Question

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
*Treat as a direct office in home expense.

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). Assumed that Ella is an employee (not an independent contractor). 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 $14,050. 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 + $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).

Relevant Social Security numbers are:

David Cole	123-45-6788
Ella Cole	123-45-6787
Sarah Cole	123-45-6799

Required:

Using the appropriate forms and schedules, compute the Coles' Federal income tax for 2016. Disregard the alternative minimum tax (AMT) and the various education credits

Answer 1

Particulars	Amount($)
David’s commission	95000
Ella’s salary	42000
Interest income W.N. 1)	1200
IRA contributions ($5,500 + $5,500)	11000
George’s employment expenses (W.N.2)	25022
Adjusted gross income	102178
Itemized deductions (Notes 4 and 5)	15400
Personal exemptions ($3,950 X 2	7900
Taxable income	78878
Tax from Tax Table	11432
Less:   Withholding and estimated tax ($5,600 + $2,000)	7600
Net tax payable (or refund due) for 2014 3832    (1)The life insurance proceeds ($200,000) are non-taxable from Eagle Assurance and $1,200 interest from the certificate of deposit is added. The gift received from Ella’s parents is non-taxable. 2)Because George is a statutory employee, his job-related expenses are deductions for AGI. These expenses are summarized below: Particulars Amounts($) Airfare 8800 Meals ($4800 – 50% discount) 2400 Lodging 5000 entertainment ($3,600 – 50% discount) 1800 Business gifts (18 X $29) 522 Auto expense: Mileage (11,000 X $0.56) 6160 Parking and tolls 340 total deduction for AGI *None of the traffic fines of $420 are deductible. The business gift limitation is $25 plus $4 for wrapping and shipping. ** David reports the information on the automobile in Part IV of Schedule C because he is using the automatic mileage method. If he were using the actual cost method, he would be required to file Form 4562 (Depreciation and Amortization) because the automobile is listed property (3) Particulars Deduction($) Real property taxes 6400 Home mortgage interest 6600 Charitable contribution 2400 Miscellaneous expenses 0 Total 15400 (4) Miscellaneous itemized deductions subject to the 2%-of-AGI floor are calculated below; Particulars Amount($) Professional dues and trade journals ($380 + $340) 720 Total 720 Less: 2% of $102,172 (AGI) 20449(rounded off) Deductible amount Nil 25022