WILLIAM MITCHELL COLLEGE OF LAW
FINAL EXAMINATION--TAKE-HOME
INCOME TAX, SECTION 1
FALL 1997
Professor DENISE ROY
Handout Date: Saturday, December 6, 1997, 12:30 p.m.
Due Date: Wednesday, December 17, 1997, 8:00 p.m.
ADDITIONAL INSTRUCTIONS:
1. ONCE YOU HAVE PICKED UP THIS EXAM, YOU MAY DISCUSS THE EXAM WITH OTHER MEMBERS OF THE CLASS. DO NOT DISCUSS THE EXAM, THE ISSUES RAISED IN THE COURSE OR ANY OTHER ASPECT OF THE COURSE WITH ANY PERSON OTHER THAN MEMBERS OF THE CLASS AND ME. YOU MUST WRITE YOUR OWN EXAM ANSWERS, INCLUDING DIAGRAMS.
2. You may use the textbook and Internal Revenue Code and Regulations volume assigned for the course, the Chirelstein and Bankman/Griffith/Pratt books recommended in connection with the course, your own notes and outlines and any course handouts. You may not consult any outside materials.
3. This examination must be typewritten or printed (not handwritten) and is subject to a 15-page length limitation. In addition, each section of the exam is subject to the page limitation specified on the exam. Any required diagrams must be provided on separate sheets of paper that will not be counted for purposes of the applying the page limitation(s). IF YOU EXCEED THE PAGE LIMITATION(S), YOU WILL BE GRADED ONLY ON THE PAGES THAT FALL WITHIN THE LIMITATION (E.G., ON THE FIRST 15 PAGES). Answers must be doubled spaced on 8-1/2 x 11 inch paper with non-proportional-type font (1) having no more than 12 characters per inch (CPI) (2) and normal top and bottom 1 inch margins and left and right 1 inch margins. Do not justify the right-hand margin of your text. Type only on one side of each sheet of paper. Do not use footnotes. PLACE YOUR TEST NUMBER ON EACH PAGE OF YOUR ANSWER AND NUMBER YOUR PAGES. FAILURE TO COMPLY WITH THESE INSTRUCTIONS MAY BE TAKEN INTO ACCOUNT IN YOUR GRADE.
4. Each section tells you the relative weight of the section to the exam as a whole. Do not assume that the number of pages you devote to a section should be proportional to the weight of the section.
5. You will be graded on the quality of your analysis rather than on the conclusions you reach. Do not discuss extraneous issues. Limit your analysis to federal income tax issues. Do not discuss other tax (e.g., payroll, estate and gift, state) issues that may be presented.
6. You need not provide numerical answers but may do so if you choose. In some cases you may not have sufficient information to provide numerical answers. If you do provide numerical answers, be sure to explain how you reached your conclusions.
Good luck on your exam. It has been a pleasure working with you this semester. Denise Roy
I (40%)
Write no more than 7 pages total (not including diagrams) on the questions in this section.
In 1977, Shep inherited a farm from his father. Immediately before his death, the father had a basis of $400,000 in the farm, and at the time of his death, the farm was worth $600,000. Shep has lived on and operated the farm since then. He is now thinking about retirement. Shep's only child, Clayton, has never had any interest in farming and works as a writer in the Big City. She bought a two-bedroom condominium apartment unit in 1991 for $140,000. She moved in with her partner, Luce, in 1993, but kept her condominum unit as rental property. Luce loves horses, and dreams of one day breeding and training horses for a living. Shep's neighbor, Chaney, is interested in buying most of Shep's farm land, but has no interest in the farm buildings. Shep is thinking of proposing a swap to his daughter. He would transfer to her and Luce the farm buildings, the land on which they sit and sufficient additional land to allow for development of horse breeding and training operations (total FMV = $300,000), all in exchange for Clayton's rental condominium (FMV = $200,000). Shep is not concerned about making up the difference in value between the farm property and the condominium; he'd just as soon give his daughter and her "friend" a hand. He would then sell the remaining farm land to Chaney for the following consideration: (1) assumption of a $300,000 recourse debt secured by the farm (proceeds from which were used in 1994 to replace rotting wooden partitions with metal partitions, repaint the farm buildings and reshingle portions of several farm building roofs), (2) $100,000 cash and (3) a nonnegotiable promissory note calling for 10 annual payments of $50,000 each beginning on April 1, 1999. For purposes of this question, you may assume that the swap and sale would take place on April 1, 1998.
(a) Explain how Shep will determine his initial basis in the farm.
(b) Explain the effect, if any, of the 1994 expenditures on Shep's farm basis. Briefly list other information you will need to determine Shep's adjusted basis in the farm as of April 1, 1998.
(c) Explain the tax consequences to Shep, Clayton and Luce from the exchange of farm property for rental condominium. If there are any ambiguities in how the transaction would be structured, make recommendations as to how the ambiguity should be resolved to minimize the parties' tax cost from the transaction. Diagram the position of the parties before and after the transaction as well as the transaction itself.
(d) Explain the tax consequences to Shep and Chaney from the sale of the remaining farm property. You may assume that the installment payments qualify for taxation under the installment method and that Shep will not elect out of the installment method, but do explain how the installment method affects Shep and Chaney's tax consequences.
(e) Briefly list additional issues you would need to consider in determining the tax consequences to Shep, Clayton, Luce and Chaney from the April 1, 1998 swap and sale.
II (40%)
Write no more than 5 pages total on the questions in this section.
A. A retail eyeglass company, ForSight, has come up with a creative marketing ploy aimed at potential customers who have a balance in a cafeteria plan health account that must be spent before the end of 1997 or forfeited. ForSight is encouraging those people to spend the health account balance on its eyeglasses (or contact lenses) by offering to rebate back to the customer an amount equal to 20 percent of the purchase price. Specifically, ForSight will mail the rebate to the customer upon submission of a rebate-request form and a copy of the eyeglasses sales receipt. ForSight advertising suggests that the customer may be reimbursed by the cafeteria plan health account for the full price of the glasses, and then receive the 20-percent rebate to boot (using that term colloquially). Mark, who is fond of expensive glasses, needs to spend the balance in his Pillsbury cafeteria plan health account, and thinks this deal is just too good to be true (as such deals often are). He purchases a pair of designer glasses, with matching clip-on sunglass lenses, for $1,000 on December 5, 1997, and immediately submits his sales receipt to the Pillsbury cafeteria plan administrators for reimbursement of the $1,000 purchase price. He also sends his rebate-request form and a copy of the sales receipt to ForSight headquarters. The cafeteria plan reimbursement check for $1,000 arrives on December 19, 1997, and Mark promptly deposits it in his checking account. The rebate check for $200 arrives on January 20, 1998, and also goes promptly into Mark's checking account.
(1) Explain the tax consequences of Mark's glasses purchase and the $1,000 Pillsbury reimbursement payment. For purposes of this analysis, do not take into account the effect of the rebate request. You may assume that the Pillsbury cafeteria plan qualifies as a "cafeteria plan" within the meaning set forth in the Internal Revenue Code and that Mark is not a "highly compensated participant" or a "key employee" but is just your average run-of-the-mill (get it?) employee. You may also assume that the Pillsbury plan administrators do not make any judgment as to whether an expenditure submitted for reimbursement from a health account is for "medical care;" that judgment is the employee's responsibility.
(2) How does the pending rebate request affect your analysis in question (1), above, if at all? Explain.
(3) Explain Mark's tax consequences from the $200 ForSight rebate.
(4) Help Mark figure out how to take tax consequences into account in deciding whether to go ahead with the glasses purchase.
B. The Powerball Lottery (a state government operation) now gives winners the option to either take a lump-sum payment or receive a series of periodic payments over a number of years (say, 20). Assume that the present value of the 20 annual payments will equal the amount of the lump-sum payment.
(1) Explain how a winner electing the periodic payment option will generally be taxed on the winnings.
(2) Explain how tax considerations should be taken into account in deciding between the lump-sum and periodic payment options.
III (20%)
Write no more than 3 pages on the question in this section.
Please answer the following question posed in the Klein and Bankman text on page 214, taking into account the tax policy factors we discussed in class (and any other factor you consider relevant):
Consider . . . the effect of the 1996 legislation that limited personal injury to physical injuries. A is injured in an automobile accident and recovers $100,000 for lost wages and pain and suffering; B recovers the same amount for damages to reputation from libel, or for a tort-based racial or age-based discrimination. A's recovery is tax-free. B's recovery is taxed in its entirety. How, if at all, can this difference in outcome be justified?
Whether you do or do not believe this difference in outcome can be justified, explain your analysis thoroughly, and feel free to disagree with any position you think I communicated about this question in class. On the taxable damages side of the comparison, address libel and discrimination damages (rather than one or the other). Include a brief explanation of the legal basis for Klein and Bankman's conclusion that A's damages are tax-free and B's are taxable.
THE END
0 Nonproportional fonts, such as Courier, have letters that are all the same size. Therefore, the number of characters per inch does not vary depending on the letters used. 0 CPI is not the same as "point" size (e.g., 10-point font). The exam questions appear in Courier font size 10, which meets the 12 CPI requirement. Use a ruler or compare with the exam questions to make sure you get the font size correct.