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Federal Income Taxation


Professor Chirelstein

Time allowed: 3 hours.

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

The examination consists of eight equally weighted short-answer/short-essay questions. Answer
each question with an appropriate explanation. BUT, do not write more than one or two brief
(and legible) paragraphs on any question. Maybe not even that much....maybe just a sentence,
maybe just a number. If you finish early, good!


1. Last year Ursula won $1,000 playing the horses but lost $600 shooting craps in an Atlantic
City casino. Also last year, Ursula sold her diamond ring for $600 more than it cost her but sold
her fur coat for $1,000 less than it cost her. As a consequence of all this, Ursula’s accountant
tells Ursula that $1,000 must be added to her gross income for the year. Is the accountant right?
Explain (briefly).

2. Suppose Father buys stock for $1,000, retains a right to receive the dividends for 10 years,
and gives the remainder to Daughter. Assume the present value of Father’s retained dividend
right is $600. § 167(e)(1)* was added to the Code in 1989 at the Treasury’s insistence to deal
with a significant tax “problem” arising out of the arrangement just illustrated (and certain
similar arrangements). What “problem” might the Treasury have been concerned about?

*[In case you have forgotten to bring your Code volume, §167(e)(1) reads as follows:
“(e) Certain term interests not depreciable –
(1) In general. – No depreciation deduction shall be allowed under this section
(and no depreciation or amortization deduction shall be allowed under any other
provision of this subtitle) to the taxpayer for any term interest in property for any
period during which the remainder interest in such property is held (directly or
indirectly) by a related person.”]

“My object.000. drawing the entire purchase price from his own resources.000. if any.” Would N’s proposal meet his declared objective? 6. This year Rupert sold the land to another investor subject to the unpaid mortgage principal. Rupert has made mortgage principal payments of $15.000 from the tenant. Do.000. the mortgage being non-recourse. XYZ Insurance Co.000 payments are treated differently. Rents having fallen. “is to make sure that the tax law is strictly neutral in its effect on a person’s decision to get married. XYZ would like to advertise (truthfully) that any and all recoveries under the policy will be exempt from federal income tax.000 which the issuing company had a right to call (that is. the tenant offered to pay Miriam $10. Later Rupert mortgaged the land for $75. among other things. that the returns were prepared by a certified public accountant). the bond issuer in fact exercised its call privilege and has paid Miriam $110.000 if she would agree to cancel the lease. Congressman N asserts that the way to solve the problem is simply to compute the tax on half of a married couple’s income and then double the amount so computed. he points out. Can it do so? 4.000 bond premium will be a long-term capital gain. How much gain or loss. The result. now $60. Interest rates having fallen this year. redeem) at any time prior to maturity for a premium of $10.000. The so-called marriage penalty is very much in the news these days. Some years ago Rupert bought a large tract of undeveloped land for $100. At the same time Miriam leased certain real property she owns to a commercial tenant. but the $10.3.” N declares (usually to wild applause).000 received on the lease cancellation will be ordinary income. will Rupert recognize on the sale? 5. Miriam did agree and has received $10. Miriam asks you to explain why the two $10. . Miriam bought a bond some time ago for $100.000 in exchange for the bond. Miriam’s accountant now tells her that the $10. which promptly vacated the leased premises.000.000. wants to offer a new type of insurance policy under which an individual will be insured for x% of any federal or New York State income tax deficiency found to be due following an audit of the individual’s tax returns by either the IRS or the State tax authorities (provided. and received cash from the buyer in the amount of $65. will then be equal to the sum of the two taxes that each of the spouses would pay if single and the “penalty” will disappear.

Must Baxter include the reimbursement in his gross income? Explain (briefly).200. GM bought the house from Gerald for $100. however. ********** . Gerald until recently was employed by General Motors as a sales manager. Gerald bought his house for $100. Baxter makes the trip and the interview takes place. GM finally managed to sell the house for only $75. The firm does. Gerald’s 5-year employment contract obligated GM to purchase Gerald’s personal residence for an amount not less than Gerald’s cost for such residence in the event that GM should decide to let Gerald go at the end of the 5-year term. and pursuant to its contract obligation. And that is just what GM decided.000. having listed the house with a real estate broker for more than a year. assuming Gerald wished to move elsewhere. Prices then fell still further and. but the firm decides not to offer Baxter a job. How should Gerald and GM report these events for tax purposes? 8. Baxter is a second-year law student at NYU Law School.000 but the best offer Gerald (who was eager to relocate) could get for it on the market was $90. A San Francisco law firm offers to fly Baxter out to San Francisco for the purpose of a job interview.000.7. reimburse Baxter’s transportation costs – air fare and taxis – in the amount of $1. Accordingly.000.