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ACCT 4414:  Income Tax Determination:  Spring, 2023

Research Assignment:  

Due at the beginning of class: SS1:  Wednesday February 22

Your clients, Tom and Patricia (Tricia) Petty, met with you in your office on January 15, 2023 to drop off the information needed to prepare their 2022  Federal income tax return.  Certain relevant facts are listed below.  For items labeled as TO BE RESEARCHED you are to identify and answer the question presented, i.e present a conclusion.   As part of a complete answer, you must (1) state your conclusion and (2) identify the authority (which should include, at a minimum, the relevant code section(s)) and (3) include the supporting RIA paragraph(s).  Regulations, revenue rulings, and relevant court cases are also encouraged.  All references must be cited in correct format (see chapter 15).   If more information is required to answer the question, you should so state; however, you will still need to provide the appropriate authority.  In addition to the correct citations, your conclusion should be expressed in language that non tax people (Tom and Tricia) will understand. In addition—if you believe there may be a planning opportunity available, please indicate that and outline what, if any, additional information would be required to address that opportunity.

I have provided an example for your use.

This is an individual project; if any question is unclear, please contact me and I will clarify.  You may use any research sources you would like (as you would in a real-life situation) EXCEPT for colleagues and other students.  However, all responses will require code citations as well as RIA paragraph references; in many of the answers, regulation, court cases and revenue rulings may well be appropriate.  Code sections and RIA paragraphs may be copied into the document.

Selected Facts:

A. Tom and Patricia, ages 47 and 46, and both U.S citizens and residents, will file married filing joint in 2022

B. Their primary residence is a single family home in the suburbs; they commute to work in the city.

C. In 2022, Tricia was employed as a Senior Vice President of a Bio-Tech concern, with a salary of $350,000 annually.

D. Tricia participates in a 401(K) plan at work and contributed the maximum amount to that plan.

E. Assume that Tom and Tricia will be claiming itemized deductions in 2022.

F. They have substantial investment income.

Sample Question and Answer

S1: Tom is an attorney; in January of 2022 he set up his own law firm in a single member LLC (SMLLC); Tom had no employees.  For 2022, Steve made $252,000 in this practice.  He has asked you how a single member LLC (SMLLC) is treated for tax purposes.  He has made no elections with respect to his SMLLC

S1 ANSWER:   Pursuant to ss. 301.7701-2(a), absent a special election, a single member LLC owned by an individual is disregarded, and its activities are treated in the same manner as a sole proprietorship.  Accordingly, the law firm will report income and expense on Schedule C as part of the individuals’ personal tax return.

Authority and support:

RIA paragraph D-1167:  Accordingly, under the check-the-box rules the default classification of a multimember business entity organized as an LLC is a partnership and the default classification of a single-member business entity organized as an LLC is a disregarded entity (see ¶ D-1151).

RIA paragraph D-1151  For the effect of treating an entity as a disregarded entity, see ¶ D-1165.

RIA paragraph D-1165   Under the check-the-box rules (see ¶ D-1150 et seq.), an eligible entity that has a single owner (i.e., a “wholly owned entity”) and isn't treated as a corporation, is disregarded as an entity separate from its owner.⁴That means that its activities are treated the same as a sole proprietorship, branch, or division of the owner.⁵

ss. 301.7701-2( a) Business entities. For purposes of this section and §301.7701-3, a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under §301.7701-3) that is not properly classified as a trust under §301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner. But see paragraphs (c)(2)(iii) through (vi) of this section for special rules that apply to an eligible entity that is otherwise disregarded as an entity separate from its owner.

Items TO BE RESEARCHED: (20 points each question)

1. Tom and Tricia own a two family home.  It was rented out for all of 2022.  There is a management company involved that arranges for the leases, takes care of snow plowing, electricity, heat and landscaping.  The activity showed a loss of $12,000 for 2022 and they would like to know if this amount is deductible in 2022.  Other than owning their own personal residence, this is the only real estate related activity they have.

2. Tom mentions that he has heard about a newly enacted 20% deduction that is available for flow through entities; he has inquired as to whether his law practice will be eligible for this deduction?  (Assume joint taxable income before consideration of this question is in excess of $600,000)

3. Tom and Tricia  plan on divorcing in 2023; they expect the divorce to be finalized by March 31, 2023.  They have agreed that Tricia will pay Tom alimony in an amount such that Tom will net $2,000, after tax, per month.  They have asked you if the amount paid will be income to Tom, as the taxability will affect the gross amount paid

4. They sold their former principal residence in September of 2022.  The home had been purchased in 2012 for $375,000.  Improvements of $45,000 had been made over the years (a room added, new roof, a back deck and a redone kitchen). The house sold for $950,000 and they purchased a new home for $1,500,000.  They have asked you how much, if any, the taxable gain will be.

5. As noted, the new residence cost $1,500,000;   to finance that purchase, they took out a 30 year mortgage of $900,000 at 4.5%.  Consistent with local real estate practices, they also paid a 1.0% point in order to obtain the mortgage.  Tom and Tricia have asked you about the deductibility of the point and the mortgage interest.

All responses must be in a memo to the client in a word document.