SM 15

CHAPTER 15
INTRODUCTION TO THE TAXATION OF INDIVIDUALS
SOLUTIONS TO PROBLEM MATERIALS
Status: Q/P
Question/ Present in Prior
Problem Topic Edition Edition
1 Taxable income calculation Unchanged 1

2 Taxable income calculation New
3 Taxable income calculation New
4 Standard deduction of dependent Modified 4
5 Personal and dependency exemptions New
6 Ethics problem Unchanged 6
7 Determine taxable income New
8 Dependents tax liability New
9 Tax liability calculations New
10 Marriage penalty Unchanged 12
11 Tax planning: alternating years for itemized Unchanged 16
deductions with standard deduction
12 Alimony and property settlement Unchanged 17
13 Prizes and awards Unchanged 18
14 Scholarship Unchanged 19
15 Damages Unchanged 20
16 Medical expense deduction and reimbursement Unchanged 21
17 Ethics problem Unchanged 22
18 Issue recognition Unchanged 23
19 Capital expenditures as medical expense deduction Unchanged 24
20 State income tax deduction and refund Unchanged 25
21 Investment interest expense: net Unchanged 26
investment income
22 Investment interest expense: net New
investment income
23 Home equity loan: calculation of interest Unchanged 28
expense deduction
24 Charitable contribution-reduced deduction election New
15-1
15-2 2001 Entities Volume/Solutions Manual
Status: Q/P
Question/ Present in Prior
Problem Topic Edition Edition
25 Choice of property for contribution Unchanged 30

26 Issue recognition Unchanged 31
27 Overall limitation on certain itemized deductions Unchanged 32
28 Adoption expense credit Unchanged 33
29 Childcare credit Unchanged 34
30 Child care credit: payment to relatives Unchanged 35
31 Education tax credit Unchanged 36
32 Education tax credit Unchanged 37
33 Earned income credit New
34 Cumulative New
35 Cumulative Unchanged 40
36 Cumulative Unchanged 41
Research
Problem
1 Filing status: qualifying for abandoned Unchanged 1

spouse treatment
2 Effect of state law on marital status New
3 Alimony Unchanged 3
4 Alimony Unchanged 4
5 Earned income credit New
6 Internet activity Unchanged 6
7 Internet activity New
Introduction to the Taxation of Individuals 15-3
PROBLEM MATERIAL
1. a. Adjustedgrossincome $50,000
Less: Itemizeddeductions (8,300)
Personalanddependencyexemptions(4X$2,800) (11,200)
Taxableincome $30,500
b. Adjustedgrossincome $45,000
Less: Standarddeduction (6,450)
Personalexemptions(3X$2,800) (8,400)
c. Adjustedgrossincome($4,200wages+$1,500interest) $5,700
Less: Standarddeduction* (4,400)
Personalexemption** (0)
*A dependent's standard deduction is limited to the sum of his or her earned

incomeplus$250,nottoexceedthebasicstandarddeduction.p.39
**Adependentmaynotclaimapersonalexemptiononhisorherreturn.
d. Adjustedgrossincome($2,500wages+$4,100interest) $6,600
Less: Standarddeduction* (2,750)
Personalexemption** (0)
*A dependent's standard deduction is limited to the sum of his or her earned

incomeplus$250.Mattwouldelectthestandarddeductionbecauseitexceedshis
itemizeddeductionsof$800.
**Adependentmaynotclaimapersonalexemptiononhisorherreturn.
pp. 15-6 to 15-8 and Figure 15-1
2. Salary $42,000
Interestonmoneymarketaccount 900
Less alimony paid (1,200)
Less:
Standarddeduction $6,450
Personalexemption 2,800
Dependencyexemption 2,800 (12,050)
Nodeductionisallowedforthechildsupportpaid.ThegiftfromCoreysfatherisan
exclusion.Nodeductionisallowedfortheunclesage.pp.153to157andFigure151
3. Salary $51,000
Less:Itemizeddeductions($12,000+$4,800+$2,400) $19,200
Dependencyandpersonalexemptions(3X$2,800) 8,400 (27,600)
Theinheritanceandlifeinsuranceproceedsareexclusions.pp. 15-3 to 15-7 and Figure

15-1
4. a. $1,050.Thegreaterof$700orthesumofearnedincomeof$800plus$250.
b. $4,400.Thegreaterof$700orthesumofearnedincomeof$4,200plus$250(but
nottoexceedthestandarddeductionof$4,400).
c. $2,400.Thegreaterof$700orthesumofearnedincomeof$1,050plus$250+
$1,100(additionalstandarddeductionforover65).
d. $2,900.Thegreaterof$700orthesumofearnedincomeof$0plus$250+$2,200
(additionalstandarddeductionforadependentwhoisbothover65andblind).
pp. 15-6 to 15-8
5. a. Two. Petulas personal exemption plus a dependency exemption for the mother.
Trent does not qualify as her dependent due to the gross income test.
b. Two. A personal exemption for Rhett and one for Penny. Normally, spouses must
file a joint return in order to claim two personal exemptions. An exception exists,
however, if the spouse has no gross income and is not claimed as a dependent by
another.
c. Two. A personal exemption for Liza and a dependency exemption for Zoe. A
cousin does not meet the relationship test, but Zoe is a member of Lizas
household; Jerold is not.
d. Four. Personal exemptions for Kurt and Nadia and dependency exemptions for
Rosalyn and Hector. Although the children appear not to qualify under the gross
income test, Rosalyn comes under the age exception (under age 19) and Hector
comes under the student exception.
pp. 15-10 to 15-13
6. The procedure followed by Martha and Roland is perfectly proper. There is no rule that
compels a person to contribute to her (or his) own support even if financially able to do
so! Thus, Roland is eligible for the dependency exemption for his mother. pp. 15-10 to
15-13
7. Salaries($44,000+$41,000) $85,000
Lesscapitalloss (2,000)
AGI $83,000
Less: Itemizeddeductions $7,400
Personalanddependencyexemptions(5X$2,800) 14,000 (21,400)
The interest on the state of Indiana bonds of $1,200 and the gift of $10,000 Yvette
received from her father are exclusions from gross income. The five exemptions are two
personal (Randall and Yvette) and three dependency (Hollis, Kelsley, and Leah).
Although it would appear that Hollis does not satisfy the gross income test, he comes
under the full-time student exception. Leah does not live with the Carters, but she meets
the relationshiptest.pp.153to1513
8. IfDonkepttheduplex,theannualtaxthereonwouldgenerateanincometaxliabilityof
$3,600(36%of$10,000). IfDontransferstitletotheduplextoSam,theincometax
consequenceswouldbeasfollows:
(1) Samwouldbelimitedtoa$700standarddeductionandwouldhavetaxableincome
of$9,300($10,000$700standarddeduction),whichwouldbetaxedathisown
ratebecauseheisnotunder14yearsofage.
(2) Samwouldpay$1,395taxonthe$9,300taxableincome($9,300X15%).
Thetaxsavingtothefamilyunitin2000ifDontransferstheduplexwouldbe$2,205
($3,600$1,395),assumingSamhadnootherincomeorexpenses. Inaddition,the
phaseout of Don's exemptions would be reduced. However, there are other tax
consequencestobeconsidered.Ifthestateinwhichthefamilyresidesimposesastate
incometax,afurthertaxsavingmightresultfromthetransfer.Anotherconsiderationis
thepossibilityofFederalandstategifttaxesthatthetransfermightgenerate.pp.158,
159,and1514
9. a. Retirementincome $36,000
Dividendincome 24,000
AGI* $60,000
Less: Standardandadditionalstandarddeductions $9,050
($7,350+$850+$850)
Personalexemptions(2X$2,800) 5,600 (14,650)
Tax on $45,350
Tax on $43,850 $6,578
Taxonexcess[28%X($45,350$43,850)] 420
Taxliabilityfor2000 $6,998
*Grossincomedoesnotincludeinterestof$3,000onCityofTulsabonds.
b. Salary $54,000
AGI $54,000
Less: Standarddeduction $6,450*
Personalexemption 2,800
Dependencyexemptions(2X$2,800) 5,600 (14,850)
Taxon$39,150*:
Taxon$35,150 $5,273
Taxonexcess[28%X($39,150$35,150)] 1,120
*Faithqualifiesforheadofhouseholdstatus.
c. Salary $60,000
AGI $60,000
Less:
Standarddeduction $6,450*
Personalexemption 2,800 (9,250)
Taxon$50,750*:
Taxon$35,150 $5,273
Taxonexcess[28%X($50,750$35,150)] 4,368
*Brandon does not qualify as a surviving spouse because his daughter is not his
dependent.However,toqualifyasheadofhousehold,anunmarriedsonordaughterneed
notbeadependent.pp.153to1513
10.
Smith,RaabeandMaloney,CPAs
5101MadisonRoad
Cincinnati,Ohio45227
September11,2000
Ms.WandaBrown
4339ElmSt.,Apt.39A
Cincinnati,OH45221
DearWanda:
AtmylastmeetingwithyouandBruce,wediscussedthesocalledmarriagepenalty.
Unfairasitmayseem,ourtaxlawsometimescausesmarriedtaxpayerstopaymore
incometaxthanwouldhavebeenthecaseiftheyhadremainedsingle.
Asyourequested,Ihavedeterminedwhat,ifany,marriagepenaltywouldresultifyou
andBrucemarryin2000.Schedule1showsyourapproximatetaxliabilitiesfor2000if
themarriageisdelayedtoJanuaryof2001.Schedule2givestheresultofaDecember
marriage.Asyoucansee,postponingthemarriageto2001savescombinedincometaxes
of$1,953[$28,337(Schedule2)$26,384(Schedule1)].
IfIcanbeoffurtherservicetoyouandBruce,pleasefeelfreetocontactme.
Sincerely,
JohnAllen,CPA
Partner
Enclosure
Schedule1
MarriageDelayedto2001
IncomeTaxComputationBasedonSingleStatus
Bruce Wanda
Adjustedgrossincome $65,000 $68,000

Lessstandarddeduction (4,400) (4,400)
Lesspersonalexemption (2,800) (2,800)
Taxableincome $57,800 $60,800
TaxfromRateScheduleX $12,772 $13,612
Totaltax:$12,772+$13,612 $26,384
Schedule2
Marriagein2000
IncomeTaxComputationBasedonMarriedStatus
Adjustedgrossincome($65,000+$68,000) $133,000
Lessstandarddeduction (7,350)
Lesspersonalexemptions(2X$2,800) (5,600)
TaxfromRateScheduleY1 $28,337
p. 15-22
11. Yes. If Gina prepays the 2000 contribution of $2,400 in 1999, her 1999 itemized
deductions will be $6,300, her taxable income will be $46,950 ($56,000 - $6,300 -
$2,750), and her tax will be $9,806 from the 1999 Tax Table. She will use the standard
deduction of $4,400 in 2000, which will result in taxable income of $52,800 ($60,000 -
$4,400 - $2,800), and her tax will be $11,372*. This will give total deductions of
$10,700 as opposed to $8,700 ($4,300 + $4,400). pp. 15-6 and 15-7
12. The receipt of the common stock is not taxable to Sandra because it is a non-cash transfer
of property under the terms of a divorce. The $300 per month actual child support
payments are not included in Sandra's gross income. The $1,000 monthly payment
includes $250 of implicit child support. That is, because the payments would be reduced
as a result of a contingency related to the child (i.e., attaining age 21), the amount of the
contingent reduction is child support. Therefore, Sandra must include only $4,500 ($750
X 6) in gross income in the current year. pp. 15-24 and 15-25
13. a. Joeisrequiredtoinclude$110,000($60,000+$50,000)ingrossincomeassociated
with the award he received. The award does not satisfy the right type of
achievementrequirementtoqualifyforexclusionfromgrossincome.Inaddition,
theprovisionwhichrequirestherecipienttocontributetheawardtoaqualified
governmentalunitornonprofitorganizationisnotsatisfied.
b. Wandaisrequiredtoincludethe$75,000ofprizesreceivedinhergrossincome.
Sheisrequiredtorendersubstantial futureservices. Inaddition,theprovision
whichrequirestherecipienttocontributetheawardtoaqualifiedgovernmental
unitornonprofitorganizationisnotsatisfied.
c. Georgecanexcludethe$950,000prizereceivedfromhisgrossincome.Allofthe
requirementsforexclusionaresatisfied.
pp. 15-25 and 15-26
14. Alejandro received a total of $11,000 and spent $7,850 ($2,900 + $3,200 + $800 + $950)
on tuition, books, and supplies. The amount received for room and board is not
excludible. Therefore, he must include $3,150 ($11,000 - $7,850) in gross income.
When he received the money in 2000, Alejandro's total expenses for the period covered
by the scholarship were not known. Therefore, he is allowed to defer reporting the
income until 2001, when all the uncertainty is resolved. pp. 15-27 and 15-28
15. a. Liz must include in gross income the punitive damages of $30,000. The other
amounts ($8,000 and $6,000) may be excluded as arising out of the physical injury,
except the $1,000 amount received for damage to her automobile. This amount is a
nontaxable recovery of capital (i.e., it reduces her basis for the automobile by
$1,000).
b. The $40,000 is included in Lizs gross income because it did not arise out of a
physical personal injury.
pp. 15-28 and 15-29
16. General discussion. All of the following expenses are deductible, subject to the 7.5%
floor: $2,400 for medical insurance, $10,000 in doctor bills and hospital expenses, and
$1,500 for prescribed medicine and drugs.
a. Assuming Sid and Andrea received the insurance reimbursement in December

2000, their medical expense deduction would be $4,600, computed as follows:
Medical insurance $ 2,400

Doctor bills and hospital expenses 10,000
Prescribed medicine and drugs 1,500
Total medical expenses incurred $13,900
Minus: December 2000 reimbursement ( 1,800)
Total medical expenses after reimbursement $12,100
Minus: $100,000 AGI X 7.5% ( 7,500)
Medical expense deduction $ 4,600
b. Assuming Sid and Andrea received the insurance reimbursement in January 2001,
they could ignore the reimbursement in computing their 2000 medical expense
deduction. Their medical expense deduction would be $6,400, computed as
follows:
Medical insurance $ 2,400

Doctor bills and hospital expenses 10,000
Prescribed medicine and drugs 1,500
Total medical expenses incurred $13,900
Minus: $100,000 AGI X 7.5% ( 7,500)
Medical expense deduction $ 6,400
c. If Sid and Andrea itemized in 2000, they would report the reimbursement as gross
income in 2001, to the extent they received a tax benefit from itemizing in 2000. If
they did not itemize in 2000, they would not be required to report the
reimbursement as gross income in 2001.
pp. 15-32 to 15-35

17. Steven primarily was interested in cosmetic surgery to improve his appearance by
shortening his nose. This would be considered unnecessary cosmetic surgery and,
therefore, nondeductible. He then discussed the surgery with his CPA and found that it
would be deductible if performed for a medical reason.
Dr. Keane indicated that Steven had a medical problem (deviated septum) that could be
repaired by surgery, and that he would be willing to write a letter to that effect.
Steven probably could take a deduction for the surgery and provide documentation that it
was necessary cosmetic surgery. However, his original intent was to have unnecessary
cosmetic surgery, which would not be deductible. A reasonable solution in this case
would be for Steven to ask Dr. Keane to issue a bill with separately stated charges for the
necessary and unnecessary components of the cosmetic surgery.
If there is any unethical behavior in this situation, it is attributable to the CPA, who told
Steven that most doctors can come up with a medical reason that would make such
surgery deductible. The CPA knew that Stevens intent was to have surgery that would
not be deductible, but steered him in a direction that would lead him to take a deduction
anyway. p. 15-33
18. Ahmad should be concerned with the following tax issues:
Is the value of the certificate includible in gross income in 1999, even though it
appeared at that time that Ahmad would not have any need for the operation?
If Ahmad uses the certificate for his daughter, is the prize includible in gross
income in 2000?
If Ahmad pays for the prescription glasses for his daughter, can he take a medical
expense deduction?
If Ahmad uses the certificate for an operation for his daughter, can he take a
medical expense deduction? If so, what is his basis in the certificate and what is
the amount of his medical expense deduction?
pp. 15-32 to 15-35
19. a. A capital improvement that ordinarily would not have a medical purpose qualifies
as a medical expense if it is directly related to prescribed medical care and is
deductible to the extent that the expenditure exceeds the increase in value of the
related property. The deduction is $3,300 [($12,000 - $3,600) - ($68,000 X 7.5%)].
b. The full cost of certain home-related capital expenditures incurred to enable a

physically handicapped individual to live independently and productively qualifies
as a medical expense. Qualifying costs include expenditures for constructing
entrance and exit ramps to the residence, widening hallways and doorways to
accommodate wheelchairs, installing support bars and railings in bathrooms and
other rooms, and adjusting electrical outlets and fixtures. These expenditures are
subject to the 7.5% floor only, and the increase in the homes value is deemed to be
zero. Allens deduction is $6,900 [$12,000 - ($68,000 X 7.5%)].
p. 15-33
20. General discussion. A cash basis taxpayer deducts state income taxes in the year paid or
withheld. Any refund of state income taxes must be reported as income in the year
received to the extent the taxpayer received a tax benefit from itemizing deductions in a
prior year. The income must be reported whether the taxpayer receives a cash refund or
has the refund applied against taxes.
a. $7,400 withheld in 2000 + $700 estimated tax payment in 2000 + $1,000 paid in
2000 for 1999 = $9,100.
b. The $1,800 will be included in 2001 gross income to the extent the taxpayer
derived a tax benefit from itemizing in 2000.
c. The $1,800 will be included in 2001 gross income to the extent the taxpayer
derived a tax benefit from itemizing in 2000, even if she elects to have the refund
applied toward her 2001 state income tax.
d. If Andrea did not itemize deductions in 2000, she is not required to report any of
the $1,800 refund as income in 2001.
pp. 15-36 and 15-37
21. a. Irina can elect to include the net capital gain in investment income for purposes of
computing the investment interest expense limitation. If she makes the election,
her investment income for purposes of computing the investment income limitation
is $46,500 ($15,000 interest + $9,000 dividends + $22,500 net capital gain).
Example 47 and related discussion
b. Taxpayers may elect to include the net capital gain as investment income, but only
if they agree to reduce capital gains qualifying for beneficial tax rate treatment
under the alternative tax by an equivalent amount. p.15-38
22. Veronicas net investment income is computed as follows:
Income from investments $10,200

Less: Investment expenses ( 0)
Net investment income $10,200
Veronicas investment interest expense deduction in 2000 would be limited to $10,200,

the amount of net investment income. The balance of $9,800 would be disallowed in
2000.
Total investment interest expense $20,000

Less: Net investment income (10,200)
Investment interest disallowed in 2000 $ 9,800
The amount of investment interest disallowed of $9,800 may be carried over and
becomes investment interest expense in the subsequent year subject to the net investment
income limitation in that later year. Veronica could increase her investment interest
deduction by electing to treat the LTCG of $4,000 as investment income. The amount so
elected would not be available for beneficial alternative tax rate treatment for net capital
gain, however.
p. 15-38
23. Interest is deductible only on the portion of a home equity loan that does not exceed the
lesser of:
The fair market value of the residence, reduced by the acquisition indebtedness
($100,000 FMV - $42,500 acquisition indebtedness = $57,500).
$100,000 ($50,000 for married persons filing separate returns).

On a joint return for 2000, John and Mary can deduct all of the interest on the first
mortgage since it is acquisition indebtedness. Of the $55,000 home equity loan, all the
interest is deductible as home equity interest. pp. 15-38 and 15-39
24. Smith,Raabe,andMaloney,CPAs
5101 Madison Road
Cincinnati, Ohio 45227
December 5, 2000
Mr. Pedro Valdez

1289 Greenway Avenue
Foster City, CA 94404
Dear Mr. Valdez:
I have evaluated the two alternatives for your charitable contribution deduction. Your
potential deduction is $120,000, the fair market value of the painting. It is not reduced by
the unrealized appreciation since the painting was assumed to be put to a related use by
the museum and the holding period is long-term. Pedro, your 2000 charitable
contribution deduction is limited to $69,000 (30% X $230,000 AGI) if you do not make
the reduced deduction election. The remaining $51,000 ($120,000 FMV - $69,000
deduction) can be carried forward for five years.
If you make the reduced deduction election, you can deduct $80,000 (adjusted basis of
the painting) in 2000, because the amount is less than the maximum potential deduction
of $115,000 (50% X $230,000 AGI). However, if you make the election, you must forgo
deducting the $40,000 appreciation on the painting ($120,000 FMV - $80,000 adjusted
basis). Based on the facts presented, it does not appear that you should make the reduced
deduction election. You would be forgoing an additional deduction of $40,000 in order to
increase your 2000 deduction from $69,000 to $80,000. You should plan your
contributions carefully over the next five years so that you do not lose any of the $51,000
carryover.
I will be pleased to discuss my recommendation in further detail if you wish. Please call
me at (510) 555-1234 if you have any questions. Thank you for consulting my firm on
this matter. We look forward to serving you in the future.
Sincerely,
Carol Eckert, CPA

Partner
pp. 15-40 to 15-46

25. Smith, Raabe, and Maloney, CPAs

5101 Madison Road
Cincinnati, Ohio 45227
December 5, 2000
Ms. Alice Young

2622 Bayshore Drive
Berkeley, CA 94709
Dear Ms. Young:
I have evaluated the proposed alternatives for your 2000 year-end contribution to the
United Way. I recommend that you sell the Gold Corporation stock and donate the
proceeds to the United Way. The four alternatives are discussed below.
Donation of cash, the unimproved land, or the Gold stock will each result in a $21,000
charitable contribution deduction. Donation of the Blue Corporation stock will result
only in a $3,000 charitable contribution deduction.
A direct contribution of the Gold Corporation stock is a bad move taxwise in that the
decline in value of $5,000 ($21,000 - $26,000) is not deductible and the amount of the
charitable contribution would be $21,000. However, you will benefit in two ways if you
sell the Gold stock and give the $21,000 in proceeds to the United Way. Donation of the
proceeds will result in a $21,000 charitable contribution deduction. In addition, sale of
the stock would result in a $5,000 long-term capital loss. If you have capital gains of
$2,000 or more in 2000, you could use the entire loss in computing taxable income for
2000. If you have no capital gains in 2000, you can deduct $3,000 of the capital loss in
2000 and carry the remaining $2,000 over to 2001.
You should make the donation in time for ownership to change hands before the end of
the year. Therefore, I recommend that you notify your broker immediately so there will
be no problem in completing the donation on a timely basis.
I will be pleased to discuss my recommendation in further detail if you wish. Please call
me at (510) 555-1234 if you have questions. Thank you for consulting my firm on this
matter. We look forward to serving you in the future.
Sincerely,
Nora Oldham, CPA

Partner
pp. 15-40 to 15-46
26. The following tax issues relate to prizes won in the Skins Game:
Are the prizes won (monetary and nonmonetary) included in gross income?
Should the players report only 90% of the total amount of money winnings as
income and claim no deduction for the amount that goes to charity?
Should the players report the total amount of money winnings as income and
deduct the 10% that goes to charity as a charitable contribution? If so, is the
deduction a business expense or an itemized deduction?
What amount should be reported as income for the automobile won by the leading
money winner - the sticker price, the average selling price, or some other amount?
If the average selling price is the appropriate amount to report as income, how
should it be determined? pp. 15-25 and 15-40 to 15-46
The following questions relate to material covered in other chapters:
If the leading money winner already has an automobile and doesnt need the new
one, what will be the tax result when he sells the automobile he won as a prize?
What is his basis in the automobile won as a prize? What kind of gain (loss)
would result? If a loss results, is it deductible?
If the leading money winner keeps the automobile he won as a prize and sells the
automobile he had been using previously, what will be the tax result when he sells
his old automobile? What kind of gain (loss) would result? If a loss results, is it
deductible?
What will be the tax result if the leading money winner gives the new automobile
to a friend or relative
What will be the tax result if the leading money winner gives the new automobile
to a charity?
Whatwillbethetaxresultiftheleadingmoneywinnergivesthenewautomobile
tohiscaddy,whoisanemployee
27. Kensitemizeddeductionsbeforetheoveralllimitationsarecomputedbelow:
Medical expenses [$21,000 (7.5% X $250,000)] $2,250

State and local income taxes 3,600
Real estate taxes 2,700
Home mortgage interest 4,200
Charitable contributions 2,900
Casualty loss [$28,000 (10% X $250,000)] 3,000
Unreimbursed employee expenses [($6,400 (2% X $250,000)] 1,400
Gambling losses ($9,600 loss limited to $5,800 of gambling income) 5,800
Total itemized deductions before overall limitation $25,850
Kens itemized deductions after application of the overall limitation are computed below:
Itemized deductions subject to overall limitation:

State and local income taxes $ 3,600
Real estate taxes 2,700
Home mortgage interest 4,200
Charitable contributions 2,900
Unreimbursed employee expenses 1,400
Total $14,800
Reduction equals the smaller of the following:
3% X ($250,000 AGI - $128,950) $ 3,632
80% of itemized deductions subject to limitation 11,840
($14,800 X 80%)
Amount of reduction ( 3,632)
Deductible itemized deductions subject to overall limitation $11,168
Itemized deductions not subject to overall limitation:
Medical expenses 2,250
Gambling losses 5,800
Casualty loss 3,000
Total itemized deductions $22,218
pp. 15-47 and 15-48
28. a. Ann and Bill must claim the adoption expense credit in 2001 of $5,000 ($2,000 +
$3,000), since they paid or incurred qualified adoption expenses prior to the year
in which the adoption was finalized and in the year finalized. In their particular
case, they may take the credit in 2001 for $5,000. The amount of expenses paid in
excess of $5,000 is a nondeductible personal expense. Further, because their
modified AGI is less than $75,000, the amount of the credit otherwise available is
not reduced.
b. $1,875 = $5,000 - [$5,000 [($100,000 - $75,000) $40,000]]
pp. 15-49
29. For two or more children, the maximum expense allowed for purposes of the credit for
child and dependent care expenses is $4,800. This amount is less than the child care
expenses paid of $5,800 and the lower earned income of $4,900. Since their combined
AGI is more than $28,000, the applicable rate for the credit is 20%. Thus, the credit
allowed is $960 (20% X $4,800). pp. 15-50 to 15-52
30. For two children, the maximum expense allowed is $4,800. However, since the
qualifying expenditures are limited to the earnings of the lesser paid spouse (i.e., $4,500),
this amount is used in calculating the credit. Using the combined AGI of $16,500
($12,000 + $4,500), the applicable rate for the credit is 26%. Thus, the credit is $1,170
(26% X $4,500).
The fact that the care was provided by Jims mother is of no consequence as long as the
mother does not qualify as Jims and Jills dependent. pp. 15-50 to 15-52
31. ColinisabletotakeeducationtaxcreditsforbothElizaandRhettsschoolingsinceboth
childrenareclaimedasdependentsonColinstaxreturn.ElizaiseligiblefortheHOPE
scholarshipcredit whileRhetts expenses areeligible forthelifetime learning credit,
sinceheisbeyondthefirsttwoyearsofpostsecondaryeducation. Room,board,and
bookcostsarenoteligibleforthecredits.
The maximum HOPE scholarship credit for Elizas tuition is $1,500 [100% X first
$1,000oftuitionexpenses+50%ofsecond$1,000oftuitionexpenses].Themaximum
lifetimelearningcreditforRhettstuitionpaidduringtheyearis$1,000[20%X$5,000].
Thefull$1,000lifetimelearningcreditisavailableforRhettsexpensessincehistuition
expensestotaling$8,000($4,000persemester)exceedthecurrent$5,000ceiling.
Sincetheeducationtaxcreditsarephasedoutforhigherincometaxpayers,Colinwillnot
receive thetotal $2,500($1,500+ $1,000)ineducation credits forEliza andRhetts
expenses. Thecreditreductionis$1,875[($95,000AGI$80,000threshold)/$20,000
phaseoutrangeX$2,500],resultingina$625($2,500$1,875)educationcreditfor
2000.
pp. 15-52 and 15-53
32. a. Bernadette is eligible to take the lifetime learning credit for qualifying tuition
expensesforhercontinuingprofessionaleducationseminarsandhersonstuition
costs.ThecostsforbooksincurredbothbyBernadetteandhersonareineligible
forthecredit. Untiltheyear2003,thelifetimelearningcreditisavailableper
taxpayer on the first $5,000 of qualifying tuition expenses. Accordingly,
Bernadettescoursetuition($2,000)plusupto$3,000ofhersonstuitionwould
qualify for the credit during 2000. Therefore, Bernadettes maximum lifetime
learningcreditwouldbe$1,000[20%X$5,000]for2000.The$1,000maximum
credit would have to be reduced by $400 since her $88,000 AGI exceeds the
thresholdlevelof$80,000formarriedtaxpayers.
[($88,000$80,000)/$20,000]X$1,000=$400reduction
Maximumcredit $1,000
Less:Phaseout (400)
Educationcredit $600
pp.1552,1553,andExamples61and62
b. How the Tax Law Can Help Pay for College and Continuing Professional
EducationOutlineforPresentationtoRotaryClub
I. Introduction.
A. Manytaxprovisionsareavailabletohelpdefraythecostofboth
collegeandcontinuingprofessionaleducation.
B. Complicatedareaoftaxlawsoplanningaheadisimportant.
II. Taxprovisionsthathelppayforcollege.
A. ContributionstoeducationIRAs.
B. PenaltyfreewithdrawalstopayforcollegefromregularIRAs.
C. Participation in statelevel prepaid tuition plans for tuition and
roomandboardcosts.
D. Deductibilityofstudentloaninterest.
E. PurchaseofSeriesEEeducationalsavingsbonds.
F. Education tax credits HOPE scholarship credit and lifetime
learningcredit.
G. Employereducationassistanceprograms.
III. Taxprovisionsthathelppayforcontinuingeducation.
A. Lifetimelearningcredit.
B. Employereducationassistanceprograms.
C. Deductibility of expenses ineligible for credit or assistance
program.
IV. Income limitations and interaction among various provisions also are
importantissues.
33. Ingeneral,theearnedincomecreditisavailabletoindividualswhoseincomeisbelow
certainthresholds.Morespecifically,in2000,theearnedincomecreditmaybeclaimed
bytaxpayerswhohaveaqualifyingchildorchildrenintheirhomeandwhoseearned
incomeorAGIdoesnotexceed$27,413(foronequalifyingchild)or$31,152(fortwoor
more qualifying children). In addition, the credit is available to taxpayers ages 25
through64whohavenoqualifyingchildrenandwhocannotbeclaimedasadependent
onanothertaxpayersreturn.Forthesesituations,thecreditisavailableeventhougha
qualifyingchildisnotlivingwiththetaxpayer,butitisnotavailableafterthetaxpayers
incomeexceeds$10,380.pp.1553and1554
34. Grossincome(Note1):
Salaries ($48,000 + $37,000) $85,000
Radio prize 1,000
Interest on certificate of deposit 3,000
Jury duty fees 400
Lessshorttermcapitalloss(Note2) (2,500)
AGI $86,900
Less: Itemizeddeductions($4,800+$3,600+$2,400) (10,800)

Personalexemptions(2X$2,800) (5,600)
Dependencyexemption(Note3) (2,800)
Notes:
(1) Gross income does not include the interest of $1,200 on the City of Beachside
bonds and the gift of $20,000 Amelia received from her mother. Under the
recovery of capital notion, the repayment of the $2,000 loan Gabe received is not
income.
(2) Ofthe$2,500shorttermcapitalloss,thefullamountcanbeusedtooffsetordinary
incomesinceitislessthanthe$3,000netcapitallossannuallimitation.
(3) The Clarks can claim Jeri as a dependent. No part of a scholarship is counted in
applying the support test. Further, the nontaxable portion of a scholarship is not
considered under the gross income test.
35. TaxComputation
Bruce'ssalary $40,000
Alice'ssalary 50,000
Interestincome 1,950
Adjustedgrossincome $91,950
Less:Itemizeddeductions(Note1) (22,524)
Less:Personalanddependencyexemptions
(Bruce,Alice,2children,Alice'smother,andBruce'sfather)(Note2) (16,500)
TaxfromTaxTable $ 9,223
Less:Prepaymentsandcredits
Incometaxwithheld($4,900+$4,500) (9,400)
Nettaxpayable(orrefunddue)for1999 ($177)
Notes
(1) Itemizeddeductionsaresummarizedbelow:
Medicalexpenses:
Medicalinsurancepremiums $5,100
Doctorbillpaidin1999forservicesin1998 2,900
OperationforBruce'sfather(adependentundera
multiplesupportagreement) 5,300
Totalmedicalexpenses $13,300
Less:7.5%of$91,950AGI (6,896)
Medicalexpensesdeductiblein1999 $6,404
Taxes:
Stateincometaxes($2,900+$600) $3,500
Propertytaxesonresidence 2,600 6,100
Interestonhomemortgage 7,500
Charitablecontributions:
Churchcontribution $2,100
Ticketstocharitydinnerdance
(Onlytheexcessoftheticketpriceof$200
overthecostofcomparableentertainment
of$80isdeductible) 120
Usedclothingdonated(limitedtofair
marketvalue) 300 2,520
Miscellaneousitemizeddeductions:
Uniforms(cost+upkeep) $602
Professionaljournals 150
Totalofdeductibleitems $752
Less:2%of$91,950AGI (1,839)
Miscellaneousitemizeddeductionsdeductiblein1999 0
Totalitemizeddeductions $22,524
AliceandBrucewouldelecttoitemizetheirdeductionsbecausethetotalexceeds
thestandarddeductionof$7,200for1999formarriedpersonsfilingajointreturn.
(2) InadditiontotheByrd'stwochildren,CynthiaandJohn,Alice'smotherqualifiesas
adependencyexemptionbecauseherSocialSecuritybenefitsdonotcountasher
own support when they are not spent for that purpose. Bruce's father, Sam,
qualifiesasadependencyexemptionunderamultiplesupportagreement.
Part2TaxPlanning
Bruce'ssalary($40,000X1.05) $42,000
Interestincome($9,000+$1,950) 10,950
Less:Personalanddependencyexemptions
(Bruce,Alice,2children,Alice'smother)(5X$2,800) (14,000)
Taxfromtaxrateschedule $ 4,700
Less:Prepaymentsandcredits
Incometaxwithheld($4,500X1.05) (4,725)
Nettaxpayable(orrefunddue)for2000 ($25)
Notes
(1) Itemizeddeductionsaresummarizedbelow:

Medicalexpenses:
Medicalinsurancepremiums $5,100
Less:7.5%of$52,950AGI (3,971) $1,129
Taxes:
Stateincometaxes($1,300X1.05) $1,365
Propertytaxesonresidence 2,600 3,965
Charitablecontributions 2,520
Professionaljournals 150
Less:2%of$52,950AGI (1,059)
Miscellaneousitemizeddeductionsdeductiblein2000 0
36. Paul'ssalary $54,000

Donna'ssalary 50,000
Dividends 750
Stateincometaxrefund 1,220
Longtermcapitalgain(Note1) 8,400
Less:Personalanddependencyexemptions (14,000)
(Paul,Donna,Larry,Jane,Hannah)(Note3)
Taxfromtaxrateschedule(Note5) $16,595
Less:Taxwithheld($9,400+$8,800) (18,200)
Nettaxpayable(orrefunddue)for2000 ($1,605)
Notes
(1) Salepriceof300sharesAcmeCorp.stock(300X$55) $16,500

Costofstock(300X$27) (8,100)
Recognizedgainofsale(LTCG) $8,400
(2) Itemizeddeductions:
Medicalexpenses:
Doctor&hospitalbills($6,700$1,800) $4,900
Prescriptiondrugs&medicine 940
Insurancepremiums 1,810
Totalmedical 7,650
Less:7.5%of$114,370AGI (8,578)
Deductiblemedical $0
Taxes:
Stateincometaxespaid($800+$700) $1,500
Realestatetaxes 2,400 3,900
Homemortgageinterest 7,460
Contributions:
Church $1,300
Books 620 1,920
Casualtyloss:
Fairmarketvalue $19,000
Less:Nondeductiblefloor (100)
Less:10%of$114,370AGI (11,437) 7,463
Airfare $440
Hotel 170
Meals(50%X$95) 48
Registrationfee 240
Totaldeductibleitems $898
Less:2%of$114,370AGI (2,287)
Deductiblemiscellaneousitemizeddeductions 0
(3) Since Donna is the custodial parent, the Decker's qualify for the dependency
deductionforbothLarryandJane.Sincetheyprovideover50%ofthesupportof
Hannah,theyalsoqualifyforadependencydeductionforher.Thus,thepersonal
exemptionanddependencydeductionis$14,000($2,800X5).
(4) Consumerinterestisnotdeductible.Therefore,neithertheinterestontheautoloan
of$1,490northecreditcardinterestof$870isdeductible.
(5) Taxon $43,850 = $6,577.50

35,777X28% = 10,017.56
$79,627 $16,595.06
RESEARCHPROBLEMS
1. a. Smith, Raabe, and Maloney, CPAs

5101 Madison Road
Cincinnati, OH 45227
March 1, 2001
Ms. Marge Hudgens

1349 Center Street
Warrensburg, MO 64093
Dear Ms. Hudgens:
Normally married persons who do not file a joint return must file separate returns. This is
an unfortunate result because the tax consequences are less desirable. Not only are the
applicable tax rates higher, but also a reduced standard deduction may have to be
claimed.
There exists, however, a special classification called abandoned spouse that permits a
married person to be treated as single. In your case, this classification would permit the
use of the more favorable head of household filing status.
Except for one condition, you appear to meet the requirements for abandoned spouse
classification. This missing condition is that you must be able to claim Monica as your
dependent. Although there are several tests to be satisfied for dependency qualifications,
the missing link is the support test. Did you furnish more than 50% of her support for the
year 2000. In this regard, compare how much of the $9,100 she earned and contributed
to her own support with what you provided. Items of support include meals, lodging,
clothing, entertainment, medical, transportation, and education expenses (i.e., books and
tuition). Since she lived with you, be sure to include the fair market value of the food and
lodging you provided for her.
If you meet the support test, as noted above, you will qualify for head of household filing
status and can claim Monica as a dependent. If not, you must use married filing separate
status and cannot claim Monica as your dependent. In either event, Monica will have to
file a return on her own.
If I can be of further assistance to you, please do not hesitate to contact me.
Sincerely,
William Adams, CPA

Manager
b. March 1, 2001
TAX FILE MEMO
FROM: William Adams
SUBJECT: Filing status of Mrs. Marge Hudgens
After a heated argument, John Hudgens left his wife in January 2000 and has not been
heard from or seen since. During 2000, Marge, John's wife, maintained a home in which
she and her daughter, Monica, lived. Monica, age 23, graduated from law school in early
May 2000. During the year, Monica earned $9,100 from part-time jobs. Monica
deposited some of her earnings in a savings account and used the balance for her support.
The remainder of Monica's support was furnished by her mother, Marge.
Marge contacted us regarding two issues. One is her filing status for 2000. The other is
whether Monica can be claimed as her dependent.
In a letter to Marge (see attached copy), I explained to her that she might qualify as an
abandoned spouse. If so, she would be treated as single and could file as a head of
household. If not, she would be relegated to married filing separately status.
Marge meets all of the criteria of abandoned spouse, but only if Monica is her dependent.
In determining dependency status, the gross income test can by disregarded as Monica
was a full-time student until May 9 (any part of five months suffices), was under age 24,
and is Marge's child (151(c)(1)(B), (c)(3), and (c)(4)). The key to dependency status,
however, is the support test. Unfortunately, we do not know what amount constitutes
Monica's support and how much was contributed by the parties (i.e., Monica and her
mother). Only if Marge furnished more that 50% is the support test satisfied.
2. BecauseoftheinequitiesthatcoulddevelopforPriscillaandotherslikeher,Congress,in
theMiscellaneousRevenueActof1980(PublicLaw96605),enactedcurrentCode66.
Underthisprovisionandthroughreferenceto879(a),Priscilla'sincomeistaxedtoher.
NoneofLayton'sincomeistaxedtoher.Inthisregard,theCodeoverlooksanyrights
statelawgivestoherastohisincome.
3. Smith, Raabe, and Maloney, CPAs

5101 Madison Road
Cincinnati, OH 45227
December 14, 2000
Mr. Donald Jansen

104 South Fourth Street
Dalton, GA 30720
Dear Mr. Jansen:
You have asked me to determine whether there is support for deducting the interest that
you pay to your former wife relative to a property settlement. I am pleased to report that I
have found two recent cases with similar facts in which the courts ruled against the IRS
on this issue.
In general, only certain types of interest are deductibleeducation interest, investment

interest, qualified residence interest, and trade or business interest. Personal interest is not
deductible.
The IRS argues that the interest you pay to Marla is nondeductible personal interest
because the obligation to make the payments arose from your divorce. However, in recent
decisions, the courts have held that the general interest tracing rules in the Internal
Revenue Code apply in situations similar to yours. In order to deduct the interest, you
will need to prove that the obligation to your former wife was incurred to enable you to
own assets that result in deductible interest. Both the corporate stock and the commercial
building are investment property, so you will be allowed to treat the interest attributable
to those assets as investment interest. The interest on your personal residence will be
deductible as qualified residence interest.
Thank you for giving me the opportunity to provide assistance with your tax questions. If
you would like to discuss my findings in this case, or if you have other tax questions,
please call me or schedule an appointment.
Sincerely,
Richard Lopez, CPA
The most important citations related to this question are as follows:

163 (h)(2).
1041.
Don Gilmore, 372 U.S. 39, 11 AFTR2d 758, 63-1 USTC 9825 (1963).
John L. Seymour, 109 T.C. 279 (1997).
4. a. The portion of the payments which are contingent upon their son's living are child
support. The remaining portion of the payments qualifies as alimony. Therefore,
Al has $85,000 ($90,000 - $5,000) alimony from the Year 1 payment.
b. Alimony paid for the first three years is $85,000 for year 1, $55,000 for year 2, and
$15,000 for year 3. Alimony recapture (a deduction for AGI for AI in year 3) is
computed as follows:
Year 2 alimony recapture:

Year 2 alimony $55,000
-Year 3 alimony (15,000)
=Decrease $40,000
-Allowable decrease (15,000)
=Year 1 alimony recapture $25,000
Year 1 alimony recapture:

Year 1 alimony $85,000
-Average of year 2 and 3 alimony* (22,500)
=Decrease $62,500
-Allowable decrease (15,000)
=Year 1 alimony recapture $47,500
Total alimony recapture ($25,000 + $47,500) $72,500
*[($55,000 - $25,000) + $15,000]/2 = $22,500
See 71.
5. Gross income (earnings) $19,500

Less: Deduction for AGI (traditional IRA) ( 500)
Adjusted gross income for Vern $19,000
Earned income credit:

$9,720 X 40% $3,888
Less: 21.06 X ($19,500* - $12,690) (1,434)
Maximum credit allowed $2,454
*Earned income ($19,500) is greater than AGI ($19,000).
6. The Internet Activity research problems require that the student access various sites on
the Internet. Thus, each students solution likely will vary from that of the others.
You should determine the skill and experience levels of the students before making the
assignment, coaching them where necessary so as to broaden the scope of the exercise to
the entire available electronic world.
Make certain that you encourage students to explore all parts of the World Wide Web in
this process, including the key tax sites, but also information found through the web sites
of newspapers, magazines, businesses, tax professionals, government agencies, political
outlets, and so on. They should work with Internet resources other than the Web as well,
including newsgroups and other interest-oriented lists.
Build interaction into the exercise wherever possible, asking the student to send and
receive e-mail in a professional and responsible manner.
7. See the Internet Activity comment above.

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SM 15

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CHAPTER 15

INTRODUCTION TO THE TAXATION OF INDIVIDUALS

SOLUTIONS TO PROBLEM MATERIALS

1 Taxable income calculation Unchanged 1

25 Choice of property for contribution Unchanged 30

1 Filing status: qualifying for abandoned Unchanged 1

*A dependent's standard deduction is limited to the sum of his or her earned

*A dependent's standard deduction is limited to the sum of his or her earned

pp. 15-6 to 15-8 and Figure 15-1

Theinheritanceandlifeinsuranceproceedsareexclusions.pp. 15-3 to 15-7 and Figure

pp. 15-6 to 15-8

pp. 15-10 to 15-13

Adjustedgrossincome $65,000 $68,000

pp. 15-28 and 15-29

a. Assuming Sid and Andrea received the insurance reimbursement in December

Medical insurance $ 2,400

Medical insurance $ 2,400

pp. 15-32 to 15-35

18. Ahmad should be concerned with the following tax issues:

pp. 15-32 to 15-35

b. The full cost of certain home-related capital expenditures incurred to enable a

pp. 15-36 and 15-37

22. Veronicas net investment income is computed as follows:

Income from investments $10,200

Veronicas investment interest expense deduction in 2000 would be limited to $10,200,

Total investment interest expense $20,000

$100,000 ($50,000 for married persons filing separate returns).

Mr. Pedro Valdez

Dear Mr. Valdez:

Carol Eckert, CPA

pp. 15-40 to 15-46

25. Smith, Raabe, and Maloney, CPAs

Ms. Alice Young

Dear Ms. Young:

Nora Oldham, CPA

pp. 15-40 to 15-46

The following questions relate to material covered in other chapters:

Medical expenses [$21,000 (7.5% X $250,000)] $2,250

Itemized deductions subject to overall limitation:

pp. 15-47 and 15-48

b. $1,875 = $5,000 - [$5,000 [($100,000 - $75,000) $40,000]]

pp. 15-52 and 15-53

Less: Itemizeddeductions($4,800+$3,600+$2,400) (10,800)

36. Paul'ssalary $54,000

(1) Salepriceof300sharesAcmeCorp.stock(300X$55) $16,500

(5) Taxon $43,850 = $6,577.50

1. a. Smith, Raabe, and Maloney, CPAs

Ms. Marge Hudgens

Dear Ms. Hudgens:

If I can be of further assistance to you, please do not hesitate to contact me.

William Adams, CPA

TAX FILE MEMO

FROM: William Adams

SUBJECT: Filing status of Mrs. Marge Hudgens

3. Smith, Raabe, and Maloney, CPAs

December 14, 2000

Mr. Donald Jansen

Dear Mr. Jansen:

In general, only certain types of interest are deductibleeducation interest, investment

Richard Lopez, CPA

The most important citations related to this question are as follows:

Year 2 alimony recapture:

Year 1 alimony recapture: