TAX RETURN PROBLEM 2
40 POINTS
Revised May 7, 2011
Stacey Harrison (453-44-5321)and Warren Harrison (444-32-5890) live at 5755 Warren Road, Santa Barbara, Ca. 90432. Stacey was born 7/1/1972. She is employed as a teacher at Milliken Secondary School. Her W-2 for 2009 shows wages of $34,982.15, federal income tax withheld of $2314.23, California State income taxes withheld of $982.53, FICAand Medicare tax were withheld at the appropriate rate. She is married to Warren Harrison, born 3/2/1960. He is employed as an accountant at Chlorox Corporation EIN 44-324351. His W-2 shows salary of $73,215.25, federal income tax withheld of $3832.74, California State income taxes withheld of $1992.35, social security and Medicare tax withheld based on the appropriate rate. They file a joint tax return. They contribute $3 to the presidential election return.
On April 1, 2010 they file their 2009tax return. On May 20, 2009 they received a $478 refund of their 2008 Federal taxes which they applied to their 2009 estimated tax. They also received a California tax refund of $964.53 on May 1, 2009 for the 2008 year which they applied to their 2009 California estimated tax. In 2008 itemized deductions totaled $24,353.53, AGI was $80,200, California tax was $5000, property tax 11,700. In 2009 they made estimated tax payments of $775 perquarter for federal taxes and $372 per quarter for state taxes. The payments were made on 4/21/09, 7/15/09, 9/01/09 and 1/10/10. On 1/24/09 they paid the fourth quarter 2008 estimated Federal tax of $700, no fourth quarter payment was made in 2009 for 2008 California taxes. The Harrisons have not received an Economic Recovery Payment. The sales tax rate they paid on purchases was 10 percent.
They have three children that they support. Barry (583-22-5787) was born 4-12-2000. He still lives at home with his parents and attends school Wally (524-31-2784) was born 4-1-2002 and Theodora (524-34-3591) was born 4/01/1989. Stacey paid job-related child care expenses of $7442 ($3000 on behalf of Wally and $4442 on behalf of Barry) to Phillip Williams (782-31-2739). He lived with the family full-time. The Harrisons did not withhold any taxes on behalf of Phillip Williams, but pay the “nanny tax” and file the appropriate forms with the 2009 tax return. No state unemployment taxes were due on behalf of Williams.
Theodora was a junior who lived in the dormitories at UC Santa Barbara, 11300 Hillside Road, Santa Barbara, 92031, where she was receiving a degree in economics. She spent her vacations at home. In addition to the amount she earned from her mother’s travel agency, she earned $10,500 from a part-time job at Wonderworld, Inc (EIN 33-444444). Her parents provided over half her support. She received an ordinary dividend that was also qualified of $1742 from Heinz, Corp on 9/25/2009. If eligible, her parents elect to report the kiddie tax on their return. If the parents are not eligible, she files her own tax return. During the year she had $1227 Federal income tax withheld and $652 California income tax withheld, FICA was withheld at the appropriate rate.
The Harrisons received interest income of $4332 from State Bank, $1322 from Fannie Mae bonds, $874 from Orange County Municipal bonds (not a private activity bond) and $953 from 5-year Treasury Bills due 9/3/2013. They received a qualified dividend which was an ordinary dividend of $2830 from Wilcox Corp. on 8/3/2009.
They sold 764 shares of Comcast stock for $37.23 per share on 10/12/2009 which they had purchased on 3/1/2000 for $28.34 per share. They sold 425 shares of Westinghouse stock on 10/12/2009 for $122 per share which they bought on 7/1/2009 for $131 per share.
The Harrisons purchased Fidelity Magellan fund on the following dates.
- 3/1/2008100 shares$35
- 12/1/200850 shares$32
- 4/1/200980 shares$40
They received the following qualified ordinary dividends which were automatically reinvested :
3/1/2009$400 reinvested in 11.11 shares at $36/share
9/1/2009$800 reinvested in 21 shares at $38/share)
On 12/15/2009 The Wilsons sold 170 shares of the fund for $42 per share. They used the average cost basis to determine the basis of the shares sold.
The Harrisons had a STCL carryover from 2008 of $5325 and a LTCL carryover of $3215.
They sold an oil painting by a well-known modern artist, Calder, on 4/8/2009 for $63,230 that Stacey received as a gift from her aunt on 3/2/2003. The value of the painting on 03/02/2003 was $77,720. Her aunt bought the painting on 05/17/1973 for $53,000 and paid a gift tax in 2003 of $8,000 on the transfer.
When her grandmother, Tina, died on 2/15/2008 Stacey inherited Tina’s wedding ring which was worth $4000 on that date. Tina received it as a wedding gift from her Aunt Gertrude on 12/13/1925 when it had a value of $300. Aunt Gertrude bought it on 1/15/1905 for $30. Stacey sold the ring for $4900 on 11/03/2009.
Stacey also inherited her grandmother’s house. She sold it on 12/1/2009 for $815,000. The property was located at 1725 Crest Road, Santa Barbara, Ca. 94113. Her grandparents bought it on 4/2/1945 for $45,000 (Land 15,000 and Building $30,000). When her grandfather, Willy, died on 5/1/1995 the house was worth $425,000 (Land 100,000 and building $325,000). When her grandmother Tina died on 2/15/2008 the house was worth $925,000 (land $240,000 and building $685,000).There was no mortgage on the property. Stacey rented it out beginning 4/1/2008 when the house had a value of $950,000 (house $650,000 and land $300,000) She received rental income of $3750 per month for and had the following expenses per month from the time of rental to the date of sale (11 months in 2009):
Gardening 100
Insurance 120
Property taxes 1000
Utilities 200
Depreciation ?
On 2/13/2009 Stacey made the following improvements: new carpeting and draperies, $5700; painting $3725; new appliances $3720.
The Harrisons purchased their home on 3/1/2005 for $1.1 million. The FMV of the house and land are as follows:
3/1/2005 4/1/2008
Cost of building 700,000 800,000
Cost of Land400,000 500,000
For 2009, the Harrisons paid the following expenses for their home (this includes home office expenses)
Mortgage payment to First California Bank
Principal 7,325
Interest13,625 $20,950
Property taxes on home 11,770
Property insurance 1,400
Earthquake insurance 1,510
House-cleaning 1,325
Utilities:
PGE 2,125
Garbage/Water 800
Gardening 1200
Alarm monitoring fee 1300
Internet connection for all computers 720
They also had the following expenditures for the property:
Added new layer to existing roof 3/2/2009$6736
On 9/2/2009 Warren took a course on real estate management at Omega Institute of Santa Monica, for which he paid $1400.
Stacey also operates a business under the name: “Wilson’s Travel Agency.” She operates the business from her home. She started doing business on the same day the Harrisons bought the home. The employer identification number is 74-2536578. Stacey uses the cash method of accounting for her business, and her records for 2009 show:
Revenue from commissions$57,241
Expenses:
Advertising 1663
Bank and service charges 142
Dues and Subscriptions 673
Business Insurance 1293
Interest on furniture loan 453
Professional services 991
Office supplies 911
Meals with clients1,421
Telephone (second line) 411
Miscellaneous expenses.1,755
Automobile expenses and amounts paid to her children are not included in the above expenses. Stacey also paid Theodora $1553 and Barry $1752, for working part-time. She did not withhold or pay any Federal income or employment taxes on Barry’s salary. Stacey withheld Federal tax of $472 on Theodora’s salary, California tax of $274, and the appropriate FICA tax. Stacey is not certain that she is allowed a deduction. No state unemployment taxes were due on behalf of Theodora or Barry. She does feel that the amounts paid to her children were reasonable, however.
Stacey used one of the rooms in the house for a home office. The square footage of the office is 425 feet. The square footage of the house is 2540 feet. She started using the home office in her business on the date she acquired the house.The percentage of business income earned in the home office was 100 percent. On 4/3/2009 she spent $4000: $1500 to replace the windows and $2500 to install sliding glass doors to the balcony in the office. She replaced the windows and doors because the room was drafty. The door and windows were energy efficient and the Harrisons have a certification from the manufacturer. She elects to take the maximum depreciation possible on these expenditures.
On November 1, 2009 Stacey purchased the following items for use in her business:
New Copying machine 2314
New Dell notebook computer 1215
She elected the maximum depreciation possible for the copying machine and new computer.
Stacey was able to trade in her old office furniture for new office furniture as a like-kind exchange on 10/12/2009. The old office furniture cost $7531 on 3/2/2007. She had deducted the cost of the office furniture under Section 179 in 2007. She was given an allowance on the old furniture of $2000. She paid $9,321 for the new furniture ($11,321 cost of new furniture less the allowance of $2000). The like-kind exchange rules apply.
She also moved some furniture from other parts of his house into the office.
She moved the following furnishings from the house:
Oriental rugcost$4,000 FMV 3,000
Deskcost$ 1,000 FMV 200
Televisioncost$ 800 FMV 300
The oriental rug, television and desk were all acquired on 6/4/2007. They were moved to the office on May 3, 2009
Stacey sold her old IBM notebook on October 1, 2009 for $635. She bought it on April 12, 2008for $3300. She had taken the appropriate MACRS depreciation for each year and used the mid-quarter convention. She did not elect Section 179 and opted out of bonus depreciation.
She also sold her old Xerox copying machine for $985 on July 15, 2009. She bought the copy machine on 4/3/2008 for $4325 and had deducted the entire amount under Section 179 in 2006.
Stacey purchased a new 2008 Lexus on October 20, 2008. Her tax accountant used the actual cost method in determining the deductible business expenses for her 2008 Federal tax return. Because the deductible amount seemed so small she is not certain whether she should claim actual expenses (including depreciation), or simply use the automatic mileage method. She has the following records relating to the business auto:
Original cost$40,000
Depreciation claimed in 2008
Bonus depreciation (40,000 x .5 x .6) max8000
Macrs (32,000 x .20% limited to 2960 x .60)1,776 9,776
Gas, oil, and repairs in 2009 1,384
Parking and tolls paid in 2009 for business 535
Insurance for 2009 1212
Interest on car loan for 2009 852
Vehicle Registration Fee:
Personal Property Tax120
License fee150
Car washes 300
Auto club fee 120
Stacey drove the auto 15,000 miles for business purposes and 10,000 miles for personal purposes during the year. The above expenses for 2009 have not been reduced to reflect her personal use of the vehicle. Stacey sold the Lexus on 12/31/2009 for $27,000 (note the sales price has to be allocated between the business and personal portion). The depreciation limit for passenger autos placed in service during 2008 was $2,960 for the first tax year and a maximum of $8000 50 percent bonus depreciation, or $10,960 taking 50% bonus depreciation into account. For the second year the limit is $4800.
Stacey purchased a new Acura TL for $38,235 plus 10 percent sales tax on 12/10/2009. She drove it 2000 miles all for personal purposes. She financed the car with a home equity loan of $35,000. The interest expense for 2009 on the car loan was $137. The Harrisons paid auto registration fees of $435, of which $135 was classified as a personal property tax on their personal-use autos.
Stacey was a skilled pottery. She had taken many courses over the years in pottery. She set up shop in the basement of the house. The square footage of the basement was 550 feet, which was not included in the total listed above. She started doing business on 4/1/2008. She classified the pottery as a business in 2008 and had a loss. During 2009 she purchased supplies for $800. On 4/2/2009 she purchased a new kiln (oven) for $3800. She took a week-long art class in San Francisco. She spent 4 hours in the class for 5 days and spent the following weekend sightseeing. She incurred the following expenses with respect to the class for all seven days:
Cost of class$ 925
Airfare$ 240
Lodging$1800
Meals$ 760
During the year there were three artists’ open studios in Santa Barbara. She was listed in the brochure. This year she sold $3600 of pottery.
Theodora paid tuition of $8753 to UC Santa Barbara and spent $1875 on books and supplies
The Harrisons also made a contribution in cash to First Congregational Church of $4500 on 8/4/2009. They paid $483 for preparation of their 2008 tax return. Warren paid the following unreimbursed employee business expenses: professional dues $425; union dues $834.
REQUIRED:
1)You may work in a group of two.
2)Prepare the federal tax return for Stacy and Warren Harrison for 2009.
3)Prepare a separate tax return for Theodora for 2009.
4)Use 2009 tax return software.
5)Please staple all pages together and make sure your name is on the tax returns.
6)Due date is Thursday May 19 at 12:35 PM in Business 122. No late assignments are accepted.
7)You can make up addresses and employer identification numbers.
8)Show your calculations for the following items on a separate schedule:
- Sale of mutual fund shares.
- Sale of wedding ring.
- Sale of grandmother’s house.
- Sale of automobile.
- Sale of Calder painting.
- Deduction for California State taxes.
9)Prepare a detailed letter (about five pages) to the clients addressing the issues listed below. I will put a major emphasis on the letter when grading the tax return particularly because it is very hard for me to follow your errors through the exam. See Chapter 2 Section 2.3 in the textbook for the format of the letter and how to conduct tax research.
- The clients want you to take the maximum amount of deductions which are permitted by the law. In other words they want to take an aggressive stance.
- If you do not know the answer you need to research it. You can go to and read the instructions. The better way to research an answer is to go to checkpoint.riag.com. Use the User ID and password that is on the first page of your textbook.
- In the letter explain to the Harrisons any risks they may be taking if they are audited by the IRS. Make sure to address the following issues:
1)Can they and should they deduct the pottery activity as a business. What are the risks they face? Address the following issues:
- Deducting the costs of the basement as a home-office expense?
- The cost of the kiln?
- Her trip to San Francisco?
- Give them advice on what Stacey should do to convince the IRS that she is in business.
- Explain to them how much more tax they would have to pay if the IRS classifies the business as a hobby.
2)Can they depreciate or deduct under Section 179, the following:
- The cost of the Oriental rug, television, and desk?
- The cost of the sliding glass doors and windows in the office?
- The new carpeting and draperies, $5700; painting $3725; new appliances $3720.
3)Can the Harrisons take a deduction or credits for the classes they took and for Theodora’s educational expenses?
4)Can the Harrisons deduct the gardening expense for the home office?
5)Can they deduct losses on the sales of property on which they realize a loss (house, etc).
10)Prepare the federal tax return for the Harrisons
- Also prepare a tax return for Theodora.
- You may make up information that is not provided like employer id numbers or social security number.
1)You may email me if there is any additional information needed that is not provided.
- Please print only Federal forms to be filed with the IRS (not schedules for personal use).
- Please staple and put in order (1040 pages 1 and 2, Schedules A, B, C, D, E, SE, then the numerical schedules in order).
- Please print out forms for filing with the IRS only (not California forms, not schedules for your records).
I WILL TAKE INTO CONSIDERATION YOUR PERFORMANCE ON THIS TAX RETURN WHEN ASSIGNING THE FINAL GRADES.
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