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Warren_Tax_2007S_Exam_A.doc

Warren_Tax_2007S_Exam_A.doc

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Published by hls13bro
warren bankruptcy outline
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Published by: hls13bro on Dec 05, 2012
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Page 1 of 12
TaxAlvin WarrenSpring 2007 – (In-Class)Grade: A
1.Pamela’s education expenses at Ames School for the Arts are not deductible tothe extent that this is a new profession she is entering and her education likely meets theminimum requirements for entry. If she has any loans coming out of Ames, she candeduct educational loan interest under 221 subject to phase-out.Pamela’s efforts fall under §212 as profit-seeking activity. As such, her travelexpenses to identify a group of young actors and musicians would be deductible asordinary and necessary for the production and collection of income. (One might argue onthe other hand that she is just carrying out a childhood dream of writing plays irrespectiveof any profit motive, but given the substantial outlays she has made, it seems like profit-seeking activity). Under the tests for 162(a)(2) – an analogous section to 212 – Pamela isaway from home (her “place of business”) and in the pursuit of a trade or business.Insofar as these were expenses designed to benefit Pamela past just this year, she willhave to capitalize these expenditures under §263 and cannot deduct them all immediately.Likewise, any payments she made to the actors would be deductible under 162(a)(1) that provides that reasonable salaries may be deducted. These are merely unknownactors, so it’s unlikely they’d be subject to any compensation limit under 162(m). Thesalary costs would be immediately deductible as per the post-
 INDOPCO
treasury Reg.1.263(a)-4(e)(4)(j) which treats employee compensation as an immediate expense nomatter its effect beyond the taxable year.
 
Page 2 of 12
If Pamela paid interest on the initial financing from Apple, it is likewisedeductible as an ordinary and necessary business expense under 212.Whatever Pamela earned in 2006 from her Miniworks contract would be taxableto her as ordinary income. This is income from property that she created herself. Pamelamight try to classify her gains from the contract as capital gains. However, she mighthave two problems. First, there’s no indication she held the copyrights to the minioperasfor more than a year. This is a requirement under 1222(3). Second, her copyrights are personal efforts created by the taxpayer and so not entitled to capital gains treatmentunder 1221(a)(3). Whatever she receives as payment from Miniworks is bestcharacterized as ordinary income. It looks like she’s just getting paid for her services.This is more like
 PG Lake – 
the form of payment shouldn’t control. It doesn’t matter thatshe’s getting downloading fees each year, it’s really payment for her own creation.
 
Acourt might take a purposive look at capital gains treatment and say that the goal was torelieve the tax burden on gains resulting from a conversion of capital investments.Taxing her at ordinary would not remove deterrent effect of realization; she NEEDS thismoney – it’s her livelihood. (Further discussion below with regard to sale and donationof these income rights)As for Pamela’s divorce, we need to determine first whether the transfer to her former husband is to be considered alimony or rather a transfer of property betweenspouses incident to divorce. Pamela will want to classify it as alimony because thatwould allow her to deduct the payment under §215. Her spouse would have to include itunder §71. The couple may wish, however, to engage in private ordering and contract
 
Page 3 of 12
around this within §71(b)(1)(B) in order to have the lower-bracket spouse pay the tax andthen they can adjust the amounts.If the couple is not able to classify this as alimony – we’ll classify this as atransfer of property under §1041. No gain or loss will be recognized on the transfer of  property provided the agreement was within one year of marriage; there is no realizationevent and no tax on either party. The husband will carryover Pamela’s basis subject to§1041(b). If he later sold, he would be subject to her low basis.Pamela’s income from being an artist-in-residence at Ames is plainly taxableunder §61 as gross income.Pamela’s sale of her 30% stake to a major financial institution for the $3,000,000lump sum is taxable to her, but we should determine whether it’s best classified as acapital gain or ordinary income. Given that it’s such a large sum, she’ll want to classifyit as capital gains to take advantage of the lower rate under 1(h). We’ll want to examineunder the 3-part
 Laterra
test used by the 3
rd
Circuit. In that case, the taxpayer won thelottery and sold rights to receive the income. Here, Pamela is selling rights to receiveincome she’s entitled to under a contract. As a “Family Resemblance,” the contractseems to be a compensation for her works. It’s just a recurring receipt, which wetypically characterize as ordinary income. Further, under 1221(a)(3), income from personal services is not deemed to be capital gains income. This includes a copyrightheld by the taxpayer whose personal efforts created it. As a result, the payments she isdue
relating to her own work 
should be ordinary income. However, she might be able totreat the 5% owed her for the downloading fees
of others
as capital gain – this is not her  benefiting from her own work. Second, this seems like a vertical carve-out; she’s giving

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