Week 4 You Decide Activity 1 TL

Topics: Taxation, Taxation in the United States, Income tax in the United States Pages: 7 (2389 words) Published: April 24, 2015
To:John & Jane Smith
From:Terrace Long
Re:Summary of various tax issues
(1) John Smith's Tax Issues:

(a) How is the $300,000 treated for purposes of federal tax income?

Applicable Law & Analysis:

The issue is to determine how the $300,000 fee that John received is to be treated for Federal income purposes. Code Sec. 61(a)(1) of the Internal Revenue Code ("IRC") states that the general definition of gross income is "all income from whatever source derived, including (but not limited to) the following items: compensation for services, including fees, commissions, fringe benefits, and similar items." IRC section 451(a) states "the amount of any item of gross income shall be included for the taxable year in which received by the taxpayer, unless under the method of accounting use in computing taxable income, such amount is to be properly accounted for as of a different period.


Since the $300,000 received a fee in the form of compensation, it is gross income as defined under Code Sec. 61(a)(1) and John must include the $300,000 fee with his gross income for the current year while preparing his income taxes per Code Sec. 451(a). Since John did not know the amount of the settlement prior to receiving the fee, he would not have been able to use the accrual method of accounting in the prior year.

(b) How is the $25,000 treated for purposes of federal tax income?

Applicable Law & Analysis:

The issue is to determine how the reimbursement of expenses, in the amount of $25,000 should be treated for Federal income purposes. According to Code Sec. 162 (a), all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business shall be deducted including the following: compensation for personal services actually rendered, any travel expenses, and rental or other payments for the trade or business.


The $25,000 would be considered as gross income from Code Sec. 61 (a) (1) as defined above as compensation for services, however, it may also be considered as a deduction for adjusted gross income as a trade or business expense per Code Sec. 162 (a). Although the expenses were not specified, they would most likely meet the criteria listed above for Code Sec. 162 (a). Since Code Sec. 162 (a) requires that expenses occur during the taxable year and the expenses in question spanned a two year period, they must be allocated appropriately. Meaning, expenses paid in the previous year should have been deducted in the previous year, and the remainder in the current year. Therefore, the $25,000 income would be offset by the amount of the $25,000 trade or business expense deduction spent in the current year.

(c) What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?

Applicable Law & Analysis:

Increasing the amount of tax deductible expenses taken, including the $25,000, will result in a reduction of taxable income reported to the IRS. To reduce your tax liability, in regards to the $300,000 in fee income, you may opt to receive it in the form of an annuity. Annuities, must be paid for a period of over a year, are offered as fixed or variable.


Taxation is based on the type of annuity (immediate or deferred) and how you chose to take the money in the annuity. However, all taxes will be paid according to your ordinary income tax rate. Income paid through immediate and annuitized deferred annuities are tax free.

(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:

Here are some other monetary benefits of leasing:

Your credit rating will not be quite as critical for leasing as it would be for buying. So again, for startups, this might be a sticking point. Your monthly lease payment is tax deductible because it's a business expense....

Cited: Smith, E., Harmelink, P., & Hasselback, J. (2014). CCH Federal Taxation: Comprehensive Topics 2015. [VitalSource Bookshelf version].
Retrieved from http://devry.vitalsource.com/books/9780808037972/epubcfi/6/44
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