Federal Taxation -You Decide Paper

2156 Words Oct 27th, 2011 9 Pages
Memo
To: John and Jane Smith
From: Desiree Looft, CPA
Date: September 24, 2011
Subject: Explanation of tax benefits and liabilities for business and personal.

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)) This total amount of taxable income will pass through to his personal taxes since he has an LLC, meaning he will be subject to self
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(Code §219(c )) With the lease payment and the IRA’s 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 concerning 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)). The requirement is 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)) Assuming a new mortgage will most likely give them a larger deduction of mortgage interest if they have lived in their current home for a while that is otherwise nondeductible. (Code § 163(h)(3)(E)(i).
In summary the only tax advantage is the ability to have a larger deduction of mortgage interest on the new home. (Code § 163(h)(3)(E)(i). With the sale of their current home they would be able to exclude the gain from the sale up to $500,000. (Code §121(b)(1) and (2)) A word of caution if the sale of their new home the gain is more than $500,000 they would have to pay tax on the amount over at a rate of 25%.
2(b) Jane has inquired about the 1031 tax exchange if they could use that plus some of John’s money from the case to purchase a more expensive house.
The words “like-kind” are

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