David (Dave) S. and Karen H. Brown are husband and wife and live at
4112 Foxglove Drive, McKinney, TX 75070. Dave is a retired petroleum engineer, and Karen is a portrait artist. They choose to file a joint tax return each year.
1. When he retired at age 65, Dave was chief of offshore operations at Pelican Exploration Corporation. While employed, Dave participated in Pelican's contributory qualified pension plan, to which he had contributed $250,000 (in after‐tax dollars). Under one of the plan options, he chose a life‐annuity payout of $60,000 per year over his life. As part of his retirement package, Dave also received nontaxable health insurance coverage for him and Karen. Due to Dave's expertise in Gulf of Mexico offshore operations, Pelican continues to use his services on a consulting basis (see item 3 below).
2. Karen, an accomplished artist, is well known regionally for oil portraits (business activity code 711510). She paints in the Photorealism style, providing her clients with portraits that are often mistaken for photographs. Painting in this style is very time‐ consuming. Consequently, her output averages between 15 and 16 portraits a year. Her fee of $3,200 per portrait was set several years ago and never varies. As this is quite reasonable for a Photorealistic oil portrait, she has a long waiting list of clients who have not yet been scheduled for sittings. She does all of her work in the studio the Browns maintain in their personal residence (see item 6 below). Karen is a cash‐basis taxpayer with respect to her art business.
3. During 2014, Dave made seven trips on behalf of Pelican as an outside consultant (business activity code 541330). On a typical trip, Dave flies by commercial airline to New Orleans, Houston, or Corpus Christi, and then takes a company helicopter to the offshore platform. If necessary, he rents a room at a local motel. Sometimes offsite consultations can solve the problem, and a trip to the rig is not necessary. His expenses for these trips are as follows: Airfare $5,100 Lodging 3,100 Meals 2,200 Ground transportation (taxis, limos, rental cars) 750
4. After each trip, Dave recovers his expenses when he is paid by Pelican for the services rendered. Pelican does not require an accounting for the expenses and reimburses Dave based on his verbal report of how much he spent.
5. In early January 2014, Karen was paid for three portraits she painted and delivered in late 2013. During 2014, Karen completed 14 portraits. Payment was received for 11 portraits when they were delivered to the buyers. One portrait was delivered in mid‐ 2014 to the CEO of a company who promised payment within 30 days. Payment was never received, and the company has since entered bankruptcy. Since the CEO has been indicted for securities fraud, Karen feels certain that she will never be paid for the portrait. The final two portraits were delivered in late 2014, and payments for both were received in early 2015. In December 2014, Karen accepted $3,200 as payment for a portrait to be done in 2015. Although she did not like the arrangement, the customer said the prepayment was motivated by anticipated cash‐flow considerations.
6. Karen keeps receipts for all her expenses. Her total cost for painting supplies in 2014 was $3,010 (e.g., for canvases, brushes, oil paints, smocks, palettes, and other art supplies). The framing of the finished portrait is left to the customer since the most appropriate frame is a matter of personal taste and consideration for where the painting will be exhibited.
7. For convenience and security reasons, Karen prefers to work at home. One‐fourth of the 4,000 square‐foot living area is devoted to Karen's studio. The Browns built the home at a cost of $350,000 on a lot previously acquired for $100,000, and they moved in on June 15, 2011. As to business use, depreciation is based on MACRS (using the mid‐month convention) applicable to 39‐year nonresidential realty. Besides home mortgage interest and property taxes (see item 19 below), residence expenses for 2014 are summarized below: Utilities $4,200 Molly Maid cleaning service 2,800 Service fee for home security system 1,600 Removal of stains from studio flooring 1,100 Homeowner's insurance 970 Repairs to studio skylight 340
8. At a mortgage foreclosure auction held on February 4, 2002, Dave acquired an abandoned sugarcane farm near Magnolia, known as LaBeaux Place, for $30,000. In view of the expansion trend in nearby Houston, he regarded the purchase as a good investment. Early in 2014, Dave was contacted by a Houston real estate developer who offered $250,000 for LaBeaux Place. Considering the prospect of a large taxable gain, Dave arranged for a property swap by written notice on May 10. In exchange for several vacant lots on Padre Island (TX) worth $240,000 and cash of $10,000, Dave transferred LaBeaux Place to the developer. The exchange took place on June 20, 2014.
9. Dave purchased unimproved land near Beaumont (TX) for $18,200 at an auction held on April 17, 1989. Described as Block 46, the property was adjacent to a modest prison rice farm owned by the Texas Department of Corrections (TDC). Dave bought the property based on a hunch that the TDC might someday wish to expand its Beaumont prison facility. In late 2013, the TDC contacted Dave and offered him $160,000 for Block 46. Dave countered with a selling price of $225,000. After prolonged negotiations, Dave and the TDC could not come to a mutually agreeable selling price. The TDC then threatened to condemn Block 46. After repeated threats of condemnation, Dave transferred the property to the TDC on June 28, 2014, for $180,000. On December 17, 2014, Dave reinvested $175,000 in vacant land located near Texas State University in San Marcos. Dave spent the remaining $5,000 on a vacation for him and Karen to Hawaii in early 2015.
10. The Browns had always thought that taking extended road trips in an RV would be fun. So in June 2014, they bought a new Winnebago Deluxe Coach RV for $106,250 [$100,000 (discounted list price) + $6,250 (state sales tax)]. However, it only took Dave and Karen two weeks on the road to determine that this method of traveling the continental United States was not for them. In August 2014, they sold the RV to a neighbor for $90,000. The neighbor paid $20,000 down and paid the balance of $70,000 in early December 2014. Dave did not charge his neighbor any interest..
11. On May 9, 1997, Dave's father gave him 400 shares of Ragusa Corporation common stock as a birthday gift. The stock cost his father $16,000 ($40 a share) and was worth $20,000 on the date of the gift. In 2009, when the stock was worth $140 per share, Ragusa declared a 2‐for‐1 stock split. On July 27, 2014, Dave sold 400 shares for $20,000 ($50 a share). For sentimental reasons, Dave kept the remaining 400 shares. Form 1099–B did not report the basis of this property.
12. On December 21, 2014, the Browns sold 500 shares of Cormorant Power common stock for $40,000 ($80 a share). They purchased the stock on February 1, 2014, for $50,000 ($100 a share), the basis reported on Form 1099–B. The Browns sold the stock to generate a loss to offset some of their capital gains. However, they considered Cormorant Power to be a good investment, so they repurchased 500 shares on February 19, 2015, for $45,000 ($90 a share).
13. On March 2, 2013, Karen was contacted by Eva Baum, a former college roommate. Over lunch Eva asked Karen for a loan of $6,000 to help finance a new venture. Karen made the loan because the venture, a summer art camp in Sedona, AZ, sounded interesting. Eva signed a note due in two years at 10% interest. In late 2014, Karen learned that Eva had disappeared after being charged by Arizona authorities with grand theft. She also learned that Eva is wanted in New Mexico for parole violation from a prior felony conviction. Eva made no payments to Karen on the note.
14. The Browns have a long‐term capital loss carryover of $7,000 from 2013.
15. On May 9, 2010, Maximilian Brown (Dave's favorite uncle) gifted him the family antique gun collection. Based on family records and qualified appraisals, the collection had an adjusted basis to Maximilian of $4,200 and was worth $13,000 on the date of the gift. Since Karen abhors guns, Dave has been under heavy pressure to get rid of the collection. After Maximilian died in early 2014, Dave donated the collection to the Alamo Siege Museum (a qualified charity). The transfer was made on December 5, 2014; at that time, several qualified appraisers valued the collection at $16,000. The museum added the guns to its extensive collection of firearms.
16. While walking the dog in late December 2013, Karen was hit by an out‐of‐control delivery truck. The mishap sent Karen to the hospital for several days of observation and medical evaluation. Aside from severe bruises, she suffered no permanent injury. Once apprehended, the driver of the truck was ticketed for DUI. The owner of the truck, a local distributor for a national brewery, was quite concerned about the adverse publicity that would result if Karen filed a lawsuit. Consequently, it paid all her medical expenses and offered Karen a settlement if she would sign a release. Under the terms of the settlement, Karen would receive $134,000—$126,000 for personal injury and $8,000 for loss of income because her injuries prevented her from painting for a period of weeks. On January 31, 2014, Karen signed the release and was immediately paid $134,000.
17. In August 2013, Dave was rear‐ended while stopped at a red light. Thankfully, Dave was uninjured. However, his car was damaged. The driver who caused the accident left the scene immediately, so Dave was forced to use his insurance to repair the damage to his car. As a result, Dave was subject to the $1,000 deductible provision in the policy which he paid with respect to his car repairs in 2013. The Browns claimed no deductions with respect to the accident on their 2013 income tax return. In 2014, the insurance company (Peregrine Casualty) located the driver at fault and recovered the amount paid for repairs by both Dave and Peregrine. Consequently, in April 2014, Dave received a check from Peregrine refunding the $1,000 he paid for repairs according to his policy's deductible.
18. After an acrimonious divorce, the Browns' only daughter (Pamela Jansen) moved back home in December 2013. She brought her twins (Malone and Macie) with her. Under the divorce decree, Pamela was given custody of the children and awarded child support of $2,100 a month. The decree does not indicate who is entitled to the dependency exemptions for the children. Pamela has no income for 2014 except the $4,200 she received for two months of child support. She plans to initiate legal proceedings against her ex‐husband for delinquent child support.
19. Besides the items already mentioned, the Browns have the following receipts for 2014: Social Security benefits (Dave, $12,000; Karen, $6,000) $18,000 Consulting income paid by Pelican (including expense reimbursement of $11,150—see item 3) 35,000 Life insurance proceeds (see below) 50,000 Qualified dividend income (reported on separate Forms 1099–DIV): Ragusa Corporation 1,200 Pelican Power 400 Interest income (reported on separate Forms 1099–INT): IBM bonds 600 CD at First National Bank of McKinney 400 Wells Fargo money market fund 300 City of Beaumont (TX) general purpose bonds 9,000
20. The life insurance proceeds relate to a policy owned by Maximilian Brown (see item 14), which named Dave as sole beneficiary. The receipt of the proceeds came as a complete surprise to Dave, as he never knew the policy existed.
21. Payments made for 2014 expenditures not already mentioned are as follows: Payment of Pamela's legal fees and court costs incident to her divorce $9,000 Medical: Medicare B insurance premiums for Dave and Karen 2,244 Health care premiums for dependents 3,600 Dental implants for Karen 8,000 Taxes on personal residence 3,600 Interest on home mortgage 2,200 Church pledge 1,200 Professional journals: Oil and gas related (Dave) 160 Art related (Karen) 120 Dues to professional organizations (Dave) 140 State professional license fee (Dave) 250 2013 tax return preparation fee ($200 for Dave's business; $250 for Karen's business; and $450 for personal income tax return) 900
22. Texas does not impose an income tax, so the Browns choose the state and local sales tax option. In addition to the state general sales tax, the local sales tax rate is 2% (1.5% city; 0.5% county). They do not keep track of sales tax expenditures for routine purchases (e.g., clothes, prepared foods) but can verify the sales tax on exceptional items (i.e., big‐ticket purchases like the RV).
23. The Browns made quarterly Federal income tax payments of $2,400 on each of the following dates: April 15, 2014, June 16, 2014, September 15, 2014, and December 15, 2014. Last year's Federal income tax return reflected an overpayment of $800 tax, which the Browns chose to apply to their 2014 income tax liability. The trustee of Dave's retirement plan also withheld $6,500 of tax with respect to his retirement withdrawals for the year. Neither Dave nor Karen holds any foreign financial accounts. Relevant Social Security numbers are noted below:
Name Social Security Number Birth Date David S. Brown 123456785 09/15/1943 Karen K. Brown 123456786 12/03/1948 Pamela Jansen 123456784 10/19/1981 Malone Jansen 123456787 06/25/2008 Macie Jansen 123456788 06/25/2008 Requirements Prepare an income tax return (with all appropriate forms and schedules) for the Browns for 2014 following these guidelines: Make necessary assumptions for information not given in the problem but needed to complete the return. The Browns are employing the same tax return preparer who completed their prior year tax return. The taxpayers have substantiation (e.g., records, receipts) to support all transactions for the year. If any refund is due, the Browns want it applied to next year's tax liability. The Browns do not want to contribute to the Presidential Election Campaign Fund.