John Smith Tax Issues

FACTS:

John Smith has worked on this case for over two years. The jury awarded his client $2,000,000 in damages, of which his fee is $300,000 plus recovery of expenses paid up front in the amount of $25,000. John wants to know how is the $300,000going to be taxed including the $25,000 and what can he do to minimize the tax consequences of each?

Also, he is thinking about buying the building that he is currently lease for his office space. His current lease is $3,500 per month. John wants to know now 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) and would he get better tax benefits for paying the lease or for buying the building? What are the differences?

Jane Smith, his wife, thinks that the fees would be better used for paying off their house and buying a new, bigger house that she has had her eyes on. She wants to know does it make better tax sense for them to pay off the mortgage, sell the house, and buy a new house, or should they just use the money to buy the new house after selling the old house?

Also, she sell handcrafted jewelry which earned her $20,000 last year. Jane wants to know where her business activities constitute a trade or business for federal income tax purposes are just a hobby? If it does constitute as a trade or business should she establish a separate trade or business to get the tax benefits on her earnings? Would it make a difference if she uses her car primarily for transporting my jewelry to different shops around town? Finally, she thinks that she could earn more money if John was willing to invest $15,000 for new jewelry making equipment since he original equipment, which cost $10,000 five years ago, is almost obsolete. From a tax point of view, would this make sense?

ISSUES/DISCUSSION:

1. John Smith tax issues:

a. How is the $300,000 treated for purposes of Federal tax income?

Section 61 of the Internal Revenue Code (IRC 61, 26 U.S.C. § 61) defines "gross income," the starting point for determining which items of income are taxable for federal income tax purposes in the United States. Section 61 states that "except as otherwise provided in this subtitle gross income means all income from whatever source derived". The United States Supreme Court has interpreted this to mean that Congress intended to express its full power to tax incomes to the extent that such taxation is permitted under Article I, Section 8, Clause 1 (the