Question

54. David R. and Ella M. Cole (ages 39 and 38, respectively) are husband and wife who live at 1820 Elk Avenue, Denver, CO 80202. David is a regional sales manager for Wren Industries, a national wholesaler of plumbing and heating supplies, and Ella is a part-time dental hygienist for a chain of dental clinics. • David is classified by Wren as a statutory employee with compensation for 2016 (based on commissions) of $95,000. He is expected to maintain his own office and pay for all business expenses from this amount. Wren does not require him to render any accounting as to the use of these funds. It does not withhold Federal and state income taxes but does withhold and account for the payroll taxes incurred (e.g., Social Security and Medicare). The Coles are adequately covered by Wren’s noncontributory medical plan but have chosen not to participate in its § 401(k) retirement plan. David’s employment-related expenses for 2016 are summarized below. Airfare $8,800 Lodging 5,000 Meals (during travel status) 4,800 Entertainment 3,600 Ground transportation (e.g., limos, rental cars, and taxis) 800 Business gifts 900 Office supplies (includes postage, overnight delivery, and copying) 1,500 The entertainment involved business meals for purchasing agents, store owners, and building contractors. The business gifts consisted of $50 gift certificates to a national restaurant. These were sent by David during the Christmas holidays to 18 of his major customers. In addition, David drove his 2014 Ford Expedition 11,000 miles for business and 3,000 for personal use during 2016. He purchased the Expedition on August 15, 2013, and has always used the automatic (standard) mileage method for tax purposes. Parking and tolls relating to business use total $340 in 2016. • When the Coles purchased their present residence in April 2013, they devoted 450 of the 3,000 square feet of living space to an office for David. The property cost $440,000 ($40,000 of which is attributable to the land) and has since appreciated in value. Expenses relating to the residence in 2016 (except for mortgage interest and property taxes; see below) are as follows: Insurance $2,600 Repairs and maintenance 900 Utilities 4,700 Painting office area; area rugs and plants (in the office) 1,800 In terms of depreciation, the Coles use the MACRS percentage tables applicable to 39-year nonresidential real property. As to depreciable property (e.g., office furniture), David tries to avoid capitalization and uses whatever method provides the fastest write-off for tax purposes. • Ella works part-time as a substitute for whichever hygienist is ill or on vacation or when one of the clinics is particularly busy (e.g., prior to the beginning of the school year). Besides her transportation, she must provide and maintain her own uniforms. Her expenses for 2016 appear below. Uniforms $690 State and city occupational licenses 380 Professional journals and membership dues in the American Dental Hygiene Association 340 Correspondence study course (taken online) dealing with teeth whitening procedures 420 Ella’s salary for the year is $42,000, and her Form W–2 for the year shows income tax withholdings of $4,000 (Federal) and $1,000 (state) and the proper amount of Social Security and Medicare taxes. Because Ella is a part-time employee, she is not included in her employer’s medical or retirement plans. • Besides the items already mentioned, the Coles had the following receipts during 2016. Interest income— State of Colorado general purpose bonds $2,500 IBM bonds 800 Wells Fargo Bank 1,200 $4,500 Federal income tax refund for year 2015 510 Life insurance proceeds paid by Eagle Assurance Corporation 200,000 Inheritance of savings account from Sarah Cole 50,000 Sales proceeds from two ATVs 9,000 For several years, the Coles’ household has included David’s divorced mother, Sarah, who has been claimed as their dependent. In late November 2016, Sarah unexpectedly died of coronary arrest in her sleep. Unknown to Ella and David, Sarah had a life insurance policy and a savings account (with David as the designated beneficiary of each). In 2015, the Coles purchased two ATVs for $14,000. After several near mishaps, they decided that the sport was too dangerous. In 2016, they sold the ATVs to their neighbor. • Additional expenditures for 2016 include: Funeral expenses for Sarah $4,500 Taxes— Real property taxes on personal residence $6,400 Colorado state income tax due (paid in April 2016 for tax year 2015) 310 6,710 Mortgage interest on personal residence (Rocky Mountain Bank) 6,600 Paid church pledge 2,400 Contributions to traditional IRAs for Ella and David ($5,500 þ $5,500) 11,000 In 2016, the Coles made quarterly estimated tax payments of $1,400 (Federal) and $500 (state) for a total of $5,600 (Federal) and $2,000 (state). Part 1—Tax Computation Using the appropriate forms and schedules, compute the Coles’ Federal income tax for 2016. Disregard the alternative minimum tax (AMT) and various education credits as these items are not discussed until later in the text (Chapters 12 and 13). Relevant Social Security numbers are: David Cole 123-45-6788 Ella Cole 123-45-6787 Sarah Cole 123-45-6799 The Coles do not want to contribute to the Presidential Election Campaign Fund. Also, they want any overpayment of tax refunded to them and not applied toward next year’s tax liability. Suggested software: H&R BLOCK Tax Software. Part 2—Follow-Up Advice Ella has always wanted to pursue a career in nursing. To this end, she has earned a substantial number of college credits on a part-time basis. With Sarah no longer requiring home care, Ella believes that she can now complete her degree by attending college on a full-time basis. David would like to know how Ella’s plans will affect their income tax position. Specifically, he wants to know: • How much Federal income tax they will save if Ella quits her job. • Any tax benefits that might be available from the cost of the education. Write a letter to David addressing these concerns. Note: In making your projections, assume that David’s salary and expenses remain the same. Also disregard any consideration of the educational tax credits (i.e., American Opportunity and lifetime learning) as they are not discussed until Chapter 13.

Answer 1

The Life Insurance proceeds and Inheritance amounts received are not taxable and not reported.

The Funeral expenses are not deductible.

2. If Ella quits her job, then the income earned from the part-time job will not be there and also related expenses will not be incurred. Disregarding the education credits and Sarah not being a dependent, the probable income tax saved would be $8,449 - $3,041 = $5,408.

If she incurs the eligible educational expenses, then she will be able to claim either American Opportunity credit or the Life time learning credit or Tuition and fees deduction, whichever is beneficial. American Opportunity has a benefit of refund. She can receive a refund of up to $1,000 if she satisfies the conditions of American Opportunity credit. Life time learning credit is non refundable. It will not reduce the tax liability less than $0. Tuition and fees deduction is an adjustment to income.