To: John and Jane Smith
From: Your Name, CPA
Date: February 2, 2013
Subject: Explanation of business and personal tax benefits and liabilities. 1(a). As a result of a recent court settlement for a client John earned $300,000 for his law practice LLC. He wants to minimize his tax liability and understand how the IRS will treat this money earned. He lease’s office space for $3,500 per month. He wants to know the advantages in leasing office space versus purchasing the building. John has income derived from a business and as such the gross income will be taxable (Code §1.61-3(a)) (Tax Almanac, 2005). This $300,000 taxable income will pass through to his personal taxes and is subject to self employment tax since he has an LLC. He will get a deduction from gross income for half of the self employment tax liability on the self employment tax. John currently has a lease payment that provides him a deduction of $42,000 per year or $3,500*12 (26 USC § 162 (a) 3) (Law Cornell, 2012). He is allowed this deduction since the lease is required for his business to continue, and he has no title or equity in the building. If he decides to purchase the building, then he will no longer have this deduction. Capital purchases are not allowed for any expenditure for new buildings or to improve property (Code §263 a 1) (Tax Almanac, 2007, May 22). John and Jane could establish traditional IRA’s and make contributions up to $5,000 each. Even though Jane has a minimal income, John is allowed to establish and contribute to an IRA on behalf of his spouse (Code §219(c)) (Tax Almanac, 2007, April 27). A Roth IRA has phase out limits but with planning this could be another option further down the road. John has would not qualify for the full tax benefits of a Roth IRA this year without hitting phase out limits. Since John and Jane do not have an employer retirement plan they will be able to deduct the full amount on a traditional IRA (§219(f) (3)) (Tax Almanac, 2007, April 27). In summary John will have to pay self employment tax on the $300,000 gross income that he earned in his business. (Code §1.61-3(a) (Tax Almanac, 2005). He will be able to reduce this gross income by the $42,000 lease payment that I recommend he keep (Code §162(a)) (Law Cornell, 2012).To reduce his liability even further, I recommend that he establish an IRA for himself and his wife and contribute $10,000 each year(Code §219(c)) (Tax Almanac, 2007, April 27). It gives them the chance to establish retirement plans the future and not pay tax on the $10,000 presently. John will also get a deduction of half of his self employment tax from gross income also. 1(b) John received $25,000 in addition to the $300,000 to reimburse him for expenses paid in advance for this client. John wants to know how the IRS will treat these funds and want kind of tax implications will this have on him. The IRS will view this as funds as any other incidental income (Code §1.61-3(a) (Tax Almanac, 2005, May 11). The $25,000 revenue will have an offsetting deduction by the receipts John has for expenses incurred. Since this is an expense that is ordinary and necessary in his line of work, he will be able to deduct the full amount of receipts and offset the full $25,000 (Deputy v DuPont, 40-1 USTC 9161, 23 AFTR 808,308 U.S. 488 (USSC, 1940)) (Justia.com - U.S. Supreme Court Center, 2013). In summary John will have this total amount included in his gross income. (Code §1.61-3(a)) (Tax Almanac, 2005, May 11). However, John has offsetting deductable receipts for this amount for expenses incurred in advance for his client. (Code § 212) 1(c) In review, John will have self-employment tax to pay on a portion of the $300,000 on his personal taxes since he has an LLC. The $25,000 will also be added to this gross income amount. However, he is able to deduct the business deductions incurred for the $25,000 that he received these funds. Keeping the lease for his office space gives a better tax deduction...
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