Tax Liability Opening: This memo concerns the income tax questions for John and Jane Smith, a married couple. John is a lawyer and has questions regarding income to his firm, investment in office space, and overall preparation techniques. Jan has questions regarding business related activities, real estate investments, business expenses, and business investments.

John Smith

How is the $300,000 treated for purposes of Federal Tax income?

Under 26 U.S.C. Section 1402, "The term "net earnings from self-employment" means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702 (a)(8) from any trade or business carried on by a partnership of which he is a member"

All income earned during a business year is considered business income. This includes the $300,000 contingency fee. Under IRS Law, income can be spread out up to two years in the future or amended back up to 3 years. In the case of the $300,000 contingency fee, it would be more advantageous for John to amend this previous two returns and include $100,000 for each year he has been working on the case. This will lower his overall...

The only question is the amount earned in prior years. Should the amount earned in the prior years along with the filing result in too high an amount, then the remaining income may be more beneficially paid in the present tax year.
1b. How is the $25,000 treated for purposes of Federal Tax income?

Under 26 U.S.C. Section 162, "There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including

(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

(2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and (3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity."

The full $25,000 was out-of-pocket costs for the business. Under IRS law, business costs are directly credited and no taxes are owed. In other words, there will not be any tax liability owed for the $25,000.

1c. What is your determination for…