Income Tax I
Bogdanski
Fall 2017

Sample Answers to Question 2

Exam No. 9443

Award

The watch that Chelsea (C) is awarded will be gross income for her of whatever the FMV of the watch is. The watch is not a gift as companies cannot gift to employees unless related and not on "bonus day", C's good standing is irrelevant - here it is clearly an 83 property as income and the she needs to declare as ordinary income whatever the FMV of the watch is on her taxes. C's basis in the watch will be the FMV/declared income amount - just in case she sells it for a gain later or uses it to settle some other debt. 

Single Parent/Nanny

C will get to claim Atticus (A) as a dependent as A meets the qualifications as C's child, lives with her more than half the year, younger than C, under 19, and doesn't support himself. If for some reason not in the facts that C and A's Dad agreed that the Dad would get the dependent exemption then that release would win, but it's presumed that C has the exemption as she has the custody. C can also use the Child Care Credit section 24, subject to phaseouts/phasedowns. C may also be able to use section 21 for a small amount depending on C's income being over 15k. Given that C pays 700/month alone for childcare alone it probably is. 

C is a single parent so she receives favorable head of household bracket rates for her gross income. C's nanny, Brittney (B) is not a deductible expense to C. Congress wants people to be responsible for their choice to have children. C has a responcility to rat on B to make sure B declares her income and at the rate C pays, she should probably issue B a W2. C should lobby the salon to provide an on site day care for A, so she could sack B and use the §129. 

Medical Expenses

C's medical expenses that are not covered by her employer's insurance plan would be deductible if they exceeded 10% of her AGI. As it is unclear how much her non-reimbursed, out of pocket expenses exceed 10% of her AGI I will assume that they don't and recommend she store up as much medical expenses as possible for a big year where she can take advantage of 213. The 2k she directs to pay the plan is under 105 and 106, under 105(b) expenses for medical care reimbursed are not income. The salon gets to deduct as a business expense the 2k it spends in providing C this benefit. 

House Calls

Right off the bat, commuting costs are not deductible to C, so her usual day of driving to and from work is not deductible. However, when C does her house calls there is a different result. When C does a house call from the salon (PPB) to a customer and back to the salon, that journey is deductible at 55 cents a mile I think which encompasses wear & tear on her car plus petrol, the parking expenses should also be deductible. For the days where C does a house call and then goes to her own home, I think that should also be considered deductible transport. Rather than messing about calculating miles and keeping track of it all, I would recommend C convince the salon to just reimburse her or provide a company card for the expenses as the salon can deduct them as business expense. C's deductions for transport are below the line so she needs to itemize to get them (maybe unlikely as facts say she has an apartment so she probably rents) and they are subject to the 2% misc deduction bar. 

Bankruptcy

The salons bankruptcy proceedings do not impact C's personal tax liability. She may qualify for some kind of unemployment benefits during the time she is out of work, or earned income credit if her income when her employer goes bankrupt and she takes a menial job in the meantime before starting her own company. 

Gift/Loan

The gift from C's mother is not income to C. The loan from a family friend is not income and is presumably a recourse loan meaning C will be personally liable for paying it back. C has no tax consequences at the point from the gift or loan. The facts don't indicate so I wont spend time on it, but if C needs to buy equipment for her start up company, which is likely because you can't run a salon without a chair, mirror, and other things, she should spend some time familiarizing herself with bonus depreciation, equipment depreciation schedules, and small business deprecations. She can get a lot of depreciation really quick. 

Welch Payments 

C is going for some good will here, and will want the Conway Twitty result rather that the Welch result. It seems like she may be heading for the Welch result of not ordinary and necessary, as she paid off her "favorite" clients lost fees rather than to everyone who was affected like Twitty did (admittedly, all his creditors were his friends also and he had Merle Haggard to be frightened of). C is looking forward rather than an incurred past expense. If C gets the Welch result she will not be able to deduct. However, there may be some hope for her in 195, new business start up expenses where there is an election between 5,000 and 15 year amortization. Maybe she could convince a judge to let her amortize the goodwill into her new company basis. I don't think she could get away with calling this advertising which would be deductible for her. 

Exam No. 9563

Debbie (D) and Chelsea (C) are not related and the watch was given to C as an award.  Section 102.c states items to from the employer shall not be excludable as gifts, nothing from your employer is a gift unless a fringe benefit.  This watch would therefore be income to C.  C could attempt to argue that this was a de minimis benefit but it does not appear to be as the watch was fashionable and custom-made.  The court would likely not buy that this watch was de minimis like having a donut from the break room in the morning. This the watch would be income to C on the FMV of the watch. This is ordinary income as she did not sell a capital asset. She received something, property. 

Because C is a single parent should would qualify as a head of household which has favorable tax rates. She also would get a child credit for having a child. Child care which enables one to go to work is not tax deductible. The problem states that C uses the nanny to watch her child while she is at work so there is no evidence that she uses the nanny for anything other than production of income. If her employer offered money for childcare the first 5k would be deductible under IRC 129. There is a tax credit for child care allowing one to go to work under IRC 21. FIrst the child must be a qualified child.  Here the child is the taxpayers child, the child lives with the taxpayer, the child is younger than the taxpayer as the taxpayer is the mother, the child is three years old and thus under the age of 13, since the child is three years old it is unlikely the child provides >50% of his own support.  Thus the child is a qualifying child. There is a tax credit for incurred expenses which is a percentage ranging from 35-20% dependent on the income of the taxpayer. There is also a tax credit cap for C of 3000 since she has one child.  The amount of the credit is amount of expenses (12X700) X the applicable percentage.  There is no evidence of an applicable Section 129 plan and thus double dipping is not a concern. C would have to disclose the SSN of Brittany the nanny in order to get the credit. 

C could potentially qualify for the Earned Income Credit, if she has low enough income because she works for this income. This is a complicated section and the benefit cuts out at a low level of income. 

C would get an exemption for the child because as stated above the child is a qualifying child, the relationship test of 152 is satisfied as the child is the son of the taxpayer, age of child is less than 19, so C would get a personal exemption for the child.  This is phased out at 287k for head of household.

On top of this credit is a Child Tax Credit IRC 24 that C gets just for the child being there, and the child not being 17 ears of age.  The credit is 1000 which phases out at 75k for single people and not indexed for inflation. 

Under Section 105(b) gross income does not include amounts which are paid directly or indirectly to the taxpayer to reimburse the taxpayer for expenses incurred by him or family for medical care.  As such the 2,000$ placed into this account is deductible from her gross income. The amount over the 2000 she spends on medical care, which is not paid by insurance, is deductible if she spends more than 10% of her AGI and then only the amount in excess of that 10% is deductible. medical care means diagnosis, cure, mitigation, prevention, or affecting any structure of the body. This is a below the line deduction so only itemizers get this deduction. This is a pretty hard benchmark to met and it is unlikely based on the facts that she will reach this level.

transportation expenses from home to work are not deductible.  However since the facts say she leaves from the salon this may be deductible. If she leaves from the salon and returns to the salon this is deductible. Under Rev Rule 99-5, if you leave from work, to an appointment for work, then leave from their home the expense is deductible. Based on the facts this appears to be tax deductible.  C can deduct these expenses if she keeps very good track of all expenses, or she can deduct the IRS standard mileage deduction of 53.5 cents per mile which is revised yearly. This covers wear and tear on the vehicle, maintenance and gas. She can further deduct the parking and any tolls she has. If the employer paid this directly the deduction would be above the line.  However, since the clients nor her employer pay these expense she must deduct them below the line and the deductions are subject to the 2% misc rule (IRC 67) of her AGI. a rough calculation shows she might be able to deduct 428 dollars for the use of her vehicle (without the parking fees), if she makes less than approximately 22,000 AGI. This seems like a low benchmark of earning and she is probably not going to be able to deduct this expense.  She should ask her employer to pay her directly or to provide a company car for her to use. 

The gift received by her mother for the startup of her salon is not excludable from income as a gift. However the startup of her salon requires all the startup expenses to be capitalized. the loan interest from the family friend may be deductible since it is a business loan and thus a business expense. Business interest is deductible as an above the line deduction under Section 62.a.1. 

Paying back the former client would not be allowed as an ordinary and necessary expense under Welch v Helvering Case. In this case the taxpayer was paying back debts of another similar business in order to keep the good will of the farmers.  It was held that this was not a necessary and ordinary deduction because people don't pay back debts they have no legal obligation to, in the business world. As such, C paying back the debts of her former company to which she had no ownership would not be allowed as a deduction as this even more removed from the Welch case. In Welch at least he was an officer of the company. C is not an officer and thus is less removed from being at fault. So she would not be able to deduct this expense. Further this would create a long term benefit of gaining clients and their good will. The Taxpayer should argue that this is deductible as a repair to the business, since she was the face of the former company, to these clients, she is repairing her reputation. Taxpayer should frame her argument highlighting the issues of the past as Jenkins v Commissioner did.  Here Jenkins was allowed to deduct the expenses of paying his friends and family back for their investment in a failed restaurant. It is very similar factually but the court allowed his deductions. He was trying to repair his reputation and not establish good will as in Welch. So taxpayer here should try and deduct them and then claim she was repairing her reputation from past clients.  She has a bigger hurdle to overcome since she was not an officer of the company but she was the face of the company to these customers. 

(Examplify crashed lost my train of thought)

Taxpayer could claim these are startup expenses and try and establish a basis. Since the basis in the startup is a long term benefit this would be a capital asset. 

Exam No. 9123

Salon Income and Watch:

The income C receives from Looks will be treated as ordinary income because it is for services rendered (IRC 61).  In addition, when C won the watch as employer of the year, this was not a gift that would be excluded from her income. Rather, she received the gift for the tremendous job she was doing, which means that it was property in receipt for services rendered.  The FMV of the watch is taxable as ordinary income as a result. 

Head-of-house hold and tax advantages of child:

Chelsea is a single parent, so she gets to take a head-of-household deduction if she chooses not to itemize and take the standard deduction because it is greater. In addition, she gets to take a dependent deduction of $4050 for her three-year-old son who she provides for because he clearly qualifies since he lives with her, is age 3, and does not provide for himself (IRC 152).  Also, the nanny that C hires allows her to be gainfully employed, so she is eligible for the child care tax credit (IRC 21) off her tax due equal to 35-20% of her employment related child care expenses.  However, the credit is capped at $3,000 for a taxpayer with 1 child, so she will not get a credit equal to the total expenses of the nanny off her tax liability.  Moreover, to get the child care credit under IRC 21, C will need to provide the nanny's SSN or taxpayer ID.  C is also eligible for the child credit under section 24, which will be $1,000 off her taxes due because her three-year-old son is a qualifying dependent, but phaseouts apply if C makes more than $75,000. 

Employer provided health insurance:

The $2,000 a year that C puts into the employer paid medical insurance trust is excluded from her gross income calculation as well. This is because the medical care payments are reimbursed and serve as employer provided health insurance, so the payments C makes into the trust are excluded from her income calculation.  However, the out-of-pocket medical expenses that are not covered by the employer's plan will have to be itemized as a below the line deduction and are subject to the 10% floor of her AGI. If C takes the head-of-household standardized deduction she will not get to itemize her deductions and deduct the medical expenses not covered by her employer.

Commuting:

C's commuting costs to the salon from her home are not deductible because those costs are considered personal in nature. However, when C drives from the salon to house calls, the mileage will be deductible because that is considered a necessary and ordinary business expense to get to a temporary business location (the deduction is 53 cents for every business mile driven); this also includes the parking expenses. That being said, when C drives back to her residence from the house calls, that mileage will be deductible .  It must be noted that these are unreimbursed employee business expenses, so they are below-the-line itemized deductions (IRC 67) subject the 2% floor of C's AGI.  C will not get to take these deductions if she chooses the head-of-household standard deduction.

New Business:

The generous gift from her mother and the loan from her friend to start her own business are not taxable income because the first was a gift and second was debt that C will have to pay back. With regards to the refunds, this situation is similar to the country music singer case; however, it is distinguishable.  The refunds will not be immediately deductible as an ordinary and necessary business expense because the cost of building a reputation for the future that makes C's own, new business more likely to be successful is a capital expenditure that must be depreciated.