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.
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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
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