Analysis: Memo Analyzing Various Tax Issues

Memo
To: John & Jane Smith
From:
Date: 03/25/2012
Re: Memo summarizing various tax issues
1. John Smith's tax issues:

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

John stated that he received a lump sum of $300,000 for winning a case on behalf of a personal injury client (total case winnings $2,000,000). John questioned how the $300,000 should be taxed.

Applicable Law & Analysis:
Per the IRS: In most cases, you must include in gross income everything you receive in payment for personal services. In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options. (IRS.gov, 2012).

Conclusion:
Though the winnings…show more content…
However, if the claimant receives a lump sum, the claimant excludes that amount but may be taxed on any yield from the investment of the lump sum. On the other hand, if a casualty insurer invests the same lump sum and pays the investment yield to the claimant in the form of a structured settlement, no part of this investment yield is taxable to the claimant. (Little, Meyers, 2012, para. 12).

Conclusion:
If the lawsuit can be collected on an annuity basis in a structured settlement, then John’s fee could potentially be non-taxable. This is an option that should certainly be explored. The $25,000 in expenses should still be deductible as business expenses.

Issue d) Do I get better tax benefits for paying the lease on office space or for buying the building? What are the differences?

John also questioned the decision whether to lease or purchase his office building for business and differences in taxation between the two.

Applicable Law & Analysis:
Rent Expense - Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible. (IRS.gov,…show more content…
Leasing the building will allow John to write off the payments as rent expense. However, if he has the capital to purchase the building, it would be considered an asset and he would be allowed to depreciate over the life of the building. This decision would have to weigh factors such as: capital investment, loan options if no capital investment, and expected future profits and expenses of the business.

2. Jane Smith tax issues:

Issue a) What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for federal income tax purposes?

Jane questioned whether they should take the $300,000 fee and use it to pay off their house, so that they could purchase a bigger house. She is asking if they should pay off the current house first and purchase a new one; or, buy a new house first and then sell the old house.

Applicable Law & Analysis:
The tax savings from the mortgage interest is only based upon the additional amount that the itemized deductions exceed the standard deduction. (Military.com, 2012).

Individuals can exclude up to $250,000 in profit from the sale of a main home (or $500,000 for a married couple) as long as you have owned the home and lived in the home for a minimum of two years. (About.com,