Question 1:

Alton Newman, age 67, is married and files a joint return with his wife, Clair, age 65. Alton and Clair are
both retired, and during 2019, they received Social Security benefits of $10,000. Both Alton and Clair are
covered by Medicare. Alton’s Social Security number is 111-11-1119, and Clair’s is 123-45-6786. They reside
at 210 College Drive, Columbia, SC 29201.
Alton, who retired on January 1, 2019, receives benefits from a qualified pension plan of $2,750 a month
for life. Her total contributions to the plan (none of which were deductible) were $168,250. In January
2019, he received a bonus of $2,000 from her former employer for service performed in 2018. No
income taxes were withheld on this bonus by her former employer (Amalgamated Industries, Inc.; EIN
12-3456789; 114 Main Street, Columbia, SC 29201). Although Amalgamated Industries, Inc., accrued the
bonus in 2018, it was not paid until 2019.
Clair, who retired on December 31, 2018, started receiving benefits of $1,400 a month on January 1,
2018. Her contributions to the qualified pension plan (none of which were deductible) were $74,100.
On September 27, 2019, Alton and Clair received a pro rata 10% stock dividend on 600 shares of stock
they owned. They had bought the stock on March 5, 2012, for $20 a share. On December 16, 2019, they
sold the 60 dividend shares for $55 a share.
On October 10, 2019, Clair sold the car she had used in commuting to and from work for $17,000. She
had paid $31,000 for the car in 2013.
On July 14, 2011, Alton and Clair received a gift of 1,000 shares of stock from their son, Thomas.
Thomas’s basis in the stock was $35 a share (fair market value at the date of gift was $25). No gift tax
was paid on the transfer. Alton and Clair sold the stock on October 8, 2019, for $24 a share.
On May 1, 2019, Clair’s mother died, and Clair inherited her personal residence. In February 2019, her
mother had paid the property taxes for 2019 of $2,100. The residence had a fair market value of
$235,000 and an adjusted basis to the mother of $160,000 on the date of her death. Clair listed the
house with a real estate agent, who estimated it was worth $240,000 as of December 31, 2019.
Clair received rent income of $6,000 on a beach house she inherited three years ago from her uncle
Charles. She had rented the property for one week during the July 4 holiday and one week during the
Thanksgiving holiday. Charles’s adjusted basis in the beach house was $150,000, and its fair market value
on the date of his death was $240,000. Clair and Alton used the beach house for personal purposes for
56 days during the year. Expenses associated with the house were $3,700 for utilities, maintenance, and
repairs; $2,200 for property taxes; and $800 for insurance. There are no mortgages on the property.
Clair and Alton paid estimated Federal income tax of $2,000 and had itemized deductions of $6,800
(excluding any itemized deductions associated with the beach house). If they have overpaid their Federal
income tax, they want the amount refunded. Both Clair and Alton want $3 to go to the Presidential
Election Campaign Fund.
Compute their net tax payable or refund due for 2019, using the appropriate tax rate schedule (not the
Tax Tables).

Solution:

Alton’s retirement income (Note 1) $ 21,209

Clair’s retirement income (Note 2) 13,380
Alten’s bonus (Note 3) 2,000
Social Security benefits (Note 4) 5,079
Net long-term capital gain (Notes 5, 6, 7, and 8) ($2,209 − 1,209
$1,000)
 Adjusted gross income $ 42,877
Less: Standard deduction (Note 10) (27,000)
Taxable income $ 15,877
Tax on $15,877 (Note 11) $ 1,467
Less: Prepayments and credits:
Estimated tax paid $2,000
Tax credit for the elderly (Note 12) –0– (2,000)
Income tax payable (or refund due) ($ 533)

Notes:

(1) Because Alton’s distribution is from a qualified retirement plan, the simplified method is used.
Alton’s investment in the plan = $168,550/210 = $802.62 exclusion per month
Number of anticipated payments

Annual payments ($2,570 × 12) $30,840

Exclusion ($801.19 × 12) (9,631)
Inclusion in gross income $21,209

(2) Because Clair’s distribution is from a qualified pension plan, the simplified method is used.
Clair’s investment in the plan = $74,100/260 = $285 exclusion per month
Number of anticipated payments

Annual payments ($1,400 × 12) $16,800

Exclusion ($285 × 12) (3,420)
Inclusion in gross income $13,380

(3) Alton is a cash basis taxpayer. Therefore, she includes the $2,000 bonus in his gross income
in 2019.
(4) Since MAGI plus one-half of the Social Security benefits exceeds $44,000, the amount of
Social Security benefits that is includible in gross income is:
Lesser of: 0.85($10,000) = $8,500
Or 0.85%[$39,975* + 0.50($10,000) − $44,000] + 0.50($10,000)** = $5,079
*AGI excluding Social Security.
**This amount is less than 0.50($39,975 + $5,000 − $32,000) or the $6,000 base amount
provided by the 85% formula.
(5) The sale of the stock that Alton and Clair had received as a stock dividend results in a
$2,209 long-term capital gain.

Amount realized from the sale (60 shares × $55) $3,300

Less: Basis of stock sold [$12,000 (original cost)/660

(number of shares held) × 60 (number of shares sold)] (1,091)
Long-term capital gain (holding period “tacks”) $2,209
(6) The loss of $14,000 ($17,000 − $31,000) on the sale of Clair’s personal use car is not
deductible.

(7) The sale of stock that Alton and Clair had received as a gift results in a $1,000 long-term
 capital loss.
Amount realized from the sale (1,000 × $24)
$24,000

Less: Basis for loss (the fair market value of the

stock on the date of the gift, 1,000 × $25 per share)
(25,000)
Long-term capital loss ($1,000)
(8) Clair’s inheritance of her mother’s personal residence is excludible from gross income. Gain
or loss is not recognized until Clair sells the house. Clair’s basis is $235,000.

(9) Because Clair rented the beach house for only 14 days, the $6,000 of rental income received
can be excluded from gross income. None of the $3,700 paid for utilities, repairs, and
maintenance or the $800 paid for insurance can be deducted.

(10) The standard deduction of $27,000 ($24,400 + $1,300 + $1,300) exceeds itemized
deductions of $9,000.

Other itemized deductions $ 6,800

Associated with the beach house:
Property taxes 2,200
Itemized deductions $ 9,000

(11) Of the $15,877 taxable income, the net long-term capital gain of $1,209 is taxed
separately. The regular tax liability is based on $14,668 ($15,877 − $1,209). The
tax liability on $14,668 from the 2019 Tax Tables is $1,467. The net long-term
capital gain of $1,209 is taxed at a 0% rate.

(12) In computing the tax credit for the elderly, the statutory maximum amount of
$7,500 (married taxpayers age 65 or older) is reduced by $4,171 (the nontaxable
part of Social Security benefits; $10,000 – $5,829). Because Alton and Clair’s 2019
adjusted gross income is greater than $10,000, the base must also be reduced
by an additional $17,902 [50% × ($45,804 – $10,000)]. Reducing the $7,500 by
$22,073 ($4,171 + $17,902) produces a negative amount; as a result, the tax
credit for the elderly is $0.
Question 2:

John Benson, age 40, is single. His Social Security number is 111-11-1111, and he resides at 150
Highway 51, Tangipahoa, LA 70465.
John has a 5-year-old child, Kendra, who lives with her mother, Katy. As a result of his divorce
in 2016, John pays alimony of $6,000 per year to Katy and child support of $12,000. The
$12,000 of child support covers 65% of Katy’s costs of rearing Kendra. Kendra’s Social Security
number is 123-45-6789, and Katy’s is 123-45-6788.
John’s mother, Sally, lived with him until her death in early September 2020. He incurred and
paid medical expenses for her of $12,900 and other support payments of $11,000. Sally’s only
sources of income were $5,500 of interest income on certificates of deposit and $5,600 of
Social Security benefits, which she spent on her medical expenses and on maintenance of
John’s household. Sally’s Social Security number was 123-45-6787.
John is employed by the Highway Department of the State of Louisiana in an executive position.
His salary is $95,000. The appropriate amounts of Social Security tax and Medicare tax were
withheld. In addition, $9,500 was withheld for Federal income taxes and $4,000 was withheld
for state income taxes.
In addition to his salary, John’s employer provides him with the following fringe benefits.
 Group term life insurance with a maturity value of $95,000; the cost of the premiums for
the employer was $295.
 Group health insurance plan; John’s employer paid premiums of $5,800 for his coverage.
The plan paid $2,600 for John’s medical expenses during the year.

Upon the death of his aunt Josie in December 2019, John, her only recognized heir, inherited
the following assets.

Asset Josie’s Adjusted Basis FMV at Date of Death

Car $35,000 $ 19,000
Land-300 acres 90,000 175,000
IBM stock 15,000 40,000
Cash 10,000 10,000

Three months prior to her death, Josie gave John a mountain cabin. Her adjusted basis for the
mountain cabin was $120,000, and the fair market value was $195,000. No gift taxes were paid.

During the year, John reported the following transactions.

 On February 1, 2020, he sold for $45,000 Microsoft stock that he inherited from his father
four years ago. His father’s adjusted basis was $49,000, and the fair market value at the
date of the father’s death was $41,000.
 The car John inherited from Josie was destroyed in a wreck on October 1, 2020. He had
loaned the car to Katy to use for a two-week period while the engine in her car was
being replaced. Fortunately, neither Katy nor Kendra was injured. John received
insurance proceeds of $16,000, the fair market value of the car on October 1, 2020.
 On December 28, 2020, John sold the 300 acres of land to his brother, James, for its
fair market value of $160,000. James planned on using the land for his dairy farm.

Other sources of income for John are:

 Dividend income (qualified dividends) $ 3,500
Interest income:
Guaranty bank 1,000
City of Kentwood water bonds 2,000
Award from state of Louisiana for outstanding 10,000
suggestion for highway beautification

Potential itemized deductions for John, in addition to items already mentioned, are:

State and local property taxes paid on his residence and $ 7,000
cabin
State property taxes paid on personalty 3,500
Estimated Federal income taxes paid 3,000
Charitable contributions 4,500
Mortgage interest on his residence 7,200
Orthodontic expenses for Kendra 4,000

Part 1—Tax Computation

Compute John’s net tax payable or refund due for 2020.

Part 2—Tax Planning

Assume that rather than selling the land to James, John is considering leasing it to him for
$12,000 annually with the lease beginning on October 1, 2020. James would prepay the lease
payments through December 31, 2020. Thereafter, he would make monthly lease payments at
the beginning of each month. What effect would this have on John’s 2020 tax liability? What
potential problem might John encounter? Write a letter to John in which you advise him of the
tax consequences of leasing versus selling.

Solution:

Part 1—Tax Computation

Salary $ 95,000
Dividends 3,500
Interest (Note 1) 3,000
Award (Note 2) –0–
Long-term capital gain (Note 3) 4,000
Group term life insurance premiums (Note 5) 54
Other fringe benefits (Note 5) –0–
$105,554
Gross income
Less: Alimony paid (Note 6) (6,000)
Adjusted gross income Less: $99,554
Itemized deductions:
$ 8,833
Medical expenses (Note 7)
Charitable contributions 4,500
Mortgage interest on his residence 7,200
 State and local taxes (Note 8) 10,000 (30,533)
Taxable income $ 69,021
Tax on $69,021 (Note 9) $ 10,974.62
Tax withheld by employer (9,500)
Estimated tax payments (Note 10) (3,000)
Net tax payable (or refund due) ($ 1,525.38)

Notes
(1) The $2,000 of interest on the City of Kentwood water bonds is taxable.
(2) The $10,000 award from the State of Louisiana for the outstanding suggestion
for highway beautification is not included in John’s gross income.
(3) Determination of net capital gain:
Amount realized on sale of Microsoft stock $45,000
Less: Adjusted basis (FMV of the stock on the date of
his father’s death) (41,000)
Long-term capital gain $ 4,000
Capital gains or losses on inherited property are automatically long term.
Amount realized on sale of 300 acres of land 160,000
Less: Adjusted basis (FMV of the land on the date of
Josie’s death) (175,000)
Disallowed loss ($ 15,000)
The loss is disallowed under § 267 because the sale is to a related party.

(4) Personal casualty (car):

Insurance proceeds $16,000

Less: Lower of adjusted basis of $19,000 (FMV of car (16,000)
on the date of Josie’s death) or value decline of
$16,000 ($16,000 FMV on date of casualty − $0 FMV
after casualty)
Casualty gain or loss $–0–

(5) The group term life insurance premiums paid by John’s employer results in $54 being included in
John’s gross income.
$95,000 − $50,000 × $0.10 × 12 months = $54
$1,000
The other fringe benefits provided by John’s employer are excludible from his gross income. This includes
the group health insurance premiums of $5,800 and the $2,600 of medical expenses paid by the plan.
(6) The $6,000 of alimony paid annually by John to Katy is a deduction for AGI. The $12,000 of child
support for Kendra is not deductible. The alimony is deductible because the divorce instrument was
put in place before 2019; the alimony remains deductible in future years unless that instrument is
modified.
(7)
Kendra’s orthodontic expenses $4,000
Medical expenses for Sally 12,900
Total medical expenses $16,900
Less: 7.5% × $107,554 (AGI) (8,067)
Deductible medical expenses $ 8,833
Sally’s medical expenses paid by John can be claimed by him (the gross income test for dependents is
ignored for this purpose). As a noncustodial parent, John also is allowed to claim the medical expenses he
paid for Kendra.
(8) John’s state and local taxes total $14,500 ($7,000 on his residence and cabin, $3,500 of personal
property taxes, and $4,000 of state income taxes). The maximum deduction allowed for state and
local taxes is $10,000.
(9) The tax liability is calculated using the 2020 tax rate schedule for a single taxpayer. John does not
qualify for head-of-household status because neither Sally nor Kendra qualifies as his dependent.
Based on his taxable income, John has a marginal tax rate of 22%.
John has a $4,000 net capital gain and $3,500 of qualified dividends, which are eligible for beneficial
alternative tax treatment under § 1(h). This $7,500 is taxed using a 15% rate rather than John’s 22% marginal
tax rate.
Tax on $61,521 ($69,021 TI − $7,500):
Tax on $40,125 $4,617.50
+ 22% × $21,396 ($61,521 – $40,125) 4,707.12 $9,324.62
Tax on NCG and dividends:
$7,500 × 22% 1,650
$10,974.62
(10) Ally does not qualify as a dependent for John because she does not pass the
gross income test. Kendra does not qualify as a dependent because John is not the custodial parent
and the mother has not granted a waiver to claim Kendra. As a result, John may not claim the child
tax credit or dependent tax credit.
Part 2—Tax Planning
Leasing the land to James would eliminate the effect of the loss
disallowance provision under § 267 [see Note (3) above]. John would
increase his taxable income for 2020 by the lease payments of
$3,000 for Octobar through Decamber. The increase in income also
would affect the amount of deductible medical expenses, thus
increasing taxable income by an additional $225 ($3,000 × 7.5%). The
only problem that John might encounter, because James is a related
party, is whether a fair rental is being charged.

Young, Nellen, Raabe,

Hoffman, & Maloney,
CPAs 5191 Natorp
Boulevard
Mason, OH 45040
September 17, 2020

Mr. John Benson

150 Highway 51
Tangipahoa, LL 70465
Dear Mr. Henson:

I am responding to your inquiry regarding the options for structuring

the transaction that will enable James to use the 350 acres of land in
his dairy business. As we discussed, the following two options are
being considered:
 Lease the land to him for $12,000 annually with the lease
commencing October 1, 2021. James wil prepay the rent through
December 31, 2021.
 Sell the land to him for $165,000, the fair market value.
Your adjusted basis in the land is $180,000; if you should sell it to
James, you will have a realized loss of $15,000 that will not be
recognized.

Amount realized $165,000

Less: Adjusted basis (180,000)
Realized loss ($ 15,000)
Recognized loss $ –0–
Because your brother is a related party, § 267 of the Internal Revenue
Code disallows the loss. Therefore, the $15,000 realized loss will never
be recognized by you. John may be able to benefit from the $15,000
disallowed loss if he should sell the land in the future. Because that
sale transaction would have no effect on your taxable income, your tax
liability would not be affected.

Under the lease option, you would increase your taxable income in
 2020 by $3,225 ($3,000 lease income + $225 reduction in medical
expenses deduction) and by $12,000 in each subsequent year (before
any itemized deduction impacts). Based on your projected taxable
income of $77,021 in 2020, the additional $3,225 would increase your
2020 tax liability by $710 ($3,225 × 22%). Therefore, your net cash flow
from the lease in 2020 would be $2,290 ($3,000 − $710). As we
discussed, the lease amount should be comparable to that charged on
similar properties in the parish.

If I can be of further assistance, please let me know.

Sincerely,
XYZ, CPA Partner

Question 3:

In 2020, Juanita and Alberto are married and file a joint tax return. They have two
dependent children, ages 6 and 8. Their AGI is $412,400. Since their AGI is over the
$400,000 threshold, the maximum child tax credit ($4,000) must be reduced by $50 for
every $1,000 (or portion of $1,000) above the $400,000 threshold. The child tax credit
allowed is $2,500, computed as follows:

1. $414,200 (AGI) - $400,000 (Threshold amount) = $14,200 (Excess amount).

2. $14,200 (Excess amount) ÷ $1,000 = Reduction factor (14.2, rounded up to 15).
3. 15 (Reduction factor) × $100 = $1,500 (Child and dependent tax credit reduction).
4. $4,000 (Maximum child and dependent tax credit amount) - $1,500 (Child and dependent
tax credit reduction) = $2,500 (Child and dependent tax credit allowed).

Question 4:

Suditha, age 14 and a dependent, has no earned income, $14,000 of interest income, and
$8,000 of qualified dividend income (QDI) in 2020. Her net unearned income is $18,800
($22,000 less $1,100 less a $1,100 standard deduction). Suditha’s taxable income is $20,900
($22,000 gross income less his $1,100 dependent standard deduction).

Suditha’s taxable income less QDI is $12,900 ($20,900 less $8,000). As a result, she must use
a modified Single Tax Rate Schedule to compute her tax on this portion of her taxable
income. Her ETI is $2,100 [taxable income ($20,900) less net unearned income ($18,800)].
So $4,700 (ETI plus $2,600) of her taxable income will be taxed using the Estate and Trust
Tax Rate Schedule. The balance of her $12,900 non-QDI taxable income ($8,200; $12,900
less $4,700) will be taxed using the Single Tax Rate Schedule (but ignoring the 10% tax
bracket).

What about the tax on her QDI?

Since her taxable income less QDI ($12,900) is greater than $3,750, none of her QDI will be
taxed at 0%. However, the 15% rate will apply to the first $1,350 of her QDI (the $14,250
breakpoint for the 15% tax rate less the $12,900 of non-QDI taxable income). The balance of
her QDI ($6,650; $8,000 less $1,350) will be taxed at a 25% rate. As a result, her total tax
liability is $4,119.5, determined as follows:

Tax on taxable income less QDI ($12,900):

(1) $4,700 Taxed using Estate and Trust Tax Rate Schedule
$4,700 × 10% $ 470
(2) $8,200 Taxed using Single Tax Rate
Schedule (but ignoring the 10% tax bracket)
$6,850 × 24% 1,644
$1,350 × 35% 472.5
Tax on QDI ($8,000):
(1) $1,350 × 15% 203
(2) $6,650 × 20% 1,330
Total tax liability $4,119.5