Accounting Question

Please ensure you use the tax reasearch database, CCH AnswerConnect to help you research the issues to be addressed in the tax memo.  Please look at the examples for the correct format for a tax memo. Please see the attached files for the instructions.

Background:
Your new client, Ricardo Salazaar (“Salazaar”), is a dentist. His filing status is Married Filing
Jointly. His spouse does not work. He owns and operates a dentistry office through an S
corporation, Dentistry Gold Inc. (“Dentistry Gold”). He is the sole owner of Dentistry Gold.
Last year Salazaar purchased the land and building where he operates the dental practice. His
attorney advised him for legal reasons to set up another S corporation to own the real property
separate from the dental practice and not in his name and rent the building to Dentistry Gold.
The new S corporation, that owns the land and building, is called Gold Land, Inc. (“Gold Land”).
Since Dentistry Gold already had a lease agreement for the rental expense the previous tax
advisor instructed Salazaar to have Dentistry Gold’s business attorney to prepare a lease
agreement between Dentistry Gold and Gold Land on the same terms and conditions.
Dentistry Gold paid a salary to Salazaar of $140,000 for the 2023 tax year. The net rental
income earned by Gold Land is $50,000 for the 2023 tax year. The net ordinary income earned
by Dentistry Gold for the 2023 tax year after all expenses is $150,000. Dentistry Gold did not
employ anyone else in the business. The unadjusted basis of the assets in Dentistry Gold is
$50,000.
In addition, Saalazaar and his wife had passive losses of $20,000 for the 2023 tax year and
investment income of $30,000.
Salazaar’s previous tax advisor died on December 15, 2023 and this is how he and his wife
became your clients. Normally his tax advisor would tell him how much income tax to withhold
from his salary for the paycheck that was paid on December 31 at the end of the year as there
were no withholdings during the year. The death of the tax advisor meant that Salazaar had the
payroll run so that he paid in $75,000 in federal income tax withholding. He and his wife own
their own home outright and their itemized deductions for the 2023 tax year would amount to
$12,000.
Salazaar remembers his previous tax advisor discussing passive income and passive losses, the
Qualifying Business Income (“QBI”) deduction and the net investment income tax (“NIIT”) but
he did not quite remember how it all worked.
Salazaar wants to understands the income taxes that he needs to pay for the 2023 tax year.
Issues:
Salazaar needs advice for the following, and requires primary authorities to support the answer:
1. Can the net rental income that he earns from Gold Land offset his passive losses for the
2023 tax year?
© 2024. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of copyright will be
subject to prosecution and considered Academic Dishonesty
2. Is the net rental income that he earns from Gold Land subject to the net investment
income tax?
3. What is his QBI deduction, if any for the 2023 tax year?
When looking for primary authorities you should consider these authorities (but this is not an
exhaustive list):
IRC §469
Regs §1.469-2(f)
IRC §1411
Regs §1.1411-4(g)
IRC §199A
Regs §1.199A-1(b)(14)
Regs §1.199A-5(c)(2)
Schumann, T.C. Memo. 2014-138.
Your research should consider the above cited authorities and the associated regulations and
other primary authorities that you believe are relevant to the situation.
Your responsibility:
Prepare a tax research memo addressing all the questions that has been raised. Please note that if
the tax memo is not in the required format and/or contains very little analysis of primary
authorities you will receive a zero (0) for the assignment.
You will need to support your conclusion using primary sources of tax law. Your textbook is
NOT a primary authority nor are IRS Publications. Please refer to Chapter 2 for primary
authorities. CCH AnswerConnect is not a primary authority, nor is Google Scholar nor are any
other websites you may access. The primary authorities are legislative, administrative and
judicial. You may use secondary authorities to assist you with identification and understanding
the primary authorities, such as CCH AnswerConnect but your memo should only contain
primary authorities.
You must use proper citation form in your memo (see Chapter 2 for help with citation form).
The form for this communication should be professional and in the form of a tax research memo
(examples posted on Canvas and a similar example in your textbook). You will see that citations
are within the text of the document in the example. Once a court case has been cited in full, it
can be referred to using simply the name in italics.
Please use your own words and do not quote large amounts from the primary authorities. If the
reader wants to see the wording of the primary authorities you have provided the citation for the
reader to go and look at the wording from the primary authorities.
© 2024. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of copyright will be
subject to prosecution and considered Academic Dishonesty
Do yourself a favor and look at the grading rubric before you submit.
This memo should be whatever length you feel is appropriate to resolve the issues. We do NOT
use a bibliography or list of references in a tax research memo. We do not include Background
in a tax memo. The Background is provided so you can identify the relevant facts.
You are required to INDIVIDUALLY prepare this document. Please upload your memo to
Canvas before the due date and time. TurnitIn will be used to check for plagiarism. Late
assignments are not accepted.
The grading rubric for Tax memos is posted in Canvas. For this assignment, points are
distributed as follows:
Aspects of the memo
Content – facts and issue(s)
Content – analysis
Content – conclusion
Organization
Audience
Style
Mechanics
Referencing
Total
Points
16
30
14
8
8
8
8
8
100
© 2024. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of copyright will be
subject to prosecution and considered Academic Dishonesty
October 17, 2021
To:
Client file
Facts
1. The name of the US client is George’s Software, Inc. (“George’s”)
2. The business, George’s, is an S corporation
3. The corporation is a calendar year end, cash basis taxpayer
4. George’s recently redeemed 23% of the shares from a shareholder Robyn Harley
(“Harley”)
5. As part of the transaction George’s and Harley entered into a Covenant Not to Compete
(“CNC”)
6. The CNC is for a period of one year and is in relation to customer contracts and
relationships
Issues
1. Which code section of the Internal Revenue Code covers the deductibility of a CNC for
George’s?
2. What is the normal period for deducting the costs of a CNC for federal income tax
purposes?
3. Is it possible to deduct the costs in accordance with the term (one year in this case) of the
CNC?
Conclusions
1. §197 of the Internal Revenue Code covers the deductibility of a CNC. The CNC is
considered a Code Sec. 197 intangible.
2. A taxpayer can deduct the cost of a CNC over a 15-year period, beginning in the month
the asset is acquired.
3. Since the CNC is a section 197 intangible that is amortizable over fifteen years, it is not
possible to deduct the costs of the CNC over its duration of one year.
© 2021. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part. Violation of copyright will be subject to prosecution and considered Academic Dishonesty
Analysis
Which code section of the Internal Revenue Code covers the deductibility of a CNC for
George’s?
As a general rule, under §197, of the Internal Revenue Code, a taxpayer is entitled to an
amortization deduction of any section 197 intangible asset. A CNC 1 is considered to be an
intangible asset that is deductible over a 15-year period, beginning with the month of the asset’s
acquisition.2 George’s is also holding the asset in connection with a trade for the production of
income, another requirement for an asset to be considered a section 197 intangible.
Furthermore, when dealing with any corporate stock acquisition, it does not matter whether the
corporate stock is substantial or not because it will still be considered a “section 197 intangible”
nonetheless.3
Certainly, there are exceptions to these assets which include: financial interests4, land5, computer
software6, certain interests or rights acquired separately7, and some more discussed further
throughout §197(e). §197(f)(1)(B) also discusses the special rule regarding covenants not to
compete, which is that no event shall be treated as disposable before the disposition of the entire
interest.
What is the normal period for deducting the costs of a CNC for federal income tax purposes?
As discussed before, Internal Revenue Code §197 covers the normal period for deducting the
costs of a CNC for federal income tax purposes. §197(a) states that the deductions are “…ratably
over [a] 15-year period…” The deductions also begin within the month the intangible asset is
obtained by the taxpayer.
In the case, Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal
Revenue, Respondent, Appellee8, the Internal Revenue Service (IRS) changed the amount of
allowed amortization deductions that Recovery Group had reported in their income tax returns
since they allocated the income from their CNC over a two-year period instead of the correct
1
Refer to §197(d)(1)(E)
Refer to §197(a)
3
Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal Revenue, Respondent, Appellee.
652 F.3d 122 (1st Cir. 2011), Affirming the Tax Court, 99 TCM 1324, Dec. 58,184(M), TC Memo. 2010-76.
4
Refer to §197(e)(1)
5
Refer to §197(e)(2)
6
Refer to §197(e)(3)
7
Refer to §197(e)(4)
8
Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal Revenue, Respondent, Appellee.
652 F.3d 122 (1st Cir. 2011), Affirming the Tax Court, 99 TCM 1324, Dec. 58,184(M), TC Memo. 2010-76.
2
© 2021. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of
15-year period. As a result, the change in the allowed amortization deductions increased
Recovery Group’s income for each year, and thus the amount of each shareholder’s share.
Is it possible to deduct the costs in accordance with the term (one year in this case) of the CNC?
In Recovery Group, Inc. v. Commissioner of Internal Revenue9, the court found in favor of the
Commissioner regarding the length of the amortization period for a CNC. They analyzed the
requirements and rules regarding an intangible asset under section 197.
The court concluded that Recovery Group’s interpretation of §197(d)(1)(E) was incorrect and
that any CNC “…entered into in connection with the acquisition of any corporate stock, even if
not ‘substantial,’ was considered a ‘section 197 intangible’ amortizable over fifteen years.” The
taxpayer must use the correct IRC §197 rules for its intangible asset and it cannot claim any
other type of depreciation or amortization to align with those rules contradicting the possibility
of the costs to be deductible in accordance with the term of the CNC.
9
Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal Revenue, Respondent, Appellee.
652 F.3d 122 (1st Cir. 2011), Affirming the Tax Court, 99 TCM 1324, Dec. 58,184(M), TC Memo. 2010-76.
© 2021. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation
of copyright will be subject to prosecution and considered Academic Dishonesty
Background:
Your Texas Band, Inc., is a calendar year corporation. The corporation is a Texas corporation that is
based in Dallas, Texas. The band recently sold tickets ($1,000,000) for concerts scheduled in the United
States for next year and the following year. For financial statement purposes, Your Texas Band will
recognize the income from the ticket sales when it performs the concerts. For tax purposes, the
corporation uses the accrual method and would prefer to defer the income from the ticket sales until
after the concerts are performed. This is the first time that it has sold tickets one or two years in
advance. Their manager, Russell Crowe has asked your advice. Write a memo to Mr. Crowe explaining
your findings.
Facts:
• Your Texas Band, Inc., is a calendar year corporation
• The corporation is a Texas corporation
• The band is based in Dallas, Texas
• The band recently sold tickets ($1,000,000) for concerts scheduled in the United States for next
year and the following year.
• For financial statement purposes, Your Texas Band will recognize the income from the ticket
sales when it performs the concerts.
• For income tax purposes, the corporation uses the accrual method.
• The band has never previously sold tickets one or two years in advance.
Issue:
Should Your Texas Band include the income from the advance sales of tickets for concerts scheduled in
future years?
Relevant Authorities:
IRC Sections 451 and 446
Rev. Proc. 2004-34, 2004-1 CB 991.
Artnell Co. v. Comm. (7 Cir., 1968), 68-2 USTC par. 9593, rev’g and rem’g 48 TC 411 (1967).
Tampa Bay Devil Rays, Ltd., 84 TCM 394 (2002).
Schlude v. Comm. (S. Ct., 1963), 63-1 USTC par. 9284, aff’g, rev’g and rem’g (8 Cir., 1962), 62-1 USTC
par. 9137, aff’g 32 TC 1271 (1959).
American Automobile Association v. U.S. (367 US 687), 61-2 USTC par. 9517, aff’g (Ct. Cl., 1960), 601 USTC par. 9301.
Auto. Club of Michigan v. Comm. (353 US 180), 57-1 USTC par. 9593, aff’g (6 Cir., 1956), 56-1 USTC
par. 9296, aff’g 20 TC 1033 (1953).
Conclusion:
Your Texas Band can defer recognition income form the ticket sales until the amounts are earned
(i.e., until the concerts are performed). Thus, the ticket sale income for the concerts will be
recognized in the year of the performance.
Analysis:
The general rule for prepaid service income is to recognize it in the year of receipt. However, Rev. Proc.
2004-34 allows a one-year deferral for prepaid services. Nonetheless, there is judicial authority (Artnell
Co. and Tampa Bay Devil Rays, Ltd.) that indicates that deferring the income until actual performance
more clearly reflects income in this particular setting. The key fact here is that the taxpayer knows
exactly when the performance will take place. If, for example, the prepaid services were for “services on
demand” like dance lessons, consulting services, etc., the most advantageous tax treatment would be a
one-year deferral under Rev. Proc. 2004-34.
There should be detailed analysis for each authority to continue the Analysis.
Current date
To:
Client file
______________________________________________________________________________
Facts
1. The name of the US client is MacKenzie, Inc. (“MI”)
2. The JV partner is a Turkish company, Turk Contracting and Trading Company (“TurkCompany”)
3. The joint venture vehicle is a Nevada (“NV”) LLC, named MacKenzie-Turk
Construction LLC (“MT LLC”)
4. The joint venture will be entering into a contract with the customer, a Cayman company
with an Iraqi operation
5. The contract is a fixed price contract with the customer
6. Each JV partner has estimated the costs for their portion of the contract, assume $4
million for Turk-Company, and $1 million for MI
7. MT LLC will be charged the fixed price from each JV partner, and together with the
direct costs incurred by MT LLC, a margin will be added to all the costs, resulting in a
price for the fixed price contract with the customer
8. In order to ensure each JV partner is responsible for managing the respective costs for
which they have quoted and are responsible it is preferable not to co-mingle the costs of
the two partners. In essence, each partner is providing a service to the JV to fulfill the
contract requirements
9. In addition to the Iraqi branch registration for MT LLC, each JV partner intends to
register an Iraqi branch for their respective parts of the proposed operation to fulfill the
contract obligations
10. The customer will likely withhold 7% from the gross payment to MT LLC.
11. Turk-Company will be doing the building and installation
1
12. MI will be providing project management, QC, EH&S, cost scheduling, interface with the
customer in Iraq, interface with the customer in the US (approx. 10% of the work
performed by MI will be done in the US).
Issues
1. Can the activities of a partner be attributed to the partnership?
2. Is it possible to utilize the Turkey-US tax treaty to avoid a Permanent Establishment
(“PE”) in the US for Turk-Company?
3. Is it possible to form a non-US partnership between the two partners to undertake the
foreign activities and have no services performed in the USA so that there is no little or
no US ECTI?
4. What if the amounts to be paid to both partners in MT LLC are structured as guaranteed
payments?
5. If the payments for services to both partners are structured as guaranteed payments are
there specific recommendations in regard to the guaranteed payments?
Conclusions
1) It is likely the activities of MI would be attributed to MT LLC, and thus Turk-Company
would have a US trade or business, and thus US ECTI and the associated § 1446
withholding.
2) There are court cases that would suggest that the Turk-Company would have a PE in the US
from the activities of the partnership, MT LLC, and thus the income would likely be US
ECTI with the associated § 1446 withholding.
3) The formation of a non-US partnership with a US partner, MI, would likely still result in the
same result of US ECTI and associated § 1446 withholding.
4) If the payments for the services provided by both members of MT LLC are structured as
guaranteed payments, then arguably the payment to the foreign partner, Turk-Company is not
US ECTI and is not subject to § 1446 withholding.
5) If guaranteed payments are to be utilized with respect to payments made to the foreign
partner for services performed for the partnership, it is recommended that there be a written
2
agreement, including: identifying the nature of the services; the place where the services will
be performed; and the fact that any payments are not dependent on partnership income
Analysis
Can the activities of a partner be attributed to the partnership?
Generally a partner can act on behalf of the partnership, as well as deal with the partnership in a
separate contracting capacity1. IRC § 875(1) does not distinguish between general and limited
partners, and when considering whether the activities of the partner can be attributed to the
partnership this may be an important factor, such that, the activities of a general partner,
generally possessing the authority to bind the partnership, would seem to be more easily imputed
to the partnership than those of a limited partner (who runs the risk of losing his limited liability
protection if he actively participates in the management of the partnership’s affairs). As the
partnership is a Limited Liability Company, as MI is the managing partner, it is likely that
activities of MI would be attributed to MT LLC.
Further, in the case U.S. v. Balanovski2, it was held that Balanovski’s activities were imputed to
the partnership, and accordingly the partnership (in which he was an 80% partner) was engaged
in a U.S. trade or business (and thus the 20% foreign partner was engaged in a trade or business
pursuant to § 875(1)). Specifically, Balanovski (i) made important partnership decisions in the
U.S., (ii) maintained a bank account for the partnership in the U.S., and (iii) operated out of the
partnership’s New York office (a hotel room), and those facts all suggested that Balanovski was
acting on behalf of the partnership and not for his own account. Thus, there is precedent that the
activities can be attributed to the partnership.
Accordingly, it is likely the activities of MI would be attributed to MT LLC, and thus TurkCompany would have a US trade or business, and thus US ECTI and the associated § 1446
withholding.
Is it possible to utilize the Turkey-USA tax treaty to avoid a Permanent Establishment (“PE”) in
the US for Turk-Company?
As a general rule, under a tax treaty, a foreign person engaged in a trade or business activity in
the U.S. will only be taxable on “business profits” generated from that to the extent the foreign
person has a PE in the USA to which the profits are “attributable.” The taxation of trade or
business income under the Code is generally a lower taxable threshold than the taxable threshold
1 Refer to § 707
2 236 F.2d 298 (2d Cir. 1956), rev’g on this issue 131 F. Supp. 898 (S.D.N.Y. 1955), cert. denied, 352 U.S. 968 (1956).
3
for a PE, and may be supplanted by treatment of the income under an applicable treaty to the
extent the treaty is invoked by the taxpayer. The US requires the taxpayer to file a disclosure
that they are electing treaty benefits.
Although most treaties do not specifically address the issue of the foreign partner having a PE,
the Service has taken the position that the imputation rule of § 875(1) also applies for purposes
of determining a partner’s permanent establishment status3. Several U.S. court cases have also
considered the issue and held in accordance with the Service’s position4.
Accordingly, it is likely Turk-Company would have a PE in the US from the activities of the
partnership, MT LLC, and thus the income would be US ECTI with the associated § 1446
withholding.
Is it possible to form a non-US partnership between the two partners to undertake the foreign
activities and have no services performed in the USA so that there is no US ECTI?
In Rev. Rul. 2004-35, the IRS considered the application of § 875(1) to a service partnership that
had been formed under German law and had two equal partners, one a U.S. resident and one a
German resident. The German resident partner performed no service in the United States. The
IRS ruled, pursuant to provisions of § 875(1), and the decisions in Donroy and Unger, that the
German resident partner should be treated as having a fixed base regularly available to him in the
United States and was therefore subject to U.S. taxation on his allocable share of income from
the German service partnership to the extent that such income was attributable to the
partnership’s fixed base in the United States. This result was reached without regard to whether
the German resident partner performed any services in the United States.
Accordingly, establishing a foreign partnership, instead of MT LLC, to undertake the proposed
Iraqi contract would not provide a different result. The foreign partnership would be seen as
having an office in the US by virtue of the US office of MI, and thus there would be US ECTI
and associated § 1446 withholding.
What if the amounts to be paid to both partners in MT LLC are structured as guaranteed
payments?
In listening to the description of the facts of the proposed contract and the business arrangement,
it appears that both members of MT LLC are providing services to MT LLC in regard to their
respective areas of expertise. Further, the expected profit margins differ for each service. An
3 See Rev. Rul. 90-80, 1990-2 C.B. 170; Rev. Rul. 85-60, 1985-1 C.B. 187
4 Donroy Ltd. v. U.S., 301 F.2d 200, (9th Cir. 1962); Unger v. Comr., T.C. Memo 1990-15, aff’d, 936 F.2d 1316 (D.C. Cir. 1991).
5 2004-7 I.R.B. 486
4
overriding business requirement is that each partner is independently responsible for the
performance of their portion of the contract – risk and reward is on the partner, not the
partnership. The amount that can be charged to MT LLC is limited to the amount that was used
for the original bid proposal.
The US partnership rules adopt the entity model with respect to transactions in which a partner is
acting at arms-length with the partnership6, and treats the transactions as if occurring between the
partnership and a third party. Thus, if a partner performs services for a partnership to which the
partner belongs, the partner will include any payment in income based on the partner’s method of
accounting, and the partnership will deduct or capitalize the payment under its method of
accounting. Such payments are generally described as a guarantee payment.
Guaranteed payments are similar in some respects to the distributive share payments (in that the
partner is acting in his or her capacity as a partner), but also share some of the characteristics of §
707(a) payments (in that the partner’s receipt of such payment is not dependent on the income of
the partnership). As provided in § 707(c) and the regulations thereunder, guaranteed payments
are fixed payments by a partnership for services (where such payment is not dependent on
partnership income).
If a guaranteed payment to a foreign partner is characterized as a payment for services, and if
those services are performed outside the United States (and not in connection with a U.S. trade or
business), then arguable that income is likely to constitute foreign source income and,
accordingly, it would not be subject to U.S. taxation7.
It should be noted there is some language that may cause some concern in that § 707(c) and the
associated regulations may appear to limit this separate treatment8.
There is no direct IRS or case authority addressing treatment of guaranteed payments to a foreign
partner for purposes of § 871. However, for purposes of the foreign earned income exclusion of
§ 911, both the Tax Court9 and the Court of Claims10 have held that guaranteed payments from a
partnership to a foreign partner for services performed by the partner are excludable from gross
income as foreign source compensation.
6 Refer to § 707(a)
7 Refer to § 862(a)(3)
8 Specifically § 61(a) (relating to gross income) and § 162(a) (relating to trade or business expenses) would be treated as separate
payments, and for other purposes of the tax rules, guaranteed payments are regarded as a partner’s distributive share of ordinary
income
9 Miller v. Comr., 52 T.C. 752 (1969), acq., 1972-2 C.B. 2.
10 Carey v. U.S., 427 F.2d 763 (Ct. Cl. 1970).
5
In Carey11, the Court of Claims stressed (as the Tax Court had in Miller12) that failure to treat the
guaranteed payment as compensation for purposes of § 911 would unfairly discriminate between
a partner who performed services for the partnership outside the U.S. and an employee who
performed services for the partnership outside the U.S. Both Courts also found that denial of the
§ 911 treatment for the service provider who also happened to be a partner in the partnership was
inconsistent with the policy underlying § 707(c)1314.
So although the tax cases and other authorities are in regard to the treatment of guaranteed
payments is in relation to § 911, and not in relation to § 871, it does not appear unreasonable to
apply the same reasoning that similar payments to a foreign partner would be foreign source
compensation income for purposes of § 87115.
If the payments for services to both partners are structured as guaranteed payments are there
specific recommendations in regard to the guaranteed payments?
If guaranteed payments are to be utilized with respect to payments made to the foreign partner
for services performed for the partnership, it is recommended that there be a written agreement,
including the following items:
•
•
•
identifying the nature of the services,
the place where the services will be performed; and
the fact that any payments are not dependent on partnership income
11 Carey v. U.S., 427 F.2d 763 (Ct. Cl. 1970).
12 Miller v. Comr., 52 T.C. 752 (1969), acq., 1972-2 C.B. 2.
13 The Tax Court noted that the legislative history suggested that the words “but only” under § 707(c) were intended to make
clear that guaranteed payments are not treated as compensation for purposes of determining when such payments are included in
income but instead are included in income at the same time as the partner’s distributive share
14 In TAM 7939005, the IRS followed Miller and Carey and, in reaching its conclusion, the IRS also acknowledged that §
861(a)(3) (and Regs. § 1.861-4(a)(1)) applied for purposes of sourcing the compensation income.
15 The same discriminatory treatment that the Courts objected to in the § 911 context would appear to exist if guaranteed
payments were not treated as compensation for purposes of § 871.
6