John & Jane Smith
Memo summarizing various tax issues
1. John Smith's tax issues:
Issue a) How is the $300,000 treated for purposes of federal tax income?
Applicable Law & Analysis: http://www.irs.gov/businesses/small/selfemployed/index.html
Conclusion: The $300,000 will be treated as self- employed income. Generally you are self-employed if you carry on a trade or business as a sole proprietor, independent contractor, or if you are a member of a partnership. Self-employed individuals are required to file an annual return, and pay estimated tax quarterly.
Issue b) How is the $25,000 treated for purposes of federal tax income?
Applicable Law & Analysis: www.irs.gov
Conclusion: The $25,000 will be treated as self- employed income as well. John was awarded the 25,000 that paid up front expenses, so the number will cancel each other out.
Issue c) What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
Applicable Law & Analysis: http://www.efile.com/tax-credit/federal-tax-credits/. Publication 526- Charitable contributions. Section 170-charitable contributions and gifts ( c). Section 48- energy credit
Conclusion: Establish a self- employed retirement plan, make IRA contributions, make charitable donations including asset donations according to organizations described in section 501 (c)(3), make energy efficient improvement to the home according to IRC code 48.
Issue d) Do I get better tax benefits for paying the lease on office space or for buying the building? What are the differences?
Applicable Law & Analysis: IRC Code 167- there should be allowable reasonable depreciation for wear and tear on property used in the trade or business. (http://www.law.cornell.edu). http://www.microsoft.com/business. IRC Code 179-allows tax payers to deduct the cost on certain types of property.
Conclusion: There are better tax benefits for buying the building. Owners of rental property can write of repairs immediately. Deprecation on commercial buildings is taken over 39 years; you can also deduct interest on the purchase loan, property tax, and other qualifying expenses. (www.microsoft.com/business). The total amount you can deduct under section 179 cannot be more than $500,000. (www.irs.gov). When leasing a building, the monthly lease payment is tax deductible, but the tax payer cannot deduct interest, property tax, or depreciate.
2. Jane Smith tax issues:
Issue a) What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for federal income tax purposes?
Applicable Law & Analysis: www.law.cornell.edu
Conclusion: Satisfying the mortgage will cancel tax deductions for that mortgage loan. Without the mortgage interest, a customer could be placed in a higher tax bracket. This will cause the tax payer to possible owe more money. Assuming a new mortgage have benefits rather than consequences.
Issue b) Can John and Jane Smith utilize a 1031 tax exchange to buy a more expensive house using additional money from John's case?
Applicable Law & Analysis:
IRC code 1031. The IRC code 1031 allows deferral of taxes on the exchange of two assets. IRC code 1031 also allows one to sell an asset with the intension to use proceeds to invest in a like asset. (http://financial-dictionary.thefreedictionary.com/Internal+Revenue+Code+section+1031)
Conclusion: John and Jane cannot utilize a 1031 tax exchange. Owners of investments and business property may qualify for a section 1031 deferral. Both properties in the exchange must be held for use in a trade or business or for investment. Property used primarily for personal use does not qualify for like-kind exchange treatment.
Issue c) Does Jane have a business or hobby? Why is this distinction important?
Applicable Law & Analysis: IRC code 183. The IRC code 183 is also called the...
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