CHAPTER 9

DISCUSSION QUESTIONS

1. Unless moving expenses are involved, Lyle’s expenses will be deductions from AGI.
Therefore, the deduction would not be available if the standard deduction is claimed.
Also, Lyle’s expenses will be subject to the 2%-of-AGI limitation. Lyle’s expenses
would be reported on Form 2106 and transferred to Schedule A. Joan’s expenses are
deductions for AGI and should be reported on Schedule C. Lyle will be subject to FICA,
whereas Joan is liable for the self-employment tax. pp. 9-3 and 9-29

2. Each stylist should pay a set rental for the use of the facility. Except for controlling the
hours when the salon will be open, Bernard should allow each stylist to determine his or
her own working hours. Each stylist should handle customer appointment and billing
functions. To the extent feasible, stylists should provide their own tools and supplies.
Preferably, each stylist should have a separate telephone. Except in the interest of public
health or safety, Bernard should exercise no control over the clientele of his stylists.
p. 9-3

3. Alexis can claim the mileage from her home to the client locations. The mileage to and
from the university qualifies as an education expense. p. 9-15 and Examples 7 and 27

4. In terms of income derived, the newspaper column he writes predominates. Since the
column is written at home, this would be considered his tax home. In this sense, the trips
to the university can be regarded as going to a second job. Consequently, the use of his
car for this purpose should be deductible. pp. 9-5, 9-8, and Example 5

5. From the facts given, it appears that Emma has never claimed any deduction for the
business use of the auto. If she has already filed for year 2003, an amended return
claiming the deduction is appropriate. Due to an absence of records, Emma cannot use
the operating cost method of determining the deduction. Consequently, the automatic
mileage method should be chosen. Emma can prove the miles driven and the percentage
of business use. pp. 9-6 and 9-7

6. Tyler’s deductible expenses include transportation and meals and lodging for the entire
trip. Expenses attributable to the Cub’s game and the museum trips are personal and are
not deductible. Because the trip is solely for business and business was conducted on
Friday and Monday, the weekend living expenses are regarded as business expenses.
p. 9-10 and Examples 10 and 20
7. The main issue to be resolved is the location of Dr. Werner’s tax home. Presuming his
salary to be more than modest, the tax home probably is the situs of Pelican University.
Thus, Dr. Werner is in travel status when he conducts continuing education programs or
testifies while out of town. p. 9-8

8. Expenses incurred during a temporary assignment will be treated as if the taxpayer is in

travel status, as the tax home does not change. If, however, the assignment is indefinite,
the tax home changes to the location of the new assignment. If the period of assignment
exceeds one year, it is not temporary. p. 9-8 and Examples 10 and 11

9. a. A taxpayer is never away from home if his or her job is the tax home. Such
would be the case of the itinerant worker or trucker who lives where they work.

b. If the taxpayer is never away from home, then all living expenses, such as meals
and lodging, become personal and are nondeductible.
 Deductions: Employee and Self-Employed-Related Expenses 9-5

c. The key to being away from home for tax purposes is the duplication of living
expenses. For example, the truck driver who otherwise sleeps at home will be
duplicating lodging expense when a motel room is rented while on the road.

p. 9-8 and Example 12

10. Dr. Hampton’s expenses clearly are deductible, while those relating to Mrs. Hampton are
not. Although she is employed by the clinic, the content of the seminar probably is not
relevant enough to her job assignment. Contrast Examples 16 and 17. p. 9-9

11. If obtaining the education does not qualify as a deduction, related travel expenses are not
allowed. Thus, none of these expenses are deductible. p. 9-9 and Example 18

12. Travel days count as business days. The weekend counts as business days if the prior
Friday and subsequent Monday are business days. The same holds true for a legal
holiday. By utilizing these guidelines, Marge can enhance her leisure time while
maximizing her deductions. p. 9-10

13. Quincy did not satisfy the 39-week time requirement. So he has two choices. First, he
may increase his income for 2006 by the amount of moving expenses deducted on the
2005 tax return. Second, he can file an amended return for 2005 and recompute his tax
after deleting the moving expenses deduction. p. 9-12

14. First, storage expenses qualify for the deduction for expatriates. Second, the time test
does not apply when the expatriate returns to the U.S. to retire. Global Tax Issues on
p. 9-13.

15. a. Nondeductible expenses would include those that are not job related (e.g., an
accountant’s expenses incurred in obtaining a law degree) or those involved in
acquiring a basic skill (e.g., cost to an accountant of taking a review course for the
CPA exam). pp. 9-13 and 9-14

b. If the expenditure falls under § 222, it is classified as a deduction for AGI.

Section 222 includes only qualified tuition and related expenses. pp. 9-15 and
9-16

c. All other education expenses (i.e., those not disallowed in part a. or included in
part b. above) are treated as deductions from AGI. pp. 9-15 and 9-28

16. a. One of the advantages of § 222 is that the education involved need not be job
related.

b. As a deduction for AGI results, the 2%-of-AGI limitation is not applicable.

c. The AGI limitation and the related partial or complete phaseout of the deduction
depends on the year involved and the filing status of the taxpayer.

d. Section 222 is not available when married taxpayers file separate returns.

p. 9-16 and Table 9-1

17. Because business entertainment involves an element of pleasure, such entertainment

should not be completely deductible.
9-6 2006 Comprehensive Volume/Solutions

a. The original scapegoat was the “three-martini lunch.” The cutback adjustment
does not preclude any deduction, but merely reduces the amount that can be
deducted.

b. The cutback adjustment is further reduced for taxpayers whose employment is

regulated by the U.S. Department of Transportation. This group is unlikely to use
business meals for pleasurable purposes.

p. 9-17

18. a. The employee is subject to the 50% cutback adjustment. p. 9-17 and Example 29

b. The employer is subject to the 50% cutback adjustment. p. 9-17 and Example 29

a. Neither is subject to the cutback adjustment. The award is compensation to the

employee and is fully deductible by the employer. p. 9-18 and Example 31

d. No one is subject to the cutback adjustment. The subsidized eating facility

provision represents one of the exceptions to the cutback adjustment rule. p. 9-
18 and Example 32

e. Employer paid recreational activities are not subject to the cutback adjustment.
p. 9-18

f. De minimis fringe benefits are not subject to the cutback adjustment. p. 9-18 and
Example 33

19. The membership dues to the club are not deductible nor are any of the expenses relating
to personal use deductible. The business lunches qualify if properly substantiated. The
expenses for the golfing activities may be difficult to deduct in view of Madison’s lack of
participation. Like the Christmas party, however, the expenses could qualify if preceded
or followed by a bona fide business discussion (or presentation). Neither the golf course
nor the Christmas party can be regarded as a clear business setting. pp. 9-19, 9-20, and
Example 36

20. Since the tickets were purchased at the last minute, a premium was probably paid. Only
the cost of regular tickets (as measured by their face value) is deductible. Any such
deduction is subject to the 50% cutback rule.

If the entertainment is of the “associated with” variety, attendance at the game must be
preceded or followed by a bona fide business discussion. In addition, a partner or an
employee of the law firm must be present during the game. p. 9-20 and Example 37

21. a. An employee who claims the standard deduction cannot benefit from an office in
the home deduction since it is an itemized deduction. A self-employed taxpayer,
however, can benefit since a deduction for AGI now is involved.

b. The office must be used exclusively for business. Otherwise the home office is
not a qualified home office.

c. Excess expenses can be carried over to future years.

 Deductions: Employee and Self-Employed-Related Expenses 9-7

d. Instead of deducting interest on home mortgage, property taxes, and depreciation,

claim an allocable portion of the rent. Such items as utilities, repairs,
maintenance, and renter’s insurance are eligible for deduction.

pp. 9-20 to 9-22 and Example 39

22. Myrna should claim $400 (employee reimbursed expenses) and $250 (school supplies
provision) as deductions for AGI. The balance of $750 is a deduction from AGI and will
be subject to the 2%-of-AGI floor. Further, the $750 will not be available if Myrna
chooses the standard deduction and does not itemize. p. 9-23 and Example 40

23. Since this seems to be Trent’s first job, his job search expenses would not qualify for
deduction. His moving expenses, however, should qualify as deductions for AGI. In this
regard, the move covers Florida to New Orleans (rather than Vanderbilt to New Orleans)
because college attendance normally does not establish residency. pp. 9-12, 9-13, and
9-23

24. a. Under a traditional IRA, a contribution is deductible, income accumulates tax-

deferred, and distributions are fully taxed. Under a Roth IRA, no deduction is
allowed for the contribution, income accumulates tax-free, and distributions are
not subject to tax.

b. A traditional IRA and Keogh (H.R. 10) plans follow the same pattern of a
deduction followed by a deferral of income tax. IRAs, however, generally arise
in an employment setting (i.e., taxpayer is an employee); whereas Keoghs are
available to those who are self-employed.

p. 9-24

25. No deduction will be allowed unless the credit card receipts also reflect the business
purpose of the expense and the business relationship of Nicholas to the person
entertained. p. 9-25

26. a. The reimbursements and expenses are omitted from the return.

b. No reporting is required. Provided the other substantiation requirements are met,

the amount of the expenses is deemed substantiated at the Federal per diem rate.

c. All reimbursements are reported as additional wages (gross income) and the
expenses (except moving) are deductible from AGI subject to the 2% of AGI
floor. Both Form 2106-EZ (Unreimbursed Employee Expenses) and Schedule A
are used. If, however, the employee makes use of the standard deduction, he or
she is in the unfortunate position of having to report the reimbursements in gross
income with no deduction for the expenses.

pp. 9-25 to 9-27

27. To avoid not being in a trade or business, Olivia should try to obtain a temporary leave of
absence from her employer. As long as any such leave is not unduly prolonged, she will
still be regarded as being in a trade or business for purposes of claiming the education
expense deduction as an itemized deduction. She will not be deemed as having acquired
a new trade or business—a graduate degree in tax merely maintains or improves existing
skills of an attorney. Note that under § 222 (deduction for qualified tuition and related
expenses), Olivia does not have to be concerned about the leave being temporary.
9-8 2006 Comprehensive Volume/Solutions

However, the maximum amount that can be deducted under § 222 in 2005 is $4,000. The
§ 222 deduction is a deduction for AGI. pp. 9-14 and 9-31

28. It would be unwise for Kim to choose the $48,000 option due to the tax consequences
involved. This option makes her subject to the 50% cutback adjustment for business
meals and entertainment. But even the portion of these expenses allowable as deductions
may not benefit Kim unless she is in a position to itemize her deductions (i.e., forgo the
standard deduction). Furthermore, the expenses are subject to the 2% of AGI floor.

If on the other hand, Kim selects the $35,000 option, Crane Corporation must suffer the
50% cutback adjustment.

pp. 9-17, 9-30, and 9-32

29. The first major tax problem Jeff is apt to encounter is the inability to deduct his moving
expenses. This problem can be avoided if Jeff would satisfy either the 39-week rule
(employee) or the 78-week rule (self-employed) once he moves to New Mexico. Being a
physician, chances are good that Jeff would have little difficulty obtaining work in the
medical field. Keep in mind that it is full-time employment that is required; the income
level of such employment is immaterial. pp. 9-12, 9-31, and Example 45

30. a. If the trip is more than 100 miles from home and includes an overnight stay, a
deduction for AGI is allowed. The deduction is limited to the maximum Federal
per diem rate applicable to the geographical area involved. Tax in the News on
p. 9-29

b. Deduction from AGI and subject to the 2%-of-AGI floor. p. 9-22

c. Deduction from AGI and subject to the 2%-of-AGI floor. As the taxpayer is not
an elementary or secondary school teacher, the school supplies provision of $250
does not apply. Example 40

d. Nondeductible, as the IRS maintains that acquiring a law degree or taking the bar
exam is qualifying for a new trade or business. p. 9-15

e. Nondeductible, as job-hunting expenses must involve the same trade or business.

Switching from teacher to stockbroker involves different trades or businesses.
p. 9-23

f. Nondeductible, as not directly related to the taxpayer’s trade or business (i.e.,

dentistry). Example 13

g. Safety clothing, if related to the job, is deductible. Since the taxpayer is self-
employed, a deduction for AGI results. p. 9-23

PROBLEMS

31. a. 50 work weeks X 5 days = 250 days X 25 miles = 6,250 miles. The deduction
allowed is determined by the distance between the two jobs. The fact that Marlon
might return home before going to the second job is immaterial. p. 9-5 and
Example 5
 Deductions: Employee and Self-Employed-Related Expenses 9-9

b. Since Marlon is not in travel status or business entertainment is not involved, the
cost of meals is a nondeductible personal expense. p. 9-7

32. $2,916. 240 days X [(10 miles + 8 miles + 12 miles) X $0.405 (automatic mileage rate
for 2005)]. pp. 9-5, 9-6, and Example 6

33. a. Nelson’s adjusted basis is determined as follows:

Cost of automobile $38,000

Less depreciation (under automatic mileage method):
2003 (15,000 miles X 90% X 16 cents) (2,160)
2004 (20,000 miles X 90% X 16 cents) (2,880)
2005 (18,000 miles X 90% X 17 cents) (2,754)
Adjusted basis of auto on 1/1/06 $30,206

pp. 9-6, 9-7, and Example 9

b. Cost of automobile $38,000

Less depreciation (allowed under actual operating
cost method—see below*) (9,819)
Adjusted basis of auto on 1/1/06 $28,181

*Depreciation allowed is the lesser of the table amount (Table 8-1 on p. 8-27) or
the recovery limitation (p. 8-14).

Depreciation
Year Table Amount Recovery Limitation Allowed

2003 $38,000 X 20% X 90% = $6,840 $3,060 X 90% = $2,754 $2,754

2004 $38,000 X 32% X 90% = $10,944 $4,900 X 90% = $4,410 4,410
2005 $38,000 X 19.2% X 90% = $6,566 $2,950 X 90% = $2,655 2,655
Total depreciation allowed $9,819

Example 19 in Chapter 8

34. a. Travel days count as business days and weekends also count as business days
when preceded (i.e., Friday) and followed (i.e., Monday) by business days. For
Margaret, Thursday is a personal day. Margaret’s deductible expenses are
determined below:

Airfare $2,200
Lodging (6 nights X $150) 900
Meals (5 days X $130) X 50% (cutback adjustment) 325
Total $3,425

p. 9-10 and Example 20

b. As Margaret was way from home for seven days, all of the airfare is deductible
and no apportionment is required. [Note: Margaret also passes the less than 25%
for personal purposes test (i.e., one day out of eight is less than 25%)].
Consequently, Margaret’s deductible expenses are $3,425—as determined in part
a. of this problem. pp. 9-10, 9-11, Examples 22, 23, and Footnote 18
9-10 2006 Comprehensive Volume/Solutions

c. Because Margaret is self-employed, a deduction for AGI results. p. 9-3

35. a. Graham’s assignment is temporary (not indefinite), so his tax home has not
changed. While in Cheyenne, therefore, he is in travel status. The deductible
portion of his weekend expenses is limited to $320, the amount he would have
spent had he not gone home.

b. The answer will not change and remains at $320 but for a different reason. A
deduction is always limited to the amount actually spent.

p. 9-8 and Example 10

36. Although they may be very useful to their family, Mrs. Lord’s activities do not constitute
a trade or business. Consequently, her expenses at the conference are not deductible.

Alvin’s deductible expenses are as follows:

Airfare (one ticket) $ 520

Lodging 660
Meals ($100 X 3 days) $300
Less: cutback adjustment (150) 150
Registration fee ($520 – $120) 400
Car rental 240
Total $1,970

p. 9-9 and Examples 13, 14, and 16

37. a. Justin’s trip is treated as being 100% for business. Weekends and holidays are
business days when preceded and followed by business days. Travel days are
business days and (though not mentioned in the text) this should include days
when travel is not possible (e.g., equipment failure, weather delays).
b. Yes, as this causes Saturday, Sunday, and Monday to be nonbusiness days.

c. Under the assumptions in part a., all of the airfare would be deductible. This is
also the case regarding part b. because of the 7-days-or-less exception. Under the
exception, the day of departure is not counted. Consequently, Justin’s trip lasted
from Friday to Thursday, or seven days.

p. 9-10 and Footnote 18

38. a. Thirteen days. Since travel days count as business, and weekends count as
business when preceding and succeeding days are business days, all of her
absence is regarded as business.

b. If Monica does not satisfy the 7-day or less-than-25% tests, then part of her
transportation cost is not deductible.
c. Monica cannot satisfy the 7-day test because she was away from home for more
than 7 days. Under the less-than-25% test and not counting partial days, she
could have vacationed for three more days assuming the days did not interfere
with the preceding and succeeding days provision.
p. 9-10 and Example 23
 Deductions: Employee and Self-Employed-Related Expenses 9-11

39. a. The job search expenses are not included in the moving expense category but are
deductible as miscellaneous itemized deductions. As such, they are classified as
deductions from AGI. Further, they are subject to the 2%-of-AGI floor.
The loss on the sale of the personal residence is not a qualified moving expense.
It is treated as a personal loss and is not deductible. Also, meals during the move
are not included in allowable moving expenses.
The deduction for AGI as to qualified moving expenses is as follows:
Packing and moving expenses for household goods $6,000
Lodging during move 620
Mileage (6,600 miles X $0.15) 990
Total deduction $7,610
b. It appears that accounting and human resources are different trades or businesses.
If so, the job search expenses become nondeductible. The change in job
descriptions does not, however, affect the allowance of the moving expense
deduction.
pp. 9-11 to 9-13, 9-23, 9-28, and Example 25
40. a. At most, $4,000 of the tuition could be a deduction for AGI. This assumes that
the AGI limitations of § 222 are not exceeded ($65,000 for an unmarried return
and $130,000 for a joint return). As Garth spent $4,300 on tuition, the § 222
deduction for AGI is limited to $4,000.

b. Presuming $4,000 is claimed under § 222 [see part (a.) above], the deduction from
AGI is as follows:
Tuition ($4,300 – $4,000) $ 300
Books and course materials 650
Lodging 1,200
Meals ($1,600 X 50% cutback adjustment) 800
Laundry and dry cleaning 220
Campus parking 300
Auto mileage ($1,500 miles X $.405) 608
Total deduction from AGI $4,078
pp. 9-15, 9-16, and Examples 27 and 28
41. a. $4,000. The education does not have to be job related.
b. $1,900. A second category of AGI (more than $65,000 and up to $80,000) for
years 2004 and 2005. However, only the amount spent for tuition qualifies.

c. Zero, as to a., because pursuing a law degree is treated as qualifying for a new
trade or business. As to b., the $200 not allowed for books qualifies as the
education is job related.
pp. 9-14 to 9-16
42. a. Calvin must include the travel allowance of $12,000 ($1,000 X 12 months) in
gross income. He may claim the following as deductions from AGI.
9-12 2006 Comprehensive Volume/Solutions

Lodging $13,600
Meals $12,480
Less: cutback adjustment (30% X $12,480)* (3,744) 8,736
$22,336
*Calvin is regulated by the U.S. Department of Transportation.
The travel expenses also will be subject to the 2%-of-AGI floor.
b. Since these expenses considered alone clearly exceed the standard deduction,
Calvin should itemize his deductions from AGI. But note that Calvin is on the
road for 44 weeks out of the year. This may mean that he is not away from a tax
home (i.e., expenses are not duplicated). If this is the case, he is not in travel
status. Because meals and lodging expenses would then not be deductible,
claiming the standard deduction could be more beneficial.
pp. 9-8, 9-17, and Example 12
43. a. Grebe Associates may deduct the following amounts:
Cost of seats ($70 X 20) $1,400
Food and beverages 450
Total entertainment expenses $1,850
Less: 50% cutback adjustment (925)
Total deduction $ 925
b. No. The deduction is determined by the seats available and not those occupied.

p. 9-20 and Example 37

44. $116. ($27 + $25 + $20) + ($88 X 50%). No deduction is allowed for the gift to George,
since he is Kevin’s boss. The deduction for the gift to John is limited to $25. The
deduction for the gifts to Darlene is limited to $27 ($25 + $2 for gift wrapping is
allowed). Subject to the cutback adjustment, the lunch also is deductible. p. 9-20
45. a. The office in home expenses are $3,500, calculated as follows:
Real property taxes (20% X $4,000) $ 800
Interest on home mortgage (20% X $5,000) 1,000
Operating expense of home (20% X $1,000) 200
Allocable depreciation 1,500
$3,500
When combined with other expenses of the business ($3,200), the total of $6,700
exceeds the income from the business by $1,200 ($6,700 – $5,500). Thus, the
depreciation allowed is limited to $300 ($1,500 – $1,200), making the deductible
office in the home expense $2,300. The nondeductible $1,200 can be carried
forward to future years.

b. Since Brittany is self-employed as to her financial planner business, all of these

transactions end up on Schedule C of Form 1040 (i.e., deductions for AGI). First,
however, Form 8829 (Expense for Business Use of Your Home) must be
completed.
 Deductions: Employee and Self-Employed-Related Expenses 9-13

The remainder of the property taxes of $3,200 (80% X $4,000) and mortgage
interest expense of $4,000 (80% X $5,000) not involved in the home office will
qualify as itemized deductions (deductions from AGI) and can be claimed on
Schedule A of Form 1040.
pp. 9-20 to 9-22 and Example 39

46. Victor must first make an allocation to determine the appropriate portion of the
reimbursement that applies to meals and entertainment and to other employee expenses.
$3,200 (meals) + $2,200 (entertainment) = 36%
$14,900 (total expenses)
Consequently, of the $10,000 reimbursement, 36%, or $3,600, applies to meals and
entertainment and 64%, or $6,400, applies to the other employee expenses. The
deductions for AGI and from AGI are reported on Form 2106 in the following manner:
Other than
Meals and Meals and
Entertainment Entertainment
Lodging $3,400
Transportation 5,200
Professional dues and subscriptions 900
Meals ($3,200) and entertainment ($2,200) $5,400
Total expenses $9,500 $5,400
Less: reimbursement (deductible for AGI) (6,400) (3,600)
Unreimbursed portion $3,100 $1,800
Less: cutback adjustment (900)
Unreimbursed deduction from AGI $3,100 $ 900

The totals from Form 2106 are reported on Schedule A, then reduced by 2% of AGI:
Total unreimbursed employee expenses ($3,100 + $900) $4,000
Less: 2% of $94,000 AGI (1,880)
Total deduction from AGI $2,120
p. 9-27 and Example 43
47. Cole must make an allocation to determine the appropriate portion of the reimbursement
that applies to meals and entertainment and to other employee expenses:

$7,200 ($4,100 meals + $3,100 entertainment) = 33%

$21,700 (total expenses)

Consequently, of the $15,000 reimbursement, $4,950 (33% X $15,000) applies to meals

and entertainment and $10,050 (67% X $15,000) pertains to the other employee
expenses.
The deductions for AGI and from AGI are reported in the following manner:
9-14 2006 Comprehensive Volume/Solutions

Other than
Meals and Meals and
Entertainment Entertainment
Airfare $ 9,200
Lodging 5,300
Meals $4,100
Entertainment 3,100
Total business expenses $14,500 $7,200
Less: reimbursement (deductible for AGI) (10,050) (4,950)
Unreimbursed portion $ 4,450 $2,250
Less: cutback adjustment (1,125)
Unreimbursed deduction from AGI $ 4,450 $1,125

The totals from Form 2106 are reported on Schedule A and are reduced by 2% of AGI as
follows:

Total unreimbursed employee expenses ($4,450 + $1,125) $5,575

Less: 2% of $98,000 (AGI) 1,960
Total deduction from AGI $3,615
p. 9-27 and Example 43

48. As the employer did not identify what the reimbursement was for, Audry must allocate it
between the items that are and are not subject to the cutback adjustment. The percentage
applicable to the cutback portion is determined as follows:

$5,000($2,800 meals + $2,200 entertainment)

= 33 1/3%
$15,000 (total expenses)

Thus, $1,500 (33 1/3% X $4,500) of the reimbursement applies to meals and
entertainment while the balance of $3,000 ($4,500 – $1,500) relates to the other
employee expenses.

Audry’s AGI is: $59,000 (salary) + $1,600 (interest income) – $2,000 (long-term capital
loss) = $58,600.

The deductions for and from AGI are determined as follows:

Other than
Meals and Meals and
Entertainment Entertainment
Transportation $ 5,500
Lodging 4,200
Professional dues and subscriptions 300
Meals and entertainment ($2,800 + $2,200) $5,000
Total employee expenses $10,000 $5,000
Less: reimbursement (treated as deduction for AGI) (3,000) (1,500)
Unreimbursed expenses $ 7,000 $3,500
Less: cutback adjustment (1,750)
Unreimbursed deductions from AGI $ 7,000 $1,750
 Deductions: Employee and Self-Employed-Related Expenses 9-15

These items are reported on Schedule A and are reduced by 2% of AGI as follows:
Total unreimbursed employee expenses ($7,000 + 1,750) $8,750
Less: 2% of $58,600 (1,172)
Total employee deductions from AGI allowed $7,578
p. 9-27 and Example 43
49. a. The Pitt’s AGI for 2005 is computed as follows:

Salaries ($51,750 + $48,000) $99,750

Contributions to traditional IRAs (8,000)
Short-term capital gain 3,000
AGI $94,750

b. Itemized deductions subject to the 2%-of-AGI limitation are determined as

follows:
Union dues (Note 1) $ 1,200
Safety clothing 500
Professional dues and subscriptions 400
Refreshments for school picnic (Note 2) 200
Correspondence study course (Note 3) 320
$ 2,620
Less: 2% X $94,750 (AGI) (1,895)
Deductible portion $ 725
Add: other itemized deductions 13,100
Total deductions from AGI $13,825
Notes
(1) It is presumed that the Pitts are cash basis taxpayers. Thus, the union dues are
deductible in the year paid.

(2) Eva’s participation in the cost of the school picnic is related to her job as a
teacher.
(3) Considering the composition of Eva’s classes (i.e., sixth grade), the
correspondence study course is job related, as it would improve her teaching
effectiveness.

p. 9-28 and Example 44

CUMULATIVE PROBLEMS
50. Salary $70,000
Performance bonus (Note 1) -0-
Travel and entertainment allowance (Note 2) 24,000
Employee discount (Note 3) 300
Other income (Note 4):
Interest income (Note 5) 1,160
Dividends (Note 6) 940
9-16 2006 Comprehensive Volume/Solutions

Contribution to IRA (4,000)

Adjusted gross income $92,400
Personal exemption (3,200)
Itemized deductions:
Not subject to 2% limitation (Note 7) $10,670
Subject to 2% limitation (Note 8) 24,366 (35,036)
Taxable income $54,164
Tax liability (Note 9) $10,112
Less: Estimated tax payments (11,000)
Net tax payable (or refund due) for 2005 ($ 888)

Notes
(1) The bonuses are taxed to Brenda in the year received. Thus, the 2004 bonus of
$12,000 is taxed in 2004 and the 2005 bonus of $15,000 is taxed in 2006.
(2) The allowance Brenda receives is income and cannot be offset against her
expenses. Because she does not account to her employer, all employment-related
expenses are classified as deductions from AGI and will be subject to the 2%
limitation.
(3) Pursuant to § 132(c)(1), qualified employee discounts are exclusions from gross
income. But the exclusion cannot exceed the equivalent of the gross profit
percentage. In Brenda’s case, this means an exclusion of $600 and income of
$300, determined as follows:

Retail price of clothing $3,000

Less: gross profit (20%) (600)
Nontaxable discounted price allowed $2,400
Cost to Brenda [$3,000 – (30% X $3,000)] 2,100
Taxable discount $ 300
See Example 27 in Chapter 5.
(4) Unlike state income tax refunds, which may cause income recognition under the
tax benefit rule, Federal refunds carry no such tax consequences.
(5) Interest on municipal bonds ($1,410) is nontaxable, while interest on CDs ($800)
and corporate bonds ($360) are included in gross income.
(6) Although qualified dividends are taxed at a preferential rate, they are included as
part of gross income.

(7) Medical expenses—

$900 (premiums) + $9,200 (dental) $10,100
Less: 7.5% X $92,400 (6,930) $ 3,170
Property taxes 2,800
Sales taxes (receipts available) 1,200
Interest on home mortgage* 2,200
Charitable contributions** 1,300
Total itemized deductions not subject to the 2%-of-AGI limitation $10,670
 Deductions: Employee and Self-Employed-Related Expenses 9-17

*Interest on amounts borrowed to purchase or carry tax-exempt municipal bonds

is not deductible.

**The political contribution of $200 is nondeductible under the public policy

limitation.
(8) Air fare $11,200
Less: nondeductible portion for European trip
(2 weeks/3 weeks X $3,300)* (2,200) $ 9,000
Meals (less 50% cutback) 1,550
Lodging 3,900
Entertainment (less 50% cutback) 1,900
Taxis, limos, rentals, valet ($1,200 + $420) 1,620
Professional expenses 390
Business gifts [10 employees X ($25 + $4)] 290
Car expense under actual expense method** 6,704
Tolls and parking 620
Education expense 240
Total itemized deductions subject to 2% limitation $26,214
Less: 2% of $92,400 (1,848)
Total itemized deductions net of 2% limit $24,366

*Foreign travel expense must be allocated between business and personal use
because neither the 7-day or less exception nor the less than 25% personal use
exception applies. Flying business class, rather than coach, is appropriate as no
rule requires that the cheapest class of transportation be used.

**Car operating expenses—

Insurance $1,300
Registration, license, etc. 70
Gasoline and oil 1,500
Tires 300
Repairs 410
Traffic fines (not deductible) -0-
$3,580
Business use percentage X 80% $2,864
Depreciation allowed for 2005 is the lesser of—
[$40,000 X 32% (recovery year 2 from Table 8-1,
p. 8-27)] X 80% (business use) = $10,240
OR
[$4,800 (recovery limitation for year 2 from
p. 8-14) X 80% business use)] = $3,840
Depreciation allowed for 2005 3,840
Total car expenses under the actual expense method $6,704

(9) Taxable income $54,164

Less specially treated items:
Qualified dividends (940)
Taxable income at ordinary rates $53,224

$4,090 + 25%($53,224 – $29,700) $ 9,971

Tax on dividends: $940 X 15% 141
Total tax liability $10,112
9-18 2006 Comprehensive Volume/Solutions

51. Part 1

George’s commissions $49,200

Martha’s salary 61,900
Interest income (Note 1) 2,100
IRA contributions ($3,000 + $3,000) (6,000)
George’s employment expenses (Note 2) (16,310)
College tuition under § 222 (Note 3) (2,800)
Adjusted gross income $88,090
Itemized deductions (Notes 4 and 5) (14,493)
Personal exemptions ($3,100 X 2) (6,200)
Taxable income $67,397

Tax from Tax Table $10,319

Less: Withholding and estimated tax ($6,250 + $4,000) (10,250)
Net tax payable (or refund due) for 2004 $ 69

Notes
(1) The life insurance proceeds ($100,000) are nontaxable, but the additional $600
received from Pyramid Life constitutes interest income and is added to the $1,500
interest from the certificate of deposit. The gift received from Martha’s parents is
nontaxable.

(2) Because George is a statutory employee, his job-related expenses are deductions
for AGI. These expenses are summarized below:

Airfare $ 1,820
Meals ($2,600 – 50% cutback) 1,300
Lodging 1,700
Entertainment ($1,400 – 50% cutback) 700
Business gifts (30 X $29) 870
Auto expense:
Mileage (24,800 X $0.375) $9,300
Parking 340
Tolls 280 9,920
Total deduction for AGI $16,310
None of the traffic fines of $420 are deductible. The business gift limitation is
$25 plus $4 for wrapping and shipping.

George reports the information on the automobile in Part IV of Schedule C

because he is using the automatic mileage method. If he were using the actual
cost method, he would be required to file Form 4562 (Depreciation and
Amortization) because the automobile is listed property.

(3) Only Martha’s tuition of $2,800 falls under § 222. The remainder of her MBA
expenses are deductions from AGI.
 Deductions: Employee and Self-Employed-Related Expenses 9-19

(4) Itemized deductions are:

Medical $7,800
Less: 7.5% of $88,090 (AGI) (6,607) $ 1,193
Real property taxes 3,200
Sales taxes (table amount) 1,000
Home mortgage interest 7,000
Charitable contributions 2,100
Miscellaneous expenses (Note 5) -0-
Total $14,493

(5) Miscellaneous itemized deductions subject to the 2%-of-AGI floor are calculated
below:

Tax return preparation fee $ 300

MBA expenses (other than tuition):
Books and supplies $360
Bus fare 120 480
Entertainment: ($68 + $74) – 50% cutback 71
Professional dues and trade journals ($140 + $220) 360
Total $1,211
Less: 2% of $88,090 (AGI) (1,762)
Deductible amount $ -0-

Not allowed are Martha’s meals of $190 while on campus (she is not in travel
status) and the lunch she bought to entertain her boss.

See the tax return solution beginning on page 9-21 of the Solutions Manual.

Part 2

a. Only the second alternative would be included in 2004 gross income. The $9,000
in dividend income yields a tax of $1,350 ($9,000 X 15%). (Note: qualified
dividend income is subject to a maximum tax rate of 15% for a taxpayer in the
25% or above bracket.)

The cash flow would be as follows:

First Second
Alternative Alternative
Income $6,750 $9,000
Less: Increase in tax -0- (1,350)
Net cash flow $6,750 $7,650

b. The stock investment produces a larger after-tax cash flow of $900 ($7,650 –
$6,750) than the municipal bonds.
9-20 2006 Comprehensive Volume/Solutions

c. Willis, Hoffman, Maloney, and Raabe, CPAs

5191 Natorp Boulevard
Mason, OH 45040

April 1, 2005

Mr. and Mrs. George Jordan

321 Oak Street
Lincoln, NV 89553

Dear Mr. and Mrs. Jordan:

As per your request, I analyzed two investment alternatives for the $150,000 you
received as gifts and life insurance proceeds during 2004. These alternatives
were:

1. An investment in municipal bonds yielding 4.5% interest.

2. An investment in common stock paying an annual cash dividend of 6%.

The stock investment not only produces a greater yield ($9,000 as opposed to
$6,750), but also it results in a higher after-tax cash flow.

Part of the reason for this result is due to the special tax treatment qualified
dividend income now receives. For someone in your tax bracket, dividends are
taxed at a maximum rate of 15%. Consequently, after income taxes are
considered, the $9,000 of dividend income is reduced to $7,650. The result
exceeds the interest income from the municipal bond investment ($6,750) by
$900!

If I can be of further assistance, please call me.

Sincerely,

Agnes Wright, CPA

Partner
 Deductions: Employee and Self-Employed-Related Expenses 9-21

51.
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51. continued