South-Western Federal Taxation 2014

Taxation of Business Entities 17th Edition

Smith Test Bank
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CHAPTER 6
LOSSES AND LOSS LIMITATIONS
SOLUTIONS TO PROBLEM MATERIALS

Status: Q/P
Question/ Learning Present In Prior
Problem Objective Topic Edition Edition

1 LO 1 Bad debts: business Unchanged 1

2 LO 1 Bad debts: nonbusiness Unchanged 2
3 LO 2 Worthless securities versus theft loss Unchanged 3
4 LO 1 Bad debt and cash basis taxpayer Unchanged 4
5 LO 1, 2 Bad debt and § 1244 stock Unchanged 5
6 LO 2 § 1244 stock Unchanged 6
7 LO 2 Transfer of § 1244 stock to another individual Unchanged 7
8 LO 3 Casualty loss: disaster area loss New
9 LO 3 Casualty loss: occurrence Unchanged 9
10 LO 3 Casualty loss: insurance recovery Unchanged 10
11 LO 4 Net operating loss: calculation Modified 11
12 LO 6 At-risk rules New
13 LO 6 At-risk rules Unchanged 13
14 LO 6,7,8 Application of at-risk and passive loss rules Unchanged 14
15 LO 6 Passive activity loss rules: general New
application

6-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
6-2 2014 Entities Volume/Solutions Manual

16 LO 5, 6 Passive activity loss rules: general Unchanged 16

application
17 LO 6 Sale of passive activity and suspended Modified 17
losses
18 LO 6 Sale of passive activity and suspended Unchanged 18
losses
19 LO 6 Passive losses of personal service Unchanged 19
corporation
20 LO 6 Passive losses of corporations New
21 LO 7 Material participation determination Unchanged 21
22 LO 7 Issue ID Unchanged 22
23 LO 6, 8 Interaction of at-risk and passive loss rules Unchanged 23
24 LO 7 Character of property: held as investment Unchanged 24
property or rental property
25 LO 8 Interaction of at-risk and passive loss rules Unchanged 25
26 LO 8 Interaction of at-risk and passive loss rules Unchanged 26
27 LO 6 Interaction of at-risk and passive loss rules Unchanged 27

Status: Q/P
Question/ Learning Present In Prior
Problem Objective Topic Edition Edition

28 LO 5, 6, 8 Interaction of at-risk and passive loss rules Unchanged 28

29 LO 5, 6, 8 Passive loss deduction amounts Unchanged 29
30 LO 9 Rental loss: active participation New
31 LO 5, 6, 7 Ethics problem Unchanged 31
32 LO 6, 9 Joint or separate return: real estate rental Modified 32
exception
33 LO 9 Real estate rental exception Unchanged 33
34 LO 9 Passive activity loss allowed, suspended Unchanged 34
losses and credits
35 LO 9 Rental real estate loss deduction Unchanged 35
36 LO 5,6,10 Ethical consideration Unchanged 36
37 LO 5,6,10 Gift of a passive activity New

Bridge
Discipline
Problem

1 Bad debt expense Unchanged 1

2 At-risk rules Unchanged 2
3 Passive activity loss rules: Unchanged 3
general application

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Losses and Loss Limitations 6-3

Research
Problem

1 Casualty loss deduction Unchanged 1

2 Definition of portfolio income and its New
relationship with passive losses
3 Classification of property as rental: Unchanged 3
extraordinary personal services
exception
4 Internet activity Unchanged 4
5 Internet activity Unchanged 5

1. Smith, Raabe, and Maloney, CPAs

5191 Natorp Boulevard
Mason, OH 45040
January 29, 2013
Loon Finance Company
100 Tyler Lane
Erie, PA 16563
Dear Sir:

This letter is to inform you of the possibility of taking a bad debt deduction.
Your loan to Sara is a business bad debt; therefore, you are allowed to take a
bad debt deduction for partial worthlessness. You will be able to take a bad debt
deduction in the current year of $26,000 ($30,000 – $4,000) based on partial
worthlessness.
Should you need more information or need to clarify anything, please contact
me.

Sincerely,
John J. Jones, CPA
Partner

TAX FILE MEMORANDUM

January 29, 2013

From: John J. Jones

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
6-4 2014 Entities Volume/Solutions Manual

Subject: Bad Debt Deduction

Loon Finance Company’s $30,000 loan to Sara is a business bad debt.

Therefore, a bad debt deduction is allowed for partial worthlessness of $26,000
(i.e., Sara has filed for bankruptcy and Loon has been notified that the most the
company can expect to receive is $4,000). Loon will be able to claim an additional
bad debt deduction in the year when a final settlement has been reached with
respect to the loan assuming the amount collected is less than $4,000.
pp. 6-2 and 6-3

2. Monty must include up to $10,000 in gross income, but only to the extent of a tax
benefit in a prior year. Because the debt is a nonbusiness bad debt, the $11,000
would have been reported as a short-term capital loss. Last year, Monty had
capital gains of $4,000 and taxable income of $20,000. Therefore, $7,000 of the
$11,000 loss produced a tax benefit. Hence, only $7,000 would be included in
Monty’s gross income this year. pp. 6-2 to 6-4

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Losses and Loss Limitations 6-5

3. Jack should be concerned with the following issues:

• Should this be treated as a worthless security?

• Should this be treated as a theft loss?

• Does the theft loss create an NOL?

• Can the NOL be carried back 3 years?

pp. 6-5 and 6-6

4. Worthless debts arising from unpaid wages are not deductible as a bad debt
unless the taxpayer has included the amount in income for the year for which the
bad debt is deducted or for a prior tax year. Jake used the cash method of
reporting income. Therefore, fees for services by Jake that allegedly were owed
by the City have never been included in income, and unpaid amounts, even if
earned, do not constitute bad debts within the meaning of §166 for which a
deduction for worthlessness may be claimed. p. 6-2

5. Salary $120,000
§ 1244 ordinary loss (limit of $100,000) (100,000)
Short-term capital gain on § 1244 stock $20,000
Short-term capital loss (nonbusiness bad debt) (19,000)
Net short-term capital gain 1,000
Net long-term capital loss (remaining § 1244 loss) (5,000)
Net capital loss (limit) (3,000)
Adjusted gross income ($ 17,000)

pp. 6-4 to 6-6

6. Sell all of the stock in the current year:

Current year’s AGI

Salary $ 80,000
Ordinary loss (§ 1244 limit) (50,000)
Long-term capital gain $ 8,000
Long-term capital loss ($80,000 – $50,000) (30,000)
Long-term capital loss (limit) (3,000)
AGI $ 27,000

Next year’s AGI

Salary $
90,000
Long-term capital gain $ 10,000
Long-term capital loss carryover (19,000)
($22,000 – $3,000)
Long-term capital loss (limit) (3,000)

© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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