Stacey and Warren Harrison (453-44-5321) live at 5755 Warren Road, Santa Barbara, Ca. 90432. Stacey was born 4/1/1966. She is employed as a teacher at Milliken Secondary School. Her W-2 for 2009 shows wages of $49,338.94, federal income tax withheld of $3314, California State income taxes withheld of $1085, social security and Medicare tax were withheld at the appropriate rate. She is married to Warren Harrison (444-32-5890) born 3/2/1960. He is employed as an accountant at Chlorox Corporation. His W-2 shows salary of $68,302.84, federal income tax withheld of $4532, California State income taxes withheld of $2015, social security and Medicare tax withheld based on the appropriate rate. They file a joint tax return.
On April 15, 2010 they filed their 2009 tax return. On May 20, 2009 they received a $862 refund of their 2008 Federal taxes which they applied to their 2009 estimated tax. They also paid $464 California tax for the 2008 tax year on April 15, 2009. In 2009 they made estimated tax payments of $400 per quarter for federal taxes and $800 per quarter for state taxes. All payments were made on a timely basis (4/15/09, 6/15/09, 9/15/09 and 1/15/10).
They have three children that they support. Barry (583-22-5787) was born 4-1-1993. He earned $10,732 from a part time job (federal tax withheld $800, California tax withheld $422) and he earned $3132 in interest income from First National Bank. Wally (524-31-2784) was born 4-1-2000 and Theodora (524-34-3591) was born 4/01/1985. Stacey paid job-related child care expenses of $9457 to Phillip Williams. Williams provided child care for the two younger children. He lived with the family full-time. The Harrisons pay the “nanny tax” and file the appropriate forms with the 2009 tax return. The Harrisons have not withheld any income tax for Phillip Williams.
Theodora was a college student who lived in the dormitories at college during the year where she was receiving a degree in accounting. She spent her vacations at home. She earned $11,300 from a part-time job. Her parents provided over half her support. She was a full-time student. She also earned $2300 interest income form First National Bank. She files her own tax return.
The Harrisons received interest income of $2732 from First Federal Bank and a qualified ordinary dividend of $2530 from Intel Corp. on 4/1/2009. They sold 200 shares of IBM stock for $4300 on 5/2/2009 which they purchased on 3/1/2000 for $9000. They sold an oil painting that Stacey received as a gift from her grandmother on 10/12/2005. The value of the painting on 10/12/2005 was $12,000. Her grandmother received it as a wedding gift from her aunt on 12/13/1925 when it had a value of $500. The aunt bought it 1/15/1905 for $30. Her grandmother paid no gift tax on the gift. When her grandmother died on 12/15/2008 Stacey inherited her grandmother’s diamond bracelet which at that date was worth $4000. Her grandmother bought the bracelet on 1/15/1935 for $200. Stacey sold the bracelet for $3100 on 11/03/2009.
The Harrisons purchased their home on 3/1/2005 for $1.1 million. At the time they allocated the cost as follows:
Cost of building 700,000
Cost of Land 400,000
For 2009, the Harrisons paid the following expenses for their home (this includes the home office)
Mortgage payment to Wachovia
Interest 14,300 $20,300
Property taxes on home $12,200
Property insurance $1,400
Earthquake insurance $1,510
Garbage/Water $ 800
Alarm monitoring fee $1300
They also had the following expenditures:
Added new layer to existing roof 3/2/2009 $6736
New carpeting * $5000
* For the entire house except basement installed on 4/1/2009
The Harrisons decided to take advantage of the low cost of housing in Fresno, California. On 3/2/2009 they closed escrow on a 10-unit apartment building at 1313 Euclid Avenue, Fresno, California 90384. The cost of the building, improvements and land (based on FMV) was as follows:
Escrow fee 1,000
Title insurance 1,500
Landscaping n 20,000
Wall to wall carpeting 22,000
Stoves, refrigerator and dishwashers
(7 -years old at purchase) 6,000
They chose segmented depreciation in order to receive the maximum depreciation. Therefore, they depreciate the personal property and improvements separately from the building.
The rental income and expenses for the year were as follows:
Rental income $146,500
Depreciation expense (for you to determine)
Interest Expense $ 35,200
Property taxes $ 22,000
Insurance Expense $ 3,200
Repairs and maintenance $ 12,200
Supplies $ 4,200
Advertising $ 842
On 6/2/2009 Warren had the asphalt parking lot of the rental property resurfaced for $5250. He also took a course on real estate management for which he paid $1400.
The Harrisons had purchased a Honda Accord on 6/1/2008 for $42,000 plus sales tax of 9.5 percent. They also took out an extended warranty for $2500. They financed the car with a home equity loan for the entire amount of the purchase. They sold the Honda Accord on 12/31/2009 for $22,000. On 3/2/2009 the car was worth $27,000.
Warren made 60 trips to Fresno by car during 2009. The mileage in each direction was 186 miles. 15 of the trips were made prior to the purchase of the apartment building in order to investigate other potential properties that they did not end up buying. 10 trips were made in order to meet with his real estate agent to purchase this particular property. The remainder of the trips were made to deal with the gardener, contractor, and tenants.
On each of these trips he would stop at his favorite restaurants for meals. He spent $42 per day on meals each day he was on the road. He always returned the same day when he drove. During 2009 the total mileage for the Honda Accord was 35,000 miles. They chose to use the actual mileage method. Other expenses for the car during 2009 were:
Interest Expense 1500
Depreciation Expense ?
Personal Property Tax 80
License fee 120
Gas and Oil 1800
Repairs and Maintenance 800
Car washes 300
Auto club fee 120
The Harrison’s home was 2400 square feet (excluding the basement which was 800 square feet). Warren set up an office in his home to manage the rental property on the same day he purchased the rental property. The room he used for an office was 400 square feet. He placed calls to contractors and tenants from the office, wrote checks and kept records in the office. He spent about 20 hours a month in the office. For the office he purchased some new furniture and equipment and also moved some furniture from other parts of his house into the office. The furnishings for his office were:
New computer, printer, fax $3,200
Property management software 220
Turbotax Premier to prepare his tax return 80
Books on property management 150
New file cabinets 600
He moved the following furnishings from the house:
Oriental rug cost $3,000 FMV 2,000
Desk cost $ 3,000 FMV 1,000
Television cost $ 800 FMV 600
Stacey was a skilled pottery. She had taken many courses over the years in pottery. She set up shop in the basement of the house. She started doing business on 4/1/2008. She classified the pottery as a business in 2008 and had a loss. During 2009 she purchased supplies for $800. On 4/2/2009 she purchased a new kiln (oven) for $2800. She took a week-long art class in San Francisco. She spent 4 hours in the class for 5 days and spent the following weekend sightseeing. She incurred the following expenses with respect to the class:
Cost of class $925
Airfare $ 140
Meals $ 560
During the year there were three artists’ open studios in Santa Barbara. She was listed in the brochure. This was the first year she sold pottery and was quite successful. She sold $3600 of pottery.
The Harrisons also made a contribution in cash to First Congregational Church of $4500 on 8/4/2009.
1) Prepare a worksheet on Excel to determine the tax.
a. Columns should include:
1) The first column should be all of the relevant items from the 1040 form.
2) The other columns should include: Ordinary income, Capital gains and losses and qualified dividends, rental income (loss), hobby income (loss)—just to show the result if it were treated as a hobby, schedule C income or loss, home office expense, itemized deductions, and any other columns you deem appropriate.
2) Prepare a separate schedule for depreciation which includes:
a. Depreciable basis, classification of property, cost recovery period, method, convention, bonus depreciation (take it if it is permitted), Section 179 (take it if it is permitted), depreciation deduction.
3) Prepare a letter to the clients giving them advice.
a. The clients want you to take the maximum amount of deductions which are permitted by the law. In other words they want to take an aggressive stance.
b. If you do not know the answer you need to research it. You can go to www.irs.gov and read the instructions. The better way is to go to checkpoint.riag.com. Use the user id and password that is on the first page of your textbook.
c. Explain to them any risks they may be taking if they are audited by the IRS? Particularly with respect to:
1) Deducting the home office and the pottery business as a business.
1. Deducting the costs of the basement?
2. The cost of the kiln?
3. Her trip to San Francisco?
4. Give her advice on what she should do to convince the IRS that she is in business.
5. Explain to them how much more tax they would have to pay if the IRS classifies the business as a hobby.
2) Deducting or depreciating:
1. The home office expenses?
2. The cost of furniture, equipment, software?
3. The cost of the Oriental rug?
4. The cost of his class? (Or can she take an education credit?)
5. The trips from home to Fresno: Before he purchased the property? After he purchased the property?
6. Meals that he ate on the road?
4) Prepare the federal tax return for the Harrisons
a. Also prepare a tax return for Theodora.
b. You may make up information that is not provided like employer id numbers or social security number.
1) You may email me if there is any additional information needed that is not provided.
c. You may use tax preparation software, but beware that in the past students have made many mistakes on the software.
1) Make sure your answer on the software MATCHES your answers on the worksheet.
d. Please print only Federal forms to be filed with the IRS (not schedules for personal use).
e. Please staple and put in order (A, B, C, then the numerical schedules in order).