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Unformatted text preview: FACTS: John Smith, Esq., a practicing attorney received $300,000 cash for winning a large jury verdict. He also received $25,000 recovery of expenses paid up front. He would like to use that money to buy a building where he leases his office for $3,500 a month. His wife prefers to use that money to pay off the mortgage on the house, and buy a new and bigger one Jane Smith, John’s wife, sells handcrafted jewelry and earned $20,000 last year. She wants John to invest $15,000 for a new jewelry making equipment to replace the 5 year old original equipment with basis of $10,000. ISSUES: 1. John Smith tax issues: a. How is the $300,000 treated for purposes of Federal tax income? b. How is the $25,000 treated for purposes of Federal tax income? c. What is your determination regarding reducing the taxable amount of income for both (a) and (b) above? 2. Jane Smith tax issues: a. What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for Federal income tax purposes? b. Can John and Jane Smith utilize a 1031 tax exchange to buy a more expensive house using additional money from John's case? c. Does Jane have a business or hobby? Why is this distinction important? d. Would Jane (and John) realize better tax benefits if she had a separate business for her jewelry making activities? e. What tax benefits would John realize if he invested $15,000 in Jane's jewelry making? f. Can Jane depreciate her vehicle or jewelry making equipment? How? 3. John and Jane Smith tax issue: a. Should John and Jane file separate tax returns or jointly? DISCUSSION: 1(a) How is the $300,000 treated for purposes of Federal tax income? According to Section 61(a) which states that “gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, fringe benefits, and similar items;” 1 the $300,000 fee should be included in gross income. The compensation is taxed when is received not when is earned, (John’s fee was earned during 2 year long case), unless a taxpayer uses accrual method to report his/hers income. 2 1 1 US Code; Sec. 61 (a); http://www.law.cornell.edu/uscode/26/usc_sec_26_00000061----000-.html 2 2 E.P. Smith; P.J. Harmelink; J.R. Hasselback; 2011 CCH Federal Taxation. Comprehensive Topics.; 2010 CCH; p. 4-8 1 1(b) How is the $25,000 treated for purposes of Federal tax income? $25,000 was received as a reimbursement for costs incurred and it should be recorded as a business expenses if it has been spent for business related activity. Publication 535 states that “business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit.” 3 1(c) What is a determination regarding reducing the taxable amount of income for both (a) and (b)...
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- Spring '11
- John Smith, Taxation in the United States, Code section, Jane Smith, jewelry making equipment