Income Taxation I
Fall 2017
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 Examplify.
You may write the answers to the essay questions either on Examplify
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. For purposes of this examination, assume that none of the tax reform bills recently passed or currently pending in Congress are enacted.
Question 37
(Suggested
time: One Hour)
Hallie, a busy physician, earns a large salary. On Hallie’s wedding anniversary, her father, Drew, transfers to Hallie, for no consideration, a house that Drew has been renting out to unrelated tenants. Drew’s adjusted basis in the rental house immediately before the transfer is $200,000.
The fair market
value of the property at the time is $400,000, and Drew owns the property free
and clear of any mortgages or other liabilities.
Knowing nothing
about property management, and never having owned rental property before,
Hallie enrolls in a course on the subject at a local college. She pays $2,000
tuition for the course, which begins a few weeks after the transfer of the
property from Drew.
Drew informs
the tenants of the change in ownership, and they immediately begin paying their
rent to Hallie. The annual rent is $8,000 greater than the annual out-of-pocket
expenses of owning the property (property taxes, maintenance, repairs, insurance,
and utilities), not counting depreciation deductions. The depreciation
deduction on the property is $10,000 a year. Hallie pays all of the expenses.
She makes no improvements to the property.
Shortly after
taking over the rental house, Hallie borrows $20,000 from a bank, Banco. This
“equity loan” is secured by a first mortgage on the rental house. Hallie uses
the borrowed money to finance a dream vacation for her and her husband. Every
month, Hallie pays principal and interest to Banco on this debt.
Two years
later, the city government notifies Hallie that it plans to condemn the rental
house to make way for a light rail line. After some negotiation, in exchange
for the property, the city pays Hallie $425,000 cash. This represents the fair
market value of the house at the time of the sale. Hallie uses $18,000 of the
cash she receives from the city to pay off the entire remaining balance on the
Banco “equity loan.” As a result, the city takes the property free and clear of
any mortgages or other liabilities. Weary of the hassles of owning rental real
estate, Hallie takes the rest of the cash she receives and invests it in the
stock market.
What are the
federal income tax consequences to Hallie 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 Hallie’s property,
at each stage of the transactions.
Discuss.
Question 38
(Suggested time:
One Hour)
Chelsea is
employed as a beautician at Looks, a salon that is owned and operated by a
corporation, XYZ. All of the stock of XYZ is owned by Debbie, to whom Chelsea
is not related. Chelsea is well regarded at the salon, and one year she wins
the “XYZ Employee of the Year” award. The award consists of a fashionable,
custom-made wrist watch. Chelsea dreams of opening her own salon some day.
Chelsea is a
single parent. She has a three-year-old son, Atticus, who lives with her.
Chelsea hires a nanny, Brittany, to watch over Atticus while Chelsea is at
work. Chelsea pays Brittany a fee of $700 a month for this service.
XYZ has a
company-wide plan under which Chelsea and other employees can designate some of
their salaries to be placed in a trust to cover out-of-pocket medical expenses.
Chelsea directs that $2,000 a year of her salary be placed into her account
under the plan. When Chelsea has out-of-pocket medical expenses, she submits a
claim to the plan administrator, and the plan reimburses her for the
out-of-pocket expenses up to the $2,000 in the account. Chelsea uses up the
full $2,000 every year. Her out-of-pocket medical expenses invariably exceed
that amount, however.
One of Looks’
features is a “house call” service whereby its beauticians perform services on
location at clients’ homes and businesses. XYZ sometimes requires Chelsea to
make these calls, using her own transportation. Chelsea drives her car from the
salon to the clients’ homes and businesses to provide manicures. Occasionally
this means that Chelsea has to pay for parking near the clients’ locations.
Sometimes Chelsea drives back to the salon after her visits to clients; other
times, she drives from the clients’ premises directly to her apartment to end
her work day. In a typical year, Chelsea drives about 800 miles on these “house
calls.” Neither XYZ nor the clients pay Chelsea anything for the use of her car
or the parking expense.
XYZ offers the
salon clients prepaid services –that is, some clients pay in advance for
services, and they receive discounted prices for doing so. XYZ abruptly goes
out of business one year, declaring bankruptcy and leaving several unhappy
clients who had paid for services that they now have nowhere to go to receive.
Ever the optimist, Chelsea sees this as a business opportunity. With a generous
gift from her mother and a loan from a family friend, Chelsea refunds to her
favorite clients some the lost fees that they had prepaid to XYZ. She then
invites these clients to utilize her services in her own salon when she opens
it later in the year.
What are the
federal income tax consequences to Chelsea 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 Chelsea’s property,
at each stage of the transactions.
Explain.
(End of examination)
Created by:
bojack@lclark.edu
Update: 10 Jan 18
Expires: 31 Aug 19