United States Federal Tax Law - Assignment Example

United s Federal Tax Law QUESTION I On January 3, 2009, Kathy and Frank Willow got married and entered into a contract with Hive Construction Corporation to build a house for $3,000,000 to be used as their main home. Kathy and Frank made a $400,000 down payment and took out a $2,600,000 mortgage to finance the remaining cost of the house with Outside Lender. Kathy and Frank are personally liable for the mortgage loan, which is secured by the home. On November 10, 2010, when the outstanding principal balance on the mortgage loan was $2,500,000, the FMV of the property fell to $1,750,000 and Kathy and Frank abandoned the property by permanently moving out. They had made interest payments of $130,000 in 2009 and 2010 and paid $50,000 of principal in each year of those years (2009 and 2010) to bring the mortgage balance from $2,600,000 to $2,500,000 just before the date of abandonment. The lender foreclosed on the property and, on December 5, 2010, sold the property to another buyer for $1,750,000. More than one year after the foreclosure, and after heated negotiations, the couple convinced Outside Lender to cancel the remaining debt. So, on December 26, 2011, the lender canceled the remaining debt owing. Kathy and Frank are filing a joint return for 2011. On December 26 2011, Kathy and Frank had $15,000 in a savings account, household furnishings with an FMV of $17,000, a car with an FMV of $10,000, and $18,000 in credit card debt. The household furnishings originally cost $30,000. The car had been fully paid off (so there was no related outstanding debt) and was originally purchased for $16,000. Kathy and Frank had no adjustments to the cost basis of the car. Kathy and Frank had no other assets. There was alsoa $20,000 potential liability over a house warranty with Hive Construction Corporation (the “Disputed Amount”). However, the Willow’s lawyer opined in a letter that there is only a 10% chance that the Kathy and Frank would have to pay the Disputed Amount. At the beginning of 2012, Kathy and Frank had $9,000 in their savings account and $15,000 in credit card debt. Kathy and Frank also owned the same car at that time (still with an FMV of $10,000 and basis of $16,000) and the same household furnishings (still with an FMV of $17,000 and a basis of $30,000). Kathy and Frank had no other assets or liabilities at that time, except for the Disputed Amount that remains in dispute. (a) What are the tax consequences to Kathy and Frank, if any, for each year? It should be noted that foreclosure occurred before Kathy and Frank cancelled their debt; therefore, they are liable to gain or loss from the foreclosure. Since they maintained personal liability for the $ 750,000 of the remaining debt, then they were liable to cancellation. Additionally, the insolvency exclusion cannot apply in the Kathy and Frank case since their indebtedness did not qualify for the principal residence (Lyon 64). However, the same could have only applied if their insolvency could have been excluded instead of the indebtedness. Additionally, it should be considered that the remaining part of the debt just before the cancellation did not qualify as principal residence indebtedness since only part of the loan could qualify as the principal indebtedness. Therefore, Kathy and Frank must have ordered for the cancellation. (b) Same as (a) except Hive Construction Corporation financed the purchase of the house for Kathy and Frank and Hive Corporation agreed to reduce the debt to 1,750,000 on December 26 2011 and Kathy and Frank continue to live in the houseand there was no foreclosure in 2010? To this extent, Kathy and Frank do not have the right to elect insolvency exclusion as could be in the case of principle residence exclusion. However, they are liable to apply for the insolvency exclusion to $500,000 for the nonqualified debts since such debt is never qualified as principal residence indebtedness. Kathy and Frank have no tax attribute up to the year 2010 other than the use of basic personal properties to reduce the borrowed amount. Nonetheless, it is vital for them to include 10a, 982 online forms to indicate or detail their properties by the end of their 2011. (c) Same as (a) except the loan from Outside Lender is nonrecourse? The nonrecourse commercial real estate loan is an indication that a person has less personal liability should they default their loan. However, the requirement herein is never the case (Lyon 71). The individual signing on behave of the sponsor or the borrowing entity is never always immune from personal liabilities. However, Kathy and Frank are likely to enjoy non-recourse to their loan since within their documents they are essentially transferring their personal liability to the sponsor. In other words, their personal liability requires them with nonrecourse to their loan. However, this case is likely to be examined under the enforcement of the release of the liability since there is a release of liability and the lenders are surviving a non-judicial foreclose sales. Notably, Kathy and Frank cannot obtain deficiency neither are they able to enforce monetary obligation to the borrower. QUESTION II John and Martha own two pieces of investment property as equal joint tenants. Blackacre has a $90,000 basis and $100,000 FMV, and Greenacre has a $110,000 basis and a $100,000 FMV. They decide to divorce. What tax consequences result under the following scenarios? (a) They sell the two pieces of property to third parties, split the cash equally, and divorce. The tax consequences in this case will depend on the level of agreement between the couples (Lyon 20). When the properties are sold out to the third party, then the resultant ownership will be considered collective and total sale will be taxed according to commercial real estate taxation rates. Nonetheless, the resultant income and assets taxation consequences will profoundly depend on the financial agreement between the couples. (b) Martha takes Blackacre, John takes Greenacre, they divorce, and they sell both properties to third parties. Since each of them have independent shared cost, after the divorce and selling their properties, they will be liable to no tax consequences since the divided properties are considered independent. (c) Change the facts so that John is the sole owner of both properties, and he transfers Greenacre to Martha as part of the divorce settlement. Should John sell Greenacre instead and transfer the $100,000 in cash to Martha (say, in 5 equal installments)? Would it make a difference if Greenacre’s basis were $20,000? Assume John is in the 35% tax bracket and Martha is in the 28% percent tax bracket. If John was the sole owner of these properties, then when he sells then off to his wife, the entire transaction will attract taxation since the entire deal shall be considered business of mutual benefit. According to tax code, any income from all sources including property, money, or services are considered gross income. Only after taxation and other deductions shall the partner receive the income either directly or indirectly. There are specific rules that govern taxation of properties during divorce; however, such special taxation rules never apply to division of assets. Therefore, if John decides to pay his wife in installments then each installment will attract different taxations. Notably, the installment taxation fees may be immense compared to one installment payment. Regardless of the taxation percentage posed on Martha, the cash given to her by John will not attract any form of taxation since she is only receiving. However, John will be taxed according to the tax rate imposed on him since he is the one transacting the business. QUESTION III Assume that Patrick, an unmarried individual who has gross income of $100,000 from his law practice operated as a sole proprietorship, incurs the following items in 2012. These items and the gross income from his law practice are his only income and deductions for the year. What are the tax consequences for each of the items and the net gains or losses for the 2012 tax year? 1. Sale of office equipment for $25,000 he purchased 2 years ago for $30,000 for which he deducted $8,000 of depreciation; No tax consequences on the properties bought for personal use. However, the tax will form part of the price of the good at the buying point. Patrick will only pay tax when selling off the equipment to other parties. Notably, the tax will only be levied on the appreciation but not the price of the items. 2. Sale of rental real property held for 3 years and actively managed by him with a sales price of $110,000, original cost of $100,000 with straight line depreciation taken of $9,000; Patrick shall ever be considered a sole proprietor. Under this consideration, all his assets will be taxed under the sole proprietor taxation codes or laws. In this case, he shall not be taxed on the depreciations, but all his assets shall be considered commutatively and taxed under the same. All the profits and losses made are added and taxed as a unit. 3. A $7,000 loss from a loan to his law school classmate; In this case, Patrick is the lender and he is accepted to tax in cases of losses. According to the enforcement release to liabilities, Patrick is expected to survive a non-judicial foreclosure since he has nothing to obtain deficiency or monetary obligation sponsor. The IRS often categories losses on loans as non-business or business bad debts and the case where an individual provides a person with loan, the same is often considered as personal debt and it is liable to IRS special tax rule for deduction. However, the deduction is limited to non-business loans. Therefore, Patrick is immune this taxation in this case. 4. Loss on sale of land used as additional parking for his law practice purchased 5years ago for $7,000 plus improvements to make it a parking lot of $5,000. The improved land was sold for $7,000; It should be noted that the sale of property is never considered as income; thus, the monetary gain obtained from the same is never taxed under the income tax. Sale of land is often considered as the long-term capital gain. The maximum taxation rate under the capital gain is at 15 percent. However, the loss made will attract no taxation since the same lose can never be incorporated in the income for generation taxation. 5. Stock he purchased 4 months ago sold at $10,000 and purchased at $7,000; The purchase of stock often attracts capital gain on the profit made on the sales made on assets. This form of tax often engulfs machinery, house, land bonds, and stocks. However, in each case, there are different taxation rates (Jones and Rhoades 121). Nonetheless, in Patrick’s case, his stock will attract the short-term capital gain taxations. This will attract 25 percent taxation on the ordinary profit taxation. 6. Bearer bond she held were stolen. They were purchased for $3,000 but he received $5,000 from the insurance company; Bonds often provide vital component of numerous financial plans. They provide stable encounter to the volatility of the stock while generating future or current investment. Taxations are never imposed or pegged on the growth rate of the bonds, but they are only taxable once they are sold. Each dividend often received special tax treatment. Additionally, different types of bonds are often subjected to different taxation mood. Patrick’s bond gain will attract 3.89 percent tax rate. 7. Patrick was a famous athlete before law school and still receives annual fee from Grain Mills for having his likeness on certain products for endorsing certain Grain Mills products. However, after several years Grain Mills decides to cancel the contract with Patrick but Gran Mills realizes that there is no clause allowing for the cancellation. They decide to pay him $500,000 and Patrick releases all of his rights under the contract; Despite the termination of the contract, Patrick contract termination fee will be taxed under the contact taxation code or law. Under the 2256 contract basis, the $500,000 above shall be considered a short-term capital gain. Notably, the levy will attract 40 percent tax rate since it shall never attract future deductions or taxations. 8. Patrick purchased an office building for investment on 6/13/2011. He purchased it for $100,000 from Sam Seller. The land was worthless at the time of the purchase. He paid $10,000 cash, gave Sam a note back for $90,000, and secured by a mortgage on the property. Patrick holds the property for some months, pays the 8% interest but no principal on the debt. Patrick finds a defect with the building and now the building is only worth $70,000. When Patrick is very wealthy, he convinces Sam Seller to reduce the note to $60,000 on 2/14/2012. The next day, 2/15/2012, he sells the note to an investment partnership that he is a 15% partner for $95,000. The partnership will pay him the purchase price in two (2) equal installments of $47,500 in 2012 and 2013. All accrued taxes in this case are considered as the capital gain taxes. Notably, IRS collects taxes as per installments agreed between individuals. However, there are reduced penalties in relation to the interest paid if the final buyer will pay fee associated with setting up the installment agreement (Jones and Rhoades 91). Additionally, there are extra fee involved in settling the installment. Nonetheless, this mode of payment has its own drawbacks in that it attracts vast interests and penalties that will payable to both Patrick and the taxman. Additionally, Patrick will also experience the same effects since every transaction on the investment is subject to taxation. According to IRS, penalties and the interest rate often make such investments to be taxed between 8 and 10 percent annually. Moreover, there are possibilities that one may have huge debts accruing than the actual debt they actually commenced with in their debt list. QUESTION IV On his 65th birthday, George purchased a single premium contract for $100,000. The contract provides for 15 annual payments of $12,000 to George, commencing on the first anniversary of the purchase. (a) What is the tax result to George in each year of the contract? The policy owners usually pay premiums and they are never deductable from the federal and state income tax. The insurer often pays the proceeds of the premiums at the death of the client. Additionally the proceeds of the premium are not also included in the cross income of both the federal and state income for tax purposes. Therefore, the value of the premium is expected to increase since the policy is never taxed (Daily 234). In addition, the insurance policies are legitimate and legal tax shelter where saving is bound to increase without taxation until the time the owner will withdraw the money from the policy. In cases of flexible premium policies, huge deposits such in the case of Mr. George’s, may make the Internal Revenue Service (IRS) to consider the contract as a modified endowment contract thereby negating tax advantages for the life insurance. Thus, the gain in Mr. George’s premium is 12,000/15 = $800 annually (b) What is the tax result if George dies the day before his 75th anniversary? $800 * 75/15 or 800 * 5 = $4,000 Works Cited Daily, Frederick W. Stand Up to the Irs. Berkeley, CA: Nolo, 2009. Print. Jones, Sally M, and Shelley C. Rhoades-Catanach. Principles of Taxation for Business and Investment Planning. Boston: McGraw-Hill/Irwin, 2008. Print. Lyon, Hastings. Principles of Taxation. S.l.: Bibliolife, 2009. Print. Internal Revenue Service: Changes Needed in the Role of Regional Offices : Report to the Chairman, Subcommittee on Oversight, Committee on Ways and Means, House of Representatives. Washington, D.C: The Office, 1994. Print. Read More