Devon Bishop, age 40, is single. He lives at 1507 Rose Lane, Albuquerque, NM 87131. His Social Security number is 111-11-1111. Devon does not want $3 to go to the Presidential Election Campaign Fund.
Devon was divorced in 2008 after 15 years of marriage. He pays alimony of $18,000 a year to his former spouse, Ariane. Ariane’s Social Security number is 123-45-6789. Devon’s son, Tom, who is age 16, resides with Ariane. Devon pays child support of $12,000 per year. Ariane has provided Devon with a signed Form 8332 in which she releases the dependency deduction to him for 2012. Tom’s Social Security number is 123-45-6788.
Devon owns a sole proprietorship for which he uses the accrual method of accounting. His revenues and expenses for 2012 are as follows:
|Cost of goods sold||405,000|
|Accounting and legal fees||7,000|
Other income received by Devon includes the following:
|City of Asheville bonds||17,000|
|Lottery winnings (tickets purchased cost $500)||10,000|
During the year, Devon and his sole proprietorship had the following property transactions:
1. Sold Blue, Inc. stock for $45,000 on March 12, 2012. He had purchased the stock on September 5, 2009, for $50,000.
2. Received an inheritance of $300,000 from his Uncle Henry. Devon used $200,000 to purchase Green, Inc. stock on May 15, 2012, and invested $100,000 in Gold, Inc. stock on May 30, 2012.
3. Received Orange, Inc. stock worth $9,500 as a gift from his Aunt Jane on June 17, 2012. Her adjusted basis for the stock was $5,000. No gift taxes were paid on the transfer. Aunt Jane had purchased the stock on April 1, 2006. Devon sold the stock on July 1, 2012, for $22,000.
4. On July 15, 2012, Devon sold one-half of the Green, Inc. stock for $40,000.
5. Devon was notified on August 1, 2012, that Yellow, Inc. stock he purchased from a colleague on September 1, 2011, for $52,500 had become worthless. While he perceived that the investment was risky, he did not anticipate that the corporation would declare bankruptcy.
6. On August 15, 2012, 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, 2009.
7. On December 1, 2012, Devon sold the condominium in which he had been living for the past 10 years. The sales price was $480,000, selling expenses were $28,500, and repair expenses related to the sale were $9,400. Devon and Ariane had purchased the condominium as joint owners for $180,000. Devon had received Ariane’s ownership interest as part of the divorce proceedings. The fair market value at that time was $240,000.
Devon’s potential itemized deductions, exclusive of the aforementioned information, are as follows:
|Medical expenses (before the 7.5% floor)||$ 9,500|
|Property taxes on residence||5,300|
|State income taxes||4,000|
|Mortgage interest on residence||9,900|
|Sales taxes paid||5,000|
During the year, Devon makes estimated Federal income tax payments of $40,000.
Compute Devon’s lowest net tax payable or refund due for 2012 assuming that he makes any available elections that will reduce the tax. If you use tax forms for your computations, you will need Forms 1040, 4562, 8332, and 8824 and Schedules A, B, C, D, and SE.
Notes (1) The net income of Devon’s sole proprietorship is calculated as follows: 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 Of the health insurance payments, only the $18,000 of health insurance paid for employees is deductible in calculating the net income of the sole proprietorship. The $8,000 paid for Devon qualifies as a deduction for AGI. (2) The $17,000 interest on the City of Asheville bonds is excluded from gross income. (3) Item a. Amount realized $45,000 Less: Adjusted basis (50,000) Realized loss ($ 5,000) Recognized loss (long-term capital loss) ($ 5,000) Item b. The $300,000 inheritance is excluded from Devon’s gross income. His adjusted basis for the Green stock is the cost of $200,000 and his adjusted basis for the Gold, Inc. stock is $100,000. Item c. Gifts are excluded from Devon’s gross income. His adjusted basis for the Orange stock is a carryover basis of $5,000. His holding period also is a carryover holding period (i.e., it includes Aunt Jane’s holding period which began April 1, 2006). Amount realized $22,000 Less: Adjusted basis (5,000) Realized gain $17,000 Recognized gain (long-term capital gain) $17,000 Item d. Amount realized $ 40,000 Less: Adjusted basis [1/2 × $200,000 (Item b.)] (100,000) Realized loss ($ 60,000) © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13-46 2014 Comprehensive Volume/Solutions Manual Orange stock $17,000 Residence 21,500 Tucson land 25,000 $63,500 Recognized loss (short-term capital loss) ($ 60,000) Item e. Amount realized Less: Adjusted basis $ –0– (52,500) Realized loss ($52,500) Recognized loss (long-term capital loss) ($52,500) The loss is deemed to occur on the last day of 2012. Therefore, the holding period is long term. Item f. Amount realized ($220,000 + $25,000) $245,000 Less: Adjusted basis (210,000) Realized gain $ 35,000 Recognized gain (long-term capital gain) $ 25,000 The exchange qualifies as a § 1031 like-kind exchange. However, the boot received of $25,000 results in $25,000 of the realized gain of $35,000 being recognized. Item g. Amount realized ($480,000 – $28,500) $451,500 Less: Adjusted basis (180,000) Realized gain $271,500 § 121 exclusion (250,000) Recognized gain (long-term capital gain) $ 21,500 Devon qualifies for the § 121 exclusion since he has owned and occupied the residence as his principal residence during at least two of the five years preceding the date of sale. Thus, his realized gain of $271,500 is reduced to $21,500. Devon’s basis for the residence he sold was the same as his and Araine’s basis ($180,000). Repair expenses ($9,400) are neither capitalizable nor deductible. Devon’s capital gains and losses are summarized as follows: Long-term capital gains: Long-term capital losses: Blue stock ($ 5,000) Yellow stock (52,500) (57,500) Net long-term capital gain $ 6,000 Short-term capital loss: Green stock ($60,000) Net capital loss ($6,000 net long-term capital gain – $60,000 net short-term capital loss) ($54,000) © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Property Transactions: Gain or Loss, Basis, Nontaxable Exchanges 13-47 Only $3,000 of the net capital loss can be deducted in 2012. The $51,000 balance is carried forward to 2013. (4) The alimony payment of $18,000 qualifies as a deduction for AGI. The child support of $12,000 is not deductible by Devon. (5) Computation of the self-employment tax: 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 $110,100 or less, multiply the Step 2 amount by 13.3%. If the Step 2 amount is more than $110,100, multiply the excess of the Step 2 amount of $135,293 over $110,100 by 2.9% and add $643.30. This is the self-employment tax. $15,373.90 The deduction for AGI for part of the self-employment tax is $8,787. (Note 11) (6) Of the $8,000 of health insurance premiums paid for Devon, 100% is a deduction for AGI. (7) Itemized deductions: Medical expenses [$9,500 – (7.5% × $144,417)] $ –0– Property taxes 5,300 Sales taxes 5,000 Charitable contributions 10,000 Mortgage interest 9,900 Lottery tickets 500 Total itemized deductions $30,700 (8) Devon qualifies for a dependency deduction for Tom. Araine, the custodial parent, released the deduction to him. (9) All of Devon’s qualified dividends of $12,000 are taxed at 15%. Taxable income $105,913 Qualified dividends (12,000) Portion of taxable income taxed at regular tax rates $ 93,913 Tax on qualified dividends ($12,000 × 15%) $ 1,800 Tax on $94,117 from Tax Table 19,760 Tax on taxable income $ 21,560 (10) The child tax credit phases out completely at Devon’s income level. (11) 50% × $15,031 (self-employment tax) $7,687 + 1,100 = Deduction $8,787