Question

Note: This problem is for the 2018 tax year. SHOW ALL WORK

Daniel B. Butler and Freida C. Butler, husband and wife, file a joint return. The Butlers live at 625 Oak Street in Corbin, KY 40701. Dan's Social Security number is 111-11-1112, and Freida's is 123-45-6780. Dan was born on January 15, 1967, and Freida was born on August 20, 1968.

During 2018, Dan and Freida furnished over half of the total support of each of the following individuals, all of whom still live at home:

1. Gina, their daughter, age 22, a full-time student, who married on December 21, 2018, has no income of her own and for 2018 did not file a joint return with her husband, Casey, who earned $10,600 during 2018. Gina's Social Security number is 123-45-6788.
2. Willie, their son, age 20, who had gross income of $6,300 in 2018, dropped out of college in October 2018. He had graduated from high school in May 2018. Willie's Social Security number is 123-45-6787.
3. Ben, their oldest son, age 26, is a full-time graduate student with gross income of $5,200. Ben's Social Security number is 123-45-6786.

Dan was employed as a manager by WJJJ, Inc. (employer identification number 11-1111111, 604 Franklin Street, Corbin, KY 40702), and Freida was employed as a salesperson for Corbin Realty, Inc. (employer identification number 98-7654321, 899 Central Street, Corbin, Ky 40701). Selected information from the W–2 Forms provided by the employers is presented below. Dan and Freida use the cash method.

Line	Description	Dan	Freida
1	Wages, tips, other compensation	$74,000	$86,000
2	Federal income tax withheld	11,000	12,400
17	State income tax withheld	2,960	3,440

Freida sold a house on December 30, 2018, and will be paid a commission of $3,100 (not included in the $86,000 reported on the W–2) on the January 10, 2019, closing date.

Other income (as reported on 1099 Forms) for 2018 consisted of the following:

Dividends on CSX stock (qualified)		$4,200
Interest on savings at Second Bank		1,600
Interest on City of Corbin bonds		900
Interest on First Bank CD		382
Prize		7,000

The $382 from First Bank was original issue discount. Dan and Freida collected $16,000 on the First Bank CD that matured on September 30, 2018. The CD was purchased on October 1, 2016, for $14,995, and the yield to maturity was 3.3%.

During the year, Dan participated on a game show and won a cash prize of $7,000.

In addition to the above information, Dan and Freida's itemized deductions included the following:

Paid on 2018 Kentucky income tax		$700
Personal property tax paid		600
Real estate taxes paid		1,800
Interest on home mortgage (Corbin S&L)		4,900
Cash contributions to the United Way		800

Sales tax from the sales tax table is $1,860. Dan and Freida made Federal estimated tax payments of $8,000. All members of the family had health insurance coverage for all of 2018. Dan and Freida do not wish to contribute to the Presidential Election Campaign. The Kentucky income tax rate is 4%.

Required:

Compute Dan and Freida’s 2018 Federal income tax payable (or refund due). Use Form 1040 and Schedules 1, 5, B, E and the Qualified Dividends and Capital Gain Tax Worksheet to complete this tax return. If there is a tax overpayment, the Butlers would like a refund. If additional tax is due, assume no underpayment penalty applies.

It may be necessary to complete the tax schedules before completing Form 1040.

• Enter all amounts as positive numbers.
• If an amount box does not require an entry or the answer is zero, enter "0".
• When computing the tax liability, do not round your immediate calculations.
• If required round your answers to the nearest dollar.
• Make realistic assumptions about any missing data.
• Use the Tax Rate Schedule provided. Do not use the Tax Tables.

Answer 1

Answer:

Part 1—Tax Computation

Gross income:
Salary and commissions ($74,000 + $86,000) (Note 1) $160,000
Interest income on certificate of deposit 382
Interest income on Second Bank savings account (Note 2) 1,600
Dividends on CSX stock (Note 3) 4,200
Prize income (Note 4) 7,000
Deductions for adjusted gross income (–0–)
Adjusted gross income $173,182
Standard deduction (greater than itemized deductions) (24,000)
Taxable income $149,182
Tax liability (Note 5) $ 24,405
Dependent credit (Note 6) (1,000)
Less: Tax withheld by employers ($12,400 + $11,000) (23,400)
Estimated tax payments (8,000)
Net tax payable (or refund due) for 2018 ($ 7,995)

See the tax return solution beginning on p. 4-28 of the Solutions Manual.

(1)

The $3,100 commission for Freida is not included in her gross income until it is received in 2020.

(2)

The $900 of interest on the City of Corbin bonds is excluded from gross income.

(3)

The dividends of $4,200 on the CSX stock are included in Dan and Freida’s gross income.

(4)

The game show winnings are taxable income. Therefore, Dan must include this amount in his gross income.

(5)

The Butler’s tax liability is $24,405:

Tax on dividend income ($4,200 × 15%) $ 630
Tax on other taxable income ($144,982) (from tax schedule) 23,775
$24,405

(6)

Gina qualifies as a dependent. Under the qualifying child requirements, she does not have to satisfy the gross income test. In any event, this is not a problem because Gina has $0 gross income. Gina does not file a joint return with her husband. Therefore, because all of the requirements are satisfied for a qualifying child, Dan and Freida can claim a dependent credit for Gina. Ben, their son, fails to qualify as a dependent because of the age requirement for a qualifying child and because of the gross income test for a qualifying relative. Willie, their son, does qualify as a dependent as a qualifying child. It appears he has too much gross income ($6,300). However, there is no gross income test under the qualifying child requirements. He does satisfy the qualifying child age requirement by being a full-time student during five calendar months. Because Willie is not under age 17, Dan and Frieda cannot claim the $2,000 child credit for Willie but can claim the $500 dependent credit.

Part 2—Tax Planning

Maloney, Raabe, Young, Nellen, & Hoffman, CPAs
5191 Natorp Boulevard
Mason, OH 45040

December 29, 2019

Dan and Freida Butler
625 Oak Street
Corbin, KY 40701

Dear Dan and Freida:

You asked me to estimate your after-tax income under the assumption that Dan will work only halftime next year. The $37,000 reduction in Dan’s pay will be partially offset by a $4,000 estimated increase in the amount Freida will earn. This net $33,000 reduction in salary and wages will also result in a decrease in your Kentucky income tax, Social Security tax, and Medicare tax. The net reduction in your after-tax cash flow will be approximately $21,000. The calculations are presented below:

Taxable Income Cash Flow
Decrease in salary and other earned income ($33,000) ($33,000)
Decrease in Social Security and Medicare tax
(0.0765 × $33,000) 2,525
Decrease in Kentucky income tax (0.04) 1,320 1,320
Decrease in Federal taxable income ($31,680)
Decrease in Federal income tax (0.22) 6,970
After-tax decrease in cash flow ($22,185)

If you have any further questions, please call me.

Sincerely,
John Jones, CPA

TAX FILE MEMORANDUM

DATE: December 27, 2019

FROM: John Jones

SUBJECT: Dan and Freida Butler, Change in Taxes for 2019

Dan plans to work only half-time in 2019, but Frieda anticipates an increase in her income. Dan’s income will decrease by $37,000, and Frieda’s income is expected to increase by $4,000 and a $400 increase in the personal and dependency exemptions deduction. This net $33,000 reduction in salary and wages will also result in a decrease in their Kentucky income tax, Social Security tax, and Medicare tax. The net reduction in their after-tax cash flow will be approximately $21,000. The calculations are presented below:

  Taxable Income Cash Flow
Decrease in salary and other earned income ($33,000) ($33,000)
Decrease in Social Security and Medicare tax
(0.0765 × $33,000) 2,525
Decrease in Kentucky income tax (0.04) 1,320 1,320
Decrease in Federal taxable income ($31,680)
Decrease in Federal income tax (0.22) 6,970
After-tax decrease in cash flow ($22,185)

My assumptions for the analysis were as follows:
1.

The $3,100 commission received on January 10, 2019, is included in the $90,000 income to be earned by Freida in 2019.

2.

The 22% 2019 marginal tax rate remains the same in 2020.

3.

Interest income, dividend income, partnership income, and the standard deduction are the same for 2019 and 2020.

4.

Gina and Willie will continue to qualify as dependents.