To: John and Jane Smith
From: Your Name, CPA
Date: February 2, 2013
Subject: Explanation of business and personal tax benefits and liabilities.
1(a). As a result of a recent court settlement for a client John earned $300,000 for his law practice LLC. He wants to minimize his tax liability and understand how the IRS will treat this money earned. He lease’s office space for $3,500 per month. He wants to know the advantages in leasing office space versus purchasing the building.
John has income derived from a business and as such the gross income will be taxable (Code §1.61-3(a)) (Tax Almanac, 2005). This $300,000 taxable income will pass through to his personal taxes and is subject to self employment tax since he has an LLC. He…show more content… Since John and Jane do not have employer sponsored retirement programs, I recommend establishing traditional IRA’s. This will allow both of them to have a retirement program and a tax deduction each year of $10,000 (§219(f) (3)) (Tax Almanac, 2007, April 27). John is able to establish Jane’s IRA and contribute since she has minimal income (Code §219(c )) (Tax Almanac, 2007, April 27). With the lease payment of $42,000 and the IRA’s of $10,000, John will have deductions of $52,000 against the $300,000 and an additional deduction of paying half of the self employment tax.
2(a) Jane inquired what the tax treatment difference if any there is in paying down a mortgage and assuming a new mortgage in terms of federal taxes.
Married taxpayers may exclude up to $500,000 of gain upon the sale of their residence every two years (Code § 121(b)(1) and (2), (Code §121(b)(3)(B)) (Tax Almanac. 2009, June 18, Internal Revenue Code:Sec. 121. Exclusion of Gain from Sale of Principal Residence). The requirement is that they need to have owned and occupied the residence as their principal residence for two out of the last five years prior to the sale (Code §121(b)(3)(A)) (Tax Almanac, 2009, June 18). Assuming a new mortgage will most likely give them a larger deduction of mortgage interest and if they have lived in their current home for a while that is nondeductible (Code § 163(h)(3)(E)(i) (Tax Almanac. 2009, June 18, . Internal Revenue Code:Sec. 163.