Flip the tax return with a professor-prepared tax return

By Dan M. Vitale, CPA/PFS

Editor: Annette Nellen, Esq., CPA, CGMA

As part of the tax overhaul caused by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, Treasury and the IRS released the long-awaited postcard-size Form 1040, U.S. Individual Income Tax Return. The combination of new tax forms and new tax law adds an increased level of opportunity in academia: Professors can assign tax return projects under the TCJA with the newly revised income tax forms, using an approach described in this column.

A traditional assignment in many individual tax courses involves student-prepared tax returns (SPTR) from a set of data or source documents. Tax return preparation projects are generally beneficial to students; however, they often require a tax return preparation software program and result in students' simply entering data without fully understanding the consequences of their input or the results of the tax return. Alternatively, manually prepared tax returns by students in introductory tax courses must be overly simplistic, and they often lack broad coverage of learning objectives, or professors risk overwhelming their students.

It is commonly evident that students and many tax preparers do not have a solid understanding of the applicable tax law, nor can they navigate a tax return via preparation of the tax return alone. Also, accurately preparing a tax return does not necessarily demonstrate knowledge of many critical taxation concepts. Many experienced tax practitioners and tax professors would certainly confirm that there is a gap between tax return input and understanding the output.

Flipped tax return assignment

To close the gap between students' input and their understanding, a professor-prepared tax return (PPTR) assignment allows faculty to introduce tax law complexities that may be difficult to address in SPTRs. The PPTR can address more issues than a tax return prepared by students, incorporate more course topics, and be customized to the appropriate level of the students.

Thought-provoking questions based on the tax return require students to identify, interpret, explain, communicate, and/or verify the tax return results, rather than to simply input data. These questions can follow the order of the tax return or be arranged to simulate real-world client interaction.

A comprehensive take-home or in-class final exam can be developed using a PPTR and a series of questions related to the return. A comprehensive final exam based on a PPTR brings many of the concepts learned throughout the term together in one final exam. Using this approach requires students to understand concepts and requires them to have an understanding of the material at a level whereby they can navigate and explain a completed tax return, rather than simply input data or prepare simple forms.

SPTR assignments deliver better student learning outcomes if the requirements go beyond student preparation of the tax return. Along with grading SPTRs for accuracy, professors should add thought-provoking questions as a follow-up, supplemental assignment to enhance and ensure students' understanding of the tax return results. The PPTR assignment offers additional benefits to students and grading efficiencies for faculty.

Opportunities for use of Excel

The PPTR assignment provides opportunities to incorporate Microsoft Excel analyses. One opportunity is to ask students to use Excel to compute or confirm the tax calculation using the tax rate schedules. For this portion of the assignment, students can confirm the tax based on the tax return as prepared, considering tax on long-term capital gains and qualified dividends. Students can also be asked to compute tax assuming all of the income is ordinary, to isolate the benefit of preferential rates.

Other opportunities involve worksheets within IRS instructions and publications. For example, 2018 Form 1040 instructions (at irs.gov) include a "Social Security Benefits Worksheet." Students can be asked to confirm the taxable Social Security amount by re-creating this worksheet using Excel and testing their spreadsheet using various scenarios, including ones included in their textbook. Similarly, the 2018 Form 1040 instructions include a "Qualified Business Income Deduction — Simplified Worksheet." Many other worksheets in the Form 1040 instructions can be used to incorporate Excel. Students should be encouraged to use the IF function in Excel to simulate the IRS worksheets whenever applicable.

Sample case study

A PPTR case study may incorporate a variety of tax return situations. For example, a 2018 tax return may involve a married couple with three dependents ranging in age from 10 to 20. Both the taxpayer and the spouse work as employees, and a supplemental schedule is provided for each that discloses federal taxable wages, federal withholding, Social Security taxes, Medicare taxes, and, possibly, state tax withholding. Alternatively, Forms W-2, Wage and Tax Statement, can be provided so students can become more familiar with source documents. Other supplemental schedules include details for medical expenses or charitable contributions. One spouse may earn more than the Social Security wage base, while the other earns a nominal amount of income from a part-time position. Depending on the level of the class, other scenarios may involve income or losses from Schedule K-1, the qualified business income (QBI) deduction, passive activity losses, additional Medicare tax, the net investment income tax, and a sole proprietorship or rental activity.

Ideally, the case study should include a copy of the couple's prior-year tax return as filed. Inclusion of a prior-year tax return requires students to make comparisons between the old form flow and the new form flow (for 2017 and 2018, where forms differed in layout). This additional activity presents students with more real-world situations and requires them to verify certain carryover amounts from one year to the next, including capital loss carryovers from Schedule D, Capital Gains and Losses, passive activity loss carryovers from Form 8582, Passive Activity Loss Limitations, and investment interest expense carryover from Form 4952, Investment Interest Expense Deduction. Students may also compare tax returns for specific sources of income, deductions, or credits from year to year, effectively performing a due-diligence function.

Some or all of the source documents may be included so students can follow the flow of income or deductions from source documents to the tax return.

The 2018 PPTR may include:

  • Other income and adjustments to income.
  • Schedule A, Itemized Deductions, including medical expenses, state taxes, mortgage interest, investment interest, charitable contributions (cash and noncash), and casualty and theft losses.
  • Schedule B, Interest and Ordinary Dividends, including interest (taxable and tax-exempt) and dividends (ordinary and qualified).
  • Schedule C, Profit or Loss From Business. One of the spouses also earns a small profit (loss) from a side business. Related to Schedule C is Schedule SE, Self-Employment Tax.
  • Schedule D and Form 8949, Sales and Other Dispositions of Capital Assets, including short-term capital gains and losses, short-term carryover losses, long-term capital gains and losses, and long-term carryover losses.
  • Schedule E, Supplemental Income and Loss, including a rental activity. This activity can be a profit or loss, depending on the learning objectives. A rental loss may result in the inclusion of Form 8582. More advanced courses may also include flowthrough income from a partnership or an S corporation, and the QBI deduction.
  • Form 8959, Additional Medicare Tax, and Form 8960, Net Investment Income Tax — Individuals, Estates, and Trusts, for higher-income taxpayers in which an emphasis was placed in class on the 0.9% and 3.8% Medicare taxes.

Based on the PPTR, a series of thought-provoking questions address many facets of the tax return. See the sidebar "Illustrative Tax Return Questions" for a list of sample questions. Some of the key concepts addressed are:

  • General Form 1040: The emphasis is on factors involving adjusted gross income (AGI); filing status; dependents; tax calculations including income tax, self-employment tax, and Social Security and Medicare taxes; and credits. Further, specific sources of income, adjustments to income, and the QBI deduction are explored.
  • Schedule A: Students should be able to explain and navigate Schedule A. Questions must address the comparison of the standard deduction with itemized deductions. Further, eligible medical expenses and the medical expense threshold, the state and local tax limitation, interest expense classifications (mortgage and investment interest) and limitations, charitable contribution types and limitations, and casualty losses are addressed.
  • Schedule B: Questions revolve around taxable and tax-exempt interest, ordinary and qualified dividends, and foreign bank account reporting. Advanced courses may address some of the more complex issues dealing with original issue discount, market discount, and government bonds.
  • Schedule C: There are numerous opportunities relating to Schedule C questions. General questions may address factors like the type of business, method of accounting for the business, and Form 1099 requirements. Other questions address the income and deductions, including methods used for auto expenses and the home office deduction. A profitable Schedule C business may also be a good place to address self-employment tax questions.
  • Schedule D and Form 8949: Much like Schedule C, there are numerous opportunities involving Schedule D questions. The capital gain (loss) netting process, carryovers into the current year, carryovers into future years, the relationship of Form 8949 to Schedule D, Form 8949 transactions including worthless securities, nonbusiness bad debts, the preferential rate on long-term capital gains, and the 3.8% tax on net investment income may be addressed.
  • Schedule E: This schedule provides a challenge to students regarding rental properties, royalties, and flowthrough entities. Basis issues and passive activity loss rules may be addressed with Schedule E. In some cases, Form 8582 can be added for passive activity loss netting and tracking.
  • Forms 8959 and 8960: For cases involving higher-income tax returns, a series of questions may be included that address the 0.9% and 3.8% Medicare taxes.

For more advanced courses, professors may also consider a series of questions covering planning situations, asking students to address marginal tax brackets, identifying tax planning strategies, evaluating capital gain and loss opportunities, and examining deductions and credits based on AGI levels. Alternatively, a series of PPTRs for the same taxpayer for multiple years can be provided so that students must evaluate the year-to-year results. In addition, a state tax return can be included, or students can be tasked with preparing one based on the federal return and their research into federal-state differences for their state.

This assignment works best for students in groups of two or three. As is the case with many income tax concepts, some students will understand certain topics better than others. In a group setting, students have the opportunity to explain to or learn from their peers in a collaborative process, enhancing important teamwork and communication skills.

MTC and AACSB relevancy

In 2014, the Model Tax Curriculum (MTC), developed by the AICPA in partnership with the American Taxation Association was updated (available at www.aicpa.org. The MTC provides learning outcomes for tax courses, as well as sample syllabuses and other information. Specifically, MTC learning outcome No. 1 covers demonstrating knowledge of the basic income tax formula for individuals. For the PPTR assignment, students will calculate gross tax liability and credits and identify allowable deductions for or from AGI, as well as demonstrate their ability to navigate a completed tax return.

MTC learning outcome No. 3 ­addresses the application of analytical reasoning to synthesize and interpret tax law. This assignment challenges ­students to analyze the tax return, interpret it, and apply what they learn from it to a specific taxpayer situation. For ­example, a sample question asks students to address applicable documentation requirements for a taxpayer's charitable contributions. Another question asks students to explain how the Sec. 199A deduction was computed, what income on the tax return drove the deduction, and what limiting factors were considered in the deduction.

Further, the Association to Advance Collegiate Schools of Business's (AACSB's) Standard A4, Accounting Curricula Content, Management and Assurance of Learning, available at www.aacsb.edu, requires the accounting learning experiences that an accounting academic unit offers to address, in part, the ability to identify issues, develop questions, apply appropriate analyses, interpret results, and communicate conclusions. A PPTR case study assignment addresses the AACSB Standard A4 objectives.

Anecdotal evidence

A PPTR assignment was used in a fall 2018 individual tax course, with draft 2018 income tax forms. One of the course evaluation questions asked students to describe a valuable learning experience from this class. Anonymous student evaluation comments provide some evidence of the effectiveness of this assignment in meeting learning objectives. One student noted that "the tax return project at the end of the course was a good way to sum up what we've learned in class." Another student indicated that the assignment "encompassed many concepts learned throughout the term. It was challenging but very informative." Other general comments and evaluations offered similar feedback on the benefits of the PPTR assignment.

A versatile model

With a PPTR, tax professors are in a unique position to develop tax returns and customize questions based on the sophistication of their students and the topics covered in their course. The questions are limited only by a professor's own creativity. With the use of tax return preparation software, PPTR cases can be developed efficiently and can be modified. This assignment model is versatile in that professors may employ the PPTR approach in homework assignments, with comprehensive in-class or take-home exams, or after grading SPTRs. Through assignments like this, students gain a deeper understanding of concepts covered in class and develop communication skills to explain those concepts, and professors are better able to assess their students' overall conceptual understanding and achievement of critical learning outcomes.

Illustrative tax return questions

General Form 1040 illustrative questions

  • Based solely on the tax return as prepared, explain whether the taxpayers are good candidates for a different filing status.
  • Verify the tax calculation, taking into consideration qualified dividends and/or long-term capital gains. Show all calculations.
  • Compute the average tax and marginal tax rates.
  • Explain how the child tax credit and other dependent credits were determined, including specific dependents who may have been considered for the credit.
  • Review the supplemental schedule of wages and withholding.
  • Determine the taxpayer's and spouse's Medicare wages. What might explain the difference, if any, between federal and Medicare wages?
  • What is the total amount of Social Security tax paid by the taxpayer and spouse? Hint: See also Schedule SE.
  • Alimony is deducted on Form 1040, Schedule 1, line 31a.
  • What might that tell you about the taxpayer's divorce or separation?
  • Explain how the Sec. 199A qualified business income deduction was computed. What income drove the deduction, and what limiting factors may have been considered in the deduction?
  • Based on the tax return, can the taxpayer or spouse contribute to a self-employed retirement plan and/or an IRA? If so, how much may be contributed to each?

Schedule A illustrative questions

  • Did the taxpayers claim the standard deduction or itemize deductions? Explain how you arrive at this conclusion.
  • Compare the standard deduction with the itemized deductions.
  • By how much did the taxpayers benefit by claiming the standard deduction over itemized deductions, or itemized deductions over the standard deduction?
  • What were the taxpayers' total medical expenses? Of this total, how much was deducted? Explain.
  • What were the taxpayers' total state taxes paid during the year?
  • How much was the taxpayers' state tax deduction?
  • Why is the box on Schedule A, line 8, checked? See the instructions for an explanation
  • Line 8a reflects mortgage interest of $x and points of $y. What explains why/how the taxpayer is deducting points?
  • If the taxpayer deducted investment interest expense, under what circumstances is Form 4952 required?
  • Explain the type of charitable contributions the taxpayers made during the year. Is there any advice you should suggest to the taxpayers to ensure their charitable contribution deductions are allowable?
  • Explain why the taxpayer was allowed or denied a casualty or

Schedule B illustrative questions

  • How many different sources of interest and/or dividend income did the taxpayers have?
  • How much tax-exempt interest did the taxpayers earn?
  • How much of the taxpayers' total dividends were "qualified" dividends?
  • Did the taxpayers have a financial interest in, or signature authority over, a foreign bank or financial account? If so, what are their filing obligations in this regard, if any?

Schedule C illustrative questions

  • Which spouse operated the Schedule C business?
  • What accounting method was used for the Schedule C business?
  • Did the business have a requirement to issue Forms 1099?
  • What is the gross income reported on Schedule C?
  • List five of the expenses claimed on Schedule C.
  • What method did the taxpayer use for claiming automobile expenses?
  • Did the Schedule C business report a profit or loss? How much was the profit or loss?
  • Was a home office deduction claimed? If so, what method was used?
  • Provide two other forms (provide form and line number) on the tax return where the Schedule C net income/loss is reflected.

Schedule D/Form 8949 illustrative questions

  • Did the taxpayers have a short-term and/or a long-term capital loss carryover into the current year? If so, how much of each?
  • Did the taxpayers have a net short-term gain or loss? Did the taxpayers have a net long-term gain or loss?
  • What asset was sold that resulted in the gain (loss) amount?
  • Do the taxpayers have a short-term and/or long-term capital loss carryover to next year?
  • If so, how much of each? On Form 8949, which security became worthless during the year?
  • On Form 8949, for which security with a loss was the loss partially disallowed by the wash-sale rules?
  • How do you know?

Schedule E illustrative questions

  • What type of property is rented?
  • What is the gross rental income reported on Schedule E?
  • What is the net rental income reported on Schedule E?
  • Is the rental activity conducted with active participation or is it passive?
  • Was the XYZ Partnership a passive or nonpassive activity?

Forms 8959 and 8960

For cases involving higher-income tax returns, as well as for more advanced courses, a series of questions may be included that address the 0.9% additional Medicare tax and the 3.8% net investment income tax.

 

Contributors

Dan M. Vitale, CPA/PFS, MST, is an assistant professor of accounting at North Central College in Naperville, Ill. Annette Nellen, Esq., CPA, CGMA, is a professor in the Department of Accounting and Finance at San José State University in San José, Calif., and is the chair of the AICPA Tax Executive Committee. For more information on this article, contact thetaxadviser@aicpa.org.

 

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