You Decide 1

Memo To:John & Jane Smith From: Re:Memo summarizing various tax issues 1. John Smith’s tax issues: Issue a) How is the $300,000 treated for purposes of federal tax income? Applicable Law ; Analysis: http://www. irs. gov/businesses/small/selfemployed/index. html Conclusion: The $300,000 will be treated as self- employed income. Generally you are self-employed if you carry on a trade or business as a sole proprietor, independent contractor, or if you are a member of a partnership. Self-employed individuals are required to file an annual return, and pay estimated tax quarterly.

Issue b) How is the $25,000 treated for purposes of federal tax income? Applicable Law ; Analysis: www. irs. gov Conclusion: The $25,000 will be treated as self- employed income as well. John was awarded the 25,000 that paid up front expenses, so the number will cancel each other out. Issue c) What is your determination regarding reducing the taxable amount of income for both (a) and (b) above? Applicable Law ; Analysis: http://www. efile. com/tax-credit/federal-tax-credits/. Publication 526- Charitable contributions. Section 170-charitable contributions and gifts ( c).

Section 48- energy credit Conclusion: Establish a self- employed retirement plan, make IRA contributions, make charitable donations including asset donations according to organizations described in section 501 (c)(3), make energy efficient improvement to the home according to IRC code 48. Issue d) Do I get better tax benefits for paying the lease on office space or for buying the building? What are the differences? Applicable Law ; Analysis: IRC Code 167- there should be allowable reasonable depreciation for wear and tear on property used in the trade or business. http://www. law. cornell. edu). http://www. microsoft. com/business. IRC Code 179-allows tax payers to deduct the cost on certain types of property. Conclusion: There are better tax benefits for buying the building. Owners of rental property can write of repairs immediately. Deprecation on commercial buildings is taken over 39 years; you can also deduct interest on the purchase loan, property tax, and other qualifying expenses. (www. microsoft. com/business). The total amount you can deduct under section 179 cannot be more than $500,000. (www. irs. gov).

When leasing a building, the monthly lease payment is tax deductible, but the tax payer cannot deduct interest, property tax, or depreciate. 2. Jane Smith tax issues: Issue a) What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for federal income tax purposes? Applicable Law ; Analysis: www. law. cornell. edu Conclusion: Satisfying the mortgage will cancel tax deductions for that mortgage loan. Without the mortgage interest, a customer could be placed in a higher tax bracket. This will cause the tax payer to possible owe more money.

Assuming a new mortgage have benefits rather than consequences. Issue b) Can John and Jane Smith utilize a 1031 tax exchange to buy a more expensive house using additional money from John’s case? Applicable Law & Analysis: IRC code 1031. The IRC code 1031 allows deferral of taxes on the exchange of two assets. IRC code 1031 also allows one to sell an asset with the intension to use proceeds to invest in a like asset. (http://financial-dictionary. thefreedictionary. com/Internal+Revenue+Code+section+1031) Conclusion: John and Jane cannot utilize a 1031 tax exchange.

Owners of investments and business property may qualify for a section 1031 deferral. Both properties in the exchange must be held for use in a trade or business or for investment. Property used primarily for personal use does not qualify for like-kind exchange treatment. Issue c) Does Jane have a business or hobby? Why is this distinction important? Applicable Law & Analysis: IRC code 183. The IRC code 183 is also called the “hobby loss rule”, it minimize losses that can be deducted from income from hobbies or other non-profit activities.

Conclusion: Jane has a business. If time and effort put into the activity is intended to make a profit, this is considered a business. Business versus hobby is important because taxpayers who incorrectly report losses from hobby activities can be subject to additional taxes, interest and penalties in an audit (http://www. irsvideos. gov/Professional/HobbyBusiness) Issue d) Would Jane (and John) realize better tax benefits if she had a separate business for her jewelry-making activities? Applicable Law & Analysis: www. irs. gov

Conclusion: Jane and John would have better tax benefits if Jane had a separate business for her jewelry- making activities. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year; this could include the cost of material. Jane can also deduct expenses for the business use of her home. Jane can also deduct car expenses mileage rates from 1/1/11-6/30/11 is . 51 per mile and from 7/1/11-12/31/11 . 55 per mile (www. irs. gov) Issue e) What tax benefits would John realize if he invested $15,000 in Jane’s jewelry making? Applicable Law ; Analysis: http://perlmutter. house. ov/index. php? option=com_content;view=article;id=707;Itemid=88- Business tax benefits under the recovery act. Conclusion: Small Business Investment: Spurs investments in small businesses by cutting the capital gains tax on investors in small businesses who buy stock (in the next two years) and hold it for more than 5 years. (www. perlmutter. house. gov) Issue f) Can Jane depreciate her vehicle or jewelry-making equipment? How? Applicable Law ; Analysis: Section 179. Section 179 allows business to deduct the full purchase price of equipment purchased or financed during the tax year. (www. section179. org)

Conclusion: Section 179 deduction enables small businesses to deduct up to $250,000 of the cost of machinery, equipment, vehicles and furniture. To qualify for the section 179 deduction, your property must have been acquired for use in your trade or business. (http://www. irs. gov/businesses/small/article/0,,id=213666,00. html). The total depreciation deduction (including the section 179 expense deduction) you can take for a passenger automobile (that is not a truck or a van) that you use in your business and first placed in service in 2009 is $2,960 ($10,960 for automobiles for which the special depreciation allowance applies. www. irs. gov) 3. John and Jane Smith tax issue: Issue a) Should John and Jane file separate or joint tax returns? Applicable Law ; Analysis: IRC Code 1- The law that impose federal income tax on income, and sets the amount of tax to be paid. Conclusion: Married individuals filing joint returns will pay $75,528. 50 plus 39. 6% of income over $250,000. If Jane establishes her activities as a trade or business they would have to pay less in taxes.