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Zolt_Tax_2008S_Exam_Aminus.doc

Zolt_Tax_2008S_Exam_Aminus.doc

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bankruptcy law outline
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Student ID #: 90676032
TAXATION B2, PROFESSOR ZOLT, MAY 1, 2008STUDENT ID #: 90676032Part IIQuestion 1: Auction of the Portraits by Harvard Law School
There are several ways to treat the auction of the portraits. These alternatives are discussed below.
 Donation as a Charitable Gift to the public Interest Auction
:Harvard might argue that this is a charitable donation to the Public Interest Auction, which might be a separate entity eligible to receive deductible donations under § 170. In this instance,Harvard would likely to attempt to deduct the FMV. However, typically when goods aredonated and then auctioned, the deduction is limited to the amount realized from sale of thegoods (in order to avoid valuation scams).
 Auction as a Sale:
Perhaps the most obvious approach would be to treat the auction as a sale of the goods. This treats the auction as if it were an arm’s-length transaction. If the transactionwere characterized this way, the chief questions are (1) what is the amount of loss or gain, and(2) should this amount be treated as capital gains or losses.
Gain or Loss
: The gain or loss is the difference between the price amount received $5000 per  painting and Harvard’s basis in the property. If Harvard purchased the property, the basis is theamount paid. If the property was donated, Harvard takes the basis of the donee. Harvard couldargue that the paintings were ‘inventory’ and that by having an appraisal done, they effectively priced their inventory at current value as permitted by § 472 (for FIFO taxpayers). However, if Harvard had wanted to do this, they should have realized gains on inventory at the time of appraisal. If this had been done, then Harvard could have attempted to take a loss of thedifference between the FMV and the sale price.1
 
Student ID #: 90676032
Ordinary Income / Capital Gains
:
 
If Harvard either purchased the property itself, or received the property from someone who purchased it, then the proceeds likely should be treated as capitalgains. However, if the property were received by gift from the creator (or indirectly by a seriesof gifts) then the sale could be treated as ordinary income. § 1221(3)(C). However, given therarity and value of the paintings, it is likely that they will be treated as a ‘collectible’ and taxed atthe special 28% rate.However, it is unlikely that this transaction will be treated as a sale of the property. The Auction provided the opportunity for the Professors to buy the property below market. The auction waslimited only to Harvard Professors. Given this, alternative treatment would be better.
 Advertising / Production of Goodwill 
: Harvard might argue that the Auction was a form of advertising and so currently deductible. They would argue that given the importance of the eventto the community, they—like Skadden, Sullivan and Kirkland—want to be represented well. If this argument were accepted, the full value of the property would be deducted. The IRS mightargue against a deduction because this grant of property produces goodwill going forward between the school and the teachers. However, this is unlikely to prevail—it is true of alladvertising. Nevertheless, it is unlikely that this would be treated as advertising. Advertising belongs in the category of ‘ordinary and necessary’ expenses (§162)—and this is simply toostrange of a method of advertising to be respected as such by the IRS.
 Auction as Compensation for Professors
: The professors have clearly benefited from theUniversity’s largesse. One way to treat this closed auction would be as a benefit to the faculty— compensation for services. The grant of the exclusive right to bid at the auction can be viewedas the grant of an option to purchase paintings from the school. This option was ‘exercised’when the professors purchased the paintings for $5000. The amount included in income for the2
 
Student ID #: 90676032 professors would be the difference between the fair market value of the paintings and the amount paid. This would also be the amount deductible by the school. It would be treated ascompensation for employees under § 162. Under § 83(h), this would be deductible at the time theProfessor’s realized income. This would be when the property was actually received at theauction.
Question II: Treatment for the Teachers
 
 Purchase
: The teachers might argue that this is simply the purchase of a good from the school asan arm’s length transaction. If we treated the teachers as ‘dealers’ in art, this expense would be‘capitalized’ in their inventory. The cost would represent their ‘cost of goods’ and theisubsequent profit would be the difference between this ‘cost of goods’ and the sale price.
Gift Treatment 
: One might argue that this is a gift, with no taxes imposed (or that the difference between the FMV and the $5000 represented a gift). This would likely fail for two reasons:First, § 102(c) bars gift treatment for transfers from an employer to an employee. Second, it isunlikely that this gift was made out of ‘detached, disinterested generosity,”
 Duberstein
, becauseof the school’s obvious interest in making its employees happy. Accordingly, gift treatment isinappropriate.
 § 132 Fringe Benefits
: The taxpayers might argue that this is should be excluded from income asa de minimis fringe benefit. Possible candidates are §132(a)(2) and § 132(a)(4). However, it islikely that neither applies. The property is not offered for sale to customers, so the ‘qualifiedemployee discount’ does not apply. And the amount of benefit is simply too great to qualifyunder § 132(a)(4) as a ‘de minimis’ benefit.3

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