CHAPTER 6 DEDUCTIONS AND LOSSES: IN GENERAL

1. Austin, a single individual with a salary of $100,000, incurred and paid the following expenses during the year:

Medical expenses	$ 5,000
Alimony	24,000
Charitable contributions	2,000
Casualty loss (after $100 floor)	1,000
Mortgage interest on personal residence	4,500
Property taxes on personal residence	4,200
Moving expenses	2,500
Contribution to a traditional IRA	4,000
Sales taxes (no state or local income tax is imposed)	1,300

Calculate Austin’s deductions forAGI.

2. Arnold and Beth file a joint return. Use the following data to calculate their deduction forAGI.

Mortgage interest on personal residence	$ 6,000
Property taxes on personal residence	2,500
Alimony payments	12,000
Moving expenses	7,000
Charitable contributions	1,500
State income taxes	5,000
Investment interest ($8,000 of expenses limited to net investment income of $7,500)	7,500
Unreimbursed employee expenses	2,500
Sales taxes	2,600

3. Robin and Jeff own an unincorporated hardware store. They determine their salaries at the end of the year by using the amount required to reduce the net income of the hardware store to $0. Based on this policy, Robin and Jeff each receive a total salary of $125,000. This is paid as follows: $8,000 per month and $29,000 on December 31. Determine the amount of the salary deduction.

4. Sandra owns an insurance agency. The following selected data are taken from the agency balance sheet and income statement prepared using the accrualmethod.

Revenue	$250,000
Salaries and commissions	100,000
Rent	10,000
Insurance	5,000
Utilities	6,000
Accounts receivable, 1/1/2014	40,000
Accounts receivable, 12/31/2014	38,000
Accounts payable, 1/1/2014	12,000
Accounts payable, 12/31/2014	11,000

Calculate Sandra’s net profit using the cash method for 2014.

5. Alfred’s Enterprises, an unincorporated entity, pays employee salaries of $100,000 during the year. At the end of the year, $12,000 of additional salaries have been earned but not paid until the beginning of the next year.

a. Determine the amount of the deduction for salaries if Alfred is a cash method taxpayer.

b. Determine the amount of the deduction for salaries if Alfred is an accrual method taxpayer.

6. Taylor, a cash basis architect, rents the building in which his office is located for $5,000 per month. He commenced his practice on February 1, 2014. In order to guarantee no rent increases during an 18-month period, he signed an 18-month lease and prepaid the $90,000 on February 1, 2014. How much can Taylor deduct as rent expense for 2014?

7. In order to protect against rent increases on the building in which she operates a dance studio, Mella signs an 18-month lease for $36,000. The lease commences on October 1, 2014. How much of the $36,000 payment can she deduct in 2014 and 2015?

a. If Mella is an accrual basis taxpayer?

b. If Mella is a cash basis taxpayer?

8. Petula’s business sells heat pumps which have a one-year warranty. Based on historical data, the warranty costs amount to 11% of sales. During 2014, heat pump sales are $400,000. Actual warranty expenses paid in 2014 are $40,000.

a. Determine the amount of the warranty expense deduction for 2014 if Petula’s business uses

the accrual method.

b. How would your answer change if Petula used the cash method for extended warranties and the purchasers paid $25,000 for the warranties which covered the second and third years of ownership?

9. Beige, Inc., an airline manufacturer, is conducting negotiations for the sale of military aircraft. One negotiation is with a U.S. assistant secretary of defense. She can close the deal on the purchase of 50 attack helicopters if she is paid $750,000 under the table. Another negotiation is with the minister of defense of a third world country. To complete the sale of 20 jet fighters to his government, he demands that he be paid a $1 million grease payment. Beige makes the payments and closes the deals. How much of these payments are deductible by Beige, Inc.?

.

10. Albie operates an illegal drug­running business and has the following items of income and expense. What is Albie’s adjusted gross income from this operation?

Income Expenses:		$800,000
	Rent	24,000
	Utilities	9,000
	Bribes to police	55,000
	Medical expense	5,000
	Legal fees	25,000
	Depreciation	30,000
	Illegal kickbacks	30,000
	Cost of goods sold	300,000

11. Kitty runs a brothel (illegal under state law) and has the following items of income and expense. What is the amount that she must include in taxable income from her operation?

Income $200,000

Expenses:

Rent 8,000

Utilities 2,000

Bribes to police 10,000

Medical expense 5,000

Legal fees 20,000

Depreciation 14,000

Illegal kickbacks 15,000

.

12. Janet is the CEO for Silver, Inc., a closely held corporation. Her total compensation for 2014 is $5 million. Of this amount, $2 million is a salary and $3 million is a bonus. The bonus was calculated as 5% of Silver’s net income before the bonus and before taxes ($60 million X 5% = $3 million). The bonus provision has been in effect since Janet became CEO five years ago and is related to Silver’s performance. It is approved annually by the entire board of directors (1 of the 5 directors is an outside director) of Silver. How much of Janet’s compensation can Silver deduct for 2014?