Problem 1

David R. and Sheri N. Johnson (ages 45 and 46) are married and live at 641 Cody Way, Casper, WY 82609. David is a consulting engineer, while Sheri is a paralegal. They file a joint return and use the cash basis for tax purposes.

• 1. Trained as a mining engineer, David has developed considerable expertise in the treatment and disposition of waste material. He also is well versed in the federal and state requirements for land reclamation projects. David maintains a consulting practice through which he advises clients on these matters. David's business activity code is 541990. Most of his clients are small and medium-size mine owner/operators located in Wyoming and contiguous states (e.g., Montana, Idaho, Utah). Usually, David is retained by a client on a contract-fee basis and is reimbursed for all out-of-pocket expenses. In performing his services, David usually visits the job site and later submits his recommendations in a written report along with a statement for his services and expenses. David received the following amounts from his consulting business in 2012:

• 2. The following fees for services rendered to mining companies are not included in the receipts listed in item 1 above

David did not incur travel expenses in any of these engagements (i.e., the work was done in his office). As Cormorant Mining is in bankruptcy, David does not expect to collect any of this fee.

• 3. Other expenses paid by David in 2012 relating to his practice are listed below.

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• 4. David operates his consulting business out of an office in his home. Twenty percent of the 3,000-square-foot living area is devoted to the office. David inherited the home on Cody Way from his father, who died on June 6, 2003, when it had a fair market value of $400,000 ($40,000 of which was allocated to the land). The Johnsons moved into the home in 2003, and David began using his home office in the same year. The home's current fair market value is $500,000 ($50,000 allocated to the land). County land records reflect that David's father bought the land in 1969 for $6,000 and built the house in 1973 at a cost of $60,000. David depreciates the business use of his home using MACRS, treating the home as 39-year nonresidential reality. Additional information regarding the properly for 2012 follows:

The properly taxes and mortgage interest paid in 2012 on the home are listed in item 15 below. In addition to the repairs and maintenance noted above, David had the office repainted at a cost of $1,200. The furniture in the office, including business equipment (e.g., computer, fax machine, copier), was properly expensed in the year bought and has a zero basis. However, on March 5, 2012, David purchased a heavy-duty, fire-resistant file cabinet with security-vault features for $4,800. He made the acquisition to safeguard and maintain the privacy of client data. If possible, David prefers to avoid capitalizing and depreciating the cabinet.

• 5. On February 4, 2011, David paid $41,000 (including sales tax) for an Infiniti crossover SUV (gross weight under 6,000 pounds), which he uses 90% of the time for business. No trade-in was involved, and he did not claim any § 179 expensing of the cost. Under the actual operating cost method, he depreciates the SUV using MACRS (half-year convention). [Hint. See Table 3 in the Instructions to Form 4562.] His operating expenses for the Infiniti for 2012 are as follows:

During business use, David received three moving traffic violations (total fines of $680) and incurred tolls and parking charges of $440. The Infiniti was driven a total of 14,500 miles during 2012 (mileage was incurred evenly during the year).

• 6. Sheri is a licensed paralegal and is employed on a part-time basis by several local attorneys. She commuted to work using the family Suburban for a total of 813 miles and paid parking fees of $310. Her earnings and job-related expenses are summarized below.

• Sheri purchased the laptop computer on March 12 and uses it 80% of the time for business. The correspondence course is required continuing education so she can retain E-2E-3her license. Sheri is considering going to law school, so she attended a series of LSAT preparation sessions at a cost of $350. Because Sheri is a part-time employee, she is not covered by any of her employers' medical or retirement plans. During 2012, however, she contributed $5,000 to a traditional IRA that she established several years ago. The Johnsons use the automatic mileage method to calculate any tax deductions to which they are entitled for use of the Suburban.
• 7. With funds received from the settlement of his father's estate, David purchased rental properly at 4620 Cottonwood Lane. Of the $250,000 purchase price, $30,000 was allocated to the land. After an $80,000 renovation to the house (e.g., new flooring, roof, heating unit), the properly was rented beginning February 1, 2006. In 2010, the Johnsons decided that their investment would be more marketable if the house was rented as furnished. Consequently, in May of that year, they spent $38,000 on new furniture (including drapes, carpeting, and appliances). Under the current lease agreement, the properly rents for $2,200 a month (payable at the beginning of each month) with utilities not included. Information regarding the properly for 2012 appears below.

The rent received includes $2,200 for January 2013. The tenants prepaid the rent in mid-December because they went on vacation during the Christmas/New Year holidays. In addition to the properly taxes listed above, David paid a special tax assessment of $2,400 to the city of Casper for repaving the street in front of the properly. The Johnsons use MACRS to depreciate the rental home and the furnishings within it (assume half-year convention for the personally).

• 8. The Johnsons acquired 1,000 shares of common stock in Cormorant Mining on March 7, 2011, to hold for investment purposes. David performed services for the company in late 2010, submitting a bill for $3,900. Because Cormorant was experiencing cash-flow problems at the time, David accepted the stock as payment for his services. Unfortunately, Cormorant is currently in bankruptcy (see item 2 above), and expectations are that the shareholders will not recover anything on their stock investments. The stock is not publicly traded.
• 9. On March 10, 1994, David's father gave the Johnsons a plot of land located in Teton County (WY) as an anniversary present. It had a value of $150,000 at the time of the gift (no gift tax was due on the transfer). The land had been purchased by David's father on June 1, 1984, for $50,000. In December 2011, a real estate developer contacted the Johnsons and offered $800,000 for the properly. After considerable negotiation, the following transaction took place on March 4, 2012: the Johnsons transferred the Teton plot in return for $8,000 in cash and four city lots in Laramie (WY) worth $792,000. The Johnsons considered the city lots to be a good investment because they are located near the state university. All closing costs and legal fees were absorbed by the real estate developer.
• 10. David inherited an antique gun collection from his father when he died-mainly large caliber rifles used for buffalo hunting. Although David has no idea what his father's cost basis was in these guns, the collection had a date-of-death value of $22,000. Concerned about the maintenance and security of the collection, David sold it to a dealer for $29,000 on July 10, 2012.
• 11. On July 12, 1998, using $50,000 of funds she had received from an aunt's life insurance policy, Sheri purchased grazing land in Converse County (WY). On August 2, 2011, she sold the land to a local rancher for $75,000. Under the terms of the sale, Sheri received a down payment of $15,000 and 10 annual notes of $6,000 each. Sheri is also to receive simple interest of 8% on the outstanding principle balance each year. On August 4, 2012, Sheri collected $10,800 ($6,000 on the note and $4,800 of interest) on the maturity of the first note.
• 12. Although the Johnsons had several Schedule D transactions during 2011, they ended up with a net short-term capital loss of $7,000. Of this loss, $3,000 was deducted in 2011, and $4,000 carried over to 2012.

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• 13. For several years, Sheri's widowed mother, Vivian Olson, has lived with the Johnsons and has been claimed by them as a dependent. On December 30, 2011, Vivian suffered a heart attack. After six days in the ICU of a local hospital, Vivian died. In early February 2012, the Johnsons paid the following expenses related to Vivian:

Fortunately, the balance of Vivian's medical expenses ($11,900) was covered by insurance. Besides personal and household effects, Vivian's major asset was life insurance. As the designated beneficiary of the policy, Sheri received $20,000 of death benefits on March 13, 2012.

• 14. Besides the items already mentioned, the Johnsons had the following receipts during 2012:

• The yard sale involved used furniture, appliances, books, toys, and other household goods, having an estimated original cost value of $1,800. In connection with her jury duty assignment in June, Sheri drove the Suburban 40 miles and incurred expenses of $30 for parking and $45 for meals.
• 15. In addition to the items already noted, the Johnsons had the following expenditures for 2012:

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The Johnsons drove the Suburban 420 miles to various medical and dental appointments. Wyoming has no state or local income tax but does impose a general sales tax. The county in which they live imposes an additional local sales tax of 1%. Although they do not keep track of their sales taxes, they purchased a camper for $40,000 in May 2012. The sales tax on this purchase was $1,600.

• 16. Besides Vivian (see item 13), the Johnsons' household includes two daughters, Meredith (age 19) and Kirby (age 18), and one son, Toby (age 17). Kirby and Toby are full-time students in high school. Meredith graduated a year ago and earned $9,000 working part time during 2012. She deposited these earnings in a savings account, hoping someday to attend college.
• 17. For tax year 2011, the Johnsons had an overpayment of $150, which they applied toward their 2012 income tax. Sheri's income tax withholdings for the year are $5,100, and the Johnsons made federal quarterly tax payments totaling $16,000 ($4,000 each installment).
• 18. Relevant Social Security numbers are noted below.

Requirements

Prepare an income tax return (with appropriate supporting forms and schedules) for the Johnsons for 2012. In doing this, utilize the following guidelines:

• Make necessary assumptions for information not given but needed to complete the return.
• The taxpayers are preparing their own return (i.e., no preparer is involved).
• The taxpayers have the necessary written substantiation (e.g., records, receipts) to support the transactions involved.
• If any refund is due, apply it toward next year's taxes.
• The Johnsons do not wish to contribute to the Presidential Election Campaign Fund.

Problem 2

Carrie A. Morgan, age 45, is single and lives with her dependent mother at 426 Grouse Avenue, Allentown, PA 18105. Her social security number is 111-11-1111.

• 1. Carrie is a licensed hairstylist and operates her own business. Located at 480 Laurel Street, Allentown, PA 18105, the business is conducted under the name of "Carrie's Coiffures." Carrie's business activity code is 812112. In addition to 10 workstations (i.e., stylist chairs) and a small reception area, the shop has display and storage areas for the products Carrie sells (see item 2 below). During the year, Carrie leased nine of the stations to other hairstylists. As is common practice in similar businesses in the area, the other stylists are considered to be self-employed. In fact, the IRS sanctioned the self-employment classification for the stylists in an audit of one of Carrie's prior tax returns. Each stylist pays Carrie a fixed rent for the use of a workstation, resulting in $68,000 of rents received during 2012. From her own station, Carrie earned $44,000 (including tips of $12,000) for the styling services she provided to her own clients.
• 2. Carrie's Coiffures is the local distributor for several beauty products (e.g., conditioners, shampoos) that cannot be purchased anywhere else. Carrie buys these items from the manufacturers and sells them to regular patrons, walk-in customers, and other beauticians (including those who lease chairs from her). Carrie's Coiffures is also known for the selection and quality of its hairpieces (i.e., wigs, toupees). Through the shop, Carrie made the following sales during the year:

•    Although Carrie operates her business on a cash basis, she maintains inventory accounts for the items she sells as required by law. Relevant information about the inventories (based on lower of cost or market) is summarized below.

   Carrie's purchases for 2012 were $30,500 of hairpieces and wigs and $26,100 of beauty products.

• 3. Carrie's Coiffures had the following operating expenses for 2012:

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   As Carrie prefers to avoid employer-employee arrangements and the payroll tax complexities, she retains outside agencies to handle her accounting and janitorial needs.

• 4. In early 2012, Carrie decided to renovate the waiting room. On May 10, she spent $10,400 for new chairs, a sofa, various lamps, coffee bar, and other furnishings. Carrie follows a policy of claiming as much depreciation as soon as possible. The old furnishings were thrown away or given to customers. For tax purposes, the old furnishings had a zero basis.
• 5. Carrie's Coiffures is located in a building Carrie had constructed at 480 Laurel Street in March 1998. The shop was built for a cost of $300,000 on a lot she purchased earlier for $35,000. Except for a down payment from savings, the cost was financed by a 20-year mortgage. For tax purposes, MACRS depreciation is claimed on the building. During 2012, the following expenses were attributable to the properly:

   In May (after her accident settlement discussed in item 11 below), Carrie paid the balance due on the business mortgage. To do so, she incurred a prepayment penally of $4,400. Prior to paying it off, she paid regular interest on the mortgage in 2012 of $6,000.

• 6. In February 2012, Carrie's Coiffures was cited by the city for improper disposal of certain waste chemicals. Carrie questioned the propriety of the proposed fine of $2,000 and retained an attorney to represent her at the hearing. By pleading nob contendere, the attorney was able to get the fine reduced to $500. Carrie paid both the fine of $500 and the attorney's fee of $600 in 2012.
• 7. In August 2012, Carrie saw an ad in a trade publication that attracted her attention. The owner of a well-respected styling salon in Reading (PA) had died, and his estate was offering the business for sale. Carrie traveled to Reading, spent several days looking over the business (including books and financial results), and met with the executor. Carried treated the executor to dinner and a music concert. Immediately after the concert, Carrie made an offer for the business, but the executor rejected it. Her expenses in connection with this trip were as follows:

• 8. In March 2011, Joan Myers, one of Carrie's best stylists, left town to get away from a troublesome ex-husband. In order to help Joan establish a business elsewhere, Carrie loaned her $7,000. Joan signed a note dated March 3, 2011, that was payable in one year with 6% interest. On December 30, 2012, Carrie learned that Joan had declared bankruptcy and was awaiting trial on felony theft charges. Carrie never received payment from Joan, nor did she receive any interest on the loan.
• 9. At Christmas, Carrie gave each of her 35 best customers a large bottle of body lotion. Each bottle had a wholesale cost to Carrie of $12 but a retail price of $24. Carrie also spent $3 to have each bottle gift wrapped. (Note: The lotion was special order merchandise and was not part of the business's inventory or purchases for the year-see item 2 above.) She also gave each of the nine stylists who leased chairs from her a basket of fruit that cost $30 (not including $5 delivery cost).
• 10. In March 2012, the Pennsylvania Department of Revenue audited Carrie's state income tax returns for 2009 and 2010. She was assessed additional state income tax of $340 for these years. Surprisingly, no interest was included in the assessment. Carrie paid the back taxes promptly.
• 11. On a morning walk in November 2011, Carrie was injured when she was sideswiped by a delivery truck. Carrie was hospitalized for several days, and the driver of the truck was E-6E-7ticketed and charged with DUI. The owner of the truck, a national parcel delivery service, was concerned that further adverse publicity might result if the matter went to court. Consequently, the owner offered Carrie a settlement if she would sign a release. Under the settlement, her medical expenses were paid and she would receive a cash award of $200,000. The award specified that the entire amount was for physical pain and suffering. Because she suffered no permanent injury as a result of the mishap, she signed the release in April 2012 and received the $200,000 settlement.
• 12. In January 2012, Carrie was contacted by the state of Pennsylvania regarding a tract of land she owned in York County. The state intended to convert the property into a district headquarters, barracks, and training center for its highway patrol. Carrie had inherited the property from her father when he died on August 11, 2011. The property had a value of $140,000 on that date and had been purchased by her father on March 3, 1980, for $30,000. On July 25, 2012, after considerable negotiation and after the state threatened to initiate condemnation proceedings, she sold the tract to the state for $158,000. Since Carrie is not comfortable with real estate investments, she does not plan to reinvest any of the proceeds received in another piece of realty.
• 13. When her father died in 2011, Carrie did not know that he had an insurance policy on his life (maturity value of $50,000) in which she was named as the beneficiary. When her mother told her about the policy in July 2012, Carrie filed a claim with the carrier, Falcon Life Insurance Company. In August 2012, she received a check from Falcon for $51,500 (including $1,500 interest).
• 14. Upon the advice of a client who is a respected broker, Carrie purchased 1,000 shares of common stock in Grosbeak Exploration for $40,000 on March 4, 2012. In the months following her purchase, the share value of Grosbeak plummeted. Disgusted with the unexpected erosion in the value of her investment, Carrie sold the stock for $28,000 on December 23, 2012.
• 15. While on her way to work in 2011, Carrie was rear-ended by a hit-and-run driver. The damage to her Lexus was covered by her insurance company, General Casualty, except for the $1,000 deductible she was required to pay. In 2012, the insurance company located the driver who caused the accident and was reimbursed by his insurer. Consequently, Carrie received a $1,000 refund check from General Casualty in May 2012 to reimburse her for her $1,000 deductible.
• 16. After her father's death, Carrie's mother (Mildred Morgan, Social Security number 123-45-6789) moved in with her. Mildred's persistent back trouble made it difficult for her to climb the stairs to the second-floor bedrooms in Carrie's house. So Carrie had an elevator installed in her personal residence at a cost of $12,000 in January 2012. A qualified appraiser determined that the elevator increased the value of the personal residence by $7,000. The appraisal cost $400. The operation of the elevator during 2012 increased Carrie's electric bill by $300.
• 17. As a favor to a long-time client who is a drama professor at a local state university, Carrie spent a weekend as a stylist preparing hairdos for the key actresses in the annual Theater Department fund-raising event. The drama professor supplied all of the resources that Carrie needed to provide her services. Carrie estimates that she would have charged $800 for the services she donated to this charitable event.
• 18. In addition to the items already mentioned, Carrie had the following receipts during 2012:

• 8. In March 2011, Joan Myers, one of Carrie's best stylists, left town to get away from a troublesome ex-husband. In order to help Joan establish a business elsewhere, Carrie loaned her $7,000. Joan signed a note dated March 3, 2011, that was payable in one year with 6% interest. On December 30, 2012, Carrie learned that Joan had declared bankruptcy and was awaiting trial on felony theft charges. Carrie never received payment from Joan, nor did she receive any interest on the loan.
• 9. At Christmas, Carrie gave each of her 35 best customers a large bottle of body lotion. Each bottle had a wholesale cost to Carrie of $12 but a retail price of $24. Carrie also spent $3 to have each bottle gift wrapped. (Note: The lotion was special order merchandise and was not part of the business's inventory or purchases for the year-see item 2 above.) She also gave each of the nine stylists who leased chairs from her a basket of fruit that cost $30 (not including $5 delivery cost).
• 10. In March 2012, the Pennsylvania Department of Revenue audited Carrie's state income tax returns for 2009 and 2010. She was assessed additional state income tax of $340 for these years. Surprisingly, no interest was included in the assessment. Carrie paid the back taxes promptly.
• 11. On a morning walk in November 2011, Carrie was injured when she was sideswiped by a delivery truck. Carrie was hospitalized for several days, and the driver of the truck was E-6E-7ticketed and charged with DUI. The owner of the truck, a national parcel delivery service, was concerned that further adverse publicity might result if the matter went to court. Consequently, the owner offered Carrie a settlement if she would sign a release. Under the settlement, her medical expenses were paid and she would receive a cash award of $200,000. The award specified that the entire amount was for physical pain and suffering. Because she suffered no permanent injury as a result of the mishap, she signed the release in April 2012 and received the $200,000 settlement.
• 12. In January 2012, Carrie was contacted by the state of Pennsylvania regarding a tract of land she owned in York County. The state intended to convert the property into a district headquarters, barracks, and training center for its highway patrol. Carrie had inherited the property from her father when he died on August 11, 2011. The property had a value of $140,000 on that date and had been purchased by her father on March 3, 1980, for $30,000. On July 25, 2012, after considerable negotiation and after the state threatened to initiate condemnation proceedings, she sold the tract to the state for $158,000. Since Carrie is not comfortable with real estate investments, she does not plan to reinvest any of the proceeds received in another piece of realty.
• 13. When her father died in 2011, Carrie did not know that he had an insurance policy on his life (maturity value of $50,000) in which she was named as the beneficiary. When her mother told her about the policy in July 2012, Carrie filed a claim with the carrier, Falcon Life Insurance Company. In August 2012, she received a check from Falcon for $51,500 (including $1,500 interest).
• 14. Upon the advice of a client who is a respected broker, Carrie purchased 1,000 shares of common stock in Grosbeak Exploration for $40,000 on March 4, 2012. In the months following her purchase, the share value of Grosbeak plummeted. Disgusted with the unexpected erosion in the value of her investment, Carrie sold the stock for $28,000 on December 23, 2012.
• 15. While on her way to work in 2011, Carrie was rear-ended by a hit-and-run driver. The damage to her Lexus was covered by her insurance company, General Casualty, except for the $1,000 deductible she was required to pay. In 2012, the insurance company located the driver who caused the accident and was reimbursed by his insurer. Consequently, Carrie received a $1,000 refund check from General Casualty in May 2012 to reimburse her for her $1,000 deductible.
• 16. After her father's death, Carrie's mother (Mildred Morgan, Social Security number 123-45-6789) moved in with her. Mildred's persistent back trouble made it difficult for her to climb the stairs to the second-floor bedrooms in Carrie's house. So Carrie had an elevator installed in her personal residence at a cost of $12,000 in January 2012. A qualified appraiser determined that the elevator increased the value of the personal residence by $7,000. The appraisal cost $400. The operation of the elevator during 2012 increased Carrie's electric bill by $300.
• 17. As a favor to a long-time client who is a drama professor at a local state university, Carrie spent a weekend as a stylist preparing hairdos for the key actresses in the annual Theater Department fund-raising event. The drama professor supplied all of the resources that Carrie needed to provide her services. Carrie estimates that she would have charged $800 for the services she donated to this charitable event.
• 18. In addition to the items already mentioned, Carrie had the following receipts during
• 2012:

Requirements

Prepare an income tax return (with appropriate schedules) for Carrie for 2012. In doing this, use the following guidelines:

• Make necessary assumptions for information not given in the problem.
• Carrie has itemized deductions ever since she became a homeowner many years ago.
• The sales tax option was not chosen in 2011, and Carrie had no major purchases that qualify for the sales tax deduction in 2012.
• Carrie has substantiation (e.g., records, receipts) to support the transactions involved.
• If a refund results, Carrie wants it sent to her.
• Carrie is preparing her own return (i.e., no preparer is involved).
• Carrie does not wish to contribute to the Presidential Election Campaign Fund.

Part I

For the Part I assignment, you are asked to use the introductory sentence about the tax payer and complete paragraph items 14 and 16. You will also use item 18 for needed Social Security numbers. Do not do additional work from any other paragraph.

Determine the forms to be completed. Once completed, save your form(s) as Your Last Name - formname (e.g., Smith-f2106.pdf). Submit your assignment to the Week 3 Assignments Dropbox.

Note: Optional Tax Software: Please note that DeVry does not provide tax software to complete the project. Using software to complete the project is optional, not required. The forms are provided in Doc Sharing for your use. Students who desire to use the software to complete the project have the following options:

H&R Block At Home: The software is included with the purchase of the hard copy of the textbook. You may use the software disk provided and follow the installation instructions. You may review the student companion website or contact the publisher's customer service to obtain information regarding the purchase of the H&R Block At Home software online. If purchased and used to complete your project assignment, you will need to submit the file created by the software.

• Save your work as an H&R Block At Home file.
• Save the problem as a PDF file.

TurboTax: If you purchased TurboTax and completed your assignment as a TurboTax file, you will need to submit your assignment as a PDF file before submitting it to your instructor.

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