How much taxable should each of the following taxpayers report?
a. Kimo builds custom surfboards.
During the current year, his total revenues are $90,000,
and he incurs $30,000 in expenses.
Included in the $30,000 is a $10,000 payment to
Kimo’s five-year-old son for his services as an assistant.
Kimo must recognize $90,000 of income from building the surfboards.
fee paid to his son for working as his assistant is not reasonable under the
circumstances - his five-year old son is not capable of providing services worth
The substance of the payment is a gift of $10,000 to his son.
the $10,000 is not a deductible expense. Kimo’s’ deductible business expenses
total $20,000 ($30,000 - $10,000) and he must report $70,000 ($90,000
taxable income from the custom surfboard business on his personal tax return.
b. Manu gives hula lessons at a local bar.
During the current year, she received $9,000 in
salary and $8,000 in tips.
In addition, she engages in illegal behavior, for which she
Manu has $27,000 ($9,000 +
$10,000) of taxable income.
She is taxed on
her salary, tips, and the money she receives from her illegal behavior.
and tips are earned income from her employer.
The payment for the illegal
behavior is also earned income - income from illegal activities is taxable.
In each of the following cases determine who is taxed on the income:
a. For $200, Lee purchases an old car that is badly in need of repair.
He works on the car
for 3 months and spends $300 on parts to restore it.
Lee's son Jason needs $2,000 to
pay his college tuition.
Lee gives the car to Jason, who sells it for $2,000 and uses the
money to pay his tuition.
Jason is taxed on the gain from the sale of the car.
By making a valid gift to Jason
(which is not taxed), Jason becomes the owner of the auto.
The assignment of
income doctrine does not tax Lee in this case because he has given away the
If Lee had sold the car and given Jason the cash, then Lee would
have been taxed on the gain from the sale of the car.
b. Erica loaned a friend $20,000.
The terms of the loan require the payment of $2,000 in
interest each year to Erica's daughter.
At the end of 4 years, the $20,000 loan principal is
to be repaid to Erica.
Erica's daughter will use the $2,000 to pay her college tuition.
The $2,000 of interest paid to Erica's daughter is taxed to Erica under the
assignment of income doctrine.
Because Erica retains ownership of the property
generating the income (the principal is to be repaid to her), she is taxed on any
income generated by the property even though she does not actually receive it.