracket and 2012 is the year when these sales occurred?
52. LO.8 During the year, Chester had the following transactions involving capital assets:
Gain on the sale of an arrowhead collection (acquired as an investment at
different times but all pieces have been held for more than one year) $ 6,000
Loss on the sale of IBM Corporation stock (purchased 11 months ago as an
Gain on the sale of a city lot (acquired 5 years ago as an investment) 2,000
a. If Chester is in the 33% bracket, how much income tax results?
b. If Chester is in the 15% bracket and 2012 is the year involved?
53. LO.9 Each year, the Bates normally have itemized deductions of $10,000, including a
$4,000 pledge payment to their church. Upon the advice of a friend, they do the following:
in early January 2012, they pay their pledge for 2011; during 2012, they pay the
pledge for 2012; and in late December 2012, they prepay their pledge for 2013.
a. Explain what the Bates are trying to accomplish.
b. What will be the tax saving if their marginal tax bracket is 25% for all three years?
(Assume that the standard deduction amounts for 2012 and 2013 are the same.)
C U M U L A T I V E P R O B L E M S
54. Alexander (Alex)
A. and Isabel P. Hill are married and live at 4692 Calhoun Drive, Charleston,
South Carolina 29402. Alex is the director of the Tourist and Convention Bureau
for the city of Charleston, while his wife is employed part-time as a physical therapist by
an orthopedic clinic.
During 2011, the Hills had the following receipts:
Salaries ($60,000 for Alex, $42,000 for Isabel) $102,000
City of Columbia general purpose bonds $3,000
Boeing Corporation bonds 2,100
Ally Bank certificate of deposit 900 6,000
Child support payments from John Morris 7,200
Annual gifts from parents 30,000
Settlement from Sumter Touring Company 80,000
Lottery winnings 900
Fees paid to Isabel for serving on a grand jury 1,300
Isabel was previously married to John Morris. When they divorced several years ago,
Isabel was awarded custody of their two children, Emily and Jaco
b. (Note: Isabel has never
issued a Form 8332 waiver.) Under the divorce decree, John was obligated to pay alimony
and child support—the alimony payments were to terminate if Isabel remarried.
In July, while going to lunch in downtown Charleston, Isabel was injured by a tour bus.
As the driver was clearly at fault, the owner of the bus, Sumter Touring Company, paid
her medical expenses (including a one-week stay in a hospital). To avoid a lawsuit, Sumter
also transferred to her $80,000 in settlement of the personal injuries she sustained.
The Hills had the following expenditures for 2011:
Medical expenses (not covered by insurance) $8,900
Taxes—Property taxes on personal residence $3,800
State of South Carolina income tax (includes
amount withheld from wages during 2011) 3,900 7,700
Interest on home mortgage 6,200
Paid church pledge 3,800
Life insurance premiums (policy on Alex’s life) 1,500
Contribution to traditional IRA (on Isabel’s behalf) 5,000
Traffic fines 200
Contribution to the reelection campaign fund of
the mayor of Charleston 400
Funeral expenses for Walter Hill 5,900
Nonreimbursed expenses incurred by Isabel in
connection with her jury duty (e.g.,
transportation and parking) 120
Lottery losses 1,100
The life insurance policy was taken out by Alex several years ago and designates Isabel
as the beneficiary. As a part-time employee, Isabel is excluded from coverage under
her employer’s pension plan. Consequently, she provides for her own retirement with a
traditional IRA obtained at a local trust company. Because the mayor evaluates Alex’s
performance as Director of the Tourist and Convention Bureau, Alex felt compelled to
make the political contribution. The Hills keep a record of their lottery activity and are
able to substantiate their winnings and losses.
The Hills’ household includes the following, for whom they provide more than half
of the support:
Social Security Number Birth Date
Alex Hill (age 42) 123–45–6786 12/16/1969
Isabel Hill (age 40) 123–45–6787 08/08/1971
Emily Morris (age 19) 123–45–6788 10/09/1992
Jacob Morris (age 17) 123–45–6789 05/03/1994
Walter Hill (age 75) 123–45–6785 06/15/1936
Emily graduated from high school on May 9, 2011, and is undecided about college.
During 2011, she earned $9,500 (placed in a savings account) playing a piano in the
lobby of a local hotel. Walter is Alex’s widower father who died on January 20, 2011. For
the past few years, Walter qualified as a dependent of the Hills.
Federal income tax withheld is $5,500 (Alex) and $3,400 (Isabel). The proper
amount of Social Security and Medicare tax was withheld.
Determine the Federal income tax for 2011 for the Hills on a joint return by completing
the appropriate forms. They do not want to contribute to the Presidential Election
Campaign Fund. If an overpayment results, it is to be refunded to them. Suggested software:
H&R BLOCK At Home.
55. Logan B. Taylor is a widower whose wife, Sara, died on June 6, 2009. He lives at 4680
Dogwood Lane, Springfield, Missouri 65801. He is employed as a paralegal by a local law
firm. During 2011, he had the following receipts:
Salary $ 80,000
Money market account at Omni Bank $ 300
Savings account at Boone State Bank 1,100
City of Springfield general purpose bonds 3,000 4,400
Inheritance from Daniel 60,000
Life insurance proceeds 200,000
Amount from sale of St. Louis lot 80,000
Proceeds from estate sale 9,000
Federal income tax refund (for 2010 tax overpayment) 700
Logan inherited securities worth $60,000 from his uncle, Daniel, who died in 2011.
Logan also was the designated beneficiary of an insurance policy on Daniel’s life with a
maturity value of $200,000. The lot in St. Louis was purchased on May 2, 2006, for
$85,000 and held as an investment. As the neighborhood has deteriorated, Logan
decided to cut his losses and sold the lot on January 5, 2011, for $80,000. The estate sale
consisted largely of items belonging to Sara and Daniel (e.g., camper, boat, furniture,
and fishing and hunting equipment). Logan estimates that the property sold originally
cost at least twice the $9,000 he received and has declined or stayed the same in value
since Sara and Daniel died.
Logan’s expenditures for 2011 include the following:
Medical expenses (including $10,500 for dental) $11,500
Taxes—State of Missouri income tax (includes withholdings
during 2011) $3,200
Property taxes on personal residence 4,500 7,700
Interest on home mortgage 4,600
Contribution to church (paid pledges for 2011 and 2012) 4,800
Logan and his dependents are covered by his employer’s health insurance policy.
However, he is subject to a deductible, and dental care is not included. The $10,500
dental charge was for Helen’s implants. Helen is Logan’s widowed mother, who lives
with him (see below). Logan normally pledges $2,400 ($200 per month) each year to his
church. On December 5, 2011, upon the advice of his pastor, he prepaid his pledge for
Logan’s household, all of whom he supports, includes the following:
Social Security Number Birth Date
Logan Taylor (age 48) 123-45-6787 08/30/1963
Helen Taylor (age 70) 123-45-6780 01/13/1941
Asher Taylor (age 23) 123-45-6783 07/18/1988
Mia Taylor (age 22) 123-45-6784 02/16/1989
Helen, Logan’s mother, receives a modest Social Security benefit. Asher, a son, is a
full-time student in dental school and earns $4,500 as a part-time dental assistant. Mia, a
daughter, does not work and is engaged to be married.
Part 1—Tax Computation
Using the appropriate forms and schedules, compute Logan’s income tax for 2011. Federal
income tax of $5,500 was withheld from his wages. If Logan has any overpayment
on his income tax, he wants the refund sent to him. Assume that the proper amounts of
Social Security and Medicare taxes were withheld. Logan does not want to contribute to
the Presidential Election Campaign Fund. Suggested software: H&R BLOCK At Home.
Part 2—Follow-up Advice
In early 2012, the following take place:
• Helen decides she wants to live with one of her daughter and moves to Arizona.
• Asher graduates from dental school and joins an existing practice in St. Louis.
• Mia marries, and she and her husband move in with his parents.
• Using the insurance proceeds he received on Daniel’s death, Logan pays off the
mortgage on his personal residence.
Logan believes these events may have an effect on his tax position for 2012. Therefore,
he requests your advice.
Write a letter to Logan explaining in general terms the changes that will occur for
tax purposes. Assume that Logan’s salary and other factors not mentioned (e.g., property
and state income taxes) will remain the same. Use the Tax Rate Schedules in projecting
Logan’s tax for 2012.
R E S E A R C H P R O B L E M S
Note: Solutions to
Research Problems can be prepared by using the Checkpoint®
Student Edition online research product, which is available to accompany this text. It is
also possible to prepare solutions to the
Research Problems by using tax research materials
Research Problems by using tax research materials
found in a standard tax library.
Research Problem 1. Don and Mary Dewey are successful professionals who have a combined
AGI of approximately $400,000. Their household includes two children: Debra
(age 16) and Van (age 23). Van is not a student but works at a part-time job where he
earns $16,000. Don has heard that it might be beneficial if Van, rather than Don and
Mary, claims Debra as a qualified child for income tax purposes. At a local Chamber of
Commerce meeting, he asks you to advise him on this matter. Send a letter to Don at
4321 Mount Vernon Road, Dover, DE 19901, advising him about the advantages of such a
choice and whether it is feasible. In your letter, discuss the relevance of Code §§ 24, 32,
151, and 152.
Research Problem 2. Sophia Durbin maintains a household in which she, her son (Ryan),
and her widowed mother-in-law (Isabella) live. Since 2010, she also has provided more
than half of their support. Sophia’s husband, Karl, left for parts unknown in April 2010
and, except for one postcard, has not been heard from since. The postcard (no return
address included) was received by Sophia in March 2011 and announced that he planned
to claim both Ryan and Isabella as dependents on his own tax return.
Ryan (age 19 in December 2010) graduated from high school on May 6, 2010, and
plans to start college in 2012. Until then, he is working as much as possible to save for college
expenses. He earned $8,000 in 2010 and $17,000 in 2011. Isabella’s income is negligible
and originates from nontaxable sources (e.g., Social Security benefits and interest on
For tax year 2010, Sophia filed her Federal income tax return as married filing separately
and claimed no exemptions for dependents. She has not yet filed for 2011. Being
somewhat perplexed with her situation, she comes to you for advice in early March 2012.
a. Write a letter to Sophia Durbin addressing her concerns. She lives at 1310 Ash Street,
Kearney, NE 68849.
b. Prepare a memo for your firm’s client files that lists and discusses the legal basis for
the advice rendered.
Research Problem 3. John and Janet Baker are husband and wife and maintain a household
in which the following persons live: Calvin and Florence Carter and Darin, Andrea, and
• Calvin and Florence are Janet’s parents, who are retired. During the year, they receive
$19,000 in nontaxable funds (e.g., disability income, interest on municipal bonds and
Social Security benefits). Of this amount, $8,000 is spent equally between them for
clothing, transportation, and recreation (e.g., vacation) and the balance of $11,000 is
invested in tax-exempt securities. Janet paid $1,000 for her mother’s dental work and
paid the $1,200 premium on an insurance policy her father owned on his own life. Calvin
also had medical expenses, but he insisted on paying for them with his own funds.
• Darin is the Bakers’ 18-year-old son who is not a student but operates a pool-cleaning
service on a part-time basis. During the year, he earns $14,000 from the business,
which he places in a savings account for later college expenses.
• Andrea is the Bakers’ 19-year-old daughter who does not work or go to school. Tired
of the inconvenience of borrowing and sharing the family car, during the year, she
purchased a Camaro for $21,000. Andrea used funds from a savings account she had
established several years ago with an inheritance from her paternal grandfather.
• Morgan is the Bakers’ 23-year-old daughter. To attend graduate school at a local university,
she applied for and obtained a student loan of $20,000. She uses the full
amount to pay her college tuition.
The Bakers’ fair rental value of their residence, including utilities, is $14,000, while
their total food expense for the household is $10,500.
a. How many dependency exemptions will the Bakers be entitled to claim for the year?
Explain your answer.
b. From a planning standpoint, how might the Bakers have improved the tax result?
Partial list of research aids:
Reg. §§ 1.152–1(a) and –1(c).
Your Federal Income Tax (IRS Pu
b. 17), Ch. 3.
Research Problem 4. Daniel and Lucy Young are husband and wife who live in Mineola, Oregon.
They have been married for 18 years and have four children, all of whom are teenagers.
After the birth of her last child, Lucy took a job as a city clerk and, over the years,
has become city treasurer. Since graduating from high school, Daniel has worked as a dispatcher
for the city fire and ambulance departments. As Lucy has some college training
in finance and accounting, she handles the family’s financial affairs, including reconciling
the bank account, paying bills, and preparing all tax returns. She also takes care of major
purchases (e.g., autos and furniture) and servicing of debt (e.g., home mortgage, auto
loans and charge accounts).
The Youngs maintain a modest lifestyle, but Lucy is quite generous with the children.
All are well-dressed, attend summer camp, and have their own cars. Daniel believes Lucy
obtains any additional funds for the children’s support through credit card financing and
The Youngs filed joint returns for 2009 and 2010 that reflected their salary income.
Lucy prepared the returns, and Daniel signed them without reviewing them first. The
returns did not show the $90,000 Lucy had embezzled from her employer over the twoyear
The city of Mineola discovers the theft, and Lucy is tried and convicted of grand larceny.
Due to the adverse publicity generated by these events, the Youngs are divorced
and Lucy moves to another state.
In 2012, the IRS assesses a deficiency against Daniel for the income taxes that would
have resulted if the embezzled amounts had been reported as income. Immediately
thereafter, Daniel files Form 8857 (Request for Innocent Spouse Relief) with the IRS. After
a hearing, Daniel’s request is denied by the IRS on the grounds that he should have
wondered about Lucy’s extra source of income and that he significantly benefited from
her embezzlement. Right after the denial, Daniel files suit in the U.S. Tax Court to overturn
the IRS holding. What should be the result?
Partial list of research aids:
§§ 6013(d)(3) and 6015.
Innocent Spouse Relief (IRS Publication 971).
Research Problem 5. Locate IRS Form 2120 and answer the following questions.
a. Who must sign the form?
b. Who must file the form?
c. Can it be used for someone who is not related to the taxpayer? Explain.
Research Problem 6. What purpose is served by IRS Form 8857? In this regard, see IRS Publication
Research Problem 7. A nonresident alien earns money in the United States that is subject to
Federal income tax. What guidance does the IRS provide on what tax form needs to be
used and on when it should be filed? In terms of the proper filing date, does it matter
whether the earnings were subject to income tax withholding?
Research Problem 8. When taxpayers pay their income taxes by means of a credit or debit
card, they are charged “convenience fees” by the issuer of the card. Are these fees deductible
for income tax purposes? Explain. (Note: The IRS issued a notice clarifying its position
on this matter.)
Research Problem 9. Locate IRS Forms 8615 and 8814. What do these forms have in common?
What purpose is served by each?