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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.”]
3. XYZ Insurance Co. 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, among other things, that the returns were prepared by a certified public accountant).
XYZ would like to advertise (truthfully) that any and all recoveries under the policy will be
exempt from federal income tax. Can it do so?

4. Some years ago Rupert bought a large tract of undeveloped land for $100,000, drawing the
entire purchase price from his own resources. Later Rupert mortgaged the land for $75,000, the
mortgage being non-recourse. Rupert has made mortgage principal payments of $15,000. This
year Rupert sold the land to another investor subject to the unpaid mortgage principal, now
$60,000, and received cash from the buyer in the amount of $65,000. How much gain or loss, if
any, will Rupert recognize on the sale?

5. The so-called marriage penalty is very much in the news these days. 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. The result, he points out, 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. “My object,” N declares (usually to wild applause), “is to make sure that the tax law
is strictly neutral in its effect on a person’s decision to get married.” Would N’s proposal meet
his declared objective?

6. Miriam bought a bond some time ago for $100,000 which the issuing company had a right to
call (that is, redeem) at any time prior to maturity for a premium of $10,000. Interest rates
having fallen this year, the bond issuer in fact exercised its call privilege and has paid Miriam
$110,000 in exchange for the bond. At the same time Miriam leased certain real property she
owns to a commercial tenant. Rents having fallen, the tenant offered to pay Miriam $10,000 if
she would agree to cancel the lease. Miriam did agree and has received $10,000 from the tenant,
which promptly vacated the leased premises. Miriam’s accountant now tells her that the $10,000
bond premium will be a long-term capital gain, but the $10,000 received on the lease
cancellation will be ordinary income. Miriam asks you to explain why the two $10,000
payments are treated differently. Do.
7. Gerald until recently was employed by General Motors as a sales manager. 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, assuming Gerald wished to move elsewhere. And that is just what
GM decided. Gerald bought his house for $100,000 but the best offer Gerald (who was eager to
relocate) could get for it on the market was $90,000. Accordingly, and pursuant to its contract
obligation, GM bought the house from Gerald for $100,000. Prices then fell still further and,
having listed the house with a real estate broker for more than a year, GM finally managed to sell
the house for only $75,000. How should Gerald and GM report these events for tax purposes?

8. Baxter is a second-year law student at NYU Law School. A San Francisco law firm offers to
fly Baxter out to San Francisco for the purpose of a job interview. Baxter makes the trip and the
interview takes place, but the firm decides not to offer Baxter a job. The firm does, however,
reimburse Baxter’s transportation costs – air fare and taxis – in the amount of $1,200. Must
Baxter include the reimbursement in his gross income? Explain (briefly).