Memorandum

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November 18, 2012

TAX FILE MEMORANDUM

SUBJECT: Peaceful Pastures Funeral Home, Inc. (Peaceful)IRS Audit Notice Today I met with Peaceful to discuss the IRS audit notice they received regarding the reporting of income from Peaceful’s prepaid program.  FACTS: Peaceful does not report payments received from a preneed contract as income until the year in which the funeral service is provided. Peaceful’s preneed contract allows for a refund of payments at the contract purchaser’s request any time until the goods and services are provided.

ISSUE: Should Peaceful include payments received from the prepaid program as income for the year in which they are received?

CONCLUSION: Based upon the refund clause in the contract and the rulings in Comm. v. Indianapolis Power & Light Co. and Perry Funeral Home, Inc. v. Commissioner, Peaceful should not have to report payments for its preneed program as gross income in the year in which they are received. Instead Peaceful should be allowed to report the income in the year in which the goods and services are delivered.

ANALYSIS: In Perry Funeral Home, Inc. v. Commissioner (Perry), the court held “…payments received by P under its preneed funeral contracts are includable in gross income only upon the provision of the subject goods and services”. The court heavily relied upon the decision of the Supreme Court in Comm.v. Indianapolis Power & Light Co. (65 AFTR 2d 90-934 Justice Blackmum delivered the opinion in which he stated, “… it does not have the requisite “complete dominion” over them deposits at the time they are made, the crucial point for determining taxable income” and “… the principal purpose of these deposits was to serve as security rather than prepayment of income”. Under the terms of Peaceful’s contract, “the payments are refundable at the contract purchaser’s request any time until the goods and services are provided to them”. Additionally, Blackmum states, “The key is whether the taxpayer has some guaranteed that he will be allowed to keep the money.”By allowing the purchaser to determine when the refund is payable, Peaceful has no guarantee they will be able to keep the money.

November 18, 2012

TAX FILE MEMORANDUM

FROM: Bobbette Barrett

SUBJECT: MegaCorp, Inc.IRS Audit Notice.
Today I met with MegaCorp to discuss the IRS audit notice they received regarding the reporting of $5million in damages paid to Ideas, Inc.

FACTS: MegaCorp purchased all of the assets of Little, Inc. MegaCorp also acquired some of Little’s liabilities which included an alleged patent violation by Ideas Inc. MegaCorp agreed it would be legally responsible for any judgment that Little would have to pay Ideas. A jury awarded Ideas $5 million in damages. MegaCorp reported the payment as a deduction under §162.

ISSUE: Upon audit, the IRS reclassified the payment as a capital expenditure under §263 and disallowed the deduction. Is MegaCorp entitled to the deduction?

CONCLUSION: MegaCorp is not entitled to the deduction and should add the judgment payment to the basis of acquiring Little, Inc.

ANALYSIS: Section 162(a) of the TRC allows for the deduction of “all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”. Section 263 of the Code allows no deduction for a capital expenditure, an “amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate”. In Illinois Tool Works Inc. et al v. Commissioner, the court opinion stated, “Generally, the payment of a liability of a preceding owner of property by the person acquiring such property, whether or not such liability was fixed or contingent at the [pg. 45] time such property was acquired, is not an ordinary and necessary business expense… Instead, payment of such a liability is capitalized and added to the basis of the acquired property.” In 93 AFTR 2d 2004-548 (355 F.3d 997), the court...
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