26. Self-Employment Tax
Carrie owns a business that she operates as a sole proprietorship. The business had a net profit of $25,000. This is Carrie's only earned income.
a. How much must she pay for self-employment taxes?
b. How much can she deduct on her tax return?
c. If the business had a net loss of $10,000 (instead of a $25,000 profit), how much in self-employment taxes must Carrie pay?
27. Self-Employment Tax
George has $71,300 in salary from his full-time position and $43,000 in net income in 2010 from his sole proprietorship. What must he pay for self-employment tax? What portion of this can he deduct?
28. Self-Employed Health Insurance
Luis operates a bakery as a sole proprietorship. He has four bakers whom he employs on a full-time basis and who participate in a company-paid health insurance plan. Luis is also covered by this same plan. The annual premiums are $2,300 per person. The business paid $11,500 for health insurance premiums for the year. Are these insurance premiums deductible? If they are, where should Luis deduct them on his tax return?
29. IRA Eligibility for Self-Employed
Alexander works as an electrician at a small company that provides no retirement benefits. He receives a salary of $45,000. In addition, Alexander operates a small roof repair service as a sole proprietor; this business has a net loss of $2,500. In addition, Alexander realizes $800 of net income from rental property and $1,500 in interest income. What is Alexander's earned income for determining the amount he is eligible to contribute to an IRA?
30. Foreign Earned Income Exclusion
Wendy is a single individual who works for MTP, Inc. During the entire calendar year she works in France and pays French taxes of $8,000 on her $90,000 salary. Her taxable income without considering her salary from MTP is $10,000. Should Wendy claim the income exclusion or tax credit and how much tax does she save by using the alternative selected?
31. Foreign Tax Credit
Mark works in a foreign country for the entire calendar year. His salary is $120,000 and he pays $18,000 in tax to the foreign government. His other taxable income (from U.S. sources) after all deductions is $30,000. If he claims the foreign earned income exclusion, how much are his creditable foreign taxes?These questions require answers that are beyond the material that is covered in this chapter.
32. Business Formation
Evan is setting up a new business. He can operate the business as a sole proprietorship or he can incorporate as a regular C corporation or as an S corporation. He expects that the business will have gross income of $130,000 in the first year with expenses of $25,000 excluding the following. He plans to take $35,000 from the business for living expenses as a salary and will have the business pay $3,000 annually for his health insurance premiums.
a. Compute the total tax cost in 2010 for each alternative if Evan is single and this is his only source of income.
b. Which alternative business form do you recommend based solely on the first year tax costs?
c. What are some of the other factors Evan should consider in deciding between a C corporation and an S corporation for his business?
33. Reasonable Compensation
Cindy is President and sole shareholder of Chipsmart Corporation. Through her hard work (frequently putting in 70 hours per week), she has managed to triple the number of clients and revenue in the past year. Chipsmart has never paid a dividend to Cindy, although it does have retained earnings. Last year, Cindy's salary was $200,000; this year, due to her success, she would like to pay herself a $600,000 salary. As Chipsmart's tax adviser, prepare a list of questions you would like to ask Cindy when you meet her to discuss the salary increase.
34. Exercising Incentive Stock Options
What tax planning should be done before exercising incentive stock options?
flow compared to holding the stock while it continues to decline.
35. Stock Option Taxation
Construct a scenario in which the tax treatment of stock options is very unfavorable for the employee.
36. Stock Option Terminology
The recent scandal on backdating stock options has introduced new terminology to describe these controversial practices. Describe what you think each of these terms means.
a. Backdating
b. Repricing
c. Reloading
d. Spring-loading
e. Bullet-dodging
37. Defined Benefit vs. Defined Contribution Plan
Would an employee who first becomes a participant in a pension plan at age 52 generally prefer to have a defined benefit plan or a defined contribution plan? Explain.
38. Retirement Contribution Taxation
What do you think the effect would be if Congress changes the law so that retirement plan contributions are included in taxable income at the time they are made rather than taxing the payment when received in retirement?
Identify the Issues
Identify the issues or problems suggested by the following situations. State each issue as a question.
39. Reasonable Compensation
Susan is the second-highest-paid executive for Sanibel Corporation, a publicly traded corporation. Her salary is $1,600,000.
40. Reasonable Compensation
Virginia is the president and founder of VT Corporation. She is extremely devoted to the business, frequently working 70-hour weeks. She did not take any salary from the business for its first two years of operations. She is now receiving a salary that is 150 percent of what comparable businesses pay their presidents.
41. Employer-Provided Lodging
George just accepted a job as an apartment manager and is paid a salary of $28,000 per year. In addition to the salary, he is offered the choice of rent-free use of an apartment or a $500 per month housing allowance. George decides to accept the rent-free apartment.
42. Personal-Use of Company-Owned Vehicle
Victor has the full-time use of a company owned Jaguar automobile. This year Victor drove 24,000 miles for business and 10,000 personal miles. His employer does not require him to report his personal mileage but, instead, includes the lease value of the full-time use of the automobile as additional compensation on his Form W-2.
43. Moving Expenses
In February, Margaret's employer asked her to move from the Miami office to the Atlanta office. In March, Margaret spent $900 on a house-hunting trip to Atlanta. She located a home and moved into it in April. Margaret's employer reimbursed her for all direct costs of moving to Atlanta and also for the cost of the house-hunting trip.
44. Traditional vs. Roth IRA
Sarah is single and earns $60,000 in salary. She wants to invest $2,500 per year in an IRA but is not sure which type she qualifies for and whether this would be a better investment than investing the money in preferred stock paying a 6 percent annual dividend.
45. Pension Contribution
Ken is single and earns a salary of $60,000 per year. He also receives $4,000 a year in taxable interest and dividend income. Ken would like to contribute the maximum allowable to his company's qualified pension plan.
Develop Research Skills
Solutions to research problems are included in a separate file.
Search the Internet
46 Excess Mileage Allowance
Go to www.legalbitstream.com. Locate and read Regulation Section 1.62-2(j), example 6. If an employer has an otherwise accountable plan but reimburses employees at 60 cents per mile, how is the reimbursement treated?
47. Flexible Spending Arrangement
Go to www.legalbitstream.com. Locate and read Revenue Ruling 2003-102. What type of medicines and drugs can be reimbursed through a flexible spending arrangement (FSA)? What change takes effect in 2011?
48. Adjusted Gross Income and Self-Employment Tax
Go to www.irs.gov and print Form 1040 and Schedule SE. Complete the first page of Form 1040 and Schedule SE for Angelina, a single individual, who reports $75,000 of net profit on her Schedule C from her sole proprietorship.
a. What is Angelina's adjusted gross income?
b. What is Angelina's self-employment tax?
49. Conversion to Roth IRA
Find an article on the Internet that describes how a traditional IRA can be converted into a Roth IRA. Summarize the process explaining any tax costs associated with the conversion. Include the URL for the article.Develop Planning Skills
50. Foreign Earned Income
Jorge, a single individual, agrees to accept an assignment in Saudi Arabia, a country that imposes no income tax on compensation, beginning on January 1. Jorge will be paid his normal monthly salary of $5,000, plus an additional $1,400 per month for each month he works in Saudi Arabia. His employer requires him to remain in Saudi Arabia for at least six months; however, he can elect to continue working there for up to six additional months if he wishes or return to work in the U.S. office. Advise Jorge of the tax ramification if he stays in Saudi Arabia only six months and if he stays there an additional six months.
51. Planning for Salary Increase
Sherry just received a big promotion at Barcardo Corporation. Last year her salary was $100,000 but due to her promotion she expects to earn $180,000 this year. She expects that she will be able to save about $60,000 of her pay raise and is interested in exploring ways to minimize her federal tax liability. List some of the tax-planning opportunities with respect to her salary.
52. Lump Sum Distribution vs. Rollover
Maria, age 42, just resigned from Bygone Corporation to accept a new job with Future, Inc. Bygone informed Maria that she has a $38,000 balance in its qualified retirement plan and wants to know if she plans to roll over this balance into another plan or prefers to receive a lump sum payment. Maria is in the 28 percent marginal tax bracket and would like to buy a new car with the funds although the local car dealer is currently offering very attractive low-interest financing. Determine the amount of after-tax funds Maria would have available to pay for the car if she takes a lump sum distribution, and make a recommendation regarding what you think she should do.
53. 401(k) vs. Municipal Bond Investment
William, an employee for Williamson Corporation, receives an annual salary of $120,000 and is in the 28 percent marginal tax bracket. He is eligible to contribute to Williamson's 401(k) plan and could contribute the pretax amount of $12,000. Alternatively, he could contribute only $6,000 to the plan and use the remaining $6,000 to purchase municipal bonds paying 6 percent interest. Evaluate the tax savings and after-tax cash-flow effect of each of these investment choices. State which option you recommend for William and explain why.
54. Traditional vs. Roth IRA
Robert, age 55, plans to retire when he reaches age 65. He is not currently an active participant in any qualified retirement plan. His budget will allow him to contribute no more than $3,000 of his income before taxes to either a traditional IRA or a Roth IRA to provide retirement income. His marginal tax rate will be 28 percent until he retires, at which time it will drop to 15 percent. He anticipates a rate of return on either type of IRA of 7 percent before considering any tax effects. Prepare an analysis for Robert comparing the tax effects of investing in a traditional IRA and in a Roth IRA..
55. Net Present Value
Melinda has been offered two competing employment contracts for the next two years. Argus Corporation will pay her a $75,000 salary in both years 1 and 2. Dynamic Corporation will pay Melinda a $100,000 salary in year 1 and a $49,000 salary in year 2. Melinda expects to be in the 25 percent marginal tax bracket in year 1 and in the 33 percent marginal tax bracket in year 2 (due to a significant amount of income from new rental properties). She does not expect either offer to change her marginal tax bracket for either year. Both Argus Corporation and Dynamic Corporation expect their marginal tax brackets to remain at 34 percent over the two-year period and expect that employment tax rates will remain the same.
a. Compute the net present value of the after-tax cash flow for Melinda and after-tax cost for Argus and Dynamic for each of the proposed employment contracts using a 6 percent discount rate.
b. Which alternative is better for Melinda and which is better from the corporation's perspective?