John Smith Tax Issues

You Decide Assignment
1. John Smith tax issues:
a. How is the $300,000 treated for purposes of federal tax income?
The issue is how the $300,000 will be treated for federal income tax purposes. According to the Internal Revenue Code Sec. 61(a), gross income includes “all income from whatever source derived” unless specifically exempted by law. Under this code, the $300,000 is considered gross income since this is income earned by performing services as a part of John’s trade.

b. How is the $25,000 treated for purposes of federal tax income?
The issue is how the $25,000 of reimbursed expenses will be treated for federal income tax purposes. According to the Internal Revenue Code Sec. 162, “Ordinary and necessary expenses incurred to carry on a trade or business are deductible.” Since the $25,000 reimbursed expenses were in relation to the services provided, it will need to be included in gross income but will be treated as a deduction to the adjusted gross income.

c. What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
The issue is determining how to reduce the taxable income for both the $300,000 and the $25,000 reimbursed expenses that are included in gross income for the current year. Since John did not know if he were going to win the case that he worked on for two years and therefore receive the income, he was unable to use the accrual method and had to use the cash method. In order to reduce his income for the current year, he can file an amendment to his previous tax year to change to use the accrual method. With this method, he can split his income and expenses between two years, effectively reducing his taxable liability for the current year. John should identify all of his expenses that were incurred during the year that were in relation to this case. He can deduct salaries