Tax Determination; Exemptions; Overview of Property Transactions3-1
CHAPTER 3
TAX DETERMINATION; PERSONAL AND DEPENDENCY EXEMPTIONS;
AN OVERVIEW OF PROPERTY TRANSACTIONS
SOLUTIONS TO PROBLEM MATERIALS
Status: / Q/PQuestion/ / Present / in Prior
Problem / Topic / Edition / Edition
1 / Tax formula / New
2 / Transactions with no income tax effect / New
3 / Gross income: exclusions / Unchanged / 3
4 / Gross income: inclusions / Unchanged / 4
5 / Income tax: international considerations / Unchanged / 5
6 / Effect of AGI on some deductions from / New
7 / Issue ID / Unchanged / 7
8 / Dependents and the determination of their standard deduction and personal exemptions / New
9 / Dependency exemption: treatment of scholarships for the support and gross income tests / Unchanged / 9
10 / Dependency exemption: multiple support agreement / Unchanged / 10
11 / Dependency exemption: gross income and relationship tests / Unchanged / 11
12 / Issue ID / Unchanged / 12
13 / Issue ID / Unchanged / 13
14 / Stealth taxes / Unchanged / 14
15 / Income tax rates: background and instability / New
16 / Characteristics of the kiddie tax / Unchanged / 15
17 / Filing requirement / Modified / 16
18 / Marriage penalty / New
19 / Surviving spouse status / Unchanged / 19
20 / Filing status / Unchanged / 20
21 / Issue ID / Unchanged / 21
22 / Treatment of capital gains / Unchanged / 22
23 / Treatment of capital gains / New
24 / Capital loss tax treatment / Unchanged / 24
25 / Capital transactions: treatment of collectibles / Unchanged / 25
26 / Issue ID / Unchanged / 26
27 / Multiple support agreement: planning for / Unchanged / 27
* 28 / Taxable income calculation / New
* 29 / Taxable income calculation / Unchanged / 29
* 30 / Taxable income calculation / Unchanged / 30
31 / Standard deduction of dependent / Modified / 31
32 / Personal and dependency exemptions / New
33 / Personal and dependency exemptions / Unchanged / 33
34 / Personal and dependency exemptions / Modified / 34
* 35 / Exemption deduction determination: phaseout / New
* 36 / Determine taxable income / Unchanged / 36
* 37 / Unearned income of child under age 14 / Modified / 37
38 / Dependency exemptions: joint return test / Unchanged / 38
39 / Dependent’s tax liability: unearned income / Unchanged / 39
* 40 / Tax liability calculations / New
* 41 / Taxable income calculation / Unchanged / 41
* 42 / Child’s income taxed at parents’ rate / Unchanged / 42
* 43 / Child’s income taxed at parents’ rate / Unchanged / 43
* 44 / Marriage penalty / New
45 / Filing requirements / Modified / 45
46 / Filing requirements / Unchanged / 46
47 / Filing status determination / Unchanged / 47
48 / Filing status determination / Unchanged / 48
49 / Filing status determination / Unchanged / 49
50 / Filing status determination; dependency exemptions / Unchanged / 50
* 51 / Capital transactions: determination of tax / New
* 52 / Capital transactions: determination of tax / New
53 / Tax planning: alternating years for itemized deductions with standard deduction / New
* 54 / Cumulative / New
* 55 / Cumulative / Unchanged / 55
Research
Problem
1 / Divorced parents with equal custody of children; no waiver / New
2 / Joint return and innocent spouse relief / Unchanged
3 / Internet activity / Unchanged
*The solution to this problem is available on a transparency master.
CHECK FIGURES
Tax Determination; Exemptions; Overview of Property Transactions3-1
28.a.$46,600.
28.b.$37,900.
28.c.$27,350.
28.d.$22,350.
29.$19,550.
30.$54,200.
31.a.$4,850.
31.b.$3,450.
31.c.$800.
31.d.$850.
31.e.$3,250.
32.a.Three.
32.b.Four.
32.c.Three.
32.d.Two.
33.a.Three.
33.b.Two.
33.c.Three.
34.a.Four.
34.b.Two.
34.c.Three.
34.d.Three.
34.e.Two.
35.$25,420.
36.$67,100.
37.a.$900.
37.b.$90.
39.Transferring the duplex saves $2,277.
40.a.$5,390.
40.b.$9,963.
40.c.$13,400.
41.$11,750.
42.Taxable income $1,550; tax $185.
43.$9,500.
- Filing separately yields same result
as filing jointly.
45.a.Sam and Lana need not file.
45.b.Bobby is not required to file.
45.c.Mike is required to file.
45.d.Marge must file.
46.a.Ben must file.
46.b.Anita must file.
46.c.Earl must file.
46.d.Karen is not required to file.
46.e.Pat must file.
47.a.Joint return.
47.b.Head of household.
47.c.Surviving spouse.
47.d.Head of household.
48.a.Head of household.
48.b.Single.
48.c.Head of household.
48.d.Single.
49.2002 married filing joint; 2003 surviving spouse; 2004 head of household.
- Head of household; one.
51.a.$3,180.
51.b.$1,400.
52.a.$1,460.
52.b.$600.
53.Yes; saves $587.
54.Taxable income $70,900.
55.Refund due $799.
Tax Determination; Exemptions; Overview of Property Transactions3-1
DISCUSSION QUESTIONS
1.b.Income (broadly conceived)
i.Exclusions
h.Gross income
d.Deductions for AGI
c.Adjusted gross income
f.The greater of the standard deduction or itemized deductions
g.Personal and dependency exemptions
a.Taxable income
Otherwise stated: b. – i. = h. – d. = c. – f. – g. = a. The child tax credit (choice e.) is subtracted from any income tax liability to arrive at the tax due (or refund). p. 3-2 and Figure 3-1
2.Borrowing money has no tax effect as it must be repaid. Collecting a loan that was made (presuming no interest is involved) and the recovery of a rent deposit are return of capital situations. A loss on the sale of a personal asset has no tax effect. p. 3-3 and Examples 1 and 35
3.b. and d. are exclusions. a., c., e., and f. are inclusions. p. 3-3, Example 2, and Exhibits 3-1 and 3-2
4.b., e., and f. are inclusions. a., c., and d. are exclusions. Although b. is described as a “gift,” it is obviously a “bribe.” pp. 3-3, 3-5, and Exhibits 3-1 and 3-2
5.The biggest difference would be the elimination of various provisions in the tax law that mitigate the effect of double taxation. Thus, there would be no need for the foreign tax credit, as foreign source income would be subject only to foreign taxes. It would not be subject to U.S. tax, as it would not be from a U.S. source. See Global Tax Issues on p. 3-5.
6.a.Yes. It reduces AGI, and this allows a larger casualty loss deduction. Casualty losses must exceed 10% of AGI.
b.Yes, it ceases to be relevant. Personal casualty losses are deductions from AGI, and the standard deduction is in lieu of such deductions.
pp. 3-5, 3-6, Examples 3 and 4 and Exhibit 3-3
7.This may not be the case. Since the Masons will become 65 years old, the standard deduction amount will increase and this alternative may prove more beneficial than itemizing (dfrom). pp. 3-6 to 3-8 and Tables 3-1 and 3-2
8.a.No personal exemption is allowed a dependent.
b.$800 is one of two choices as a standard deduction. The other is earned income + $250.
c.Both are taxed, but earned income may help determine the standard deduction selected.
d.Additional standard deductions for age and blindness (if appropriate) are allowed a dependent.
pp. 3-9, 3-10, and Examples 9 and 11
9.a.A scholarship received by a student is not included for purposes of computing whether the taxpayer furnished more than half of the student’s support. p. 3-11 and Example 13
b.For purposes of satisfying the gross income test, the nontaxable portion of a scholarship is not considered, but the taxable (i.e., included in gross income) portion is. p. 3-14
10.a.The person being claimed under a multiple support agreement must otherwise qualify as a dependent. Thus, the gross income, relationship, absence of a joint return, and citizenship tests must also be satisfied.
b.A person cannot be awarded the dependency exemption unless his or her contribution is more than 10%.
c.Form 2120 must be completed by the parties waiving the exemption and included with the return of the person claiming the exemption.
pp. 3-11, 3-12, and Example 17
11.As to the cousins, only the one who lives with Nelda qualifies. Cousins do not satisfy the relationship test; so they must qualify as members of the taxpayer’s household. Nieces meet the relationship test; so the niece qualifies. p. 3-13
12.a.Adriana and Hector qualify for 2004.
b.Adriana, Hector, and Carrie.
c.An ex-spouse cannot be claimed as a dependent in the year of the divorce.
d.If their relationship was in violation of state law.
p. 3-13 and Footnote 14
13.Roberto should definitely encourage his parents and aunts to move to Mexico. As residents of Mexico, they will now qualify as dependents. Needless to say, being able to claim four additional dependency exemptions is bound to help Roberto’s income tax situation. p. 3-14
14.a.Stealth taxes are not separate taxes. On a phase-out basis (predicated on increasing income), they operate to deny higher bracket taxpayers various tax benefits available to others. They avoid the need for Congress to enact new taxes to raise revenue.
b.The Tax Relief Reconciliation Act of 2001 provides for the elimination of two of these stealth taxes—phase-out of personal and dependency exemptions and of certain itemized deductions. Unfortunately, the phase-out does not begin until 2006 and is not complete until 2010. The Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerated some of the 2001 Act provisions.
See the Tax in the News on p. 3-16.
15.a.The rates were 15%, 28%, 31%, 36%, and 39.6%.
b.Over a phase-in period from 2001 to 2006, the rates would become 10%, 15%, 25%, 28%, 33%, and 35%.
c.JGTRRA accelerated the phase-in to 2003.
d.After 2010, pre-2001 rates are to be restored.
e.Adam Smith’s canon of certainty this is not!
pp. 3-17, 3-18, and Tax in the News on p. 3-18
16.a.For the kiddie tax to apply, the child must not have reached age 14 by the close of the taxable year.
- The kiddie tax does not apply unless unearned income is more than $1,600.
c.For married individuals filing separate returns, the individual with the greater taxable income is the applicable parent.
d.For children of divorced parents, the taxable income of the custodial parent is used to determine the allocable parental tax.
pp. 3-20 to 3-22
17.a.In 2004, a single individual who is age 65 or over and blind would have a filing requirement of $9,150 ($4,850 standard deduction + $1,200 additional standard deduction for age + $3,100 personal exemption). The additional standard deduction for blindness is not considered in computing the filing level.
b.The standard deduction, the additional standard deduction for being age 65 or over, and the personal exemption are taken into consideration in determining the filing requirements, but the additional standard deduction for blindness is not considered.
pp. 3-7, 3-8, 3-23, and Tables 3-1, 3-2, and 3-4
18.a.It causes some married couples to pay a larger income tax than if they were single. See the results of Example 30 in the text and compare Example 31.
b.The standard deduction was increased, and the reach of the 15% tax bracket was extended for married persons filing a joint return. p. 3-27
c.Lower-income couples who claim the standard deduction will benefit the most. See Tax in the News on p. 3-27.
19.For 2004, Ginger can file either a joint return or as married filing separately. The former filing status is preferable, but this depends on whether the executor of her husband’s estate agrees. Ginger does not qualify as a surviving spouse for 2005 and 2006, because she does not have a dependent “child” as a member of her household. She would, however, qualify for head of household filing status. p. 3-28 and Example 32
20.a.Head of household. Example 33
b.Single. p. 3-28
c.Head of household. p. 3-28
d.In c., Florence qualifies as a surviving spouse. This is not so in a. and b. as Derrick is not Florence’s dependent. p. 3-28 and Example 30
21.If Fran maintains a household for a dependent child, she probably qualifies as an abandoned spouse. If so, Fran can file as a head of household. pp. 3-28 and 3-29
22.The loss on the RV is not deductible, while the gain on the sailboat is taxable. Both gains (i.e., sailboat and land) are capital. Whether they are short- or long-term depends on the holding period (more than one year for long-term capital gains). pp. 3-29, 3-30, and Example 35
23.Kaitlyn’s stamp collection is a “collectible,” and the former rate of 28% was not changed by JGTRRA of 2003.
a.$4,200 (28% X $15,000).
b.$2,250 (15% X $15,000).
pp. 3-30 and 3-31
24.Of the loss, $3,000 ($2,000 short-term and $1,000 long-term) is deducted against ordinary income with the short-term loss being used first. The remaining $1,000 of long-term capital loss is carried over to 2005 as a long-term capital loss. p. 3-31 and Example 40
- Collectibles include art, antiques, gems, metals, stamps, some coins and bullion, and alcoholic beverages which are held as investments.
a.If held for more than one year, collectibles are taxed at a maximum rate of 28%. If the taxpayer’s marginal tax rate is lower, the lower rate applies.
b.The beneficial treatment under the alternative tax applies only if the holding period is greater than one year. If held for one year or less, they are taxed at the taxpayer’s regular tax rate.
pp. 3-30, 3-31, and Example 39
26.a.If the parties live in New York, Marcie can claim Audry as her dependent. The fact that Audry filed a joint return does not matter when the purpose of the filing is to recover amounts withheld. However, Marcie cannot claim Jamie because he fails the gross income test. But since Marcie can claim Audry, she qualifies for head of household filing status. pp. 3-14 and 3-28
b.If the parties live in Arizona, Marcie can claim both Jamie and Audry. Jamie’s income now becomes $1,750 (50% X $3,500), and he now satisfies the gross income test (not in excess of $3,100). As in part a. above, Marcie qualifies for head of household filing status. p. 3-33 and Example 43
27.Under a multiple support agreement, Erica should claim her mother as a dependent. As part of the contribution toward support, Erica should pay for any medical expenses her mother incurs. With her children and because her brothers do not itemize, Erica is the party most likely to obtain a tax benefit from her mother’s medical expenses. However, if Erica receives no benefit from a medical expense deduction (due to 7.5% of AGI limit), then the dependency exemption should be rotated and the medical expenses divided accordingly. p. 3-33 and Example 44
PROBLEMS
28.a.AGI$70,000
Less: Itemized deduction(11,000)
Personal and dependency exemptions (4 X $3,100)(12,400)
Taxable income$46,600
No additional standard deduction is allowed for a dependent age 65 or over (one of Emily’s parents).
b.AGI$60,000
Less:Standard deduction(9,700)
Personal and dependency exemptions (4 X $3,100)(12,400)
Taxable income$37,900
c.AGI$50,000
Less:Standard deduction (head of household) (7,150)
Personal and dependence exemptions (5 X $3,100)(15,500)
Taxable income$27,350
d.AGI$40,000
Less: Standard deduction (head of household)(7,150)
Additional standard deduction (Abigail)(1,200)
Personal and dependency exemptions (3 X $3,100) (9,300)
Taxable income$22,350
pp. 3-9, 3-10, 3-26 to 3-29, Table 3-1 and 3-2
29.Salary$40,000
Interest on GMC bonds1,200
Alimony(2,400)
Capital loss(3,000)
IRA contribution(3,000)
Office pool 3,200
AGI$36,000
Standard deduction(7,150)
Personal and dependency exemptions (3 X $3,100) (9,300)
Taxable income$19,550
The child support payments are nondeductible. The gift is a nontaxable exclusion. Only $3,000 of the capital loss is deductible—the balance of $1,000 is carried over to 2005.
pp. 3-5 to 3-8, 3-31, Figure 3-1, Exhibits 3-1 and 3-2, and Table 3-1
30.Salary$70,000
Prize 5,000
AGI$75,000
Itemized deductions ($4,800 + $3,600)(8,400)
Personal and dependency exemptions (4 X $3,100)(12,400)
Taxable income$54,200
The $2,000 of interest on the Chicago bonds, the insurance proceeds of $50,000, and the $90,000 of damages for personal injuries are all exclusions. Itemized deductions ($8,400) were claimed as they exceeded the standard deduction ($7,150).
pp. 3-6, 3-8, Figure 3-1, and Exhibits 3-1 to 3-3
31.a.$4,850. Although $4,800 (earned income) + $250 = $5,050, the amount allowed cannot exceed that available in 2004 for single taxpayers.
- $3,450. $3,200 (earned income) + $250.
- $800. The greater of $800 or $400 (earned income) + $250.
- $850. The greater of $800 or $600 (earned income) + $250.
- $3,250. $1,800 (earned income) + $250 + $1,200 (additional standard deduction).
pp. 3-9, 3-10, Tables 3-1 and 3-2, and Examples 8 to 11
32.a.Three. Ann does not qualify due to the gross income test. Although she is their child who is a full-time student, she is not under age 24.
b.Four. Although Pierce is not a full-time student, he is their child under age 19. Ann now qualifies because she meets the gross income test.
c.Three. As Elton meets the relationship test, he does not have to live with Alice.
d.Two. Trent does not meet the relationship test as does Petula, but he is a member of the household. However, Trent does not pass the gross income test. He does not meet the under-19-years-of-age exception or the student exception, as he is not a “child” of the taxpayer.
pp. 3-10 to 3-14
33.a.Three. The parents qualify as dependents under the Mexico/Canada exception.
b.Two. Pablo’s father does not qualify. Pablo’s mother qualifies since she is a resident of the U.S.
c.Three. The parents qualify since they are U.S. citizens.
p. 3-14
34.a.Four. Two personal exemptions (Miles and Macy) and two dependency exemptions (Macy’s parents). The parents need not live with Miles and Macy as they meet the relationship test.
b.Two. The ex-wife does not meet the relationship test although her brother (Rhett’s ex-brother-in-law) does.
c.Three. The ex-wife now satisfies the member of the household test. The ex-brother-in-law meets the relationship test.
d.Three. One personal exemption and two dependency exemptions. Nephews and nieces meet the relationship test and do not have to live with the taxpayer (although the niece does).
e.Two. One personal exemption and one dependency exemption (the nephew). The niece does not meet the gross income test. The full-time student exception applies only to a child of the taxpayer.
pp. 3-10 to 3-14
35.Exemption amount (10 X $3,100)$31,000
Step 1:AGI$235,000
Phase-out threshold(214,050)
Excess amount$ 20,950
Step 2:$20,950 ÷ $2,500 = 9 (rounded up) X 2 = 18% (phase-out percentage)
Step 3:Less: $31,000 X 18% (5,580)
Step 4:Deduction for personal and dependency exemptions$25,420
p. 3-15
36.Salaries ($46,000 + $51,000)$97,000
Interest income2,100
Contributions to traditional IRAs (5,000)
Adjusted gross income$94,100
Less:Itemized deductions$11,500
Personal exemptions (2 X $3,100)6,200
Dependency exemptions (3 X $3,100) 9,300(27,000)
Taxable income$67,100
The $900 of interest on San Francisco bonds and the $24,000 gift from Keri’s parents are exclusions. The $16,000 loss on the sale of the RV is a personal loss and nondeductible. Demi falls under the full-time student exception to the gross income test. As to the same test, Kevin satisfies the under-the-age-of-19 test. Consequently, each can be claimed as a dependent. Homer passes the gross income test because at that income level Social Security benefits are exclusions.
pp. 3-4 to 3-6, 3-8, 3-14, Example 35, Exhibits 3-1 and 3-2, and Figure 3-1
37.a.Wages$2,100
Bank interest1,150
Bond interest (City of Chicago bond interest is tax-exempt) -0-
Gross income$3,250
Less:Standard deduction*(2,350)
Personal exemption** (-0-)
Taxable income$ 900
b.Bank interest$1,150
Bond interest -0-
Total unearned income$1,150
Minus: $800 + $800 standard deduction(1,600)
Income taxed at parents’ rate$ -0-
Income taxed at Bob’s rate$ 900
Total tax ($900 X 10%)***$ 90
*A dependent’s standard deduction is limited to the greater of $800 or the sum of his or her earned income plus $250.
**A dependent may not claim a personal exemption on his or her return.
***Since Bob’s unearned income is not more than $1,600, his tax is determined without using his parents’ rate. Thus, Bob’s 2004 tax liability is $90 ($900 taxable income X 10%).
pp. 3-9, 3-10, 3-20 to 3-22, Exhibits 3-1 and 3-2, and Example 10.
38.a.In Louisiana, John and Irene are each deemed to have income of $1,600 (50% X $3,200). Consequently, neither would violate the gross income test of $3,100. They both can be claimed as dependents by Walter and Nancy. Example 43