tax midterm - Your client, Morris Norris, was quite busy this year managing his various -acc171

1. Your client, Morris Norris, was quite busy this year managing his various properties and
investments. He has invested a significant amount of money with a broker who has full
control over the trades within guidelines set by Morris upon the initial funding of the
brokerage account. There were over 1,000 total trades in the account and the form 1099B that was originally supplied to Morris showed only the sales price of each one. Your
supervisor requested Morris to ask for the basis for each trade and being a little greedy
decided to ask the broker to supply the gain or loss and type (short-term vs. long-term)
for each trade. Luckily, Morris is a big client of this broker so the broker was willing to
comply with the request and provided the details. The attached sheet (see below for the
summary) summarizes the data provided for the brokerage account. Morris being Morris,
he also had several transactions that were outside of the broker account. He sold some
stock that he had acquired by inheritance from his grandfather 26 years ago. The sales
price of the stock was $257,000 for all of the 5,000 shares of IBM stock he had sold.
Your supervisors research noted that the IBM stock had split several times during the
years, such that the 5,000 shares he sold were originally 1,250 shares. The discussion
between your supervisor and Morris resulted in a conclusion that Morris had no idea of
his grandfathers original cost basis or of the fair value of the stock at the time of the gift.
The only piece of information you have is that grandpa bought the stock just before he
died on June 15, 1984. Morris also sold some stock he received from his brother as a
birthday present in 2011. Morriss brother has not had a good track record at picking
stocks. Morris sold the stock in two separate transactions one in June 2012 and the
other in December 2012. Each time, he sold half of the shares. At the date of the sale in
December 2012, the gross sales price of half of the shares Morris received was $4,375.
The June transaction resulted in gross sales price of $3,000. Having been through this
before, Morris remembered on his birthday in 2011 to ask his brother for the original cost
basis of the 5,000 shares and the date of purchase. His brother was so offended by this
that he has not spoken to Morris since then. Morris told your supervisor that the best he
could get out of his brother was that he (the brother) purchased the shares in the
companys Initial Public Offering (IPO) and that he paid $1.50 per share (not much of an
IPO). Further research indicates that the IPO was completed in August 2011. Knowing
that Morriss birthday is in November, your supervisor also tracked down the fair market
value of the stock on his birthday as $1.30 per share.
MORRIS
NORRIS
BROKER
SUMMARY

SALES PRICE

BROKER
FEES

BASIS

GAIN/(LOSS)

SHORT TERM
SUMMARY:
GAINS

276,500

2,765

177,500

96,235

(131,558
LOSSES

375,750

3,758

503,550

GAINS

424,500

4,245

209,750

LOSSES

327,500

3,275

495,800

)

LONG TERM
SUMMARY
210,505
(171,575
)

Required: Calculate Morriss net gain or loss from all of these transactions and determine
whether the net amount is short term or long-term. Show your calculations and explain your
reasoning for each conclusion you make.

2. In May 2002, Wanda purchased a house on the beach in San Diego with an original cost
of $2,000,000. The house was on the beach and was a perfect weekly rental. Wanda
would occasionally stay in the house on short vacation trips when the place was not being
rented. The rental company statement provided the following information for 2009 and
2010 (the information is provided toWanda for comparative purposes). Note that your
supervisor made sure that the 2009 amounts appearing here also tied to the amounts used
on the 2009 return:
Item
2009
2010
Days rented at market value
315
304
Daily rental income
$225
$200
Management fees
$15,000
$12,000
Interest on mortgage
$35,000
$0 (*)
Property taxes
$25,000
$26,000
Cleaning costs
$2,000
$2,500
Repairs
$1,500
$1,200
Insurance
$2,500
$2,500
New carpet
$0
$5,000
Painting the exterior
$3,000
$0
New kitchen countertops
$0
$10,000
New appliances
$0
$4,000
Alarm company
$1,000
$1,000
(*) Wanda originally used a 7 year loan to purchase the property and it was fully paid off during
2009.
In November 2010, Wanda received an offer to purchase the San Diego house that she just could
not refuse and sold the property for a purchase price of $2,250,000. The sale closed on
December 30, 2010. As part of the closing process, the escrow agent was required to withhold
3% of the sales price and remit the money to the state of California as income tax withholding
(this is standard procedure when a non-resident sells California real property and thus there was

no way for Wanda to avoid the cost). For both 2009 and 2010, Wandas AGI exclusive of the
impact from the rental is over $200,000.
Required: Calculate Wandas total net gain or loss on the sale of the property in 2010. Show
your work as to how you arrived at the amounts.

3. Dano has decided to start his own enterprise growing wheat grass in 2012. The particular
strain of wheat grass he plans on growing is very susceptible to direct sunlight, so Dano
buys a vacant home in Elk Grove. He proceeds to board up all the windows, except the
ones in his bedroom, and installs sophisticated hydroponic watering and growing light
systems. Because Dano had previous experience working in a plant nursery that recently
closed down, he did not spend any money investigating this new venture but just started
right up. Dano brought in $25,000 selling his wheat grass at local craft shows on the
weekends and to friends. He incurred the following expenditures during the year.
Expenditure

Amount

Lighting system
Hydroponic equipment
Wheat grass seeds
Gas to the craft shows
Danos time, based upon his prior jobs
wage rate of $12/hour
Doritos and other snacks
Window coverings
Electricity
Water bills
Purchase of the house
Property taxes
Mortgage interest
Containers
Plastic baggies for delivery

$12,000
$10,000
$3,000
$4,000
$12,000
$1,000
$2,500
$8,000
$3,000
$175,000
$1,500
$6,000
$1,000
$2,500

Dano lived in the house full time to avoid having to move back in with his mother.
Required: Calculate Danos gross income and net income for tax purposes. Show all of
your calculations and explain your reasoning for each item.

4. During the flood of 1997 in Sacramento, the first floor of Bernards house was
completely covered with water. Because he had just purchased the home two months

before the flood, he knew it was worth $250,000 because that is what he paid for it. He
also lost his car in the flood which originally cost him $10,000 in 1988 and was worth
$1,000 in 1997. Once the water receded, Bernard obtained a contractor to begin fixing
his new home. Unfortunately for Bernard, he had decided against flood insurance during
the purchase process of his new home, thus there was little likelihood of receiving any
type of insurance reimbursement for the repairs. Since he was already in the process of
repairs, Bernard decided to have the contractor add a deck on the back of the house.
Bernard and the contractor agreed upon an aggregate price for the repairs and the deck of
$40,000. Bernards car was a total loss and he was reimbursed by his car insurance
company for $1,000. Bernards AGI for 1997 was $275,000 (he is a doctor with a
successful private practice). Assume the cost of the deck by itself is $10,000. During
this same flood, Bernards doctor office was also inundated with water. His medical
equipment which originally cost $400,000 in 1995 was waterlogged, but not completely
destroyed. Bernard made a claim against his business insurance and was reimbursed
$200,000 for the damage. The medical equipment was eventually salvaged by a water
repair company and Bernard placed it back in service in 1998. Bernard runs his medical
practice as a sole proprietorship. Bernard used a 5 year life under MACRS for all of the
medical equipment.
Required: Calculate Bernards casualty gain or loss, if any, from the above transactions. Show
your work and explain your reasoning for each one.

5. Tomas is thinking about starting or acquiring a new business. He is currently in the pie
making business where his company bakes special order pies for parties and for grocery
stores. The grocery store pies are mass produced as opposed to the special order pies.
Tomas thinks that his business expertise will lend itself to a catering business. He has
spent considerable time looking into the catering business, to determine whether he
should buy an existing business or start his own. He has incurred legal fees from
lawyers, and accountants fees for various advice with respect to the new venture. The
legal and accounting fees to date have been $15,000. Tomas decides to start his own
catering business and begins to work on getting the business up and running starting on
September 1, 2012. He incurs the following costs during 2012. He loans some of his
own pie staff to the new business in order to get it going. Tomas gets his first catering job
on December 20, 2012. The catering salaries were incurred ratably throughout the
period. Tomas hired his first staff in September.
Legal/accounting (same as above)
Incorporation costs
Loaning his pie staff time
Purchasing of catering equipment
Advertising
Salaries of newly catering staff

$15,000
$4,000
$10,000
$50,000
$8,000
$12,000

Truck purchase

$25,000

Required: Decide what to do with each of the expenditures mentioned above for income tax
purposes. Explain how much you think Tomas can deduct during 2012 and how much we will
be able to deduct, if any, in future years.
6. Leonard has the following transactions. Leonard purchased 1,500 shares of stock on
January 15, 2008 at $10 per share. Leonard purchased an additional 500 shares of stock
in the same company on June 15, 2008 at $15 per share. Leonard was given 250 shares
of stock in the same company by his grandmother on December 15, 2008. His
grandmother passed away on December 30, 2008, leaving all of her remaining assets to
Leonard and his brother Sheldon. They each received 2,000 shares of stock in the same
company. The value of the company stock on December 15 was $25 per share and the
value on December 30 was $30 per share. Their grandmother was the founder of the
company and paid $1 per share for all of her shares in the company. Leonard did not
want to run the company and so began selling his shares in January 2009. On January 22,
2009, Leonard sold 2,000 shares for $35 per share. On December 15, 2009 Leonard sold
an additional 2,000 shares for $5 per share (after Sheldon had run the business into the
ground).
Required: Calculate the each gain or loss on the above transactions and determine the net total
includible in Leonards taxable income for 2009. Also calculate how many shares, if any
Leonard has left and what is his basis in those shares as of the end of 2009.

7. Willie is currently in the business of manufacturing wooden crates. He is interested in
purchasing some additional crate making equipment and is asking you, as his CPA, what
is the best answer for tax purposes with respect to generating the lowest possible taxable
income for the year of purchase. The total purchase amount is expected to be $1,750,000.
Required: Using all potential depreciation related deductions, determine how much
depreciation Willie can take for the year of the purchase under each of the following
situations. Presume that the crate making equipment falls in the 7 year life for MACRS.
Show each of your calculations and explain your conclusions.
a. The equipment is purchased and placed in service during the first month of 2010.

b. The equipment is purchased in June 2009.

c.

The equipment is purchased in October 2010.

8. Willie (same Willie as question 7) has grown tired of the crate making business and
decides in 2011 to sell all of his equipment that he bought in 2009. He engages an
equipment broker to sell the equipment for a commission of 3% of the sales price. After
6 months of work, the broker has sold all of the equipment to a single buyer for a gross
sales price of $1,200,000. Using your answers to parts a, b and c in question 7, determine
how much gain or loss, if any, Willie must recognize in 2011, explain whether the gain or
loss is capital or ordinary and explain under what code section you made your
conclusions.
a.

b.

c.

9. Peter is in the business of selling medical marijuana in California where state law
currently allows this as a legal business. Federal law has not yet caught up to the wisdom
of the California population. Peter recognizes a good opportunity when he sees one and
decides to expand his operation. The front of his shop continues to sell product only to
those with a legitimate medical marijuana doctors prescription. However, since he can
obtain more supply than needed just for those people, he decides to use the back of the
store to sell to anyone. Being a former accountant, Peter recognizes the need for detailed
accounting records and makes sure to segregate all revenues between the front of the
store sales and the back of the store sales. Peter is not quite as detailed with the expenses
of the store.
Front

Back

Total

Revenue $
Ounces sold

350,000
3,500

650,000
8,667

$1,000,000
12,167

Cost of goods sold

175,000

433,350

608,350

(product only)
Electricity
Gas
Water
Costs to start up
back room
Political
donations
Salaries
Employees
Rent
Square feet used
Stamp tax on
product purchased
Total Expenditures

4,000
2,000
1,000
65,000
1,000
2

3

500

100

120,000
5
10,000
600
60,835
872,185

Required: Given the above information, determine what you believe to be Peters taxable
income from the store operations. Explain your choices for each expenditure.

10. Sheila had a terrible year during 2012. Not only did her grandmother pass away in the
first part of the year, but she lost her job in May. In March, she took some of the cash she
inherited from grandma and loaned it to one of her friends who had convinced her that he
had an idea for a new iPhone app that was sure to be a huge hit. She loaned Albert
$25,000 in cash and made him sign a promissory note that did not charge him interest and
required repayment only once Alberts app had sold 25,000 copies at the Apple App store.
After she lost her job, she took some of the stock inherited from grandma and sold it to
make her mortgage payment for June. The sales price of the shares was $4,000 for 4,000
shares. The stock price at the date of grandmas death on January 1 was $10 per share.
Sheila was the executor of grandmas estate. Starting in July, Sheila tried to get in touch
with Albert but found out his cell phone had been turned off and he had moved away with
no forwarding address. She continued to look for him until November when she finally
gave up; however when she checked the App store, she found the exact app that Albert
had described to her. It was selling for $0.99 per copy. A little more investigation and
she found out that the App store had sold nearly 1 million copies of Alberts Flashing
App (dont ask what it does). In November, she found out that the company in which
grandma had invested and left to her (she originally owned 100,000 shares) had gone
bankrupt. She was very sad because she knew that grandma was one of the original
investors in this company and had worked hard before her death (perhaps the cause?) to
make the company be successful. The other investors had been her uncle and aunt who
each had invested $250,000 along with grandmas $450,000. Then in December, her
bank foreclosed on her house because she had not made any payments since June 1,
2012. Her total mortgage at the time of the foreclosure was $150,000.

Required: based on all of the above information, determine what transactions, if any, impact
Sheilas 2012 taxable income. Calculate the amounts for each transaction you feel has some
type of impact on her taxable income and describe the character of the income or loss (capital
vs. ordinary and short term vs. long-term).
11. Ted provided you the following information about his business income and outflows for
the years 2010 through 2012. After a long discussion with Ted about his business, you
also determined that in 2010, Ted entered into a long-term contract to provide services to
a large client of his. The contract terms called for an advance payment in 2010 of
$200,000 and the length of the contract was to be 20 months. Ted signed the contract on
July 2, 2010 and started work for this client the next day. The client paid him upon
signing of the contract and this amount is included in the cash receipts listed below for
2010. After 16 months, the client decided to terminate Teds services and demanded the
remainder of their money back. Ted returned the remainder of the money at the
beginning of 2012, but instituted a lawsuit for breach of contract to get the money back.
The cost to Ted is included in the cash payments shown below for year 3. Ted also pays
his employees and himself a monthly salary payable on the last day of the month, with
the exception of December when Ted tells the payroll accountant to move payday to the
next day for that month only. Ted runs the business as a corporation. The employees
monthly salaries are $10,000 and Teds salary is $20,000 per month. These amounts are
not included in the below balances of accounts payable. Below is relevant information
on the cash ins and outs of Teds business.
2010
Beginning Accounts Receivable
Ending Accounts Receivable
Cash Received
Beginning Accounts Payable
Ending Accounts Payable
Cash Expenses

200,000
350,000
600,000
150,000
250,000
380,000

2011
350,000
175,000
700,000
250,000
275,000
450,000

2012
175,000
150,000
800,000
275,000
300,000
500,000

Required: Calculate Teds business net taxable income based upon the accrual method. Then
calculate Teds business net taxable income on the cash method. Ignoring tax law that would
have required Ted to make a choice in the first year of his business and based solely on the three
years of information you have available, recommend the best method of accounting for Teds
business and explain your reasoning.