Professional Documents
Culture Documents
Discussion Questions
I:6-1 Deductions for AGI reduce the taxpayer's gross income by the full amount of the deduction even
if the standard deduction is used. Deductions from AGI are not beneficial unless their sum exceeds
the standard deduction, in which case these deductions will be included as itemized deductions. Also,
many deductions from AGI are decreased by a percentage of AGI (e.g., 10% for medical expenses,
10% for casualty losses, and 2% for miscellaneous itemized deductions). pp. I:6-3 and I:6-4.
I:6-2 Expenses incurred in producing rental income are deductions for AGI. p. I:6-3.
I:6-3 A deduction for a loss incurred on the sale of a capital asset held for investment is a
deduction for AGI. p. I:6-3
The $4,000 mortgage interest on his personal home and the $2,000 for medicine and doctors that
Joe paid during the year are deductions from AGI. pp. I:6-3 and I: 6-4.
I:6-5 a. If the expenses are deductions for AGI, Mario's taxable income for 2017 is:
Income $55,000
Deductions for AGI ( 9,000)
AGI $46,000
Standard deduction ( 6,350)
Personal exemption ( 4,050)
Taxable income $35,600
b. If the expenses are deductions from AGI, Mario's taxable income is:
Income $55,000
Deductions for AGI ( 0)
AGI $55,000
Deductions from AGI ( 7,900)a
Personal exemption (4,050)
Taxable income $43,050
3. The time and effort expended by the taxpayer in carrying on the activity,
I:6-7 No, it is not automatically deemed a hobby. The other factors mentioned in the
Regulations can be relied upon to determine that the activity is, in fact, a business. The burden
to prove it is not a hobby is generally on the taxpayer. However, meeting the 3 out of 5 year test
shifts the burden of proof to the IRS. pp I:6-29 and I:6-30.
I:6-9 An ordinary expense is an expense that bears a reasonable and proximate relationship to
the income-producing activity or property. It must be customary or usual to the particular
activity. Also, ordinary expenses are currently deductible as opposed to expenditures that must
be capitalized.
Pursuant to the new tangible property regulations, capital expenditures are amounts paid for:
1. New buildings
p. I:6-10.
I:6-11 The disallowance for expenses related to tax-exempt income prevents the taxpayer from
enjoying a double tax benefit. If expenses related to tax-exempt income were deductible, the
taxpayer would benefit by not paying tax on the income and at the same time would be able to
deduct the expenses related to that income. p. I:6-12.
I:6-12 A bribe or kickback that is illegal under state law may be deducted by the taxpayer if the
state law is not generally enforced. pp. I:6-12 and I:6-13.
I:6-13 a. The entire $400 is deductible under Sec. 212 because it is incurred in the
determination of a tax. However, all $400 is a miscellaneous itemized deduction (a from AGI
deduction). Miscellaneous itemized deductions are only deductible to the extent they exceed 2%
of AGI, and then only if the taxpayer itemizes deductions rather than taking the standard
deduction.
b. Because $250 of the fee is attributable to Michelle's business, this amount is a for
AGI deduction. The remaining $150 is a miscellaneous itemized deduction, subject to the
limitation explained in part a. pp. I:6-6 and I:6-7.
I:6-14 a. Although Otter Corporation’s lobbying expenses relate to its business, they are
not deductible because they are not incurred in an attempt to influence local legislation.
b. Yes. Now since the lobbying expenses relate to its business and are incurred in an
attempt to influence local legislation, they are deductible.
c. Yes. These are in-house expenditures that do not exceed $2,000 for the year.
Thus, under the de minimis exception they are deductible. pp. I:6-14 and I:6-15.
I:6-17 Generally, under the cash method of accounting the prepayment of expenses will not
result in a current deduction if the expenditure creates an asset with a useful life which extends
substantially beyond the close of the taxable year. However, prepaid interest paid in the form of
points charged in connection with the improvement of the taxpayer's principal residence may be
deducted in the year paid if (1) the loan is secured by the residence, (2) the payment of points is
an established business practice, and (3) the amount of the prepayment does not exceed the
amount generally charged. If the points are paid to purchase (as opposed to improve) the
taxpayer's residence, two additional requirements are that (1) the closing agreement must clearly
designate the amounts as points (e.g., a loan origination fee), and (2) the amount must be
computed as a percentage of the amount of the loan. pp. I:6-19 and I:6-20.
I:6-18 Except for certain taxpayers in certain industries with annual gross receipts of $10 million
or less (or taxpayers with annual gross receipts of $1 million or less), inventories must be
accounted for using the accrual method. As a result, a cash method taxpayer who has inventory
may use both methods of accounting. This constitutes a hybrid method. p. I:6-18.
I:6-19 a. Economic performance occurs as the taxpayer actually provides the property or
services.
b. Economic performance occurs when the property or services are actually provided
to the taxpayer.
c. For recurring liabilities, economic performance can be treated as having occurred
in the year of accrual if all of the following tests are met:
2. Economic performance occurs within the shorter of (a) 8 ½ months after the close
of the tax year, or (b) a reasonable period after the close of the tax year.
4. Either (a) the item is not material or (b) the accrual of the item in the tax year
results in a more proper matching against income than accruing the item in the tax year in
which economic performance occurs.
4. The taxpayer must make payments to another for rebates, refunds, awards or
prizes, insurance or service contracts, or taxes.
I:6-20 Congress enacted the "wash sale" provisions to prevent taxpayers from generating
artificial tax losses in situations where taxpayers do not intend to reduce their holdings in the
stock or securities that are sold. pp. I:6-23 and I:6-24.
I:6-21 Judicial and administrative rulings have held that preferred stock of a corporation is not
considered substantially identical to common stock of the same corporation. However, bonds of
the same corporation that have maturity dates within a few months of each other have been held
to be substantially identical. pp. I:6-24 and I:6-25.
I:6-22 a. An individual's spouse, brothers and sisters, ancestors, and lineal descendants are
considered members of the taxpayer's family for purposes of Sec. 267.
b. The term "related parties" under Sec. 267(b) includes (1) an individual and a
corporation in which the individual owns more than 50% of the value of the outstanding stock,
(2) various relationships between grantors, beneficiaries, and fiduciaries of a trust, a corporation and
a partnership if the same persons own more than 50% in value of the stock of the corporation and
more than 50% of the partnership, and two corporations if the same persons own more than 50% in
value of both corporations and at least one of the corporations is an S corporation. These
relationships are included because the taxpayer may be able to exert control or influence which may
keep transactions between the parties from being completely at arm's length. pp. I:6-26 and I:6-27.
I:6-23 Congress has imposed the concept of constructive ownership to prevent taxpayers from
attempting to circumvent the related party rules by dispersing ownership of a corporation among
family members or related entities while at the same time retaining economic control. p. I:6-26.
I:6-24 On a subsequent sale of the property, the related purchaser may reduce a gain the
purchaser realized by the amount of the disallowed loss. However, the disallowed loss is
Copyright © 2018 Pearson Education, Inc.
I:6-5
allowable only to the extent of the gain recognized on the subsequent sale by the related
purchaser. p. I:6-28.
I:6-25 The $1,000 income from the hobby is included in Jill's gross income. Since hobby
expenses are deductible up to the amount of the income from the hobby, $1,000 of the hobby
expenses are potentially deductible. However, they are deductible as from AGI miscellaneous
itemized deductions subject to the 2% of AGI limit. Thus, unfortunately none of the expenses of
the hobby are deductible since they do not exceed this limit ($71,000 x .02 = $1,420). pp. I:6-29
and I:6-30.
I:6-26 Under Section 280A, a day of personal use of the vacation home includes any day that the
property is used for personal purposes, (1) by the taxpayer or his/her family, (2) by any
individual under a reciprocal-use arrangement, and (3) by an individual not paying a fair rental
for the property. p. I:6-32.
I:6-27 According to the IRS, expenses are allocated to the rental use of a vacation home by the
following formula:
However, the Tax Court and the 9th and 10th circuit courts of appeal have held that the
allocation of interest and taxes to the rental use may be done by taking into account all the days
in the year. Thus, the denominator in the allocation fraction for interest and taxes would be 365 if
this approach is used.
The expenses allocated to rental use are deducted in the same order as expenses under the
hobby loss rules:
1. Expenses that the taxpayer may deduct even if not incurred in a trade or business
or investment activity,
3. Expenses of the vacation home that could have been deducted if incurred in a
trade or business or investment activity that do reduce the tax basis in the asset.
pp. I:6-32 and I:6-33.
I:6-28 Pursuant to Sec. 280A(g), the taxpayer will not have to report any rental income or rental
expenses from the vacation home if two tests are met. These tests are, (1) the taxpayer uses the
vacation home as a residence for the taxable year, and (2) the taxpayer actually rents the vacation
home for less than 15 days during the taxable year. In order for the vacation home to qualify as a
residence of the taxpayer, the taxpayer must use the vacation home for personal purposes for
more than the greater of (a) 14 days or 10% of the total rental days for the taxable year. Thus, in
this case since the taxpayer has rented the property for only 12 days during the year, if
the taxpayer personally uses the vacation home for more than 14 days during the taxable year
I:6-30 The primary tax issue is whether Gus may deduct the $50,000 payment to his
ex-girlfriend as an ordinary and necessary business expense. To be deductible under Sec. 162(a),
an expense must be ordinary and necessary, and incurred in carrying on the taxpayer's trade or
business. To be deductible under Sec. 212(1), an expense must be ordinary, necessary, and paid
for the production of income. The facts in this question are similar to a tax court case Michael
Harden, 1991 PH T.C. Memo ¶ 91,454, 62 TCM 756 in which the court held that the potential
charges were personal in nature, rather than of a business nature. Thus, the payment was
nondeductible. The threat of termination is a consequence of the personal matter. The taxpayer
argued that he would never have paid the amount if the team had not threatened to fire him.
However, the tax court held that the reason for the payment was of no consequence. pp. I:6-7
and I:6-8.
I:6-31 The primary tax issue is whether the payment of the mortgage interest by Kathleen is
deductible as an itemized deduction. The facts in this question are similar to Kathleen M.
Emmons, 1961 PH T.C. Memo ¶ 61,290, 20 TCM 1513 where the tax court did not allow
Kathleen an interest expense deduction because the indebtedness was not hers. The fact that
Molly was Kathleen's dependent was irrelevant to the issue. pp. I:6-9 and I:6-10.
I:6-32 The primary tax issue is whether the activity is a business or a hobby. If the activity is
deemed to be a business, the classification of the income and expenses and the deductibility of
the losses need to be considered. If the activity is deemed to be a hobby, the application of the
hobby loss limitation rules needs to be considered. The facts in this situation appear similar to
Mark A. Stephens, 1991 PH T.C. Memo ¶ 91,383 62 TCM 430 where the Tax Court ruled that
the activity was a business. However, this situation is different from the Stephens case in a few
Copyright © 2018 Pearson Education, Inc.
I:6-7
respects. Most importantly, there is no evidence that Katie and Alan conduct the activity like a
business, that they maintain an accounting system, or that they promote the activity. However,
Katie and Alan might still be found to have a business because Alan acquired training and advice
from professionals and they take patrons out during the times of demand. Katie and Alan could
elect to keep the tax year open to take advantage of the presumptive rule. But, if their company
goes out of business because of inability to obtain liability insurance, like the Stephens’ did, the
presumptive rule will not help Katie and Alan. pp. I:6-5, I:6-29, I:6-30 and I:6-37.
Problems
I:6-33 a. Because Roberta is not reimbursed for any of these employee business expenses,
she must report them as miscellaneous itemized deductions from AGI. All of the expenses
qualify for deductibility. However, Roberta must reduce the potentially deductible amount of the
client meals by $200 (50% of the total $400 meals and entertainment expenses). Thus, the total
of Roberta’s unreimbursed employee business expenses that are potentially deductible is $1,225
($1,425 - $200). Roberta must then add this amount to her other miscellaneous itemized
deductions to determine if the total exceeds 2% of Roberta’s AGI. If so, Roberta adds the
amount in excess of the 2% of AGI to the rest of her itemized deductions to determine if the total
of all her itemized deductions exceeds the standard deduction. Itemized deductions are discussed
in more detail in Chapter 7.
b. Reimbursed employee business expenses generally are deductions for AGI. In
this case, Roberta won’t have to report either (1) the reimbursement as income or (2) the
reimbursed employee business expenses because the expenses are accounted for and reimbursed
under a plan where Roberta must report the expenses to her employer in order to be reimbursed.
Thus, the reimbursement and the expenses cancel each other out. Under this situation, the 50%
reduction of the deduction for the client meals and entertainment applies to the employer.
(See Chapter 9 for a discussion of the treatment of employee business expenses).
c. All of the expenses qualify as for AGI deductions because Roberta incurred them
in her own business. Thus, Roberta will report them as deductible business expenses on her
Schedule C. Here again, however, Roberta can only report $1,225 ($1,425) as deductions
because she can only deduct 50% of the client meals and entertainment. pp. I: 6-3 and I: 6-4.
Note that the Treasury has recently issued new regulations that have very detailed
instructions and examples regarding how to determine whether an expenditure is to be
capitalized or deducted.
I:6-37 a. Not deductible. The title search should be capitalized as part of the cost of the
building.
b. Deduction for AGI. This is an ordinary and necessary business expense.
c. $400 is a deduction for AGI and $100 is a miscellaneous itemized deduction.
d. Not deductible. This represents a personal expenditure.
e. Deduction for AGI. This is an ordinary and necessary business expense.
pp. I:6-6 and I:6-7.
I:6-38 Damian Corp.’s taxable income from this illegal business activity is $355,500, computed
as follows:
a. Sales $750,000
Minus: Cost of goods sold (270,000)
Gross income $480,000
Minus: Salaries $75,000
Freight 22,500
Lease Payments 15,000
Interest 12,000
Total (124,500)
Taxable income $355,500
The bribes of $30,000 are not deductible. pp. I:6-12 through I:6-14.
I:6-39 a. The payment is not deductible because it is an illegal bribe paid to a government
employee. Note that the Department of Veterans Affairs is an agency of the federal government.
b. Not deductible if it is unlawful under the Foreign Corrupt Practices Act of 1977.
c. Not deductible if the state law making the payment illegal is generally enforced.
pp. I:6-12 through I:6-14.
I:6-41 a. The expenses are not deductible because Big Bang, LLP is not engaged in the
entertainment business and it did not enter the new business.
b. $6,600 current year deduction. Big Bang, LLC may deduct $5,000 in the current
year under Sec. 195, which permits a deduction in the year the business starts up to the lesser of
(1) the amount of start-up expenditures or (2) $5,000. The remaining $36,000 must be amortized
over 180 months starting in May. Thus, this year Big Bang may also deduct an additional $1,600
($36,000/180 x 8 months) of the remaining costs for a total deduction of $6,600 in the current
year. pp. I:6-15 and I:6-16.
a. 1. Solutions may deduct only $4,000 in the current year. The all-events test
requires that (1) the existence of liability is established, and (2) the amount of
the liability is determined with reasonable accuracy. Although a liability to
the contractor is established, the amount of the liability is uncertain. Because
the amount of the liability can be accurately established only with respect to
$4,000, Solutions Corporation can only deduct that amount on its current-year
tax return. The economic performance test is met because the contractor
performed the remodeling service before the year-end of December 31.
2. Solutions Corporation may deduct $11,500 on its current-year tax return for
the amounts actually paid to service the warranties during the current year. It
cannot take a deduction for its estimated liability for next year because it fails
both the all-events test and the economic performance test. First, the liability
is not certain in existence or amount. Second, the corporation did not perform
work related to the estimated liability.
3. As of December 31, Solutions reports the following related to the trade seminars:
Expenses paid in current year: Expenses to be paid in the following year:
Solutions can definitely deduct the $3,750 paid in the current year. These
expenses meet both the all-events test and the economic performance test.
The expenses to be paid in the following year meet the all-events test because
they are certain in existence and amount. However, the expenses do not meet
the general economic performance test because the services to which they
relate are not performed in the current year. However, Solutions Corporation
Copyright © 2018 Pearson Education, Inc.
I:6-11
can deduct the entire $7,500 liability in the current year under the exception to
the economic performance test for recurring liabilities, because:
i. The all-events test is met in the current year,
ii. Economic performance will occur before August 15 of next year,
which is within 8 ½ months of the close of next year,
iii. The expense is recurring and the taxpayer (we assume)
consistently treats the item as incurred in the tax year; and
iv. The accrual of the item in the tax year results in a more proper
matching against income than accruing the item in the tax year in
which economic performance occurs.
*Note: Following the Zaninovich case cited on p. I:6-19 of the text a taxpayer could deduct the
full $12,000. Perhaps this is also possible in other jurisdictions.
pp. I:6-18 through I:6-20.
I:6-44 a. Total deductions in the current year are $16,200 ($12,000 mortgage interest +
$4,200 in points which represent interest). The points of $4,200 are computed as follows:
$280,000 x .015.
b. The other closing costs (appraisal fee and the title search) are added to the cost
basis of the home. pp. I:6-19 and I:6-20.
b. Broward’s basis in the 250 shares of Silver Fox common stock is $3,417 ($1,750
purchase price plus the $1,667 disallowed loss). The holding period for the newly purchased 250
shares begins on April 17, 2011. Broward’s basis in the preferred stock is its cost of $1,000.
Broward’s holding period in the preferred stock begins on January 2, 2017. pp, I: 6-23 through
I: 6-25.
I:6-46
Transactions
Date in Western Common Stock Amount
March 8, 2011 Purchases 1,000 shares $12,000
October 3, 2017 Purchases 300 shares 3,000
October 12, 2017 Sells original 1,000 shares 8,500
November 1, 2017 Purchases 500 shares 4,000
a. Cougar realizes a total loss of $3,500 ($8,500 - $12,000). However, Cougar can
only recognize $700 ($3,500 x .2) of the total loss. Under the wash sale rules, the remaining
$2,800 of the realized loss is disallowed because Cougar repurchased 80% of the common stock
sold [(300 + 500)/1,000) = 80%] within the 61 day period beginning 30 days before the date of
sale and ending 30 days after the date sale. Because the $700 recognized loss is a capital loss,
Cougar can only deduct it against any capital gains it realizes during the year.
b. The basis in the 300 shares purchased October 3, 2017 is $4,050. [$3,000
purchase price + $1,050 (3/8 x $2,800 disallowed loss)]. The basis in the 500 shares purchased
November 1, 2017 is $5,750. [($4,000 purchase price + $1,750 (5/8 x $2,800 disallowed loss))].
The holding period for both of these blocks of stock starts on March 8, 2011.
Percentage Troy’s
Owner Ownership constructive ownership
Tom (Troy’s son) 20% 20%
Jimmy (Troy’s cousin) 15% 0%
Jimmy’s Father (Troy’s uncle) 30% 0%
Angie (Troy’s wife) 10% 10%
Nicole (Angie’s sister) 25% 0%
100% 30%
Troy Tom
Jimmy Angie
50%
Jimmy’s 50%
Father Nicole
TJ
15%
20% 10%
30%
25%
Berry
Corporation
b. Troy may recognize the entire $5,000 loss because he and Berry Corporation are
not related parties under Sec. 267. Because this loss is a capital loss, Troy can only deduct the
recognized capital loss against his capital gains for the year, plus an additional $3,000 of capital
losses in excess of his capital gains.
Copyright © 2018 Pearson Education, Inc.
I:6-14
c. Troy cannot recognize the $5,000 loss. Troy is deemed to own 70% in Berry
Corporation. Thus, he and the corporation are related parties and he cannot recognize the $5,000
loss. He is attributed 10%, from Angie, his wife, and 20% from Tom, his son, because they are
family members under Section 267. He is attributed 12.5% from the partnership, because
partners own their proportionate share of what the partnership owns. Thus, because of this
constructive ownership from the partnership, Troy is treated as owning stock in Berry, Inc. in a
way other than just from his family (Angie and Tom). He is also attributed the 15% that Jimmy
(his partner) directly owns and the 12.5% that Jimmy is deemed to own through the partnership,
because a taxpayer is attributed everything his partner owns except stock that is attributed to the
partner through family attribution (the 30% owned by Jimmy’s father.)
Percentage Troy’s
Owner Ownership constructive ownership
Tom (Troy’s son) 20% 20%
Jimmy (Troy’s cousin) 15% 15%
Jimmy’s Father (Troy’s uncle) 30% 0%
Angie (Troy’s wife) 10% 10%
TJ Partnership 25% 25%
100% 70%
Troy
TJ
Jimmy’s Angie
15% 20%
Father
25%
30% 10%
Berry
Corporation
Because under Sec. 267, Ralph doesn’t own over 50% in Burnham, Inc., he may
recognize the loss.
b. Thann’s entire loss is disallowed. Under Sec. 267, Thann is treated as owning
100% of Burnham, Inc., computed as follows:
Total 100%
Note that since Thann owns stock in Burnham, Inc. other than through a family
member, he is treated as owning the stock actually and constructively owned by his partners.
Thus, the loss is disallowed. However, when Burnham, Inc. subsequently sells the land for a
gain, it may offset up to $10,000 of the gain it recognizes. If it subsequently sells the land at a
loss, Thann’s disallowed $10,000 loss is completely lost.
c. Thann can recognize the loss and offset it against his other capital gains. Any
capital loss in excess of his other capital gains is deductible up to $3,000 in the
current year. The remainder is carried over to subsequent years. Thann is treated
as owning only the 40% that Ralph owns. Because the only stock he is
considered as owning is attributed to him from a family member, he is not treated
as owning the stock in Burnham, Inc. that his partner, Sara owns.
I:6-50 a. Since CVI Corporation and Sandi are related parties under Sec. 267, the $23,000
loss is disallowed.
b. 1. Sandi will recognize no gain or loss. The $10,000 subsequent gain
($85,000 - $75,000) is reduced by the $23,000 disallowed loss. The entire disallowed loss
cannot be used to create a loss on the subsequent sale.
2. There are no tax consequences to CVI Corporation upon the subsequent
sale by Sandi. The remaining $13,000 loss is completely lost.
c. Sandi will recognize a loss of $5,000 ($70,000 - $75,000 basis). The $23,000
previously disallowed loss is completely lost.
d. Sandi will recognize a gain of $7,000 ($105,000 - $75,000 = $30,000 gain,
reduced by the $23,000 disallowed loss). pp. I:6-25 through I:6-28.
I:6-51 Rachel may make an election to keep 2016 open for possible audit with respect to her
bath product sales until the end of 2019 is past so that the presumptive test may be applied. If
she has income from her sales in 2017, 2018, and 2019, the burden of proof will shift to the IRS.
The IRS will have to prove that her bath product business is a hobby in order to disallow the loss
from 2016. pp. I:6-29 and I:6-30.
I:6-52 Emily cannot make the election to keep the year open. The election allows the year in
question to remain open with respect to the activity until sufficient years have passed so that the
presumptive test may be applied. The election must be made within 3 years after the due date for
the year in which the taxpayer first engages in the activity. In this situation, Emily has had losses
four out of six years and the profits test is not met during those years. pp. I:6-29 and I:6-30.
b. All of the expenses are deductions from AGI since the activity is a hobby. If
Chuck itemizes his deductions, all of the property taxes may be deducted and all but $200 of the
feed and veterinary expenses may be deductible subject to the 2% of AGI limit on miscellaneous
itemized deductions. No depreciation is allowed. These expenses, of course, are deductible only
if the sum of Chuck’s itemized deductions exceeds the standard deduction.
c. -0-. None of the depreciation was deducted so the basis of the hutches is not
reduced. pp. I:6-29 through I:6-31.
I:6-54 a. Since this activity is a hobby, Chuck can potentially deduct a total of $1,500 of
the expenses related to the hobby activity. This amount is limited to the income Chuck realizes
from the hobby ($1,200 + $300), and is calculated as follows:
b. All of the expenses are deductions from AGI since the activity is a hobby. All of
the property taxes and all the feed and veterinary expenses are deductible. However, the
deduction for depreciation is limited to $200. The deduction for the feed, veterinary fees and
depreciation are miscellaneous itemized deductions subject to the 2% of AGI limitation.
c. $200 The cost basis in the rabbit hutches is reduced only by the amount of the
depreciation that is deducted. pp. I:6-29 through I:6-31.
*Note, however, that if the approach sanctioned in the Bolton case (see the discussion on page
I:6-32 and 33 and footnote I6-52 in the text) is used, $658 (60/365 x $4,000) of interest and taxes
would be allocated to the rental portion leaving more of the second and third tier expenses to be
deductible.
pp. I:6-31 through I:6-34.
I:6-56 Since Kim used the condominium over 14 days during the year for personal purposes, it
qualifies as a residence. The condo was rented out for less than 15 days during the year. Thus,
Kim will report no income or deductions from the property. However, Kim may deduct the
property taxes from AGI, and if Kim chooses the condominium as her second personal residence,
she also can deduct the interest from AGI. pp. I:6-31 through I:6-34.
Salary $100,000
Net capital gain (3,000 + 5,000 – 2,000) 6,000
Hobby income 2,500
AGI $108,500
Itemized deductions:
Property taxes $125
Misc. itemized deductions:
Other 5,000
Hobby Expenses:
(2,900 + 270 + 200 = 3,370)
Limited to remaining income (2,500 – 125) 2,375 7,375
2% of AGI ($108,500 x 0.02) (2,170) 5,205
Total (less than standard deduction) $5,330
Standard deduction (12,700)
Personal exemptions (2 x 4,050) (8,100)
$87,700
Because the building lot was sold to Bryce's brother, the $7,000 loss is
disallowed. Bryce realized a $3,000 ($8,000 - $5,000) gain on the sale of Gold Corporation
stock, a $4,000 loss ($5,400 - $9,400) on the sale of the Silver stock, and a $5,000 gain ($12,000
- $7,000) on the sale of the United stock. All $8,000 of the gain is recognized. However,
because Bryce purchased 100 shares of Silver Corporation stock within 30 days before the sale
of the Silver Corporation stock, one-half of the loss is disallowed. Thus, only $2,000 (0.50 x
$4,000) of the loss is recognized. Assuming Bryce’s fly-tying activities are a hobby, the
deductible expenses are limited to the gross income generated from the activity. Furthermore,
they are all deductions from AGI.
2. Bryce's basis in the Silver stock is $4,800 ($2,800 + $2,000 disallowed loss).
I:6-58 1. Jaron qualifies as a surviving spouse because his wife died just two years ago.
Jaron receives three personal exemptions at $4,050 each for a total of $12,150 (one for himself
and one each for his two youngest children). His son Danny doesn’t qualify as a dependent
because Danny is neither a qualifying child (he is over 19 and is not a full-time student) nor a
qualifying relative (Danny’s gross income exceeds the exemption amount of $4,050). Laura
doesn’t qualify because she is filing a joint return with her husband, Chad.
2. Jaron is not allowed a home office deduction for the expenses allocable to his
home office because Jaron’s use of the office in his home doesn’t meet any of the following
requirements: (1) the home office is not his principal place of business, (2) Jaron doesn’t meet
with clients in the home office, and (3) Jaron has another office where he conducts the
administrative and managerial activities of the business. The property taxes on Jaron’s home are
Copyright © 2018 Pearson Education, Inc.
I:6-20
deductible as a “from” AGI deduction if the sum of all itemized deductions exceeds the standard
deduction of $12,700. In this case, the sum is less than the standard deduction, so Jaron receives
no deduction for the payment of the property taxes on his personal residence.
3. Laura and Chad’s use of the rental apartment is considered personal use of the
apartment. However, Jaron’s personal use of the rental apartment is less than 10% of the number
of days the apartment was rented out (270 x .1 or 27 days) so the condominium is not considered
Jaron’s resident and the provisions of §280A do not apply. The net income from the rental is
calculated as:
a. Rental income $18,000
b. Interest (3,150) x (270/294)= ( 2,893)
c. Taxes (1,700) x (270/294)= ( 1,561)
d. Other expenses (6,000) x (270/294)= ( 5,510)
e. Depreciation (7,090) x (270/294)= ( 6,511)
f. Total $ 1,525
Note that the allocation formula used for interest and taxes is based on the total number of days
used rather than the modified allocation formula allowed by the courts (which would have
allocated the interest and taxes using a ratio of 270/365. Use of this ratio allocates more interest
and taxes to the rental use of the condominium, which allows Jaron to claim more overall
deductions. Since the condo does not qualify as Jaron’s residence, the interest allocated to the
personal use is not deductible. Furthermore, although the taxes of $139 allocated to the personal
use ($1,700 - $1,561) generally would be deductible as a “from” AGI deduction, the total of
Jaron’s itemized deductions does not exceed the standard deduction.
With the $1,000 LTCG on the land and the $2,000 STCL on the Genomics stock, Jaron
will have a net STCL of $1,000, all of which is deductible (up to $3,000).
6. Jaron reports $98,500 net income from his consulting business on Schedule C,
calculated as follows:
AGI: $99,025
Standard deduction (12,700)
Personal & dependency exemptions (3 x $4,050) (12,150)
I:6-59 The business is currently facing a $200 loss for 2017. If the loss is reported on Danielle’s
Schedule C, it will be the third loss reported in the past five years. Therefore, the activity will
not meet the safe-harbor rule (ie. if a business activity generates a profit in three out of five
consecutive years, the burden of proof shifts to the IRS, and the activity will not likely be subject
to hobby loss rules).
If the business can generate a profit for 2017, it will meet the safe-harbor rule. To do so,
Danielle must accelerate income recognition and defer payment of expenses.
First, she can accelerate the recognition of income. Danielle should not wait until the end
of the month to bill the Springville Orchestra, but should hand-deliver a bill immediately. The
orchestra will likely pay the bill within ten days, before December 31. As soon as the orchestra
mails the check, Danielle can recognize the income. By including this item of income, the
business reports a profit of $800.
If Danielle continues her practice of paying bills right away, she will incur $1,000 in
additional expenses. If she also claims a $75 deduction for meal costs, she will net a $275 loss.
So, she should delay paying her bills until January 1, even if the delay requires her to hand-
deliver payment at that time. She should still take the meal deductions, as that expense will be
lost if she does not claim it on her 2017 return. The final result is as follows:
The tax practitioner should strongly advise the client to distinguish her performing
activities from personal activities by maintaining a separate bank account, account books and
records, and perhaps dedicating an area of her home to performing managerial and administrative
duties relating to the business.
I have looked over your transaction, and it appears that selling your printing press to
Chamberlain Corporation will produce some unfavorable tax consequences.
You are not allowed to deduct any loss on a sale of property to a related party. Under the
definition of related parties in Sec. 267 of the Internal Revenue Code, you are considered
owning 75% of Chamberlain Corporation. (12.5% through the Coxmann Partnership,
30% through Emily Cox (Emily is considered as owning 12.5% through Coxmann
Partnership and 17.5% through Chloe, International, Inc.) 7.5% through your sister,
Susan, and 25% through your brother, Brian.) This means that you are considered related
to Chamberlain Corporation, and you will not be able to deduct the $40,000 loss if you
sell the press to Chamberlain. Chamberlain will have a basis of $50,000 in the press. If
Chamberlain sells the press at a gain later, it will be able to offset the gain to the extent of
your disallowed loss.
Sincerely,
Student, CPA
I:6-64 FACTS:
1. John left his employment in 2010 and in 2011 created a fishing charter service.
2. John was an avid fisherman and Kathy, a CPA, assisted John in creating a
business plan. They also opened a bank account for the charter service,
developed a bookkeeping system, and acquired insurance to cover the boat and
passengers.
DISCUSSION:
Reg. Sec. 1.183-2(b) provides a list of factors to assist in determining whether an
activity is engaged in for profit. The list is as follows:
For the following reasons the charter activity might be determined to be engaged in for
profit:
2. The Browns’ expertise. John is an avid fisherman with many years of experience.
Kathy is a practicing CPA and she assisted John in the business portion of the
activity.
3. The time and effort expended in the activity. Even though John was employed
full-time, he devoted substantial amounts of time to the activity.
4. The element of pleasure which is involved. Although John enjoys fishing, almost
all of his trips were either with paying parties or promotional non-paying parties.
The fact that Kathy would rarely accompany John is an additional indicator that
the activity was an attempt to produce income and not done for recreation.
2. John’s history of income and profits indicate the activity was a hobby. He
incurred a loss in three of the five years of operation.
3. When a profit was made, the amount of profit was relatively small.
4. John’s financial status also might indicate the activity was a hobby. He was
employed in a full-time job during 2015.
The factor dealing with the taxpayer's success in carrying on other similar activities does
not apply to the Brown's situation. They had never tried a similar venture.
Using the regulation as a research source, a student may be able to establish a strong
argument for both sides in this case. However, the weight of the evidence probably leans
towards a determination that John is engaged in a business. See John R. Zwicky, 1984 PH T.C.
Memo ¶84,471, 48 TCM 1026.
p. I:6-36.
I:6-65 FACTS:
1. Richard Penn is the president and part owner of an architecture consulting firm.
3. Many unsecured creditors of the corporation were unable to collect on the debts.
4. Some of the bankrupt corporation's creditors are also clients of Richard's firm.
5. Richard was not obligated to pay off the corporation's debts. However, he did pay
the debts because he felt that it was necessary to improve his business reputation
with the customers of his architecture firm.
CONCLUSIONS:
1. Richard may deduct, under Sec. 162, the amount paid to those who are also
customers of his consulting firm.
2. Richard may not deduct the amount paid to the other creditors of the corporation.
DISCUSSION:
Sec. 162 allows a deduction for business expenses that are incurred for a business motive,
and are ordinary and necessary.
The determination of whether a necessary business motive is present can also be difficult.
In Paul L. Dunmire, 1981 T.C. Memo ¶81,372, 42 TCM 438 the taxpayer owned 99% of
a furniture corporation; however, he did not actively participate in the operations of the
corporation. The taxpayer pledged stock owned in another corporation to obtain the
furniture corporation's loans. When the furniture corporation wasn't able to pay its
creditors, he made direct payments to the corporation's creditors so that he would not lose
his stock and maintain his business reputation. The court decided that a business motive
did not exist.
The courts have decided that payments made to maintain a present professional
reputation are deductible. In William A. Thompson, 1983 PH T.C. Memo ¶83,487, 46
TCM 1109, the taxpayer owned 51% of a coal mine, which eventually liquidated. The
taxpayer stated he felt morally bound to repay the corporation's creditors and later repaid
all the debts of the liquidated mine. The court allowed a deduction for the payments
made to creditors who were also clients of Thompson's engineering firm. See also
Warren Young v. US, 56 AFTR 2d 85-5196, 85-2 USTC 9643 (D.C. No. Dist. of Okla.)
and Harold L. Jenkins, 1983 PH T.C. Memo ¶83,667, 47 TCM 238.
From the court cases cited, Richard can make a strong argument for deducting the
payments he made to the creditors who were also clients of his architecture firm.
ISSUES:
1. Do Paul’s activities constitute a trade or business, or are they an investment
activity?
2. What is the tax treatment of his expenses? Specifically, are they deductions “for”
or “from” AGI?
CONCLUSIONS:
1. Paul’s activities are not considered a business. Instead, Paul is involved in an
investment activity.
2. The expenses are deductions “from” AGI. Additionally, they are deductible only
to the extent they exceed two percent of Paul’s AGI.
3. Paul cannot deduct the purchase of the computers and office furniture under Sec.
179 because they are not used in a business. Instead, they must be capitalized and
depreciated.
DISCUSSION:
In Higgins v. CIR, 25 AFTR 1160, 41-1 USTC §9233 (USSC, 1941), the Supreme Court
held that a taxpayer who merely kept records and collected interest and dividends from
his securities was not involved in a trade or business. This was the case, despite the size
of the taxpayer’s holding. Subsequent cases also indicate that a taxpayer who buys and
sells stocks and securities for the dividends and long-term growth and who is not
involved in short-term trading is not engaged in a trade or business. See also Estate of
Louis Yaeger, Deceased, Judith Winters, Ralph Meisels, Abraham J. Weber and the Bank
of New York, 889 F2d 29, 89-2 USTC ¶9633 (CA-2), Frederick R. Mayer and Jan Perry
Mayer, 67 TCM 2949 (1994), and Rudolph W. and Abbie A Steffler, 69 TCM 2940
(1995). In each of these cases, the taxpayer was more interested in the long-term
investing potential rather than merely trading based upon short term market fluctuations.
Furthermore, the taxpayers were not involved in selling stocks and securities to others in
the capacity of a broker.
The determination of whether an activity is truly a business or merely a hobby is always a hot
topic for the IRS because so many taxpayers try to deduct the expenses associated with the
activity even though their intent and purpose of engaging in the activity is really for personal
pleasure rather an attempt to make money. Because you have a long term relationship with
Mr. Gerbeuses, you should feel comfortable initiating a serious and detailed discussion with him.
In this discussion you should address the factors that the IRS uses to determine whether an
activity is a business or a hobby. A partial list of these factors include:
You should also help him understand the differences in the tax consequences if the activity is a
hobby instead of a business. In this discussion, using actual analytical data could help him
understand the importance of making the right decision and then properly following and
documenting the plan.
Conway House.
The first occupant of the fourth house on the site of the Freemasons’
buildings seems to have been Lord Conway. A deed, dated 20th December,
1641,[382] mentions Edward, Lord Viscount Conway, as then in occupation,
and no doubt the house is identical with that referred to as Lord Conway’s
residence in Queen Street in a letter dated 31st March, 1639.[383]
Edward, second Viscount Conway and Killultagh, was born in 1594,
and succeeded to the title in February, 1631.[384] Shortly afterwards he was
living in Drury Lane.[385]
His residence in Great Queen Street dates from 1638
or the commencement of 1639, but he did not purchase the
house until 17th July, 1645.[386]
Conway died at Lyons in 1655[387], and was succeeded
by his son Edward, the third Viscount and first Earl of
Conway, born about 1623. He held several important military Conway.
appointments, and was for two years, 1681–3, secretary of
state for the north department. He was the author of a work
entitled Opuscula Philosophica. He was married three times, his first wife
being Anne, the daughter of Sir Henry Finch. Lady Conway was a most
accomplished woman, her chief study being metaphysical science, which
she carried on with the utmost assiduity in spite of tormenting headaches
which never left her. In later life she adopted the tenets of the Society of
Friends. She died on 23rd February, 1679, while her husband was absent in
Ireland, but in order that he might be enabled to see her features again, Van
Helmont, her physician, preserved the body in spirits of wine and placed it
in a coffin with a glass over the face. The burial finally took place on 17th
April, 1679. She was the author of numerous works, but only one, a
philosophical treatise, was printed, and that in a Latin translation published
at Amsterdam in 1690. Conway was created an Earl in 1679 and died in
August, 1683, leaving his estates to his cousin, Popham Seymour, who
assumed the name of Conway.
Up to 1670 the Earl seems to have resided frequently in Great Queen
Street. The Hearth Tax Rolls for 1665 and 1666 show him as occupier,
though the former contains a note: “Note, Lord Wharton to pay,”[388] and
several references to his residence there occur in the correspondence of the
time. Thus on 18th March, 1664–5, he writes to Sir Edward Harley, “Direct
to me at my house in Queen Street”;[389] in June [?], 1665, he informs Sir
John Finch: “I am settled in my house in Queen Street”;[390] a letter to him
describes how on the occasion of the Great Fire in 1666, “your servant in
Queen Street put some of your best chairs and fine goods into your rich
coach and sent for my horses to draw them to Kensington, where they now
are”;[391] on 19th October, 1667, his mother writes to him at “Great Queen
Street, London”;[392] in February, 1667–8, he tells Sir J. Finch that he hopes
“you will ere long be merry in my house in Queen Street, which you are to
look upon as your own”;[393] and on 4th March, 1668–9, Robert Bransby
asks for payment of his bill of £200 “for goods delivered at your house in
Queen Street.”[394] On 25th September, 1669, we learn that a new (or
perhaps rather an additional) resident is expected, Edward Wayte
mentioning in a letter that “the room your lordship wished to have new
floored is going to be occupied by Lord Orrery’s[395] daughter, who is
coming with her mother to England.”[396] The visit evidently took place, for
on 4th November, 1669, Conway’s importunate creditor, Bransby, writes, in
connection with the non-payment of his account, “I beg the delivery of
divers goods in the house in Queen Street, which are being used by some of
Lord Orrery’s family, and also of some green serge chairs lent, which are in
your study”;[397] and again on 15th March, 1669–70: “there are some goods
belonging to me in the house in Queen Street, which are in Lord Orrery’s
wearing.”[398] Later in the same year the house seems to have been given
up, as Bransby on 27th September in the course of another pitiful complaint
says: “I hear that you have disposed of your house in Queen Street and sent
the furniture to Ragley.”
The Hearth Tax Roll for 1673 shows the house in occupation of
“Slingsby, Esq.,” who was probably the immediate successor of Conway.
In the absence of more definite information Slingsby cannot be
identified. It is just possible that he was Henry Slingsby, the Master of the
Mint, and friend of Evelyn.
In the Hearth Tax Roll for 1675 the house is shown as empty, and in
the ratebook for 1683 the name of the occupier is given as: “Sir Fr. North,
Knt., Lord Keeper of the Great Seal of England.” It is known (see below)
that the offices of the Great Seal were situated in this street in 1677, and
there can be no doubt that this was the house.
It would appear, therefore, that the premises were taken for the
purpose of the offices of the Great Seal some time in the period 1675–77,
and consequently during the time that the seal was in the custody of Finch.
Heneage Finch, first Earl of Nottingham, was born in 1621, the eldest
son of Sir Heneage Finch, recorder of London and speaker in Charles I.’s
first parliament. On leaving Christ Church he joined the Inner Temple,
where he acquired a great reputation and an extensive practice. On the
Restoration he became solicitor-general and was created a baronet. As the
official representative of the court in the House of Commons, he seems to
have given every satisfaction to the king, despite the fact that on at least one
important point (the toleration of dissent) he opposed the royal desire. He
was indeed in such favour that the king, with all the great officers of state,
attended a banquet in his house at the Inner Temple in 1661. In 1670, he
became attorney-general and counsellor to the queen. On the dismissal of
Shaftesbury in 1673, he was made Lord Keeper of the Great Seal, and was
raised to the peerage as Baron Finch of Daventry, and a year afterwards was
appointed Lord Chancellor. During his term of office the well-known
burglary took place at the house in Great Queen Street. Under date of 7th
February, 1676–7, Anthony Wood writes: “About one or two in the morning
the Lord Chancellor his mace was stolen out of his house in Queen Street.
The seal lay under his pillow, so the thief missed it. The famous thief that
did it was Thomas Sadler, soon after taken and hanged for it at Tyburn.”[399]
As Lord Chancellor, Finch had the unpleasant task of explaining to
the House of Commons how the royal pardon given to Danby in bar of the
impeachment bore the great seal. He was created Earl of Nottingham in
1681 and died in December, 1682. “The fact that throughout an
unceasing official career of more than twenty years, in a time of
passion and intrigue, Finch was never once the subject of
parliamentary attack, nor ever lost the royal confidence, is a
remarkable testimony both to his probity and discretion.”[400] He
was the Amri of Dryden’s Absalom and Achitophel.
Finch. Francis North, first Baron Guilford, was the
third son of Dudley, fourth Baron North, and was
born in 1637. He entered the Middle Temple in 1655,
and at once gave himself up to hard study. He was called to
the Bar in 1661, and seems very early to have acquired
practice. His first great case occurred in 1668, when he was
called upon, in the attorney-general’s absence, to argue in the
House of Lords for the King v. Holles and others. He at once North.
sprang into favour and became king’s counsel. In 1671 he was
made solicitor-general and received the honour of
knighthood. In 1673, he succeeded Finch as attorney-general, and in 1675
was appointed chief justice of the common pleas. On the death of the Earl of
Nottingham in 1682 he succeeded him as Lord Keeper, and from that day,
his brother Roger says, “he never (as poor folks say), joyed after it, and he
hath often vowed to me that he had not known a peaceful minute since he
touched that cursed seal.”[401] In 1683 he was raised to the peerage as Baron
Guilford. From this time his health began more and more to fail, and
though he continued diligently to perform his duties, he was compelled in
the summer of 1685 to retire to his seat at Wroxton, Oxfordshire, taking the
seal with him and attended by the officers of the court. Here he died on 5th
September, 1685, and the next day his brothers, accompanied by the
officials, took the seal to Windsor, and delivered it up to the king, who at
once entrusted it to Jeffreys.
George Jeffreys, first Baron Jeffreys of Wem, was born in 1648 at
Acton in Denbighshire. He was ambitious to be a great lawyer, and after
overcoming with difficulty his father’s objections, he was admitted to the
Inner Temple in 1663. He was called to the Bar in 1668, and by his wit and
convivial habits making friends of the attorneys practising at the Old Bailey
and Hicks’s Hall, he soon gained a good practice. He was appointed
common serjeant of the City of London in 1671. He now began to plead in
Westminster Hall, and by somewhat doubtful means he obtained an
introduction to the court. In 1677 he was made solicitor-general to the Duke
of York, and was knighted, and in 1678 became Recorder of the City. Both as
counsel and recorder he took a prominent part in the prosecutions arising
from the Popish Plot, and as a reward for his services in this direction, and
for initiating the movement of the “abhorrers” against the “petitioners,” who
were voicing the popular demand for the summoning of parliament, he was
appointed chief justice of Chester.
The City having complained to the House of Commons of the action
of its recorder in obstructing the citizens in their attempts to have a
parliament summoned, the House passed a resolution requesting the king
to remove him from all public offices. The king took no such action, but
Jeffreys submitted to a reprimand on his knees at the bar of the House, and
resigned the recordership, eliciting the remark from Charles that he was
“not parliament proof.”
In 1683, Jeffreys was promoted to be Lord Chief Justice, and was
soon a member of the privy council. Shortly afterwards he tried Algernon
Sidney for high treason, conducting the proceedings with manifest
unfairness and convicting the prisoner on quite illegal grounds. On the
accession of James II. in 1685, he was raised to the peerage, an honour
never before conferred upon a chief justice during his tenure of office.
In July, after the battle of Sedgmoor, he was appointed president of
the commission for the western circuit, and on 25th August he opened the
commission at Winchester. This, the “bloody assizes,” was conducted with
merciless severity, but the king was so satisfied that, on Jeffreys calling at
Windsor on his return to London, he was given the custody of the great seal
with the title of Lord Chancellor. During the next three years he vigorously
supported the king in his claims to prerogative. He presided over the
ecclesiastical commission, and over the proceedings against the
Universities. Jeffreys thus became identified with the most tyrannical
measures of James II., and therefore, when the king in December, 1688,
fled from the country, he also endeavoured to escape. He disguised himself
as a common sailor, but was recognised, and was only saved from lynching
by a company of the train-bands. He was confined at his own request in the
Tower, and here, his health having been seriously undermined by long
continued disease and dissipation, he died in April, 1689. His name has
become a by-word of infamy, although there can be little doubt that he was
not entirely as black as he has been painted, and no impartial account can
fail to insist on the traditional picture of him being modified in many
respects. Nevertheless, when every allowance is made, the character of
Jeffreys is one of the most hateful in English history.
On his accepting the Great Seal he also took over the house in Great
Queen Street,[402] but about 1687 he removed to the new mansion, which he
had had built in Westminster overlooking the park.[403]
For the next few years the history of Conway House is a blank. In
1696 a private Act[404] was obtained, which, after reciting that there was a
mansion house, with stables and outhouses, in Queen Street, St. Giles,
forming portion of the estate belonging to the Marchioness of
Normanby[405] (life tenant) and of the estate belonging to Popham Seymour
alias Conway, and that the house was liable to fall down from want of
repair, gave authority to arrange with a builder to effect the repairs and to
let the house for 51 years at a proper rent.
The work was evidently carried out without delay, for the Jury
Presentment Roll for 1698 has the entry “Dr. Chamberlain for the Land
Credit Office,” but little luck seems to have attended the house during most
of its remaining half-century of existence.
The sewer ratebooks for 1700 and 1703 make no mention of the
house. Those for 1715, 1720 and 1723, and the parish ratebooks from their
commencement in 1730 until 1734 mention it as “The Land Bank.” The first
entry refers to it as “Empty many years,” and it was still empty in 1720.
Certain deeds of later date[406] allude to the premises as a “large old house
or building commonly called or known by the name of the Land Bank.”[407]
The Land Bank, as known to history, was an institution founded in
1696, for the purpose of raising a public loan of two millions on the basis of
the estimated value of real property. Its promoter was Dr. Chamberlain, an
accoucheur.[408] It is unnecessary to give here a full account of the scheme,
but it may be regarded as certain that it would never have been supported in
Parliament but for the satisfaction felt by many influential members in
dealing a blow at the recently formed Bank of England.
The evidence given above is decisive as to some connection between
the house and this scheme, but no reference to the former has been found
amongst the literature on the Land Bank.[409] The fact that Dr. Chamberlain
was in occupation of the premises in 1698, two years after the ignominious
collapse of the scheme, shows that the Land Bank still pursued some kind of
existence, and, indeed, there is other evidence that it was surviving in some
form in January, 1698.[410]
The above evidence shows that for many years after Dr.
Chamberlain’s tenancy the house lay empty, and not until 1735 is the name
of an occupier given. This was Thomas Galloway, who stayed until 1739.
After this, the house again remained empty, until in 1743 it was pulled
down, and its frontage to Great Queen Street was occupied by four smaller
houses. The residents in the two westernmost of these (the other two
occupied the site of Markmasons’ Hall) were as follows:—