CHAPTER 7 ACCOUNTING PERIODS AND METHODS AND DEPRECIATION

Solutions for Questions and Problems Chapter 7 159 CHAPTER 7 ACCOUNTING PERIODS AND METHODS AND DEPRECIATION Group 1 - Multiple Choice Questions 1. C (1/12 of $150,000) x 2 8. C (20% x $35,000) 16. D (Section 7.9) (Section 7.1) (Sections 7.4, 7.5) 17. A (Section 7.9) 2. D (Section 7.1) 9. B ($14,000 x 7.14%) (Section 7.4) 18. C (Section 7.9) 3. D (Section 7.1) 10. C (Section 7.4) 19. C (40% + 35%) 4. D (Section 7.2) 11. A (Section 7.4) (Section 7.9) 5. B (Section 7.2) 12. C (Section 7.5) 6. C ($100,000 x 1.364%) 13. C (Section 7.6) (Sections 7.3, 7.4) 14. D (Section 7.8) 7. A (Sections 7.4, 7.6) 15. D (Section 7.8) Group 2 - Problems 1. a. $11,000 = ($300,000 / 12 x 2 x (35% maximum rate + 1%)) $7,000. b. May 15, 2008. (Section 7.1) 2. Sales income $65,000 Expenses: Other than rent and interest 40,000 Rent ($12,000 x 1/6) 2,000 Interest 0 Net Income $23,000 (Section 7.2) 3. Income: Other than rental $220,000 Rental 21,000 Expenses: Other than rental 170,000 Rental ($12,000 / 6) 2,000 Net Income $ 69,000 (Section 7.2) 4. a. Even though the contribution is paid in cash in 2008, it is deductible in 2007 if it is designated as a contribution for 2007. b. If an election has been made, the increase in value of savings bonds is included in income each year even though no cash is received. c. The half-year prepayment of interest for 2008 is not allowed as a deduction on her 2007 tax return. d. All of the standard business expenses which have already been invoiced and are paid at year end are deductible in 2007. e. Even though the work was performed in 2007, the income is not recognized until it is received in cash in 2008. (Section 7.2) 159

160 Chapter 7 Accounting Periods and Methods and Depreciation 5. Land is not allowed to be depreciated. It is held on the taxpayer s books at its cost basis. Land is considered to be an asset that is not subject to obsolescence. (Section 7.3) 6., the tax law allows a taxpayer to take tax depreciation on a residential rental building no matter what happens to its value in the market. Even if the value of the building doubles or triples, the depreciation is allowed and remains the same regardless of fluctuations up and down in value. The term depreciation does not necessarily mean physical deterioration or loss of value of the asset, though this is usually true of the asset. The depreciation of computers, office furniture, automobiles, etc. often follows the decline in value of the assets reasonably well. (Section 7.3 and following sections) 7. a. $5,067 = ($39,080 1,080)/60 months x 8 months. b. $3,908 = $39,080 x 10%. The taxpayer must use the annual percentage rates from the optional straight-line table (Table 3). c. $7,816 = $39,080 x 20% (Table 2). (Section 7.4) 8. Election to expense $ 6,500 Depreciation on automobile: $21,500 x 20% = $4,300, but limited to $3,060 3,060 Total depreciation $ 9,560 For 2007, the automobile is five-year recovery property; however, the depreciation deduction is subject to the annual automobile depreciation expense limitations. (Sections 7.4, 7.5, 7.7) 9. a. $20,762 = ($800,000 x 1.364%) + ($500,000 x 1.97%.) b. $47,268 = ($800,000 x 3.636%) + ($500,000 x 3.636%.) (Section 7.4) 10. a. $2,295 = ($3,060 x 75%); limit is less than MACRS of $5,250 = ($35,000 x 20% x 75%). b. $3,675 = $4,900 x 75%; limit is less than actual of $8,400 = ($35,000 x 75% x 32%). (Sections 7.4, 7.6, 7.7) 11. $540 = ($3,000 x 20%) x (80% + 10%). The total depreciation on the computer must be divided between the business use, $480, (80%/90% x $540); and the investment use, $60, (10%/90% x $540). (Sections 7.4, 7.6) 12. See Form 4562 on pages 163 and 164. (Sections 7.4, 7.6, 7.7) 13. a. 5 years b. 7 years c. 5 years d. 27.5 years e. 39 years f. life, no depreciation allowed. (Section 7.4) 14. When a taxpayer acquires more than 40% of its MACRS depreciable property (other than real estate) during the last quarter of the year, the taxpayer must use the mid-quarter convention in calculating depreciation rather than the mid-year convention. There are separate MACRS percentage tables for the mid-quarter depreciation convention. This treatment requires all assets purchased in any quarter of the year to be treated as purchased at the middle of that quarter. (Section 7.4)

Solutions for Questions and Problems Chapter 7 161 15. a. 2.273% x $200,000 = $4,546 b. 32% x $3,000 = $960 c. 10% x $4,000 = $400 d. 17.49% x $10,000 = $1,749 (Section 7.4) 16. Tom should expense the machine under the Section 179 election to expense. Under the election to expense he can write off the entire cost of the machine in 2007 and bring his taxable income down to $75,000. If Tom does not elect to expense the machine, he must depreciate it over a life of 7 years, and will get only a small immediate tax benefit for the purchase. (Section 7.5) 17. See the answer to Problem 12. (Sections 7.4, 7.6, 7.7) 18. Even though a car has a 5 year life under MACRS, the depreciation allowed for the car is limited to the amounts allowed under the luxury auto rules. The car is allowed $3,060, $4,900 and $2,850 of depreciation in the first three years and then $1,775 a year thereafter. The car will be fully depreciated in 14 years using this schedule: Year 1 $3,060 Year 2 $4,900 Year 3 $2,850 Years 4-13 $1,775 Year 14 $1,440 Total $30,000 (Section 7.7) 19. a. $85,000 = $40,000 + $45,000 b. $1,889 deductible for 2007. $85,000/(15 x 12) x 4 months = $1,889. (Section 7.8) 20. The purchased goodwill and going-concern value should be amortized over 15 years at $300 a month as a Section 197 intangible asset. (Section 7.8) 21. a. 36% = 20% + (80% x 20%) b. 60% = 30% + 30% c. 60% = 30% + 30% d. $0 Brian owns more than 50% of JBC Corporation, directly or indirectly. (Section 7.9) 22. Section 267(a) is not reproduced here. (Section 7.9) Group 3 - Comprehensive Problems 1. See pages 165 through 168. 2. See pages 169 through 174.

162 Chapter 7 Accounting Periods and Methods and Depreciation Group 4 - Cumulative Software Problem The solution to the Cumulative Software Problem is posted on the Internet site for the text at http://www.thomsonedu.com/taxation/whittenburg.

Solutions for Questions and Problems Chapter 7 163 Problem 12 Form 4562 Department of the Treasury Internal Revenue Service Name(s) shown on return Depreciation and Amortization (Including Information on Listed Property) See separate instructions. Business or activity to which this form relates Part I Election To Expense Certain Property Under Section 179 te: If you have any listed property, complete Part V before you complete Part I. 1 Maximum amount. See the instructions for a higher limit for certain businesses 1 2 Total cost of section 179 property placed in service (see instructions) 2 3 Threshold cost of section 179 property before reduction in limitation 3 4 Reduction in limitation. Subtract line 3 from line 2. If zero or less, enter -0-4 5 Dollar limitation for tax year. Subtract line 4 from line 1. If zero or less, enter -0-. If married filing separately, see instructions 5 6 Palo Fiero Manufacturing Attach to your tax return. (a) Description of property (b) Cost (business use only) (c) Elected cost 0 6 /2 0 /2 0 0 7 OMB. 1545-0172 Attachment Sequence. 67 Identifying number $125,000 $500,000 7 Listed property. Enter the amount from line 29 7 8 Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 7 8 9 Tentative deduction. Enter the smaller of line 5 or line 8 9 10 Carryover of disallowed deduction from line 13 of your 2006 Form 4562 10 11 Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions) 11 12 Section 179 expense deduction. Add lines 9 and 10, but do not enter more than line 11 12 13 Carryover of disallowed deduction to 2008. Add lines 9 and 10, less line 12 13 te: Do not use Part II or Part III below for listed property. Instead, use Part V. Part II Special Depreciation Allowance and Other Depreciation (Do not include listed property.) (See instructions.) 14 Special allowance for qualified New York Liberty or Gulf Opportunity Zone property (other than listed property) and cellulosic biomass ethanol plant property placed in service during the tax year (see instructions) 14 15 Property subject to section 168(f)(1) election 15 16 Other depreciation (including ACRS) 16 Part III MACRS Depreciation (Do not include listed property.) (See instructions.) Section A 17 MACRS deductions for assets placed in service in tax years beginning before 2007 17 18 If you are electing to group any assets placed in service during the tax year into one or more general asset accounts, check here Section B Assets Placed in Service During 2007 Tax Year Using the General Depreciation System 2007 (a) Classification of property (b) Month and (c) Basis for depreciation (d) Recovery year placed in (business/investment use period service only see instructions) (e) Convention (f) Method (g) Depreciation deduction 19a 3-year property b 5-year property 3,500 5 yrs HY 200 DB 700 c 7-year property 39,500 7 yrs HY 200 DB 5,645 d 10-year property e 15-year property f 20-year property 25-year property g 25 yrs. h Residential rental 27.5 yrs. MM property 27.5 yrs. MM i nresidential real 03/23/07 165,000 39 yrs. MM 3,354 property MM Section C Assets Placed in Service During 2007 Tax Year Using the Alternative Depreciation System 20a Class life b 12-year 12 yrs. c 40-year 40 yrs. MM Part IV Summary (see instructions) 21 Listed property. Enter amount from line 28 21 2,754 22 Total. Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21. Enter here and on the appropriate lines of your return. Partnerships and S corporations see instr. 22 12,453 23 For assets shown above and placed in service during the current year, enter the portion of the basis attributable to section 263A costs 23 For Paperwork Reduction Act tice, see separate instructions. Cat.. 12906N Form 4562 (2007)

164 Chapter 7 Accounting Periods and Methods and Depreciation Problem 12, cont. Form 4562 (2007) Page 2 Part V Listed Property (Include automobiles, certain other vehicles, cellular telephones, certain computers, and property used for entertainment, recreation, or amusement.) te: For any vehicle for which you are using the standard mileage rate or deducting lease expense, complete only 24a, 24b, columns (a) through (c) of Section A, all of Section B, and Section C if applicable. Section A Depreciation and Other Information (Caution: See the instructions for limits for passenger automobiles.) 24a Do you have evidence to support the business/investment use claimed? 24b If, is the evidence written? (c) (e) (i) (a) (b) Business/ (d) (f) (g) (h) Basis for depreciation Elected Type of property (list Date placed in investment Cost or other Recovery Method/ Depreciation use (business/investment section 179 vehicles first) service basis period Convention deduction percentage use only) cost 25 Special allowance for qualified New York Liberty or Gulf Opportunity Zone property placed in service during the tax year and used more than 50% in a qualified business use (see instructions) 25 26 Property used more than 50% in a qualified business use: Passenger automobile 05/31/07 90 % % % 35,000 31,500 5 yrs 200DB 2,754 27 Property used 50% or less in a qualified business use: % % % 28 Add amounts in column (h), lines 25 through 27. Enter here and on line 21, page 1 28 2,754 29 Add amounts in column (i), line 26. Enter here and on line 7, page 1 29 Section B Information on Use of Vehicles Complete this section for vehicles used by a sole proprietor, partner, or other more than 5% owner, or related person. If you provided vehicles to your employees, first answer the questions in Section C to see if you meet an exception to completing this section for those vehicles. 0 6 /2 0 /2 0 0 7 30 31 32 33 34 35 36 Total business/investment miles driven during the year (do not include commuting miles) Total commuting miles driven during the year Total other personal (noncommuting) miles driven Total miles driven during the year. Add lines 30 through 32 Was the vehicle available for personal use during off-duty hours? Was the vehicle used primarily by a more than 5% owner or related person? Is another vehicle available for personal use? (a) Vehicle 1 (b) Vehicle 2 (c) Vehicle 3 (d) Vehicle 4 (e) Vehicle 5 (f) Vehicle 6 Section C Questions for Employers Who Provide Vehicles for Use by Their Employees Answer these questions to determine if you meet an exception to completing Section B for vehicles used by employees who are not more than 5% owners or related persons (see instructions). 37 Do you maintain a written policy statement that prohibits all personal use of vehicles, including commuting, by your employees? 38 Do you maintain a written policy statement that prohibits personal use of vehicles, except commuting, by your employees? See the instructions for vehicles used by corporate officers, directors, or 1% or more owners 39 Do you treat all use of vehicles by employees as personal use? 40 Do you provide more than five vehicles to your employees, obtain information from your employees about the use of the vehicles, and retain the information received? 41 Do you meet the requirements concerning qualified automobile demonstration use? (See instructions.) te: If your answer to 37, 38, 39, 40, or 41 is, do not complete Section B for the covered vehicles. Part VI Amortization (a) Description of costs (b) Date amortization begins (c) Amortizable amount 42 Amortization of costs that begins during your 2007 tax year (see instructions): (d) Code section (e) Amortization period or percentage (f) Amortization for this year 43 Amortization of costs that began before your 2007 tax year 43 44 Total. Add amounts in column (f). See the instructions for where to report 44 Form 4562 (2007)

Solutions for Questions and Problems Chapter 7 165 Comprehensive Problem 1 SCHEDULE C (Form 1040) Department of the Treasury Internal Revenue Service Name of proprietor Profit or Loss From Business (Sole Proprietorship) Partnerships, joint ventures, etc., must file Form 1065 or 1065-B. Attach to Form 1040, 1040NR, or 1041. See Instructions for Schedule C (Form 1040). 0 6 /1 2 /2 0 0 7 OMB. 1545-0074 Attachment Sequence. 09 Social security number (SSN) A Principal business or profession, including product or service (see page C-2 of the instructions) B Enter code from pages C-8, 9, & 10 C E Retail Family Clothing Store 4 4 8 1 4 0 Business name. If no separate business name, leave blank. F Accounting method: (1) Cash (2) Accrual (3) Other (specify) G Did you materially participate in the operation of this business during 2007? If, see page C-3 for limit on losses H If you started or acquired this business during 2007, check here Part I Income 1 Gross receipts or sales. Caution. If this income was reported to you on Form W-2 and the Statutory employee box on that form was checked, see page C-3 and check here 1 2 Returns and allowances 2 3 Subtract line 2 from line 1 3 4 Cost of goods sold (from line 42 on page 2) 4 5 Gross profit. Subtract line 4 from line 3 5 6 Other income, including federal and state gasoline or fuel tax credit or refund (see page C-3) 6 7 Gross income. Add lines 5 and 6 7 Part II Expenses. Enter expenses for business use of your home only on line 30. 8 Advertising 8 18 Office expense 18 9 Car and truck expenses (see page C-4) 9 19 20 Pension and profit-sharing plans Rent or lease (see page C-5): 19 10 11 12 Commissions and fees Contract labor (see page C-4) Depletion 10 11 12 21 a Vehicles, machinery, and equipment b Other business property Repairs and maintenance 20a 20b 21 13 22 Supplies (not included in Part III) 22 Depreciation and section 179 23 Taxes and licenses 23 expense deduction (not included in Part III) (see 24 Travel, meals, and entertainment: page C-4) 13 a Travel 24a 14 Employee benefit programs b Deductible meals and (other than on line 19) 14 entertainment (see page C-6) 24b 15 Insurance (other than health) 15 25 Utilities 25 16 Interest: 26 Wages (less employment credits) 26 a Mortgage (paid to banks, etc.) 16a 27 Other expenses (from line 48 on b Other 16b page 2) 27 17 Legal and professional services 17 900 28 Total expenses before expenses for business use of home. Add lines 8 through 27 in columns 28 29 30 31 32 (99) Business address (including suite or room no.) City, town or post office, state, and ZIP code Tentative profit (loss). Subtract line 28 from line 7 Expenses for business use of your home. Attach Form 8829 Net profit or (loss). Subtract line 30 from line 29. If a profit, enter on both Form 1040, line 12, and Schedule SE, line 2, or on Form 1040NR, line 13 (statutory employees, see page C-6). Estates and trusts, enter on Form 1041, line 3. If a loss, you must go to line 32. If you have a loss, check the box that describes your investment in this activity (see page C-6). If you checked 32a, enter the loss on both Form 1040, line 12, and Schedule SE, line 2, or on Form 1040NR, line 13 (statutory employees, see page C-6). Estates and trusts, enter on Form 1041, line 3. If you checked 32b, you must attach Form 6198. Your loss may be limited. For Paperwork Reduction Act tice, see page C-8 of the instructions. Cat.. 11334P D Employer ID number (EIN), if any 29 30 31 32a 32b 2007 Sherry Hopson 123 45 6789 Family Clothing Store 9 5 1 2 3 4 3 2 1 4321 Circle Drive Houston, TX 77001 x x 350,000 4,500 345,500 221,500 124,000 124,000 2,100 750 7,686 9,000 2,600 1,500 1,850 38,000 64,386 59,614 59,614 All investment is at risk. Some investment is not at risk. Schedule C (Form 1040) 2007

166 Chapter 7 Accounting Periods and Methods and Depreciation Comprehensive Problem 1, cont. Schedule C (Form 1040) 2007 Part III Cost of Goods Sold (see page C-7) 33 Method(s) used to value closing inventory: a x Cost b Lower of cost or market c Other (attach explanation) 34 Was there any change in determining quantities, costs, or valuations between opening and closing inventory? If, attach explanation 35 36 37 38 39 40 41 Inventory at beginning of year. If different from last year s closing inventory, attach explanation Purchases less cost of items withdrawn for personal use Cost of labor. Do not include any amounts paid to yourself Materials and supplies Other costs Add lines 35 through 39 Inventory at end of year 0 6 /1 2 /2 0 0 7 42 Cost of goods sold. Subtract line 41 from line 40. Enter the result here and on page 1, line 4 42 Part IV Information on Your Vehicle. Complete this part only if you are claiming car or truck expenses on line 9 and are not required to file Form 4562 for this business. See the instructions for line 13 on page C-4 to find out if you must file Form 4562. 35 36 37 38 39 40 41 82,500 210,000 x 292,500 71,000 221,500 Page 2 43 When did you place your vehicle in service for business purposes? (month, day, year) / / 44 Of the total number of miles you drove your vehicle during 2007, enter the number of miles you used your vehicle for: a Business b Commuting (see instructions) c Other 45 Do you (or your spouse) have another vehicle available for personal use? 46 Was your vehicle available for personal use during off-duty hours? 47a Do you have evidence to support your deduction? b If, is the evidence written? Part V Other Expenses. List below business expenses not included on lines 8 26 or line 30. 48 Total other expenses. Enter here and on page 1, line 27 Printed on recycled paper 48 Schedule C (Form 1040) 2007

Solutions for Questions and Problems Chapter 7 167 Comprehensive Problem 1, cont. Form 4562 Department of the Treasury Internal Revenue Service Name(s) shown on return Depreciation and Amortization (Including Information on Listed Property) See separate instructions. Business or activity to which this form relates Part I Election To Expense Certain Property Under Section 179 te: If you have any listed property, complete Part V before you complete Part I. 1 Maximum amount. See the instructions for a higher limit for certain businesses 1 2 Total cost of section 179 property placed in service (see instructions) 2 3 Threshold cost of section 179 property before reduction in limitation 3 4 Reduction in limitation. Subtract line 3 from line 2. If zero or less, enter -0-4 5 Dollar limitation for tax year. Subtract line 4 from line 1. If zero or less, enter -0-. If married filing separately, see instructions 5 6 Attach to your tax return. (a) Description of property (b) Cost (business use only) (c) Elected cost 0 6 /2 0 /2 0 0 7 OMB. 1545-0172 Attachment Sequence. 67 Identifying number $125,000 $500,000 7 Listed property. Enter the amount from line 29 7 8 Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 7 8 9 Tentative deduction. Enter the smaller of line 5 or line 8 9 10 Carryover of disallowed deduction from line 13 of your 2006 Form 4562 10 11 Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions) 11 12 Section 179 expense deduction. Add lines 9 and 10, but do not enter more than line 11 12 13 Carryover of disallowed deduction to 2008. Add lines 9 and 10, less line 12 13 te: Do not use Part II or Part III below for listed property. Instead, use Part V. Part II Special Depreciation Allowance and Other Depreciation (Do not include listed property.) (See instructions.) 14 Special allowance for qualified New York Liberty or Gulf Opportunity Zone property (other than listed property) and cellulosic biomass ethanol plant property placed in service during the tax year (see instructions) 14 15 Property subject to section 168(f)(1) election 15 16 Other depreciation (including ACRS) 16 Part III MACRS Depreciation (Do not include listed property.) (See instructions.) Section A 17 MACRS deductions for assets placed in service in tax years beginning before 2007 17 18 If you are electing to group any assets placed in service during the tax year into one or more general asset accounts, check here Section B Assets Placed in Service During 2007 Tax Year Using the General Depreciation System 2007 Sherry Hopson Retail family clothing store 123-45-6789 (b) Month and (c) Basis for depreciation (d) Recovery (a) Classification of property year placed in (business/investment use (e) Convention (f) Method (g) Depreciation deduction period service only see instructions) 19a 3-year property b 5-year property 37,000 5 yrs HY 200 DB 7,400 c 7-year property 2,000 7 yrs HY 200 DB 286 d 10-year property e 15-year property f 20-year property 25-year property g 25 yrs. h Residential rental 27.5 yrs. MM property 27.5 yrs. MM i nresidential real 39 yrs. MM property MM Section C Assets Placed in Service During 2007 Tax Year Using the Alternative Depreciation System 20a Class life b 12-year 12 yrs. c 40-year 40 yrs. MM Part IV Summary (see instructions) 21 Listed property. Enter amount from line 28 21 22 Total. Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21. Enter here and on the appropriate lines of your return. Partnerships and S corporations see instr. 22 23 For assets shown above and placed in service during the current year, enter the portion of the basis attributable to section 263A costs 23 For Paperwork Reduction Act tice, see separate instructions. Cat.. 12906N 7,686 Form 4562 (2007)

168 Chapter 7 Accounting Periods and Methods and Depreciation Comprehensive Problem 1, cont. Form 4562 (2007) Page 2 Part V Listed Property (Include automobiles, certain other vehicles, cellular telephones, certain computers, and property used for entertainment, recreation, or amusement.) te: For any vehicle for which you are using the standard mileage rate or deducting lease expense, complete only 24a, 24b, columns (a) through (c) of Section A, all of Section B, and Section C if applicable. Section A Depreciation and Other Information (Caution: See the instructions for limits for passenger automobiles.) 24a Do you have evidence to support the business/investment use claimed? 24b If, is the evidence written? (c) (e) (i) (a) (b) Business/ (d) (f) (g) (h) Basis for depreciation Elected Type of property (list Date placed in investment Cost or other Recovery Method/ Depreciation use (business/investment section 179 vehicles first) service basis period Convention deduction percentage use only) cost 25 Special allowance for qualified New York Liberty or Gulf Opportunity Zone property placed in service during the tax year and used more than 50% in a qualified business use (see instructions) 25 26 Property used more than 50% in a qualified business use: % % % 27 Property used 50% or less in a qualified business use: % % % 28 Add amounts in column (h), lines 25 through 27. Enter here and on line 21, page 1 28 29 Add amounts in column (i), line 26. Enter here and on line 7, page 1 29 Section B Information on Use of Vehicles Complete this section for vehicles used by a sole proprietor, partner, or other more than 5% owner, or related person. If you provided vehicles to your employees, first answer the questions in Section C to see if you meet an exception to completing this section for those vehicles. 30 31 32 33 34 35 36 Total business/investment miles driven during the year (do not include commuting miles) Total commuting miles driven during the year Total other personal (noncommuting) miles driven Total miles driven during the year. Add lines 30 through 32 Was the vehicle available for personal use during off-duty hours? Was the vehicle used primarily by a more than 5% owner or related person? Is another vehicle available for personal use? (a) Vehicle 1 0 6 /2 0 /2 0 0 7 (b) Vehicle 2 (c) Vehicle 3 (d) Vehicle 4 (e) Vehicle 5 (f) Vehicle 6 Section C Questions for Employers Who Provide Vehicles for Use by Their Employees Answer these questions to determine if you meet an exception to completing Section B for vehicles used by employees who are not more than 5% owners or related persons (see instructions). 37 Do you maintain a written policy statement that prohibits all personal use of vehicles, including commuting, by your employees? 38 Do you maintain a written policy statement that prohibits personal use of vehicles, except commuting, by your employees? See the instructions for vehicles used by corporate officers, directors, or 1% or more owners 39 Do you treat all use of vehicles by employees as personal use? 40 Do you provide more than five vehicles to your employees, obtain information from your employees about the use of the vehicles, and retain the information received? 41 Do you meet the requirements concerning qualified automobile demonstration use? (See instructions.) te: If your answer to 37, 38, 39, 40, or 41 is, do not complete Section B for the covered vehicles. Part VI Amortization (a) Description of costs Sherry Hopson 123-45-6789 (b) Date amortization begins (c) Amortizable amount 42 Amortization of costs that begins during your 2007 tax year (see instructions): (d) Code section (e) Amortization period or percentage (f) Amortization for this year 43 Amortization of costs that began before your 2007 tax year 43 44 Total. Add amounts in column (f). See the instructions for where to report 44 Form 4562 (2007)

Solutions for Questions and Problems Chapter 7 169 Comprehensive Problem 2 Department of the Treasury Internal Revenue Service 1040 U.S. Individual Income Tax Return Label Your first name and initial Form (See instructions on page 16.) Use the IRS label. Otherwise, please print or type. L A B E L H E R E Presidential Election Campaign Filing Status Check only one box. Exemptions If more than four dependents, see page 19. Income Attach Form(s) W-2 here. Also attach Forms W-2G and 1099-R if tax was withheld. If you did not get a W-2, see page 23. Enclose, but do not attach, any payment. Also, please use Form 1040-V. Adjusted Gross Income For the year Jan. 1 Dec. 31, 2007, or other tax year beginning, 2007, ending, 20 If a joint return, spouse s first name and initial Last name Home address (number and street). If you have a P.O. box, see page 16. City, town or post office, state, and ZIP code. If you have a foreign address, see page 16. 0 6 /0 8 /2 0 0 7 OMB. 1545-0074 Your social security number Spouse s social security number 1 Single 4 Head of household (with qualifying person). (See page 17.) If 2 x Married filing jointly (even if only one had income) the qualifying person is a child but not your dependent, enter 3 Married filing separately. Enter spouse s SSN above this child s name here. and full name here. 5 Qualifying widow(er) with dependent child (see page 17) Boxes checked 6a Yourself. If someone can claim you as a dependent, do not check box 6a on 6a and 6b b Spouse 2 x. of children c Dependents: (3) Dependent s (2) Dependent s (4) if qualifying on 6c who: social security number relationship to child for child tax lived with you (1) First name Last name you credit (see page 19) did not live with you due to divorce or separation (see page 20) Dependents on 6c not entered above d Total number of exemptions claimed 7 Wages, salaries, tips, etc. Attach Form(s) W-2 7 8a Taxable interest. Attach Schedule B if required 8a b Tax-exempt interest. Do not include on line 8a 8b 9a Ordinary dividends. Attach Schedule B if required 9a b Qualified dividends (see page 23) 9b 10 Taxable refunds, credits, or offsets of state and local income taxes (see page 24) 10 11 Alimony received 11 12 Business income or (loss). Attach Schedule C or C-EZ 12 13 Capital gain or (loss). Attach Schedule D if required. If not required, check here 13 14 Other gains or (losses). Attach Form 4797 14 15a IRA distributions 15a b Taxable amount (see page 25) 15b 16a Pensions and annuities 16a b Taxable amount (see page 26) 16b 17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17 18 Farm income or (loss). Attach Schedule F 18 19 Unemployment compensation 19 20a Social security benefits 20a b Taxable amount (see page 27) 20b 21 Other income. List type and amount (see page 29) 21 22 Add the amounts in the far right column for lines 7 through 21. This is your total income 22 23 Check here if you, or your spouse if filing jointly, want $3 to go to this fund (see page 16) Educator expenses (see page XX) 2007 24 Certain business expenses of reservists, performing artists, and fee-basis government officials. Attach Form 2106 or 2106-EZ 24 25 Health savings account deduction. Attach Form 8889 25 26 Moving expenses. Attach Form 3903 26 27 One-half of self-employment tax. Attach Schedule SE 27 28 Self-employed SEP, SIMPLE, and qualified plans 28 29 Self-employed health insurance deduction (see page 29) 29 30 Penalty on early withdrawal of savings 30 31a Alimony paid b Recipient s SSN 31a 32 IRA deduction (see page 31) 32 33 Student loan interest deduction (see page 33) 33 34 Tuition and fees deduction. Attach Form 8917 34 35 Domestic production activities deduction. Attach Form 8903 35 36 Add lines 23 through 31a and 32 through 35 37 Subtract line 36 from line 22. This is your adjusted gross income For Disclosure, Privacy Act, and Paperwork Reduction Act tice, see page 80. 23 (99) IRS Use Only Do not write or staple in this space. Larry Williams 998 09 8526 Last name Lisa Williams 445 81 1423 638 Arctic Way Apt. no. Fairbanks, AK 99701 x You x 360 8,000 Cat.. 11320B Checking a box below will not change your tax or refund. 36 37 You must enter your SSN(s) above. Spouse Add numbers on lines above 150,000 500 0 150,500 8,360 142,140 2 Form 1040 (2007)

170 Chapter 7 Accounting Periods and Methods and Depreciation Comprehensive Problem 2, cont. Form 1040 (2007) Tax and Credits Standard Deduction for People who checked any box on line 39a or 39b or who can be claimed as a dependent, see page 34. All others: Single or Married filing separately, $5,350 Married filing jointly or Qualifying widow(er), $10,700 Head of household, $7,850 Other Taxes Payments Refund Direct deposit? See page 61 and fill in 74b, 74c, and 74d, or Form 8888. Amount You Owe Sign Here Joint return? See page 17. Keep a copy for your records. Paid Preparer s Use Only 38 Amount from line 37 (adjusted gross income) 38 39a Check You were born before January 2, 1943, Blind. Total boxes if: Spouse was born before January 2, 1943, Blind. checked 39a b If your spouse itemizes on a separate return or you were a dual-status alien, see page 34 and check here 39b 40 Itemized deductions (from Schedule A) or your standard deduction (see left margin) 40 41 Subtract line 40 from line 38 41 42 If line 38 is $117,300 or less, multiply $3,400 by the total number of exemptions claimed on line 6d. If line 38 is over $117,300, see the worksheet on page XX 42 43 Taxable income. Subtract line 42 from line 41. If line 42 is more than line 41, enter -0-43 44 Tax (see page 36). Check if any tax is from: a Form(s) 8814 b Form 4972 c Form(s) 8889 44 45 Alternative minimum tax (see page 39). Attach Form 6251 45 46 Add lines 44 and 45 46 47 Credit for child and dependent care expenses. Attach Form 2441 47 48 Credit for the elderly or the disabled. Attach Schedule R 48 49 Education credits. Attach Form 8863 49 50 Residential energy credits. Attach Form 5695 50 51 Foreign tax credit. Attach Form 1116 if required 51 52 Child tax credit (see page XX). Attach Form 8901 if required 52 53 Retirement savings contributions credit. Attach Form 8880 53 54 Credits from: a Form 8396 b Form 8859 c Form 8839 54 55 Other credits: a Form 3800 b Form 8801 c Form 55 56 Add lines 47 through 55. These are your total credits 56 57 Subtract line 56 from line 46. If line 56 is more than line 46, enter -0-0 6 /0 8 /2 0 0 7 57 58 Self-employment tax. Attach Schedule SE 58 59 Unreported social security and Medicare tax from: a Form 4137 b Form 8919 59 60 Additional tax on IRAs, other qualified retirement plans, etc. Attach Form 5329 if required 60 61 Advance earned income credit payments from Form(s) W-2, box 9 61 62 Household employment taxes. Attach Schedule H 62 63 Add lines 57 through 62. This is your total tax 63 64 Federal income tax withheld from Forms W-2 and 1099 64 65 2007 estimated tax payments and amount applied from 2006 return 65 If you have a 66a Earned income credit (EIC) 66a qualifying b ntaxable combat pay election 66b child, attach Schedule EIC. 67 Excess social security and tier 1 RRTA tax withheld (see page 60) 67 68 Additional child tax credit. Attach Form 8812 68 69 Amount paid with request for extension to file (see page 60) 69 70 Payments from: a Form 2439 b Form 4136 c Form 8885 70 71 Refundable credit for prior year minimum tax from Form 8801, line 27 71 72 Add lines 64, 65, 66a, and 67 through 71. These are your total payments Third Party Designee 73 If line 72 is more than line 63, subtract line 63 from line 72. This is the amount you overpaid 74a Amount of line 73 you want refunded to you. If Form 8888 is attached, check here b Routing number c Type: Checking Savings d Account number 75 Amount of line 73 you want applied to your 2008 estimated tax 75 76 Amount you owe. Subtract line 72 from line 63. For details on how to pay, see page 62 76 77 Estimated tax penalty (see page 62) 77 Do you want to allow another person to discuss this return with the IRS (see page 63)?. Complete the following. Designee s name Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge. Your signature Spouse s signature. If a joint return, both must sign. Preparer s signature Firm s name (or yours if self-employed), address, and ZIP code Phone no. ( ) Date Date Your occupation Date Company President Spouse s occupation Homemaker 10,000 Check if self-employed EIN Phone no. 72 73 74a Personal identification number (PIN) Daytime phone number ( ) Preparer s SSN or PTIN ( ) 142,140 92,300 49,840 6,800 43,040 5,671 5,671 5,671 5,671 10,000 4,329 4,329 Page 2 Form 1040 (2007)

Solutions for Questions and Problems Chapter 7 171 Comprehensive Problem 2, cont. SCHEDULES A&B (Form 1040) Schedule A Itemized Deductions (Schedule B is on back) 0 6 /0 7/2 0 0 7 OMB. 1545-0074 Department of the Treasury Attachment Internal Revenue Service (99) Attach to Form 1040. See Instructions for Schedules A&B (Form 1040). Sequence. 07 Name(s) shown on Form 1040 Your social security number Medical and Dental Expenses Taxes You Paid (See page A-2.) Interest You Paid (See page A-5.) Caution. Do not include expenses reimbursed or paid by others. 1 Medical and dental expenses (see page A-1) 1 2 Enter amount from Form 1040, line 38 2 142,140 3 Multiply line 2 by 7.5% (.075) 3 10,661 4 Subtract line 3 from line 1. If line 3 is more than line 1, enter -0-4 5 State and local (check only one box): a Income taxes, or 5 b General sales taxes 1,700 x 6 Real estate taxes (see page A-5) 6 5,600 7 Personal property taxes 7 8 Other taxes. List type and amount 8 9 Add lines 5 through 8 9 10 Home mortgage interest and points reported to you on Form 1098 10 35,000 11 Home mortgage interest not reported to you on Form 1098. If paid to the person from whom you bought the home, see page A-6 and show that person s name, identifying no., and address te. 11 Personal 12 Points not reported to you on Form 1098. See page A-6 interest is for special rules 12 not deductible. 13 Qualified mortgage insurance premiums (See page A-7) 13 14 Investment interest. Attach Form 4952 if required. (See page A-7.) 14 15 Add lines 10 through 14 15 Gifts to 16 Gifts by cash or check. If you made any gift of $250 or Charity more, see page A-8 16 10,000 If you made a 17 Other than by cash or check. If any gift of $250 or more, gift and got a see page A-8. You must attach Form 8283 if over $500 17 40,000 benefit for it, 18 Carryover from prior year 18 see page A-7. 19 Add lines 16 through 18 19 Casualty and Theft Losses 20 Casualty or theft loss(es). Attach Form 4684. (See page A-9.) 20 Job Expenses 21 and Certain Miscellaneous Deductions 22 (See 23 page A-9.) Unreimbursed employee expenses job travel, union dues, job education, etc. Attach Form 2106 or 2106-EZ if required. (See page A-9.) Tax preparation fees Other expenses investment, safe deposit box, etc. List type and amount 24 Add lines 21 through 23 25 Enter amount from Form 1040, line 38 25 142,140 26 Multiply line 25 by 2% (.02) 26 2,843 27 Subtract line 26 from line 24. If line 26 is more than line 24, enter -0-27 Other 28 Other from list on page A-9. List type and amount Miscellaneous Deductions 28 Total 29 Is Form 1040, line 38, over $156,400 (over $78,200 if married filing separately)? Itemized. Your deduction is not limited. Add the amounts in the far right column Deductions for lines 4 through 28. Also, enter this amount on Form 1040, line 40. 29 92,300 x. Your deduction may be limited. See page A-10 for the amount to enter. 30 If you elect to itemize deductions even though they are less than your standard deduction, check here For Paperwork Reduction Act tice, see Form 1040 instructions. Cat.. 11330X Schedule A (Form 1040) 2007 21 22 23 24 2007 Larry and Lisa Williams 998 09 8526 7,000 Safe Deposit Box Rental 750 300 1,050 * Itemized Deductions of $92,300 Limited per IRC Sec. 68; reduced by $2,045. 0 7,300 35,000 50,000 0

172 Chapter 7 Accounting Periods and Methods and Depreciation Comprehensive Problem 2, cont. Schedules A&B (Form 1040) 2007 Name(s) shown on Form 1040. Do not enter name and social security number if shown on other side. Part I Interest (See page B-1 and the instructions for Form 1040, line 8a.) te. If you received a Form 1099-INT, Form 1099-OID, or substitute statement from a brokerage firm, list the firm s name as the payer and enter the total interest shown on that form. Part II Ordinary Dividends (See page B-1 and the instructions for Form 1040, line 9a.) 1 Schedule B Interest and Ordinary Dividends List name of payer. If any interest is from a seller-financed mortgage and the buyer used the property as a personal residence, see page B-1 and list this interest first. Also, show that buyer s social security number and address OMB. 1545-0074 0 6 /0 7/2 0 0 7 2 Add the amounts on line 1 2 3 Excludable interest on series EE and I U.S. savings bonds issued after 1989. Attach Form 8815 3 4 Subtract line 3 from line 2. Enter the result here and on Form 1040, line 8a 4 te. If line 4 is over $1,500, you must complete Part III. 5 List name of payer 1 Page 2 Your social security number Larry and Lisa Williams 998 09 8526 Attachment Sequence. 08 Amount Alaska National Bank 500 500 500 Amount te. If you received a Form 1099-DIV or substitute statement from a brokerage firm, list the firm s name as the payer and enter the ordinary dividends shown on that form. 5 Part III Foreign Accounts and Trusts (See page B-2.) 6 Add the amounts on line 5. Enter the total here and on Form 1040, line 9a te. If line 6 is over $1,500, you must complete Part III. You must complete this part if you (a) had over $1,500 of taxable interest or ordinary dividends; or (b) had a foreign account; or (c) received a distribution from, or were a grantor of, or a transferor to, a foreign trust. 7a At any time during 2007, did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account? See page B-2 for exceptions and filing requirements for Form TD F 90-22.1 b If, enter the name of the foreign country 8 During 2007, did you receive a distribution from, or were you the grantor of, or transferor to, a foreign trust? If, you may have to file Form 3520. See page B-2 For Paperwork Reduction Act tice, see Form 1040 instructions. Schedule B (Form 1040) 2007 Printed on recycled paper 6 x x

Solutions for Questions and Problems Chapter 7 173 Comprehensive Problem 2, cont. SCHEDULE D (Form 1040) Department of the Treasury Internal Revenue Service Name(s) shown on return Part I 1 (99) Capital Gains and Losses Attach to Form 1040 or Form 1040NR. See Instructions for Schedule D (Form 1040). Use Schedule D-1 to list additional transactions for lines 1 and 8. Short-Term Capital Gains and Losses Assets Held One Year or Less (a) Description of property (Example: 100 sh. XYZ Co.) (b) Date acquired (Mo., day, yr.) (c) Date sold (Mo., day, yr.) (d) Sales price (see page D-6 of the instructions) (e) Cost or other basis (see page D-7 of the instructions) 0 6 /0 8 /2 0 0 7 2 Enter your short-term totals, if any, from Schedule D-1, line 2 2 3 Total short-term sales price amounts. Add lines 1 and 2 in column (d) 3 4 Short-term gain from Form 6252 and short-term gain or (loss) from Forms 4684, 6781, and 8824 4 5 Net short-term gain or (loss) from partnerships, S corporations, estates, and trusts from Schedule(s) K-1 5 6 Short-term capital loss carryover. Enter the amount, if any, from line 10 of your Capital Loss Carryover Worksheet on page D-7 of the instructions 6 OMB. 1545-0074 2007 Attachment Sequence. 12 Your social security number Larry and Lisa Williams 998 09 8526 (f) Gain or (loss) Subtract (e) from (d) ( ) 7 Net short-term capital gain or (loss). Combine lines 1 through 6 in column (f) Part II Long-Term Capital Gains and Losses Assets Held More Than One Year 7 8 (a) Description of property (Example: 100 sh. XYZ Co.) (b) Date acquired (Mo., day, yr.) (c) Date sold (Mo., day, yr.) (d) Sales price (see page D-6 of the instructions) (e) Cost or other basis (see page D-7 of the instructions) (f) Gain or (loss) Subtract (e) from (d) Land 07/01/02 07/01/07 75,000 160,000 Related Party Loss Disallowed 9 Enter your long-term totals, if any, from Schedule D-1, line 9 9 10 Total long-term sales price amounts. Add lines 8 and 9 in column (d) 10 75,000 11 Gain from Form 4797, Part I; long-term gain from Forms 2439 and 6252; and long-term gain or (loss) from Forms 4684, 6781, and 8824 12 Net long-term gain or (loss) from partnerships, S corporations, estates, and trusts from Schedule(s) K-1 11 12 13 Capital gain distributions. See page D-2 of the instructions 13 14 Long-term capital loss carryover. Enter the amount, if any, from line 15 of your Capital Loss Carryover Worksheet on page D-7 of the instructions 14 ( ) 15 Net long-term capital gain or (loss). Combine lines 8 through 14 in column (f). Then go to Part III on the back 15 0 For Paperwork Reduction Act tice, see Form 1040 or Form 1040NR instructions. Cat.. 11338H Schedule D (Form 1040) 2007

174 Chapter 7 Accounting Periods and Methods and Depreciation

Solutions for Questions and Problems Chapter 7 175 Key Number Tax Return Summary Chapter 7 Comprehensive Problem 1 Schedule C, Gross Income (Line 7) Form 4562, Depreciation on 7-Year Property (Line 19c) Schedule C, Depreciation (Line 13) Schedule C, Total Expenses (Line 28) Schedule C, Net Profit or (Loss) (Line 31) 124,000 286 7,686 64,386 59,614 Comprehensive Problem 2 Adjusted Gross Income (Line 37) Deductions (Line 40) Exemptions (Line 42) Tax Liability (Line 63) Tax Overpaid (Line 73) 142,140 92,300 6,800 5,671 4,329

176 Chapter 7 Accounting Periods and Methods and Depreciation