1977 U.S. Tax Court Examination for Non-Attorneys

 *  *  *


(Note: Non-attorneys who wish to practice before the Tax Court must first pass written examinations, given on the last Wednesday in October of each year. The texts of previous examinations are made available to practitioners studying for the tests. The text of the 1978 examination, however, will not be available until February 1979, following release of the results of the examination.)

The following is designed to test your overall knowledge of Federal taxation, procedure, and trial practice and to indicate your competence in representing taxpayers before the Tax Court. There is space provided for writing your answer, but you may insert additional sheets if needed, numbering the added pages with the number of the page provided for the answer showing in some manner that the page is a continuation page, such as marking it "12(a)".

Extra paper will be provided. The only reference material permitted to be with you during the exam is a copy of the Internal Revenue Code, a copy of the Rules of Practice and Procedure of the Court and a copy of the Income Tax Regulations. You may refer to these materials in taking the examination.

Clarity and conciseness of expression will be a significant factor in grading your paper. Answer only the questions that are asked. Discussion of issues which are not raised by a specific question will detract from your score on that question even if you give an otherwise correct answer.

You will have four hours to complete this examination. Each question has been allotted a specific number of minutes (see notation in parenthesis at the beginning of each question). Your answer will be weighted accordingly.

The examination is comprised of two sections. The first section deals with the Tax Court Rules of Practice and Procedure and evidentiary matters. The second section deals with substantive Federal income tax problems. Each section will be graded separately and you must separately show your qualifications to be satisfactory on each section of the examination.

As soon as you have read these instructions begin the test. When you have completed your examination, or when the time for completion of your examination has elapsed, burn into the examiner your questions and answers and the materials furnished to you.


Section A: Practice And Procedure
(80 minutes)

Part I. (suggested time for questions in Part I: 40 minutes)

Question 1 (4 minutes)
Dr. Stone is the petitioner before the Tax Court in a civil fraud case. On cross-examination, he is asked whether he received from his patients substantial cash payments which he failed to record in his books and records. Dr. Stone denies that he ever received any payments which were not properly recorded. The question is repeated, and he gives the same answer.

At this point, Government counsel seeks to introduce into evidence a certified copy of a transcript of the proceedings in the case of United States v. Stone, in which Dr. Stone was the defendant charged with criminal fraud for the same years presently at issue before the Tax Court. In his criminal trial, Dr. Stone testified under oath that he did receive cash payments which he failed to record. Despite this evidence, he was acquitted by a jury In the criminal case.

Dr. Stone's counsel objects that his client's prior testimony is inadmissible hearsay. How should the Court rule?

(Select the best answer--choose only one.)

a. Evidence of his prior testimony is inadmissible hearsay.

b. Dr. Stone's prior testimony is admissible, but only for purposes of impeachment.

c. The prior testimony is admissible as substantive evidence.

d. The testimony is inadmissible because he was acquitted in the criminal case.

Question 2 (4 minutes)
John Jones is the petitioner before the Tax Court. The issue is whether $100,000 worth of GM stock which John received from his Uncle Bill constituted taxable income to him. John's position is that the stock was a gift. However, for several years John managed his uncle's affairs, devoting substantial time to this endeavor. The IRS asserts that the stock was compensation for services rendered.

The case turns in part on whether Uncle Bill intended the stock as payment for services. Unfortunately, Uncle Bill is now deceased, and therefore not available to testify. However, his nurse, Nancy Andrews, was present at the time the transfer took place. The IRS calls Nancy to testify. In response to counsel's questions, she testifies that at the time the transfer was made, Uncle Bill said to his nephew: "John, you have served me faithfully, and I believe you deserve to be compensated for your efforts. I am signing over my CM stock to you, as payment for all you have done."

John's counsel objects that the testimony is inadmissible hearsay. As proof of Bill's intent, should the Court admit this evidence? Why or why not?

Question 3 (4 minutes)
Uncle Bill's Estate is the petitioner before the Tax Court. The transfer was made on January 5, 1975; Uncle Bill died on December 1, 1975. The IRS seeks to include the value of the stock in Uncle Bill's estate under section 2035.

The IRS called Nancy to the stand. She testifies that at the time of the transfer Uncle Bill said to his nephew: '1 know I am dying, and I want to be sure that you will be taken care of after I'm gone. " Counsel for the estate objects to the admission of this statement as hearsay. How should the Court rule?

(Select the best answer -- choose only one. )

(a) The statement is inadmissible hearsay because it is not the best evidence of Uncle Bill's state of mind.

(b) The statement is admissible as an exception to the hearsay rule because the declarant is unavailable,

(c) The statement is admissible as a dying declaration.

(d) The statement is an admission by a party opponent, is not hearsay, and therefore is admissible,

Question 4 (6 minutes) (This question has 2 parts)
Jimmy for many years has operated an illicit but highly successful bookmaking operation. The IRS has asserted deficiencies and fraud penalties against Jimmy for the years 1970-1975, and Jimmy has filed a petition with the Tax Court.

In contrast to many taxpayers engaged in Illicit businesses, Jimmy has maintained extensive financial records which the IRS has acquired through the Court's discovery procedure. The records show daily receipts and payouts, and demonstrate that Jimmy had income substantially in excess of that reported on his returns for the years at issue.

Jimmy's bookkeeper, who maintained the records, is called to the stand to identify them. IRS counsel then offers the records into evidence.

Jimmy's counsel objects that the records are hearsay,

a, Name, and discuss briefly, 2 hearsay exceptions which may be applicable.

b. Define hearsay.

Question 5 (4 minutes)
Scott Corp. is the petitioner before the Tax Court. The Issue is whether compensation paid to the corporation's president and sole shareholder is reasonable.

Scott Corp, call as an expert witness Ben Smith, a certified public accountant with extensive knowledge of the paper products industry in which Scott is engaged. Scott's counsel elicits testimony concerning compensation paid to key executives of other comparable companies in the industry. Counsel then asks the witness whether, in his opinion, the compensation paid Scott's president was reasonable.

IRS counsel objects that the question calls for testimony on the ultimate issue in the case. How should the Court rule?

Question 6 (4 minutes)
Charles Smith is the petitioner before the Tax Court. The issue is the includability in 1972 of payment received by Smith in such year in satisfaction of a $10,000 note. The note was received by Smith in 1967. Smith's position is that the fair market value of the note was properly includable in income in 1967, the year in which the note was received, and that in fact he included the face amount of the note in income in that year.

To dispute Smith's claim that he included the note in income when it was received, the IRS offers into evidence a photographic reproduction of Smith's 1967 tax return, Smith objects; although not disputing the authenticity of the document, he argues that the best evidence rule requires production of the original document.

How should the Court rule? Why?

Question 7 (4 minutes)
Describe briefly the proper scope of cross-examination.

Question 8 (2 minutes)
Brown Corporation is the petitioner before the Tax Court. The issue is the depreciation deduction taken by the corporation on its factory buildings. The IRS extended the useful lives of the buildings, and adjusted the depreciation deduction accordingly,

Brown Corp. is arguing that the deficiency determination was arbitrary and without rational foundation, and that therefore the burden of proof should be shifted to the Commissioner. Counsel for Brown Corp. calls as a witness the revenue agent who audited the corporation's returns. After some preliminary questions, counsel for Brown Corp. asks: "Isn't it a fact that you made your decision to lengthen the useful lives of these buildings before you ever saw the buildings?''

IRS counsel objects with the following statement: "Your Honor, counsel is leading his own witness."

How should the Court rule?

Question 9 (4 minutes)
Timothy Black is the petitioner before the Tax Court. The issue is the substantiation of Timothy's alleged gambling losses. Timothy calls as a witness his friend, Will White, who testifies that he went with Tim to the racetracks, and "saw him drop $20,000 in a day."

On cross-examination, IRS counsel asks Will: "Isn't it true that 2 years ago you were convicted of embezzlement, and served a year in prison?" Timothy objects that the information sought is irrelevant.

Is evidence of the witness" prior conviction admissible? If so, for what purpose?

Question 10 (4 minutes)
Frances Reynolds is the petitioner in the Tax Court. The issue is a casualty loss deduction taken on Frances' 1974 return. In October of that year, Frances' apartment was burglarized, and money, jewelry, clothing, and some household items were stolen. The day the theft occurred, Frances made a list of every item which had been taken, as she needed the information for the police and insurance company.

At trial, Frances cannot recall all of the items, and her recollection is not refreshed after looking at the list. Frances' counsel wishes to have her read the list into the record. IRS counsel objects that the list is hearsay.

How should the Court rule? Why?

Section A

Part II. (suggested time for questions in Part II: 40 minutes)

Question 1 (10 minutes) (This question has 5 subparts)
(a) M. Perry, attorney, is involved in his first "big" case before the Tax Court. Although he has handled a few "S" cases before, he has very little Tax Court experience; in fact, most of his prior litigation experience is in the areas of criminal law and domestic relations. His relations with his adversaries are usually acrimonious Based on his past experience, Perry sees no reason for cooperation with the IRS attorney assigned to his client's case.

Therefore, immediately upon the expiration of the requisite 30 days after joinder of issue, and before any consultation with the IRS attorney assigned to his client's case, Perry serves upon the Commissioner written interrogatories, and a request for the production of documents. The Commissioner objects in writing, on the grounds that the requests are premature. Perry then files a motion asking the Tax Court to compel the Commissioner to comply with his requests, and the Commissioner renews his objections.

How should the Court rule? Why?

(b) Assume the same facts except that the Commissioner asserts as his only objection that the responses and documents sought are not admissible evidence.

How should the Court rule? Why?

(c) Perry decides that preparation of his case will be helped by taking the deposition of the Internal Revenue agent who audited his client's returns. He files with the Tax Court an application to take a deposition; the application states that the deposition is to be taken "solely for purposes of discovery."

How should the Court rule? Why?

(d) The IRS attorney has asked Perry to enter into a stipulation of facts. Perry still does not want to cooperate. However, he has come to suspect that the Tax Court practice is different from practice in the criminal and domestic relations courts. He asks you, an experienced Tax Court practitioner, for advice.

Briefly state his obligations with respect to the stipulation process.

(e) Perry also has some documents which are relevant to the case. How, (other than through the stipulation process) can he ask the Commissioner to admit the genuineness of the documents?

Question 2 (5 minutes) (This question has 5 subparts)
Where does appellate venue lie for review of a decision of the Tax Court:

(a) In the case of a petitioner other than a corporation?

(b) In the case of a corporation?

(c) How does one initiate an appeal?

(d) How does one initiate an appeal to the appropriate Circuit Court of Appeals in a small tax case?

(e) What can a taxpayer do to stay assessment and collection of the deficiency determined by the Tax Court pending an appeal?

Question 3 (2 minutes)
Your client's case involves an issue of law on which the Tax Court has ruled several times previously. Unfortunately, its decisions have been adverse to your client. However, the court to which an appeal would lie has decided the issue in favor of your client's position, in a case which seems squarely In point. How will this affect the Tax Court's decision?

Question 4 (5 minutes) (This question has 5 subparts)
Tom Jones timely files a petition with the Tax Court. The commissioner's answer, also timely filed, contains affirmative allegations of fact. Tom fails to file a reply within 45 days of service of the answer.

(a) The Commissioner timely moves for an order that the allegations in the answer be deemed admitted. What should Tom do?

(b) What happens if, in (a) above, Tom does nothing.

(c) Tom files a timely reply, but neglects to admit or deny some of the allegations in the answer. What is the effect?

(d) Tom's failure to reply to some of the allegations was due to the fact that he didn't know whether they were true or false. What should he have done?

(e) The Commissioner fails to answer new matter contained in the reply. What is the effect?

Question 5 (9 minutes) (This question has 3 subparts)
Mr. and Mrs. Wright are the petitioners before the Tax Court in a case involving deficiencies and additions to tax for fraud for the years 1960, 1961 and 1962. Mr. and Mrs. Wright filed joint Federal income tax returns for each of the years at issue. However, in prior criminal proceedings, only Mr. Wright was indicted. He was convicted by a jury of filing fraudulent returns for each of the years in issue.

(a) Is Mrs. Wright liable for the additions to tax for fraud because of her husband's conviction? Explain why or why not.

(b) The notices of deficiency were mailed more than 10 years after the returns for the years at issue were filed. Mrs. Wright argues that she is not liable for the deficiencies because the statute of limitations has run. At the Tax Court trial, the Commissioner establishes by clear and convincing evidence, independently of the criminal conviction, that a part of the underpayment for each year at issue was due to fraud solely on the Dart of Mr. Wright. How should the Court rule on Mrs. Wright's argument? Why?

(c) Assume that in (b) above, the Commissioner relied entirely on Mr. Wright's prior criminal conviction, arguing that Mrs. Wright was estopped from pleading the statute of limitations by such conviction. How should the Court rule? Why?

Question 6 (4 minutes) (This question has 4 subparts)
Who has the burden of proof on each of the following issues:

(a) Additions to tax for negligence.

(b) Additions to tax for failure to file a return on the prescribed due date.

(c) Additions to tax for fraud.

(d) A deficiency in tax.

Question 7 (5 minutes) (This question has 3 subparts)
(a) On April 25, 1977, the Commissioner mailed Wayne a notice of deficiency. What is the last day for timely filing of a Tax Court petition? [See 1977 calendar below]

(b) Assume Wayne was outside of the United States when the notice was mailed. How long does he have to file a timely petition?

(c) Wayne and his wife filed a joint return; and the Commissioner issued a joint notice of deficiency. Wayne was outside the United States at the time tile notice was mailed, but his wife was in the country. How long does she have to file her petition?

		S	M	T	W	Th	F	S

	January							1
		2	3	4	5	6	7	8
		9	10	11	12	13	14	15
		16	17	18	19	20	21	22
		23	24	25	26	27	28	29
		30	31

	February		1	2	3	4	5
		6	7	8	9	10	11	12
		13	14	15	16	17	18	19
		20	21	22	23	24	25	26
		27	28

	March		1	2	3	4	5
		6	7	8	9	10	11	12
		13	14	15	16	17	18	19
		20	21	22	23	24	25	26
		27	28	30	31

	April						1	2
		3	4	5	6 	7	8	9
		10	11	12	13	14	15	16
		17	18	19	20	21	22	23
		24	25	26	27	28	29	30

	May	1	2 	3	4	5	6	7
		8	9	10	11	12	13	14
		15	16	17	18	19	20	21
		22	23	24	25	26	27	28
		29	30	31

	June				1	2	3	4
		5	6	7	8	9	10	11
		12	13	14	15	16	17	18
		19	20	21	22	23	24	25
		26	27	28	29	30

	July						1	2
		3	4	5	6 	7	8	9
		10	11	12	13	14	15	16
		17	18	19	20	21	22	23
		24	25	26	27	28	29	30

	August		1	2	3	4	5	6
		7	8	9	10	11	12	13
		14	15	16	17	18	19	20
		21	22	23	24	25	26	27
		28	29	30	31

	September				1	2	3
		4	5	6	7	8	9 	10
		11	12	13	14	15	16	17
		18	19	20	21	22	23	24
		25	26	27	28	29	30

	October							1
		2	3	4	5	6	7	8
		9	10	11	12	13	14	15
		16	17	18	19	20	21	22
		23	24	25	26	27	28	29
		30	31

	November		1	2	3	4	5
		6	7	8	9	10	11	12
		13	14	15	16	17	18	19
		20	21	22	23	24	25	26
		27	28	30

	December				1	2	3
		4	5	6	7	8	9 	10
		11	12	13	14	15	16	17
		18	19	20	21	22	23	24
		25	26	27	28	29	30	31


Section B: Substantive Tax Law
(160 minutes)

Part I (suggested time for questions in Part I: 60 min.)

Question 1 (2 minutes)
In 1976 Jane (an unmarried taxpayer) works as an assistant manager for a large department store. The department store has an employee pension plan and trust which qualify under section 401(a) and 501(a). However, because Jane has not met the minimum service requirements of the plan she is not eligible to participate in the plan during 1976.

In 1976 Jane makes $20, 000 and wants to invest in an individual retirement account. Is Jane entitled to a deduction for amounts she contributed to a qualified individual retirement account? Why? What is the maximum amount Jane can deduct if she is eligible?

Question 2 (3 minutes)
Frank, an insurance underwriter, and his wife, who is a housewife, attend the annual CLU (Chartered Life Underwriter) convention in Miami for two days. When Frank purchased the airline tickets, he was delighted to find out that he only had to pay half fare for his wife because of the airline's family discount. At the convention Frank attends various seminars and lectures and his wife relaxes on the beach.

What amount of the following items may Frank deduct from his federal income tax. his wife.

(a) Airline tickets for him and his wife.

(b) Meals and lodging at the convention for him and his wife.

Question 3 (5 minutes) Which of the following items must Jim include in his gross income.

(a) 100 shares of IBM stock inherited from his father with a value of $300, 000. Why?

(b) a $1 000 dividend on the IBM stock declared and paid to Jim; after the death of his father. Why?

(c) a $250 prize paid on a New York state lottery ticket. Why ?

(d) $10,000 in compensatory damages received in settlement of a law suit arising from a traffic accident in which Jim suffered a broken leg. Why?

(e) $3,000 given to Jim by his mother, who is trying to reduce the size of her estate. Why?

Question 4 (4 minutes)
Which of the following items may Aaron, an unmarried calendar year taxpayer deduct, and, if deductible, how much may he deduct:

(a) Fees of $200 charged by his CPA for preparation of his federal tax return. Why?

(b) Attorneys' fees of $500 incurred in purchasing a new home for himself. Why?

(c) A $6, 000 loss on the condemnation of his personal residence in April 1977. Why?

(d) A $250 political contribution to the Democratic National Committee. Why?

Question 5 (4 minutes)
David and Chris obtain a divorce in 1975. The divorce decree provides that Chris will have custody of their three year old son David, Jr., and that David will pay Chris $200 a month child support. In addition, David is entitled to the dependency exemption for David, Jr. under the terms of the decree.

In 1976, David pays Chris a total of $2,400 for child support. Chris expends $3, 000 of her own money for David, Jr. In addition, because she works full time, she spends $1, 000 in day care expenses for David, Jr.

(a) Must Chris include the $2,400 she received from David in her gross income? Why?

(b) Is Chris entitled to claim a dependency exemption for David, Jr. ? Why?

(c) Is Chris entitled to a deduction or credit for the child care expenses she paid in 1976? If so, how much?

Question 6 (4 minutes)
In April 1975, Mike's stockbroker informed him that he could purchase New York City Municipal Bonds which will pay 9-1/2% interest annually. Mike decides to buy the bonds as an investment. But because he has no cash available he borrows $10,000 with which to purchase the bonds. The personal note Mike signs for the loan calls for 8% interest. Briefly discuss the tax consequence to Mike with respect to the interest payments he received on the bonds and the interest he must pay on his personal loan.

Question 7 (3 minutes)
Bill and Barbara, after several years of marriage, decide to obtain a divorce. Because Bill is unable to find an apartment, he continues to live in the same house with Barbara, but in a different bedroom. During this period, Bill pays Barbara $200 per month pursuant to a written separation agreement drafted by their attorneys. At the end of the year, Bill and Barbara file separate returns. Must Barbara include the monthly payments in her gross income? Why?

Question 8 (3 minutes)
After her divorce, Barbara increasingly devoted much of her spare time to volunteer work at the Red Cross. Barbara wants to know if she can deduct the following items as charitable contributions:

(a) The cost of her Red Cross uniform which she paid herself.

(b) The cost of gas which she incurred and paid in driving blood donors to the Red Cross center.

(c) The value of the time spent performing services for the Red Cross.

Question 9 (2 minutes)
Sam operates a plumbing business as a sole proprietorship. He files his income tax returns on the calendar year and uses the cash method of accounting. In October 1976, Sam is forced to borrow $10,000 from Friendly Finance Company in order to meet his payroll for the remainder of the year. In March 1977, Sam repays the loan in its entirety along with $700 interest.

Sam wants to know if he can deduct the $10,700 in payments he makes in March on his 1977 income tax return.

Question 10 (8 minutes)
Carol, a widow for the past 10 years, lives alone except for the summer when her only child, Mary, a 22-year old full time medical student at Yale, returns to live with Carol. Carol gives Mary $4,000 this year to cover all her personal expenses, including room and lodging while at school. She also spent $1,000 for Mary's support while Mary lived at home. Mary paid her own tuition bill of $5,000 from what she earned over the summer.

(a) Carol wants to know whether she can claim Mary as a dependent and use the head of household rates.

(b) Would your answer differ if Mary did not live at home during the summer, and had not lived at home since she was 18?

Question 11 (4 minutes) (this question has 3 sub-parts)
As part of its basic contract with all employees, Corporation C obtains $120,000 of group-term life insurance on each employee. The policy provides that the employee can designate the beneficiary of 50% of the proceeds of the policy, while the remaining 50% go to Corporation C. The employee cannot designate Corporation C as a beneficiary.

(a) How much, if any, of the premiums paid on the group-term life insurance contract must each employee report as gross income.

(b) How much, if any, of the premiums paid on the group-term life insurance policies may the corporation deduct.

(c) If 50% of the proceeds of the group-term life insurance policy are paid at the death of an employee to his named beneficiary, how much, if any, of the proceeds must the beneficiary report as gross income.

Question 12 (12 minutes)
Carl, a student at the University of Chicago School of Law, will graduate in June 1976. In November of 1975 Carl accepted a job with a Washington, D.C. law firm beginning July 1, 1976. In April of 1976 he travels to Washington to find an apartment. The airplane ticket costs Carl $300. And he incurs $200 in meals and lodging expenses while in Washington searching for an apartment. Carl also pays a rental agency $100 to locate an apartment.

On June 1, 1976, Carl leaves Chicago for Washington, D. C. He moves his furniture by way of a commercial mover at a cost of $1,500 and drives to Washington, incurring total travel, meals and lodging expenses of $200.

Prior to leaving Chicago, Carl must forfeit a $250 security deposit on his Chicago apartment for breaking the lease.

Upon arrival in Washington, Carl stays in a motel from June 3, 1976 to July 1, 1976 when he moves into his new apartment. During the period from June 3-July 1 Carl incurs meals and lodging expenses of $500.

(a) Which, if any, of the above amounts may Carl deduct on his 1976 income tax return? Are the deductions above the line or below the line?

(b) Assume that the April trip was a job searching trip and that it is successful. Also assume that Carl does not look for an apartment until June 1976 when he moves to Washington, at which time he incurs the $100 rental agency fee. How, if at all, would your answer differ.

Question 13 (3 minutes)
Mark Is a professional agent and represents numerous entertainers. As an agent Mark attempts to obtain acting roles for his clients. His business dealings are primarily with motion picture producers. In 1969 Mark entertains several of the producers at a hunting lodge he owns in Oregon. When not entertaining producers at the lodge Mark will use the lodge to rest and relax or to entertain friends. In 1969 the lodge was used 75% of the time for such personal purposes by Mark. Is Mark entitled to a deduction for interest and taxes paid in 1969 with respect to the hunting lodge? Why?

Question 14 (3 minutes)
In 1976 Jan who is 26 years old and has worked days and attended school exclusively at night for nine months a year, for each of the last 5 years, obtains a full-time position with the federal government. In the 5 previous years Jan's parents supplied over one-half of her support. Jan is a citizen. Is Jan an "eligible individual" within the meaning of Section 1303? Why?

Section B

Part II. (suggested time for questions in Part II: 100 minutes)

Question 1 (16 minutes)
I, an individual, owns all of the stock of X corporation. X has only one asset which is a non-depreciable capital asset. X has earnings and profits of $2,000. I has a basis in his X stock of $20,000. X has a basis in its one asset of $15,000. X acquired the asset 3 years ago, shortly after I formed X and acquired his X stock. X is not a collapsible corporation to which section 341 applies.

Describe the tax consequences to each party involved, including X, in the following transactions. Specifically, your answer should include the amount of gain or loss recognized, the basis of the asset to any recipient, and the character of any gain or loss involved. Be sure to give references to the Internal Revenue Code.

(a) X adopts a plan of complete liquidation on January 4, 1977. On February 8, 1977, X sells its only asset to ACME, a corporation owned by a third party unrelated to I, for $30,000. On March 1, 1977, X distributes the money to I.

(b) X adopts a plan of complete liquidation on January 4, 1977. On February 8, 1977, X distributes its asset to I, who sells it to Acme the next day for $15,000, its fair market value on February 8th and 9th.

(c) Would your answer in #1 be different if X had sold its asset to Acme on January 2, 1977? Question 2 (10 minutes)
Family Corporation is a small but successful wholesale grocer. Family has 100 shares of common stock outstanding. The stock of Family is owned as follows:

	H. Smith		60 Shares
	W. Smith		30 Shares
	M. Jones		10 Shares
H. Smith and W. Smith are husband and wife. H. Smith owned the building and land used by Family in the corporation's trade or business. H. Smith has acquired the property in 1970 at a cost of $10,000 for the land and $20,000 for the building. On March 18, 1977, H. Smith sold the land to Family for $15, 000 and the building to Family for $30,000, for a total of $45,000 (the fair market value of the property). On the date of sale, H. Smith's adjusted basis in the building was $16,500. Depreciation of the building was computed on the straight line basis. In Smith's hands, the property represented a capital asset. What is the amount and character of Smith's gain or loss on the sale?

Question 3 (27 minutes)
On January 2, 1977, individuals A & B, and corporation C, all of whom are unrelated, formed the Little Corporation. Little has no liabilities. has only one class of stock. and Is not a corporation described in sec. 341. The respective exchanges incident to the formulation of Little are reflected in the following table:

							 	Received in Exchange
Transferor	Property Transferred to Little		     	 From Little

A		Farm Machinery valued at $60,000 with a basis	50 shares of
		of $70,000 (the difference between the basis	Little stock
		and Machinery's initial cost to A of $80,000,	(value $50,000)
		is due to depreciation of the machinery while	and $10,000
		used in a trade or business since 1974 when it	in cash.
		was acquired by A).

B		$20,000 cash and 100 shares of National Corp.	50 shares of
		valued at $30,000 having a basis of $15,000.	Little stock
								(value $50,000).

C		1,000 acres of Farmland valued at $100,000	100 shares of
		having a basis of $30,000.			Little stock
								(value $100,000).
(Part i) All parties are calendar year taxpayers and utilize the cash basis method of accounting.

(a) Compute the amount and state the character of the gain or loss, if any, recognized by each shareholder as a result of the foregoing transaction and the basis of each shareholder in the Little stock received.

(b) What is the amount and character Or the gain or loss, if any, recognized by Little?

(c) What is Little's basis in the farm machinery contributed by A?

(d) If all shareholders agreed, could Little elect to be taxed as a small business corporation under subchapter S of the Internal Revenue Code? (Assume that Little does not expect to earn passive investment income in excess of $3,000 during 1977.)

(e) Assume only for this part of Question III that A's adjusted basis in the farm machinery had been $40,000 on January 2, 1977. Compute the amount and state the character of the recognized gain or loss, if any, to A on the transaction.

(Part ii) On December 31, 1977, Little has current earnings and profits (E & P) of $40,000 and distributes its National stock as a dividend. On that date the 100 shares of National stock owned by Little have a fair market value of $60,000. Little recognized no gain or loss on the distribution under sec. 311.

(a) What are the effects of this distribution to each shareholder as a result of the pro rata distribution and what deductions or exclusions from gross income, if any, could the taxpayers use to reduce the tax consequences of having received the distribution?

(b) Following the distribution, what is the adjusted basis of A's Little stock? What is C's adjusted basis in the National stock received?

(c) What is the effect of the distribution on the earnings and profits of Little?

Question 4 (16 minutes)
(Part i) A, B, & C are members of the same car pool. They are calendar year cash basis taxpayers. On August 11, 1977, while riding to work they decided to form a partnership to invest in residential real estate. The next day they met at B's office, where they executed a partnership agreement, and made the following contributions to the partnership (which would not be treated as an investment company if the partnership were incorporated).

			FMV of Property				Year
Partner	Property	or Amount of Money	AB		Acquired

A	House & Lot	$100,000		$20,000		1960

B	Cash		$100,000		-		-

C	House & Lot	$100,000		$105,000	1975
Under the terms of the partnership agreement, all profits and losses were to be shared equally. The property contributed by A & C consisted of their personal residences which they agreed to vacate. On August 12, 1977:

(a) What 19 the basis of each partner in his partnership interest?

(b) What is the partnership's adjusted basis in the contributed property on August 12, 1977?

(c) What is the amount of gain or loss recognized by the partnership and each of the partners as a result of formation of the partnership?

(d) May the partnership elect a fiscal year ending August 12 for Federal income tax purposes?

(Part ii) In 1977 the partnership encumbers the house and lot contributed by A to the extent of $60, 000 and receives $60,000 in cash from the XYZ bank, mortgagee. By agreement with the bank, none of the partners are personally liable on the debt. The partnership then purchases vacant land for $160, 000. What is the effect of the encumberance on B's adjusted basis in his partnership interest?

(Part iii) On December 1, 1977, the partners disagree over the wisdom of purchasing the vacant land. As a result A sells his partnership interest to B for $90,000. (Assume sees. 1250 and 751 are not applicable.)

(a) What is B's basis in the partnership upon acquiring A's interest?

(b) What is the amount and character of A's gain or loss, if any, attributable to the disposition of his partnership interest?

Question 5 (15 minutes)
On September 1, 1977, A & B form a partnership for the purpose of producing a motion picture. All parties are calendar year cash basis taxpayers. A contributed $100,000 in cash to the partnership. B contributed a movie script that he had purchased one month earlier with all rights attached from a well-known screenwriter for $100,000, its fair market value. On September 5, the partnership contracts for the services of Mark Macho, a top box office attraction, to play the leading role in the proposed movie. On September 6, the partnership obtains a nonrecourse loan from C in the amount of $1,000,000 to cover the production expenses involved. The partnership avoided personal liability on the note by pledging the movie rights to the script and Macho's employment contract as collateral. During the balance of 1977, the partnership expended $600,000 (which is currently deductible) toward the production of the movie and earned no income.

One day during a break while filming the movie on location in the tropics, Macho explains to A that roles for actors have suddenly become scarce. Macho says his accountant attributes this to a recent change in the Federal income tax law.

A immediately contacts you and requests the following information. (Please include Code references.)

(a) What is the maximum amount of $600,000 loss incurred by the partnership in 1977 that he (A) may deduct on his return assuming that he earns $800,000 of other income in 1977?

(b) If A & B as partners were personally liable for the $2,000,000 debt and C were A's wife, would your answer be different? Explain.

(c) If A & B are personally liable for the $2,000,000 debt and B is unrelated to A or C, what is the maximum amount B could deduct for 1977 if he has other income of $800,000 for the year?

Question 6 (16 minutes)
On January 2, 1976, X Corporation was organized, and adopted a calendar year ending December 31, 1976. X issued 100 shares of common stock. Of the 100 shares of stock, nine (9) individuals, all of whom are calendar year taxpayers, received 10 shares each. The remaining 10 shares of stock were issued to H and his wife W, who are calendar year taxpayers and held the stock as joint tenants. Each share of stock was issued in exchange for $1,000.00. On January 8, 1976, X Corporation filed an election under 1372 (a) to be treated as a small business corporation. On the same day its shareholders filed consents under section 1372(a).

In 1976, X Corporation realized ordinary income from operations of $40,000. It also had section 1231 gain on the sale of various items of equipment of $4, 0000 On December 30, 1976, X Corporation distributed pro rata to its shareholders $20,000 in money.

(a) Does X Corporation qualify as a small business corporation. Why?

(b) May X Corporation elect a fiscal taxable year ending June 30, instead of a calendar taxable year?

(c) Does X Corporation have any undistributed taxable income on December 31, 1976, and if so, in what amount?

(d) What are the tax consequences to X's shareholder H and W (who file a joint return) arising from their stock ownership in X corporation? Include in your answer the treatment of all pertinent items and their basis in the X stocks.

(e) What are the tax consequences to X Corporation during 1976, including X's earnings and profits?

(f) On March 14, 1977, X Corporation distributed $10,000 in money pro rata to its shareholders. What are the tax consequences to H and W by reason of this distribution, including their adjusted basis in their X stock?

(g) What are the consequences to X Corporation of this distribution including X Corporation's earnings and profits?


Created: June 19, 1998; Last updated: January 29, 2004

This site is designed and maintained by [Internet By Aviva logo]