Carrie A. Morgan, age 45, is single and lives with her dependent mother at 426 Grouse Avenue, Allentown, PA 18105. Her Social Security number is 111-11-1112.
- Carrie is a licensed hairstylist and operates her own business. Located at 480 Laurel Street, Allentown, PA 18105, the business is conducted under the name of “Carrie’s Coiffures.” Carrie’s business activity code is 812112. In addition to 10 workstations (i.e., stylist chairs) and a small reception area, the shop has display and storage areas for the products she sells (see item 2 below). During the year, Carrie leased nine of the stations to other hairstylists. As is common practice in similar businesses in the area, the other stylists are considered to be self-employed. In fact, the IRS sanctioned the self-employment classification for the stylists in an audit of one of Carrie’s prior tax returns. Each stylist pays Carrie a fixed rent for the use of a workstation, resulting in $68,000 of rents received during 2015. From her own station, Carrie earned $44,000 (including tips of $12,000) for the styling services she provided to her own clients.
- Carrie’s Coiffures is the local distributor for several beauty products (e.g., conditioners, shampoos) that cannot be purchased anywhere else. Carrie buys these items from the manufacturers and sells them to regular patrons, walk-in customers, and other beauticians (including those who lease chairs from her). Carrie’s Coiffures is also known for the selection and quality of its hairpieces (i.e., wigs, toupees). Through the shop, Carrie made the following sales during the year:
|Hairpieces and wigs||$69,000|
Although Carrie operates her business on a cash basis, she maintains inventory accounts for the items she sells as required by law. So, she uses the hybrid method of accounting for tax reporting purposes. Relevant information about the inventories (based on lower of cost or market) is summarized below.
|Hairpieces and wigs||$10,700||$12,600|
Carrie’s purchases for 2015 were $30,500 of hairpieces and wigs and $26,100 of beauty products.
Carrie’s Coiffures had the following operating expenses for 2015:
|Utilities (i.e., gas, electric, telephone)||$12,900|
|Ad valorem property taxes:|
|On realty (e.g., shop building and land)||$4,200|
|On personalty (e.g., equipment, inventory)||1,800||6,000|
|Styling supplies (e.g., rinses, dyes, gels, hair spray)||5,700|
|Fire and casualty insurance||4,100|
|Sewer service, garbage pickup||2,300|
|Occupation licenses (city and state)||1,500|
|Waiting room supplies (e.g., magazines, coffee)||1,300|
As Carrie prefers to avoid employer-employee arrangements and the payroll tax complexities, she retains outside agencies to handle her accounting and janitorial needs.
- In early 2015, Carrie decided to renovate the waiting room. On May 10, she spent $10,400 for new chairs, a sofa, various lamps, coffee bar, etc. Carrie follows a policy of claiming as much depreciation as soon as possible. The old furnishings were thrown away or given to customers. For tax purposes, the old furnishings had a zero basis.
- Carrie’s Coiffures is located in a building Carrie had constructed at 480 Laurel Street in March 2001. The shop was built for a cost of $300,000 on a lot she purchased earlier for $35,000. Except for a down payment from savings, the cost was financed by a 20-year mortgage. For tax purposes, MACRS depreciation is claimed on the building. During 2015, the following expenses were attributable to the property:
|Repainting (both exterior and interior)||$8,000|
|Repairs (plumbing and electrical)||1,900|
In May (after her accident settlement discussed in item 10 below), Carrie paid the balance due on the business mortgage. To do so, she incurred a prepayment penalty of $4,400. Prior to paying off the mortgage, she paid regular interest on the mortgage in 2015 of $6,000.
- In February 2015, Carrie’s Coiffures was cited by the city for improper disposal of certain waste chemicals. Carrie questioned the propriety of the proposed fine of $2,000 and retained an attorney to represent her at the hearing. By pleading nolo contendere, the attorney was able to get the fine reduced to $500. Carrie paid both the fine of $500 and the attorney’s fee of $600 in 2015.
- In August 2015, Carrie saw an ad in a trade publication that attracted her attention. The owner of a well-respected styling salon in Reading (PA) had died, and his estate was offering the business for sale. Carrie traveled to Reading, spent several days looking over the business (including books and financial results), and met with the executor. Carried treated the executor to dinner and a music concert. Immediately after the concert, Carrie made an offer for the business, but the executor rejected her offer. Her expenses in connection with this trip were as follows:
|Entertainment of executor (dinner and concert)||280|
|Motel (August 6–7)||220|
- In March 2014, Joan Myers, one of Carrie’s best stylists, left town to get away from a troublesome ex-husband. In order to help Joan establish a business elsewhere, Carrie loaned her $7,000. Joan signed a note dated March 3, 2014, that was payable in one year with 6% interest. On December 30, 2015, Carrie learned that Joan had been declared bankrupt and was awaiting trial on felony theft charges. Carrie never received payment from Joan, nor did she receive any interest on the loan.
- At Christmas, Carrie gave each of her 35 best customers a large bottle of body lotion. Each bottle had a wholesale cost to Carrie of $12 but a retail price of $24. Carrie also spent $3 to have each bottle gift wrapped. (Note: The lotion was special order merchandise and was not part of the business’s inventory or purchases for the year—see item 2 above.) She also gave each of the nine stylists who leased chairs from her a fruit basket that cost $30 (not including a $5 delivery cost).
- In March 2015, the Pennsylvania Department of Revenue audited Carrie’s state income tax returns for 2012 and 2013. She was assessed additional state income tax of $340 for these years. Surprisingly, no interest was included in the assessment. Carrie paid the back taxes promptly.
- On a morning walk in November 2014, Carrie was injured when she was sideswiped by a delivery truck. Carrie was hospitalized for several days, and the driver of the truck was ticketed and charged with DUI. The owner of the truck, a national parcel delivery service, was concerned that further adverse publicity might result if the matter went to court. Consequently, the owner offered Carrie a settlement if she would sign a release. Under the settlement, her medical expenses were paid and she would receive a cash award of $200,000. The award specified that the entire amount was for physical pain and suffering. Since she suffered no permanent injury as a result of the mishap, she signed the release in April 2015 and received the $200,000 settlement.
- In January 2015, Carrie was contacted by the state of Pennsylvania regarding a tract of land she owned in York County. The state intended to convert the property into a district headquarters, barracks, and training center for its highway patrol. Carrie had inherited the property from her father when he died on August 11, 2014. The property had a value of $140,000 on that date and had been purchased by her father on March 3, 1980, for $30,000. On July 25, 2015, after considerable negotiation and after the state threatened to initiate condemnation proceedings, she sold the tract to the state for $158,000. Since Carrie is not comfortable with real estate investments, she does not plan to reinvest any of the proceeds received in another piece of realty.
- When her father died in 2014, Carrie did not know that he had an insurance policy on his life (maturity value of $50,000) in which she was named the beneficiary. When her mother told her about the policy in July 2015, Carrie filed a claim with the carrier, Falcon Life Insurance Company. In August 2015, she received a check from Falcon for $51,500 (including $1,500 interest).
- Upon the advice of a client, who is a respected broker, Carrie purchased 1,000 shares of common stock in Grosbeak Exploration for $40,000 on March 4, 2015. In the months following her purchase, the share value of Grosbeak plummeted. Disgusted with the unexpected erosion in the value of her investment, Carrie sold the stock for $28,000 on December 23, 2015.
- While on her way to work in 2014, Carrie was rear-ended by a hit-and-run driver. Thankfully, she was not injured in the accident. The damage to her Lexus was covered by her insurance company, General Casualty, except for the $1,000 deductible she was required to pay. In 2015, the insurance company located the driver who caused the accident and was reimbursed by his insurer. Consequently, Carrie received a $1,000 refund check from General Casualty in May 2015 to reimburse her for the $1,000 deductible.
- After her father’s death, Carrie’s mother (Mildred Morgan, Social Security number 123-45-6789) moved in with her. Mildred’s persistent back trouble made it difficult for her to climb the stairs to the second-floor bedrooms in Carrie’s house. So, Carrie had an elevator installed in her personal residence at a cost of $12,000 in January 2015. A qualified appraiser determined that the elevator increased the value of the personal residence by $5,000. The appraisal cost $400. The operation of the elevator during 2015 increased Carrie’s electric bill by $300.
- As a favor to a long-time client who is a drama professor at a local state university, Carrie spent a weekend as a stylist for the key actresses in the annual Theater Department fund-raising event. The drama professor provided all of the resources that Carrie needed to provide her services. Carrie estimates that she would have charged $800 for the services she donated to this charitable event.
- In addition to the items already mentioned, Carrie had the following receipts during 2015:
|CD at Scranton First National Bank||$900|
|City of Lancaster general purpose bonds||490|
|Money market account at Allentown State Bank||340||$1,730|
|Qualified dividends on stock investments:|
|Federal income tax refund (for tax year 2014)||791|
|Pennsylvania state income tax refund (for tax year 2014)||205|
- Expenditures for 2015, not previously noted, are summarized below.
|Contribution to pension plan||$10,000|
|Premiums on medical insurance||$4,800|
|Property taxes on personal residence||3,800|
|Interest on home mortgage||3,200|
|Subscriptions to trade journals||$180|
|Dues to beautician groups||140||320|
- The $10,000 contribution to the pension plan is to a § 401(k) type of plan she established in 2015. Previously, she had contributed to an H.R. 10 (Keogh) plan but found that the § 401(k) retirement arrangement provides more flexibility and is less complex. The medical insurance policy covers Carrie and her dependents and was issued in the name of the business (i.e., “Carrie’s Coiffures”). It does not cover dental work or capital modifications to a residence (see item 15 above).
- During 2015, Carrie made total estimated tax payments with respect to her 2015 tax returns of:
|Federal estimated income tax payments||$20,800|
|Pennsylvania estimated income tax payments||2,400|
|Allentown City estimated income tax payments||800|
- Prepare an income tax return (with appropriate schedules) for Carrie for 2015. In doing this, use the following guidelines:
- Make necessary assumptions for information not given in the problem.
- Carrie has itemized deductions ever since she became a homeowner many years ago.
- The sales tax option was not chosen in 2014, and Carrie had no major purchases that qualify for the sales tax deduction in 2015.
- Carrie has substantiation (e.g., records, receipts) to support the transactions involved.
- If a refund results, Carrie wants it sent to her.
- Carrie is preparing her own return (i.e., no preparer is involved).
- Carrie does not wish to contribute to the Presidential Election Campaign Fund.
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