Personal Financial Planning

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c a s e

8 Clara Morrish

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114 Personal Financial Planning: Cases & Applications Textbook 11th Edition 2020

Today is January 1, 2020. Clara Morrish has come to you, a financial planner, for help in developing a plan to accomplish her financial goals. From your initial meeting with Clara, you have gathered the following information.

Personal Background and Information

Clara Morrish (Age 68)

Clara is a retired homemaker. She is a recent widow. Clara was born on April 15, 1951.

Tim Morrish (deceased)

Clara was married to Tim Morrish, who died November 1, 2019, at the age of 69, after a brief battle with cancer. His date of birth was June 1, 1950.

Tim’s estate is in probate. Tim was employed 45 years as a supervisor at ABC Co., Inc. (ABC) before retiring at age 65.

The Morrishes

They were married for 50 years. Clara’s health is fair.

The Morrishes’ Children

Clara has two children from her marriage to Tim: George (age 50) and Vince (age 49). George and Vince are each married, healthy, employed, and self-sufficient.

The Morrishes’ Grandchildren

George and his wife, Kathy, have one daughter, Sarah (age 18). Sarah is currently a senior in high school and will be a freshman at a university in September. The cost of tuition for the university is currently $20,000. Clara would like to pay Sarah’s tuition for this year. As a graduation gift, Clara is paying for Sarah’s trip to Europe this summer. The cost of this trip is $3,000.

Vince and his wife, Laena, have one son, Kirby (age 17). Kirby is a junior in high school. Kirby is in need of orthodontic work that will cost $6,000. Clara would like to pay for Kirby’s orthodontic work. Clara is also considering gifting stock worth $9,000 to Kirby.

Personal and Financial Objectives 1. Clara wants to have sufficient income at retirement ($30,000 per year in today’s

dollars including Social Security benefits).

2. Clara will consider acquiring a smaller residence.

3. Clara wants to explore long-term care alternatives (average annual cost in today’s dollars $40,000).

4. Clara wants to donate to the American Cancer Society.

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115Case 8 | Clara Morrish

5. Clara wants to provide for her children and grandchildren.

6. Clara wants to pay Sarah’s university tuition ($20,000).

7. Clara wants to gift stock to Kirby ($9,000).

8. Clara wants to pay for Kirby’s orthodontic work ($6,000).

9. Clara wants to send Sarah to Europe ($3,000).

Economic Information ■ Inflation is expected to be 4% annually.

■ She lives in a state with no state income tax.

■ Stocks are expected to grow at 9.5%.

■ Bank lending rates are as follows: 3.5% for a 15-year mortgage, 4% for a 30-year mortgage, and 10% for a secured personal loan.

Life Expectancies from Table III, Uniform Lifetime

Age Life Expectancy Factor

72 27.3

73 26.4

74 25.5

Insurance Information

Life Insurance Irrevocable Life Insurance Trust (ILIT)

Tim created an ILIT 10 years ago. The only assets in the trust are $200,000 in pro- ceeds from the life insurance policy the ILIT owned at Tim’s death. The income benefi- ciary of the ILIT is Clara. The remainder beneficiaries are the grandchildren. Clara cur- rently receives an annual income of $10,000 based on a return of 5% on the trust assets.

Health Insurance

Tim and Clara were both covered under Medicare Part A and B until the time of his death. Clara is still covered under Medicare Part A and B.

Investment Information Clara’s investment risk tolerance is low.

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Income Tax Information The Morrishes filed as married filing jointly for 2018. Clara and Tim have always

lived in a community property state. Clara has been making and selling jewelry for six years with some success. Since

Tim’s death last year, she has devoted more time to her craft and enjoys it tremendously. Her grandson, Kirby, created a website for her last year and Clara is amazed at the sales results. While she had been traveling to jewelry shows for most of her sales, the online sales this year have eliminated the need to travel. Because Clara will be itemizing her deductions this year, she believes she can report her income and expenses on Schedule C. Her gross sales from the jewelry business this year are $19,500. Her expenses in 2019 were:

Cost of goods sold $12,900

Supplies $ 500

Web-related costs $ 600

Web advertising $ 200

Postage/delivery costs $ 1,200

She has kept detailed records from the beginning and can track her profit and loss from each year. In Year 1 she had a loss of $2,000; Year 2 was a loss of $1,000; Year 3 showed a profit of $3,000; Year 4 had another loss of only $500; Year 5 showed a profit of $6,000.

Retirement Information Tim had a profit-sharing plan sponsored by ABC with Clara designated as the ben-

eficiary. The plan has a value of $150,000 as of January 1, 2020. The plan permits the beneficiary to take a lump-sum distribution.

Clara currently has an IRA with Tim as the named beneficiary. Clara is the named beneficiary on Tim’s IRA. They had both decided to defer IRA withdrawals until they are mandatory after age 72. Clara has no plans to change this since Tim’s death. She will move Tim’s IRA into an IRA in her name early in 2020. Both Tim and Clara began receiving Social Security benefits on their 66th birthdays. Tim’s benefit for 2020 would have been $1,200 per month, and Clara’s benefit for 2020 was estimated to be $600 per month.

Gifts, Estates, Trusts, and Will Information Tim’s will left all probate assets to Clara. The grandchildren are named as contin-

gent beneficiaries (equally). Clara does not have a will.

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STATEMENT OF FINANCIAL POSITION Tim (deceased) and Clara Morrish

As of January 1, 2020

Assets1 Liabilities and Net Worth Cash and equivalents Liabilities2

CP Cash $ 25,000 Credit cards3 $ 20,000 CP Savings account 20,000

Total cash and equivalents $ 45,000

Invested assets S1 Stocks6 $ 20,000 Total liabilities $ 20,000 CP IRA - Clara's 40,000 CP IRA - Tim's 50,000 CP Profit-sharing plan7 150,000 Net worth $ 980,000

Total invested assets $ 260,000

Personal use assets CP Primary Residence4 $ 400,000 S2 Vacation Home5 200,000 CP Auto 18,000 CP Furniture and personal property 77,000

Total personal use assets $ 695,000

Total assets $1,000,000 Total liabilities and net worth $1,000,000

Notes to financial statements 1Assets are stated at fair market value. 2Liabilities are stated at principal only as of January 1, 2020, before January payments. All liabilities are community property. 3Interest rate 18.3%. 4The primary residence was originally purchased for $110,000. There have been no additions or upgrades. The FMV was $400,000 on Tim's date of death. 5The vacation home was inherited by Clara from her mother. Adjusted tax basis is $125,000. 6Inherited from a sibling. 7Present value of Tim's profit-sharing plan.

Other notes to financial statements The income beneficiary of the ILIT is Clara. Remainder beneficiaries are the grandchildren. The ILIT is not listed on the Statement of Financial Position.

Title designations: S1 - Tim S2 - Clara CP - Community property

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Information Regarding Assets and Liabilities

Primary Residence

■ Purchased April 1, 1984

■ Market value $400,000 as of November 1, 2019, and January 1, 2020

■ Original purchase price $110,000

Vacation Home

■ This home is owned by Clara (fee simple).

■ Clara inherited the home from her mother who paid $75,000 for it. The fair market value at the date of transfer to Clara was $125,000 in July 2003.

■ The current fair market value is $200,000.

■ The vacation home is located in a noncommunity property state. All payments for repairs and maintenance have been made by using community property assets.

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1. What is Clara’s federal income tax filing status for 2019, 2020, 2021, and 2022?

2. On November 1, 2020, Clara decides to sell her personal residence for the fair market value as of January 1, 2020. What will be her tax consequences? Disregard the vacation home.

3. Clara will attain age 72 in 2023. If she elects to take a distribution from Tim's profit- sharing plan in 2023, to what extent will she be required to include it in her gross income?

4. How should Clara report the income and expenses from her jewelry business for 2019?

5. Ten years ago, Tim and Clara gave their grandchildren stock in a U.S. domestic corpora- tion that is publicly traded. Because of an important advance in technology in the last year, the company is growing rapidly and in 2020 it pays $3,000 in qualified dividends to each child. What are the kiddie tax implications of the dividends on the income of the grandchildren in 2020? To their parents (assume a marginal tax rate of 22%)? To Clara?

6. Rather than let the vacation home sit unused during Tim’s last illness, Tim and Clara rented it to vacationers for 180 days in 2019. However, Clara used her vacation home for the last 40 days of the year after Tim’s death in 2019. The only expenses for the home were utilities, taxes, and maintenance. How much of these expenses may she deduct? Where does she report the income and expenses on her tax return in 2019?

7. How much of Tim’s IRA must Clara include in taxable income in 2019?

8. How much of Clara’s Social Security is taxable in 2020?

9. What is Clara’s gross income in 2020?

10. Assume that in 2021, Clara decides to sell the stock she inherited from Tim that now has a fair market value of $24,000. She directs the broker to make the check payable to her sons, George and Vince, because she does not need the extra income from the sale. What are the tax consequences to Clara, George, and Vince as a result of this stock sale in the year of the sale?

11. A thief entered Clara’s home on New Year's Day in 2020 while she was away from home and stole an antique gun that had been one of Tim’s treasures that he had pur- chased for $3,500. Unfortunately, while Clara had the gun appraised after Tim’s death, she did not specifically insure it and only recovered $200 for the gun that had been val- ued at $4,500. Assuming her AGI is the same in 2020 as in 2019, how much may Clara claim as a casualty loss on her tax return for 2020?

12. Assume that Clara’s best friend, Marlene, who is 67 and legally blind, is in poor health and has only a meager Social Security income of $3,250 annually. Clara invited her to live with her beginning January 1, 2020, and is providing more than 50% of her total support. Assuming her AGI is the same in 2020 as in 2019, how will this affect Clara’s tax return in 2020?

Q U e s T I O N s

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13. Sarah, Clara’s granddaughter, has a qualified tuition plan (QTP) currently valued at $195,000. Contributions from various family members were $145,000 over the years. Sarah has the following expenses for her first year at the university:

Tuition $20,000

Room and board $ 4,000

University fees $ 900

Books for classes $ 600

Laptop required by the university $ 2,500

Auto to use on campus $11,000

Total 1st year expense $39,000

If Sarah pays for all of her expenses using a distribution from her qualified tuition plan, what effect does it have on her gross income?

14. On April 2, 2020, Clara received a refund of $4,800 from the hospital where Tim died. She had paid the hospital $5,600 late in the prior year for the medical bill and planned to add the expense to the rest of the unreimbursed medical expenses from Tim’s death. Her son, Vince, told her to allow the estate to reimburse her when she paid the bill, but Clara chose to forego reimbursement. Faced with the check from the hospital, Clara fears she may have made a mistake in how she handled the expense. She consults her financial planner about the $4,800 refund. The 2019 income tax return has not been filed. How should the financial planner advise Clara?

15. George and Kathy vacationed in Guatemala in 2018 and after a visit to a local orphan- age, decided to adopt a three-year-old little boy. George and Kathy felt their annual AGI of $260,000 could adequately provide for another child and that their time and cost would be greatly rewarded. Sarah is excited about her new little brother and looks forward to his arrival in the US. In February 2019, Marcus came to live with the family and his adoption became final in August 2020. The couple incurred qualified adoption costs in 2019 of $9,000 and an additional $7,500 in 2020. How much of an adoption credit can the couple use on their income tax return in 2020? Assume they file MFJ.

16. Clara is considering selling the vacation home she inherited from her mother. Her mother paid $75,000 for the home 20 years before she died and Clara inherited it. If Clara sells it today for its full fair market value of $200,000, how much would her taxable gain be on the sale of the house?

17. Assume a forest fire destroyed Clara’s mountain vacation retreat in May 2020. Clara’s basis in the property is $125,000. The insurance company paid Clara $226,000 in July 2020 to rebuild. Clara decided not to rebuild in such a remote area and bought a vaca- tion home near a lake in November 2022 for $220,000. How should Clara treat the gain, if any, on this involuntary conversion?

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