Assignment

I. Carol is a single mother who owns a wholesale auto parts distributorship. The business is organized as a sole proprietorship. Her business has advanced, and she can no longer devote the time necessary to do her own tax return. Because she always has prepared her own return, Carol is familiar with most tax rules applicable to her business and personal affairs. However, she has come to you for advice with respect to a number of items she paid during the current year. You are to determine whether she can take a deduction for the expenditures in the current year.

a. Carol purchased a small building on March 2 to use as a warehouse for her auto parts inventory. To purchase the building, she borrowed $180,000 on a 30-year loan and paid $20,000 in additional cash. Carol also incurred $3,200 in legal and other fees to purchase the building. The bank charged her $3,600 in points (prepaid interest) to obtain the loan. After acquiring the building, Carol spent an additional $25,000 to renovate it for use as a warehouse. The $25,000 included $8,000 for painting.

b. Carol had her office building painted at a cost of $14,000 and paid $6,000 to have it landscaped. She paid for the building renovation in part a and the office building work by borrowing $60,000 on April 1 at 7% interest. (See part f for details of the interest payments.)

c. On April 1, Carol prepaid a 1-year fire insurance policy on her 2 buildings. The policy cost $1,500, and the insurer required the prepayment. On September 1, Carol prepaid a $5,000, 2-year maintenance contract on the buildings.

d. Carol started a self-insured medical reimbursement plan for her employees this year. Based on actuarial assumptions, she deposited $13,500 in a fund to pay employees' medical expenses. Actual payments from the fund totaled $11,200.

e. Carol purchased a new automobile costing $32,000. She can document that her business use of the automobile came to 90% and that her out-of-pocket operating costs totaled $3,600.

f. Carol paid the following interest on business-related loans:

Warehouse $15,300
Office building 4,000
Renovation loan 5,400

The renovation loan was for $60,000. Because she spent only $45,000 renovating the new building and painting and landscaping the old one, she used the additional $15,000 to purchase city of Seattle bonds with a yield of 6%.

g. Carol became active in politics and contributed $1,000 to the presidential campaign of an independent candidate. She made the contribution because she believed that, if elected, the candidate would institute policies beneficial to her business. The candidate lost the election and immediately started a grassroots lobbying organization. The purpose of the organization is to keep track of elected officials' campaign promises and report to the public when they vote contrary to their stated campaign promises. Carol paid $1,600 in dues to join the lobbying organization.

h. Carol's oldest son began college during the current year. She paid his tuition and living expenses, a total of $13,300, out of the company's checking account. During the summer, her son worked for the business, and Carol paid him $4,300, the same amount she paid other college students working during the summer. Because she consults her son from time to time on the operation of the business, she thinks that at least some of the $13,300 should be deductible.

i. Carol has always itemized her deductions. This year, her mother and father retired and could no longer afford the mortgage interest and property taxes on their home. Rather than have them sell the house, Carol made the payments for them. They received a statement from their bank indicating that a total of $8,125 in mortgage interest and taxes were paid in the current year. Carol knows that mortgage interest and property taxes are deductible as itemized deductions and would like to add them to her personal interest and property tax payments.

j. Because of the success of her business, Carol has received many offers to invest in various business ventures. One offer was to establish a chain of nursing homes in Florida. Carol spent two weeks in Florida evaluating the prospects of the proposed venture and incurred costs of $2,100. After careful consideration, she decided the venture was too risky and decided not to expand into the health-care business.

II. Rufus and Rhonda are a married couple with 3 dependent children, all under 16 years of age. Rufus, 46, is an executive with Plowshare Corporation. Rhonda, 39, is a self-employed attorney.

Rufus receives an annual salary of $78,000. He participates in Plowshare's qualified pension plan by contributing 4% of his annual salary, which is matched by Plowshare. Rufus also receives group term life insurance at twice his annual salary. The coverage costs Plowshare $2,100. All employees are covered by a medical insurance policy. (Rufus's policy costs $2,300.) He also participates in the company's flexible benefits plan by paying $200 per month into the plan. During the year, Rufus submits claims totaling $1,800 to the plan. An additional benefit that only top-level executives such as Rufus enjoy is the payment of $2,300 in country club dues by Plowshare. Although Rufus occasionally entertains clients at the club, his primary use of the facility is personal. Rhonda bills clients a total of $125,000 for services rendered during the current year. She receives $17,000 in payments from billings in prior years and $87,000 from current-year billings. Rhonda pays the following expenses related to her legal practice:

Office rent                                                                           $14,400
Secretary's salary                                                                 24,000
Withholdings from secretary's salary
Federal income taxes                                             $2,250
State income taxes                                               520
Social Security taxes                                             1,836        4,606
Matching Social Security tax payment                                      1,836
Entertainment costs                                                              4,000
Seminar costs                                                                       1,155
Insurance on building-2 years prepaid on August 1                   1,600
Supplies                                                                               2,250
Bar association dues                                                              600
State licensing fee                                                                  725
Automobile costs                                                                   4,700
Business gifts                                                                        850
Salary paid to Rhonda                                                             64,000
Salary paid to Rhonda's son                                                    2,500

In addition to these out-of-pocket costs, Rhonda determines that $2,400 in accounts receivable from previous years' billings are uncollectible.
The entertainment costs consist of the following:

Dues to social club $1,000
Meals while discussing cases with clients 1,200
Open house 1,800

Rhonda has records that show that she uses the club 70% of the time for entertainment directly related to business, 10% for entertainment associated with her business, and 20% for personal purposes. The open house costs consist of $1,400 for food and $400 for a jazz combo at a reception she hosted for clients when she moved into her new offices this year. Rhonda uses her automobile extensively in her business. She keeps a log to record business miles and related costs. Her records show that she drove 10,000 business miles and 3,000 personal miles during the current year. In past years, she had always kept track of her business miles but failed to keep an accurate record of her actual costs. Accordingly, her records indicate that she has never depreciated any of the $26,000 cost of the automobile she purchased 2 years ago-she has used the standard mileage rate method. Every year, Rhonda gives her top 8 clients a gift to thank them for their support of her practice. This year, she gives each client a marble paperweight engraved with the client's name. Each paperweight costs $75 plus $5 for engraving and $5 for gift wrapping.

The seminar costs relate to a 3-day meeting in New York on a legal topic involving her biggest client. Because of a special airline promotion, she takes along her 16- year-old son free. However, she has to pay $200 per night for her hotel room instead of the $175 per night single rate. A summary of the seminar costs is as follows:

Airfare $325
Lodging (3 nights @ $200 each) 600
Meals (including $80 for her son) 200
Taxi to and from the airport 30

Rhonda pays the $2,500 salary to her son for cleaning up after the open house reception. Although she could hire a service to do the job for $400, he needs the money to buy a used motorcycle. Rufus is hit by a car one morning while he is out jogging. The driver is at fault, and his insurance company pays Rufus $8,000 for his pain and suffering and $13,000 of his $15,500 medical expenses. The remaining medical expenses are paid by Plowshare's medical insurance policy. Rufus also receives $2,650 in disability pay from the Plowshare policy for the time he misses from work recovering from the injury. Rufus and Rhonda have the following investment-related items during the current year:

Interest on savings account $ 1,900
Interest on Puerto Rico development bonds 7,000
Cash dividends on stock 3,200
Stock dividend shares
(300 shares received when the market value of
the stock was $40 per share) 12,000

Early in the year, Rhonda inherits 900 shares of stock from her grandmother. The total value of the shares is $16,000. Later in the year, the stock value begins to fall rapidly, and she sells the shares at a $4,500 loss.

Rufus and Rhonda own a cabin in the mountains. They use it on weekends and for short holidays and rent it out whenever they can. During the current year, they use the cabin 25 days and rent it out 75 days. Details on the cabin income and expenses are as follows:

Rental income $10,000
Mortgage interest 9,000
Property taxes 2,300
Utilities and maintenance 840
Depreciation (unallocated) 7,500

In addition, Rufus and Rhonda have $19,220 in other allowable itemized deductions. Based on the information provided, calculate Rufus and Rhonda's taxable income and their tax liability. Assume that they are cash basis taxpayers and want to be as aggressive as possible in taking their allowable deductions.

III. Calzone Trucking Company is a corporation that is 100% owned by Fred Calzone. Before he incorporated in 2010, Fred had operated the business as a sole proprietorship. The taxable income (loss) of Calzone for 2010 through 2012 is as follows:

                                    2010        2011         2012
Taxable income (loss)   $32,000   $(64,000)   $18,000

The 2012 taxable income includes a net long-term capital gain of $4,000. Calzone Trucking's 2013 operating income is $43,300 before considering the following transactions:

a. hailstorm caused part of the roof of the truck barn to collapse. A truck inside sustained damage from the falling debris. The truck barn had a fair market value of $59,000 before the damage and an adjusted basis of $35,000. Repairs to the roof cost $13,200, of which $9,700 was reimbursed by insurance. The truck, which had an adjusted basis of $35,000, was worth $62,000 before the damage and had a fair market value after the damage of $37,000. Calzone Trucking's insurance company paid $16,600 for the damages.

b. Another truck was totally destroyed when its brakes failed and it plunged off a cliff. Fortunately, the driver was able to jump from the truck and escaped unharmed. The truck, which had an adjusted basis of $24,000, was worth $30,000 before the accident. Calzone received $13,700 from its insurance company for the destruction of the truck. In addition, the company was cited for failure to properly maintain the truck and paid a $7,250 fine to the state trucking commission.

c. Calzone sold equipment that had become obsolete for $10,800. The equipment had cost $28,000, and depreciation of $15,400 had been taken on it before the sale.

d. Calzone sold stock it owned in two other companies. Retro Corporation stock, which had cost $21,400, sold for $36,200. Shares of Tread Corporation stock with a cost of $62,100 sold for $31,700. Both stocks had been purchased in 2009.

e. Fred's son wanted to start a delivery business. To help his son out, Fred sold him one of Calzone's used trucks for $8,000. The truck had a fair market value of $15,200 and an adjusted basis of $10,100 at the date of the sale.

Calculate Calzone Trucking's 2013 taxable income. Indicate the amount and the effect of any carryforwards or carrybacks on Calzone Trucking's current, past, or future income.