To: Mr. John Smith and Mrs. Jane Smith
From: Sarah Gong
Date: November 25, 2012
RE: 2011 Tax Strategy
Dear John and Jane,
Thank you for the opportunity to work on your behalf for tax preparation this year. Per our previous discussion, I have prepared this memo as a preliminary work on this year’s tax strategy. The three main sections are constructed according to inquiries made by each of you individually and, then, to conclude on the options available for you both and my recommendation.
1. John Smith tax issues
a) The $300,000 of attorney’s fee should be included in gross income and subject to federal and state tax. The Internal Revenue Code Section 61 (IRC 61, 26 U.S.C. § 61) defines gross income as all income from…show more content… c) Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit4. IRS uses the "3-of-5" test to determine if you have profit motive. If your business made a profit in any three out of the past five consecutive years, it is presumed to have a profit motive, and your activity will be likely considered as a business. Per our discussion, you are thinking about adding new equipment to your activity, which is also evidence that your activity can be considered as a business.
d) If your hobby activity produces income, you owe tax on it. And if your hobby activity keeps bringing in income over years, you will have tax benefits to set up a separate business for the activity because you can deduct ordinary and necessary expenses from the income to lower your taxable income. When you have loss, you can also use it as a tax shelter to reduce your overall gross income (if you have other income sources).
e) Yes, there may be an indirect benefit to John if he makes a $15,000 investment into Jane's business if John and Jane file “Married filing jointly tax return”. Jane must use the $15,000 for business deductible purchases. If the money sits in the bank it will not provide a tax benefit.
f) Yes, Jane can depreciate the vehicle and her jewelry making machine. The equipment can be depreciated with MACRS or