83 Other Itemized Deductions Teaching Suggestions 1. Most taxpayers do not have enough miscellaneous itemized deductions subject to the 2% of AGI rule. However, employees who are not reimbursed for their travel (such as sales people) should always keep good records of these expenses, just in case. 2. Taxpayers might have their standard deduction within reasonable range of their itemized deductions. Taxpayers can minimize their tax liability by planning their payments to take the standard deduction in one year and then to itemize deductions in the next year or vice versa. Solutions to Questions and Problems 1. The six elements include the (1) amount, (2) date, (3) place, (4) business purpose, (5) business relationship, and (6) identity of the individuals. 2. a. When the reimbursement comes from an accountable reimbursement plan, the employee is not taxed on the reimbursement. Martin is entitled to deduct the amount by which his deductible car expenses (4,305 $.485 = $2,087.93) exceed his $1,506.75 reimbursement. Martin would deduct this $581.18 as an employee business expense. The deduction is taken as a miscellaneous itemized deduction on Schedule A (subject to the 2% AGI rule). 602.01. b. When the reimbursement is made from a nonaccountable reimbursement plan, the employee is taxed on the full amount of the reimbursement. Thus, the $1,506.75 would be included in Martin s gross income as additional taxable wages. Martin is allowed to deduct on Form 2106 the $2,087.93 that he can substantiate as deductible car expenses. This amount is then deducted as a miscellaneous itemized deduction (subject to the 2% AGI rule) on Schedule A. 602.01. c. An accountable plan is one that both (1) requires employees to account for (turn in) adequate substantiation for their business expenses, and (2) return any excess reimbursements. Thus, a nonaccountable plan would be one where the employer advances the employee amounts and does not require any excess to be returned. A nonaccountable plan also would be one where the employer reimburses employees without checking to see that proper documentation exists for the expense. 602.01. 3. a. Under the standard mileage method, his deduction would be $2,692 [(12,400 $.485) + $398 (12,400 $.30)]. 602.03. b. Under the actual mileage method, Estes s car deduction would be $1,361 [($6,927 12,400/18,340 + $398 (12,400 $.30)]. 602.03. c. Because the standard mileage method produces a larger deduction, Estes should use this method to deduct his car expenses in 2007. However, he can only use the standard mileage method if he has not used an accelerated depreciation method to deduct car expenses in a prior year with respect to this vehicle. 602.03. d. If Estes has used an accelerated method of depreciation in computing his car expenses with respect to this car in a prior year, then he will be required to use the actual method to compute his car expenses for all subsequent tax years involving this vehicle. 602.03. 4. a. Under the actual method, Plank s car deduction would be $268 [($8,084 2,235/15,544 (2,235 $.40)]. Under the standard mileage method, her deduction would be $190 [(2,235 $.485) (2,235 $.40)]. Since actual method produces a greater deduction, Plank would want to use the actual method to deduct her car expenses. However, if she uses an accelerated depreciation method to deduct car expenses this year, she will be precluded from using the standard mileage method to deduct car
84 Essentials of Federal Income Taxation expenses with respect to this automobile in all future tax years. This all assumes that Plank s miscellaneous itemized deductions exceed 2% of her AGI. 602.03. b. Since the reimbursement is made from an accountable plan, Plank is not taxed on the reimbursement. If she wants to deduct the excess of her car expenses over the reimbursed amount, she will report both the business portion of her car expenses and the reimbursement on Form 2106. The excess amount would then be deducted as a miscellaneous itemized deduction on Schedule A. 602.03. 5. a. Only Ricardo s mileage between job one and job two is deductible. 602.02. 12 miles (distance from first to second job) 250 days 3,000 total deductible business miles b. $1,455 (3,000 $.485). 602.02. 6. a. Since Joshua s domestic trip was primarily for business, all of the airfare is deductible. However, only the business portion (60% of the travel time) of the other expenses is deductible. 602.05. Airfare... $1,500 Lodging (60% $1,250)... 750 Meals (60% $500)... $300 Entertainment... 130 $430 Less: 50% $430... (215) 215 Total miscellaneous deduction (subject to the 2% AGI rule)... $2,465 b. Since the personal portion of the foreign travel exceeded 25%, Joshua must allocate his airfare between business and pleasure. The other expenses are deductible as in part a. 602.05. Airfare (60% $1,500)... $900 Lodging (60% $1,250)... 750 Meals (60% $500)... $300 Entertainment... 130 $430 Less: 50% $430... (215) 215 Total miscellaneous deduction (subject to the 2% AGI rule)... $1,865 7. a. $1,340. Since her trip was not primarily for business, she is only allowed to deduct the business portion of her lodging and meals. She cannot deduct any of the costs of traveling to and from the convention. Her business deduction is $1,340 [($200 6 nights) + (50% $40 7)]. 602.05. b. $1,755. If her travels are outside of the U.S., she can prorate all of her expenses between business and personal days. This would allow her to deduct an additional $415 ($830 7 /14) for her airfare and transportation to and from the airport. 602.05. c. $2,170. If Barnes were to reduce her personal days by one, her six personal days would be 50% or less of her 13 total days gone. She would then be allowed to deduct the full $830 of her costs of getting to and from her destination. 602.05. d. $1,787. Her deductible airfare and transportation to and from the airport would increase to $447 ($830 7/13). This would increase her total deduction by $32 ($447 $415). 602.05. 8. Fitch can deduct $125 ($250 50%) for the concert tickets. It is not necessary that she attend the concert with the customer to claim the deduction. Because she did not dine with the other customer, she cannot 2007 CCH. All Rights Reserved.
Textbook Solutions 85 deduct any of the $210. She reports the $125 on Form 2106 along with any other employee business expenses she has for the year. She then deducts the total of her unreimbursed employee business expenses as a miscellaneous deduction (subject to the 2% AGI rule) on Schedule A. 602.06. 9. a. Yes. Expenses incurred to meet a state s CPE requirements to perform as a CPA would qualify as deductible education expenses. The $525 would be deductible from AGI on Schedule A, as supported by Form 2106. 602.07. b. No. Seeking a degree is considered to be a personal expense. It is regarded as a qualification for a new job or career. 602.07. c. Yes. The $2,700 of education expenses are deductible from AGI as itemized deductions subject to the 2% rule to the extent not reimbursed. The expenses are deductible since the teacher must complete a certain amount of continuing education to renew her teaching certificate. Without incurring these expenses, the teacher would not be able to retain the teaching position. 602.07. d. Yes. Having already been promoted to an executive management position, obtaining an MBA is not the minimum education requirement, nor will it qualify him for a new career. Expenses incurred to improve business skills are deductible. To the extent not reimbursed, the $8,000 of expenses are deductible from AGI as itemized deductions subject to the 2% rule. 602.07. 10. If Patel is currently employed as a manager, he can deduct the $1,700 as a miscellaneous itemized deduction (subject to the 2% AGI rule), regardless of whether his efforts result in a new position. If Patel is not currently employed as a manager, his job hunting expenses are not deductible. Therefore, in Parts a. and b. the deduction will be allowed; it Parts c. and d. it will not. 602.07. 11. Item Answer a. State inheritance taxes ( 504)... C b. Transportation between home and work( 602.03)... C c. Rental of safe-deposit box( 603)... B d. Fee to register for the CPA examination( 602.07)... C e. Federal income tax penalty( 504)... C f. Fee to accountant for property tax return on rental property( 105.01)... A g. Loss in operating bookstore( 105.01)... A h. Auto registration for business automobile( 105.01)... A 12. Item Answer a. Cost of uniforms suitable for street wear( 602.07)... C b. Insurance on personal residence( 604.03)... C c. Union dues paid by employee( 602.07)... B d. Travel expense by employee, no reimbursement( 602.05)... B e. Mortgage interest on rental property( 105.01)... A f. Loss of trees due to storm( 507)... B 1 g. Loss on sale of personal automobile( 117.01)... C h. Car damage paid to X, taxpayer s fault( 507.03)... C 1 After adjusting for $ 100 deductible and 10% of adjusted income.
86 Essentials of Federal Income Taxation 13. Item Answer a. Loss on sale of stock( 117.01)... A b. Interest on loan for vacation( 505)... C c. Entertainment expense for outside salesperson( 601)... A d. Depreciation on rental property( 105.01)... A e. Charitable contribution to university( 506)... B f. Cost of seminar for sole proprietor( 105.01)... A g. Storm damage to rental property( 105.01)... A 14. a. A hobby is an activity from which a taxpayer does not expect to make a profit. The question of whether a profit motive exists arises in cases where an activity has elements of both personal pleasure and profit. Some of the factors considered in determining whether an activity is a business or a hobby include: (1) The taxpayer s past success with other activities. (2) Whether separate books and records were kept for the activity. (3) Whether there have been both profits and losses in prior years. (4) The relative amount of pleasure derived from the activity. (5) The extent of dependency on the activity for financial support. (6) The amount of time and effort devoted to the activity. (7) The taxpayer s expertise in the area. (8) The amount of the occasional profits from the activity. (9) The expectation that the property used in the activity will rise in value. The taxpayer must show that the activity is being pursued for profit but does not need to justify that the expectation of profit is necessarily reasonable. The taxpayer does not need to show a profit each year. If the activity shows a profit in any three of five consecutive years (two years out of seven for activities involving horses), the burden of proof shifts to the IRS. The IRS then must prove the activity is a hobby. 603.01. b. No. However, if the activity shows a profit in any three of five consecutive years, the burden of proof is on the IRS to prove that the activity is a hobby. The taxpayer may also exercise an election to postpone any IRS challenge until five years of business activity have been completed. 603.01. 15. a. Expenses of painting activity treated as a business: Allocated expenses of the home: Property taxes... $3,600 Electricity... 2,400 Heat... 2,900 Total general household expenses... $8,900 Business use percentage... 12% Portion of general expenses related to the painting activity... $1,068 Expenses related directly to the painting activity: Interest on loan... 140 Painting supplies... 1,750 Total expenses for the painting activity... $2,958 2007 CCH. All Rights Reserved.
Textbook Solutions 87 If Long s painting activity is treated as a business, he reports an above the line deduction for the loss of $658, computed as follows: Revenues... $2,300 Less: Total expenses (from above)... ( 2,958 ) Net loss... $ ( 658) Long could deduct the loss on the assumption that the painting activity is a business, and expects to report a profit in three of the first five years of the business. 603.01. b. If Long cannot justify the activity as a business, then he is required to report the $2,300 of revenue from the sale of the paintings as income. He is allowed to deduct expenses up to the amount of the revenue (as a miscellaneous itemized deduction subject to the 2% AGI rule) when an activity is a hobby, but excess expenses would not be deductible. Thus, if the painting activity is treated as a hobby, Long would report revenues and expenses as follows. 603.01. Revenues... $2,300 Less: Total expenses ($2,958, but limited to hobby income)... ( 2,300 ) The allowable expenses ($2,300) are deductible as follows: (1) $432 (12% $3,600) is deductible as property tax (line 6). (2) $1,868 (remainder) is deductible only to the extent that miscellaneous itemized deductions exceed 2% of AGI. c. Long might support his claim that the painting activity is a business by arranging for regular displays of his paintings in galleries and by making every effort to earn a profit in three of five consecutive years. If he has discretionary expenses related to the activity, such as subscriptions to art magazines, he might be able to postpone payments until early in the next year in order to show a profit in a given year to help meet the three-out-of-five-year profit rule. The timing of the payment of property taxes and electricity bills might also support the opportunity to show a profit in certain years. 603.01. 16. a. $321.40. Wendy Rogers can include as itemized deductions $116.40 for transportation expenses (240 $.485) plus $205 [(50% $120) + $110 + $35] for meeting expenses, union dues, and her license. 603.01. b. These expenses would be combined with other 2% miscellaneous itemized expenses such as safedeposit box rents, subscriptions, and tax return preparation fees; this total can be deducted to the extent that it exceeds 2% of adjusted gross income. 603.01. 17. a. Downing should report $1,400 of the gains and $1,400 of the losses on his income tax return. All gambling winnings are included in gross income, but gambling losses are deductible only to the extent of gambling income. Gambling losses are not subject to the 2% limitation. 604.01. b. The $1,400 of the gains is entered as Other Income on Form 1040. Only $1,400 of the losses can be entered on Schedule A as a miscellaneous deduction not subject to the 2% of AGI limitation. Deductions from AGI must be itemized in order for any gambling losses to be deductible. 604.01. 18. See filled-in Form 2106 for Lopez. Since PSI included the $9,000 reimbursement on Lopez s W-2, no amount is shown on Form 2106 (line 9). 602.08.
88 Essentials of Federal Income Taxation Filled-in Form 2106 for Lopez, page 1. 2007 CCH. All Rights Reserved.
Textbook Solutions 89 Filled-in Form 2106 for Lopez, page 2.
90 Essentials of Federal Income Taxation 19. Taxpayers may deduct only the price of nonluxury box seats when they entertain clients in a luxury skybox rented for more than one event. Thus, Alpha-Beta may consider only $4,800 as its entertainment cost for the rental of the skybox. This amount represents the cost of 96 seats (12 seats for 8 games) at $50 per seat. It should also be pointed out that only 50% of the $4,800 is actually deductible ($2,400). See also pages 12 and 13 of Publication 463. 2007 CCH. All Rights Reserved.
Textbook Solutions 91 Page 12 of Publication 463.
92 Essentials of Federal Income Taxation Page 13 of Publication 463. 2007 CCH. All Rights Reserved.
Textbook Solutions 93 20. a. False. Statutory employees report travel expenses on Schedule C. 602.05. b. True. 602.01. c. False. Only one-half is deductible. 602.06. d. False. Self-employed taxpayers deduct education expenses for AGI on Schedule C. 602.07. 21. 603, 604. 1. Unreimbursed employee expenses, $1,044 [$376 + $115 + ($256 50%) + $340 + $85] 2. Tax preparation fees, $175 3. Other expenses subject to the 2% rule, $165 ($45 + $120) 4. Total expenses, $1,384 5. Less: 2% of AGI, $948 ($47,400.02) 6. Deductible expenses, $436 7. Other miscellaneous expenses, $65 (limited to winnings) 22. See filled-in Schedule A for the Churches. 605.
94 Essentials of Federal Income Taxation Filled-in Schedule A for the Churches. 2007 CCH. All Rights Reserved.
Textbook Solutions 95 23. a. See filled-in Schedule A for the Gomezes. The Gomezes have ample net investment income to deduct the $2,000 of investment interest expense. 605. Reduction in Itemized Deductions (lesser of): Itemized deductions subject to the limitation: Taxes... $ 5,500 Mortgage... 8,000 Contributions... 4,000 Total subject to limitation... $17,500 80 % Net 80% of deductions... $14,000 OR 2% of AGI in excess of $156,400: ($181,050 $156,400) 2%... $ 493 b. Adjusted gross income... $181,050 Less: Itemized deductions... (19,007) $162,043 Less: Personal exemptions... (10,200) Taxable income... $151,843 c. In computing the Gomezes tax liability, the $11,630 of qualified dividends will be taxed at a 15% tax rate. The rest of their taxable income ($151,843 $11,630 = $140,213) will be taxed using tax rate schedule Y-1 for married filing jointly taxpayers. This amount of taxable income falls in the 28% tax bracket. The itemized deduction limitation resulted in a $493 reduction in the amount of allowable itemized deductions [see part a. above]. With a marginal tax rate of 28%, this would increase the tax liability by $138 ($493 28%).