Tax Return problem?

TAX RETURN PROBLEM 2 November 20, 2012 (60 points) Due December 10, 2012 Corinne Penrose (453-44-5321) and Norman Penrose (444-32-5890) live at 5755 Hastings Road, Santa Barbara, Ca. 90432. Corinne was born 7/1/1972. Norman was born 3/2/1960 She is employed as a teacher at Sherman Secondary School (EIN 33-534133). Her W-2 for 2011 shows wages of $37,631.15, federal income tax withheld of $2413.23, California State income taxes withheld of $923.53, FICA and Medicare tax were withheld at the appropriate rate. Norman is employed as an accountant at Kinsey Corporation (EIN 44-324351). His W-2 shows salary of $78,313.25, federal income tax withheld of $3713.74, California State income taxes withheld of $2012.35, social security and Medicare tax withheld based on the appropriate rate. They file a joint tax return. They contribute $3 to the presidential election return. On April 30, 2012 they file their 2011 tax return late. On May 20, 2011 they received a $531 refund of their 2010 Federal taxes which they applied to their 2011 estimated tax. They also received a California tax refund of $889.53 on May 1, 2011 for the 2010 year which they applied to their 2011 California estimated tax. In 2010 itemized deductions totaled $25,38.53, AGI was $79,312, California tax was $4923, and property taxes were $12,312. In 2011 they made estimated tax payments of $813 per quarter for federal taxes and $401 per quarter for state taxes. The payments were made on 4/21/2011, 7/15/2011, 9/01/2011 and 1/11/2012. On 1/24/2011 they paid the fourth quarter 2010 estimated Federal tax of $692. No fourth quarter payment was made in 2011 for 2010 California taxes. They have three children that they support. Neil (583-22-5787) was born 4-12-2000. He still lives at home with his parents and attends Dennis's Academy Day School. His parents pay $13,238 tuition for the year. Willis (524-31-2784) was born 4-1-2003 and Sharon (524-343591) was born 4/01/1989. The Penroses (EIN 53-413531) paid job-related child care expenses of $7352 ($2000 on behalf of Willis and $5352 on behalf of Neil) to Dennis Harris (782-312739). He lived with the family full-time. The Penroses did not withhold any taxes on behalf of Dennis Harris, but pay the \"nanny tax\" and file the appropriate forms with the 2011 tax return. No state unemployment taxes were due on behalf of Harris. Sharon Penrose was a senior at UCSD who lived at 11300 Western Road, Santa Barbara, 92031, where she was receiving a degree in economics. She spent vacations at home. In addition to the amount she earned from her mother's travel agency, she earned $5,312 from a part-time job at Greystone,Inc (EIN 33-444444). Her parents paid $6781, half of her tuition, directly to the University and gave her an addition $3300: of this amount she spent $1570 for school books and the $1730 remainder for pre-school for her son. Sharon paid $6781 of her own tuition. She received a 1098-T for the tuition paid. She received an ordinary dividend that was also qualified of $6882 from Crumbs Corp. on 9/25/2011. She spent all of her gross income in 2011. During the year she had $1338 Federal income tax withheld and $771 California income tax withheld, FICA was withheld at the appropriate rate. Sharon had a child who lived with her, Lawrence (452-11-7142), born 03-02-2007. Lawrence Penrose received interest income of $1712 from World Savings from an account set up for him by his grandparents. Sharon used the $1712 to hire a babysitter while she was in classes and worked. The Penroses sold 764 shares of Westinghouse stock for $37.53 per share on 09/12/2011 which they had purchased on 3/1/2000 for $31.12 per share. The Penroses purchased Vanguard Pacific fund on the following dates. a. 3/1/2010 113 shares $37 b. 12/1/2010 61 shares $31 c. 4/1/2011 75 shares $42 The mutual fund declared dividends on 4/1/2011 and 10/1/2011. The Penroses had chosen the dividend reinvestment plan for the Vanguard Pacific fund they owned. The reinvested dividends, all ordinary and qualified, were as follows: 4/11/2011 10/13/2011 $400 reinvested in 11.11 shares at $36/share $800 reinvested in 21 shares at $38/share) On 12/15/2011 The Shleppers sold 170 shares of Vanguard Pacific Mutual fund for $47 per share. They used the average cost basis to determine the basis of the shares sold. They want you to show how you calculated the LT or ST gain or loss. The Penroses had a STCL carryover from 2010 of $6113 and a LTCL carryover of $7412. They sold an oil painting by a well-known modern artist, Wallace, on 5/18/2011 for $66,230 that Corinne received as a gift from her aunt on 8/2/2004. The value of the painting on 08/02/2004 was $77,720. Her aunt bought the painting on 06/17/1973 for $48,213. In 2004 the aunt paid a gift tax of $7523 on the transfer. Corinne paid $150 to insure the painting. When her grandmother, Alice, died on 2/15/2010 Corinne inherited Alice's wedding ring which was worth $3991 on that date. Alice had received it as a wedding gift from her Aunt Hilda on 12/13/1925 when it had a value of $5000. Aunt Hilda had purchase it on 1/15/1905 for $30. Corinne sold the ring for $5622 on 08/08/2011. Corinne also inherited her grandmother's Alice's house. The property was located at 1725 Crest Road, Santa Barbara, Ca. 94113. Corinne sold the house on 12/1/2011 for a selling price of $911,113. From the selling price she paid the real estate agent a five percent commission. Corinne's grandparents bought the house on 4/2/1945 for $45,000 (Land $15,000 and Building $30,000). When her grandfather, Willy, died on 5/1/1995 the house was worth $425,000 (Land $100,000 and building $325,000). When her grandmother Alice died on 2/15/2010 she received two appraisals one at $925,000 (land $220,000 and building $705,000) the other at $945,000 (land $270,000 and building $675,000). She seeks your advice on which one of the appraisals to choose. There was no mortgage on the property. Corinne rented it out beginning 4/1/2010 when the house had a value of $950,000 (house $650,000 and land $300,000) She received rental income of $3825 per month and had the following expenses per month from the time of rental to the date of sale (11 months in 2011): Gardening Insurance Property taxes Utilities Depreciation 100 120 1000 200 ? On 3/1/2010 Corinne made the following improvements to the rental house: new granite tile counters in the kitchen, $6000, granite floor tiles $2115, draperies, $2700; painting the outside of the house $4725; new appliances $3250. The sales price of $911,113 for the house included the improvements. She estimated the draperies to be worth $1000 and the appliances to be worth $1150 at the date of sale. The Penroses had purchased their home on 3/1/2007 for $1.1 million. The FMV of the house and land were as follows: 3/1/2007 4/1/2010 Cost of building 700,000 800,000 Cost of Land 400,000 500,000 For 2011, the Penroses paid the following expenses for their home (this includes the costs of the home office): Mortgage payment to First California Bank Principal 7,325 Interest 13,625 Property taxes on home Property insurance Earthquake insurance House-cleaning Utilities: PGE Garbage/Water Gardening Alarm monitoring fee Internet connection for all computers $20,950 11,323 1,512 1,813 1,125 2,039 782 1311 1423 784 They also added a new layer to existing roof on 3/2/2011 that cost $7731. On 9/2/2011 Norman took a course on real estate management at Omega Institute of Santa Monica, for which he paid $1511 for tuition and $282 for books which were required. He bought the books from the bookstore. The school qualified as a recipient of federal financial aid. Corinne also operates a business under the name: \"Shlepper's Travel Agency.\" She operates the business from her home. The employer identification number is 74-2536578. She started doing business on the same day the Penroses bought the home. Corinne uses the cash method of accounting for her business, and her records for 2011 show: Revenue from commissions Expenses: Advertising Bank and service charges Dues and Subscriptions Business Insurance Interest on furniture loan Professional services Office supplies Meals with clients Telephone (second line) Miscellaneous expenses. $58,651 1663 142 673 1293 453 991 911 1,421 411 1,755 Automobile expenses and amounts paid to her children are not included in the above expenses. Corinne also paid Sharon $1481 and Neil $1881, for working part-time. She did not withhold or pay any Federal income or employment taxes on Neil's salary. Corinne withheld Federal tax of $531 on Sharon's salary, California tax of $292, and the appropriate FICA tax. Corinne is not certain that she is allowed a deduction. No state unemployment taxes were due on behalf of Sharon or Neil. She does feel that the amounts paid to her children were reasonable, however. Corinne used one of the rooms in the house for a home office. The square footage of the office is 475 feet. The square footage of the house is 2425 feet (not including the basement). She started using the home office in her business on the date she acquired the house. The percentage of business income earned in the home office was 100 percent. On 4/3/2011 she spent $4000: $1500 to replace the windows and $2500 to install sliding glass doors to the balcony in the office. She replaced the windows and doors because the room was drafty. The door and windows were energy efficient and the Penroses have a certification from the manufacturer. Corinne elects to take the maximum amount of deduction or credits possible on these expenditures. On November 14, 2011 Corinne purchased the following items for use in her business. She used the copier and Dell notebook computer 80 percent in her business and 20 percent for personal purposes. New Copier New Dell notebook computer 2213 1312 She elected the maximum depreciation possible for the copier and new computer. She elects Section 179 and/or bonus depreciation if available. Corinne was able to trade in her old office furniture for new office furniture as a like-kind exchange on 11/12/2011. The old office furniture cost $7531 on 3/2/2009. She had deducted the cost of the office furniture under Section 179 in 2009. She was given an allowance on the old furniture of $2000. She paid $9,321 for the new furniture ($11,321 cost of new furniture less the allowance of $2000). The like-kind exchange rules apply. She also moved some furniture from other parts of the house into the office. She moved the following furnishings from the house: Oriental rug cost $ 5,000 FMV Desk cost $ 1,000 FMV Television cost $ 900 FMV 3,000 200 300 The oriental rug, television and desk were all acquired on 6/4/2009. They were moved to the office on May 3, 2011. Corinne sold her old IBM notebook on October 1, 2011 for $635. She bought it on April 12, 2010 for $3300. She had taken the appropriate MACRS depreciation for each year and used the mid-quarter convention. She had not elected Section 179 and opted out of bonus depreciation in 2010. She also sold her old Xerox copNorman machine for $985 on July 15, 2011. She bought the copy machine on 4/3/2009 for $4325 and had deducted the entire amount under Section 179 in 2009. Corinne purchased a new 2010 Lexus on October 20, 2010. Her tax accountant used the actual cost method in determining the deductible business expenses for her 2010 Federal tax return. In 2010 she used the car 60% of the time for business. She has the following records relating to the business auto. Original cost $41,000 Sales tax $ 4,100 10-year warranty $ 2,600 Depreciation claimed in 2010: Max depreciation in 2010 (10,960 x 60%) 6,576 Expense for 2011 Including both business and personal use: Gas, oil, and repairs in 2011 1,384 Parking and tolls paid in 2011 for business 535 Insurance for 2011 1212 Interest on car loan for 2011 852 Vehicle Registration Fee: Personal Property Tax 120 License fee 150 Car washes 300 Auto club fee 120 In 2011 Corinne drove the auto 15,000 miles for business purposes and 10,000 miles for personal purposes during the year. Corinne sold the Lexus on 12/31/2011 for $34,000 (note you must allocate the sales price between the business and personal portion). The depreciation limit for passenger autos placed in service during 2010 was $2,960 for the first tax year plus $8000 bonus depreciation. The second year limitation in 2010 was $4800. Corinne purchased a new Acura TL for $41,235 11/13/2011. She also paid sales tax of 10 percent, a license fee of $350. She drove it 2000 miles all for personal purposes. She financed the car with a home equity loan of $35,000. The interest expense for 2011 on the car loan was $237. The Penroses paid auto registration fees of $435, of which $135 was classified as a personal property tax on their personal-use autos. All the other expenses were equal to 1/12 of the amounts above. Corinne was a skilled pottery. She had taken many courses over the years in pottery. She set up shop in the basement of the house. The square footage of the basement was 550 feet, which was not included in the total listed above. She is not sure that it would be beneficial for her to deduct the space as a home office space and asks for your advice on that matter. While the children were young she didn't have time to do pottery. She started doing business on 4/1/2010. She classified the pottery as a business in 2010 and deducted a loss of $4000 on Schedule C in 2010. During 2011 she purchased supplies for $800. On 4/2/2011 she purchased a new kiln (oven) for $3800. In April 2011, she took a week-long art class at the San Francisco Art Institute, a school that awards Federal financial aid. She spent 4 hours in the class from Monday through Friday and spent the following weekend sightseeing. She incurred the following expenses with respect to the class for all seven days: Cost of class Cost of art supplies Xeroxed materials Airfare Lodging Meals Car rental $ 825 400 56 $ 283 $312/ per night $ 76/per day $ 54/per day During the year there were three artists' open studios in Santa Barbara. She was listed in the brochure. This year she sold $4931 of pottery. Corinne wants to continue reporting her losses on Schedule C but is concerned that the IRS will audit her and determine that her pottery business is a hobby. She is further concerned about deducting the trip to San Francisco since she went with her husband and they did have a good time. The Penroses had no additional itemized deductions. REQUIRED: 1. Prepare a joint federal tax return for the Penroses for 2011. a. Prepare a separate federal tax return for Sharon. 2. Prepare a detailed letter (at least five pages) to the clients addressing the most important issues including those listed below. I will put a major emphasis on the letter when grading the tax return particularly because it is very hard for me to follow your errors through the tax return. See Chapter 2 Section 2.3 in the textbook for the format of the letter and how to conduct tax research. a. The clients want you to take the maximum amount of deductions which are permitted by the law. In other words they want to take a very aggressive stance. However, they want you to explain the risks to them they are taking. b. In the letter explain to the Penroses any risks they may be taking if they are audited by the IRS. Make sure to address the following issues: b.1) Can they claim Sharon as a dependent? b.2) Is Sharon subject to the kiddie tax? b.3) Who may take a credit or deduction for educational expenses and on which form? b.4) Can they and should they deduct the pottery activity as a business. What are the risks they face? Address the following issues: b.4.1. Deducting the costs of the basement as a home-office expense? b.4.2. The cost of the kiln? b.4.3. Her trip to San Francisco? b.4.4. Give them advice on what Corinne should do to convince the IRS that she is in business. b.4.5. Explain to them how much more tax they would have to pay if the IRS classifies the business as a hobby. b.5) Can they depreciate, deduct under Section 179, or take a credit for the following: b.5.1. The cost of the Oriental rug, television, and desk? b.5.2. The cost of the sliding glass doors and windows in the office? b.5.3. The new carpeting , draperies, painting and new appliances b.6) Can the Penroses deduct any of the gardening expense for the home office? b.7) Can they deduct losses on the sales of property on which they realize a loss? 3. Prepare a schedule calculating the gain or loss on each asset sold ., MAKE SURE YOU INCLUDE HOW YOU CALCULATED DEPRECIATION. a. Amount realized b. Less adjusted basis b.i. Cost basis b.ii. less accumulated depreciation (provide year by year detail) c. = Realized gain or loss d. Less deferred gain e. Less excluded gain f. = Recognized gain or loss. 4. Prepare a schedule on excel with separate columns for: a. AGI b. Ordinary income c. Capital gains and losses c.i. Three columns (0/15%, 25%, 28%) d. Section 1231 gains and losses e. 1245 recapture f. 1250 unrecaptured depreciation 5. Prepare tax return a. You may need to look at www.IRS.gov and read the instructions to fill out the return. READ THE INSTRUCTIONS TO THE FORMS CAREFULLY. b. Please print only Federal forms to be filed with the IRS (not schedules for personal use). c. Please staple or clip and put in order (1040 pages 1 and 2, Schedules A, B, C, D, E, SE, then the numerical schedules in order). d. Please print out forms for filing with the IRS only (not California forms, not schedules for your records). ON THE SOFTWARE DO NOT SELECT THE OPTION THAT PRINTS OUT ALL THE SCHEDULES INCLUDING THOSE FOR YOUR FILES. OTHERWISE, YOU WILL END UP PRINTING 100 PAGES