David R. and Ella M. Cole (ages 39 and 38, respectively) are husband and wife who live at 1820 Elk Avenue, Denver, CO 80202. David is a regional sales manager for Wren Industries, a national wholesaler of plumbing and heating supplies, and Ella is a part-time dental hygienist for the Smile For Me chain of dental clinics.
• David is classified by Wren as a statutory employee with compensation for 2016 (based on commissions) of $95,000. He is expected to maintain his own office and pay for all business expenses from this amount. Wren does not require him to render any accounting as to the use of these funds. It does not withhold Federal and state income taxes but does withhold and account for the payroll taxes incurred (e.g., Social Security and Medicare). The Coles are adequately covered by Wren's noncontributory medical plan but have chosen not to participate in its § 401(k) retirement plan.
David's employment-related expenses for 2016 are summarized below.
Airfare ...................................................................... $8,800
Lodging ...................................................................... 5,000
Meals (during travel status) ................................................. 4,800
Entertainment ................................................................ 3,600
Ground transportation (e.g., limos, rental cars, and taxis) ................ 800
Business gifts ................................................................... 900
Office supplies (includes postage, overnight delivery, and copying) ... 1,500
The entertainment involved business meals for purchasing agents, store owners, and building contractors. The business gifts consisted of $50 gift certificates to a national restaurant. These were sent by David during the Christmas holidays to 18 of his major customers.
In addition, David drove his 2014 Ford Expedition 11,000 miles for business and 3,000 for personal use during 2016. He purchased the Expedition on August 15, 2013; David always has used the automatic (standard) mileage method for tax purposes. Parking and tolls relating to business use total $340 in 2016.
• When the Coles purchased their present residence in April 2013, they devoted 450 of the 3,000 square feet of living space to an office for David. The property cost $440,000 ($40,000 of which is attributable to the land) and has since appreciated in value. Expenses relating to the residence in 2016 (except for mortgage interest and property taxes; see below) are reported as follows.
Insurance ......................................................................... $2,600
Repairs and maintenance .............................................................. 900
Utilities ................................................................................ 4,700
Painting office area; area rugs and plants (in the office) ........................ 1,800
In terms of depreciation, the Coles use the MACRS percentage tables applicable to 39-year nonresidential real property. As to depreciable personalty (e.g., office furniture), David tries to avoid capitalization and uses whatever method provides the fastest deduction for tax purposes.
• Ella works part-time as a substitute for whichever hygienist is ill or on vacation or when one of the clinics is particularly busy (e.g., prior to the beginning of the school year). Besides her transportation, she must provide and maintain her own uniforms. Her expenses for 2016 appear below.
Uniforms .............................................................. $690
State and city occupational licenses ................................. 380
Professional journals and membership dues in the American Dental
Hygiene Association .................................................. 340
Correspondence study course (taken online) dealing with teeth
whitening procedures ............................................... 420
Ella's salary for the year is $42,000, and her Form W-2 for the year shows income tax withholdings of $4,000 (Federal) and $1,000 (state) and the proper amount of Social Security and Medicare taxes. Because Ella is a part-time employee, she is not included in her employer's medical or retirement plans.
• In addition to those items already mentioned, the Coles had the following receipts during 2016.
Interest income-
State of Colorado general purpose bonds ....................... $2,500 ........................
IBM bonds .............................................................. 800 ........................
Wells Fargo Bank .................................................... 1,200 ............. $ 4,500
Federal income tax refund for year 2015 ................................................... 510
Life insurance proceeds paid by Eagle Assurance Corporation ................... 200,000
Inheritance of savings account from Sarah Cole ...................................... 50,000
Sales proceeds from two ATVs ........................................................... 9,000
For several years, the Coles household has included David's divorced mother, Sarah, who has been claimed as their dependent. In late November 2016, Sarah unexpectedly died in her sleep. Unknown to Ella and David, Sarah owned a life insurance policy and a savings account (with David as the designated beneficiary of each).
In 2015, the Coles purchased two ATVs for $14,000. After several near mishaps, they decided that the sport was too dangerous. In 2016, they sold the ATVs to their neighbor.
• Additional expenditures for 2016 include:
Funeral expenses for Sarah ............................................................. $ 4,500
Taxes- ..............................................................................................
Real property taxes on personal residence ........................ $6,400 ....................
Colorado state income tax due (paid in April 2016
for tax year 2015) ........................................................ 310 ............6,710
Mortgage interest on personal residence (Rocky Mountain Bank) ................. 6,600
Paid church pledge ........................................................................ 2,400
Contributions to traditional IRAs for Ella and David
($5,500 + $5,500) ................................................................ 11,000
In 2016, the Coles made quarterly estimated tax payments of $1,400 (Federal) and $500 (state) for a total of $5,600 (Federal) and $2,000 (state).
Part 1-Tax Computation
Using the appropriate forms and schedules, compute David and Ella's joint Federal income tax for 2016. Disregard the alternative minimum tax (AMT) and various education credits. Relevant Social Security numbers are:
David Cole ................................................................ 123-45-6788
Ella Cole ................................................................... 123-45-6787
Sarah Cole ................................................................ 123-45-6799
The Coles do not want to contribute to the Presidential Election Campaign Fund. They want any overpayment of tax refunded to them and not applied toward next year's tax liability. Suggested software: H&R BLOCK Tax Software.
Part 2-Follow-Up Advice
Ella has always wanted to pursue a career in nursing. To this end, she has earned a substantial number of college credits on a part-time basis. With Sarah no longer requiring home care, Ella believes that she now can complete her degree by attending college on a full-time basis.
David would like to know how Ella's plans will affect their income tax position.
Specifically, he wants to know:
• How much Federal income tax they will save if Ella quits her job.
• Any tax benefits that might be available from the cost of the education.
Write a letter to David, addressing these concerns. In making your projections, assume that David's salary and expenses remain the same. Disregard any consideration of the educational tax credits (i.e., American Opportunity and lifetime learning).