1990 Tax Court Admission Examination

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Four hours will be allowed to answer all of the questions in the examination. Each question has been allocated a specific number of minutes (see the notation in parenthesis at the beginning of each question). Your answers will be weighted accordingly.

Write your answers legibly in ink in the bound answer book/s furnished you for this purpose. Write your name on the cover of each answer book that you use. Identify each answer by the same number as the question. Remove no pages from your bound answer book/s; you are being furnished loose sheets of paper for you to use as scratch paper.

This examination is designed to test your overall knowledge of Federal taxation, procedure, and trial practice, and also to test your competence in representing taxpayers before the United States Tax Court. The examination consists of two sections. The first section (80 minutes) deals with procedural and evidentiary matters, including application of the Tax Court Rules of Practice and Procedure. The second section (160 minutes) deals with substantive Federal income, gift, estate, and generation-skipping transfer taxation. Each section will be graded separately, and you must show that your qualifications are satisfactory with respect to each section of the examination.

The only reference materials permitted to be with you during the examination are (1) a copy of the Internal Revenue Code, and (2) a copy of the Rules of Practice and Procedure of the Court. You may refer to these materials in taking the examination.

Clarity and conciseness of expression will be a significant factor in grading your examination. Answer only the questions that are asked.

Do not inquire of the proctor regarding the examination questions. If you think a question contains an ambiguity, state the ambiguity, resolve the ambiguity by stating an assumption in your answer, and then answer the question based upon your resolution of the ambiguity.

Assume all taxpayers use the cash method of accounting and are calendar year taxpayers, unless otherwise indicated. All statutory references are to the Internal Revenue Code, unless otherwise indicated. Unless indicated to the contrary in a question, assume that all events occur during November 1990 and apply the tax court rules of practice and procedure as of November 1990.

The proctor will tell you when you may begin the test, and you will be given a warning 5 minutes before the examination is over. When time is called, put your pen down. Absolutely no extension of time is permissible. When the time for completion of your examination has elapsed, turn in to the proctor this examination, your answer books, and the materials furnished to you. If you complete the examination early, you may turn in the material and leave.


Section One
Tax Court Procedure and Evidence
(80 minutes)

Question P-1. (2 minute/s) Determine whether the Tax Court has subject matter jurisdiction to hear the case. State YES or NO.

(a) The IRS asserted an underpayment of sec. 3402 withholding taxes against Taxpayer, a sole proprietor who employed 7 individuals. Taxpayer petitioned the Tax Court for a review of the asserted underpayment.

(b) Taxpayer, who is engaged in the business of preparing tax returns for other persons, received from the IRS a notice and demand for penalty pursuant to sec. 6695(b) for failing to sign the tax returns of some of Taxpayer's customers, Taxpayer petitioned the Tax Court to challenge the penalty.

Question P-2. (2 minute/s) Taxpayer receives a statutory notice of deficiency and then timely petitions the Tax Court. Before the Tax Court takes any action with respect to the case, the IRS assesses the tax to which the petition relates, and Taxpayer files a motion asking the Tax Court to enjoin the assessment and collection of such tax. Discuss whether the Tax Court may grant such a motion.

Question P-3. (2 minute/s) Taxpayer petitions the Tax Court, and the Court enters a decision that Taxpayer overpaid tax. One hundred and thirty days after the decision of the Tax Court is final, Taxpayer moves for an order directing that the IRS issue a refund to Taxpayer because the IRS has failed to make a refund in accordance with the decision of the Court. Discuss whether the Tax Court may issue such an order.

Question P-4. (2 minute/s) The taxpayer pays a deficiency determined by the Tax Court as well as the interest associated with the deficiency as determined by the IRS. Taxpayer files an appropriate petition six months after the Tax Court decision becomes final to challenge the amount of interest payable on the deficiency. Discuss whether the Tax Court may determine the amount of interest payable on the deficiency.

Question P-5. (2 minute/s) Taxpayer wants the Tax Court to modify a final decision in an estate tax case to reflect the estate's entitlement to an administrative expense deduction for interest paid during an extended payment period under sec. 6166. Discuss whether such a modification could be accomplished, and if so, how.

Question P-6. (2 minute/s) Taxpayer has received a statutory notice of deficiency. Taxpayer wants to challenge the deficiency in the U.S. Tax Court, but wants to avoid the accrual of interest on the asserted deficiency. Discuss what Taxpayer may do.

Question P-7. (4 minute/s) Discuss whether the statutory notice of deficiency is valid.

(a) Wife ("W") and Husband ("H") filed joint Federal income tax returns for their 1976 and 1977 taxable years. W filed a Federal income tax return in the status of married, filing separately, on June 15, 1982, with respect to her 1981 taxable year, and the return indicated a new address for W. On November 30, 1982, the IRS sent a notice of deficiency to W and H with respect to their 1976 and 1977 taxable years. Although the IRS computer records contained a different address for W and H, the IRS issued only a single joint notice concerning W and H's 1976 and 1977 taxable years to the address its records contained with respect to H. W never received actual notice of the notices of deficiency, concerning 1976 and 1977, until the IRS levied on W's bank accounts and put a lien against her house in 1986. Following such levies and lien, W filed an untimely petition seeking a redetermination of deficiency for taxable years 1976 and 1977.

(b) Same facts as Question 7.(a) except that H actually provided W with a copy of the notice of deficiency the day after H receives the notice. W and H then file a timely joint petition with the Tax Court. W then moves to dismiss W from the proceeding due to lack of jurisdiction because the notice was not properly issued to W at W's last known address (and because the IRS could not then issue another notice due to the statute of limitations).

Question P-8. (2 minute/s) Taxpayer is a United States citizen who resides in the Unites States and is physically present in the United States on January 22, 1990, the date the IRS mailed a statutory notice of deficiency to Taxpayer regarding Taxpayer's 1988 income tax return. Taxpayer received the notice on January 28, 1990. What is the last day on which Taxpayer can timely file a petition with the Tax Court? You may wish to refer to the following 1990 calendar:

		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	29	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	31

	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

	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	29	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
Question P-9. (1 minute/s) Discuss what document or documents must be submitted to the Tax Court to effect an amendment to a pleading after issue has been joined.

Question P-10. (1 minute/s) If a Tax Court petition is silent with respect to one or more issues raised in the deficiency notice, what is the effect?

Question P-11. (3 minute/s) With respect to papers filed with the Tax Court:

(a) Each original document must be signed by taxpayer's counsel; the taxpayer may not sign documents submitted to the Court if the taxpayer is represented by counsel. State TRUE or FALSE.

(b) Each document signed by taxpayer's counsel must contain the counsel's Tax Court bar number. State TRUE or FALSE.

(c) Except as otherwise provided in the Tax Court Rules, three conformed copies of each document submitted to the Court, plus the executed original, must be filed. State TRUE or FALSE.

(d) May a document submitted for filing, but which does not conform to the Tax Court Rules, be returned by the Clerk unfiled. State YES or NO.

(e) Counsel for taxpayer is a professional corporation. Describe the proper name (and signature) to be used on documents submitted to the Court by the professional corporation.

Question P-12. (1 minute/s) Discuss whether informal discovery is required before use of formal discovery procedures.

Question P-13. (1 minute/s) Tax Court discovery may not be commenced before what date?

Question P-14. (2 minute/s) The date of the calendar call for a case is August 21, 1990. By what date must discovery be completed? Please refer to the calendar in Question P-8 to answer this Question.

Question P-15. (3 minute/s) Under what conditions may taxpayer take depositions as a method of discovery in the Tax Court?

Question P-16. (2 minute/s) IRS interrogatories consisted of a request to petitioner to complete blank attached Forms 1040 (for the years in issue before the Court) and, with respect to each Form 1040, four sheets of paper on which petitioner was to list: (1) documents in support of each item on the Form 1040, (2) the relationship of the document to each item, and (3) his relevant personal knowledge of the item. Explain whether the IRS interrogatories are valid.

Question P-17. (2 minute/s) Briefly state:

(a) the responsibility of a party to a Tax Court case regarding stipulations and

(b) whether a stipulation is binding on a party.

Question P-18. (3 minute/s) State the statute of limitations rule that applies to the following income tax returns (that are properly, completely, timely, and nonfraudulently filed except as indicated below):

(a) An income tax return with respect to a deduction claimed on the face of the return.

(b) An income tax return with respect to a gross income item not included in the return.

(c) An income tax return that is not signed by the taxpayer.

(d) A fraudulent income tax return.

(e) A fraudulent income tax return for year 1 is filed in year 2, and in year 3 a nonfraudulent and correct return for year 1 is filed.

Question P-19. (2 minute/s) Discuss the effect of a taxpayer signing an IRS Form 872-A. Include in your answer a discussion of termination of the IRS Form 872-A.

Question P-20. (2 minute/s) Taxpayer received a statutory notice of deficiency, but Taxpayer did not file a petition with the Tax Court because Taxpayer believed that the notice of deficiency was invalid because it was issued after expiration of the relevant statute of limitations. 250 days after issuance of the statutory notice of deficiency, the IRS began collection proceedings against Taxpayer. Taxpayer immediately filed a petition with the Tax Court. Discuss whether the Tax Court has jurisdiction.

Question P-21. (2 minute/s)

(a) Define collateral estoppel.

(b) A husband and wife were acquitted of tax evasion for 2 particular tax years. In a subsequent civil proceeding in the Tax Court regarding the same two years, a husband and wife attempt to collaterally estop the IRS from litigating fraud and understatement of income issues for the two years. Discuss whether the taxpayers may use collateral estoppel in this manner.

Question P-22. (1 minute/s) Discuss the effect of the stipulation of facts between parties on the burden of proof in a Tax Court case the facts of which are fully stipulated.

Question P-23. (1 minute/s) Describe how a party to a Tax Court case may have the Court take cognizance of certain property code provisions of state law with respect to a property law issue that is relevant to the Tax Court proceeding.

Question P-24. (2 minute/s) Taxpayer is an Arizona Corporation. The IRS audited the taxpayer and sent a formal document request by registered mail to the taxpayer's last known address. The request specified:

(a) the time and place for the production of the documents,

(b) a description of the documents being sought (all of taxpayer's accounting records relating to a foreign branch in Country X and which records are located outside of the U.S. in Country X), and

(c) the consequences to the taxpayer for the failure to comply with the request: the taxpayers would be prohibited from introducing in a civil proceeding any foreign-based documentation covered by the request.

The taxpayer never sent the IRS any of the requested documents. The IRS did receive a document entitled "Notice of Writ of Preliminary Injunction" issued by a court of Country X. The document purported to enjoin production of the records requested by the IRS because such production would violate the criminal laws of Country X. Four months after issuance of the document request, the IRS issues a statutory notice of deficiency. The taxpayer thereafter properly petitions the Tax Court, and at trial attempts to introduce into evidence the accounting records of the foreign branch in Country X. The accounting records are relevant and material to the issue before the Court. The IRS objects to admission of the evidence. Briefly explain how the Tax Court should rule.

Question P-25. (1 minute/s) Define "hearsay" under the rules of evidence in the Tax Court and give an example of hearsay evidence.

Question P-26. (2 minute/s) Explain whether legally seized accounting ledgers, not prepared by the taxpayer, detailing various illegal sales and purchases of drugs by the taxpayer are admissible into evidence in the Tax Court.

Question P-27. (2 minute/s) The IRS issued to Taxpayer a statutory notice of deficiency for year 1 income tax. Taxpayer properly filed a petition with the Tax Court to place the year 1 income tax liability before the Tax Court. After the petition was filed, an IRS special agent of the Criminal Investigation Division issued an administrative summons to Taxpayer requesting information directly related to the matters at issue before the Court regarding Taxpayer's income tax liability for year 1. Taxpayer sought a protective order from the Tax Court that the IRS not use any information obtained from the summonses in the prosecution of the cases pending in the Tax Court. Discuss whether the Tax Court should issue such an order.

Question P-28. (2 minute/s) A petition was properly filed with the Tax Court regarding the estate tax due with respect to the estate of A. The issue as to the estate tax is the value of certain Y Corporation stock owned by A at death. The primary asset of Y Corporation was stock of X Corporation. The appraiser previously had been retained by X Corporation and the estate of A's son (who predeceased A) to assist in valuing certain stock of X Corporation owned by A's son. Neither A nor A's estate had ever retained the services of the appraiser. The IRS then retained the appraiser for purposes of determining the fair market value for federal estate tax purposes of the Y Corporation stock owned by A. A's estate submitted to the Court a motion in limine to prevent the IRS from "consulting with, reviewing and/or introducing at trial any expert reports, memoranda or oral testimony prepared by or on behalf of the appraiser." A's estate seeks to disqualify the appraiser due to a conflict of interest or a violation of a privileged and confidential relationship. How should the Tax Court rule?

Question P-29. (2 minute/s) Under what circumstances may a witness be excluded from the Tax Court courtroom during the testimony of other witnesses, and what sanctions are available to the Court for noncompliance by the witness.

Question P-30. (3 minute/s) Describe briefly the essential elements of the small tax case procedure in the Tax Court.

Question P-31. (2 minute/s) An IRS notice of final partnership administrative adjustment was mailed seven days after the mailing of the commencement notice required by S 6223(a)(1). Discuss whether the notice of final partnership administrative adjustment is valid.

Question P-32. (6 minute/s) Discuss the rules regarding the award of litigation costs incurred by the petitioner in a Tax Court proceeding that is commenced in 1990. Include in your answer a description of the amount that may be paid as attorneys fees.

Question P-33. (2 minute/s) Counsel for the petitioners executed and filed a petition with the Tax Court. Attached to the petition was an IRS final notice of intention to levy for the petitioners' 1978 taxable year. No statutory notice of deficiency was issued to the petitioners for 1978 because the tax assessed was reflected on their 1978 return, but it had not been paid. The IRS moved to dismiss for lack of jurisdiction. The IRS further moved for an award of counsel fees under Tax Court Rule 33(b), alleging that, in the filing of the petition and subsequent documents, counsel for the petitioners unnecessarily delayed the proceeding. Briefly discuss the circumstances under which the Tax Court may order the payment of reasonable expenses, including counsel fees, to the government.

Question P-34. (2 minute/s) Discuss whether and how counsel may withdraw from representation in a case in which counsel has entered an appearance before the Tax Court if the basis for withdrawal is the failure of the client to pay agreed upon fees to the counsel.

Question P-35. (3 minute/s) Discuss the conflict of interest rules applicable to counsel in the Tax Court.

Question P-36. (2 minute/s) Taxpayers submitted a motion to the Tax Court to strike portions of the IRS reply brief which referenced and quoted several books and articles in support of a certain method of valuing corporate stock, the value of which was a Question before the Tax Court. The books and articles were not relied upon or referred to by any witness at trial or established as reliable authority by any witness. Briefly discuss whether the Tax Court should grant the motion.

Question P-37. (2 minute/s) Counsel discovers after a Tax Court trial that the testimony of a witness was incorrect with respect to the dates of certain events. The trial transcript correctly recites the testimony of the witness at the trial, but the witness states that the trial testimony was incorrect. Discuss how the Tax Court would rule on a motion to correct the transcript with respect to such errors.

Question P-38. (1 minute/s) Taxpayer failed to enter into stipulations as ordered by the Tax Court and failed to appear at the time of trial. The Court dismissed the case due to Taxpayer's failure to properly prosecute, and damages were awarded to the United States and against petitioners in the amount of $5, 000 pursuant to section 6673. Taxpayer then filed a motion to vacate the judgment, raising only tax protector arguments which the Tax Court has consistently rejected in the past. Briefly discuss the risks associated with Taxpayer's motion to vacate.

Question P-39. (1 minute/s) Before trial in the Tax Court, only one issue remains, the factual issue of the value of certain real property. Neither party wants to participate in a full trial over the sole factual issue of the land valuation, but between themselves the parties cannot settle the dispute. Briefly discuss any alternatives the parties may have.


Section Two
Substantive Tax Law
(160 minutes)

Question S-1. (4 minutes) T Corporation had 950,000 shares outstanding, but the stock not actively traded in an established market. After struggling financially for several years, T Corporation sought additional financing through several bank loans. T Corporation previously had borrowed from two individuals and a corporation, T Corporation's three largest shareholders (none of whom was employed by T Corporation). As a condition for obtaining the loans, the banks required personal guarantees, indemnity agreements, and subordination agreements from the two individuals and the corporation from whom T Corporation previously had borrowed money. The three shareholders entered into the guarantees and subordinations voluntarily and without the expectation of consideration or payment from T Corporation. Several years later and in recognition of the increased risks the shareholders had assumed under the guarantees and subordinations, T Corporation distributed to the three shareholders stock warrants to purchase T Corporation common stock. The shareholders exercised their stock warrants two years later, just prior to C Corporation's acquisition of all of the stock of T Corporation. Describe the tax consequences to the three shareholders of T Corporation.

Question S-2. (3 minutes) Taxpayer, an accrual-basis corporation, settled a patent infringement suit on January 1, 1990, by agreeing to pay the claimant $1,250 each month for the rest of the claimant's life. The agreement further obligated Taxpayer to make at least 48 monthly payments regardless of the date of death of the claimant ($60,000). As of December 31, 1990, the claimant was alive. Taxpayer retained complete control over use of the funds required to satisfy the obligation until such times as payments were made to the claimant. Briefly discuss whether Taxpayer may deduct in 1990 any amount with respect to the settlement agreement.

Question S-3. (4 minutes) X and Y are cash method, calendar year taxpayers. On December 1, 1988, X delivered to Y 60 widgets to be sold in Y's store. The terms of the sale were that payment was due within 30 days of delivery of the widgets. The following are alternative situations.

(a) On December 31, 1988, Y offered to pay X in cash for the widgets, but X declined and requested payment in January 1989. If Y made payment to X in January 1989, when should X have reported the gross income from the sale of the widgets?

(b) On December 27, 1988, X received as payment from Y a check from Y that was dated December 24, 1988. If X cashed the check on January 4, 1989, when should X have reported the gross income?

(c) On December 27, 1988, X's bookkeeper, a full-time employee of X, received as payment a check from Y that was dated December 24, 1988, and which was payable to X. The bookkeeper left on a ski trip without depositing the check and did not return until January 4, 1989, on which date X received and cashed the check. When must X report the gross income?

(d) On December 27, 1988, X received from Y a promissory note of Y in the amount of Y's indebtedness to X. The note was executed because Y had no cash and was in severe financial difficulty. The note was nonnegotiable, bore no interest, and was due in 180 days. During December, January, February, and March, X attempted to negotiate the promissory note, but no one would accept the note. On May 1, 1989, Y made full payment on the note. When must X report the gross income?

Question S-4. (4 minutes) In May 1990, a residential rental apartment building in Florida owned by Taxpayer is totally destroyed in a hurricane. Taxpayer's adjusted gross income for 1990 is $800,000 (determined without regard to Sections 86, 135, and 219). The building had a fair market value of $300,000 before the hurricane. Taxpayer's adjusted basis in the building was $200,000. Taxpayer received no insurance or other compensation regarding this loss. Taxpayer's rental income from the property for 1990 prior to the hurricane was $25,000 and his expenses for that period totalled $60,000. Taxpayer did not materially participate in the management of the apartment building. Discuss whether any deductions are available to Taxpayer for 1990.

Question S-5. (4 minutes) Determine whether the following damage awards are excludable from the recipient's gross income and briefly explain why (treat each part separately).

(a) As a result of the negligence of her surgeon, Taxpayer lost the use of her right hand. A jury awarded her both compensatory and punitive damages.

(b) In the presence of other employees, Taxpayer was accused by her employer of embezzlement and was summarily fired. She filed suit for injury suffered as the result of defamation, pleading for both compensatory and punitive damages. Taxpayer was awarded a judgment for $500,000 in compensatory damages and $450,000 in punitive damages. Taxpayer also filed an action against the employer's insurance company, based on the insurance company's defense of Taxpayer's suit against the employer. The suit against the insurance company alleged knowledge of lack of a meritorious defense to her first action and conspiracy on the part of the insurance company to defame her so her testimony at trial would be less credible. Taxpayer settled her suit against the insurance company. The settlement agreement provided for a lump-sum payment of $525,000, with $300,000 allocated to compensatory damages and $225,000 allocated to punitive damages.

(c) P suffered serious injuries when stuck by a truck while riding his bicycle. P retained Attorney and, on Attorney's advice, settled the personal injury claim for $160,000. P later sued Attorney for malpractice, alleging that Attorney negligently persuaded P to accept an unreasonable settlement. In the trial of the malpractice ease, the jury found Attorney negligent and awarded damages to P of $610,000. P and Attorney appealed the judgment, but the appeals court upheld the trial court decision. P eventually received $690,000 ($610,000 of damages and $80,000 postjudgment interest).

(d) Taxpayer was one of a group of tenants of an apartment building who brought suit against their former landlord on allegations of fraud and to retain their rights to their apartments after their apartment building was converted to a condominium and the tenants were evicted. As part of a settlement, and in exchange for the termination of his occupancy rights, Taxpayer accepted a lump-sum cash payment from the landlord. Taxpayer simultaneously executed a document that released and discharged the landlord from all causes of action.

Question S-6. (4 minutes) Taxpayer, a chemist who had achieved internationally recognized status as a leader in his field, received a $10,000 cash award from his employer based on his record of performance with the company over a period of 10 years. He was nominated without his knowledge by his supervisor to be a recipient of the award, the purpose of which was to honor technical employees with 10 or more years of service. The employer's letter accompanying the cheek stated that the employee's achievements generally constituted important contributions to the work of his department and also specifically noted the usefulness of the work performed by the taxpayer to the employer. Discuss whether the award may be excluded from Taxpayer's income and explain why.

Question S-7. (3 minutes) Briefly discuss whether Taxpayer recognizes gain on the following transactions and determine the amount of gain to be recognized where appropriate.

To finance the development of a residential subdivision, Taxpayer borrowed from Bank and executed a recourse promissory note to Bank that was secured by a mortgage on the subdivision. Taxpayer later became insolvent, defaulted on the debt, and negotiated a settlement agreement with Bank. The agreement transferred the subdivision to Bank in complete satisfaction of the debt. After the transaction, Taxpayer was still insolvent. When the subdivision was transferred to the bank, its fair market value was $100,000, Taxpayer's adjusted basis was $80,000, and the amount due on the debt was 120,000.

Question S-8. (4 minutes) Briefly explain whether Taxpayer would be entitled to a deduction in the following situations:

(a) Taxpayer, was indicted by a federal grand jury under the Racketeer Influenced and Corrupt Organizations Act for racketeering activities. If Taxpayer were to be found guilty, all property and contractual rights acquired by him with respect to the racketeering activities would be subject to forfeiture. Taxpayer was acquitted by a jury and claimed a deduction for the legal fees incurred in his defense on the ground that, because the indictment sought the forfeiture of assets, the fees were incurred to conserve and maintain income-producing property.

(b) Taxpayer, a corporation, obtained a loan to obtain working capital. The promissory note included a conversion feature that allowed the holder of the note to convert the note to 20% of the corporation's outstanding common stock on the conversion date. Shortly before the due date for the final payment, the note was sold to a hostile third party, who sought to convert the note to stock. The corporation refused to convert the note and the third party brought suit for specific performance. The taxpayer claimed a deduction for legal fees incurred in connection with the litigation as an ordinary and necessary business expense.

(c) Taxpayer, a corporation engaged in the printing business, made various payments to the purchasing agents of all of its principal customers over a five-year period to ensure the business patronage of those customers. Such payments were extorted by the purchasing agents and were customary in the printing industry. Taxpayer claimed deductions for the payments as ordinary and necessary business expenses.

Question S-9. (3 minutes) Taxpayer, who lived in Michigan, suffered from chronic coronary artery disease and associated lung problems and required an oxygen tank to assist in breathing. Because the health problems became more acute in the winter months, Taxpayer was advised by a physician to spend the winter in a warmer climate. Acting on the doctor's advice, the taxpayer travelled to Florida in October and remained there for five months. The doctor did not specifically refer Taxpayer to doctors in Florida or prescribe specific medical treatment. The taxpayer lived in a travel trailer parked at a campground, and over the five-month period paid a total of $1,500 in rental fees to the campground. Because of Taxpayer's poor health, Taxpayer did not enjoy any significant element of personal pleasure, recreation, or vacation during the winter months spent in Florida. Taxpayer visited a Florida physician during the five months spent in Florida for routine check-ups, treatment for incidental ailments, and renewal of prescriptions for medications. Discuss whether Taxpayer is entitled to a medical expense deduction for the $1,500 in rental fees as lodging expenses during the winter months in Florida.

Question S-10. (4 minutes) Briefly discuss whether the taxpayer is entitled to any deductions with respect to the offices described in the following parts of this Question (treat each part separately).

(a) Taxpayer, a self-employed physician, works in three hospitals. Because none of the hospitals provides Taxpayer with an office to manage his practice, Taxpayer set up an office in Taxpayer's residence. Taxpayer maintains patient records and does all of the billing and scheduling in this office. Taxpayer also keeps a medical library in the office to keep current with professional reading. The office is used regularly and exclusively for these activities which are essential to Taxpayer's practice. No patients are seen in the office, but Taxpayer normally spends approximately two to three hours per day at the office, less than half the time spent at the hospitals.

(b) Taxpayer is an actor. As an actor, Taxpayer performs as an independent contractor, and has a room in his residence in which he trains and rehearses. Taxpayer also is employed by an acting school as a teacher and administrator and is provided by the employer with an adequate office at the school. The theater employer does not require or expect Taxpayer to do any work at home, but Taxpayer uses the residential office in connection both with employment at the acting school and the work as an independent actor.

Question S-11. (3 minutes) N Corporation wanted to hire Taxpayer for a high-level executive position. Taxpayer was concerned about the financial risk associated with relocation to Nowhereville, N Corporation's business headquarters. To provide greater mobility in the event of termination of employment with N Corporation, Taxpayer insisted that N Corporation agree to purchase Taxpayer's home in Nowhereville if employment were to be terminated. The employment agreement provided for such a purchase at the property's fair market value. Two years later, Taxpayer was terminated because of unsatisfactory performance and N Corporation bought the home for $285,000, the fair market value of the property. It took two more years for N Corporation to sell the property, during which time the house was never rented nor considered as rental property. On the sale of the house, N Corporation realized $186,000. Discuss whether N Corporation's loss on the sale of the residence is deductible as an ordinary and necessary business expense.

Question S-12. (3 minutes) Y Corporation offered to acquire all of the outstanding stock of X Corporation. The board of directors of X corporation determined it would be in X's long-term interest to shift ownership of X stock to Y Corporation, and the board and officers of X Corporation willingly negotiated with Y Corporation as to the proposed transaction. As recommended by counsel (to assure compliance with fiduciary duties to all shareholders), X engaged an investment banking firm to value its stock, render a fairness opinion, and assist if the tender offer became hostile. X Corporation incurred approximately $2,900,000 of investment banking and legal fees and other expenses in connection with the transaction. The transaction was completed, and X Corporation became a wholly-owned subsidiary of Y Corporation. Discuss the deductibility of the expenses incurred by X Corporation.

Question S-13. (4 minutes) Taxpayer properly was entitled to carryover $150,000 of investment interest expense from 1988 to 1989. In 1989, Taxpayer incurred $25,000 of investment interest expense and properly was allowed to deduct $15,000 under the investment interest limitations. Taxpayer's 1989 taxable income was $8,000. Briefly discuss the amount of Taxpayer's investment interest carryover to 1990.

Question S-14. (6 minutes) Discuss the amounts of the following transfers that qualify as alimony (treat each part separately).

(a) Under the terms of a divorce decree, Taxpayer is obligated to make annual alimony payments to former spouse, X, of $30,000, terminating on the earlier of the expiration of six years or the death of X. X maintains custody of their minor children. The decree provides that, at the death of X, if there is then living a minor child of the marriage, Taxpayer will make annual payments of $10,000 to a trust until the youngest child attains the age of majority. The income and corpus of the trust are to be used for the benefit of the minor child or children. At termination of the trust, any remaining trust property is to be distributed to Taxpayer's children in equal shares.

(b) Husband and Wife are divorced on July 1, 1985, when their children, L (born July 15, 1970) and T (born September 23, 1972), are 14 and 12, respectively. Pursuant to a divorce decree, Husband is to make alimony payments to Wife of $2,000 per month. The payments are to be reduced to $1,500 per month on January 1, 1991, and to $1,000 per month on January 1, 1995.

(c) Husband and Wife are divorced in 1989. Husband and Wife enter into a marital property and support agreement that is approved by the divorce court and adopted as its order. The agreement requires Wife to make alimony support payments in cash to Husband as follows:

	Year	Amount of Alimony
	1990	$90,000
	1991	 70,000
	1992	 50,000
Assuming that all required payments are made by Wife, briefly discuss the tax consequences to Wife and Husband in 1992.

Question S-15. (3 minutes) Husband owns real property having a fair market value of $10,000 and an adjusted basis of $1,000. On January 15, Husband borrows $5,000 from a bank, using the property as security for the loan. Husband and Wife are divorced on June 1, and pursuant to the divorce decree, Husband transfers title to the property to Wife on July 1. Wife takes the property subject to the liability to pay the $5,000 debt. In September, Wife sells the real property to a third party for $11,000 cash.

Briefly discuss the tax consequences to Wife with respect to the September sale to the third party.

Question S-16. (4 minutes) Discuss the liability consequences of each spouse who signs and files a joint income tax return, and explain whether a spouse may avoid liability.

Question S-17. (4 minutes) X transfers investment real estate with an adjusted basis of $10,000 and a fair market value of $11,000, plus stock with an adjusted basis of $5,000 and fair market value of $2,000 for investment real estate owned by Y with a fair market value of $13,000. Determine the tax consequences of this transaction to X. X and Y are unrelated individuals.

Question S-18. (3 minutes) Taxpayer, the sole owner of all outstanding stock of C Corporation, owns real property held for investment purposes, Blackacre, with a basis of $40,000 and a fair market value of $50,000. C Corporation owns real property, Whiteacre, with a basis of $10,000 and a fair market value of $50,000. On January 10, 1990, Taxpayer and C Corporation enter into an exchange of the two real properties. On March 1, 1991, Taxpayer sells Whiteacre for $60,000. Discuss the tax consequences of these transactions.

Question S-19. (7 minutes) Because Taxpayer was required by his employer to relocate to Massachusetts, Taxpayer (age 45 years) sold his New York residence, in which his basis was $40,000, for $100,000 in 1988. In 1988, Taxpayer purchased a residence in Massachusetts, which he occupied as his principal residence, for $120,000. In 1989, his employer relocated him to Virginia, where he purchased a residence for $90,000. In 1990, Taxpayer subsequently sold his home in Massachusetts for $110,000. For purposes of this Question, assume that the conditions of sec. 217(c) relating to moving expenses were satisfied with respect to the sales of both the New York and Massachusetts residences.

(a) Determine the amount of gain realized and recognized by Taxpayer upon the sale of the New York and Massachusetts residences.

(b) Determine the amount of Taxpayer's adjusted basis in the Virginia residence.

Question S-20. (3 minutes) In 1989, G gave her granddaughter, D, a diamond necklace with a fair market value of $5,000. G had purchased the necklace in 1985 for $6,000. G paid no gift tax on the transfer.

What are the gain and loss consequences to D, if D sold the necklace in 1989 for:

(a) $6,500
(b) $4,000
(c) $5,500

Question S-21. (3 minutes) Fred, who is 58 years old, and Ann, who is 35 years old, are married. Fred decides to sell the residence in which he and Ann reside. Fred, who owns the home as his separate property, sells the home for $175,000, and elects to exclude $125,000 of gain under sec. 121. Ann joins in the election as required by sec. 121(c). Two years later, Fred and Ann are divorced, and Ann marries Toby, age 55. Because Toby and Ann decide to spend the rest of their lives traveling, Toby decides to sell his separate property residence. Explain whether Toby qualifies within 121.

Question S-22. (6 minutes) In 1990, Taxpayer, a physician, contributed $10,000 to X Corporation in exchange for 100 shares of common stock, giving him a one-sixth ownership interest in the corporation. Shortly after its incorporation, X Corporation timely filed an election under sec. 1362(a). Because X Corporation was in need of additional funds to purchase equipment, X Corporation negotiated a loan in the amount of $250,000 from B Bank in 1990. B agreed to lend the money to X Corporation only if all the shareholders agreed to guarantee the loan and to assign insurance policies of $50,000 each on their lives. The shareholders accepted B Banks's terms and conditions, and all six shareholders individually signed a guarantee for the full amount of the loan, which was further secured by a mortgage on the equipment purchased with the loan proceeds. X Corporation timely made the principal and interest payments on the loan.

In 1991, in a separate transaction, Taxpayer loaned X Corporation $5,000.

X Corporation properly reported a loss of $36,000 in 1990, its first year of operation. In 1991, X Corporation properly reported a loss of $300,000.

(a) Briefly discuss the deductions available to Taxpayer, treating each year separately.

(b) How would your answer change if Taxpayer made payments in 1990 of $50,000 cash to the B Bank under the terms of the guarantee agreement.

Question S-23. (3 minutes) Briefly state the circumstances under which an S corporation that elects S corporation status in 1990 and which formerly was a C corporation will be subject to tax at the corporate level on the distribution of property.

Question S-24. (3 minutes) Taxpayer owned all of the outstanding shares of A Corporation. Taxpayer transferred all of the stock of A Corporation to N Corporation, a widely held and publicly traded corporation of which Taxpayer owned no stock prior to the transaction by which N Corporation acquired control of A Corporation. Taxpayer received from N Corporation 300,000 shares of common stock (less than one percent of the outstanding common stock of N Corporation) and cash of $3,250,000 in a transaction that qualified as a reorganization under sec. 368(a)(1). Discuss the tax consequences to Taxpayer.

Question S-25. (6 minutes) Discuss the tax consequences of the following transactions to A, B, and the partnership.

(a) Upon the formation of a partnership on November 1, 1989, A contributed land with a fair market value of $100,000 and a basis of $30,000 for his one-half interest, and B contributed $100,000 in cash for her one-half interest. A and B now agree that more cash is needed to purchase a larger inventory. Because B is in a lower marginal tax bracket than is A, the partnership makes a nonliquidating distribution of the land to B. B plans to sell the land and contribute the proceeds, net of tax, to the partnership. At the time of the distribution to B, the fair market value of the land is $150,000. On the day before the distribution, A's basis in A's partnership interest was $80, 000 and B's basis in B's partnership interest was $150,000. The partnership's basis in the land was $30,000.

(b) Assume the same facts as in Question (a), except the fair market value of the land is $70,000 at the time of the distribution to B.

Question S-26. (4 minutes) Discuss the effect under sec. 2032A of the transactions described below.

(a) D died in 1989. D devised real property being used as a farm to her son, S. D's estate qualified for and properly elected special use valuation under S 2032A. At the time of D's death, the farm was operated by G, who was D's grandson and S's nephew, under a crop-share lease. D's estate leased the farm to G for calendar year 1990 under a fixed amount cash rental agreement. During calendar year 1991, S operated the farm. In December 1991, S entered into a fixed amount cash rental agreement with G for four years under which G was to lease the land and conduct farming operations.

(b) Assume the same facts as in (a), except that D devises the farm to her husband, H, who immediately enters into a fixed amount cash rental agreement with G for four years under which G was to lease the land and conduct farming operations.

Question S-27. (4 minutes) Decedent dies in 1989. Discuss whether bequests pursuant to the following provisions in the decedent's will qualify for the estate tax marital deduction (assuming any required election is made).

(a) D's will includes a $100,000 bequest to D's son, S, if S survives D. If S predeceases D, the bequest goes to D's wife, W, if she survives D. Both S and W survive D. S makes a qualified disclaimer pursuant to sec. 2518 of one-half of his $100,000 bequest, and the property passes to W.

(b) D's will directs his executor to purchase for $100,000 a nonrefund life annuity for his surviving spouse, W.

(c) D's will bequeaths $500,000 in trust. The trustee is required to distribute all the trust income, at least annually, to the wife for life. The trustee also is given the discretionary power to invade trust corpus for any "emergency needs" of the surviving spouse and D's brother. Upon the wife's death, any remaining trust property passes to D's brother.

(d) Decedent's will leaves real property, Blackacre, valued at $250,000, to his surviving spouse, W, for her life. Under Decedent's will, W has the exclusive and unrestricted right to use Blackacre as her personal residence or to rent the property and receive the income. After W's death, Blackacre passes to Decedent's son.

Question S-28. (3 minutes) M and W are married and are citizens of Peru but permanent resident aliens of the United States. M dies and bequeaths all of M's property (all of which is located in the U.S.) to W. Explain whether and under what conditions the estate tax marital deduction will be available to M's estate.

Question S-29. (4 minutes) After a one week illness, Taxpayer died on February 2, 1989. Discuss whether the properties discussed below should be included in Taxpayer's gross estate for federal estate tax purposes.

(a) On February 8, 1987, Taxpayer established an irrevocable inter vivos trust, naming a bank as trustee. Under the terms of the trust, the trustee was authorized, but not required, to invest the trust principal in life insurance policies. The trustee purchased an insurance policy on Taxpayer's life on April 1, 1987. Taxpayer made cash contributions to the trust on February 8, 1987, and periodically thereafter, a portion of which contributions were used by the trustee to pay the periodic premium obligations of the trust on the insurance policy.

(b) Taxpayer created an inter vivos trust and named an independent bank as the trustee. The trust instrument authorized (but did not require) the trustee to make discretionary distributions of income and principal to Taxpayer's children. The trust was to terminate when there was no living child of the taxpayer who was less than the age of 21 years. The trust instrument reserved to Taxpayer the right to remove and replace the trustee with any individual or corporation. Taxpayer dies without having exercised the right to remove and replace the trustee.

Question S-30. (4 minutes) X and S were married recently, and because each had a prior marriage with children, they executed an antenuptial agreement. The antenuptial agreement created a trust ("Trust 1") for the benefit of S if she survived X. The trust was required to distribute income to S until S's death or remarriage. Upon S's death or remarriage, the corpus of Trust 1 poured over to Trust 2, which was the residuary beneficiary of X's estate.

The principal asset of X's estate was stock of Z Corporation. X died and X's estate had only $20,000 in liquid assets to pay Federal estate taxes of $205,000. X's executor borrowed $205,000 to pay the estate tax. With the approval of the Probate Court administering X's estate, the executor borrowed from G Corporation, a closely held corporation controlled by X's family, rather than selling stock held by Decedent's trust. The note was unsecured and provided that interest and principal were due in a single payment at maturity 15 years later, which was the life expectancy of S at the time of X's death. Prepayment of both principal and interest was prohibited. The interest rate on the loan from G Corporation was 15% per year, the prime rate of interest on that date.

Discuss whether the interest expense of the loan is a deductible administration expense.

Question S-31. (4 minutes) In 1980, Taxpayer and Spouse, residents of Illinois, acquire Blackacre, real property, as joint tenants with the right of survivorship. Taxpayer and Spouse contributed equally from their separate properties to the purchase price of Blackacre. On January 1, 1990, Spouse dies. On June 15, 1990, Taxpayer renounces her survivorship interest in Blackacre, and the survivorship interest passes to Taxpayer's child. Discuss whether Taxpayer has made a taxable gift as to Blackacre.

Question S-32. (7 minutes) Decedent's will created a trust funded with assets from Decedent's estate. The trust instrument requires that all the income of the trust be distributed currently to W during her lifetime. Capital gains are allocable to corpus, and all expenses of the trust are chargeable against corpus. The will requires that a reserve against trust income be created in amount equal to the annual depreciation deduction for federal income tax purposes. During 1990, the trust has the following items of income and expense:

1. Receipts
	a. Rental income from real property . . . .  $60,000
	b. Taxable interest income  . . . . . . . . . 30,000
	c. Tax exempt interest income . . . . . . . . 10,000

2. Expenses and charges
	a. I.R.C. sec. 162 business expenses
	   (maintenance)  . . . . . . . . . . . . . . 20,000
	b. I.R.C. sec. 168 depreciation deduction  . . . 40,000
	c. I.R.C. sec. 165 casualty loss to rental
	   realty . . . . . . . . . . . . . . . . . . 10,000
	   (The $10,000 loss to the property is
	   attributable to principal (not income)
           under local law.)

Determine the amount of:

(a) the distributable net income of the trust;
(b) the trust's distribution deduction; and
(c) the taxable income of the trust.

Question S-33. (6 minutes) Explain in general terms the operation of the "throwback" rules of sections 665-667 (ignoring the multiple trust penalty of sec. 667(c)).

Question S-34. (4 minutes) X gave real property with a fair market value of $50,000 to X's father on January 1, 1990. No gift tax was payable on the transfer. The adjusted basis of the property to X was $10,000. Six months later, the father died of a heart attack when the property has a fair market value of $75,000. Under the terms of the father's will, the real property is specifically devised to X. The estate has distributable net income during the estate's taxable year that includes the date of the distribution of the real property to X. What income, if any, does X realize at the time of the distribution of the property, and what is X's adjusted basis in the property?

Question S-35. (3 minutes) Taxpayer is a certified public accountant who failed to file income tax returns for years 1 to 7 until after an IRS Special Agent contacted Taxpayer in year 10 about the unfiled returns. The accountant then filed proper returns. Discuss the applicability to Taxpayer of the substantial underpayment of income tax penalty as to the late-filed returns, assuming that all years are after 1990.

Question S-36. (7 minutes) During taxable year 1, $10,000 was withheld from the wages of Taxpayer who also makes estimated tax payments of $3,000, but Taxpayer fails to file the required income tax return on or before the due date of April 15, year 2. The total amount of tax required to be shown on the return for year 1 is $15,000. The delinquency in filing continues until May 25, year 2, at which time Taxpayer files the required return showing a tax of $15,000 and pays $1,500 of the $2,000 tax due. The delinquency in payment for the remaining $500 continues until July 30, year 2. Discuss and quantify the additions to tax that will apply to Taxpayer.

Question S-37. (3 minutes) Discuss whether a taxpayer can avoid a sec. 6651(a)(1) addition to tax if the taxpayer relied on a tax return preparer to timely prepare the tax return, but the preparer did not prepare the return prior to the due date.

Question S-38. (3 minutes) A return preparer mailed a tax return to the IRS. The envelope contained the correct address for the IRS Service Center to which the return was required to be filed. The return preparer personally delivered the envelope to the local postmistress who manually placed the correct first class postage on the envelope, manually postmarked the envelope with that day's date, and deposited it in the outgoing mail as first class postage. The envelope containing the return was delivered by the return preparer to the postmistress on the due date of the return. The postmistress knows the return preparer, and she remembers processing the envelope to the IRS and the date on which the processing occurred. The IRS claims never to have received the return. Discuss whether the return was timely filed.

Question S-39. (6 minutes) In year 2, Taxpayer files an individual income tax return for year 1 (the return for which was due after 1989). The return shows for year 1 taxable income of $U and income tax liability of $V. An IRS audit of the taxpayer's return causes two adjustments that increase Taxpayer's taxable income to $W and tax liability to $X. The first adjustment, for which there was substantial authority and which was not a tax shelter item, increased taxable income by $Y. The second adjustment item increased taxable income in the amount of $Z, and there was not substantial authority and not adequate disclosure as to the second item. Discuss the applicability of the addition to tax for substantial understatement of income tax.


Created: March 21, 1996; Last updated: January 29, 2004

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