Individual Taxation Paper 12

(a) The requirement is to determine the amount the Burgs should deduct for taxes in their itemized deductions. The $1,200 of state income tax paid by the Burgs is deductible as an itemized deduction. However, the $7,650 of self-employment tax is not deductible as an itemized deduction. Instead, a portion of the self-employment tax is deductible from gross income in arriving at the Burgs’ adjusted gross income.

(c) The requirement is to determine the correct statement regarding an individual taxpayer’s deduction for interest on investment indebtedness. The deduction for interest expense on investment indebtedness is limited to the taxpayer’s net investment income. Net investment income includes such income as interest, dividends, and short-term capital gains, less any related expenses.

(b) The requirement is to determine the correct statement regarding the interest on the Browns’ $20,000 loan that was secured by their home and used to purchase an automobile. Qualified residence interest consists of interest on acquisition indebtedness and home equity indebtedness. Interest on home equity indebtedness loans of up to $100,000 is deductible as qualified residence interest if the loans are secured by a taxpayer’s principal or second residence regardless of how the loan proceeds are used. The amount of home equity indebtedness cannot exceed the fair market value of a home as reduced by any acquisition indebtedness. Since the Browns’ home had a FMV of $400,000 and was unencumbered by other debt, the interest on the $20,000 home equity loan is deductible as qualified residence interest.

(c) The requirement is to determine how much interest is deductible by the Philips for 2012. Qualified residence interest includes the interest on acquisition indebtedness. Such interest is deductible on up to $1 million of loans secured by a principal or second residence if the loans were used to purchase, construct, or substantially improve a home. Here, the Philips’ original mortgage of $200,000 as well as the additional loan of $15,000 qualify as acquisition indebtedness, and the resulting $17,000 + $1,500 = $18,500 of interest is deductible. On the other hand, the $500 of interest on the auto loan is considered personal interest and not deductible.

(c) The requirement is to determine the maximum amount allowable as a deduction for Jackson’s second residence. Qualified residence interest includes acquisition indebtedness and home equity indebtedness on the taxpayer’s principal residence and a second residence. Here, the $5,000 of mortgage interest on the second residence is qualified residence interest and is deductible as an itemized deduction. In contrast, the $1,200 of utilities expense and $6,000 of insurance expense are nondeductible personal expenses.

(c) The requirement is to determine the amount of interest expense deductible as an itemized deduction. The $3,600 of home mortgage interest, and the $900 mortgage prepayment penalty are fully deductible as interest expense in computing itemized deductions. The $1,200 interest on the life insurance policy is not deductible since it is classified as personal interest.

(a) None of the items listed relating to the tax deficiency for 2011 are deductible. The interest on the tax deficiency is considered personal interest and is not deductible. The additional federal income tax, the late filing penalty, and the negligence penalty are also not deductible.

(b) The requirement is to determine the amount that Smith should deduct as a charitable contribution. If appreciated property is contributed, the amount of contribution is generally the property’s FMV if a sale of the property would result in a long-term capital gain. Here, the art object worth $3,000 was purchased for $2,000 just four months earlier. Since its holding period did not exceed twelve months, a sale of the art object would result in only a short-term capital gain, and the amount of allowable contribution deduction is limited to its $2,000 cost basis. Additionally, the donation of $5,000 cash to Smith’s church is deductible but no deduction is available for the $1,000 contribution to a needy family. To be deductible, a contribution must be made to a qualifying organization.

(c) The requirement is to determine the amount of charitable contributions deductible on Stein’s current year income tax return. The donation of appreciated stock held more than twelve months is a contribution of intangible, long-term capital gain appreciated property. The amount of contribution is the stock’s FMV of $25,000, but is limited in deductibility for the current year to 30% of AGI. Thus, the current year deduction is limited to 30% × $80,000 = $24,000. The remaining $1,000 of contributions can be carried forward for up to five years, subject to the 30% limitation in the carryforward years.

(c) The requirement is to determine the maximum amount of properly substantiated charitable contributions that Moore could claim as an itemized deduction for 2012. Moore gave $18,000 to her church during 2012 and had a $10,000 charitable contribution carryover from 2011, resulting in a total of $28,000 of contributions. Since an individual’s deduction for charitable contributions cannot exceed an overall limitation of 50% of adjusted gross income, Moore’s charitable contribution deduction for 2012 is limited to ($50,000 AGI × 50%) = $25,000. Since Moore’s 2012 contributions will be deducted before her carryforward from 2011, Moore will carry over $3,000 of her 2011 contributions to 2013.