Analysis of Tax Issues - Income Tax Law - Solved Exam, Exams of Law

Download Analysis of Tax Issues - Income Tax Law - Solved Exam and more Exams Law in PDF only on Docsity! ID: ID: Exam Name: Instructor: Grade: FedIncTax_LSN_Stanley_Final_2011SL (Exam Number) FedincTax_LSN_Stanley_Final_2011SL Stanley Stanley a Sure Page 1 of 1 ID: ~ FedIncTax_LSN_Stanley_Final_2011SL Stanley 1) Tax consequences for Eric Sleezo MINDLESS ENTERTAINMENT (ME) For tax purposes it is important to evaluate whether or not ME falls under 162 (business deductions), 212 (activity for profit) or TSHeby). The distinction is important because under 162 and 212 all expenses can be deducted to the point of a net operating loss, while under section 183 the taxpayer can only deduct up to the amount of income. In order to meet a 162 trade or business requirement, Groetzinger sets out a three fold test: 1) Is it the taxpayer's full time activity, 2) Is the taxpayer involved on a continual and regular basis and 3) is the activity intended as a source of the taxpayer's income. For Mr. Sleezo the facts seem to slant in his favor. Due to his appearance on a teality TV show, Mr. Sleezo has earned more than $5 million and ever since has made it a "goal to try and build a brand." The reality star has never been afraid of exposure, and has created many products in the hopes of continuing the his fame and fortune as a result of his recent popularity. Sleezo has become so famous that a catch phrase has caught on in reference to him as a person. He has deals with Iphone apps, ab focused work out videos and a contract to pen an autobiography. All of these signs point more towards a serious attempt to create a brand, and not merely have ME operate as a hobby. ME has also reported significant’ profits for the last two years on his individual tax return and Sleezo owns the rights to all of the Ocean Beach merchandising. The Page 1 of 12 (Question 1 continued) ID: : FedIncTax_LSN_Stanley_Final_2011SL Stanley Regarding wkecres will result from Sleezo and ME being forced to destroy merchandise valued at $130k, Sleezo should be able to deduct these expenses pursuant to section 165 (loss sustained during the taxable year and not compensated for by insurances) as they have incurred “in a trade or usines: , (c)(1), Sleezo may, (je lu would be WA ony 1M sold, but this is speculative and not likely to pass muster. IF, and in my opinion this is a argue that he should be able to deduct the cost for whai (es big IF, the IRS was capable of proving that Sleezo was not in a trade or business, Sleezo could try and argue that because it was sudden.these losses are ‘Sosy losses" under 165(c)(3). However, this argument would fall because it did not arise out of a fire, storm, shipwreck or other casualty, or from theft. This means unless they would fall under “other casualty” this argument would not work for Sleezo. . RETURN OF ADVANCE While the advance from Outrageous Books initially constituted payment that Sleezo would need to report under section 61, because he is required to pay back the amount, —_— the $150k advance will likely be viewed by the IRS similar to that of a mortgage or another type of loan. Because the proceeds have to be paid back they do not constitute income and Sleezo will not lik xed on the advance that he will have to pay back for breach of contract. Sleezo is best to return the advance for the facts already tell us that he has racked up a lot of attorney fees. If he was to go to court in an attempt to show that he did not breach the contract, if he were to win the right to keep the $150k Page 4 of 12 (Question 1 cantinued) ID: FedIncTax_LSN_Stanley_Final_2011SL Stanley this award would be taxed Koay eco it would not be the result of personal, phyiscal injury (you ask “in lieu of what were the damages awarded?"). INCOME FOR APPEARANCES AND AS AN INDEPENDENT CONTRACTOR Sleezo will be taxed on the $500k and the 150k based as income. Section 61. He received an accession to wealth that was clearly realized over which he has complete dominion. If the money had been paid to ME, Sleezo still would have been taxed as Sleezo owns ME as a sole proprietor. PETO Peto's salary (minimum of $250k) will fail under the category of 162 expenses and can be deductible in the current year as a result of Peto managing Sleezo in his efforts to get his name and ME out in the market. The IRS Gould potentially attack this salary as “unreasonable” as salaries are only deductible under 162 if they are reasonable. The attack is on the corporation (or in this case Sleezo). However, based on the independent investor or the multi factor test mentioned in Exacto Springs Corporation v. Commissioner, Sleezo should be able to show that the salary was reasonable as before the lawsuit with BigCorp Sleezo has been able to increase his income and find extra ventures to take his "brand" into. Sleezo should be able to point out that without Peto he would not have been able to accomplish this and because he stood to make more than $5 million dollars in 2010 a minimum payment of $250k to your manager is Page 5 of 12 (Question 1 continued) ID: FedIncTax_LSN_Stanley_Final_2011SL Stanley reasonable under the circumstances. THINGS SLEEZO CAN SELL 1) corporate stock purchased 8 months ago would net Sleezo AG, if he were to sell them (Basis is 35 and they are now worth 50). This gain woul tegorized as "short term capital gain" and would need to be matched against the net “long term capital gain" to see what it would be taxed at. Because it is stock this should he taxed at 15% if Sleezo were to end up with a gain in this category of capital gains. Crermch Ghorwd We diay 2) The motorcycle could be sold and if it was sold fpr $30, Steezo would realize no gain or loss as nasi she Weare the FMV at the time it was exchanged for services (Philadelphia Park Amusement Co v. United States). However, the catch will be that Sleezo will be taxed on his original receipt of the motorcycle. Gross income is broad and is the result of “whatever sourced dérived" including property received in exchange for services. Income is a three prong conjunctive test: 1) accession to wealth, 2) clearly realized, 3) over which taxpayers have complete dominion. Here the $30k value will be taxed to Sleezo as income. Sleeze would not be wise to try and argue that the motorcycle was a fringe benefit that is so small or infrequent that it is not worth accounting for. This is unlikely to pass the reed tJaced test. Sleezo best argument could be that he wants to keep the bike and (hes cere wn a his bad boy, reality star image. He could argue that under 162 the bike is ordinary and necessary and therefore is a proper capital expenditure and therefore is allowed to take depreciation. If placed in Page 6 of 12 {Question 1 continued) ID: FedIncTax_LSN_Stanley_Final_2011SL Stanley fees could be deductible under 162 but this is a real long shot and is unlikely to pass the straight face test. For the $150k that Sleezo paid his person: ey for managing his employment and merchandising contracts, similar to INDOPCO these expenses will fall under professional fees that have to be added to the basis of what was acquired and therefore should be capitalized. If the attorney's settle with Sleezo for the $75k that he has already paid because they are tired of wasting resources attempting to collect payment, then this would constitute a discharge of indebtedness and Sleezo would be taxed on the $75k as income received. For the $40k paid for tax advice, anytime a professional is paid to help you determine your tax liability that is deductible (even for something like turbo tax), thus, the $40k paid will be deductible and not likely to be disputed by the IRS. MEDICAL EXPENSES AND OTHER CARE Extraordinary medical expenses are deductible under 213 to the extent they exceed 7.5% of taxpayer's AGI. However, this section applies only to medically necessary expenses (those that include diagnosis, care, treatment by and MD that is not experimental and intended to restore a taxpayer to their natural condition. Plastic surgery is not deductible under 213 unless it is to ameliorate a deformity to make a persona "whole." Here, a judge obviously recommended (slash required) Sleezo to stay in an inpatient drug rehabilitation treatment center for a total cost of $15k, but a doctor Page 9 of 12 (Question 1 continued) ID: FedIncTax_LSN_Stanley_Final_2011SL Stanley did not. It doesn’t help that Sleezo did not personally believe that he needed help, but appears to have only done so as a result of the judges orders. The code, however, does say "affecting structure/function of the body" so Sleezo may be able to deduct his costs for lodging and meals (only 50% of meals). | would need more information from Sleezo to see exactly how all this calculated out as | am only told $15k which included SY 0 meals. | can however safely say that he will not be able to deduct all of this even if IRS , ge accepts these are extraordinary medical expenses because you are only allowed 50% 4 of meals. Sleezo may also try and argue that this wag’a 162 ¢xpense regarding his "brand" and that it was ordinary and necessary for his business. Sadly, a cynical person might joke that it is ordinary for a reality star to spend some time in a drug clinic, but the IRS is likely to take a stem stance that it is neither and ordinary or necessary expense. It might be helpful, but they are unlikely to label it a 162 expense. Yes, Sleezo believes that it reparied his personal reputation, but what be more helpful to me as your advisor would be if | could see evidence of this change in your reputation. This means that if after your stint in rehab you were able to land more TV contracts or endorsement deals it would hold more weight that these expenses were both ordinary and necessary. One problem Sleezo also might have is depending how much income he actually brought in. If he really did bring in 5 million, even if he paid off the 3 million in damages that would still leave him with 2 million for the year (lets for argument sake not look at all the other factors). If this was the case, Sleezo would have to have medical expenses 97 over 7.5% of AGI (7.5% of 2 million is $150,000). Se tee DAsduTion : The second part of his treatment that must be evaluated is the month in which he was Page 10 of 12 (Question 1 continued) ID: FedIncTax_LSN_Stanley_Final_2011SL Stanley in outpatient care. The rules are different for outpatient care. Section 213(d)(2) allows expenses for lodging (but not meals) while away from home to seek medical treatment. The amount is capped at $50 per night and only if 1) it is “primarily for and essential to" medical treatment, 2) not lavish and extravagant, 3) medical care is provided by a physician in a licensed hospital and 4) there is no significant element of pleasure, recreation or vacation in the travel away from home. The wording of the code means that Sleezo is going to have trouble deducting these expenses. First he golfed almost every day which shows elements of pleasure. Second he ran up a bill of $15k which is way above the max of $1,500 ($50 for 30 nightsy. And last, there are no facts showing that this is essential. Once again, Sleezo could make an argument that these are 162 expenses as they are ordinary and necessary to repair his brand. Because he is a big star that is recognizable, Sleezo does have a legitimate argument that he needs to stay in a place that is isolated and with lots of security. Unfortunately for Sleezo, the IRS is probably not well versed in the business of reality TV stars and is unlikely to see these expenses as being ordinary and necessary. MISCELLANEOUS More information such as when the payments are due to know ex: million loss (lawsuit) will be treated. Likely it can be treated as a business Id amount and how much for each year will need to be discussed under more detaiis. Page 11 of 12