Federal taxation

BACKGROUND:

The taxpayers, George A. Warden (social security number 333-33-3330) and Mary S.

Warden (social security number 444-44-4440) file a joint return. Both are 50 years old,

have good eyesight, and live with their three children, Edward, John and Ruth, at 789 N.

Code Drive, Chicago, Illinois 60699, (312) 679-9999. Mr. Warden wants to contribute $3

of his income tax to the Presidential Election Campaign Fund. Mrs. Warden elects not to

contribute.

The Wardens%u2019 son, Edward, is a junior in college and he is 20 years old. He worked

during the summer and earned $4,000. Their other son, John, is a 17-year old high school

student. He earned $3,600 during the summer and worked part-time during the remainder

of the year. Neither son had any additional income. Their daughter, Ruth, is eight years

old and an elementary school student. She had no earned or unearned income during the

year. In August, the Wardens paid $4,000 in tuition for their son, Edward, for the

academic period that started in September. Edward%u2019s social security number is 300-11-

0001, John%u2019s social security number is 300-22-0002, and Ruth%u2019s social security number is

300-33-0003.

The Wardens claim Mrs. Warden%u2019s mother, Grace D. Taylor, as a dependent under a

multiple-support agreement. The total support of Mrs. Taylor is $6,000, received from the

following three sources:

(1) $3,000 from Mary Warden,

(2) $1,000 from another daughter, Thelma Taylor, and

(3) $2,000 in social security benefits.

Mrs. Grace D. Taylor lived with the Wardens during all of 2012. Her social security

number is 400-44-0004. Thelma Taylor provides the Warden%u2019s with a written, signed

statement, that she will not claim her mother as a dependent in 2012. Thelma Taylor lives

at 1425 S. 62nd Street, Chicago, IL 60699, and her social security number is 500-55-

0005.

The Wardens use Trish Ford, a professional tax preparer, to prepare their income tax

return. Trish Ford%u2019s PTIN is P98765432, and she works for E&Z Tax Preparation (EIN

#36-0987654), which is located in a nearby suburb of Middle America (telephone

number 1-312-555-1040). However, the Warden%u2019s do not authorize her to discuss their

return with the IRS.

INCOME AND EXPENSES GENERALLY

During 2012, Mrs. Warden was employed as a salesperson by a publishing company. Her

Form W-2 for 2012 reports the following:

Box 1. Wages, tips and other compensation $75,000

Box 2. Federal income tax withheld $4,950

Box 4. Social security tax withheld $4,650

Box 6. Medicare tax withheld $1,088

Box 17. State income tax $2,250

Mrs. Warden is not covered by her employer%u2019s retirement plan. In addition, Mr. Warden

is a self-employed individual who does not maintain a Keogh or a SEP plan. Mrs.

Warden made a $1,500 contribution to a traditional IRA and a $2,000 contribution to a

Roth IRA in 2012. Mr. Warden decided against making a contribution to a traditional

IRA.

The Wardens received a $30 state income tax refund. They itemized in the prior year and

elected to take the state income tax as a deduction. The Wardens also received a $20

federal income tax refund.

Form 1040, Schedule A

The Wardens made federal estimated tax payments of $2,000 for 2012.

The Wardens incurred the following medical expenses during 2012:

%u2022 prescription drugs, $1,000;

%u2022 doctor bills, $3,550;

%u2022 hospital bills, $1,750;

%u2022 transportation, $100; and

%u2022 eyeglasses, $500.

In addition, Mr. Warden, who is self-employed, paid $3,750 in premiums for health

insurance coverage for himself and his family.

The Wardens paid their 2011 real estate taxes of $1,810 due on July 1, 2012.

In addition, they sold their residence on September 13, 2012. They allowed the buyer a

credit equal to 70% of the estimated real estate taxes of $2,000 for 2012. The real estate

taxes on the new property they purchased on May 1, 2012, are not payable until 2013.

There was no taxable gain on the sale of their prior residence.

Mr. and Mrs. Warden paid $3,878 in deductible home mortgage interest to a bank. They

also paid $3,000 in points when they purchased their new home.

They paid the following personal interest in 2012:

%u2022 $600 to finance Mrs. Warden%u2019s car, and

%u2022 $400 in credit card interest.

The Wardens gave $1,500 in cash to various recognized charities; no individual gift was

$250 or more; all charities sent an acknowledgment of the contribution.

Form 2106

Mrs. Warden incurred employee business expenses in connection with her occupation as

salesperson for the publishing company. On January 3, 2012, she purchased a new car

that was used primarily for business reasons. The car cost $19,500, and she paid $500 in

sales tax. During 2012, the car was driven a total of 20,000 miles by Mrs. Warden. Of

those miles, 16,600 were business related. Mrs. Warden drove 1,250 miles while

commuting (five-mile daily roundtrip commute), and 2,150 miles for personal purposes.

Mrs. Warden depreciates the car using a five-year MACRS recovery period, the 200%

declining-balance method, and the half-year convention. However, it should be noted that

depreciation on the car is limited because of the %u201Clisted property%u201D rules. Mrs. Warden%u2019s

gasoline, oil and insurance expenses on the car amounted to $4,750. She paid $600 in

interest on the installment loan incurred to purchase the car. She also paid $50 for

business parking fees and $75 for a car rental while away from home. Mrs. Warden elects

to claim the actual automobile-related expenses.

Assume the answers for Form 2106, Lines 18, 19, 20 and 21 are %u201CYes.%u201D

Mrs. Warden elected not to claim any Code Sec. 179 deduction or additional bonus

depreciation on the car in 2012.

Mrs. Warden incurred the following other business expenses:

%u2022 meals and entertainment, $1,500;

%u2022 airfare, $233;

%u2022 gifts to customers, $150; and

%u2022 business seminar, $60.

Mrs. Warden received $5,000 as a car expense reimbursement from her employer under a

plan that required her to account for the expenses. The $5,000 was not reported on her

Form W-2. Mrs. Warden was not reimbursed for her other business expenses.

The Wardens paid $500 for the preparation of their 2011 tax return (including $200 for

the preparation of Schedule C, Profit or Loss from Business for George Warden%u2019s

furniture business), $50 for the rental of a safe deposit box where they stored their

securities, and $350 for investment publications.

Form 1040, Schedule B

During 2012, the Wardens received $500 in interest from the Heartland National Bank

and $150 as nominees from the Third National Savings and Loan. They received $200 in

interest from tax-exempt bonds issued by the state of Illinois.

The Warden%u2019s received the following qualified dividends: $400 from E&Z Tax

Preparation, Inc., $300 from Secure Money Market Fund, and $250 from Rapid Growth

Mutual Fund. They also received a $100 capital gain distribution from Rapid Growth. In

addition, the Warden%u2019s received $700 in nonqualified foreign corporation dividends from

Consolidated Tapioca, and paid foreign taxes of $10 to various countries in connection

with this investment. The responses to the questions on Part III of Schedule B are %u201CNo.%u201D

Form 1040, Schedule D

During 2012, the Wardens sold the following capital assets:

(1) On February 2, 100 shares of Ahab Inc. were sold for $1,000. They had been

purchased on November 12, 2010 for $2,500.

(2) On November 5, 200 shares of Pequod Inc. were sold for $5,000. They had

been purchased on January 5, 2011 for $2,000.

(3) On December 4, 100 shares of Squall Inc. were sold for $10,000. They had

been purchased on January 4, 2001 for $4,000.

(4) On December 10, 200 shares of Kismet Inc. were sold for $5,000. They had

been purchased on September 5, 2005 for $2,000.

(5) On December 15, a number of gold coins were sold for $2,000. The coins had

been purchased on October 15, 2004 for $3,000.

Form 1040, Schedule E

Mr. and Mrs. Warden own and rent a brick two-flat apartment building located at 12

West 5th Ave., Chicago, Illinois 60626. The apartment building is not used for personal

purposes by either the Wardens or members of their family. Mr. Warden actively

participates in the operation of the building. The Wardens received rents of $12,000 in

2012. Their expenses are as follows:

cleaning and maintenance, $2,500;

mortgage interest, $4,000;

repairs, $750;

advertising, $500

insurance, $1,000 and

real estate taxes, $1,250.

The current depreciation figure, taken from the Wardens%u2019 work papers (not reproduced) is

$3,000.

Form 2441

During 2012, the Wardens%u2019 daughter, Ruth, attended two child care centers. They were:

Happy Day Care, 4210 W. Maple, Chicago, Illinois 60699, whose identification number

is 36-0987654; and Greenfields Day Care, 901 N. Ash, Chicago, Illinois 60699, whose

identification number is 36-1234567. The Wardens paid $3,720 to Happy Day Care and

$1,860 to Greenfields Day Care. The Wardens did not receive employer-provided

dependent care benefits.

BUSINESS INCOME

Form 1040, Schedule C

Mr. Warden operated Interiors Unlimited, selling home furnishings at retail, as a sole

proprietor during the entire year. The business address is 45 Boswell Blvd., Villa Park,

Illinois 60181. His employer identification number is 36-3456789. The business code is

442200. In order to clearly show business income, Mr. Warden maintains an inventory at

cost and he uses the accrual method of accounting for his sales and purchases.

Total gross receipts of the business were $127,247 and returns and allowances amounted

to $1,500.

The business books showed the following information:

Inventory at beginning of year (valued at cost) . . . . . . $35,000

Merchandise purchased . . . . . . . . . . . . . . . . . . . . . . . . 70,000

Inventory at end of year . . . . . . . . . . . . . . . . . . . . . . . . 22,000

Truck expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550

Other interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300

Rent (property) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,800

Repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000

Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,541

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,450

Utilities and telephone . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,240

Legal and accounting

(includes $200 of tax preparation fees) . . . . . . . . . . . . 400

Office expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,858

Travel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400

Meals and entertainment . . . . . . . . . . . . . . . . . . . . . . . . 1,040

Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 330

FARM INCOME AND EXPENSES

Form 1040, Schedule F

Mr. Warden owned and operated a farm in Illinois. The Principal Agricultural Activity

Code for this farm is 112111, and the principal product raised is beef cattle. Mr. Warden

utilizes the cash basis to report farm income and expenses. His books and records show

the following information:

Farm income Amount

Livestock sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $29,500

Cooperative distributions ($30 nontaxable) . . . . . . . . . . . . 150

Farm expenses Amount

Livestock purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000

Depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000

Feed purchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750

Freight and Trucking. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400

Laborhired. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Other Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

Pasturerentals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450

Veterinary fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500

Assume that Mr. Warden%u2019s basis in the livestock sold during 2012 was $19,500.

ASSIGNMENT:

You are to Prepare the Wardens%u2019 2012 Form 1040 Joint Individual Tax Return, including

Schedules A, B,, C, D, E, and F and Forms 2106, and any other form which you think is

appropriate.