John Smith Operates His Personal Attorney Service,

John Smith operates his personal attorney service, which for tax purposes the limited liability company (LLC) and treated as a partnership. A partnership's income and expenses are to be reported on the U.S. Return of Partnership Income, Form 1065, on an annual basis. If there is more than one owner to John Smith's business, each partner will pay the income tax by filing a Form 1065 Schedule K-1, Partner's Share of Income, Deductions, Credits, etc. This form will identify the income, expenses, and other items, as well as how much is distributed to each partner's share in accordance with their agreement (IRS.gov, 2011).

John Smith is also curious as to how the $25,000 of prepaid expenses will be treated on his federal taxes. The federal government considers business expenses as those that are the cost of operating a trade or a business. Because these costs were used in the operation of Mr. Smith's business in order to make profit, he may use them as a deductible on his federal taxes. However, in order for it to be deductible, it must be ordinary and necessary for the operation of his business. This may be easily defined as an expense that is helpful or appropriate in the legal industry. This will also be reported on the Form 1065 Schedule K-1 (IRS.gov, 2010).

John Smith does not wish to report the lump sum of $325,000 as 2011 income because he had been working on this particular client's case for a total of two years. If Mr. Smith wishes, he is able to create an amended return in which he will report a specific amount of the income on the prior year's income and expenses sheet. In order to do so, Mr. Smith will need to file a Form 1040X, an Amended U.S. Individual Income Tax Return. This form is used because the business is an LLC, and most commonly LLCs report on each partner's individual returns (IRS.gov, 2011).

Jane Smith, John's wife, has many questions regarding her mortgage situation. Whether or not Jane decides to pay down her current mortgage or purchase a new home, Jane may be assisted by the Home Acquisition Debt Deduction, in which qualified loans allow tax payers to deduct interest on their home up to $1 million, assuming they are filing jointly. In the event that the Smith's home interest exceeds $1 million, the couple is able to deduct the mortgage interest paid on their home equity debt on their federal income taxes (IRS.gov, 2010)

When John Smith receives his money from his client, he may exchange it for property of a like-kind without recognizing a gain or a loss under Internal Revenue Code Section 1031. However, because he is receiving revenue money and wishes to exchange it for property, the gain will be recognized (IRS.gov, 2008).

Jane Smith enjoys creating jewelry as a past-time, but has earned $20,000 in profit this last year. In order to determine whether it is strictly a business or strictly a hobby by federal government terms, Jane must determine if it has made profit at least three of the last five years. If it is a business, she will be able to deduct expenses relating to her business, such as vehicle or jewelry depreciation when used for business purposes. If Jane determines that her business is a hobby, she may deduct expenses on a Schedule A for Form 1040 (IRS.gov, 2008). If Jane and John determine that Jane's jewelry making is for hobby, they will be able to claim personal expenses like home mortgage interest and taxes. If they determine that it is a business, she is able to deduct capital expenses, cost of goods sold, and business assets from her federal income taxes (IRS.gov, 2009).