Week 4 You Decide Essay Example
1-A:
How is the $300,000 treated for purposes of Federal tax income?
The tax issue here is that John Smith wants to know how the $300,000 he earned through his client fee is taxed. The $300,000 is taxed as ordinary income and is taxed in the year received. John Smith worked on the case for two years but he did not earn the $300,000 until this year so he will include it in this year’s taxable income. Therefore John Smith needs to include the entire $300,000 as ordinary income on his Federal tax return. Gross Income means all income from whatever source derived which includes compensation for services, including fees, commissions, fringe benefits, and similar items. (IRC Sec. 61(a),(1))
1-B:
b. How is the $25,000 treated for purposes of Federal tax income?
The tax issue at play here is how to handle the additional $25,000 received by John Smith from expenses he paid up front. If John previously expensed the $25,000 then the recovery of the $25,000 will be considered as income in the current year. If he didn’t then he may use the $25,000 to offset the deferred expenses and it will have no impact on his taxable income. “Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter.“ (IRC Sec. 111 (a))
1-C:
c. What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
John wants to know what would be the best way to go about reducing his taxable income for the current year. The best way for John to reduce his taxable income in this scenario would be to set up annuity payments. Taxpayers are allowed to recover their contributions free of tax to a non-qualified annuity. This would allow John to reduce his taxable income by the amount of the annuity payments. (IRC Sec. 72(b)) This would be preferable to having the entire $300,000 settlement
How is the $300,000 treated for purposes of Federal tax income?
The tax issue here is that John Smith wants to know how the $300,000 he earned through his client fee is taxed. The $300,000 is taxed as ordinary income and is taxed in the year received. John Smith worked on the case for two years but he did not earn the $300,000 until this year so he will include it in this year’s taxable income. Therefore John Smith needs to include the entire $300,000 as ordinary income on his Federal tax return. Gross Income means all income from whatever source derived which includes compensation for services, including fees, commissions, fringe benefits, and similar items. (IRC Sec. 61(a),(1))
1-B:
b. How is the $25,000 treated for purposes of Federal tax income?
The tax issue at play here is how to handle the additional $25,000 received by John Smith from expenses he paid up front. If John previously expensed the $25,000 then the recovery of the $25,000 will be considered as income in the current year. If he didn’t then he may use the $25,000 to offset the deferred expenses and it will have no impact on his taxable income. “Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter.“ (IRC Sec. 111 (a))
1-C:
c. What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
John wants to know what would be the best way to go about reducing his taxable income for the current year. The best way for John to reduce his taxable income in this scenario would be to set up annuity payments. Taxpayers are allowed to recover their contributions free of tax to a non-qualified annuity. This would allow John to reduce his taxable income by the amount of the annuity payments. (IRC Sec. 72(b)) This would be preferable to having the entire $300,000 settlement