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45. LO.2, 5 Finch Construction Company provides the carpenters it employs with all of the required tools.

However, the company believes that this practice has led to some employees not taking care of the tools and to the mysterious disappearance of some tools. The company is considering requiring all of its employees to provide their own tools. Each employees salary would be increased by $1,500 to compensate for the additional cost. Write a letter to Finchs management explaining the tax consequences of this plan to the carpenters. Finchs address is 300 Harbor Drive, Vermillion, SD 57069.

Hotman and Smith, CPAs 5191 King Street Honolulu, HI 96814

February 18, 2014 Finch Construction Company 300 Harbor Drive Vermillion, SD 57069 Dear Management: You asked me to determine the tax implications of requiring the companys employees who are carpenters to furnish their own tools, with a compensating increase in their salaries of about $1,500 each. In short, most employees would experience a net decrease in after-tax income. Under the companys present way of doing business, the carpenters do not recognize income when the employer provides tools. This is a working condition fringe. If the employees salary is increased and he or she must purchase the necessary tools, the employee must include the additional $1,500 in salary in gross income. But the cost of the tools in many cases will not be deductible, or less than the actual cost will be deductible. This results from the employees expense being a deduction from adjusted gross income as a miscellaneous itemized deduction. If the employee takes the standard deduction, no deduction for the tool expenses is allowed. If the taxpayer does itemize deductions, the total miscellaneous itemized deductions must be reduced by 2% of the employees adjusted gross income. In many cases, the total miscellaneous itemized deductions will be less than 2% of AGI. When the total miscellaneous itemized deductions do exceed 2% of AGI, less than the entire expenses are deductible because of the 2% factor. Another possibility would be for the employees to purchase the tools, but account to you for their cost, and obtain reimbursement. Under this plan, the employee would be allowed to directly offset the reimbursement with the expense, in arriving at adjusted gross income. The request for reimbursement would also provide you with a means of controlling costs. Please contact me if you would like to discuss this further. Sincerely,

Amy Evans, CPA Partner

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