Income Tax I
Bogdanski
Fall 2009

Sample Answers to Question 2

Exam No. 3050

 

1. Unreimbursed Expenses – Amber is required to pay many unreimbursed job-related expenses.  These would be deductible in general as ordinary and necessary business expenses under § 162, (since they are expenses made in the pursuit of making an income, are not capital expenses and not personal) but as they are not included in § 67’s list, if Amber itemizes them they will be counted as “miscellaneous deductions.”  Therefore these sorts of deductions are allowed only to the extent that they exceed 2% of Amber’s Adjusted Gross Income (AGI), in the aggregate.  To the extent that they do exceed that 2%, the unreimbursed expenses will be ordinary deductions in the year the expense was incurred.  If Amber chooses not to itemize, she will not be able to take any of these as deductions.

 

2. Commuting and Other Travel – Amber commutes to work each day.  Under the Flowers decision, Amber is not allowed to deduct commuting expenses on her taxes.  Travel is only deductible to the extent that it is reasonable and necessary, incurred away from Amber’s “business home” (i.e. her office), and necessitated by her business employment.  Commuting to work does not count as “away from home” (§ 162’s language).  However, her travel around town that is not between her home and office does count as deductible business expense assuming it meets the reasonably necessary and business-related requirements.  The final leg returning home at night will also not be deductible, even if it is from a client’s place of business, since it is also considered personal expense just like getting to work was.  The first and last legs of the day are generally considered personal expense.  Since Amber uses her own car, she is entitled to take a deduction for her qualifying travel for things like depreciation (some – there are limits also, for depreciation of high end vehicles that may apply (IRC § 280F)), fuel, maintenance, operating expenses, etc.  The shorthand for these expenses is the mileage rate, currently at 55 cents per mile.  Since Amber keeps meticulous records, she will be able to elect the option to easily calculate and deduct the proper amount without having to also keep track of the various expenses by simply multiplying the qualifying miles by the 55 cents and taking an ordinary deduction for the total amount.  These deductions are not mandatory, and she cannot take them if she does not itemize.

 

3. Job Related Damage Control – In dealing with the situation with Sandy, Amber has qualified travel (she is reasonably required to travel away from her office for business exigencies) and will be able to get an ordinary deduction for the miles traveled to Sandy’s office (and to the restaurant, etc., and back to her office, but not back to her home). 

The dinner and drinks qualify as business-related expenses that are deductible because Amber and Sandy are discussing business related matters over the meal and Sandy is a client or at least not a coworker.  The deduction Amber can take on her income taxes for this year is limited, however, by the 50% rule.  As a policing measure, meal and entertainment expenses for both Sandy and Amber can be deducted by Amber (they are not income for Sandy), but only up to 50% of the amount under § 274(n).  The restaurant was a “high-end” restaurant, so this could also be considered “lavish under the circumstances,” and denied as a deduction under the 162(a)(2) standard, but this could be considered reasonable depending on the restaurant and the need to retain the client.  Also, the IRS in reality never enforces the “lavishness” standard.

 

4. The flowers Amber sends the next day may not qualify as ordinary and necessary business expenses and thus may not be deductible.  This may be considered more like purchasing good will as happened in the Helvering case (where it was denied as a deduction).  However, it could also qualify as a business-related gift since it could arguably have been made with detached and disinterested generosity, but that is a question of intent and of fact.  Regardless, if it is a business-related gift, the deduction would be limited (along with any other gifts given to Sandy that year) to a total of $25 under § 102(c).  The fact that her note also referred only to friendship, though, may make this more of a question.  It could go to showing the flowers were intended as a pure gift and not work-related at all, in which case it could be considered a plain old gift, which is a non-event for taxes, and Amber would not be able to deduct anything.

 

5. Divorce – Amber is required by the decree to pay her ex-husband’s mortgage for three years.  This qualifies as alimony and as an ordinary above the line deduction on her taxes in the amount of the payments for each year under § 215, because it is a payment that is not property (fact that it is in relation to a mortgage has no bearing), it is made “on behalf of” Henry because she is paying his bills, under a divorce decree (would have to be a written instrument – no specific evidence that it was not in writing), the decree did not designate the payments as NOT alimony for tax purposes (no evidence that it did from the question stated), Amber and Henry do not live together (no evidence that they do, especially since she must also hire a nanny), and while she must pay for three years, there is nothing stated in the agreement that Amber will have to continue paying Henry’s lease if he dies (remarriage is mentioned, but that’s not the same thing as death – at least not for tax purposes).  Thus the payments on Henry’s mortgage are a deduction in the year they are made on Amber’s taxes (and are gross income for Henry). 

 

Amber also received custody of their daughter.  Since she has custody, she is entitled to the daughter’s personal exemption amount under § 151 as a qualifying dependent (since the daughter qualifies under § 152 as Amber’s child, living in her house for more than ½ the year, is younger than Amber, and doesn’t provide more than ½ of her own support) and under the Tie-breaker rules even though Henry is also a parent, a tie between parents goes to the one with greater custody rights and Amber has custody.  Also, Amber will get the child tax credit for her daughter under § 24 since she is also under 17 yrs old.

 

6. Paying for the nanny – Amber is paying for work related child care.  Child care is normally a personal expense as a family-related expense, even if there is but-for causation from a business-related reason, and is therefore disallowed as a deduction under § 262.  However, there is a tax credit for child care under § 21.  This credit is allowed for 20-35% (based on AGI) of up to $3000 of expenses for child care that enables Amber to be gainfully employed.  Thus, depending on Amber’s AGI, she would be able to get a tax credit for her child care expenses.  She would have to divulge the tax ID of the nanny to the IRS, and cannot get this tax credit if the child care expenses were to be reimbursed by her employer.

 

 

Exam No. 3608

 

Amber’s Traveling Expenses

 

            Amber’s business expenses are not reimbursed by her employer. If they were reimbursed, she would be able to take an above the line deduction, meaning that the deduction would be taken from her gross income to determine her adjusted gross income under § 62. Because she is unreimbursed, her various expenses are below the line, and furthermore they are miscellaneous under § 67, and she will only be able to take these deductions is she 1) chooses to itemize in lieu of taking the standard deduction and 2) the aggregate of all of her miscellaneous deductions exceeds 2% of her adjusted gross income. Section 67 lists several deductions that are excluded from miscellaneous treatments, but most of the deductions that end up under this section are business related.

 

            Taxpayers are allowed a deduction for traveling expenses while “away from home” under § 162(a)(2). This would seem to indicate that Amber would be able to deduct the costs of her travel as soon as she leaves her personal residence, however this is not the case. Commuting expenses are NOT deductible. Her “home” for business purposes is Medco’s office in central city. Therefore, all of the travel from the office to the various satellite clinics and media outlets is deductible. But since Amber sometimes drives directly to her personal residence from these places, this is also considered commuting and is not deductible. In sum, only the trips from the office to work-related places and back to the office are deductible.

 

            Since Amber drives her own car, she can deduct for depreciation, gas and maintenance. However, this is very difficult to calculate. Alternatively, the IRS has published mileage rates, which currently are $0.55/mile. Since Amber has taken great record, she should be able to separate out the mileage that is deductible from the mileage that isn’t, multiply it by the rate, and figure out her deduction. She can also add on any costs of parking and tolls.

 

Dinner, Drinks, and Flowers for Sandy

 

            Again, these expenses are unreimbursed so if they are deductible at all they would be “miscellaneous” deductions under § 67.  As a primary matter, dinner and drinks are deductible if there is a business purpose – either doing business over the meal or entertaining clients, customers or other business contacts. But, food is only deductible up to 50% of the cost under IRC § 274(n)(2). If Amber were reimbursed for this expense, she would be allowed to deduct the full cost of the meal so it would amount to a wash, but since she is not, she must abide by the 50% rule. Therefore the fancy meal at the high end restaurant is only half-deductible.

 

            It is likely that this meal would count as a business meal. Amber is a public relations professional and her job is “to foster positive relationships” with the media. Sandy is a powerful media figure, and she is unhappy. Amber is just doing her job. This can be contrasted with the case of Welch v. Helvering where a businessman, on his own initiative, repaid his company’s debt with certain clients. He did so on the theory that he had personally guaranteed the money. This was seen as a capital expenditure on preserving his good name and hence not deductible. Even though Amber broke a promise that she had made to Sandy, it was in the course of her ordinary business duties to foster goodwill.

 

            If the flowers are a gift then they may be deductible up to $25. This amounts to a business gift. However, there are some good reasons why Amber might not want to even bother to try to deduct this. First, under § 274, Amber would have to send Sandy a 10-99 form disclosing what she spent on the flowers in order to take the deduction. It is also unlikely that this is a gift since it is not motivated by detached or disinterested generosity. She is sending the flowers to preserve a beneficial business relationship. All of the § 274 rules about gift deductions are evidence that Congress thinks that gifts between business contacts are fishy. However, it is possible that she will be able to deduct the flowers as an ordinary and necessary business expense. If she can show that is it usual for her or other public relations professionals to send flowers as part of their jobs then it will be ordinary. Under § 162, this would be an allowable business expense.

 

Divorce

 

            If the mortgage payments to Henry are “alimony for tax purposes” she will be allowed to deduct them as an above the line deduction from her gross income under § 215. It is likely that these payments are alimony. Under § 71, alimony for tax purposes has the following requirements. Alimony must be 1) any payment in cash, 2) to or for the benefit of the ex-spouse, 3) pursuant to a written instrument, 4) with no election to have the payments not be alimony, 5) with the payee/payor living apart, and 6) no obligation to pay after the payee dies. Here most of the requirements are met. The payments are for the benefit of her ex, it is pursuant to a divorce decree, they do not live together (presumably) and they haven’t expressly described it as “not alimony”. Therefore it could be alimony if it is not a property settlement and if she is not obligated to pay if Henry should die within the three year period. The facts don’t indicate whether she has a continuing obligation to pay if Henry should die. If she did, then it would not be alimony and she would not be able to deduct it. Also, it is possible that this could be construed as a property settlement, however, that is not likely. Under the Disguised Payment Rules, § 71(f), if there were a big drop-off in the payments in the third year, it would be construed as a property settlement, and she would not be able to deduct it. Because payments on the mortgage are likely to be steady for three years, this is most likely deductible alimony payments.

 

Custody of Darla

 

            Because Amber has retained custody of Darla, she will receive some tax benefits. First, Darla is a dependent. A dependent is a qualifying child (§ 152(c)), who lives with the taxpayer for more than half the year, is younger than the taxpayer and under age 19, and doesn’t provide more than one half of their own support, and is not filing a joint return with someone else. Darla clearly meets these requirements as an 11-year old residing with her mom. Therefore, Amber is a “head of household” under § 1 and will have a more favorable rate schedule than if she just filed as a single person. Furthermore, she will be able to take a personal exemption for both herself and her daughter under § 151.  However, we do not know Amber’s income, other than it is generous, so she may be subject to a phaseout of her personal exemptions, but she would need to make more than $331,000 to lose all of it. Also because she has a child, she may be able to claim a Child Tax Credit under section 24, but it is likely that she makes too much income.

 

            What will be more useful to Amber is the Child Care Tax Credit under § 21. Because she makes more than $ 15,000 per year (since her salary is described as generous and she is making her husband’s alimony payments), she will be able to deduct 20% of her child care cost. This seems generous but there is a cap on how much of this expense she will be able to consider. She can only take 20% of  $3,000 per year, because she has one child. She would also be required to report her nanny’s social security number on her tax return, which would possibly deter some taxpayers, but since she has hired a professional, this likely would not be a deterrence. This may not make so much of a difference since she spends a lot of money and the most credit she will be able to get is $600.

 

 

Exam No.  3839

 

Amber’s unreimbursed job related expenses could lead to deduction on her income tax return.  Under § 162, ordinary and necessary expenses incurred while carrying on a trade or business are deductible.  Amber is the director of public relations for a large medical clinic, and part of her job is to foster positive relationships with the local media.  She pays many expenses out of her pocket, and is not reimbursed.  Under § 212, individual expenses incurred for the production of income, is deductible.  As long as Amber has a profit motive theme, then her business expenses are deductible. 

 

The question is whether her expenses are for business or personal reasons.  Personal expenses are not deductible under § 262.

 

When Amber drives her car from her residence in the suburbs to her office, the expense she incurs is not deductible because it is a personal expense.  Under Reg. § 1.262-1(b)(5), Regular commuting from your home to your work is not deductible.  What is deductible is going from your “business home” to another place where you need to go to perform you job.  Amber’s work duties require her to go to various media outlets and satellite clinics around the metro area.  The expenses she incurs on these drives from her work “home” to another work location are deductible.  If she drives her own car, she could deduct the depreciation, gas and maintenance of the car.  There is a limit to the depreciation of a high end vehicle under § 280A.  However, Amber could make it easy on herself and just use the published IRS mileage rates, which are currently $0.55/mile since she keeps meticulous work records.  However, the last trip from her work place to her home is not deductible. 

 

When Amber takes Sandy, the editor of a newspaper and a business contact out for dinner, Sandy could deduct the expense under § 274(a)(1).  She is meeting with Sandy for because Sandy is angry that Amber leaked a news story to a blogger rather than going directly to the Journal, Sandy’s newspaper – as per their agreement.  Amber’s job is to foster good relations with the media, and its not going to be good for her job to have a pissed off editor in chief.  Amber goes to Sandy’s office (which she could deduct the miles for) and takes Sandy out to dinner.  Presumably, they are going to have a bona fide business discussion since Amber does it with the intent to “control the damage caused by the incident.” Under 274(a)(1), Amber could deduct the cost of her meal and Sandy’s meal and both of their drinks. However, under 274(n)(1)(B), Ambers’ deduction would be subject to the 50% rule.  She would only get to deduct half of the cost of taking Sandy out.  This would be an above the line deduction, so it would really be a wash for Amber.  When Amber sends flowers to Sandy, she is presumed to be giving the gift because of her business relationship.  While it is arguable that she is sending flowers because they are friends b/c the card reads “True friendships endure,”  we know that Amber is doing it to try to fix the damaged business relationship she has with Sandy.  Amber would get to deduct up to $25 for the cost of the flowers and the card, but not more. 

 

Finally, Amber’s deductions would be subject to the 2% AGI floor under § 67.  If the aggregate of her allowable deductions would be more than 2% of her AGI, then she would be able to take these deductions.  Also, Amber would have to itemize in order to these deductions, or she could take the standard deduction.  Its possible that Amber could meet 2% of AGI, but since she has a “generous salary,” it is possible that she may not meet the floor.

 

Amber’s divorce leads to some deductions.  The divorce decree requires that she makes the mortgage payments for Henry’s residence for 3 years.  The payments may be considered alimony under its definition of § 71 because the divorce decree is presumably written, the payment, while not cash, is paid on behalf of the ex spouse (the mortgage payemt), there does not seem to be an election that the payment is not alimony, and they presumably do not live in the same household b/c she is paying for his mortgage.  There is also nothing that says that if Henry dies, then Amber would have to keep paying for the mortgage.  Presumably, this mortgage payment has nothing to do with child support because Amber gets custody of their child.  Arguably, it might be considered a property settlement b/c Amber still has to keep paying even if Henry remarries.  If this was considered a property transfer, it would be a “tax nothing” under § 1041.  However, the payments to do not drop off after the 3rd year, so under the regs, there is no presumption that it is a property transfer.  Amber could deduct the alimony payments she pays to Henry under § 217 as an above the line deduction that would help to lower her adjusted gross income and help her meet the 2% AGI floor for miscellaneous deductions. 

 

When Amber pays for Darla’s professional nanny, Amber would be entitled to a Child Care Credit under § 21.  A credit means that Amber would still get money back, even if she ends up not having tax liability.  The credit would be equal to the applicable percentage of the employment related expenses during the years. The applicable percentage is between 35% and 20%, but there is a phasedown for this credit.  Presumably, since Amber has a “generous salary”, she would be at the 20% range for this credit.  There is a cap on this credit, $3000 per child.  So, the  maximum that Amber could get as a credit is 20% (presuming her high income) of $3,000.  That would be $600 tax credit.  In order to take this credit, Amber would have to get the Social Security Number of her professional nanny, and report her income to the IRS. Amber has one child who is a dependant.  Darla is 11 years old, lives with Amber, and presumably does not make any income b/c none are stated in the facts.  Amber has a divorce decree saying she gets custody, so Darla qualifies as her dependent. Under § 24, Amber would get to also take the Child credit for each qualifying child.  However, this credit also has a phaseout.  The credit is reduced by $50 for each $1000 that Amber’s “generous salary” is over the AGI threshold.    Amber would also get to take her own personal exemption, as well as a personal exemption for Darla.  The amount adjusted for inflation is $3,650.  This exemption also has a phaseout under § 151(d)(3) of a really high amount.  However, this phase out is being phased out in January of 2010.