Question

Elisa and Clyde operate a retail sports memorabilia shop. For the current year, sales revenue is $55,000 and expenses are as follows:

Cost of goods sold $21,000 Advertising 1,000 Utilities 2,000 Rent 4,500 Insurance 1,500 Wages to Boyd 8,000

Elisa and Clyde pay $8,000 in wages to Boyd, a part-time employee. Because this amount is $1,000 below the minimum wage, Boyd threatens to file a complaint with the appropriate Federal agency. Although Elisa and Clyde pay no attention to Boyd's threat, Chelsie (Elisa's mother) gives Boyd a check for $1,000 for the disputed wages. Both Elisa and Clyde ridicule Chelsie for wasting money when they learn what she has done. The retail shop is the only source of income for Elisa and Clyde.

a. Calculate Elisa and Clyde's AGI.
$

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To be deductible, an expense must be incurred for the taxpayer's benefit or arise from the taxpayer's obligation. An individual cannot claim a tax deduction for the payment of the expenses of another individual. There is one exception.

b. Can Chelsie deduct the $1,000 payment on her tax return?

No

The obligation is that of Elisa and Clyde since it is related to their business.

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Correct

c. Assume instead that Chelsie makes a gift of the $1,000 to Elisa and Clyde and they pay the $1,000 to Boyd.

Can Elisa and Clyde deduct the $1,000 as part of the wage expense?

Yes

Can Chelsie (Elisa's mother) deduct the $1,000 payment to Boyd on her tax return?

No

Answer 1

a. Calculate Elisa and Clyde's AGI.

$17,000

Feedback: To be deductible, an expense must be incurred for the taxpayer's benefit or arise from the taxpayer's obligation. An individual cannot claim a tax deduction for the payment of the expenses of another individual. There is one exception.

Answer: $17,000.

To be deductible, an expense must be incurred for the taxpayer’s benefited or arise from the taxpayer’s obligation. An individual cannot claim a tax deduction for the payment of the expenses of another individual. One exception to this disallowance rule is the payment of medical expenses for a dependent. Such expenses are deductible by the pay or subject to the normal rules that limit the deductibility of medical expenses.

Sales revenue                                                                       $55,000

Deduct:Cost of goods sold                            21,000

Advertising 1,000

Utilities 2,000

Rent 4,500

Insurance 1,500

Wages to Boyd 8,000 (38,000)

AGI $17,000

Elisa and Clyde can deduct only the $8,000 in wages they paid to Boyd.

b.Can Chelsie deduct the $1,000 payment on her tax return?

No

The obligation is that of Elisa and Clyde since it isrelated to their business.

• Correct

Answers: No; is that; related. An expense must be incurred for the taxpayer's benefit or arise from the taxpayer's obligation. An individual cannot claim a tax deduction for the payment of the expenses of another individual. Note: One exception to this disallowance rule is the payment of medical expenses for a dependent. Such expenses are deductible by the pay or subject to the normal rules that limit the deductibility of medical expenses.

Chelsie is not entitled to a deduction on her tax return. The obligation is that of Elisa and Clyde since it related to their business.

c.Assume instead that Chelsie makes a gift of the $1,000 to Elisa and Clyde and they pay the $1,000 to Boyd.Can Elisa and Clyde deduct the $1,000 as part of the wage expense?

Yes

Can Chelsie (Elisa's mother) deduct the $1,000 payment to Boyd on her tax return?

No

• Correct

Answers: Yes; No. If Chelsie makes a gift of the $1,000 to Elisa and Clyde or had she loaned the $1,000 to them, then they could deduct it, assuming that they pay the $1,000 to Boyd. Deductions are not allowed for gifts; therefore, Chelsie may not deduct the $1,000 payment gift on her tax return.