Drill re Deductions Above or Below AGI Line

1
Drill re Deductions Above or Below AGI Line

• Which of the following is a deduction from AGI?
• a. Trade or business expenses.
• b. Losses on the sale of property.
• c. IRA contributions.
• d. Medical expenses.
• e. None of the above.

2
Answer to Drill re Deductions Above and Below AGI
Line

• d a., b., and c. are deductions for AGI or above
  the AGI line. Medical expenses are deductible
  below the line to the extent they exceed 7.5 of
  AGI. pp. 6-3 to 6-5 and Figure 6-1

3
Drill re Determination of AGI

• Larry, a calendar year cash basis taxpayer, has
  the following transactions
• Salary from job 60,000, Alimony paid to ex-wife
  9,000, Medical expenses 4,500
• Based on this information, Larry has
• a. AGI of 46,500.
• b. AGI of 51,000.
• c. AGI of 60,000.
• d. Medical expense deduction of 0.
• e. None of the above.

4
Answer to Drill re AGI Determination

• b. Larrys AGI is calculated as follows
• Salary 60,000 Alimony paid (9,000)AGI51,000 
• Larrys medical expense deduction (below the AGI
  line) is 675 4,500 total medical expenses
  3,825 (which is 7.5 x 51,000) 675. pp. 6-3,
  6-4, and Example 2

5
Drill re Accrual v Cash Methods for Tax Purposes

• During 2009, the first year of operations,
  Silver, Inc., pays salaries of 175,000. At the
  end of the year, employees have earned salaries
  of 20,000 which are not paid by Silver until
  early in 2010. What is the amount of the
  deduction for salary expense?
• a. If Silver uses the cash method, 175,000 in
  2009 and 0 in 2010.
• b. If Silver uses the cash method, 0 in 2009 and
  195,000 in 2010.
• c. If Silver uses the accrual method, 175,000 in
  2009 and 20,000 in 2010.
• d. If Silver uses the accrual method, 195,000 in
  2009 and 0 in 2010.

6
Answer to Drill re Cash v. Accrual

• d pp. 6-9 and 6-10. 195,000 is the correct
  answer 175,000 salaries which Silver both owed
  and paid and 20,000 in salaries which Silver owed
  but had not paid the 20,000 is deductible in the
  year owed under the accrual method.

7
Drill re Deductibility of Reserves

• Cotton, Inc. is an accrual basis taxpayer.
  Cotton uses the aging approach to calculate the
  reserve for bad debts. During 2009, the
  following occur associated with bad debts.
• Credit sales,300,000 Collections on credit
  sales, 260,000 Amount added to the reserve,
  45,000 Beginning balance in the reserve
  -0-Identifiable bad debts during 2009,18,000.
• The amount of the deduction for bad debt expense
  for Cotton for 2009 is
• a. 18,000.
• b. 45,000.
• c. 40,000.
• d. 63,000.
• e. None of the above.

8
Answer to Drill re Deductibility of Reserves

• A, 18,000. Only the specific charge-off method
  can be used. Reserves for estimated expenses are
  not allowed for tax purposes because the economic
  performance test cannot be satisfied. p. 6-10.
  So only the 18,000 which has been identified as
  uncollectible is deductible as a bad debt loss.
  Only an issue with accrual basis taxpayers.
  There is lots of litigation over the issue of
  when a debt becomes worthless/uncollectible.

9
Drill re Deductible Expenses

• Rufus operates a drug-running operation and
  incurred the following expenses
• Salaries 200,000
• Illegal kickbacks 32,000
• Bribes to border guards 24,000
• Cost of goods sold 400,000
• Rent 12,000
• Interest 18,000
• Which of the above amounts reduces his taxable
  income?
• a. 330,000.
• b. 400,000.
• c. 486,000.
• d. 686,000.
• e. None of the above.

10
Answer to Drill re Deductible Expenses

• B, 400,000 Cost of goods sold is treated as a
  negative item in calculating gross income rather
  than as a deduction. That is, it reduces his
  income but is not considered a deduction For a
  drug dealer, all deductions are disallowed. pp.
  6-12 and 6-13

11
Drill re Deductibility of Salaries

• The New York Yankees pay Alex Rodriguez an annual
  salary of 25 million. IBM pays its CEO 25
  million. What, if any are the differences in
  deductibility to The Yankees and IBM?

12
Drill re Deductibility of Salaries

• The entire 25 million is deductible to the
  Yankees. Only 1 million is deductible to the
  CEO because he is one of the covered executives
  under IRC Sect. 162 (m) and IBM is a
  publicly-traded corporation. Even if the Yankees
  were publicly traded (George Steinbrenner would
  never let that happen), it would still be
  deductible because ARod is not a covered
  executive. That is, he is not the CEO or one of
  the four other most highly compensated officers.

13
Drill re Rental Property

• Susan rents part of her personal residence in the
  summer for 10 days for 1,000. Anne rents all of
  her personal residence for 3 weeks in December
  for 2,500. How much is each required to include
  in gross income?

14
Answer to Drill re Rental Property

• Anne must include the 2,500 in her gross income
  whereas Susan is not required to include the
  1,000 in her gross income.

15
Conversion of Personal Residence

• Beulahs personal residence has an adjusted basis
  of 190,000 and a fair market value of 175,000.
  Beulah converts the property to rental use on
  December 1, 2009. What is her basis for
  depreciation and what limits apply to the
  deductibility of expenses?

16
Answer to Drill re Conversion of Personal
Residence

• The adjusted basis for depreciation is 175,000,
  the lower of Beulahs adjusted basis of 190,000
  or the fair market value of 175,000 on the date
  of the conversion. However, additional data is
  necessary to determine whether the vacation home
  gross income ceiling on deductions rule applies.
  If the qualified rental period exception applies,
  the gross income limit does not apply. If the
  qualified rental period exception does not apply,
  then the gross income limit does apply.

17
Drill re Related Party Transaction

• Dolly sells land to her adult son, Garrett, for
  its 30,000 appraised value. Her adjusted basis
  for the land is 45,000. What is Dollys gain or
  loss on the transaction and what is Garretts
  basis in the property when acquired?

18
Answer to Drill re Related Party Transaction

• Dollys recognized loss is 0. Her realized loss
  of 15,000 (30,000 amount realized 45,000
  adjusted basis) is disallowed because Garrett is
  a related party. However, Garretts adjusted
  basis for the land is his cost of 30,000. p.
  6-25.

19
Issue Identification Drill Chapters 5 and 6

• Your Client, Petunia Schmackatella consults with
  you regarding the following facts
• She works as a mechanic for Fly-by-Nite
  Airlines, has 12 children, and her husband stays
  at home with the children. Her employer provides
  child care payments made directly to the Diaper
  Dandy daycare center in the amount of 10,000
  and also provides a house on work premises at the
  airport where the Airlines has its facilities.
  The Airlines provides the housing because it is
  convenient for the employer to have employees at
  the facility in case emergency repairs are
  needed. The Airlines allows employees to fly
  space available on its flights, stay for free
  at hotels owned by the Airlines and eat at the
  E-coli steak houses owned by the airline. It
  also sends Petunia to its Katmandu facility to
  work from time to time, usually on 8 to 12 month
  tours. Petunia is 43 years old and bought EE
  bonds 20 years ago which are now maturing. She
  wants to cash those bonds in to pay college
  expenses for her daughter, Euphemia. The
  interest on the bonds is 20,000, tuition is
  15,000. She also has stock in Ajax Co. which is
  offering to pay a dividend of 10 per share or
  give a 1 for 1 stock dividend. She has a note to
  the bank on a rental property paying 4. The
  balance due is 100,000 and the bank wants to
  lend the money out at a higher rate, so offers to
  accept 90,000 as payment in full. Debts are
  1,000,000 assets are 500,000. She owes
  10,000 in back garbage collection fees for her
  rental property and wants to pay the debt by
  credit card and get a deduction this year to
  offset rental income.
• What are the issues?