Sample Return 2 (SR2) Information for Sole Proprietorship Tax Return with Explanations and Completed Tax Forms The Spicers and Bill’s Market Facts The Spicers live at 2345 Carolina Avenue, Durham. NC 27212. William’s social security number is 123-45-6789 and June’s is 987-65-4321. They do not contribute to the Presidential campaigns. They have two dependent children—Sophie is 9 (SS#333-33-3333) and Carl is 4 (SS#444-44-4444). William operates a gourmet market in Raleigh, Bill’s Market (TIN# 79-7979797 and business code of 445290), as a cash basis sole proprietorship. The store is located at 387 Spring Street, Raleigh, NC 29288. William supplied the following information about the market to his accountant: Gross sales Beginning inventory Purchases Ending inventory (at cost) Expenses: Advertising Charitable contributions Cleaning/maintenance Depreciation (pre-2002 purchases) Sec. 179 expense (6/1/02 display case) Employee FICA taxes Health insurance Insurance (excludes health) Interest on line of credit Licenses/fees Meals/entertainment Office expenses Rent Salary/wages Travel Utilities $2,700,000 320,000 2,000,000 340,000 $40,000 2,000 12,000 3,000 5,000 18,000 15,000 * 18,000 1,000 4,000 1,000 14,000 120,000 210,000 8,000 16,000 *Includes $3,000 for health insurance for William and his family. The market sold a unique piece of equipment for $13,000. It had originally cost $5,000 when purchased on March 5, 2000; it had an adjusted basis of $3,000 when sold on August 15, 2002. The market also sold a display case for $1,000 on December 12, 2002, which had cost $12,000 when purchased on June 6, 1998; it had an adjusted basis of $4,000 when sold. The following information pertains to the completion of the Spicer’s personal tax return: Interest income $500 Dividend income 1,300 Loss on stock sale (long-term) Unreimbursed doctor’s bills Unreimbursed hospital bills Dental bills Mortgage interest Real estate taxes Contributions to their church (14,000) $8,000 12,000 2,000 14,000 4,000 1,500 June is a volunteer at the children’s school but does not otherwise work outside the home. Her total mileage for her trips to and from the school was 1,200 miles. She also had unreimbursed out-of-pocket expenses for teaching materials of $232. Additionally, she spent $1,500 on childcare so that she could be there during after-school hours to tutor at-risk students. The Spicers contribute $3,000 each to regular IRAs. The Spicers made quarterly estimated tax payments of $65,000. All payments were made when due. The completed Forms 1040, Schedules A, B, C, D, and SE, and Forms 4562 and 4797 for the Spicers follow along with an explanation of the treatment of various items. Explanation The Spicers will prepare only one tax return—their Form 1040 along with all the required schedules and forms. Because the business is a sole proprietorship, only the Schedule C is required to report the income and expenses for the business. Because of the nature of some of the expense items, several other forms will have to be prepared. The first item that must be completed is the schedule C for Bill’s Market. The preparation of Schedule C is relatively straightforward; that is, the income items are entered on the Schedule C and the expenses are deducted. There are several exceptions to this procedure, however. First, the results of the property dispositions are not included on the Schedule C, but are included directly on the Spicers’ return. A Form 4797 is completed for the business property dispositions, and the net gain on the equipment dispositions is included on the Spicers’ Schedule D. The $2,000 depreciation recapture is also entered on Form 4797 but is transferred directly to the Spicers’ Form 1040. Two other items are not included on the Schedule C--the charitable contribution and the health insurance for William and his family. The charitable contribution is included with the Spicers’ personal charitable deduction on their Schedule A. The Spicers can deduct the health insurance premium—but it must be split into two parts. For 2002, 70 percent of the medical insurance premium is deducted on page 1 of the Form 1040 as part of the deductions for AGI. The remaining 30 percent of the premium is included with their other medical expenses and deducted on their Schedule A. The second page of the Schedule C is used to calculate cost of goods sold of $1,980,000. Of the business’s other expenses (excluding those explained above), only two items were combined and shown on one line—the FICA taxes and licenses/fees were summed and entered on line 22 as one item. Because the business claimed depreciation expense of $3,000 and a Sec. 179 expense of $5,000, Form 4562 (page 1 only) was prepared for the business. The net income from the sole proprietorship is $238,500. After Schedule C is completed, the Schedule SE to determine William’s self-employment taxes can be completed. The short form can be used to calculate the $16,915 of self-employment tax, half of which ($8,458) becomes a deduction for AGI on Form 1040. The Schedule D can then be completed. The net $9,000 capital loss is a result of netting the $5,000 Sec. 1231 gain from Form 4797 with the $14,000 loss on the stock on Schedule D. The deductible loss is limited to $3,000 and there is a $6,000 capital loss carryover. 2 Once these other forms are complete, the Spicer’s Form 1040 and Schedules A and B can be completed. Their AGI ($222,742) is the sum of their income from interest ($500), dividends ($1,300)(Schedule B), Schedule C business ($238,500), and property transactions ($2,000 – $3,000) less $6,000 IRA contributions, one-half the self-employment tax ($8,458), and 70 percent of the medical insurance premium ($2,100) that is paid on behalf of William and his family (which is treated as paid by him directly). On Schedule A, their medical expenses include not only the unreimbursed doctor, hospital and dental bills, but the other 30 percent ($900) of the cost of the health insurance. They also include the charitable contribution made by the sole proprietorship with their other cash contributions. June is allowed to deduct 14 cents per mile for the 1,200 driven ($168) for her volunteer work along with her out-of-pocket expenses of $232. She cannot, however, claim any child care credit for the babysitting expenses incurred doing the volunteer work. Their total itemized deductions must be reduced by 3 percent of the excess of their AGI over $137,300 to $25,531. Their exemptions (4 x $12,000) must also be reduced based on their AGI in excess of $206,000 to $10,320. Their taxable income is $186,891 and their tax is $47,225. They are not able to benefit from the child tax credit as their AGI is too high. When they add the self-employment taxes of $16,915 to their income tax their total tax liability is $64,140 and they will have a refund due of $860. They may have this amount refunded to them or applied to their following year’s tax liability. Tax Forms for this problem: File Name Forms Included SR2f1040return.pdf Form 1040: U.S. Individual Income Tax Return Schedule A: Itemized Deductions Schedule B: Interest and Dividends Schedule C: Profit or Loss From Business (Sole Proprietorship) Schedule D: Capital Gains and Losses Schedule SE: Self-Employment Tax Form 4562: Depreciation and Amortization Form 4797: Sales of Business Property 3