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Taxation Memorandum

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Problem

Carol and Jerry, LLP, pays the Good Eats Cafe each month for the lunches the two accountants eat there each work day. While at lunch, Carol and Jerry always discuss some business. Often Carol and Jerry invite friends who work at another CPA firms to join them, so they can keep up with what is happening in the accounting community. Are these meals deductible?

Requirement:
Develop a tax file memorandum for a client based on the information in scenario above.

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Solution Preview

The problem with this scenario is that we have the use of the word "some." While at lunch, the two accountants discuss "some" business. They also invite friends at times, who are colleagues, so they can "keep up with what is happening." Due to the way that this ...

Solution Summary

This solution explains how the student should develop a memorandum for the client based on the information in the tax scenario given. The issues are identified and the related tax laws are discussed.

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Taxation Memo: KimTech's sole shareholder compensation. Is it reasonable?

I need help getting started in the right direction.

ASSIGNMENT
Write a memorandum addressing each of the three issues listed below.

FACTS
Mr. Kim is the sole shareholder and CEO of KimTech, Inc., a technology company valued at approximately $5,000,000. KimTech is a C corporation for federal tax purposes. In 2007, KimTech had net pretax profits--before deducting Kim's compensation--of $1,000,000. After deducting Kim's base salary of $100,000 and bonus of $800,000, the company was left with a small after-tax profit, which was retained by KimTech (i.e., no dividends were paid to Kim). KimTech has two other officers, a CFO and a VP of Sales and Marketing, each of whom received salaries of $100,000 and no bonuses. Kim's bonus was awarded by the board of directors, which consists of three directors: Kim, who serves as Chairman, the CFO and the VP of Sales and Marketing. In determining Kim's bonus, the board multiplied pretax profits, before Kim's compensation, by 80% (i.e., $1,000,000 x .8 = $800,000 bonus). In recent years, KimTech's value has been appreciating at 7% per year. Assume that the average compensation for CEOs of similar-sized companies in the same industry is $500,000 (salary and bonus combined).

APPLICABLE LAW
Use the typical tax resources both primary and secondary which include statutes, regulations, and court decisions to formulate your advice regarding each of the three issues listed below:

ISSUES

1. Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim's compensation package in light of the five factors enumerated in the Elliotts case. If audited by the IRS, will Kim's compensation be deemed reasonable? Why or why not? What can KimTech do to show that Kim's compensation is reasonable?

2. Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim's compensation using the independent investor/return on equity approach. Is Kim's compensation package reasonable under this test? Why or why not?

3. Is contingent compensation (e.g., a compensation package involving a significant bonus) more likely to result in a determination that compensation is unreasonable than a compensation package that is all, or primarily, a fixed salary?

FORMAT
Use the following heading and other specifics:

MEMORANDUM
TO: Mr. Kim
FROM: Your Name
DATE: Today's Date
RE: Tax Memo #2-Executive Compensation

For each issue, begin by restating the issue. Then, explain and discuss the tax rules that apply to the issue, which you gleaned from the sources listed in the Applicable Law section above. Then, conclude with a definitive answer to the issue, supported by citations to the sources used. So, for each issue, you should:

1. State the issue,
2. Explain and discuss the applicable law (IRC sections, regulations, court decision, etc.), and
3. Present your answer in the form of a concluding paragraph that refers to specific language from the IRC sections, regulations, court decisions, and other sources (if applicable) to support the conclusion.

CITATIONS
Citations are required. You must provide cites whenever you refer to the sources of tax law used in this memorandum. You may cite your sources in numbered footnotes, numbered endnotes, or in parentheses immediately after the sentence mentioning the cited source.

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