CONCEPTS IN
FEDERAL TAXATION
CHAPTER 8:
TAXATION OF
INDIVIDUALS
October 26,
2012
ADMINISTRATIVE
 Attendance
 Midterm 1
Pass out exams
Income dividend—5 points
 Research project
Fill out spreadsheet
Include email!
HOMEWORK PROBLEMS
HW Problems:
Assignment #9
Chapter 8
P#46, 48, 52, 55, 57
Extra problems:
#44
Keith bought his home several years ago for $110,000. He paid
$10,000 down on the purchase and borrowed the remaining
$100,000. When the home is worth $230,000 and the balance
on his mortgage is $40,000, Keith borrows $120,000 using a
home equity loan. Keith uses the proceeds of the loan to pay
of f some gambling debts. During the year, Keith pays $3,200 in
interest on the original home mortgage and $7,600 in interest
on the home equity loan. What is Keith’s allowable itemized
deduction for interest paid ?
#44
Allowable home mortgage interest deduction:
 Interest paid on acquisition debt of up to $ 1 ,000,000
Must be used to acquire, construct, or substantially improve
residence
 Interest paid on home equity loans of up to $100,000
Proceeds of the home equity loan may be used for any purpose
 Total acquisition debt and home equity debt cannot exceed
the fair market value of the property
 Debt must be secured by the taxpayer’s qualified residence
#44
 Total debt: $160,000 ($40,000 + $120,000)
Less than FV ($230,000)
 Only interest on $100,000 of the home equity loan is
deductible: $6,333 [$7,600 x ($100,000 ÷ $120,000)]
 The remaining $1 ,267 of interest is considered personal
interest and is not deductible
 All of the interest on the original home mortgage ($3,200)
qualifies for deduction
 Keith’s total interest deduction is $9,533 ($6,333 + $3,200 )
#48
Stoycho and Selen are married and have the following investment income
for 2011 and 201 2:
2011
201 2
Interest on U.S. Treasur y notes
$ 1 ,200
$ 1 ,400
Cash dividends
3,000
2,200
Interest on savings
2,000
1 ,500
Interest on State of Montana bonds
800
800
Net long-term capital gain
1 ,000
500
Their adjusted gross income before considering the investment income is
$84,000 in 2011 and $73,500 in 201 2. Stoycho and Selen pay $9,000 in
investment interest in 2011 and $5,000 in 201 2. The investment
interest is incurred to acquire all the investments in their por tfolio. Write
a letter to Stoycho and Selen explaining how much investment interest
they can deduct in 2011 and 201 2.
#48
2011:
 The investment interest deduction is limited to net investment
income
Investment income is $3,200 ($1,200 + $2,000)
 The interest received on the municipal bonds is tax -exempt
Not included
 The net long-term capital gain cannot be used in the
calculation of gross investment income because it will
be taxed at 15%
 Dividends receive special tax treatment and are taxed at a
maximum rate of 15%
#48
 The $9,000 of interest is paid to produce $7,200 of taxable
income and $800 of tax -exempt income
 The portion of the interest related to the production of the
tax-exempt income is not deductible
$900 [$9,000 x ($800 ÷ $8,000)] of the interest is not deductible
 Their investment interest expense is $8,100 ($9,000 - $900)
 Because this amount exceeds their investment income, their
investment interest deduction is limited to $ 3,200
 The remaining $4,900 ($8,100 - $3,200) is carried forward
to 2012
#48
2012:
 Investment income: $2,900 ($1 ,400 + $1 ,500)
 Interest received on the municipal bonds is tax-exempt
Not allowed for purposes of computing allowable investment interest
deduction
 Dividends and net long-term capital gain cannot be used in
the calculation of gross investment income because it will be
taxed at 15%
#48
 The $5,000 of interest is paid to produce $5,600 of taxable
income and $800 of tax -exempt income
 The portion of the interest related to the production of the
tax-exempt income is not deductible
$625 [$5,000 x ($800 ÷ $6,400)] of the interest is not deductible
 Their investment interest expense is $4,375 ($5,000 - $625)
 Because $4,375 exceeds their investment income, their
investment interest deduction is limited to $ 2,900
 The remaining $1 ,475 ($4,375 - $2,900) along with the
$4,900 from 2011 is carried forward to the following year
Total carryforward to 2013 is $6,375 ($4,900 + $1,475)
#52
Miguel is a successful businessman who has been approached by
St. Kilda University to make a donation to its capital campaign. He
agrees to contribute $75,000, but he is unsure which of the
following assets he should contribute :
Asset
Ordinary income property
Long-term capital gain property
Long-term capital gain property
Basis
$ 41 ,000
84,000
32,000
FMV
$ 75,000
75,000
75,000
Write a letter to Miguel advising him which property he should
contribute to St. Kilda’s capital campaign.
#52
Ordinary income property:
 The amount of the contribution is limited to the lesser of:
1. the property’s fair market value at the date of the gift
2. the property’s adjusted basis
 Appreciation in the value of ordinary income property is not
allowed as a deduction
 Limited to a maximum deduction of 50% of AGI
#52
Long-term capital gain property:
 FM valuation allowed
 Appreciation in the value of a long -term capital gain property
is allowed as a deduction
 Any property valued at fair market value is limited to a
maximum deduction of 30% of AGI
 The taxpayer can elect to treat the long -term capital gain
property as ordinary income property (valuing property at it’s
adjusted basis) and be subject to the 50% limitation
 Any amounts in excess of the limits are carried forward
#52
 If Miguel contributes the ordinary income property, his
charitable contribution is limited to his basis in the property
($41 ,000)
 Contributing either long-term capital gain property results in a
charitable contribution of $75,000
 If he contributes the capital gain property with a basis of
$84,000, Miguel loses the benefit of being able to recognize
the $9,000 ($75,000 - $84,000) loss
 If he contributes the capital gain property with a basis of
$32,000, he does not recognize the $44,000 ($75,000 $32,000) gain on its appreciation
#52
 Miguel should contribute the long -term capital gain property
that has a basis of $32,000
#52
Alternative solution:
 If Miguel wants to contribute the long -term capital gain
property with a basis of $84,000, he could sell the property
and realize the $9,000 loss
 He will recognize a $3,000 capital loss in the current year
 The amount of his donation to St. Kilda is $75,000
 Instead of receiving property, St. Kilda would receive cash
#55
Edna works as a marketing consultant. In her spare time, she
enjoys painting. Although she sells some of her work at local
craft shows, she either displays most of her paintings at home
or gives them to family and friends. During the year, she
receives $750 from the sale of her paintings. The cost of
producing the sold paintings and the cost of attending the
crafts shows is $1 ,850. Edna has other allowable
miscellaneous deductions of $1 ,400, and her adjusted gross
income before considering her painting activity is $48,000.
Write a letter to Edna explaining her allowable miscellaneous
itemized deduction for the year.
#55
 Edna must include the $750 from the sale of the paintings in
her gross income
Deduction of hobby expenses is limited to the $750 of income
 Hobby expenses are deducted as a miscellaneous itemized
deduction
Subject to the 2% of AGI limitation
#55
 Edna’s AGI af ter considering the income from her paintings is
$48,750 ($48,000 + $750 )
 Total miscellaneous itemized deduction is $2,150 ($1 ,400 +
$750)
 $2,150 is reduced by the 2% of AGI limitation on
miscellaneous itemized deductions:
Total miscellaneous itemized deductions
Less: $48,750 x 2%
Allowable miscellaneous itemized deduction
$2,150
(975)
$1 ,175
#57
Michael owns a hair salon. During the current year, a tornado
severely damages the salon and destroys his personal
automobile, which is parked outside. It costs Michael $12,000
to make the necessary repairs to the salon. He had paid
$21 ,500 for the automobile, which was worth $17,100 before
the tornado. Michael’s business insurance reimburses him for
$7,000 of the salon repair costs. His automobile insurance
company pays only $12,000 for the automobile destruction.
Michael’s adjusted gross income is $34,000 before considering
the ef fects of the tornado. Write a letter to Michael explaining
his deductible loss from the tornado.
#57
 The damage to the hair salon is a business casualty, which is
deductible for adjusted gross income
 The deductible loss is $ 5,000
$12,000 cost of repairing the salon less $7,000 insurance
reimbursement
#57
 The loss on the automobile is a personal casualty loss, which
is deductible as an itemized deduction
 The amount of the loss is the lesser of:
1. $21,500 basis
2. $17,100 decline in value
 The $5,100 unreimbursed personal casualty loss ($17,100 $12,000) is reduced by the $100 statutory floor
 Total casualty loss for the year is subject to 10% of AGI
 Michael’s adjusted gross income is $29,000 ($34,000 $5,000 business casualty loss from the salon)
 The $5,000 allowable personal casualty loss is reduced by
$2,900 ($29,000 x 10%)
Casualty loss deduction is $2,100
#57
Amount of loss
Less: Insurance reimbursement
Less: Statutory floor
Allowable loss before 10% of AGI limitation
Less: Annual loss limitation (10% x $29,000)
Deductible casualty loss
$ 17,100
(12,000)
(100)
$ 5,000
(2,900)
$ 2,100
EXTRA PROBLEMS—#36
Rebecca and Ir ving incur the following medical expenses during the current
year:
Medical insurance premiums
$4,100
Hospital
950
Doctor s
1 ,225
Dentist
575
Veterinarian
170
Chiropractor
220
Cosmetic surger y
1 ,450
Over-the-counter drugs
165
Prescription drugs
195
Crutches
105
They receive $4,000 in reimbur sements from their insurance company of
which $300 is for the cosmetic surger y. What is their medical expense
deduction if:
a. Their adjusted gross income is $44,000?
EXTRA PROBLEMS—#36
Medical insurance premiums
Hospital
Doctors
Dentist
Veterinarian
Chiropractor
Cosmetic surgery
Over-the-counter drugs
Prescription drugs
Crutches
$4,100
950
1 ,225
575
170
220
1 ,450
165
195
105
No
No
No
EXTRA PROBLEMS—#36
Medical insurance premiums
Hospital
Doctors
Dentist
Chiropractor
Prescription drugs
Crutches
Total Allowable medical expenses
$ 4,100
950
1 ,225
575
220
195
105
$ 7,370
EXTRA PROBLEMS—#36
 Reimbursed medical costs:
Insurance reimbursement: $4,000
Reimbursement for cosmetic surgery: $300
Reimbursement related to medical expense deduction: $3,700
 The $3,670 of medical expenses is subject to the 7.5% AGI
limitation
EXTRA PROBLEMS—#36
Medical insurance premiums
Hospital
Doctors
Dentist
Chiropractor
Prescription drugs
Crutches
Total Allowable medical expenses
Less: Insurance reimbursements
Unreimbursed medical expenses
Less: AGI limitation ($44,000 x 7.5%)
Medical expense deduction
$ 4,100
950
1 ,225
575
220
195
105
$ 7,370
(3,700)
$ 3,670
(3,300)
$ 370
EXTRA PROBLEMS—#36
b. Their adjusted gross income is $61 ,000?
 No deduction is allowed
 The AGI limit is $4,575 ($61 ,000 x 7.5%), which is greater
than their $3,670 of unreimbursed costs
EXTRA PROBLEMS—#35
Arthur and Cora are married and have 2 dependent children.
They have a gross income of $95,000. Their allowable
deductions for adjusted gross income total $4,000, and they
have total allowable itemized deductions of $14,250.
a. What is Arthur and Cora’s taxable income?
EXTRA PROBLEMS—#35
Gross income
Deductions for AGI
Adjusted gross income
Deductions from AGI:
The greater of:
Itemized deductions $ 14,250
or
Standard deduction $ 11 ,900
$ 95,000
(4,000)
$ 91 ,000
(14,250)
Personal & dependency exemptions (4 x $3,800) (15,200)
Taxable income
$ 61 ,550
EXTRA PROBLEMS—#35
b. What is Arthur and Cora’s income tax?
$1 ,740 + [15% x ($61,550 - $17,400)] =
Less: Child tax credit (2 x $1 ,000)
Net tax liability
$ 8,363
(2,000)
$ 6,363
EXTRA PROBLEMS—#35
c. If Arthur has $2,900 and Cora has $3,800 withheld from their
paychecks, are they entitled to a refund, or do they owe
additional taxes?
 They are entitled to a refund of $337 [$6,363 - ($2,900 +
$3,800)]