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FEDERAL INCOME TAXATION

L6256X

Final Examination - - December 1995

Professor Chirelstein

Time Allowed - - Three Hours

This examination consists of five pages. Check now to
see that your exam has all five pages.

ANSWERS MUST BE WRITTEN IN INK OR TYPEWRITTEN.

IF YOU ARE A CANDIDATE FOR GRADUATION IN FEBRUARY, 1996, WRITE ON THE COVER
OF YOUR FIRST ANSWER BOOK (OR, IF TYPEWRITTEN, AT THE TOP OF YOUR FIRST PAGE),
"CANDIDATE FOR GRADUATION IN FEBRUARY, 1996."

INSTRUCTIONS:

This is a limited open-book examination. You may bring with you to the examination your Code
and Regulations volume, but nothing else.

Answer each of the following questions - - there are four - - in sufficient detail to convey your
reasoning as well as your conclusions, but please use no more space than is really necessary. And do,
please, write legibly.
_________________________________

Question I

Walgreen Co., a drugstore chain, has for some years operated a pharmacy in the Northpark Mall

outside Milwaukee. Under the terms of Walgreen's lease (which still has six years to run), the Mall owner,

Sara Creek Property, Inc., promised not to lease space in the Mall to any other store that operates a

pharmacy. In 1994, concerned that its main tenant (K-Mart) was about to close up and move, Sara Creek

informed Walgreen that it planned to replace that tenant with a large store operated by Phar-Mor Corp., a

deep-discount chain, that would in fact contain a pharmacy. Walgreen promptly brought suit against Sara

Creek in State court seeking specific performance of the lease restriction mentioned above. The suit was

successful: the State court entered a permanent injunction prohibiting Sara Creek from renting space to

Phar-Mor until the Walgreen lease expired.

The cost of the training program and the nutritionist's services totalled $1. Sara Creek is unable to pay so large a sum but Phar-Mor. and Phar-Mor .000 in exchange for Walgreen's agreement to dissolve the injunction. Advise each of them. pending the outcome of which he has been permitted to remain at his usual job. has stated that it is prepared to accept Walgreen's offer and pay the $250. His legal fees (so far) amount to $1.000. He lost in the trial court but has taken an appeal.. to-wit: Jones joined a physical training program and hired a personal nutritionist to help him lose weight. FEDERAL INCOME TAXATION . Question II Early this year the New York City Fire Department promulgated a new set of physical fitness regulations which apply to all firemen who are engaged in daily fire-fighting activity. Walgreen offered to terminate the lease restriction (in effect. any fireman who is more than 25 pounds overweight on December 15 (based on Tables published by a well-known health insurance company) will be subject to demotion in grade or even dismissal.Page 2 of 5 Immediately after the court's decision.now ask you to analyze the federal income tax consequences of the proposed deal. He succeeded in getting his weight down to the required level by the deadline date and. Smith and Brown were all well over their respective weight limits at the time the new regulations were issued. hence. Each responded to the regulations in a different way.Walgreen. All three parties .. Under the new regulations. which anticipates good business at the Mall despite the continued presence of the Walgreen pharmacy. .500. Smith brought a legal action against the Fire Department seeking to enjoin enforcement of the new fitness regulations on the ground that those regulations were arbitrary and capricious. Jones.500.. release Sara Creek from the injunction) for a cash consideration of $250. Sara Creek. has been able to keep his regular job on the fire truck.

Despite the simplification benefit. Senator Richard Lugar of Indiana has proposed that we scrap the present federal income tax and substitute for it a national sales tax. and actually obtain.no more individual income tax returns. e. Smith and Brown all want to know whether they can deduct their $1.g.the Lugar proposal as "nothing more or less than a tax on wages". The Pace College course cost him $1. Why is a sales tax. one learned commentator. .. no more audits by revenue agents.500. having heard the interview. Certainly one advantage of the Lugar proposal (others are claimed) is simplification -. has characterized -. A friend of yours. What is your advice to each? Question III In his campaign for the Republican presidential nomination this year. Jones. The course enabled him to pass an exam for. Your friend is in a hurry to keep an appointment. Do it. The fitness regulations apply only to active-duty fire-fighters but not to administrators and other office personnel. she wonders.500 outlays.Page 3 of 5 Brown reacted by signing up for a six-month course in "accounting and management" at Pace College. an administrative post within the Fire Department. and so on.and by implication denounced -. equivalent to "a tax on wages"? Accordingly.. interviewed on the evening news. medical care). so she hopes you can enlighten her in not more than 3 or 4 booklet pages. admits to being puzzled by the quoted statement. Such a sales tax (like our State and City sales taxes) would apply to the purchase at retail of all goods and services (maybe with various limited exemptions. The salary Brown now receives as an administrator (clerk) is slightly less than the salary he got as a regular fireman. she now asks you to try to explain that statement to her and to say whether you think the statement is accurate. FEDERAL INCOME TAXATION .

To make matters worse. Howard's cost for the Westchester residence. Howard's income has declined sharply during the past few years and he now finds himself unable to meet the monthly mortgage payments when due. and Howard.000.000 out of his own resources and borrowed the balance. one that would . at least. assumed personal liability for the mortgage . Howard insists (a) that the mortgage-loan be converted into a nonrecourse obligation. $1..which. The vacation home was the securing property. If this is done. FEDERAL INCOME TAXATION .000) currently stands at about $1. however.000.000.000. Fortunately (in a sense). which he bought a long time ago.Howard owns that property free and clear. the Hampton vacation home has plummeted in value and is now appraised at only $400. Howard also owns a regular family residence in Westchester with an appraised value of $800.050. on a 10-year mortgage from the Long Island Savings Bank (the Bank).000. As a result.150. he is several months behind at present.000. an investment banker. has an appraised value twice that of the vacation home .loan. indeed. The unpaid principal balance of the mortgage-loan (Howard did pay off $50.000. Howard has proposed to the Bank that the Westchester residence . among other things).. enjoyed some very high income years back in the mid-1980's and in 1985 bought a vacation home in the Hamptons for $1. the Bank has announced that it intends to foreclose. like almost all residence purchasers. There is no debt on the Westchester residence -.000 mortgage debt. of course. In order to avoid the Hampton foreclosure (a terrible embarrassment..000.be substituted for the Hampton property as security for the $1. Howard paid $100. is $300.Page 4 of 5 Question IV Howard.

Howard consults you. Worried.. Having recently described the above proposal to one of his golfing friends. FEDERAL INCOME TAXATION . The Bank. and (b) that the mortgage-loan itself be changed from a 10-year to a 30-year loan so that the monthly payments will be less burdensome. Howard was surprised to hear the friend mutter something about possible income tax consequences to Howard himself if the proposal should be accepted by the Bank. is apparently interested in Howard's proposition and may well accept it. eager to avoid the cost of a foreclosure proceeding. Advise him. End of Examination .Page 5 of 5 involve no personal liability for him in the event of a future default.