Income Taxation I
Fall 2016
Bogdanski
INSTRUCTIONS
This examination consists of 36 multiple-choice questions (Questions 1 through 36) and two essay questions (Questions 37 and 38). An hour and a half (90 minutes) is recommended for the multiple choice questions, and two hours is recommended for the two essay questions (one hour per essay question).
In determining grades, each multiple choice question will count for 1 point, and each essay question will count for 24 points. Therefore, you should budget your time according to the allocation just given. Experience has shown that failure to budget one’s time appropriately can result in a drastic lowering of one’s overall grade on this examination.
For the multiple choice questions, you must submit your answers using SofTest. You may write the answers to the essay questions either on SofTest or by hand. If you choose to write the essay answers by hand, you must write them in the bluebook(s) you have been provided, and return the bluebook(s) along with the hard copy of the essay questions.
At the end of the exam, all students must return the hard copy of the essay questions in the envelope in which it came. However, no credit will be given for anything written on the hard copy of the essay questions. Only your electronic answer file (and bluebook(s), if any) will be graded.
For the multiple choice questions, choose the best answer to each question posed. Choose one, and only one, answer to each question. Although an incorrect answer earns no credit, there is no penalty for an incorrect answer on the multiple choice questions, so it is in your interest to answer every question, guessing if necessary.
In the essay questions, pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit. In your essays, be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.
Unless otherwise expressly instructed, assume that all taxpayers described in the questions are individuals, and that they report their income on the cash method and the calendar year for federal income tax purposes. Any references to the “Code” mean the Internal Revenue Code of 1986, as amended.
QUESTION 37
(One hour)
Willa and her husband Hugh separate late in 2016 and begin divorce proceedings. Willa moves out of the couple’s home and takes their eight-year-old daughter, Darla, with her to live in an apartment. In October 2017, the decree of divorce takes effect and the couple’s divorce becomes final. Willa and Hugh set forth the terms of the divorce in a written settlement agreement (the “Agreement”), which is a binding contract under state law. The Agreement is incorporated into the divorce decree entered by the local family law court. Willa and Hugh do not live, and have never lived, in a community property state.
Under the Agreement, Hugh transfers to Willa a substantial sum of cash and several of Hugh’s assets. Among these are a vacation home with a fair market value of $300,000. The home has an adjusted basis to Hugh of $250,000. Another of Hugh’s assets that Willa acquires in the divorce is Hugh’s stock in a corporation, XYZ. The XYZ stock has a fair market value throughout 2017 of $20,000 and an adjusted basis in Hugh’s hands of $30,000. The cash and the stock are transferred in October 2017. The transfer of the home is delayed by unforeseen circumstances, but finally takes place in January 2019.
The Agreement also requires Hugh to pay to Willa $1,000 cash each month, and in addition to pay to Willa and Darla’s landlord the rent on their apartment (up to $1,800 a month). Hugh is required by the Agreement to pay the $1,000 plus the rent every month for three years, but only so long as Willa remains alive and does not remarry. The amount of these spousal support payments is hotly contested between Willa and Hugh, and their attorneys spend a great deal of time negotiating over the issue. Hugh makes all the required payments for the three years. Willa never remarries.
Under the Agreement, Darla remains in Willa’s custody; Hugh is required to pay Willa $800 per month for the support of Darla, which constitutes a little more than half of Darla’s support. When Darla reaches the age of 14 (in 2022), the required monthly child support payment under the Agreement is to increase to $1,100. When Darla reaches age 21 (in 2029), or upon her death before reaching age 21, Hugh’s obligation to pay the child support is to terminate. Hugh makes all the required payments.
Willa pays sizeable professional fees to her capable lawyer, Bryan, in connection with the divorce. Bryan’s fees include charges for negotiating the Agreement and for advice that Bryan rendered to Willa about the income tax aspects of the divorce settlement.
In 2019, Willa sells the XYZ stock on the public market for $25,000 cash.
What are the federal income tax consequences to Willa and Darla of each of the transactions and events just discussed, with and without any available elections? Be sure to discuss the amount, timing, and character (ordinary or capital) of each item of income, gain, loss, deduction, or credit, and the basis of Willa’s and Darla’s property, at each stage of the transactions.
Discuss.
QUESTION 38
(One hour)
Farah is a self-employed operator of a food cart, in operation since 2013. Farah owns her cart, which is located in a space that she rents from a land owner. Other food carts, owned by others, are nearby on the same lot –in the same “pod,” as some would call it.
Farah’s cart, a customized truck, is equipped with various items of equipment. Among these are a cooking unit that includes a stove and an oven. One day in the summer of 2016, the cooking unit stops working. Farah calls in her appliance service person, Rick, who cheerfully replaces several parts in the stove. A few weeks later, the refrigerator stops working. Rick somberly informs Farah that parts for the refrigerator are no longer available. As a result, Farah promptly buys a new refrigerator, which Rick installs.
The mishaps with the equipment make for a difficult year for Farah. Taking into account the transactions just discussed, her 2016 tax return shows gross income of $50,000, and deductions attributable to her food cart business of $75,000. It is the first year that the business has not been profitable. To pay her living expenses for 2016, Farah is forced to withdraw money from her nondeductible individual retirement account (IRA).
In 2017, Farah’s food cart, which at that point has an adjusted basis of $10,000, is destroyed in a fire. Farah has casualty insurance, which pays her $40,000 on account of the loss of the cart. Farah receives the check in September 2017. Shaken by her bad luck, Farah takes time off from working to decide what to do next. (At age 45, she is not sure what her next career move should be.) In November 2019, Farah buys a new food cart, for $60,000, and starts operating in rented space in a new “pod.”
In 2020, Farah dies in a mountaineering accident. All of her property passes to her sole surviving relative, a nephew named Nikhil. Among the assets that Nikhil inherits is the food cart. Nikhil, wanting nothing to do with the food service industry, promptly sells the cart for its fair market value, $52,000.
What are the federal income tax consequences to Farah and Nikhil of each of the transactions and events just discussed, with and without any available elections? Be sure to discuss the amount, timing, and character (ordinary or capital) of each item of income, gain, loss, deduction, or credit, and the basis of Farah’s and Nikhil’s property, at each stage of the transactions.
Explain.
(End of examination)
Created by:
bojack@lclark.edu
Update: 8 Jan 17
Expires: 31 Aug 17