Tax Return 5:

Matthew B. (age 42) and Shelli R. (age 48) Thomson are married and live at 7605 Walnut Street, Kansas City, MO 64114. Matthew is a chemist employed by Sargent Pharmaceuticals, Inc., and Shelli is a self-employed doctor of anesthesiology. They are calendar-year, cash-basis taxpayers.

1.      1. Sargent Pharmaceuticals develops and produces injectable medicines used in chemotherapy treatments for cancer patients. Matthew manages the Kansas City facility for an annual salary of $90,000. Sargent makes contributions to a qualified defined contribution pension plan for all of its full-time employees. Although Matthew also has the opportunity to make contributions into the plan, he chose not to do so in 2013. Matthew participates in his employer’s group health insurance plan to which he contributed $4,000 in 2013 for medical coverage. These contributions were made with after-tax dollars. The health plan covers Matthew, Shelli, and their two dependent children. Because of the risk associated with Matthew’s work (i.e., processing of chemotherapy drugs), Sargent provides all of its employees with $200,000 of group term life insurance coverage. An additional $180 of income is included in Matthew’s Form W–2 to report the taxable value of this insurance.

2.      2. In late 2012, three employees at Sargent’s Chicago facility were seriously injured while processing a customer order. While the injuries occurred in what the company described as a “freak accident,” Matthew began to look for a safer job in the chemical industry. He incurred the following expenses during 2013:

Employment agency fee $3,200

3.      Vita consultation, preparation, and distribution 1,800

4.      Expenses in connection with job interviews 4,100

5.       

6.      Matthew received several attractive offers but ultimately decided against changing jobs. Influential in his choice was a promotion to regional manager and a $20,000 pay raise (starting in 2014).

7.       

8.      3. Sargent generally reimburses Matthew for expenses related to his work for the company. However, as a matter of policy, Sargent does not reimburse for the following:

 

Monthly dinner sessions of the Midwestern chemists

Association (11 meetings in 2013) $825

Dues to professional organizations 240

Subscriptions to professional journals 180

MIA correspondence study course 230

 

Each dinner involved the following costs: $40 (fee for speaker), $25 (price of meal), and $10 (parking). Matthew goes to the meeting from work and returns home the same night. The MIA (Management Institute of America) charge was for an online home study course on ways to improve safety measures and avoid accidents in the industrial workplace.

1.       

2.       

3.      4. Shelli Thomson is a board-certified doctor of anesthesiology. She provides anesthesiology services at a handful of hospitals and surgical centers in the greater Kansas City area on a part-time basis. Shelli is well respected by the surgeons with whom she works. She uses her home as her business address. She keeps her records there and otherwise conducts business (e.g., accepts surgery appointments, renders professional advice, and bills patients) on the premises. Because Shelli does not maintain a specific area for exclusive business use, she does not claim an office in the home for tax purposes. Shelli’s receipts from her practice during 2013 were $245,000, $16,000 of which was for services performed in 2012. Not included in these amounts is $17,500 that she received in January 2014 for services rendered in December 2013. Shelli’s professional activity code is 621111.

4.       

5. Shelli had the following business expenses in 2013:

 

Medical clothing (eg., lab coats, surgical scrubs) $2,200

Medical malpractice insurance 9,500

State medical license fee 450

Dues to professional organizations 350

Subscriptions to professional journals 340

 

1.      In addition, she drove the family Suburban (purchased on March 2, 2012) 2,900 miles in connection with her work. She uses the standard mileage method. Total mileage for the Suburban is 9,000 miles for the year.

2.       

3.      6. Matthew’s widowed mother, Lucy, suffered a stroke on December 30, 2012, and died in the hospital on February 3, 2013. Most of Lucy’s medical expenses were covered by Medicare, with Matthew paying the rest. On February 18, 2013, he paid $9,800 to the hospital, half of which was attributable to expenses incurred in 2012. At the same time, Matthew also paid the funeral expenses of $16,000. Although Lucy lived in her own home prior to the stroke, Matthew and Shelli have properly claimed her as a dependent for the past few years.

4.       

7. As Lucy’s sole heir, Matthew inherited her home and its furnishings (located at 1420 Chickadee Lane, Topeka, KS 66546). The costs and values involved are as follows:

 

 

Cost Basis FVM on 2/3/13

Lot $ 10,000 $ 30,000

House110,000 250,000

Furnishings 55,000 25,000

1.       

2.      Because the real estate market was depressed and the home was located in an attractive rental area, Matthew decided not to sell. Instead, he rented the property fully furnished on May 1, 2013. The terms of the lease (executed on April 30) provide for the following: one-year lease at $2,500 per month (payable on the first of each month), last month’s rent payable in advance, and damage deposit of $3,000. In total, Matthew received $25,500 from the tenants in 2013 for their use of the property. Besides depreciation, his expenses were as follows:

 

3.      Property taxes $4,800

4.      Insurance 3,900

5.      Repairs 2,100

6.      Real estate renter’s location service 400

7.       

8.      Matthew plans to use MACRS straight-line depreciation (mid-month convention) for the realty. Regarding the personalty, seeExhibit 8.1 in chapter 8 of the text.

9.       

10.  8. While walking the family dogs in late July, Shelli was struck by a delivery van and seriously injured. After being hospitalized for a week, she was released—bruised and sore, but with no permanent injuries. The driver of the van was arrested and ticketed by the police for reckless operation of a vehicle and was later prosecuted for drug use. To prevent adverse publicity related to a lawsuit, the owner of the delivery service paid for Shelli’s medical expenses and sent her a check on August 16, 2013, for $90,000. The check was accompanied by a letter that stated: “This $90,000 is a settlement for physical injuries sustained by Shelli Thomson.” Shelli was represented in the negotiations with the delivery company by her brother, a practicing attorney. He did not charge the Thomsons for his services.

11.   

12.  9. The Thomsons had the following property transactions during 2013:

1.      a. On October 5, the City Council condemned unimproved land owned by Matthew for the construction of a fire station. He purchased the land (two vacant lots at 3400 and 3402 Sycamore Lane) as an investment on May 25, 2007, for $14,000. In exchange for the lots, the city gave Matthew a large unimproved lot at 440 Genoa Street that was valued at $20,000. All in all, he was satisfied with the exchange because the Genoa Street property is in a better neighborhood and has a greater potential for appreciation.

2.      b. On November 22, Matthew sold a gun collection for $32,000 to an avid collector. The collection was a gift from Matthew’s father on December 25, 2009, when it was worth $22,000. His father bought the collection in 1997 for $14,000. The sale was evidenced by a bill of sale.

3.      c. On November 9, they sold 3,000 shares of Dove Pharmaceuticals for $2,000. The stock was purchased by the Thomsons on December 4, 2012, for $25,000. The investment was motivated by the rumor that Dove was developing a new drug for infertility. After the FDA failed to approve the drug, the Thomsons decided to cut their losses. Their broker provided them with a Form 1009–B, which reported the gross proceeds from the sale and their basis in the stock.

13.   

14.  10. The Thomsons have a long-term capital loss carryover of $1,500 from 2012.

15.   

16.  11. In March 2013, the Thomsons were audited by the Missouri Department of Revenue for tax years 2010 and 2011. The audit proposed no changes for the 2010 tax return. However, the Thomsons were assessed $2,250 additional income tax for 2011 (no interest or penalties were included). The Thomsons agreed with the assessment and paid the $2,250 immediately.

17.   

18.  12. During 2013, Matthew was called to serve on a jury. As a result of the service, he was paid $700 and incurred nonreimbursed expenses (e.g., parking) of $60. In conformance with company policy, Matthew remitted the $700 of fees to Sargent.

19.   

13. Besides the items already noted, the Thomsons had the following receipts in 2013:

 

Life insurance proceeds $50,000

2012 Missouri state income tax refund 450

Proceeds from garage sale 2,600

Interest income-

Kansas City general purpose bonds$480

Citibank certificate of deposit 600 1,080

1.       

2.       

3.      The insurance proceeds relate to a policy on Lucy’s life, which paid Matthew as the designated beneficiary. At the garage sale, the Thomsons sold personal items (e.g., camper, furniture, hunting and fishing equipment) that belonged to Matthew’s father and mother (i.e., Lucy). Matthew and Shelli estimated that the items they sold had cost $7,100. The garage sale proceeds were donated to the Alzheimer’s Association (a qualified charity) in memory of Matthew’s father.

4.       

5.      14. The Thomsons had additional expenditures for 2013 as follows:

 

6.      Dentist bills not covered by insurance $3,100

7.      Ad valorem property taxes on personal residence 4,100

8.      Interest on home mortgage 2,600

9.      Contributions to Goodwill (a qualified charity) 3,600

10.   

11.  As part of a program sponsored by their church (a qualified charity), the Thomsons used the family Suburban to transport senior citizens to religious services for a total of 900 miles. The Suburban also was used for medical purposes (e.g., visits to an orthodontist) for 480 miles.

12.   

13.  15. The Thomsons’ household includes two dependent children: Ethan (age 15) and Bella (age 14), both of whom are full-time students. Relevant Social Security numbers follow:

 

NameSocial Security Number

Matthew B. Thomson 111-11-1111

Shelli R. Thomson 123-45-6786

Lucy E. Thomson123-45-6787

Ethan M. Thomson123-45-6788

Bella A. Thomson123-45-6789

 

 

1.      16. Matthew’s Form W–2 from Sargent Pharmaceuticals reflects income tax withholdings of $6,500 (Federal) and $4,000 (state). The Thomsons made quarterly income tax payments of $20,000 (Federal) and $9,000 (state) for total payments of $80,000 (Federal) and $36,000 (state). They had their Federal income tax refund of $3,000 for 2012 applied toward their 2013 income tax.

Requirements

Prepare an income tax return (with appropriate schedules) for the Thomsons for 2013, using the following guidelines:

·         * The Thomsons choose to file a joint income tax return.

·         * The Thomsons do not wish to contribute to the Presidential Election Campaign Fund.

·         * The Thomsons do not own any foreign bank accounts or other investments.

·         * The Thomsons want to apply any federal tax refund to their 2014 tax liability.

·         * The taxpayers are preparing their own return (i.e., no preparer is involved).

·         * For the past several years, the Thomsons have itemized their deductions from AGI instead of using the standard deduction. In addition, the Thomsons have deducted state income taxes (not sales taxes) for the past several years.

·         * The taxpayers have the necessary substantiation (e.g., records, receipts) to support all transactions reported in their tax return.

·         Make necessary assumptions for information not given in the problem but needed to complete the return.

TAX RETURN 6

 

Carrie A. Morgan, age 45, is single and lives with her dependent mother at 426 Grouse Avenue, Allentown, PA 18105. Her social security number is 111-11-1111.

 

1. Carrie is a licensed hairstylist and operates her own business. Located at 480 Laurel Street, Allentown, PA 18105, the business is conducted under the name of “Carrie’s Coiffures.” Carrie’s business activity code is 812112. In addition to 10 workstations (i.e., stylist chairs) and a small reception area, the shop has display and storage areas for the

products Carrie sells (see item 2 below). During the year, Carrie leased nine of the stations to other hairstylists. As is common practice in similar businesses in the area, the other stylists are considered to be self-employed. In fact, the IRS sanctioned the self-employment classification for the stylists in an audit of one of Carrie’s prior tax returns. Each stylist pays Carrie a fixed rent for the use of a workstation, resulting in

$68,000 of rents received during 2012. From her own station, Carrie earned $44,000

(including tips of $12,000) for the styling services she provided to her own clients.

 

2. Carrie’s Coiffures is the local distributor for several beauty products (e.g., conditioners,

shampoos) that cannot be purchased anywhere else. Carrie buys these items from the

manufacturers and sells them to regular patrons, walk-in customers, and other

beauticians (including those who lease chairs from her). Carrie’s Coiffures is also

known for the selection and quality of its hairpieces (i.e., wigs, toupees). Through the

shop, Carrie made the following sales during the year:

 

Hairpieces and wigs $69,000

Beauty products 48,000

 

3. Although Carrie operates her business on a cash basis, she maintains inventory

accounts for the items she sells as required by law. Relevant information about the

inventories (based on lower of cost or market) is summarized below.

4.

12/31/11 12/31/12

Hairpieces and wigs $10,700 $12,600

Beauty products 11,400 9,900

 

5. Carrie’s purchases for 2012 were $30,500 of hairpieces and wigs and $26,100 of beauty

products.

 

6. Carrie’s Coiffures had the following operating expenses for 2012:

 

Utilities (i.e., gas, electric, telephone) $12,900

Ad valorem property taxes:

On realty (e.g., shop building and land) $4,200

On personalty (e.g., equipment, inventory) 1,800 6,000

Styling supplies (e.g., rinses, dyes, gels, hair spray) 5,700

Fire and casualty insurance 4,100

Liability insurance 4,000

Accounting services 3,800

Janitorial services 2,400

Sewer service, garbage pickup $ 2,300

Water 2,200

Occupation licenses (city and state) 1,500

Waiting room supplies (e.g., magazines, coffee) 1,300

7. As Carrie prefers to avoid employer-employee arrangements and the payroll tax

complexities, she retains outside agencies to handle her accounting and janitorial

needs.

 

8. In early 2012, Carrie decided to renovate the waiting room. On May 10, she spent

$10,400 for new chairs, a sofa, various lamps, coffee bar, and other furnishings. Carrie

follows a policy of claiming as much depreciation as soon as possible. The old

furnishings were thrown away or given to customers. For tax purposes, the old

furnishings had a zero basis.

 

9. Carrie’s Coiffures is located in a building Carrie had constructed at 480 Laurel Street in

March 1998. The shop was built for a cost of $300,000 on a lot she purchased earlier

for $35,000. Except for a down payment from savings, the cost was financed by a 20-

year mortgage. For tax purposes, MACRS depreciation is claimed on the building.

During 2012, the following expenses were attributable to the property:

 

Repainting (both exterior and interior) $8,000

Repairs (plumbing and electrical) 1,900

 

10. In May (after her accident settlement discussed in item 11 below), Carrie paid the

balance due on the business mortgage. To do so, she incurred a prepayment penalty of

$4,400. Prior to paying it off, she paid regular interest on the mortgage in 2012 of

$6,000.

 

11. In February 2012, Carrie’s Coiffures was cited by the city for improper disposal of

certain waste chemicals. Carrie questioned the propriety of the proposed fine of $2,000

and retained an attorney to represent her at the hearing. By pleading nolo contendere,

the attorney was able to get the fine reduced to $500. Carrie paid both the fine of $500

and the attorney’s fee of $600 in 2012.

 

12. In August 2012, Carrie saw an ad in a trade publication that attracted her attention.

The owner of a well-respected styling salon in Reading (PA) had died, and his estate

was offering the business for sale. Carrie traveled to Reading, spent several days

looking over the business (including books and financial results), and met with the

executor. Carried treated the executor to dinner and a music concert. Immediately after

the concert, Carrie made an offer for the business, but the executor rejected it. Her

expenses in connection with this trip were as follows:

 

Car rental $140

Entertainment of executor 280

Motel (August 6-7) 220

Meals 110

 

13. In March 2011, Joan Myers, one of Carrie’s best stylists, left town to get away from a

troublesome ex-husband. In order to help Joan establish a business elsewhere, Carrie

loaned her $7,000. Joan signed a note dated March 3, 2011, that was payable in one

year with 6% interest. On December 30, 2012, Carrie learned that Joan had declared

bankruptcy and was awaiting trial on felony theft charges. Carrie never received

payment from Joan, nor did she receive any interest on the loan.

 

14. At Christmas, Carrie gave each of her 35 best customers a large bottle of body lotion.

Each bottle had a wholesale cost to Carrie of $12 but a retail price of $24. Carrie also

spent $3 to have each bottle gift wrapped. (Note: The lotion was special order

merchandise and was not part of the business’s inventory or purchases for the year—see item 2 above.) She also gave each of the nine stylists who leased chairs from her a

basket of fruit that cost $30 (not including $5 delivery cost).

 

15. In March 2012, the Pennsylvania Department of Revenue audited Carrie’s state income

tax returns for 2009 and 2010. She was assessed additional state income tax of $340

for these years. Surprisingly, no interest was included in the assessment. Carrie paid

the back taxes promptly.

 

16. On a morning walk in November 2011, Carrie was injured when she was sideswiped by

a delivery truck. Carrie was hospitalized for several days, and the driver of the truck

was ticketed and charged with DUI. The owner of the truck, a national parcel delivery

service, was concerned that further adverse publicity might result if the matter went to

court. Consequently, the owner offered Carrie a settlement if she would sign a release.

Under the settlement, her medical expenses were paid and she would receive a cash

award of $200,000. The award specified that the entire amount was for physical pain

and suffering. Because she suffered no permanent injury as a result of the mishap, she

signed the release in April 2012 and received the $200,000 settlement.

 

17. In January 2012, Carrie was contacted by the state of Pennsylvania regarding a tract of

land she owned in York County. The state intended to convert the property into a

district headquarters, barracks, and training center for its highway patrol. Carrie had

inherited the property from her father when he died on August 11, 2011. The property

had a value of $140,000 on that date and had been purchased by her father on March

3, 1980, for $30,000. On July 25, 2012, after considerable negotiation and after the

state threatened to initiate condemnation proceedings, she sold the tract to the state

for $158,000. Since Carrie is not comfortable with real estate investments, she does not

plan to reinvest any of the proceeds received in another piece of realty.

 

18. When her father died in 2011, Carrie did not know that he had an insurance policy on

his life (maturity value of $50,000) in which she was named as the beneficiary. When

her mother told her about the policy in July 2012, Carrie filed a claim with the carrier,

Falcon Life Insurance Company. In August 2012, she received a check from Falcon for

$51,500 (including $1,500 interest).

 

19. Upon the advice of a client who is a respected broker, Carrie purchased 1,000 shares of

common stock in Grosbeak Exploration for $40,000 on March 4, 2012. In the months

following her purchase, the share value of Grosbeak plummeted. Disgusted with the

unexpected erosion in the value of her investment, Carrie sold the stock for $28,000 on

December 23, 2012.

 

20. While on her way to work in 2011, Carrie was rear-ended by a hit-and-run driver. The

damage to her Lexus was covered by her insurance company, General Casualty, except

for the $1,000 deductible she was required to pay. In 2012, the insurance company

located the driver who caused the accident and was reimbursed by his insurer.

Consequently, Carrie received a $1,000 refund check from General Casualty in May

2012 to reimburse her for her $1,000 deductible.

 

21. After her father’s death, Carrie’s mother (Mildred Morgan, Social Security number

12345-6789) moved in with her. Mildred’s persistent back trouble made it difficult for

her to climb the stairs to the second-floor bedrooms in Carrie’s house. So Carrie had an

elevator installed in her personal residence at a cost of $12,000 in January 2012. A

qualified appraiser determined that the elevator increased the value of the personal

residence by $7,000. The appraisal cost $400. The operation of the elevator during

2012 increased Carrie’s electric bill by $300.

 

22. As a favor to a long-time client who is a drama professor at a local state university,

Carrie spent a weekend as a stylist preparing hairdos for the key actresses in the annual Theater Department fund-raising event. The drama professor supplied all of the

resources that Carrie needed to provide her services. Carrie estimates that she would

have charged $800 for the services she donated to this charitable event.

 

23. In addition to the items already mentioned, Carrie had the following receipts during

2012:

 

Interest income—

CD at Scranton First National Bank $900

City of Lancaster general purpose bonds 490

Money market account at Allentown State Bank 340 $1,730

Qualified dividends on stock investments—

General Motors $470

AT&T common 380 850

Federal income tax refund (for tax year 2011) 791

Pennsylvania state income tax refund (for tax year 2011) 205

 

24. Expenditures for 2012, not previously noted, are summarized below.

Contribution to pension plan $10,000

Medical—

Premiums on medical insurance $4,800

Dental bills 1,400 6,200

Property taxes on personal residence 3,800

Interest on home mortgage 3,200

Professional expenses—

Subscriptions to trade journals $ 180

Dues to beautician groups 140 320

25. The $10,000 contribution to the pension plan is to a § 401(k) type of plan she

established in 2011. Previously, she had contributed to an H.R. 10 (Keogh) plan but

found that the § 401(k) retirement arrangement provides more flexibility and is less

complex. The medical insurance policy covers Carrie and her dependents and was

issued in the name of the business (i.e., “Carrie’s Coiffures”). It does not cover dental

work or capital modifications to a residence (see item 16 above).

 

26. During 2012, Carrie made the following total estimated tax payments with respect to

her 2012 tax returns:

 

Federal estimated income tax payments $20,800

Pennsylvania estimated income tax payments 2,400

Allentown City estimated income tax payments 800

Requirements

Prepare an income tax return (with appropriate schedules) for Carrie for 2012. In doing this, use the

following guidelines:

1) Make necessary assumptions for information not given in the problem.

2) Carrie has itemized deductions ever since she became a homeowner many years ago.

3) The sales tax option was not chosen in 2011, and Carrie had no major purchases that

qualify for the sales tax deduction in 2012.

4) Carrie has substantiation (e.g., records, receipts) to support the transactions involved.

5) If a refund results, Carrie wants it sent to her.

6) Carrie is preparing her own return (i.e., no preparer is involved).

7) Carrie does not wish to contribute to the Presidential Election Campaign Fund.