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Acc553 Week 4 You Decide Project

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MEMORANDUM

To: John and Jane Smith

From: XXXXXX, CPA Near Lakes City

Date: February 7, 2013

Dear Mr. & Mrs. Smith,

Thank you for coming to our offices and allowing us to review and discus your concerns regarding your tax questions. I have been assigned to reply to your questions and I have listed my recommendations below. After you both have reviewed these recommendations, please contact me so we can go over any additional questions you may have.

Mr. Smith’s questions:

1(a) How is the $300k treated for purposes of Federal tax income?

According to the IRC §61(a)(1), “Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, fringe benefits, and similar items”, the $300,000 you received must be included as part of your gross income, compensation for services, and as such it is taxable.

1(b) How is the $25,000 treated for purposes of federal tax income?

The $25k you received as a recovery for expenses you paid in advance must also be treated as income. In general, an expense cannot be deducted if paid in advance. This is true for both the cash basis method of accounting and the accrual method of accounting. The prepaid amount is treated as an asset with a useful life extending beyond the current tax year, and carried over to the tax year where the expense applies. The Internal Revenue Service treats your out of pocket expenses, that you incurred in this contingency fee case, as a loan to you and therefore disallows any deductions, for this loan, as expenses, as outlined under IRC §162(a), which outlines trade or business expenses.

However, if you incurred any additional expenses during the tax year, you may claim them as long as they were ordinary and necessary as…...

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