Overview
ACCT633 Dialogue one
Richard and Rachel Douglas are married and maintain a household in which the following persons live: Herman and Sharon Clemmons and Wesley, Shawn and Cathy Douglas.
Herman and Sharon are Richard’s parents, who are retired. During the year, they receive $21,000 in nontaxable funds (e.g., disability income, interest on municipal bonds, and Social Security benefits). Of this amount, $8,400 is spent equally between them for clothing, transportation, and recreation (e.g., vacation) and the balance of $12,600 is invested in tax-exempt securities. Richard paid $1,000 for his father’s dental work and the $2,200 premium on an insurance policy his mother owned on her own life. Sharon had medical expenses, but she insisted on paying for them with her own funds.
Wesley is the Douglas’ 18-year-old son, who is not a student but operates a landscaping service on a part-time basis. During the year, he earns $12,000 from the business, which he places in a savings account for later college expenses.
Shawn is the Douglas’s 19-year-old son, who does not work or go to school. Tired of the inconvenience of borrowing and sharing the family car, during the year, he purchased a Mustang for $27,000. Shawn used funds from a savings account he had established several years ago with an inheritance from his maternal grandfather.
Cathy is the Douglas’ 23-year-old daughter. To attend graduate school at a local university, she applied for and obtained a student loan of $25,000. She uses the full amount to pay her college tuition.
The Douglas’ fair rental value of their residence including utilities is $14,000, and their total food expense for the household is 10,500.
1. How many dependents are the Douglas’ entitled to claim for the year? Explain your answer.
2. From a planning standpoint, how might the Douglas’ have improved the tax result?
Summarize your findings in a memo for the tax research file.
Reginald and Courtney Stone always had taken their Form 1040 data to the franchise tax preparers in a local mall, but this year, his wife suggested a friend of a friend do their taxes. In a conversation with a co-worker Michelle Sanchez, Courtney found out that her co-worker got a nice tax refund when Felicia Jennings prepared her income taxes. So Courtney asked Michelle to introduce her to Felicia Jennings. After a brief phone conversation, Reginald and Courtney asked Felicia to prepare their tax return. Felicia quoted a reasonable fee, and Reginald and Courtney figured that during covid with finances especially tight they could save money and help Felicia out.
Reginald and Courtney delivered his Forms W-2, 1099, and other documentation and said, “I’ll pick up the finished return from you on Friday.” Felicia completed the return by that deadline, and without signing and reviewing the forms, Reginald and Courtney allowed Felicia to e-file it that day. Felicia suggested a special arrangement to Reginald and Courtney so they could get their refund faster. The arrangement was that Felicia would receive the refund through a special bank account and write Reginald and Courtney a check for that amount, minus her fee. When the refund came through about two weeks later, Felicia wrote Reginald and Courtney a check for $4,500, and all parties were satisfied. Reginald and Courtney were especially happy because the most they received in previous tax refunds was about $1,200. Reginald and Courtney gladly used Felicia to e-file the next year’s return using the same arrangement and procedures.
To their surprise, Reginald and Courtney received a letter from the IRS about two years later. The IRS auditor had found that the return Felicia had e-filed vastly overstated deductions and wrongly calculated the earned income tax credit. According to the audit report, the refund issued was $6,500-Felicia had pocketed the difference of $2,000! As a result of the past two years tax filings, the corrected tax liability meant that Reginald and Courtney now owed over $10,000 in tax, before considering interest and penalties. Reginald and Courtney tried to reach Felicia Jennings to tell her about the IRS letter and findings but after leaving several messages, she never returned their call.
Reginald and Courtney contend that they relied on Felicia’s expertise in the tax law and e-filing procedures. Consequently, there was reasonable cause for the underpayment of tax, and the IRS should waive the understatement and negligence penalties. The IRS has expressed sympathy for Reginald and Courtney’s position, but it maintains that the penalty should stand.
1. What do you think? Please explain you reasoning. Summarize your findings in a memo for the tax research file.