Income Taxation I

Fall 2011

Bogdanski

FINAL EXAMINATION – PART TWO

(Two hours)

INSTRUCTIONS

This second part of the examination consists of two essay questions, each of which will be given equal weight in determining grades. Two hours will be permitted for this part.

At the end of the two hours, you must turn in this set of essay questions in the original envelope in which this set came. If you are using a computer, unless you have been otherwise expressly instructed, you must submit your answers using SofTest. If you are writing answers by hand, you must write them all in the bluebook(s) you have been provided, and return the bluebook(s) along with this set of questions in the envelope.

No credit will be given for anything written on this set of questions. Only your electronic answer file or bluebook(s) will be graded.

Pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit.

Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.

The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.

Unless otherwise expressly instructed, assume that all taxpayers described in the questions are individuals, and that they report their income on the cash method and the calendar year for federal income tax purposes. Any references to the “Code” mean the Internal Revenue Code of 1986, as amended.

QUESTION ONE

(One hour)

Willa, an accountant, files for divorce from her husband, Henry. In their divorce property settlement, Henry gets $30,000 of cash that previously belonged to Willa as her separate property, and Willa gets Blackacre, a vacant lot in the central city that Henry previously owned for years as his separate property. Blackacre has a fair market value of $70,000 at the time of the divorce; Henry’s adjusted basis in Blackacre immediately before the divorce was $55,000. Willa holds on to Blackacre as an investment. Over time, Henry spends the $30,000 cash on basic living expenses.

A few years later, Willa enters into a real estate exchange transaction with Vince, a winemaker. At the time the exchange agreement is entered into (in mid-October), pursuant to that agreement, Willa transfers Blackacre to Vince. Five weeks later, also pursuant to the agreement, Vince transfers to Willa a parcel of agricultural land and 50 cases of fine wine. The agricultural land has a fair market value of $103,000, and the wine has a fair market value of $12,000.

Shortly after she turns 60 years old, Willa withdraws $10,000 from her traditional individual retirement arrangement (IRA) account. She also borrows $10,000 from a whole-life life insurance policy that she owns on her own life. Willa uses the $20,000 to create a new business for herself, selling pools and hot tubs. Despite many hours that Willa devotes to the new enterprise, it operates at a loss for its first year.

What are the federal income tax consequences to Willa of all the transactions just discussed, with and without any available elections? Be sure to discuss the amount, timing, and character (ordinary or capital) of each item of income, gain, loss, deduction, or credit, and the basis of each item of Willa’s property, at each stage of the transactions.

Explain.

(End of Question 1)

QUESTION TWO

(One hour)

Ken is employed as an executive of Corp, a large corporation whose stock is traded on a national stock exchange. In 2011, when Corp stock is trading at $10 per share, Corp grants to Ken the option to purchase up to 100,000 shares of its stock at that $10 price at any time over the next two years. The option, which is not an incentive stock option or part of a qualified retirement plan, is fully vested at the time it is granted. (Unlike Corp stock, Corp options are not traded on a public market.)

In 2013, Ken partially exercises the option, purchasing 50,000 shares of Corp stock for a total exercise price of $500,000. At the time of the purchase by Ken, the stock is trading on the national market at $25 per share, so that the stock Ken acquires has a total fair market value of $1,250,000 at the time of the exercise.

In 2015, Ken sells 40,000 of the Corp shares on the public market for $30 per share, or a total price of $1,200,000. Also in 2015, Ken donates the other 10,000 Corp shares, which have an aggregate fair market value of $300,000, to a local nonprofit medical school. The medical school promptly sells the stock on the public market for $300,000 cash.

The following year, the medical school admits Ken’s son, Sam, as a student. The school awards Sam a scholarship that covers all of his tuition, fees, books, and supplies for his four years pursuing his M.D. degree. These items would normally cost an aggregate of $50,000 a year. Sam’s academic record and test scores are slightly below what the school normally requires for admission.

Corp pays Ken’s monthly dues at a downtown businesspersons’ club near Corp’s business headquarters. Ken uses the club membership solely to entertain customers, employee prospects, financiers, investors, and other business contacts. Corp also reimburses Ken for his meal expenses at the club, which are substantial. Ken eats lunch there with his guests about 100 days each year.

What are the federal income tax consequences to Ken of all the transactions just discussed, with and without any available elections? Be sure to discuss the amount, timing, and character (ordinary or capital) of each item of income, gain, loss, deduction, or credit, and the basis of Ken’s stock, at each stage of the transactions.

Discuss.

(End of examination)

Created by: bojack@lclark.edu
Update:  20 Jan 12
Expires:  31 Aug 13