Tax Memoradum - John and Jane Smith

Tax Memoradum

To: File

From: XXXXXXXX, CPA

Subject: John and Jane Smith

Facts:

John Smith, Esq., with his wife Jane Smith came to my office seeking for tax advice. John is a practicing attorney who has his own office for his law practice which is a separate business entity established as an LLC. He has been working on a case for the last two years, and his client was awarded by the jury for $2,000,000. He receives the amount of $300,000 as his fee from his client plus the recovery of expense paid up front of $25,000. John wants to know how to treat the $300,000 and the $25,000 for tax purposes. John is also thinking about purchasing the building where he’s currently leasing his law office into for $3,500. In addition, he wants to know what will be the difference in his tax benefits for buying or leasing the building.

Jane Smith thinks that they can use the $300,000 fees received by her husband, John Smith to pay off their house and purchase a bigger house. But her question is what would make better sense for tax purposes; is it better if they pay off the mortgage and sell the house before buying the new house or should they just use the fees to buy the new house, and then sell the old house later. Jane sells handcrafted jewelries which she earned $20,000 last year. She is inquiring whether her business activity would be treated as a trade or business or a hobby for federal income tax purposes, would she receive better tax benefits on her earnings if she establish a separate trade or business. She drives her car primarily for transporting her jewelry to different shops around town; would it make any difference for tax purposes? Finally she is thinking of buying a new jewelry making equipment costing $15,000, since her old equipment which cost $10,000 five years ago is about obsolete; does this makes sense from a tax perspective?

Issues and conclusions:

1. John Smith Issues:

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

John Smith wants to know how the $300,000 be treated for federal tax purposes. The $300,000 is earned income on his part; it is taxable, and will be included in his gross income. According to Internal Revenue Service earned income is all taxable income or wages you receive from working. Two ways to earn your income are either by working for someone that pays you or working in your own business. Based on the 26 U.S.C. § 61 gross income means all income from whatever source derived, unless excluded by law.

The $300,000 is a taxable income for John Smith; he will include the full amount in his gross income in the year that it’s reimbursed. Also as a Sole Proprietorship-LLC, he can file his law practice