Tax Research Assignment

Research Case 11-1

For the case of Sarah who came home one day to find significant water damage to her home as a result of the hose of the washing being worn out and split spitting water over the place and in the next several months mildew appearing, Sarah is entitled to casualty loss deduction having that she also does not have a homeowners insurance which would have covered the damage costs. In this case, we must determine whether Sarah is entitled to a casualty loss deduction and what is covered under this deduction that she can claim deduction for. If ones home or property is damaged due to fire, earthquake, flood, hurricane or vandalism, one is allowed by the IRS to take a deduction for the loss. For this event to be deductible as a casualty loss the tax payer in this case Sarah has to prove that the damage, loss was destroyed by a sudden, unexpected or unusual event. According to the Current Internal Revenue Code, SEC. 165. LOSSES. Section 165(a) 1 allows as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 165(c)limits the allowance of losses in the cases of individuals. Section 165(c) (3) allows as a deduction to an individual certain losses commonly referred to as casualty losses. A casualty loss is allowable to an individual for a loss of property not connected with a trade or business or with a transaction entered into for profit if the loss results from fire, storm, shipwreck, or other casualty, subject to limitations set forth in section 165(h). The damage to petitioner's home and personal belongings directly resulted from the failure of the washing machine hose. The water damage to petitioner's house and personal belongings was the result of an identifiable event, sudden in nature. The failure of the hose was the precipitating event, and the flooding immediately thereafter was proximately caused by the event. The damage resulting from the flood in the house is a casualty within the meaning of section 165(c)(3). The Commissioner has recognized the distinction between damage to equipment, which was gradual and consequential damage resulting from failure of the equipment. In Rev. Rul. 70-91, 1970-1 C.B. 37, the Commissioner held as follows: A taxpayer suffered rust and water damage to his rugs, carpets, and drapes when the water heater in his one-story dwelling burst from normal deterioration (rust and corrosion) over a period of time and flooded a portion of the house with water. The taxpayer had no insurance to reimburse him for these losses. Held, since the rust and corrosion of the water heater itself was gradual and progressive; its loss is not a casualty within the meaning of section of the Internal Revenue Code of 1954. Held further, the rust and water damage to the rugs, carpets, and drapes caused by the bursting of the water heater was the result of an identifiable event, sudden in nature, fixing a point at which the loss to the damaged property can be measured, and was also unexpected or unusual in the context in which the damage occurred. Therefore, such damage is a casualty within the meaning of section 165(c)(3) of the Code, and the taxpayer is entitled to a nonbusiness casualty loss deduction. The amount of the damage is the lesser of either (1) the difference between the fair market value of the property immediately before and immediately after the casualty, or (2) the adjusted basis of the property. That amount reduced by $100 is allowable as a casualty loss deduction.
(Source : Tax Court Small Tax Cases (Archive), Pamela S. Cooper v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2003-168, (Dec. 17, 2002 )Pamela S. Cooper v. Commissioner. Docket No. 8859-02S . Filed December 17, 2003.)

Research Case 11-2

Richie is a wealthy rancher who operates his ranch through a grantor trust set up by his grandparents. Due to not liking his hands to get dirty, he hired a professional management company to run the ranch. At the end of the year the property generated a $500,000 loss. We have to determine whether Richie can deduct this loss on his schedule E given the material participation rules of 469. Yes Richie can deduct this loss on his schedule E given the material participation rules of 469. According to Tax Research Consultant, BUSEXP: 33,162,Estates and Trusts and Material Participation Under Passive Activity Rules, An estate or trust is deemed to materially participate in an activity if an executor or other fiduciary, in his capacity as such, materially participates in the activity. 1 In the case of a grantor trust, material participation is determined from the grantor's participation.2 According to section 469, says that a trust is a taxpayer, I.R.C. 469(a)(2)(A), and that a taxpayer is treated as materially participating in a business if its activities in pursuit of that business are regular, continuous, and substantial, id. 469(h)(1). To assert this conclusion let us look at The Mattie K. Carter Trust, by Benjamin J. Fortson, Jr., Trustee, Plaintiff v. United States of America, Defendant. U.S. District Court, North. Dist. Tex.;4:02-CV-154-A, 256 FSupp2d 536, April 11, 2003, 256 FSupp2d 536 , the district court ruled that a testamentary trust materially participated in a ranching business when its fiduciaries, employees, and agents collectively performed activities that were regular, continuous, and substantial. This is further supported by code Sec 469 itself which regards the "material participation" of a testamentary trust in a ranching business had to be determined by addressing the activities of the trust through its fiduciaries, employees, and agents, and not to be decided by evaluating only the activities of the trustee. The plain meaning of Code Sec. 469 dictates that the trust itself was the taxpayer, and its participation in the ranch operations had to be evaluated by reference to the persons who conducted the business on its behalf, including the trustee. Because the collective activities of those persons were regular, continuous, and substantial, the material participation requirement was satisfied. Moreover, the trustee's activities, standing alone, constituted material participation. The court rejected the IRS's position that only the trustee's activities are taken into account in determining whether the trust materially participates in a business. The court also found that the trustee did materially participate in the ranching business. 3 Thus, the trust's ranching loss deductions were improperly disallowed as passive activity losses and it was entitled to a refund of the overpaid taxes, with interest. Back reference: 21,966.53.( http://intelliconnect.cch.com.lib.kaplan.edu/scion/secure/ctx_contentbus_kaplan_edu_AC560_1202D_page_pHBfhjCa6Xs08ZXdiSKHIA_1_htm/index.jsp?cpid=WKUS-TAA-IC#page[5])

So we can use this case a precedent in advising Richie that within the rules of material participation 469 he is allowed to deduct the losses incurred in the year on his schedule E.

1
2

Senate Committee Report to P.L. 99-514 (1986), S. Rep. No. 99-313. Senate Committee Report to P.L. 99-514 (1986), S. Rep. No. 99-313; Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 100th Cong., 2d Sess. 242 (1987). 3 Tax Research Consultant,BUSEXP: 33,162,Estates and Trusts and Material Participation Under Passive Activity Rules

Research Case 11-5

Sally works under a one -year contract assigned nearby her home which is affirmed in the current years contract but incurs a 90 -mile roundtrip commute to a different office due to working conditions in relation to her supervisor which management has allowed her to do this. How many deductible commuting miles does sally accumulate on a work day? It is important to establish whether Sallys commuting expenses are deductible and if so the change in location would affect the miles to be deducted. In general, daily transportation expenses incurred in going between an employees residence and a work location are nondeductible commuting expenses. However, Rev. Rul. 99-7 provides an exception to this general rule for an employee who, in working for an employer, has one or more regular work locations away from the employees residence: Daily transportation expenses incurred in going between the employees residence and a temporary work location (for the employer) are deductible business expenses. Rev. Rul. 99-7 establishes three rules for determining whether a work location is a temporary work location for these purposes: -- If employment at a work location is realistically expected to last (and does in fact last) for 1 year or less, the employment is temporary in the absence of facts and circumstances indicating otherwise. -- If employment at a work location is realistically expected to last for more than 1 year or there is no realistic expectation that the employment will last for 1 year or less, the employment is not temporary, regardless of whether it actually exceeds 1 year. -- If employment at a work location initially is realistically expected to last for 1 year or less, but at some later date the employment is realistically expected to exceed 1 year, that employment will be treated as temporary (in the absence of facts and circumstances indicating otherwise) until the date that the realistic expectation changes, and will be treated as not temporary after that date. (Source: Chief Counsel Advice Memorandum,UIL No. 162.08-06 Trade or business (Deductible v. not deductible), Travel (See also issues 162.12-06 and 162.13-03), Commuting, Chief Counsel Advice 200018052 ,Internal Revenue Service,(Mar. 10, 2000) A taxpayer who works or performs services at a regular place or places of business may deduct daily transportation costs of travel between the taxpayer's residence and a temporary work location, regardless of the distance. 4 Some courts have made an exception to the general rule against the deductibility of commuting expenses and allowed a deduction for transportation expenses incurred by a taxpayer in traveling unusually long distances to a job that is temporary, as opposed to indefinite, in duration. See, e.g., Peurifoy v. Commissioner [ 58-2 USTC 9925], 358 U. S. 59, 60 (1958); Boone v. United States, supra at 419; Sanders v. Commissioner, supra at 298.As such Sally is eligible to deduct the total commuting miles she incurs round-trip on her work day regardless of the office she commutes to as it is the same company , same work being done and still a temporary assignment.

J.E. Epperson v Commr, 50 TCM 561, Dec. 42,264(M), TC Memo. 1985-382; N. Ellwein v US, CA-8, 85-2 USTC 9853, 778 F2d (Tax Research Consultant, BUSEXP: 24,458.10, Commuting to Temporary Job).

Advanced Case 11-43

According to the IRS has ruled that, when interests in no statutory stock options and nonqualified deferred compensation are transferred from an employee spouse to his or her former spouse (the nonemployee spouse) pursuant to their divorce, the transfer does not result in a payment of wages for purposes of the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA). However, there are FICA and FUTA tax consequences when the options are eventually exercised or the nonqualified deferred compensation is paid or made available.5 A previous ruling made by the IRS (Rev. Rul. 2002-22) on the income tax treatment of such transfers of non statutory stock options and non qualified compensation gives an idea of when tax consequences would result after such a transfer. Under that ruling, an employee spouse is not required to include amounts in gross income upon the transfer of interests in non statutory stock options and nonqualified deferred compensation to his or her former spouse (the nonemployee spouse) incident to their divorce. After the transfer, the income tax consequences shift to the nonemployee spouse who essentially steps into the shoes of the employee spouse. Amounts are not included in the nonemployee spouse's gross income until the stock options are exercised or the deferred compensation is paid or made available to the nonemployee spouse. With respect to income tax withholding, income realized by the nonemployee spouse upon the exercise of the non statutory stock options and amounts distributed to the nonemployee spouse from the nonqualified deferred compensation plans are considered wages subject to income tax withholding. Prior to their divorce in 2002, A and B were married individuals residing in State X who used the cash receipts and disbursements method of accounting. 6 Under the Revenue Ruling 2002-22, I.R.B. 2002-19, 849, May 8, 2002. , Example is cited of a case scenario to better understand the laws applicable in regards to question provided, A is employed by Corporation Y. Prior to the divorce, Y issued non statutory stock options to A as part of As compensation. The non statutory stock options did not have a readily ascertainable fair market value within the meaning of 1.83-7(b) of the Income Tax Regulations at the time granted to A, and thus no amount was included in As gross income with respect to those options at the time of grant.Y maintains two unfunded, nonqualified deferred compensation plans under which A earns the right to receive post-employment payments from Y. Under one of the deferred compensation plans, participants are entitled to payments based on the balance of individual accounts of the kind described in 31.3121(v)(2)-1(c)(1)(ii) of the
5

Tax Research Consultant,SALES: 39,266,Transfers of Property Between Former Spouses Incident to Divorce http://intelliconnect.cch.com.lib.kaplan.edu/scion/secure/ctx_TRUE/index.jsp?cpid=WKUS-TAA-IC#page[26]

Standard Federal Tax Reporter (2002), 2002FED 46,461, Transfers of property: Transfers incident to divorce: Nonstatutory stock options: Nonqualified deferred compensation: FICA: FUTA: Withholding.--, Revenue Ruling 2002-22, I.R.B. 2002-19, 849, (May 08, 2002),Internal Revenue Service,(May 8, 2002)

Employment Tax Regulations. By the time of As divorce from B, A had an account balance of $100x under that plan. Under the second deferred compensation plan maintained by Y, participants are entitled to receive single sum or periodic payments following separation from service based on a formula reflecting their years of service and compensation history with Y. By the time of As divorce from B, A had accrued the right to receive a single sum payment of $50x under that plan following As termination of employment with Y. As contractual rights to the deferred compensation benefits under these plans were not contingent on As performance of future services for Y. Under the law of State X, stock options and unfunded deferred compensation rights earned by a spouse during the period of marriage are marital property subject to equitable division between the spouses in the event of divorce. Pursuant to the property settlement incorporated into their judgment of divorce, A transferred to B (1) one-third of the nonstatutory stock options issued to A by Y, (2) the right to receive deferred compensation payments from Y under the account balance plan based on $75x of As account balance under that plan at the time of the divo rce, and (3) the right to receive a single sum payment of $25x from Y under the other deferred compensation plan upon As termination of employment with Y.7 In 2006, B exercises all of the stock options and receives Y stock with a fair market value in excess of the exercise price of the options. In 2011, A terminates employment with Y, and B receives a single sum payment of $150x from the account balance plan and a single sum payment of $25x from the other deferred compensation plan.8 Section 1041(a) provides that no gain or loss is recognized on a transfer of property from an individual to or for the benefit of a spouse or, if the transfer is incident to divorce, a former spouse. Section 1041(b) provides that the property transferred is generally treated as acquired by the transferee by gift and that the transferees basis in the property is the adjusted basis of the transferor.9 Section 1041 was enacted in part to reverse the effect of the Supreme Courts decision in United States v. Davis, 370 U.S. 65 (1962), which held that the transfer of appreciated property to a spouse (or former spouse) in exchange for the release of marital claims was a taxable event resulting in the recognition of gain or loss to the transferor. See H.R. Rep. No. 432, 98th Cong., 2d Sess. 1491 (1984). Section 1041 was intended to make the tax laws as unintrusive as possible with respect to relations between spouses and to provide uniform Federal income tax consequences for transfers of property between spouses incident to divorce, notwithstanding that the property may be subject to differing state property laws. Id. at 1492. Congress thus intended that 1041 would eliminate differing federal tax treatment of property transfers and divisions between divorcing taxpayers who reside in community property states and those who reside in non-community property states.10

Revenue Ruling 2002-22, I.R.B. 2002-19, 849, May 8, 2002. Revenue Ruling 2002-22, I.R.B. 2002-19, 849, May 8, 2002. Revenue Ruling 2002-22, I.R.B. 2002-19, 849, May 8, 2002. Revenue Ruling 2002-22, I.R.B. 2002-19, 849, May 8, 2002.

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Tax Year

Market Price For Ednas Option Transferred to Ron Event

Tax Consequences to Edna

Tax Consequences to Ron The Rev. Rul.. 22 also concludes that the former spouse, rather than the taxpayer, is required to include an amount in gross income when the former spouse exercises the stock options or when the deferred compensation is paid or made available to the former spouse. As such Ron would have to include this in his taxes when filing his return Ron would be required to include the amount he receives from holding the stock less the fair market value of the stock as part of his taxable income per Rev Ruling 2002-22 which states amounts are not included in the nonemployee spouse's gross income until the stock options are exercised or the deferred compensation is paid or made available to the nonemployee spouse in this case Ron exercised that option

2005

$9

Divorce

Rev. Rul. 2002-22 states that a taxpayer who transfers interests in no statutory stock options and nonqualified deferred compensation to the taxpayer's former spouse incident to divorce is not required to include an amount in gross income upon the transfer, therefore in this case there would be no tax consequence for Edna

2008

$14

2011

$20

Ron exercises stock options with $10 cash payment , then holds stock received Edna terminates employment with Adley $100 lump sum of deferred compensation is distributed to Ron

After the transfer, the income tax consequences shift to the nonemployee spouse who essentially steps into the shoes of the employee spouse. Amounts are not included in the nonemployee spouse's gross income until the stock options are exercised or the deferred compensation is paid or made available to the nonemployee spouse.

The lump received will be distributed equally between Edna and Ron , For Edna it will added as part of income that will need to recognized and taxed

Ron as nonemployee and receiving the lump sum payment will file 1099 Misc and will taxed as a form of income

2013

$22

Ron Sales shares received via option contracts

Ednas tax consequence would depend on the option price in that there would be 2 scenarios to consider; the excess of the fair market value of the shares at the date of exercise over the option price or the excess of the amount realized on the disposition over the option price. So that the difference between the sale price and the option price will be taxed as a capital gain or a loss depending on sale price of shares.

Since Section 1041(b) allows for the transfer of the shares received from divorce to be treated as gifts there would be no tax consequence for Ron 1041(a)Sec. 1041 [1986 Code]. General Rule.--No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)--

Advanced Case 11-44

Wes and Donna are the only members of LLC and to fend off unwanted suitors to their business they created a charter clause whereby shares could only change hands with unanimous approval from both owners. Wes being 70 yrs old makes a gift of 10% of the LLC shares to his son Jeffrey as his way of phasing out of the business. Donna agrees to this transfer. The shares are worth 20,000. What is Wess taxable gift in the year of transfer? Per the Rev. Rul. 77-293 21 illustrates the typical situation involving an intrafamily transfer of the ownership of a family business. There, A owned all 100 shares of the outstanding stock of X, a corporation. A was president of X, and A's son, B, had been employed by X for many years as an officer. As part of A's plan to retire from the business, A gave B 60 shares of X stock "as a gift, and not as consideration for past, present, or future services." Immediately thereafter, X redeemed A's remaining 40 shares of X stock. The primary issue presented by the ruling was whether the redemption of A's 40 shares of Xstock qualified for sale or exchange treatment as a complete termination of

interest under Code Sec. 302(b)(3). In concluding that the redemption so qualified, the ruling observed:Here, the gift of stock by A was to B who is active and knowledgeable in the affairs of the business of X and who intends to control and manage the corporation in the future. The gift was intended solely for the purpose of enabling A to retire while leaving the business to B.The ruling made no reference to Code Sec. 83. While it also did not discuss the gift tax consequences of A's transfer to B, it must be inferred that A and B viewed the transfer as being subject to gift tax. (TAXES - The Tax Magazine (2006 to Present),Intrafamily Transfers of Interests in the Family Business: Gift, Compensation or Both?,(Oct. 1, 2008) By James A. Nitsche. As such IRS provides tips to determine whether the gift is liable to a gift tax, as most gifts are not subject to the gift tax. For example, there is usually no tax if you make a gift to your spouse or to a charity. 11 If you make a gift to someone else, the gift tax usually does not apply until the value of the gifts you give that person exceeds the annual exclusion for the year. So in this case Wess taxable gift will depend on what the annual exclusion for the year was when he gifted his son the shares taking the difference of that with the worth of shares.

11

http://www.irs.gov/uac/Eight-Tips-to-Determine-if-Your-Gift-is-Taxable