Interest Payment Essay

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Date: February 12, 2013 To: Dr. McCoskey From: Giovanny Ayala Re: Interest Payment Facts: A very prosperous taxpayer is president of a company and owns a good deal of assets. On January of year 1, he issues a $1,000,000 loan with a rate of 10% from Bank 1; it is an interest only loan with interest to be paid annually on the principle date of issuance. He uses the loan amount to purchase stock. On November 1, of year 1, he issues a $100,000 loan with a rate of 9% from Bank 2 to cover the interest expense of the principle loan, due on January of year 2; loan #2 is secured by assets and is a regular amortizing loan. On December 1, of year 2, the taxpayer receives the proceeds from loan #2, and deposits it into his checking account in Bank 3. At the end of December of year 1, his account balance in Bank 3 amounts to $115,000. On January 2, of year 2, the taxpayer wrote a $100,000 check to Bank 1, from his checking account in Bank 3. On the taxpayer’s tax return for Year 2, he took a $100,000 deduction as an investment interest expense under §163, and had enough investment income to cover such a deduction. Later it is found that Bank 1 owns 90% of Bank 2’s stock. The client is completely unaware. Upon being notified of this relationship, the IRS stipulates that such a deduction has never been paid as required by §163 and therefore plans to disallow the deductible. Issues: 1. What are the code §163 stipulations, on investment interest expense? 2. Is the $100,000 loan proceeds from Bank 2 considered taxable income? 3. What does Bank 1 owning 90% of Bank 2’s stock have to do with this scenario? 4. Is there any ground for the taxpayer’s position? What amount can the TP report on his tax return for Year 2? Conclusions: 1. Investment interest expense is interest expense on a loan that is used to buy an investment, in this case stock;

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