Your next assignment will involve doing the necessary tax research and preparing a tax return for some clients whose tax situation presents a variety of issues involving the reporting of income and losses, and possible deductions and credits.

Sanjay and Barbara Patel are both successful professionals. Sanjay has recently taken early retirement from his job at an independent oil company, and Barbara is a university administrator. Their daughter, Anita, is in her freshman year at Washington University in St. Louis.

Sanjay was 56 on December 31 last year. His social security number is 800-12-8769. Barbara was 51 on December 31, and her social security number is 802-13-3916. Anita was 19, and her social security number is 802-77-1898.

The family lives at 1201 Maple Ave, in Wichita Falls, TX 76301.

Sanjays final W-2 from Sandrise Petroleum reports $120,000 in Box 1 (wages received), and $16,500 in federal withholding. Barbaras W-2 from the university reports $185,000 in Box 1, and $27,000 in federal withholding.

Sanjay also received a 1099-R from his traditional 401-K plan. It reports a $100,000 taxable distribution, and $20,000 in federal withholding. Since Sanjay has not reached the age of 59 and a half, a code of 1 is reported in Box 7 of the form. The Patels also received a Form 1098 from MCC, which is the administrator of the mortgage on their new home. It reports $23,200 in interest paid on the mortgage, $6,200 in real estate taxes, and $3,000 paid for fire and casualty insurance payments.

This has been an eventful year for the Patel family, and they are concerned about the impact that several developments will have on their taxes.

1. Sanjay has retired, and taken a substantial distribution ($100,000) from his 401-K. What will be the tax consequences? Will it be considered a premature distribution? Consider the Tax Codes definition of premature distributions, and whether any exceptions will apply to a taxpayer in Mr. Patels situation.

2. The Patels have bought a new house. Instead of selling their old house, they are converting it to rental property. Since they were fortunate enough to find renters right away, the Patels were able to collect 12 months of rent: $12,000. They had the following expenses on the property:

Mortgage interest: $2,850

Fire and casualty insurance: $2,250

Property taxes: $4,350

Plumbing repairs: $3,750

The Patels have some questions about their new status as landlords. They are familiar with the concept of depreciation, and they want to know what basis will be used for the depreciation of their property. They purchased the house 20 years ago for $125,000, but its current fair market value is $275,000. What is the IRSs position on the tax basis of personal property converted to business or rental use?

Since it looks like they will have an operating loss on the rental property, they want to know how that will affect their taxes.

3. Anitas tuition at Washington University was $18,000. She did not qualify for any financial aid, but she did receive a $5,000 scholarship because of her high SAT scores and grades. Since the Patels had to pay the remaining amount, they want to know if this expense can be used to reduce their taxes.

4. Barbaras mother passed last year, and she received a $150,000 bequest from her estate. They want to know if this is taxable.

III. Steps to Completion

Step 1 Tax Research Conduct the research necessary to answer the questions posed by the Patel family. Where possible, rely on primary sources, such as the Internal Revenue Code, Treasury Regulations, and Revenue Rulings and Revenue Procedures issued by the IRS. If you use IRS publications, be sure to use current publications, rather than older ones that may be based on old law. See the separate section under Learning Resources for guidance on doing tax research using free online resources.

Step 2 Tax Return All IRS tax forms need to prepare the return are presented in the Appendix A at the end of this project file. The tax return you prepare for the Patels will be a complex one. In addition to Form 1040 and its schedules, your return will include Schedule A, Schedule E, Form 5329, Form 4562, Form 8863, and Form 8582