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ACC243 Accounting Research Oakton Community College Research Case #1 - Individual Income Tax You are a senior staff accountant at a CPA firm and have met a married couple, Mary and Joe, who just moved from another state and looked for a CPA to prepare their individual income tax return. Mary and Joe were married in February 2012 and Mary gave birth to their first child on December 31, 2012. Mary's mother is retired and lives with them for seven months a year when she does not stay in her condo in Florida. Additionally, Mary's mother does not have adequate retirement income and they have to provide majority of financial support to Mary's mother. For this case, all people are U.S. citizens. May and Joe used to live in Louisville, Kentucky and in May 2012, Joe received a new job offer in Chicago, Illinois. They were lucky and sold their house, where they had lived for 3 years, within sixty days. They purchased the house for $150,000 and put in $20,000 for renovation. The selling price was $200,000. In May 2012, Joe bought some lottery tickets from a gasoline store and won $7,000 in the state lottery. Joe has a passion for winning and has spent a couple of dollar each week purchasing tickets. Prior to winning, he had spent $650 in total on the tickets and all receipts had been kept for record purposes. In April 2012, Joe's father died and left him with an inheritance of $250,000. In May 2012, Mary gave her 18-year old cousin $12,000 to congratulate her being accepted by Princeton University. Mary is a free-lance writer and has a strong interest in real estate investment. She has acquired six single homes in the past. She spends about 15 hours per week on average managing the rental properties. In 2012, the overall losses were $50,000. Your manager has asked you to conduct research and present solutions to the following tax issues. She would like you to prepare the write-up in a memo (including all appropriate sections). The purpose of this memo is to conduct tax research. As part of your research, she would like you to answer the following questions and include the answers in your memo to support your recommendation. Be sure to include all references such as IRS codes and court cases supporting your research. Questions: 1. Personal Exemptions - on Mary and Joe's 2012 tax return, what is the number of personal exemptions can they claim and why? Your explanations should include the discussions of the Relationship Test for each exemption taken. 2. Recognition of gain from home sale - will Mary and Joe need to recognize any gain from the sale of their Kentucky home and why? 1 3. Income tax for prizes - what are the general rules for income tax on prizes? Can Joe deduct the ticket prices as expenses? 4. Gift tax - should Joe pay taxes on the $250,000 of inheritance he received? Can Mary deduct the $12,000 she gifted to her cousin? 5. Real estate deductions - assuming the couple's 2012 AGI is $250,000, how much of the losses can they deduct on the return? Mary heard that the entire loss can be deducted if she qualifies as an Active Investor. Please explain to her the difference between Passive Investing and Active Investing. Checklist of the Case (70 Points) The following list will be used to grade the write-up. Please use it as a guideline to complete your write-up. 1) Good introductory paragraph - 7 points 2) Reached a reasonable opinion about how to address the matter using the tax codes or court cases as guides. Explained thought process clearly. Q1 - 10 points Q2 - 10 points Q3 - 10 points Q4 - 10 points Q5 - 10 points 3) Good closing paragraph for memo - 7 points 4) Good use of grammar, spelling, and format - 6 points Sample Write-Up Instructor's Comments - 2 Below is a part of a good tax research paper. The issues are listed and the Recommendations are clearly explained and supported by the IRS tax codes. References are provided so that the readers will have access to the original sources. The write-up in this paper is rather lengthy. You can your own discretion to determine the appropriate length. __________________________________________________________________ TO: Manager of Tax Department FROM: RE: Mary and Joe (tax year 2015) _____________________________________________________________________________ Intro For this case all individuals are U.S. citizens. Mary and Joe, are married since February 2013 and have one child who was born on December 31, 2014. Etc. This Memo is to conduct tax research and provide opinions and suggestions on the issues. Issue I. Number of personal exemptions Mary and Joe can claim in their 2012 tax return. Authoritative Support Materials I. According to the IRS publication 501 (2013), there are two types of exemptions that a person may take which are personal exemptions for yourself and your spouse, and exemptions for dependents. If you are married the IRS allows for you to take one exemption for yourself and one for your spouse and you are allowed to one exemption for each person you claim as a dependent. The IRS publication 501 (2013) also defines a dependent as a qualifying child or qualifying relative. It states that a child must meet the five tests in order to be a qualifying child. The first test is the \"Relationship Test \"which basically states that the child has to be your son, daughter, stepchild, foster child, or a descendant of any of them, or your brother, sister, half-brother, halfsister, stepbrother, stepsister, or a descendant of any of them. The second test is the \"Age Test\" which states that the child has to be less than 19 years old at the end of the year or a student less than 24 years old and has to be younger than you or your spouse, or the child is permanently and completely disabled no matter the age. The third test is the \"Residency Test\" which says that a child has to have lived with you for more than half of the year but there are some exceptions. For instance, one of the exceptions is the death or birth of a child which states that a child who was born or died during the year is considered to have lived with you more than half of the year if your home was the child's home more than half of the time he or she was alive during the year. To meet the fourth test which is the \"Support Test\" the child did not provide more than half of his/her own support for the year. Finally, the fifth test states that the child cannot file a joint return for the year. 3 According to the IRS publication 501 (2013), four tests must be met for a person to be your qualifying relative. The first one is that the person is not a qualifying child or the qualifying child of any other taxpayer. The second test is the \"Member of Household or Relationship Test\" which is that the person must meet either had lived with you all year as a member of your household, or be related to you in one of the ways listed under the relatives who do not have to live with you. The third test is the \"Gross Income Test\" that says that a person's gross income for the year has to be less than $3,900. Also, the IRS defines gross income as all income in the form of money, property, and services that is not exempt from tax. The final test is the \"Support Test\" which basically is that you generally must provide more than half of a person's total support during the calendar year. Analysis I. The first rule clearly states that you can claim an exemption for yourself and your spouse which in this case would be Mary and Joe. Then, you can claim an exemption for each person you claim as a dependent which can either be a qualifying child or a qualifying relative. In this case, Mary and Joe's child approves all the five tests that the IRS sets in order for someone to be a qualifying child. Their child is a new born and he or she is their son or daughter which helps meet the relationship and age test. Also, even though their child has not lived with them for more than half the year, the residency test is met because their child was born during the year and has lived with them for all the time since he or she has been alive. The support and the joint return test are evidently met because they are completely supporting their child and their child is not filing a joint return. Next, we have Joe's mother who might be able to meet all four tests to be a qualifying relative. She is not a qualifying child which helps her meet the first test. Then, she meets the second test \"Member of Household or Relationship Test\" because even though she doesn't live with them the whole year which is what is stated to be a member of household, she qualifies because she is in the list under relatives who do not have to live you. For the last two test more information is needed about Joe's mother because if she has less than $3,900 in gross income and Joe and Mary provide more than half of Joe's mother total support during the year, then she would be a qualifying relative. Finally, Mary's mother meets all tests to be a qualifying relative. She is able to meet the first test because ................................ Conclusion I. In conclusion, by looking on what the IRS allows when taking personal exemptions, Mary and Joe can take X number of exemptions. The child can /can't be treated as a dependent because... His mother can be regarded .... in view of ................ References - 4 http://www.irs.gov/publications/p17/ch03.html 5