Concepts in Federal Taxation American Recovery and Reinvestment Tax Act of 2009
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- Chapter 3 Unemployment Compensation
- Tax Treatment of Capital Gains
- Chapter 7 Net Operating Losses
- Chapter 8 Taxes
- Higher Education Tax Credits
- Chapter 10 Section 179 and Additional 1 st Year Depreciation
- Section 179 Election to Expense
- Limitations on Deduction
- Additional First-Year Depreciation
- Example 11
- Example 12
- Basis Subject to Cost Recovery
- Example 14
- Depreciation Method Alternatives
- Example 2 3
- Limitation on Passenger Autos
- Example 29
- Regular MACRS Depreciation
- Chapter 11 Capital Gain Exclusion on Qualified Small Business Stock
- Chapter 15 Alternative Minimum Tax Exemptions
| Concepts in Federal Taxation
American Recovery and Reinvestment Tax Act of 2009 The American Recovery and Reinvestment Act of 2009 (P.L. 111-5) (hereafter, AART) made numerous changes to the income tax law that affects the 2010 edition of Concepts in Federal Taxation. This update explains the changes as it impacts each chapter and provides problems that illustrate these changes. The following topics are covered in this update: Exclusion of unemployment benefits (Chapter 3) Qualified Small Business Stock exclusion increased (Chapters 3 & 11) Carryback of 2008 Net Operating Losses expanded (Chapter 7) Sales tax on new vehicles deductible (Chapter 8) Increase in refundable portion of child credit (Chapter 8) Increase in earned income credit expanded (Chapter 8) Hope Scholarship Tax Credit increased (Chapter 8) Section 179 deduction increased (Chapter 10) Additional first-year depreciation allowed (Chapter 10) Alternative Minimum Tax Exemption increased (Chapter 15) Chapter 3 Unemployment Compensation Amounts received from state unemployment compensation benefits are considered substitutes for earned income and are taxable to the recipient. Beginning in 2009, the AART allows the exclusion of up to $2,400 of unemployment compensation benefits. Example 1 Erica is laid off from her job at an electronics store during 2009. She receives $6,800 in unemployment compensation benefits during 2009. How much of the unemployment compensation payments are included in Erica’s gross income? Discussion: Erica is allowed to exclude $2,400 of the unemployment compensation benefits. Therefore, she includes $4,400 ($6,800 - $2,400) in her gross income. Tax Treatment of Capital Gains To stimulate investment in certain small businesses, 50 percent of the gain (not reduced by capital losses) from qualified small business stock that is held for more than five years is excluded from taxation. The gain remaining after the exclusion is taxed at a maximum rate of 28 percent; it is not eligible for the 15 percent long-term capital gains rate. The AART increases the exclusion percentage to 75 percent for stock acquired after February 17, 2009 and before January 1, 2011. Problems 50. Has the taxpayer in each of the following situations received taxable income? If so, when should the income be recognized? Explain. a. Charlotte is a lawyer who specializes in drafting wills. She wants to give her husband a new gazebo for Christmas. In November, she makes a deal with Joe, a local handyman, to build a gazebo. In return, Charlotte is to draft a will for Joe's father. The gazebo normally would cost $3,000, which is approximately what Charlotte would charge for drafting the will. Joe builds the gazebo in time for Christmas. Charlotte drafts the will and delivers it to Joe the following January. b. Ed buys 500 shares of Northstar common stock in January 2006 for $4,000. On December 31, 2006, the shares are worth $4,600. In March 2007, Ed sells the shares for $4,500. c. Dayo is the director of marketing for Obo, Inc. In December, the board of directors of Obo votes to give Dayo a $10,000 bonus for the excellent work she had done throughout the year. The check is ordered and written on December 15 but is misplaced in the mail room and is not delivered to Dayo until January 5. d. John is unemployed. During the current year he receives $4,000 in unemployment benefits. Because the unemployment is not enough to live on, John sells drugs to support himself. His total revenue for the year is $120,000. The cost of the drugs is $60,000. 51. Elwood had to retire early because of a job-related injury. During the current year, he receives $10,000 in Social Security benefits. In addition, he receives $6,000 in cash dividends on stocks that he owned and $8,000 in interest on tax-exempt bonds. Assuming that Elwood is single, what is his gross income if a. He receives no other income? b. He also receives $11,000 in unemployment compensation? c. He sells some land for $80,000? He paid $45,000 for the land. Chapter 7 Net Operating Losses Taxpayers that suffer a net operating loss (NOL) can generally take a deduction for the loss in another tax year. Under the general rule, taxpayers may carry back an NOL two years. If there is insufficient income in the carry back period, the remaining loss is carried forward for twenty years. A taxpayer may elect not to carry back the loss and instead use the twenty year carry forward period to deduct the loss. The AART allows eligible small businesses to elect to carry back 2008 net operating losses for three, four, or five years. An eligible small business is generally a business that had average annual gross receipts of no more than $15 million for the three-year period ending with the year of the loss. A 2008 net operating loss is defined as a loss incurred in a year ending in 2008. Eligible small businesses may elect to use the expanded carry back periods on an NOL for a tax year that begins in 2008. Example 1 Torino Corporation is an eligible small business that has a September 30 fiscal year end. It has suffered losses for the past two years. Under the general rule, Torino’s NOL for the year ended September 30, 2008 is eligible for the expanded carry back period. However, it could elect to apply the expanded carry back for the tax year that began on October 1, 2008. The expanded NOL carry back allows small businesses to obtain immediate relief for 2008 operating losses that would not be available under the general rule. Example 2 Lambert Inc., an eligible small business, incurs a $40,000 net operating loss in 2008. Lambert had operating incomes of $40,000 in 2004 and $60,000 in 2005, but suffered operating losses of $10,000 and $20,000 in 2006 and 2007. Discussion: Under the general rule for NOL’s, Lambert would have carried back the 2006 and 2007 NOL’s to 2004 (reducing 2004 operating income to $10,000) and obtained refunds of taxes paid in those years. Under the general rule, it would not be able to carry back the 2008 NOL to 2004 or 2005. However, as an eligible small business, Lambert can elect to carry back its 2008 NOL to 2004 and 2005. This allows Lambert to get an immediate refund of taxes for the 2008 operating loss. Problems 3. What are the net operating loss carryback and carryforward periods? Does a taxpayer have a choice of the years to which a net operating loss can be carried? Explain. 20. Ronaldo Inc., suffers a net operating loss of $200,000 for its 2008 tax year. It had taxable income of $50,000 in 2003, $50,000 in 2004, $100,000 in 2005, and $25,000 in 2006 and 2007. If Ronaldo Inc., is an eligible small business, how should it treat the 2008 net operating loss? Chapter 8 Taxes Taxpayers are allowed a deduction from gross income for state sales and excise taxes paid on new motor vehicles purchased after February 17, 2009 and before January 1, 2010. The deduction is allowed for both the regular tax calculation and the alternative minimum tax calculation. Taxpayers who do not itemize deductions may deduct the tax as increase in the standard deduction amount. To prevent a double deduction, a taxpayer who elects to deduct state and local sales taxes in lieu of deducting state and local income taxes cannot take an extra deduction for motor vehicle taxes. Deductible taxes are defined as any state or local sales or excise tax paid on the purchase of a qualified motor vehicle. A qualified motor vehicle is a passenger automobile, light truck, or motorcycle weighing 8,500 pounds or less, or a motor home of any weight. The motor vehicle purchased must be a new, not a used, vehicle. The amount of the deduction is limited to the taxes imposed on the first $49,500 of the vehicles purchase price. The amount of the deduction is phased-out over a $10,000 range when the taxpayer’s modified adjusted gross income exceeds $125,000 ($250,000 married, filing jointly). Taxpayers with MAGI greater than $135,000 ($260,000 married, filing jointly) are not eligible for the deduction. Example 1 Lynn is married. He and his wife purchase a new vehicle costing $40,000 on July 1, 2009. They pay $1,800 in state and local sales tax on the purchase. Their itemized deductions for 2009 total $9,000 without considering their deduction for motor vehicle sales taxes. What is their deduction from AGI? Discussion: The vehicle is new and costs less than $49,500. Therefore, Lynn and his wife may deduct the $1,800 in state and local taxes. Because their total itemized deductions are less than their $11,400 standard deduction, they will deduct the standard deduction amount. However, the motor vehicle tax deduction is added to the standard deduction amount, resulting in a deduction from AGI of $13,200 ($11,400 + $1,800). Example 2 Assume the same facts as in example 1, except that their itemized deductions total $13,000 without considering the deduction for motor vehicle sales taxes. What is their deduction from AGI? Discussion: Because their total itemized deductions are greater than their standard deduction amount, they will itemize their deductions. The $1,800 in motor vehicle sales taxes are added to their other $13,000 of itemized deductions, for a total deduction of $15,800. Example 3 Assume the same facts as in example 1, except that the vehicle cost $60,000. What is the amount of their deduction for sales taxes paid on the vehicle purchase? Discussion: Because the vehicle costs more $49,500, the amount of the deduction is reduced. They are only allowed to deduct the state and local sales tax on the first $49,500 of the purchase price, $1,485 ($1,800 x [$49,500 ÷ $60,000]. As in Example 1, they will deduct their standard deduction amount plus the $1,485 deduction for state and local sales tax paid on the vehicle. Example 4 Assume the same facts as in example 1, except that their modified adjusted gross income is $254,000. What is the amount of their deduction for sales tax paid on the vehicle purchase? Discussion: Because their modified adjusted gross income exceeds $250,000, the amount of the deduction for motor vehicle sales taxes is phased-out over a $10,000 range. The $1,800 in sales taxes paid is reduced by 40% [($254,000 - $250,000) ÷ $10,000), resulting in a $1,080 [$1,800 – ($1,800 x 40%)] deduction. As in Example 1, they will deduct their standard deduction amount plus the $1,080 deduction for state and local sales tax paid on the vehicle. Note: If their modified adjusted gross income was greater than $260,000, no deduction for motor vehicle sales taxes would be allowed. Child Credit The child tax credit is refundable to the extent the taxpayer’s earned income exceeds a base amount that is adjusted for inflation ($12,550 in 2009). The AART reduces the base amount to $3,000 for 2009 and 2010 (the 2010 amount will be adjusted for inflation). Therefore, for 2009, the refundable credit for families with 1 or 2 qualifying children is calculated as follows: Maximum refundable credit = 15% x (earned income - $3,000) However, the amount refunded cannot exceed the amount of the credit remaining after reducing the tax liability to zero. For families with 3 or more qualifying children, the maximum credit is the greater of the amount calculated using the above formula or the following formula: Maximum refundable credit = Social Security tax paid – earned income credit Generally, a taxpayer with 3 or more qualifying children will benefit from the second formula only if the taxpayer is not eligible for the earned income credit because of excessive earned income. Example 48 Howard and Paula have 2 children under age 17, have earned income of $26,100 and pay $2,000 in Social Security tax. Their tax liability is $300 before the child credit. What amount can they claim as a child credit and what portion is refundable? Discussion: Howard and Paula’s child tax credit is $2,000 ($1,000 x 2), which is greater than their $300 income tax liability. The maximum amount of the credit that can be refunded is $3,465 [15% x ($26,100 - $3,000). The $2,000 child credit will reduce their $300 tax liability to zero, and they will receive a refund of $1,700 ($2,000 - $300). Example 49 Assume the same facts as in example 48, except that Howard and Paula have 3 children under age 17 and are not eligible for the earned income credit. Their tax liability is $700 before the child credit. What amount can they claim as a child credit and what portion is refundable? Discussion: Howard and Paula’s child credit is $3,000 ($1,000 x 3), which is greater than their $700 income tax liability. The maximum amount of the credit that can be refunded is the greater of: $3,465 = 15% x ($26,100 - $3,000) or
The available child credit of $3,000 will reduce their $700 tax liability to zero. The maximum child credit that can be refunded is $3,465. However, the refundable credit is limited to the $2,300 ($3,000 - $700) credit remaining after reducing the tax liability to zero. Earned Income Credit The earned income credit (EIC) is a refundable tax credit designed to provide relief to low-income taxpayers who continue to work. The amount of the credit depends on the taxpayer’s earned income and phases out after the taxpayer’s income reaches a predetermined amount. Although having a qualifying child is not required to receive the credit, taxpayers with one or two qualifying children receive a larger credit. For 2009 and 2010, the AART provides an increased credit for taxpayers with 3 or more qualifying children. In addition, the beginning of the phase-out is increased by $5,000 for all married taxpayers, increasing the amount of their EIC. Higher Education Tax Credits The Hope Scholarship Tax Credit (HSTC) is a nonrefundable credit for tuition and related expenses paid for the first two years of post-secondary education. In 2009, the HSTC provides for a 100 percent tax credit on the first $1,200 of qualifying expenses and a 50 percent tax credit on the next $1,200 of qualifying expenses paid during the year for each qualifying student (maximum credit of $1,800). The credit is phased-out ratably for married taxpayers with adjusted gross income between $100,000 and $120,000 and for all other taxpayers with adjusted gross income between $50,000 and $60,000. The AART renames the HSTC the American Opportunity Tax Credit (AOTC) and modifies if for 2009 and 2010. First, the credit is expanded to cover the first four years of post-secondary education, allowing students in their third and fourth years of education to claim the credit in 2009 and 2010. The second modification expands the definition of qualifying expenses to include course materials (books and other required course materials). In addition, forty percent of the otherwise allowable AOTC is refundable in 2009 and 2010. The calculation of the HSTC is modified in two significant ways. First, the amount of the credit is increased to the sum of 100 percent of the first $2,000 of qualifying expenses and 25 percent of the next $2,000 of qualifying expenses (maximum credit of $2,500). In addition, the phase-out ranges are increased to ratably phase-out for married taxpayers with adjusted gross income between $160,000 and $180,000 and for all other taxpayers with adjusted gross income between $80,000 and $90,000. Example 57 Shaw and Oriana are married and have two children. In 2009, Sophia is a sophomore and Jonas is a junior in college. Shaw and Oriana’s adjusted gross income is $110,000. They pay $1,700 in tuition, $500 for books, and $2,200 for her room and board. Jonas’s tuition and fees are $4,500, his books cost $600 and his room and board is $2,600. What amount can Shaw and Oriana claim for the American Opportunity Tax Credit? Discussion: Both Sophia and Jonas’s expenses qualify for the AOTC. Only tuition and related fees and course materials qualify for the credit. Sophia’s qualifying expenses total $2,200 ($1,700 + $500) and her allowable credit is $2,050 {$2,000 + [($2,200 - $2,000) x 25%]. Jonas has $5,100 ($4,500 + $600) in qualifying expenses and his AOTC is the $2,500 maximum credit. Shaw and Oriana’s total allowable American Opportunity Tax Credit is $4,550. Because their AGI is less than $160,000, the full amount of the credit is allowed. Example 59 Assume the same facts as in example 57, except that Shaw and Oriana’s adjusted gross income is $164,000. What is their allowable higher education tax credit? Discussion: Shaw and Oriana’s higher education tax credit is reduced to $3,640. Because their adjusted gross income exceeds $160,000 they must reduce their allowable tax credit ratably over a $20,000 range: 20% = ($164,000 - $160,000) ÷ $20,000 $3,640 = $4,550 – ($4,550 x 20%) Example 60 Assume the same facts as in example 57, except that Shaw and Oriana’s adjusted gross income is $66,000, their taxable income is $35,000, and their income tax liability is $4,415. What is their allowable higher education tax credit? Discussion: As in example 57, Shaw and Oriana’s otherwise allowable credit is $4,550, which is greater than their $4,415 income tax liability. However, forty percent of their $4,550 credit, $1,820 ($4,550 x 40%) is refundable. The remaining $2,730 ($4,550 - $1,820) credit is nonrefundable and is limited to their income tax liability. Therefore, Shaw and Oriana can claim the full $4,550 ($1,820 refundable + $2,730 nonrefundable) credit. Example 61 Assume the same facts as in example 60, except that their taxable income is $21,600 and their income tax liability is $2,400. What is their allowable higher education tax credit? Discussion: As in example 60, forty percent of their $4,550 credit ($1,820) is refundable. The remaining $2,730 credit is nonrefundable and is limited to their $2,400 income tax liability. Therefore, Shaw and Oriana can only claim a $4,220 ($1,820 refundable + $2,400 refundable) higher education tax credit. Problems 25. Is the child credit refundable? Explain. 28. Compare and contrast the Hope Scholarship Tax Credit with the Lifetime Learning Tax Credit. 40. Paula lives in South Carolina which imposes a state income tax. During 2009, she pays the following taxes: Federal tax withheld 5,125 State income tax withheld 1,900 State sales tax – actual receipts 270 Real estate tax 1,740 Property tax on new car (ad valoreum) 215 Social Security tax 4,324 Gasoline taxes 124 Sales tax on new car 112 a. If Paula’s adjusted gross income is $35,000 what is her allowable deduction for taxes? b. Assume the same facts as in part a, except that Paula pays $1,600 in sales tax on a sail boat she purchased during the year. What is Paula’s allowable deduction for taxes? c. Assume the same facts as in part a and that Paula’s other allowable itemized deductions total $800. What is her allowable deduction from adjusted gross income? 68. Miguel and Katrina have 2 children under age 17, have earned income of $24,300, and pay $1,836 in Social Security tax. Their tax liability is $1,050 before the child credit. a. What amount can they claim as a child credit, and what portion of the credit is refundable? b. Assume the same facts as in part a, except that Miguel and Katrina have 3 children under age 17 and are not eligible for the earned income credit. Their tax liability is $800 before the child credit. What amount can they claim as a child credit, and what portion of the credit is refundable? 73. Martina is single and has two children in college. Matthew is a sophomore, and Christine is a senior. Martina pays $3,200 in tuition and fees, $600 for books, and $2,000 for Mathews room and board. Christine's tuition and fees are $4,800, her books cost $750, and her room and board expenses are $1,800. Martina's adjusted gross income is $50,000. a. What amount can Martina claim as a tax credit for the higher education expenses she pays? b. Assume that Martina’s income tax liability is $4,000. How much of the higher education tax credit is refundable? c. Assume that Martina's adjusted gross income is $82,000 and her income tax liability is $8,500. What amount can she claim as a tax credit for the higher education expenses she pays? 74. Brendan and Theresa are married and have three children in college. Their twin daughters, Christine and Katlyn, are freshmen and attend the same university. Their son, Kevin, is in an MBA program. Brendan and Theresa pay $12,000 in tuition and fees ($6,000 each) for their daughters and $4,200 in tuition and fees for Kevin. The twins’ room and board is $2,600, while Kevin's room and board is $1,400. Brendan and Theresa have an adjusted gross income of $77,000. a. What amount can they claim as a tax credit for the higher education expenses they pay? b. Assume that their adjusted gross income is $107,000. What amount can they claim as a tax credit for the higher education expenses they pay? c. Assume the same facts as in part a, except that Kevin is a freshman and the twins are in graduate school. What amount can Brendan and Theresa claim as a tax credit for the higher education expenses they pay? 75. Daniel is 25, single, and operates his own landscaping business. He enrolls in a turf management class at Vorando University. The tuition for the class is $4,000 and he spends $500 on books and other related course materials. He pays the tuition by borrowing $4,000 from a local bank. His adjusted gross income for the year is $42,000 and he is the 25% marginal tax rate bracket. What is the most advantageous tax treatment for Daniel’s higher education expenses? 89. Casandra and Gene are married and have a daughter who is a junior at State University. Their adjusted gross income for the year is $78,000, and they are in the 25% marginal tax bracket. They paid their daughter's $3,600 tuition and $3,200 in room and board with $4,500 in savings and by withdrawing $2,200 from a Coverdell Education Savings Account. Chapter 10 Section 179 and Additional 1st Year Depreciation The American Recovery and Reinvestment Act of 2009 (ARRT) increases the Section 179 Election to Expense deduction and provides for additional 1st year depreciation for qualifying property placed in service during tax years that begin after December 1, 2007 and before January 1, 2010. Property placed in service in tax years beginning after 2009 are not eligible for the increased deductions provided by the ARRT. The Section 179 Election to Expense is increased to $250,000 (from $133,000). In addition, the phase-out of the deduction for excess investment is increased from $530,000 to $800,000. Thus, taxpayers who place less than $800,000 of qualifying property in service during a tax year beginning in 2009 will be able to expense up to $250,000 of the cost of the property. Section 179 Election to Expense Section 179 allows an annual current expense deduction for the cost of qualifying depreciable property purchased for use in a trade or business. The deduction for expensed assets is treated as a depreciation deduction. This election allows many small businesses to expense assets as they are purchased instead of depreciating them over several years. The immediate deduction promotes administrative convenience by eliminating the need for extensive depreciation schedules for small purchases. Qualified Taxpayers In 2009, individuals, corporations, S corporations, and partnerships may elect to deduct as an expense up to $250,000 in investment in qualified property to be used in an active trade or business. A husband and wife are considered one entity for purposes of the election to expense. Although the phrase ‘‘active trade or business’’ is not defined in the tax law, it appears to have the same meaning as the phrase ‘‘trade or business’’ (Chapter 5). The elements of profit motivation, regularity, and continuity of the taxpayer’s involvement in the activity and the absence of hobby, amusement, and similar motivations are important factors to consider when determining whether an activity qualifies for the Section 179 election. This interpretation is supported by the fact that the deduction is not allowed for assets purchased for use in an activity related to the production of income (an investment activity). However, the portion of a mixed-use asset that is used in a trade or business does qualify for immediate deduction under Section 179. Estates and trusts cannot use the Section 179 election to expense assets. The election is not available to these entities because they are formed to protect and conserve the entity’s assets for the benefit of the beneficiaries and not to operate an active trade or business. Qualified Property The Section 179 expense deduction is allowed only on depreciable, tangible, personal property used in a trade or business. Examples of eligible property are trucks, machinery, furniture, computers, and store shelving. Real property, such as buildings and their structural components, does not qualify for the special election to expense. Also excluded from the deduction are land and improvements made directly to the land, such as a parking lot, sidewalks, or a swimming pool. In addition, qualifying property does not include intangible assets such as patents, copyrights, and goodwill. Example 3 Kelly purchases a new computer and a new telephone system and installs a new roof and an air-conditioning system in her office building. Which of the expenditures qualify for the election to expense? Discussion: The computer and the telephone system are depreciable, tangible, personal property and therefore qualify under Section 179. The roof and the air-conditioning system are integral parts of the office building. Therefore, they are real property and do not qualify for immediate expensing. Limitations on Deduction The Section 179 election-to-expense deduction is subject to three limitations: ■ A taxpayer’s annual Section 179 deduction cannot exceed the maximum annual limitation ($250,000 for 20098). ■ If the taxpayer’s investment in Section 179 property exceeds $800,000 for the tax year, the annual deduction limit is reduced by one dollar for each dollar of investment over $800,000 in 2009. For 2009, a taxpayer who purchases more than $1,050,000 of qualifying property may not take any election-to-expense deduction for any of the purchases. ■ The Section 179 deduction allowed for a tax year cannot exceed the taxable income from the active conduct of all the taxpayer’s trade or business activities.
The annual deduction limit does not have to be prorated according to the length of time an asset is used during the year. The annual deduction limit applies to all tax entities entitled to use Section 179. Thus, the annual limit applies separately to a partnership and to its individual partners. The annual limit also applies separately to an S corporation and to its shareholders.5 Because the partnership and S corporation are conduit entities, a portion of the entity’s total deduction is allocated to each owner, who subtracts it as an expense on the owner’s personal tax return. However, the Section 179 deduction allocated to the taxpayer from the conduit entity plus the taxpayer’s Section 179 deduction from all other sources cannot exceed the annual limit. Any excess Section 179 election resulting from allocations from several entities must be carried forward to be used in subsequent years. Example 4 Roberto is a 50% shareholder and full-time employee of an S corporation. During 2009, the S corporation invests $324,000 in equipment qualifying for the Section 179 deduction. Roberto also owns a sole proprietorship that constructs kitchen cabinets. The cabinet business qualifies as an active business for Roberto. During 2009, he purchases $200,000 worth of equipment to use in his cabinet business. What is the maximum amount that Roberto can deduct as a Section 179 expense for 2009? Discussion: Roberto’s deductible Section 179 expenditures are limited to $250,000. The S corporation can elect to deduct $250,000 of its $324,000 in capital expenditures. The remaining $74,000 is subject to regular depreciation. The S corporation allocates $125,000 (50% × $250,000) of its Section 179 deduction to Roberto. Thus, Roberto’s qualified Section 179 expenditures total $325,000 ($125,000 from the S corporation + $200,000 from the cabinet business). However, the $250,000 annual deduction limit applies at the shareholder level as well as at the S corporation level. Therefore, Roberto may elect to deduct only $250,000 as a Section 179 expense. A taxpayer may choose to use all, part, or none of the annual deduction. By electing to expense less than the limit for a tax year, the taxpayer can avoid a Section 179 deduction carryforward resulting from either the annual limitation or the trade or business income limitation. Example 5 Based on the information in example 4, how should Roberto allocate his Section 179 deduction in 2009? Discussion: Roberto should claim as a Section 179 deduction the $125,000 allocated to him from the S corporation plus $125,000 of the cost of the equipment purchased for use in the cabinet business. The remaining $75,000 cost of the equipment used in his cabinet business is depreciated using regular depreciation methods. If Roberto expenses the $200,000 worth of equipment he purchased for the cabinet business, he will lose $75,000 of the deduction allocated to him from the S corporation by exceeding the $250,000 annual limitation by $75,000 ($200,000 + $50,000 = $250,000) this year. The $75,000 carries forward to be used in subsequent years. Any amounts that flow to a taxpayer from a conduit entity should always be expensed under Section 179 before any amount is elected from another trade or business of the taxpayer. After an asset’s basis is reduced by the amount expensed under Section 179, the remaining basis is subject to regular depreciation under any valid method. Example 6 Devra Corporation purchases a machine costing $300,000 for use in its business. Devra wants to expense $250,000 of the asset’s cost under Section 179. If Devra makes the Section 179 election to expense $250,000 of the asset’s cost, what is its depreciable basis in the machine? Discussion: Devra’s depreciable basis for regular depreciation is $50,000. The depreciable basis of the machine is its $300,000 cost, less the $250,000 it elects to expense under Section 179. The reduction of depreciable basis by amounts expensed under Section 179 is necessary to ensure that the total capital recovery on the machine does not exceed the $300,000 invested. The Section 179 deduction can be allocated to reduce the basis of qualifying assets in any manner the taxpayer chooses. This allows the deduction to be allocated equally to all assets acquired during the year or to specific assets. This option is important. Two general rules apply to choosing assets to expense. First, do not use the Section 179 election to expense automobiles. As discussed later, automobiles are subject to annual depreciation deduction limits. For purposes of this annual limitation, the Section 179 expense is treated as a depreciation deduction. Because MACRS depreciation on most automobiles exceeds the first-year annual limitation amount, using the election to expense on an automobile does not result in additional tax savings. Second, based on time value of money concepts, taxpayers should take the depreciation deduction as early as possible. This is accomplished by expensing the assets with the longest life and using regular depreciation methods to depreciate assets with the shortest life. Example 7 Gwendolyn purchases equipment costing $250,000 and a computer system that also costs $250,000 for use in her business in 2009. Under MACRS, the equipment is 7-year property, and the computer system is 5-year property. How should Gwendolyn allocate her $250,000 Section 179 expense deduction? Discussion: If Gwendolyn wants to deduct the $250,000 maximum election to expense, she should elect to expense the $250,000 cost of the equipment (7-year property). The $250,000 cost of the computer system will be deducted over its 5-year life, resulting in greater deductions sooner than if she elected to expense the computer. Gwendolyn could elect to deduct less than the full $250,000 Section 179 limit. Because Section 179 is elective, Gwendolyn can decide how much to deduct and the specific assets to expense. This allows taxpayers who do not want or need the extra deductions in the current year to spread the deductions out through depreciation charges. Annual Investment Limit The annual deduction limit is reduced dollar for dollar by the amount of the investment in qualifying property in excess of $800,000. As a result of this limitation, a taxpayer who purchases $1,050,000 or more of qualified property during 2009 cannot expense any amount under Section 179. Because of the $800,000 annual investment limitation, only relatively small businesses can use the election to expense. Example 8 During 2009, the Allen Partnership places $828,000 of Section 179 property in service for use in its business. What is Allen’s maximum Section 179 deduction? Discussion: Allen’s election to expense is reduced to $222,000 by the $800,000 annual investment limit. Because the partnership invested $28,000 more than the $800,000 annual investment limitation ($828,000 - $800,000), it must reduce the annual deduction limit dollar for dollar by the excess ($250,000 - $28,000 = $222,000). NOTE: The $28,000 lost through the annual investment limit is not carried forward to future years. It is lost forever. Additional First-Year Depreciation Taxpayers are allowed to claim an additional 50-percent depreciation deduction (bonus depreciation) on qualified property acquired during tax years beginning in 2009. Qualifying property is new MACRS property with a recovery period of 20 years or less, MACRS water utility property, computer software not acquired as an acquisition of all of the assets of a business, and qualified leasehold improvement property. The original use of the property must be by the taxpayer and cannot be purchased from a related party. Property that must be depreciated using the alternative depreciation system (ADS) does not qualify. The original use requirement eliminates used property from qualifying for bonus depreciation. Similarly, assets acquired as part of the acquisition of all the assets of a business will not meet the original use requirement. However, any additional capital expenditures incurred to recondition or rebuild otherwise qualifying property does satisfy the original use requirement and therefore, is eligible for additional first-year depreciation. To ensure that the capital recovery concept is not violated, the depreciable basis of the property is reduced by the bonus depreciation for purposes of computing the regular MACRS depreciation deduction. Example 11 Omer Corporation purchases $600,000 of new machinery on February 19, 2009. The machinery is 5-year MACRS property. What is the depreciable basis in the machinery? Discussion: MACRS property with a recovery period of 20 years or less qualifies for the 50-percent additional depreciation deduction. Accordingly, Omer deducts $300,000 ($600,000 50%) in bonus depreciation. Its depreciable basis in the machinery is reduced to $300,000 ($600,000 - $300,000). The additional first-year depreciation must be claimed on all eligible property unless a taxpayer makes an election not to claim the deduction. The election is made on a class-by-class basis. Example 12 Assume that in Example 11, Omer Corporation does not want to claim the additional first-year depreciation on the machinery. What is Omer’s depreciable basis in the machinery? Discussion: Omer must make an election not to claim the additional first-year depreciation deduction. The election applies to all 5-year MACRS property that Omer acquires in 2009. Omer’s depreciable basis in the machinery is $600,000 if it elects not claim bonus depreciation on the machinery. Any Section 179 expense election is claimed prior to calculation of the additional first-year depreciation allowance. Therefore, the adjusted basis of the property is reduced by any Section 179 expense deduction for purposes of calculating the bonus depreciation. Example 13 Bomhoff Inc. purchases office equipment costing $400,000 on April 1, 2009. What is Bomhoff’s depreciable basis in the office equipment? Discussion: To maximize the 2009 cost recovery deduction, Bomhoff should elect to expense $250,000 of the cost of the office equipment. This reduces the adjusted basis (and depreciable basis) of the equipment to $150,000 ($400,000 - $250,000). Office equipment is 7-year MACRS property and is eligible for the bonus depreciation deduction. Bomhoff deducts $75,000 ($150,000 50%) in additional first-year depreciation. The depreciable basis is reduced to $75,000 ($150,000 $75,000 $75,000). Important points to remember about additional first-year depreciation: ■ To qualify for bonus depreciation, the property must be acquired during a tax year that begins in 2009. ■ The original use of the property must commence with the taxpayer. Used property does not qualify. ■ The 20 year or less recovery period requirement for qualifying property eliminates residential rental property and nonresidential real property from receiving additional first-year depreciation. ■ If a qualifying property is purchased, bonus depreciation must be claimed unless an election not to claim the bonus depreciation is made. The election is made on a class by class basis. Therefore, a taxpayer can claim the bonus depreciation on one or more classes of property (eg, 10-year property) and not claim the bonus depreciation on other classes of property (eg, 3-year property) acquired during the applicable period. ■ The depreciable basis must be reduced by any allowable bonus depreciation. ■ Unlike the Section 179 election to expense, there is no purchases limit nor is there an annual income limit. That is, additional first-year depreciation can be deducted even if it causes the business to have a net operating loss.
Depreciable basis is the asset’s original basis for depreciation less any amounts deducted under the Section 179 election to expense assets. Therefore, the basis rules discussed in Chapter 9 provide the starting point for computing the capital recovery deduction. An asset’s basis for depreciation does not have to be reduced by its salvage value. The depreciable basis of an asset is the amount of basis that is subject to depreciation and is the amount used to determine the annual depreciation deduction. The depreciable basis does not change during an asset’s tax life unless additional capital expenditures are made for the asset. The total capital recovered as a depreciation deduction over an asset’s useful life may never be more than its depreciable basis. Do not confuse the term depreciable basis with adjusted basis. Adjusted basis refers to the unrecovered capital of an asset at any point in time. An asset’s adjusted basis decreases as cost recovery deductions are taken. The capital recovery under MACRS does not necessarily relate to the true remaining useful life and salvage value of the asset. That is, an asset’s depreciable basis can be fully recovered, even though the asset remains in service and salvage value exists. Example 14 In 2009, Estelle Corporation purchases office equipment costing $280,000 for use in its repair business. Because equipment is eligible to be expensed under Section 179, Estelle elects to expense $250,000 of the cost of the equipment. What is Estelle Corporation’s depreciable basis in the equipment? Discussion: Estelle’s initial basis in the equipment is $280,000. The election to expense reduces the depreciable basis to $30,000 ($280,000 - $250,000). Unless Estelle elects not to claim the additional first-year depreciation, it deducts $15,000 ($30,000 50%) in additional first-year depreciation. This reduces the depreciable basis to $15,000 ($30,000 - $15,000). The corporation recovers its $280,000 investment in the equipment through expensing $250,000 in the year of purchase, $15,000 in additional first-year depreciation deducted in the year of purchase, and $15,000 in depreciation charges over the life of the equipment. If the office equipment had cost only $100,000 and Estelle elected to expense the entire $100,000 cost under Section 179, the corporation would fully recover its capital investment in 2009. The depreciable basis in the equipment then is zero, and the corporation is allowed no further capital recovery deductions on its initial $100,000 investment. However, the equipment remains in service and may provide several years of quality use. Depreciation Method Alternatives Under current tax law, taxpayers have three alternatives for calculating depreciation: ■ Regular MACRS ■ Straight-line over the MACRS recovery period ■ Straight-line over the Alternative Depreciation System (ADS) recovery period Figure 10–2 illustrates these choices for depreciating personal property. A taxpayer decides which to use by first choosing whether to maximize or minimize the depreciation deduction in the year of acquisition. The taxpayer would maximize by using the Section 179 election, claiming the additional first-year depreciation, and using regular MACRS for the remaining depreciable basis. Regular MACRS depreciates property in the 3-, 5-, 7-, and 10-year classes using the 200-percent declining balance method with an optimal, automatic switch to straight-line in the IRS percentage tables. Assets in the 15- and 20-year classes are depreciated using the 150-percent declining balance method. The taxpayer who needs a slower depreciation rate can minimize the deduction by using straight-line (S-L) MACRS or ADS. Because of the longer recovery period, ADS produces the smallest depreciation deduction. Taxpayers will need to elect not to claim additional first-year depreciation to secure the smallest depreciation deduction. Example 22 On March 14, 2009, Lorange Mining company purchases a bus costing $400,000 to transport its employees from the parking area to the mines. What should Lorange do if it wants to recover its $400,000 cost as quickly as possible (i.e., maximize the cost recovery)? Discussion: To maximize cost recovery, Lorange should elect to expense $250,000 of cost under Section 179 and claim the 50 percent additional first-year depreciation. The additional first-year depreciation is $75,000 [($400,000 - $250,000) × 50%], leaving a depreciable basis of $75,000 ($150,000 − $75,000), which would be recovered using the regular MACRS 200% declining balance method over the 5-year recovery period for buses. The recovery period is found in Table A10–1 under the column labeled General Depreciation System. The regular MACRS method (using Table 10–4) provides the fastest depreciation write-off for the property’s depreciable basis: Initial basis $ 400,000 Section 179 election (250,000) Adjusted basis $ 150,000 Additional first-year depreciation $150,000 × 50% (75,000) Depreciable basis $ 75,000 MACRS% (Table 10–4) × 20% 2009 depreciation $ 15,000
Depreciable basis $400,000 Full-year S-L deduction ($400,000 ÷ 9) $ 44,444 Mid-year convention × ½ First-year depreciation $ 22,222
Passenger autos are subject to a limitation on the annual amount of the deductible depreciation. The annual depreciation deduction for a passenger automobile cannot exceed a specified amount, which is based on the year a car is placed in service. Any depreciation that is disallowed because of the annual limitations may be deducted when the auto’s recovery period ends. Table A10–10 lists the auto depreciation tables and the annual auto limits that are allowed for 100-percent business use of an auto placed in service in 2008. If an auto is not used wholly for a business purpose, the amount of the annual passenger automobile limitation must be reduced by multiplying it by the business use percentage. The depreciation subject to the first-year annual limitation includes any amount that is expensed using Section 179. As mentioned earlier, the annual limitation on the auto depreciation deduction makes it impractical to deduct any of the cost of an auto under Section 179. The maximum first-year depreciation deduction on a passenger automobile is $2,960 for automobiles ($3,160 for trucks and vans) placed in service in 2009. The maximum first-year depreciation deduction on new automobiles that qualify for additional first-year depreciation increases by $8,000 for automobiles placed in service in tax years beginning in 2008. To take advantage of the increased cap, additional first-year depreciation must be claimed the increased maximum is not available if a taxpayer makes an election not to take the additional first-year depreciation. Example 29 On July 5, 2008, Oscar purchases a new car for $40,000. Based on his mileage records, Oscar uses the car 80% of the time for a qualified business use. What is his depreciation deduction on the car for 2008? Discussion: Automobiles are 5-yearMACRS property. Because he uses the automobile more than 50% of the time for business, his allowable depreciation is the lesser of the regular MACRS depreciation or the passenger automobile limitation. Oscar’s 2008 depreciation is limited to $8,768: Regular MACRS Depreciation Initial Basis $40,000 Business use percentage 80% Business depreciable basis $32,000 Additional first-year depreciation percentage 50% Additional first-year depreciation $16,000
MACRS table percentage 20% MACRS depreciation $ 3,200
Passenger Automobile LimitationAnnual depreciation limit for an automobile placed in service in 2008 $ 2,960 Additional first-year allowance in 2008 8,000 2008 automobile depreciation limit $10,960 Business use percentage 80% Oscar’s maximum 2008 depreciation on auto $ 8,768
44. Rograin Corporation purchases turning lathes costing $670,000 and a bus costing $280,000 in June of the current year. The lathes are 7-year MACRS property, and the bus is 5-year MACRS property. What is Rograin's maximum Section 179 deduction? Assuming that Rograin deducts the maximum Section 179 expense, what are the depreciable basis of the lathes and the bus? c. If Rograin wants to maximize its cost recovery this year, how much first-year depreciation may it deduct in addition to the Section 179 deduction? 45. Baker, Inc., purchases office furniture (7-year MACRS property) costing $280,000 and a computer system (5-year MACRS property) costing $280,000 in 2009. What is Baker's maximum cost-recovery deduction in 2009? (Hint: Maximize the Section 179 election effect.) 48. The Gladys Corporation buys office equipment costing $290,000 on May 12, 2009. In 2012, new and improved models of the equipment make it obsolete, and Gladys sells the old equipment for $34,000 on December 27, 2012. a. What is Gladys Corporation's gain or loss on the sale assuming that Gladys takes the maximum cost-recovery deduction allowable on the equipment? b. What is Gladys Corporation's gain or loss on the equipment assuming that Gladys takes the minimum cost-recovery deduction allowable on the equipment? 55. On June 1, 2008, Kirsten buys an automobile for $42,000. Her mileage log for the year reveals the following: 20,000 miles for business purposes; 7,000 miles for personal reasons; and 3,000 miles commuting to and from work. What is Kirsten's maximum cost-recovery deduction for 2008? 49. In June of 2009, Copper Kettle, Inc., purchases duplicating equipment for $350,000. a. Compare cost recovery deductions using maximum, minimum, and intermediate methods over the recovery period of the equipment. b. Explain why Copper Kettle, Inc., would elect to use each of these methods. Chapter 11 Capital Gain Exclusion on Qualified Small Business Stock To encourage investment in small businesses, 50 percent of the gain (not reduced by capital losses) from qualified small business stock that is held more than five years is excluded from taxation. The remaining gain is taxed at a maximum rate of 28 percent; it is not eligible for the 15 percent long-term capital gains rate. The AART increases the percentage exclusion for qualified small business stock to 75 percent for stock acquired after February 17, 2009 and before January 1, 2011. The effect of this provision is to limit the marginal tax rate on such gains to 7% (25% of gain taxed x 28% maximum tax rate). Example 18 Isabell purchases 1,000 shares of qualified small business stock on November 18, 2009. On December 20, 2014, she sells the 1,000 shares at a gain of $120,000. What is the effect of the sale on Isabel’s tax liability, assuming that she has no other capital asset transactions and is in the 35% marginal tax bracket? Discussion: Because the qualified small business stock was held for more than five years and acquired after February 17, 2009 and before January 1, 2011, Isabel excludes 75% of the gain, $90,000 from her capital gain income. Because she has no other capital gains or losses, her net capital gain position is a net long-term capital gain of $30,000 ($120,000 - $90,000). The gain is taxed at the 28% maximum rate for gains on qualified small business stock, resulting in a tax liability of $8,400 ($30,000 x 28%). Note that the tax on the gain is 7% of the total gain ($8,400 ÷ $120,000 = 7%). Example 19 Assume the same facts as in example 18, except that Isabel has a net capital loss of $20,000 from her other capital asset transactions. What is the effect of the sale of the stock on Isabel’s tax liability? Discussion: The 75% exclusion is taken before the capital gain-and-loss netting. Therefore, Isabel is entitled to an exclusion of $90,000. The $30,000 long-term capital gain that remains after the exclusion is netted against the $20,000 capital loss, resulting in a net long-term capital gain of $10,000. Isabel’s tax on the $10,000 net long-term capital gain is $2,800 ($10,000 x 28%). Problems 7. What is (are) the current tax advantage(s) of selling an asset at a long-term capital gain? 9. Under what conditions may a taxpayer exclude a portion of a realized capital gain? 48. Yorgi purchases qualified small business stock in Gnu Company, Inc., on September 15, 2009, for $50,000. She sells the shares for $400,000 on December 30, 2014. The stock retains its qualified small business status through the date of the sale. a. Determine the amount of realized and recognized gain on the sale. b. What is Yorgi's effective tax rate on this transaction? (Assume her marginal tax rate is 33%.) 49. Return to the facts of Problem 48. Assume that Yorgi has a net capital loss of $80,000 from her other capital asset transactions in 2014. What is the effect of the sale of the stock on Yorgi’s tax liability if her marginal tax rate is 33%. Chapter 15 Alternative Minimum Tax Exemptions After making all the required adjustments and adding the preference items to taxable income, the result is the tentative alternative minimum taxable income. In determining the AMTI tax base, an exemption amount is allowed as a reduction in of the tentative AMTI. The exemption is designed to eliminate taxpayers with relatively moderate amount of taxable income who do not have significant amount of adjustments and/or preferences from the AMT. The exemption amount starts at a tentative amount based on the type of taxpayer and then is reduced by 25 percent of every dollar by which the tentative AMTI exceeds a specified level. The AART increases the exemption amount for individuals for 2009. The 2009 exemption amounts for individuals are: $70,950 for married taxpayers filing jointly and surviving spouses $46,700 for unmarried taxpayers $35,475 for married taxpayers filing separately The $40,000 corporate exemption amount and the exemption phase-out ranges were not increased. Problems 36. What is the AMT exemption amount? Is it available to all taxpayers? 79. Alice and Frank had the following items on their current-year tax return: Adjusted gross income $100,000 Less: Deductions from adjusted gross income Medical expenses $ 7,950 Less: 7.5% x $100,000 (7,500) $ 450 Home mortgage interest 5,300 Home equity loan interest 1,200 State income taxes 2,325 Property taxes 950 Charitable contributions (cash) 575 Miscellaneous itemized deductions $ 2,400 Less: 2% x $100,000 (2,000) 400 (11,200) Less: Exemptions (2 x $3,650) (7,300) Determine the amount of the adjustments that Alice and Frank will have to make in computing their alternative minimum tax. 80. Joan and Matthew are married, have two children, and report the following items on their current year’s tax return: Adjusted gross income $158,000 Less: Deductions from adjusted gross income Medical expenses $14,000 Less: 7.5% x $158,000 (11,850) $ 2,150 Home mortgage interest 13,500 Home equity loan (for college education) 9,000 State income taxes 11,000 Property taxes 6,500 Charitable contributions 7,000 Miscellaneous itemized deduction $ 4,000 Less: 2% x $158,000 (3,160) 840 Total Itemized deductions (49,990) Less: Exemptions (4 x $3,650) (14,600)
82. Determine the AMT exemption amount for each of the following taxpayers: a. Nominal Corporation has an alternative minimum taxable income of $140,000. b. Janine is a single individual with an alternative minimum taxable income of $155,000. c. Jagged Corporation has an alternative minimum taxable income of $220,000. d. Peter and Wendy have an alternative minimum taxable income of $110,000. e. Popup Corporation has an alternative minimum taxable income of $900,000. Directory: resource uploads -> downloads downloads -> Chapter 19 Chapter Outline downloads -> Chapter 1 Practice Quiz Introducing the Economic Way of Thinking downloads -> Bltc-8e Case Problem with Sample Answer Chapter 30: Partnerships 20. 5 Case Problem with Sample Answer downloads -> Cross-7e: Case Problem with Sample Answer downloads -> Atmospheric circulation downloads -> September 3, 2007 downloads -> August 30 2009 Website Update downloads -> Chapter 3 exercises downloads -> Review Sheet: Chapt. 1: The Moral Point of View Moral concerns are unavoidable in life. Ethics downloads -> Chapter 17 Chapter Outline Download 124.54 Kb. Share with your friends:
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