Research Problems
Research Problem 1. Gray Chemical Company
manufactured pesticides that were toxic. Over the course of several years, the
toxic waste contaminated the air and water around the company’s plant. Several
employees suffered toxic poisoning, and the Environmental Protection Agency
cited the company for violations. In court, the judge found Gray guilty and
imposed fines of $15 million. The company voluntarily set up a charitable fund
for the purpose of bettering the environment and funded it with $8 million. The
company incurred legal expenses in setting up the foundation and defending
itself in court. The court reduced the fine from $15 million to $7 million.
Gray Chemical Company deducted the $8
million paid to the foundation and the legal expenses incurred. The IRS
disallowed both deductions on the grounds that the payment was, in fact, a fine
and in violation of public policy.
Gray’s president, Ted Jones, has contacted
you regarding the deductibility of the $7 million fine, the $8 million payment
to the foundation, and the legal fees. Write a letter to Mr. Jones that
contains your advice, and prepare a memo for the tax files.
Gray’s address is 200 Lincoln Center,
Omaha, NE 68182.
Research Problem 2. Rex and Agnes Harrell
purchased a beach house at Duck, North
Carolina, in early 2015. Although they
intended to use the beach house occasionally for recreational purposes, to help
pay the mortgage payments, property taxes, and maintenance costs, they also
planned to rent it through the realty agency that had handled the purchase. Rex
is a surgeon, and Agnes is a counselor.
The beach house was in need of substantial
repairs. Rather than hiring a contractor,
Rex and Agnes decided they would make the
repairs themselves. During both high school and college, Rex had worked summers
in construction. In addition, he had taken an advanced course in woodworking and
related subjects from a local community college several years ago.
During 2015, according to a log maintained
by the Harrells, they occupied the beach house 38 days and rented it 49 days.
The log also indicated that on 24 of the 38 days they occupied the beach house,
one or both of them were engaged in work on the beach house. Their two teenage
children were with them on all of these days but did not help with the work
being done. On their 2015 income tax return, Rex and Agnes, who filed a joint
return, treated the beach house as a rental property and deducted a pro rata
share of the property taxes, mortgage interest, utilities, maintenance and
repairs, and depreciation in determining their net loss from the beach home. In
the current year, after examining their return, an IRS agent has limited the
deductions to the rent income. He contends that the
14-day personal use provision was exceeded
and that many of the alleged repairs were capital expenditures. Advise the
Harrells on how they should respond to the IRS.
Research Problem 3. Mona viewed herself as
a creative individual who had chosen to go to law school for economic reasons.
Mona’s undergraduate majors were creative writing and American Indian studies.
Mona was very successful as an attorney and
eventually was admitted to partnership in her law firm, having an expertise in
negotiating settlements involving Indian water rights.
While practicing law, Mona continued her
interest in the arts. She had directed plays in high school and maintained her
involvement in the theater, even during law school. She belonged to local
theater organizations while she practiced law. She took several courses in
filmmaking and read extensively in the area. She even took several months off
from her legal practice to enroll in NYU’s filmmaking program. Her enrollment
in the program provided her with hands-on experience and taught her about the
technical aspects of filmmaking and allowed her to meet individuals who would
later work with her on her documentary.
When she discovered that her husband had
similar interests, she decided to create a documentary about Way to Sing
America. After acquiring the rights to all of the archival footage of Way to
Sing America, she hired a video production company to film interviews that she
conducted with Way to Sing America alumni (over 400 hours of such interviews).
She spent weekends and nights over a three-year period working on the
documentary.
Once the documentary was completed, Mona
began marketing it at film festivals.
At some of these festivals, her documentary
received awards. At the same time, she developed a business plan, hired a
bookkeeper to manage the finances, and hired an accounting firm to provide tax
advice.
During this three-year period, she reported
the following losses:
2013 $ 30,000
2014 400,000
2015 200,000
On her tax returns for the three-year
period, in each year, she offset these amounts against her law firm income of
approximately $1 million.
Upon audit by the IRS, the agent concluded
that her filmmaking activity is a hobby and therefore the losses cannot be
deducted except to the extent of the income generated.
Who is correct? Explain.
Research Problem 4. Sarah was contemplating
making a contribution to her traditional
IRA in 2015. She determined that she would
contribute $5,000 in December
2015, but forgot about making the
contribution until she was preparing her 2015 tax return in February 2016. Use
the website of any well-known IRA provider (e.g., Fidelity,
Vanguard, T. Rowe Price) to determine if
Sarah can make a 2015 contribution to her IRA after the tax year has ended.
Research Problem 5. The $1 million maximum
compensation deduction does not seem to have deterred large corporations from
remunerating their executives at very high levels. What techniques are being used
to work around the millionaires’ provision?
Are executives taking pay cuts, or are
their salaries being deferred or changed in nature due to § 162(m)?
Roger CPA Review Questions
1. Newton, a business owner, signed a
ten-year lease beginning in July of 2016 and immediately paid rent for the
remainder of 2016, all of 2017, and all of 2018. How much of the rent paid at
the lease signing can be declared as a business expense on
Schedule C of Newton’s 2016 tax return?
a. All of it
b. The July 2016–June 2017 portion only
c. None of it
d. The 2016 portion only
2. Freddy, a sole proprietor, is one of
several retail business owners competing to rent space in a desirable location
that rents at a rate of $2,000 per month. Freddy pays the landlord 12 months’
rent up front, even though only two months’ advance rent is required. The lease
term begins October 1, 2016. In addition, Freddy gives the landlord a $2,500
cash gift in order to sweeten the deal. Considering only these facts, what
amount is deductible on Schedule C of Freddy’s 2016 tax return?
a. $4,000
b. $6,000
c. $6,500
d. $8,500
3. Rebecca owns and runs an auto repair
shop that is assessed an environmental fine of $2,500 by the state government
for failing to properly dispose of used engine oil.
Rebecca incurs $1,500 in legal fees to
fight this assessment, but does not prevail.
She also contributes $2,000 to the
political campaign of a gubernatorial candidate who is a lawyer by profession
and who specifically promises to simplify the
Use the tax resources of the Internet to
address the following questions. Do not restrict your search to the Web, but
include a review of newsgroups and general reference materials, practitioner
sites and resources, primary sources of the tax law, chat rooms and discussion
groups, and other opportunities.
Internet
Activity environmental ordinance under
which Rebecca’s fine was assessed. Considering the above facts, what total
amount is deductible on Rebecca’s business tax return?
a. $0
b. $1,500
c. $3,500
d. $6,000
4. Aman, a sole proprietor and rental
property owner, had the following expenses in
2016:
Payment to tax lawyer for advice related to
business tax liability $1,000
Property taxes paid on rental home 2,000
Management fee for Aman’s retirement
portfolio 500
Specify whether each expense would be
deducted for adjusted gross income (AGI) or from AGI on Aman’s 2016 tax return.
Tax Lawyer Property Taxes Management Fee
a. For From From
b. For For From
c. From For For
d. From From For
5. A sale between which of the following
could trigger a gain or a loss for federal tax purposes?
a. Husband and wife
b. Cousin and cousin
c. Majority shareholder and corporation
d. Ancestor and descendent