54.

Assume Sarah is a cash-method calendar-year taxpayer, and she is considering making the following cash payments related to her business. Calculate the after-tax cost of each payment assuming she has a 5 percent marginal tax rate. a. b. c. d. a. ! ,""" payment for next year#s property taxes on her place of business. !$"" to reimburse the cost of meals incurred by employees while tra%eling for the business. !&, "" for football tickets to entertain out-of-town clients during contract negotiations. !5"" contribution to the mayor#s re-election campaign. $1,500 = $2,000*(1-.25) all allowable under the 12-month rule. Note that property taxe are !enerally dedu"t#ble a pa#d ( ub$e"t to 12-month rule) unle an ele"t#on # made under %e". &'1(") to dedu"t them a a""rued. $(00 = $)00**1-(.5*.25)+ only hal, o, the "o t o, meal # dedu"t#ble $1,050 = $1,200**1-(.5*.25)+ only hal, o, the "o t o, enterta#nment # dedu"t#ble $500 not dedu"t#ble

b. ". d.

55.

'enee manufactured and sold a (gadget,) a speciali*ed asset used by auto manufacturers that +ualifies for the domestic production acti%ities deduction. 'enee incurred !&5,""" in direct expenses in the pro,ect which includes ! ,""" of wages 'enee paid to employees in the manufacturing of the gadget. -hat is 'enee#s domestic production acti%ities deduction for the gadget in each of the following alternati%e scenarios. a. b. c. a. 'enee sold the gadget for ! 5,""" and she reported A/0 of !15,""" before considering the manufacturing deduction. 'enee sold the gadget for ! 5,""" and she reported A/0 of !5,""" before considering the manufacturing deduction. 'enee sold the gadget for !4",""" and she reported A/0 of !5",""" before considering the manufacturing deduction. Description Qualified domestic gross receipts Allocable costs and expenses Qualified production activit income !tatutor percentage D$AD Amount $ 25,000 - 15,000 $ 10,000 x "# $ "00

%enee&s modified A'( of $)5,000 exceeds Q$A( and t*e $"00 deduction is less t*an 50# of +ages paid in t*e activit ,1-2 of $2,000 . $1,000/.

b.

%enee&s modified A'( of $5,000 does not exceed Q$A( so Q$A( is limited to modified A'(. Amount Qualified domestic gross receipts Allocable costs and expenses Qualified production activit income 0odified A'( !tatutor percentage D$AD Description $ 25,000 - 15,000 $ 10,000 $ 5,000 x "# $ 150

%enee&s $150 deduction is less t*an 50# of +ages paid in t*e activit ,1-2 of $2,000 . $1,000/. c. %enee&s tentative $2,250 deduction is more t*an 50# of +ages paid in t*e activit so t*e D$AD is limited to $1,000. . Amount Qualified domestic gross receipts Allocable costs and expenses Qualified production activit income !tatutor percentage 2entative D$AD 50# of +age limitation D$AD 51. Description $ 10,000 - 15,000 $ 25,000 x "# $ 2,250 $ 1,000

2his year Amy purchased ! ,""" of e+uipment for use in her business. 3owe%er, the machine was damaged in a traffic accident while Amy was transporting the e+uipment to her business. 4ote that because Amy did not place the e+uipment into ser%ice during the year, she does not claim any depreciation expense for the e+uipment. a. After the accident, Amy had the choice of repairing the e+uipment for !&,$"" or selling the e+uipment to a ,unk shop for !5"". Amy sold the e+uipment. -hat amount can Amy deduct for the loss of the e+uipment. After the accident, Amy repaired the e+uipment for !$"". -hat amount can Amy deduct for the loss of the e+uipment. After the accident, Amy could not replace the e+uipment so she had the e+uipment repaired for ! ,5"". -hat amount can Amy deduct for the loss of the e+uipment. Note- %#n"e the ma"h#ne wa not pla"ed #n er.#"e, /my "annot "la#m any "o t re"o.ery. a. 0or the "omplete de tru"t#on o, a bu #ne a et, /my "an "la#m a "a ualty lo dedu"t#on ,or the tax ba # o, the ma"h#ne le any re"o.ery. 1en"e, /my "an "la#m a "a ualty dedu"t#on ,or $1,(00 ($2,000-$200)

b. c.

b.

0or part#al de tru"t#on o, a bu #ne a et, /my "an "la#m a "a ualty lo dedu"t#on ,or the le er o, the e"onom#" lo (the "o t o, repa#r) or the tax ba # o, the ma"h#ne. 3n th# "a e, /my "an dedu"t $)00. 0or part#al de tru"t#on o, a bu #ne a et, /my "an "la#m a "a ualty lo dedu"t#on ,or the le er o, the e"onom#" lo (the "o t o, repa#r) or the tax ba # o, the ma"h#ne. 3n th# "a e /my "an dedu"t $2,000.

".

5$.

62ax 7orms8 0n 9uly of this year Stephen started a proprietorship called :C' ;which stands for electric car repair<. :C' uses the cash method of accounting and Stephen has produced the following financial information for this year. 7ill out a draft of the front page of Stephen#s Schedule C. :C' collected !$&,""" in cash for repairs completed during the year and an additional !5, "" in cash for repairs that will commence after year end. Customers owe :C' !&4,5"" for repairs completed this year, and while Stephen isn#t sure which bills will e%entually be paid, he expects to collect all but about !&,="" of these re%enues next year. :C' has made the following expenditures> 0nterest expense Shop rent ;!&,5"" per month< ?tilities Contract labor Compensation @iability insurance premiums ;!55" per month< 2erm life insurance premiums ;!&5" per month< ! &, 5" 1,""" &,"15 $, 5" &,&"" 4, "" &,$""

2he interest paid relates to interest accrued on a !54,""" loan made to Stephen in 9uly of this year. Stephen used half of the loan to pay for &$ months of shop rent and the remainder he used to upgrade his personal wardrobe. 0n 9uly Stephen purchased & months of liability insurance to protect against liability should anyone be in,ured in the shop. :C' has only one employee ;the remaining workers are contract labor<, and this employee thoroughly understands how to repair an electric propulsion system. An 4o%ember & of this year Stephen purchased a & -month term-life policy that insures the life of this (key) employee. Stephen paid /ecko 0nsurance Company !&,$"", and in return /ecko promises to pay Stephen a !4",""" death benefit if this employee dies any time during the next & months. 4nder the "a h method, re.enue are re"orded a .alue # re"e#.ed whether the re.enue are earned or not. 5e.enue are not, howe.er, re"orded ,or a""ount re"e#.able. 1en"e, 675 w#ll only re"o!n#8e $)&,200 o, re.enue #n the ,#r t #x month o, th# year. 5e!ard#n! dedu"t#on , 675 "an only dedu"t $'25 o, the #ntere t expen e (the port#on o, the loan pro"eed u ed ,or bu #ne purpo e ). 9#:ew# e, 675 "an only dedu"t $;,000 o, the hop rent relat#n! to th# year be"au e the lea e extend o.er 2& month (#t doe not <ual#,y ,or the

12-month rule). =here are no apparent problem w#th dedu"t#n! the payment ,or "ontra"t labor, ut#l#t#e , or "ompen at#on. =he l#ab#l#ty #n uran"e payment relate to the la t ' month o, th# year and the ,#r t ' month o, next year. 1owe.er, th# ent#re payment # dedu"t#ble under the 12-month rule. =he prem#um pa#d on the l#,e #n uran"e pol#"y o, the :ey employee are not dedu"t#ble. >edu"t#on are not allowed ,or prem#um on pol#"#e that "o.er the l#.e o, o,,#"er or other :ey employee and "ompen ate the bu #ne ,or the d# rupt#on and lo t #n"ome they may exper#en"e due to the death o, a :ey employee.

B .

property for accidents and casualties. 9ustin is a calendar-year taxpayer who uses the cash method of accounting. -hat amount of the insurance premium may 9ustin deduct in year " in each of the following alternati%e scenarios. a. b. c. d. a. 2he policy co%ers the business property from April & of year " through Carch 5& of year &. 2he policy begins on 7ebruary & of year & and extends through 9anuary 5& of year . Assume 9ustin paid !B,""" for a 4-month policy that co%ers from April &, year " through Carch 5&, year . Assume that instead of paying an insurance premium, 9ustin paid !4,$"" to rent his business property from April & of year " through Carch 5& of year &. =he ent#re prem#um o, $&,)00 # dedu"t#ble under the 12-month rule be"au e the #n uran"e "o.era!e doe not ex"eed 12 month and doe not extend beyond the end o, next year. No dedu"t#on th# year. 6.en thou!h the "ontra"t per#od # 12 month or ,ewer, ?u t#n # re<u#red to "ap#tal#8e the "o t o, the prepayment ,or the #n uran"e pol#"y be"au e the "ontra"t per#od extend beyond the end o, next year. @e"au e the len!th o, the #n uran"e "o.era!e la t lon!er than 12 month , ?u t#n may only dedu"t the port#on o, the prem#um perta#n#n! to th# year. ?u t#n "an dedu"t $2,250 o, the $',000 #n uran"e prem#um payment (; month A 2& month t#me $',000). >edu"t $&,)00 rent. =he 12-month rule ,or "ap#tal#8#n! expend#ture appl#e to rent (but not #ntere t) payment ,or a "a h method taxpayer. 3n "ontra t, ,or an a""rual method taxpayer both rent and #ntere t are dedu"ted o.er the per#od relat#n! to the lea e or loan term be"au e o, e"onom#" per,orman"e.

b.

".

d.

B1.

2his year Amber opened a factory to process and package landscape mulch. At the end of the year, Amber#s accountant prepared the following schedule for allocating manufacturing costs to the mulch in%entory, but her accountant is unsure of what costs need to be allocated to the in%entory under ?40CAD. Approximately " percent of management time, space, and expenses are spent on this manufacturing process. Caterial> Salaries> Droperty taxes> Fepreciation> a. Culch and packaging Administrati%e supplies 7actory labor Sales E ad%ertising Administration 7actory Affices 7actory Affices Costs ! 5,""" 5" & ,""" 5,5"" 5, "" 4,B"" ,1"" $,""" &,5"" 2ax 0n%entory . . . . . . . . .

At the end of the year, Amber#s accountant indicated that the business had processed &",""" bags of mulch but only &,""" bags remained in the ending in%entory. -hat is Amber#s tax basis in her ending in%entory after applying the ?40CAD rules to allocate indirect costs to in%entory. ;Assume direct costs are allocated to in%entory according to the le%el of ending in%entory. 0n contrast, indirect costs are first allocated by time spent and then according to le%el of ending in%entory.< ?nder what conditions could Amber#s business a%oid ha%ing to apply ?40CAD to allocate indirect costs to in%entory for tax purposes. =he "o t o, ell#n!, ad.ert# #n!, and re ear"h are not re<u#red to be allo"ated to #n.entory. >#re"t "o t (mater#al, labor, taxe , and depre"#at#on) are allo"ated to #n.entory a""ord#n! to the le.el o, end#n! #n.entory (10B) . 3n "ontra t, #nd#re"t "o t (adm#n# trat#on) are ,#r t allo"ated by t#me pent (20B) and then a""ord#n! to the le.el o, end#n! #n.entory. Cater#alCul"h and pa":a!#n! /dm#n# trat#.e uppl#e %alar#e 0a"tory labor %ale D ad.ert# #n! /dm#n# trat#on Eroperty taxe - 0a"tory F,,#"e >epre"#at#on- 0a"tory F,,#"e 7o t $ 5,000 250 $12,000 2,500 5,200 $ &,'00 2,(00 $ ),000 1,500 =ax 3n.entory $ 500 5 1,200 0 10& &'0 5& )00 20

b. a.

b.

/mber "an a.o#d 4N37/E #, he <ual#,#e to a""ount ,or mer"hand# e ,or ale a mater#al and uppl#e under 5e.. Ero". 2001-10 (a.era!e annual !ro re"e#pt not o.er $1 m#ll#on).

15.

2ra%is is a professional landscaper. 3e pro%ides his clients with a one-year ;& -month< warranty for retaining walls he installs. 0n 9une of year &, 2ra%is installed a wall for an important client, Sheila. 0n early 4o%ember, Sheila informed 2ra%is that the retaining wall had failed. 2o repair the wall, 2ra%is paid !1"" cash for additional stone that he deli%ered to Sheila#s location on 4o%ember " of year &. 2ra%is also offered to pay a mason !$"" to repair the wall. Fue to some bad weather and the mason#s work backlog, the mason agreed to begin the work by the end of 9anuary of year . :%en though 2ra%is expected the mason to finish the pro,ect by end of 7ebruary, 2ra%is informed the mason that he would only pay the mason the !$"" when he completed the ,ob. a. b. a. Assuming 2ra%is is an accrual-method taxpayer, how much can he deduct in year & from these acti%ities. Assuming 2ra%is is a cash-method taxpayer, how much can he deduct in year & from these acti%ities. 4nder the a""rual method, e"onom#" per,orman"e o""ur a =ra.# #n"ur "o t a o"#ated w#th pro.#d#n! !ood and er.#"e to another party. 1en"e, =ra.# "an dedu"t the $(00 "o t o, the tone th# year. 1owe.er, be"au e =ra.# # h#r#n! another (the ma on) to pro.#de a er.#"e that =ra.# # l#able to per,orm, e"onom#" per,orman"e o""ur a the ma on per,orm the er.#"e . 7on e<uently, =ra.# w#ll not be allowed to dedu"t the "o t ,or the ma on unt#l year 2 when the ma on per,orm the er.#"e . =he t#m#n! and amount o, the dedu"t#on under the "a h method # the ame a #t # under the a""rual method.

b.

11.

2his year -illiam pro%ided !4, "" of ser%ices to a large client on credit. ?nfortunately, this client has recently encountered financial difficulties and has been unable to pay -illiam for the ser%ices. Coreo%er, -illiam does not expect to collect for his ser%ices. -illiam has (written off) the account and would like to claim a deduction for tax purposes. a. b. a. -hat amount of deduction for bad debt expense can -illiam claim this year if he uses the accrual method. -hat amount of deduction for bad debt expense can -illiam claim this year if he uses the cash method. 4nder the a""rual method, G1'' pro.#de that H#ll#am "an "la#m a bad debt dedu"t#on ,or the a""ount re"e#.able #, #t # part#ally or "ompletely un"olle"t#ble. @e"au e H#ll#am doe not expe"t to "olle"t ,or h# er.#"e and he ha wr#tten o,, the re"e#.able, he # allowed to dedu"t the ,ull $&,200 o, er.#"e that he ha #n"luded #n #n"ome under the a""rual method. 4nder the "a h method, H#ll#am would not be able to "la#m a bad debt expen e dedu"t#on be"au e, under th# method he ha not yet re"o!n#8ed the #n"ome ,or h# er.#"e .

b.