John Smith tax issues:
a. How is the $300,000 treated for purposes of Federal tax income?
The $300,000 that John received for services rendered from the court case is considered earned income for the year. The $300,000 is earned income for John Smith and will be reported as gross income either on Schedule C of the individual return or as gross income on the LLC return. “US code defines gross income in 26 U.S.C § 61 states except as otherwise provided in this subtitle, 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.” (http://www.gpo.gov/fdsys/pkg/USCODE-2006-title26/pdf/USCODE-2006-title26-subtitleA-chap1-subchapB-partI-sec61.pdf) There isn’t any other way to treat the $300,000 because it is considered gross income and has to be taxed as such
b. How is the $25,000 treated for purposes of Federal tax income?
John received, in addition to the $300,000, $25,000 for expenses he incurred during the trial. I would assume that the incurred expenses were deducted and when he was paid the $25,000 it would be considered a reimbursement and it would not be considered income. John paid these expenses out of his pocket and was merely reimbursed for what he spent on the case.
c. What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
John would like to reduce his taxable income. One way to do so is to take advantage of itemized deductions. Itemized deductions include expenses for health care, state and local taxes, personal property taxes (such as car registration fees), mortgage interest, gifts to charity, job-related expenses, tax preparation fees, and investment-related expenses. (http://taxes.about.com/od/taxplanning/a/taxplanning.html) Another way to reduce his taxable income is to form an LLC. According to IRS “an LLC is...