Current Nj Automobile Sales Tax by stt16066

VIEWS: 190 PAGES: 17

More Info
									                                          CHAPTER 5

                                  BUSINESS DEDUCTIONS

                          SOLUTIONS TO PROBLEM MATERIALS
PROBLEMS

1.   The two issues involved are whether the payment should be made and, if made, is it
     deductible. If made to the representatives of a U.S. government, it would be a bribe. Not
     only would it be nondeductible, it could result in criminal charges. If the payment is made
     to the representative of the foreign country, more than likely, it would be an accepted
     trade practice in that country. In this case, since the payment would not violate the U.S.
     Foreign Corrupt Practices Act of 1977, it would therefore be deductible. pp. 5-6 and 5-7

2.   Only c., the price paid for drugs purchased for resale. Whether the business is legal or
     illegal, cost of goods sold is allowed as a reduction from total sales in arriving at gross
     income from the business. Thus, cost of goods sold is treated as a negative income item
     rather than as a deduction. p. 5-8

3.   From a legal perspective, Cardinal is responsible for having its drivers break the law by
     speeding. The speeding fines that are levied are therefore not deductible by Cardinal. On
     the other hand, the salaries paid to the suspended drivers are deductible by Cardinal.

     From an ethical perspective, a case can be made both for and against having the drivers
     drive at excessive speeds. Supporting the ―for‖ perspective are the reasons mentioned by
     Cardinal and the fact that Cardinal takes care of (i.e., continues the driver‘s salary during
     the suspension period) its employees. Supporting the ―against‖ perspective are the
     following:

         The potential danger to the general public of such excessive speeding.

         Requiring or encouraging its employees to break the law and rewarding them
          for doing so.

         Business standards being subordinated to the demands of others.

     pp. 5-6 and 5-7

4.   No, a deduction is not permitted for political contributions. p. 5-8

5.   Carmine may not deduct any of the political contribution (i.e., $6,000). Generally, lobbying
     expenditures cannot be deducted, but an exception applies for influencing local
     legislation. Therefore, Carmine may deduct the $5,000 payment to the Lexington law firm
     to lobby members of the Lexington City Council. pp. 5-8 and 5-9

6.   a.   The following are considered to be related parties:
             Father.
             Brother.
                                               5-1
5-2


               Grandson.
               C corporation.
           The niece, uncle, and cousin are not related parties under § 267. For the corporation
           to be a related party, the shareholder must own more than 50% (directly or indirectly)
           of the stock.
      b.     The related party rules under § 267 can produce two negative tax results. First,
             losses from the sale or exchange of property between related parties are
             disallowed. Second, an accrual method related party payor is not allowed to take a
             deduction for unpaid expenses and interest until a cash method payee includes
             the amount in gross income (i.e., until payment is made).
      pp. 5-11 and 5-12

 7.   a.   Although Jake receives interest payments of $4,000, all of this amount is excluded
           from his gross income. Interest on municipal bonds is tax-exempt.

      b.   None of Jake‘s interest payments of $4,100 on the loan can be deducted. The
           proceeds of the loan were used to purchase tax-exempt bonds. Consequently, the
           interest expense deduction is disallowed. Likewise, none of the principal payments
           of $1,000 can be deducted.

      p. 5-13

 8.   a.   Drew and Cassie are trying to use the salaries to reduce the taxable income of
           Thrush to zero ($800,000 – $400,000 – $300,000 – $100,000). By so doing, they
           can avoid the potential for double taxation.

      b.   If the salaries paid to the children are deemed reasonable, Thrush‘s taxable income
           is reduced to zero. Each of the children will report gross income of $25,000.

      The more likely result is that a substantial portion of the $100,000 salary payments will be
      labeled as unreasonable compensation. In this case, Thrush‘s taxable income will be
      increased by the amount of unreasonable compensation. Each of the children will report
      gross income equal to the amount labeled reasonable compensation. Drew and Cassie
      will have additional dividend income equal to the amount of the unreasonable
      compensation.

      pp. 5-3 and 5-4

 9.   Since all of the payments are lobbying expenses, none are deductible. pp. 5-8 and 5-9

10.   Even though Joanne decides not to pursue the expansion of her restaurant chain into
      another city, the investigation expenses of $32,000 are deductible in the current year.
      Because Joanne is in the restaurant business, all investigation expenses associated with
      the restaurant business are deductible in the year paid or incurred. Since Joanne was not
      in the hotel business, she can deduct only part of these investigation expenses. Of the
      $54,000, an amount of $1,000 [$5,000 – $4,000 (reduction for excess over $50,000)] can
      be immediately expensed. The balance of $53,000 ($54,000 – $1,000) is amortized over
      a period of 180 months at the rate of $294 per month ($53,000 ÷ 180) commencing in
      November (the month the business is started). Consequently, the total deduction for the
                          Business Deductions                                         5-3


year is $32,000 for the restaurant investigation + $1,588 [$1,000 + ($294 × 2 months)] for
the hotel investment, or a total of $33,588. pp. 5-10 and 5-11
5-4


11.   a.   Eleanor‘s $5,000 loss ($60,000 amount realized – $65,000 adjusted basis) is not
           deductible due to § 267. Example 17

      b.   If sold for $75,000, Ridge‘s recognized gain is $10,000 [$75,000 (sales price) less
           $60,000 (basis), reduced by the $5,000 loss that previously was not allowed to
           Eleanor].

           If sold for $52,000, a $8,000 loss [$52,000 (sales price) less $60,000 (basis)] is
           recognized by Ridge. The $5,000 loss that was realized by Eleanor is not
           deductible by either Eleanor or Ridge and is lost permanently.

           If sold for $64,000, there is no recognized gain to Ridge [$64,000 (sales price) less
           $60,000 (basis), reduced by $4,000 of the $5,000 loss that previously was not
           recognized by Eleanor]. The remaining $1,000 of unrecognized loss is lost
           permanently as a deduction for both Eleanor and Ridge. Examples 17 and 18

      c.                          Smith, Raabe, and Maloney, CPAs
                                       5191 Natorp Boulevard
                                          Mason, OH 45040
           June 22, 2008

           Ms. Eleanor Saxon
           32 Country Lane
           Lawrence, KS 66045

           Dear Ms. Saxon:

           As you requested in your note, I am providing you with the tax consequences of the
           proposed sale of stock to your brother Ridge. Although you would have a potential
           loss of $5,000 ($60,000 selling price – $65,000 cost), you would not be able to
           recognize this loss on your tax return. The tax law disallows the recognition of
           losses between certain related parties.

           If you do sell the stock to Ridge, his tax basis for calculating gain or loss on a
           subsequent sale by him would be his cost of $60,000. However, if he should sell it
           at a gain, he could use as much of your $5,000 disallowed loss as necessary to
           reduce his gain to zero.

           From a planning perspective, you could recognize the $5,000 loss on your tax
           return if you were to sell the stock to an unrelated party rather than selling it to
           Ridge.

           If you would like to discuss this further, please let me know.

           Sincerely,

           Ellen Allen, CPA

      p. 5-11
                               Business Deductions                                           5-5


12.   a.   Taxable income for purposes of applying the 10% charitable contributions limitation
           does not include the dividends received deduction or domestic production activities
           deduction. For purposes of the 10% limitation, taxable income is $290,000
           ($500,000 – $240,000 + $30,000). The maximum charitable contribution allowed
           for the year, therefore, is $29,000 (10% × $290,000).

      b.   The excess $6,000 not allowed ($35,000 contribution – $29,000 allowed) is carried
           forward to 2009 (5 year carryforward).

      Example 27

13.                               Smith, Raabe, and Maloney, CPAs
                                       5191 Natorp Boulevard
                                          Mason, OH 45040

      December 6, 2008

      Mr. Dan Simms, President
      Simms Corporation
      1121 Madison Street
      Seattle, WA 98121

      Dear Mr. Simms:

      On December 3 you asked me to advise you on the timing of a contribution by Simms
      Corporation to the University of Washington. My calculations show that the corporation
      will maximize its tax savings by making the contribution in 2008.

      If the corporation makes the contribution in 2008, it can deduct $20,000 as a charitable
      contribution, which will save $7,800 (39% tax rate × $20,000 deduction) in Federal
      income tax. However, if the corporation makes the contribution in 2009, the percentage
      limitations applicable to corporations will limit its 2009 deduction to $10,000 ($100,000
      projected profit × 10% limit). The corporation will save $3,400 (34% tax rate × $10,000
      deduction) in taxes as a result of this deduction. The corporation may carry the
      remaining $10,000 forward and deduct the amount in 2010. If the corporation continues
      at the 2009 profit level, it will save an additional $3,400 in tax in 2010, for a total tax
      savings of $6,800.

      This analysis makes it clear that the corporation will save $1,000 more ($7,800 –
      $6,800) if it makes the contribution in 2008. In addition, all of the savings will occur in
      2008. If the corporation makes the contribution in 2009, its tax savings will be split
      between 2009 and 2010. My advice is that the corporation should make the contribution
      immediately so ownership of the stock can be transferred by December 31.

      Sincerely,

      Alicia Gomez, CPA

      pp. 5-14 to 5-16
5-6


14.   a.   2008
           Salaries                                                           $300,000
           Materials                                                            80,000
           Insurance                                                            10,000
           Utilities                                                             7,000
           Equipment depreciation                                               10,000
           Total expenses                                                     $407,000

           Cost of inspection of materials for quality control ($4,000), promotion expenses
           ($10,000), and cost of market survey ($8,000) are not included as research and
           experimental expenditures.

           2009
           Salaries                                                           $400,000
           Materials                                                            70,000
           Insurance                                                            15,000
           Utilities                                                             8,000
           Equipment depreciation                                               12,000
           Total expenses                                                     $505,000

           Cost of inspection of materials for quality control ($4,000), advertising ($30,000),
           and promotion expenses ($7,000) are not included as research and experimental
           expenditures.

           2010

           No deduction based on data provided.

      b.   The research and experimental expenditures are amortized over a 60-month
           period beginning with the month in which the taxpayer first realizes benefits from
           the experimental expenditures (i.e., July 2010 for Blue Corporation). The monthly
           amortization is $15,200 ($912,000  60).

           2008

           No deduction for research and experimental expenditures.

           2009
           No deduction for research and experimental expenditures.

           2010
           Deduction for research and experimental expenditures: $15,200 × 6 months =
           $91,200

      pp. 5-16 to 5-18
                                Business Deductions                                       5-7


15.   $2,100 ($100,000 × .35 × 6%), assuming the §199 deduction is not limited by the
      taxable income and the W–2 wage restrictions. pp. 5-19 to 5-21

16.   The DPAD is $150,000 (50% × $300,000 associated W–2 wages) which is less than
      $180,000 (6% × $3,000,000). Because the wage base limits the deduction, Rose may
      want to outsource less of its work. pp. 5-19 to 5-21

17.   Cost of asset                                                                 $100,000
      Less: Greater of allowed and allowable cost recovery:
           2006                                                        $ 455
           2007                                                         3,636
                                                                          (4,091)
      Basis at the end of 2007                                                      $ 95,909
      Less: Cost recovery for 2008 ($100,000 × 3.636% × .5/12)                          (152)
      Basis on date of sale                                                         $ 95,757
      Gain on sale of asset ($98,000 – $95,757)                                     $ 2,243

      Example 38

18.   a.    2008
            Additional first-year depreciation ($200,000 × .50)                     $100,000
            MACRS [($200,000-$100,000) × 20%](Table 5-1)                            $ 20,000
                                                                                    $120,000
      b.    2009
            MACRS cost recovery [$100,000 × 32% (Table 5-1) × 1/2]                   $16,000

      pp. 5-24 to 5-26 and Table 5-1

19.   2008: $1,800,000 × .02247 (Table 5-3 )                                         $40,446

      2018: $1,800,000 × .02564 (Table 5-3)                                          $46,152

      pp. 5-28 and 5-29

20.   The building‘s depreciable basis is $1,200,000 [$1,400,000(cost)-$200,000(land)].

      a.    2008: $1,200,000 ($1,400,000 – $200,000) × 1.97%                         $23,640

      b.    2014: $1,200,000 × 3.636% × (10.5/12)                                    $38,178

      pp. 5-28, 5-29, and Table 5-3

21.   Under these circumstances, the straight-line method must be used.

      MACRS cost recovery
      Additional first-year depreciation ($70,000 × .50)                             $35,000
      ($70,000-$35,000) × .05 (Table 5-6)                                              1,750
                                                                                     $36,750
      p. 5-30
5-8


22.   Cost of leasehold improvement                                             $80,000
      Less: Cost recovery
                2002 (.02247 × $80,000)                                          (1,798)
                2003–2007 (.02564 × $80,000 × 5)                                (10,256)
                2008 [.02564 × (11.5/12) × $80,000]                              (1,966)
      Loss (unrecovered cost)                                                   $65,980

      pp. 5-30, 5-31, and Table 5-3

23.   a.   1999: $850,000 × 1.177%                                              $10,005
      b.   2008: $850,000 × 2.564% × 4.5/12                                      $ 8,173

      p. 5-28 and Table 5-3

24.   a.   Copier
              Immediate expense deduction under § 179                          $ 50,000

           Furniture
              Immediate expense deduction under § 179                           200,000
              Additional first-year depreciation ($16,000 × .50)                  8,000
              MACRS cost recovery
                     [($216,000 – $200,000 – $8,000) × .1429]                     1,143
              Total deduction                                                  $259,143

      b.   Furniture
              Immediate expense deduction under § 179                          $216,000

           Copier
              Immediate expense deduction under § 179                            34,000
              Additional first-year depreciation ($16,000 × .50)                  8,000
              MACRS cost recovery
                    [($50,000 – $34,000 – $8,000) × .20]                          1,600
           Total deduction                                                     $259,600

      c.   The deduction for the year would be $457 ($259,600 – $259,143) larger if § 179
           expense is first allocated to the furniture (i.e., the longer lived asset).
      pp. 5-31 and 5-32
25.   Cost recovery for 7-year class assets
           [($550,000 – $250,000 )  .1429]                                    $ 42,870
      Income limitation
          Income before § 179 and cost recovery                    $250,000
          Cost recovery ($95,000 + $42,870)                        (137,870)
          Income before § 179 amount                               $112,130

      Section 179 amount of $250,000 (limited to $112,130)                      112,130
      Total deduction with respect to the 7-year assets in 2008                $155,000

      Section 179 carryforward ($250,000 – $112,130)                           $137,870
                                 Business Deductions                                         5-9


      pp. 5-31 and 5-32

26.   a.   Yoon must use the mid-quarter convention.
           3-year class ($20,000 × 58.33%)                                         $11,666
           5-year class ($340,000 × 5%)                                             17,000
           Total cost recovery                                                     $28,666

      b.   Section 179 amount on 5-year class property                            $250,000
           3-year class ($20,000 × 58.33%)                                          11,666
           5-year class [($340,000 – $250,000) × 5%]                                 4,500
           Total deduction                                                        $266,166

      c.   Section 179 election—total deduction                                   $266,166
           No § 179 election—total deduction                                       (28,666)
           Increase in deduction from § 179 election                              $237,500

           Tax benefit (.33 × $237,500)                                           $ 78,375

      pp. 5-27, 5-31, and 5-32
27.                                Smith, Raabe, and Maloney, CPAs
                                        5191 Natorp Boulevard
                                           Mason, OH 45040
      December 20, 2007
      Mr. John Johnson
      100 Morningside Drive
      Clinton, MS 39058

      Dear Mr. Johnson:

      I am responding to your inquiry concerning the amount of cost recovery you may deduct
      in the first year of operation of a new taxi. If the automobile is purchased at the
      beginning of 2008 for $35,000, the total recovery in the first year would be $35,000.

      Because the car will be used as a taxi, it is not subject to the cost recovery limitations
      imposed on passenger automobiles. This $35,000 recovery assumes that your income
      from your taxi business before considering this recovery would be at least $35,000 and
      an election is made under § 179 to expense the maximum allowable amount.

      If you need additional information or need clarification of our calculations, please
      contact me.

      Sincerely yours,

      John J. Jones, CPA
      Partner
5-10


       TAX FILE MEMORANDUM

       December 20, 2007

       FROM: John J. Jones

       SUBJECT: John Johnson: Calculations for cost recovery in year of acquisition

       Facts. John Johnson is considering purchasing an automobile at the beginning of 2008
       to be used 100% as a taxi. The cost of the automobile is $35,000. John wants to know
       the total recovery for the year of acquisition of the car.

       Calculations. Because the automobile will be used as a taxi, it is not subject to the cost
       recovery limitations for passenger automobiles. Therefore, John can elect § 179
       expensing. In deducting the §179 amount of $35,000, the assumption is made that
       John‘s income from the taxi business before considering the § 179 expense will equal or
       exceed $35,000.

       pp. 5-32 to 5-36 and §280F(d)(5)(B)(ii)
28.    MACRS cost recovery:

       Cost                                                                      $30,000
       Statutory percentage (mid-quarter convention)                                × 5%
       Cost recovery but subject to the limitation                                $ 1,500

       Recovery limit (limited to $3,060*)                                       $ 1,500
       Less: Personal usage (20% × $1,500)                                          (300)
       Cost recovery                                                             $ 1,200

       *These cost recovery limits are indexed annually. The 2007 amounts are used because
       the 2008 amounts were not available yet.

       pp. 5-27 and 5-33

29.    Deduction for 2008
       {[($20,000 × 50%) + [($20,000-$10,000) × 20%] = $12,000}                  $11,060
       limited to $11,060*

       Deduction for 2009
       [($20,000-$10,000) × 32%]                                                 $ 3,200

       *These cost recovery limits are indexed annually. The 2007 amounts are used because
       the 2008 amounts were not available yet.

       pp. 5-32 to 5-34

30.    Deduction for 2008
       {($40,000 × 50%) + [($40,000-$20,000) × 20%] = $24,000}
       limited to $11,060* × 80%                                                  $8,848
                                  Business Deductions                                  5-11


      Deduction for 2009
          Straight-line ($40,000 × 20% = $8,000);
          limited to $4,900 × 70%                                           $3,430

      Cost recovery recapture in 2009
           2008 deduction                                                   $8,848
           Straight-line [($40,000 × 10% = $4,000 × 80%]                     (3,200)
           Excess                                                           $5,648

      *These cost recovery limits are indexed annually. The 2007 amounts are used because
      the 2008 amounts were not available yet.
      pp. 5-32 to 5-35

31.   For regular income tax liability

             MACRS cost recovery ($14,000 × .20)                            $2,800

      For AMT liability($14,000 × .15)                                      $2,100

      pp. 5-32, 5-33, and 5-36

32.   MACRS:
         Year 1 [$100,000 × 14.29% (Table 5-1)]              $14,290
          Year 2 ($100,000 × 24.49%)                          24,490
          Year 3 ($100,000 × 17.49%)                          17,490
          Total cost recovery                                              $56,270

      ADS:
            Year 1 [$100,000 × 10.71% (Table 5-5)]           $10,710
            Year 2 ($100,000 × 19.13%)                        19,130
            Year 3 ($100,000 × 15.03%)                        15,030
            Total cost recovery                                            (44,870)
      Cost recovery lost by electing ADS                                   $11,400

      Tax cost of election ($11,400 × 28%)                                 $ 3,192

      pp. 5-24 to 5-26 and 5-36

33.                            Smith, Raabe, and Maloney, CPAs
                                   5191 Natorp Boulevard
                                      Mason, OH 45040
      October 15, 2008

      Mr. Mike Saxon
      200 Rolling Hills Drive
      Shavertown, Pennsylvania 18708
5-12


       Dear Mr. Saxon:

       This letter is in response to your request concerning the tax consequences of allocating
       the purchase price of a business between the two assets purchased: a warehouse and
       goodwill.

       If the purchase price of $2,000,000 is allocated $1,200,000 to the warehouse and
       $800,000 to goodwill, the total recovery in the first year of operations would be $82,865.
       Cost recovery on the warehouse would be $29,532 and amortization of the goodwill
       would be $53,333. If the purchase price is allocated $1,500,000 to the warehouse and
       $500,000 to goodwill, the total recovery in the first year of operations would be $70,248.
       Cost recovery on the warehouse would be $36,915 and amortization of the goodwill
       would be $33,333.

       Therefore, under the first option, your deductions in the first year would be $12,617
       greater ($82,865 – $70,248). The building is written off over 39 years, while the goodwill
       is written off over 15 years. Thus, the higher the allocation to goodwill, the faster the
       write-off will be. Should you need more information or clarification of calculations, please
       contact us.

       Sincerely yours,

       John J. Jones, CPA
       Partner

       TAX FILE MEMORANDUM

       October 15, 2008

       FROM:          John J. Jones

       SUBJECT:       Mike Saxon: Calculations of amount of recovery depending on the
                      allocation of purchase price between a warehouse and goodwill
       Facts

       Mike is negotiating the purchase of a business. The final purchase price ($2 million) has
       been determined, but the allocation of the purchase price between a warehouse and
       goodwill is still subject to discussion. Two alternatives are being considered. The first
       alternative would allocate $1,200,000 to the warehouse and $800,000 to goodwill. The
       second alternative would allocate $1,500,000 to the warehouse and $500,000 to
       goodwill. Mike wants to know the total recovery during the first year of operations from
       the two alternatives.
                                Business Deductions                                        5-13


      Calculations

      Alternative 1
            Warehouse [$1,200,000 × 2.461% (Table 5-3)]                                $29,532
            Goodwill ($800,000/15 years)                                                53,333
            Total recovery                                                             $82,865
      Alternative 2
            Warehouse [$1,500,000 × 2.461% (Table 5-3)]                                $36,915
            Goodwill ($500,000/15 years)                                                33,333
            Total recovery                                                             $70,248
      Additional deductions in first year under alternative 1
            ($82,865 – $70,248)                                                        $12,617
      pp. 5-28, 5-37, and Table 5-3

34.   Computing Cost Depletion. It is proper for Sam to re-compute a new cost depletion
      amount based on a revised estimate of the tons of granite stone remaining in the quarry.
      However, Sam should reduce the adjusted basis ($600,000) for the portion of the basis
      allocable to the condemned land. Sam‘s computation determines a cost per ton based
      on a basis for the whole tract of land and a revised stone reserve estimate for only a
      portion of the land.

      Percentage Depletion. Percentage depletion is based on a specified percentage
      provided for in the Code.

      (a)   The percentage varies in accordance with the type of mineral interest involved.

      (b)   The rate is applied to the gross income from the property, but it generally may not
            exceed 50% of the taxable income from the property before the allowance for
            depletion.

      (c)   Special rules apply to certain oil and gas wells under § 613A (e.g., the 50% ceiling
            is replaced with a 100% ceiling, and the percentage depletion may not exceed
            65% of the taxpayer‘s taxable income from all sources before the allowance for
            depletion).

      pp. 5-37 to 5-40

35.   Gross income                                                                 $12,000,000
      Less: Expenses                                                                (5,000,000)
      Taxable income before depletion                                              $ 7,000,000
      Cost depletion ($10,000,000/250,000 × 45,000) = $1,800,000
      Percentage depletion (22% × $12,000,000 = $2,640,000,                         (2,640,000)
           limited to 50% × $7,000,000 = $3,500,000)
      Taxable income                                                               $ 4,360,000

      pp. 5-37 to 5-40
5-14


BRIDGE DISCIPLINE PROBLEMS
1.     The analysis below shows that Sparrow Corporation would incur a smaller cost if the
       asset is leased ($10,439) as compared to the cost of the purchase ($10,757).

       If the asset is purchased, the present value of the after-tax cash flows follows:

                                               Tax Benefit
                                            from Depreciation         Discount     Net Present
       Year            Cash Flow               Deduction*              Factor          Value
          0            ($15,000)                                         1.000          ($15,000)
          1                                       $1,700                 0.909             1,545
          2                                        2,267                 0.826             1,873
          3                                          755                 0.751               567
          4                                          378                 0.683               258
          5

       Net Present
         Value                                                                          ($10,757)

       *The tax benefit is calculated based on the MACRS depreciation deduction for the year
       times Sparrow‘s tax rate of 34%. For each year, this benefit is assumed to arise at the
       beginning of the following year when the tax liability is paid. The tax benefit from the
       initial year‘s depreciation is $1,700 ($15,000 × 33.33% × 34%).

       If the asset is leased, the present value of the after-tax cash flows follows:

                                   Tax Benefit
                                   from Lease        Net           Discount         Net Present
       Year     Cash Flow          Deduction*      Cash Flow        Factor            Value
         0       ($3,625)                            ($3,625)        1.000              ($ 3,625)
         1         (3,625)            $1,233          (2,392)        0.909                (2,174)
         2         (3,625)             1,233          (2,392)        0.826                (1,976)
         3         (3,625)             1,233          (2,392)        0.751                (1,796)
         4         (3,625)             1,233          (2,392)        0.683                (1,634)
         5                             1,233           1,233         0.621                  766
       Net Present
          Value                                                                         ($10,439)

       *The tax benefit is calculated based on the lease deduction for the year times Sparrow‘s
       tax rate of 34%. For each year, this benefit is assumed to arise at the beginning of the
       following year when the tax liability is paid. The annual benefit is $1,233 ($3,625 × 34%).


2.     The analysis below shows that Lark Corporation would incur a smaller cost if the asset is
       purchased ($10,364) as compared to the cost of leasing the asset ($10,439).

       If the asset is purchased and the expensing election is made, the present value of the
       after-tax cash flows follows:
                                Business Deductions                                             5-15


                                              Tax Benefit
                                          from Depreciation         Discount          Net Present
     Year              Cash Flow             Deduction*              Factor              Value
       0                ($15,000)                                       1.000           ($15,000)
       1                                       $5,100                   0.909              4,636
       2
       3
       4
       5
      Net Present
         Value                                                                          ($10,364)

     *The tax benefit is calculated based on the amount expensed under § 179 ($15,000)
     for the year times Lark‘s tax rate of 34%. This benefit is assumed to arise at the
     beginning of the following year when the tax liability is paid.

     If the asset is leased, the present value of the after-tax cash flows follows:

                                    Tax Benefit
                                    from Lease    Net             Discount            Net Present
     Year           Cash Flow       Deduction* Cash Flow           Factor                 Value
      0             ($3,625)                       ($3,625)         1.000               ($ 3,625)
      1              (3,625)         $1,233         (2,392)         0.909                 (2,174)
      2              (3,625)          1,233         (2,392)         0.826                 (1,976)
      3              (3,625)          1,233         (2,392)         0.751                 (1,796)
      4              (3,625)          1,233         (2,392)         0.683                 (1,634)
      5                               1,233          1,233          0.621                    766
     Net Present
        Value                                                                           ($10,439)

     *The tax benefit is calculated based on the lease deduction for the year times Lark‘s tax
     rate of 34%. For each year, this benefit is assumed to arise at the beginning of the
     following year when the tax liability is paid. The annual tax benefit is $1,233 ($3,625 ×
     34%).

3.   Sales revenue                                                                     $185,000
     Less: Operating expenses                                                          (125,000)
             Depreciation for book                                                      (13,000)
             Loss on sale of delivery truck to Neil‘s brother                            (5,000)
             Amount paid to fruit inspector to overlook below
                 standard fruit shipped to various vendors (bribe)                        (3,000)

     Net income before tax for book purposes                                            $ 39,000

     Deductions allowed for tax purposes not expensed per books
             Excess of cost recovery for tax over book depreciation
             ($17,500 – $13,000)                                                          (4,500)
5-16


       Deductions not allowed for tax purposes but expensed per books
          Loss on sale of delivery truck to Neil‘s brother                            5,000
          Amount paid to fruit inspector to overlook below standard                   3,000
             fruit shipped to various vendors (bribe)
       Taxable income                                                             $ 42,500

       See Bridge to Financial Accounting in Chapter 3, which discusses differences between
       financial accounting income and taxable income.

RESEARCH PROBLEMS

1.     With facts similar to those of Amos and Susan, the Tax Court [Stanley M. Kurzet, 73
       TCM 1867, T.C. Memo. 1997–54] disallowed the $700,000 deduction for the Lear jet. To
       be deductible, the Lear jet would have to be used in a § 162 trade or business or a § 212
       production of income activity.
       Based on an analysis of the facts, the Tax Court concluded that the Lear jet costs
       allocable to the travel to the Tahiti property and to Park City were personal expenses
       and therefore nondeductible. Both the Oregon timber farm and the computer consulting
       business were classified as § 162 trades or businesses.
       However, in order for the related Lear jet costs to be a deduction, they must satisfy the
       ‗‗ordinary and necessary‖ requirement of § 162(a). The $700,000 expenditure for
       operating the Lear jet appeared extraordinary. In light of the extent of its usage for
       business purposes, the need for a Lear jet appeared to be out of the ordinary and
       unnecessary. Other air travel arrangements were available. Therefore, the Tax Court
       disallowed the $700,000 deduction for the Lear jet and permitted instead a deduction for
       transportation costs to the Oregon timber farm and to the computer conferences equal to
       the cost of first class tickets for Amos.

2.     The facts of the case are similar to Trentadue v. Comm., 128 TC 91, No. 8, (2007). In
       this case, the court ruled the trellis system was farm equipment with a 10-year class life.
       The trellis system components could be moved and reused, they were not designed to
       remain permanently in place, and the post were not set in concrete and could easily be
       removed from the ground. pp. 5-29 and 5-30

3.     In a similar fact pattern, Chief Counsel Advice 199924044, re-released on April 29, 2005,
       concluded that the new magnetic strip keycard door locking system is classified as
       nonresidential real property.

4.     The facts of the case are similar to Bruce Selig, 70 TCM 1125, T.C. Memo 1995-519. In
       this case, the court ruled that a deduction was allowable. They found that over time,
       the exotic automobiles would, because of those exotic features, become obsolete
       in the petitioner‘s business. The fact that the petitioner failed to show the useful lives of
       the automobiles was irrelevant.
                               Business Deductions                                         5-17


5.   The facts are similar to those in Field Service Advice 200136010. The FSA indicates that
     costs directly related to the acquisition of the credit card accounts and related
     receivables are separate and distinct assets of the taxpayer and provide the taxpayer
     with significant future benefits including an interest income stream. Such benefits extend
     beyond the close of the taxable year in which the acquisition expenses are incurred.
     Such costs are not currently deductible or eligible for amortization under § 195.
     Therefore, the costs in question must be capitalized under § 263.

6.   The Internet Activity research problems require that the student access various sites on
     the Internet. Thus, each student‘s solution likely will vary from that of the others.

     You should determine the skill and experience levels of the students before making the
     assignment, coaching them where necessary so as to broaden the scope of the exercise
     to the entire available electronic world.

     Make certain that you encourage students to explore all parts of the World Wide Web in
     this process, including the key tax sites, but also information found through the web sites
     of newspapers, magazines, businesses, tax professionals, government agencies,
     political outlets, and so on. They should work with Internet resources other than the Web
     as well, including newsgroups and other interest-oriented lists.

     Build interaction into the exercise wherever possible, asking the student to send and
     receive e-mail in a professional and responsible manner.

7.   See the Internet Activity comment above.

								
To top