John Smith - I worked on this case for over two years. The jury awarded my client $2,000,000 in damages, of which my fee was $300,000 plus recovery of expenses paid up front in the amount of $25,000. How is the $300,000 taxed? What about the $25,000? What can I do to minimize the tax consequences of each? Also, I am thinking about buying the building that I currently lease my office space in. My current lease is $3,500 per month. How is this lease reported on my income tax returns (either personally or for my business which is a separate law practice established as an LLC)? Do I get better tax benefits for paying the lease or for buying the building? What are the differences?
1. How is the $300,000 treated for purposes of Federal tax income?
2. How is the $25,000 treated for purposes of Federal tax income?
3. What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
How is the $300,000 taxed?
The $300,000 is earned income for John Smith and will be reported as gross income either on Schedule C of the individual return or as gross income on the LLC return. The reason why it could be either is a result of the variance in state laws as to whether a single person LLC can report on a business return or not. For the states that don't allow separate reporting, the LLC is said to be 'transparent' meaning it does not report separately from the individual.
What about the $25,000?
The $25,000 advanced for expenses would have been classified as a client advance (on the balance sheet) two years ago. It would not have been reported as a deductible expense following the matching principle. In the current year when the $25,000 is reimbursed, the revenue minus the expense equal to zero. In other words, there is no net income to report as taxable.
I should note that it is possible that John Smith might have ...
In a 665 word solution, each question is carefully discussed and answered.
Taxable income for an individual is defined as
Please some help with the attached questions. Would be greatly appreciated.
1. Taxable income for an individual is defined as:
a. AGI reduced by itemized deductions.
b. AGI reduced by personal and dependency exemptions.
c. total income reduced by deductions for AGI.
d. AGI reduced by deductions from AGI and personal and dependency exemptions.
2. All of the following items are generally excluded from income except
a. child support payments.
b. interest on corporate bonds.
c. interest on state and local government bonds.
d. life insurance proceeds paid by reason of death.
3. All of the following items are deductions for adjusted gross income except
b. trade or business expenses.
c. rent and royalty expenses.
d. state and local income taxes.
4. All of the following items are deductions for adjusted gross income except
a. moving expenses.
b. unreimbursed employee business expenses.
c. contributions to medical savings accounts.
d. one-half of self-employment taxes paid.
5. Which of the following credits is considered a refundable credit?
a. child and dependent care credit
b. earned income credit
c. adoption expense credit
d. credit for the elderly
6. The standard deduction is unavailable to all of the following taxpayers except
a. resident aliens.
b. nonresident aliens.
c. an individual filing a return for a period of less than 12 months.
d. a married taxpayer filing a separate return when the other spouse itemizes.
7. The regular standard deduction amount is available to which one of the following taxpayers?
a. Married taxpayer filing a separate return where the other spouse itemizes.
b. A person who has only unearned income and is a dependent of another.
c. An individual filing a return for a period of less than 12 months because of a change in accounting period.
d. An abandoned spouse.
8. Lewis, who is single, is claimed as a dependent on his parents' tax return. He received $1,000 during the year in dividends, which was his only income. What is his standard deduction?
9. Charlie is claimed as a dependent on his parents' tax return. He received $750 during the year in dividends, which was his only income. What is his standard deduction?
10. To qualify as an abandoned spouse, the taxpayer is not required to
a. be a U.S. citizen or resident.
b. live apart from the spouse for the last six months of the year.
c. pay more than half the cost of maintaining the home.
d. have a son or daughter in the home for the entire year.
11. In October 2005, Joy and Paul separated and have not lived with each other since. Joy supports their children after the separation and pays the cost of maintaining their home. Joy's filing status in 2005 and 2006 is, respectively,
a. single for both years.
b. head of household and single.
c. married filing separately for both years.
d. married filing separately and head of household.
12. Which one of the following items is not considered gross income for tax purposes?
a. gambling winnings
b. illegal income
c. life insurance proceeds
d. forgiveness of loan
13. Frasier and Marcella, husband and wife, file separate returns. Frasier and Marcella live in a community property state that considers separate property income to be separate. Frasier's salary is $32,000 and Marcella's salary is $35,000. Marcella receives dividend income of $4,000 from stock inherited from her parents. Frasier receives interest income of $5,000 from bonds purchased with his salary after marriage. Frasier and Marcella receive $10,000 dividend income from stock they purchased jointly. Marcella's income would be
14. Bill and Hillary, husband and wife, file separate returns. Bill and Hillary live in a community property state that considers separate property income to be community income. Bill's salary is $32,000 and Hillary's salary is $36,000. Hillary receives dividend income of $4,000 from stock inherited from her parents. Bill receives interest income of $5,000 from bonds purchased with his salary after marriage. Bill and Hillary receive $10,000 dividend income from stock they purchased jointly. Hillary's income would be
15. All of the following statements are true except
a. Under the cash method, prepaid income such as rent is usually taxed when received rather than when earned.
b. The annual increase in the cash surrender value of life insurance is taxable.
c. Interest on Series EE savings bonds is not taxable until maturity.
d. All of the above statements are true.
16. Examples of income which are constructively received include all of the following except
a. interest credited to a savings account.
b. a check received after banking hours.
c. a paycheck received from employer, when employer does not have funds in the bank to cover the check.
d. dividends available on December 31; unclaimed dividends will be mailed out.
17. Ms. Marple's books and records reflect the following information:
Salary earned this year $65,000
Interest on savings account (credited to her
account this year, withdrawn next year) 1,800
Interest on county bonds earned and collected this year 2,000
Interest on savings account (credited to her account
last year, withdrawn this year) 200
What is the amount Ms. Marple should include in her gross income this year?
18. Alex is a calendar year sole proprietor. He began business on December 1, this year. He uses the accrual method of accounting. Alex had the following collections in December.
Collected $7,000 in December, from clients who paid cash for services to be
performed next year.
Collected $5,000 in December, for services performed during December; deposited
in an operating account on December 31, this year.
Collected $9,000 in December; on accounts receivable for services performed in
December; deposited in operating account on January 2, next year.
What is the amount Alex must include in his income for December?
19. All of the following are excluded from taxable income as a fringe benefit except:
a. Christmas bonus check.
b. group term life insurance.
c. employee discount.
d. contribution to retirement plans.
20. Which of the following bonds do not generate tax exempt Federal income?
a. U.S. Treasury bonds
b. bonds issued by fire districts
c. school district bonds
d. bonds issued by port authorities
21. In December 2006, Max, a cash basis taxpayer, rents an apartment to Charlie. Max receives both the first and last months' rent totaling $1,000 plus a security deposit of $400. The amount of income reported as taxable in 2006 is:
22. Rocky, an accrual basis taxpayer, leases out an office building at $1,000 per month, starting in October. Rocky receives rent for October and November. He also charges a refundable security deposit of $800 which he also received in October. Rocky's tenant does not pay the December rent until January 2, of next year. This year, Rocky must report rental income of
23. Which of the following is not included in gross income when received?
a. prepaid rent
b. mineral rights
c. amounts received to cancel or modify a lease
d. refundable security deposit
24. Professor Jones rents property and does not provide any services associated with the rentals. He is also a cash basis taxpayer. If Professor Jones collects advanced rent of $3,600 on October 1 of this year for a one-year lease, how much is reported as income on this year's tax return?
25. Which of the following is not excluded from income? (Assume that any amounts received by the taxpayer were kept).
a. public assistance payments
b. fair market value of prize won on a game show
c. qualified adoption expenses paid by the employer
d. life insurance proceeds paid by reason of death
26. During the year, Cathy received the following:
? Dividends of $1,000 from Lindsay corporation. Cathy's father owned the stock and directed the corporation to send the dividends to Cathy.
? A car worth $20,000 for being the 100th customer at a car dealership.
? $2,500 cash gift from her uncle.
? $10,000 inheritance from her grandmother.
What amount must Cathy include in gross income?
27. Bette is beneficiary of a $80,000 insurance policy on her father's life. Upon his death, she may elect to receive the proceeds in five yearly installments of $17,500 or may take $80,000 lump sum. She elects to take the $80,000 lump sum payment. What are the tax consequences in year one?
a. All $17,500 each year is taxable.
b. $7,500 interest is taxable in the first year.
c. There is no taxable income.
d. $1,500 of the $17,500 payment is taxable each year.
28. Bert transfers a $150,000 life insurance policy to a partnership in which Bert is a partner. Subsequent to Bert's transfer, the partnership pays $10,000 of premiums before Bert's death. How much of the insurance proceeds of $150,000 is includable in income?
29. Albert paid $45,000 in premiums on an endowment life insurance policy with a face value of $80,000. Upon reaching 65, Albert collected the face value of the policy. In the year of collection, Albert will report
a. no income.
b. $35,000 of taxable income.
c. $45,000 of taxable income.
d. $80,000 of taxable income.
30. Hope receives a $8,500 per year scholarship from State University. The university specifies that $5,500 is for tuition, books, supplies, and equipment, while $3,000 is for room and board. In addition, Hope works part time at the campus library and earns $5,000 to cover other expenses. Hope's gross income is
31. Donovan was in an automobile accident while he was going to work. The doctor advised him to stay home for eight months due to his physical injuries. The resulting lawsuit was settled and Donovan received the following amounts:
Compensatory damages for physical injury $30,000
Punitive damages 55,000
How much of the settlement must Donovan include in ordinary income on his tax return?
a. $ 0
32. John Black, a police officer, was injured in the line of duty. He received the following during 2006:
Workers' compensation 5,000
Compensatory damages for physical injury 18,000
Punitive damages for physical injury 14,000
Cash reward for preventing a break-in 2,000
What is the amount that is taxable in 2006?
33. FlyJet (an airline) and Fly and Stay (a corporation which owns a hotel chain, StayHere, and an airline) have an agreement which allows employees of either company to utilize, at no charge, services provided by the other company. Employees of both are allowed to fly standby on either airline for no charge; employees of both are allowed to stay at any StayHere hotel at no charge as long as there are empty rooms available. Sofia Carlino is an airline attendant with Fly and Stay. In July 2006, she flew on standby to Los Angeles on FlyJet at no cost. (The cost of the flight to paying customers was $450.) She also stayed at no charge in an unoccupied room owned by Fly and Stay. The regular room charge is $180 per night. How much must Sofia include in her gross income for 2006 as a result of these actions?
34. Charlie Drilling is an off shore exploration and production company. Charlie requires its employees to be on 24 hour call and consequently gives them $800 per month housing allowance and a $200 per month food allowance. Rocky, an employee of Charlie, receives a salary of $40,000 per year (this does not include the allowances). Rocky will be taxed each year on
35. Three years ago, Joseph purchased stock of a newly formed corporation for $32,000. During the current year, he receives a $40,000 distribution, constituting a return of capital, from the corporation. What is the amount of Joseph's realized gain and the basis in his stock after the distribution?
Realized gain Basis of stock
a. $0 $(8,000)
b. $8,000 $32,000
c. $8,000 $0
d. $8,000 ($8,000)
36. Will exchanges a building with a FMV of $80,000, a basis of $35,000, and subject to a liability of $30,000 for land with a FMV of $50,000 owned by Will. The amount realized by Will is
37. Jack exchanged land with an adjusted basis of $65,000 subject to a liability of $22,000 for $50,000 (FMV) of stock owned by Hayden. Hayden takes the land subject to the liability. Jack incurs $500 of selling expenses. What is the amount of Jack's realized gain on the exchange?
a. ($14,000) loss
b. ($14,500) loss
c. $6,500 gain
d. $7,000 gain
38. Michelle purchased her home for $150,000, and subsequently added a garage costing $25,000 and a new porch costing $5,000. Repairs to the home's plumbing cost $1,000. The adjusted basis in the home is
39. Which one of the following does not affect the adjusted basis of a house held as rental property?
a. depreciation deduction
b. adding a new room to the house
c. painting of more than 50% of the rooms in the home
d. installation of a completely new plumbing system
40. Jordan paid $30,000 for equipment two years ago and has claimed depreciation deductions of $15,600 for the two years. The cost of repairs during the same time period was $2,000 while a major overhaul which extended the life of the equipment cost $7,000. What is Jordan's basis in the equipment at the end of the two-year period?
41. Mr. Dennis, sole proprietor of Dennis Company, purchased a machine for use in his business. Mr. Dennis' costs in connection with this purchase were as follows:
Note to seller $33,000
Cash paid to seller 5,000
State sales tax 2,400
Freight to place of business 1,500
Wages paid to workers to install machine 4,200
What is the amount of Mr. Dennis' basis in the machine?
42. Kathleen received land as a gift from her grandfather. At the time of the gift, the land had a FMV of $85,000 and an adjusted basis of $110,000 to Kathleen's grandfather. One year later, Kathleen sold the land for $105,000. What was her gain or (loss) on this transaction?
a. No gain or loss
b. ($ 5,000)
43. Kathleen received land as a gift from her grandfather. At the time of the gift, the land had a FMV of $85,000 and an adjusted basis of $110,000 to Kathleen's grandfather. One year later, Kathleen sold the land for $105,000. What was her gain or (loss) on this transaction?
a. No gain or loss
b. ($ 5,000)
44. Dale gave property with a basis of $1,600 to Sarah when it had a FMV of $1,200. Sarah later sold the property for $2,200 resulting in a recognized gain of
45. Mr. Moore inherited 1,000 shares of Corporation Zero stock from his father who died on March 4, of the current year. His father paid $30 per share for the stock on September 2, 1975. The FMV of the stock on the date of death was $50 per share. On September 4 this year, the FMV of the stock was $55 per share. Mr. Moore sold the stock for $65 per share on December 3. What is the amount and nature of any gain or loss?
a. $ 10,000 LTCG
b. $ 10,000 STCG
c. $ 15,000 LTCG
d. $ 15,000 STCG
46. Christine purchases a personal residence for $78,000 but subsequently converts the property to rental property when its FMV is $75,000. Assume depreciation of $15,000 has been deducted after conversion to rental use. If Christine sells the property for $58,000, her gain or loss will be
a. ($2,000) loss.
b. ($5,000) loss.
c. ($17,000) loss.
d. ($20,000) loss.
47. Jamie sells investment real estate for $60,000, resulting in a $15,000 loss. Jamie's loss is
a. an ordinary loss.
b. a capital loss.
c. a Sec. 1231 loss.
d. a Sec. 1244 loss.
48. Jamie has a casualty loss of $2,500 on investment property, after receiving an insurance settlement. This is Jamie's only casualty transaction this year. Jamie's loss is
a. an ordinary loss.
b. a capital loss.
c. a Sec. 1231 loss.
d. a Sec. 1244 loss.
49. All of the following are true of losses from the sale or worthlessness of small business corporation (Section 1244) stock with the exception of
a. the stock must be owned by an individual or a partnership.
b. the stock must have been issued by a domestic corporation.
c. the stock must have been issued for cash or property other than stock or securities.
d. a single taxpayer may deduct, as ordinary losses, up to a maximum of $100,000 per tax year with the remainder treated as capital losses.
50. Shirley, who is married and sole shareholder of ABC Corporation, sold all of her stock in the corporation for $100,000. Shirley had organized the corporation in 1990 by contributing $225,000 and receiving all of the capital stock of the corporation. ABC Corporation is a domestic corporation engaged in the manufacturing of ski parkas. The stock in ABC Corporation qualified as Sec. 1244 stock. The sale results in a (n)
a. ordinary loss of $125,000.
b. long term capital loss of $125,000.
c. long term capital loss of $100,000 and ordinary loss of $25,000.
d. ordinary loss of $100,000 and long term capital loss of $25,000.