Student Test No. ________
 

1. Your examination will be anonymously graded. To maintain anonymity, use the assigned test number received in the mail.
 

2. Put your test number on this page and on all of your answer sheets.
 

3. If you do not know your test number, you may obtain it in Student Services (Room 102). If you have any concern about the anonymity of your test number, you may have it changed in Student Services.
 

4. If you do not use your test number, you will be deemed to have waived your privilege of anonymous grading.
 

5. Your typewritten answers are due in the student services office no later than 8:30 p.m. on Wednesday,

December 22, 1993, you must sign the exam confidentiality pledge below using your test number. When you turn in your exam have the student services personnel sign and acknowledge time and date of receipt.
 

LATE EXAMINATIONS WILL BE ACCEPTED ONLY UPON A GRADE PENALTY DETERMINED BY THE PROFESSOR AND THE DEAN OF STUDENTS.
 

STUDENT CODE

IT IS A VIOLATION OF THE CODE:
 

1. To use any sources which are forbidden by the instructor to complete an exam.

2. To submit as one's own work the work of another.

3. To engage in any conduct which tends to give an unfair advantage to any student in any academic matter.

4. Knowledge of any violation should be promptly reported.
 

By placing my examination test number in this space ________ I hereby certify that between the receipt and due date of this examination I did not consult or discuss with any person other than other students in this class any matter relating to this examination or to any matter discussed in the Fall 1993 Income Tax (Section 1) course, that I did not consult any written material other than my own notes and outlines, course handouts, the Chirelstein book and the textbook and Internal Revenue Code volume assigned in this course and that I did not work or consult with anyone in writing the answers to these exam questions. In addition, I hereby certify that I have no knowledge of any other classmate's violation of this rule.
 

VIOLATIONS OF THE STUDENT CONDUCT CODE MAY RESULT IN EXPULSION OR SUSPENSION FROM THE COLLEGE OR DISMISSAL FROM THE CLASS.
 

GRADUATING SENIORS: If you are a graduating senior, note this fact on all answer sheets and this exam paper. DO SO CONSPICUOUSLY.
 

ADDITIONAL INSTRUCTIONS
 

1. Once you have picked up this exam, you may not discuss the exam, the issues raised in the course or any other aspect of the course (except how much fun it was) with any person other than members of the class and me.
 

2. You may use the Chirelstein book, the textbook and Internal Revenue Code volume assigned for the course, your own notes and outlines and any course handouts. You may not consult any outside materials.
 

3. This examination must be typewritten and is subject to a 13-page length limitation. In addition, each section of the exam is subject to the page limitation specified on the exam. Answers must be doubled spaced on

8-1/2 x11-inch paper with 12 font type, and normal top and bottom 1-inch margins and left and right 1-1/4 inch margins. Type only on one side of each sheet of paper. Do not use footnotes. PLACE YOUR TEST NUMBER ON EACH PAGE OF YOUR ANSWER.
 

4. Each section tells you the relative weight of the section to the exam as a whole. Do not assume that questions in each section are of equal weight or that the number of pages you devote to an answer should be proportional to the weight you think the question will be given.
 

Good luck on your examination. It has been a pleasure working with you this semester. Professor Denise Roy.
 

I. (20%)
 

Write no more than 2 pages total on these questions.
 

A. Hennepin County has made an offer to retirees who owe county property taxes: in lieu of paying your property taxes, you can reduce or eliminate your tax liability by working for the county. At $4.25 per hour, the

county expects that the average retiree who accepts this offer will work about 10 days to eliminate about $300 in taxes. What are the federal income tax consequences to the retirees who accept this offer?
 

B. Olive, a businessperson, overpaid when she spent $10,000 for business travel in 1990. It turns out that the airlines she dealt with were engaged in various practices violating the U.S. antitrust laws. Unaware that she had been cheated in this way, she claimed the full $10,000 as a business expense on her 1990 tax return. In 1993, Olive received a $2,000 payment in settlement of the antitrust claims raised in a class action lawsuit. What are the federal income tax consequences to Olive from the payment in 1993?
 

C. In 1989, Harry purchased 100 shares of Volkswagen stock for $5,000. That same year, Harry met Sally. In 1991, as a token of friendship, Harry transferred the 100 shares, worth $3,000, to Sally. When the transfer was

made, Harry and Sally had no plans to marry (each other). In 1992, they changed their minds and got married. Six months later, Sally exchanged the stock with Harry in return for $1,000. Harry sold the stock to a third party

three months later for $4,000. Assuming the original transfer of stock from Harry to Sally in 1991 was a gift, what are the federal income tax consequences to Harry from the sale of the stock to the third party for $4,000?
 

II. (60%)
 

In this section, you must all answer Question A. You may then select one of the remaining questions to skip. In other words, you need answer only 3 of the remaining 4 questions (B through E). Write no more than 8 pages total on the questions in this section.
 

A Kristy owns an apartment building with 12 units. (She does not live there.) The building is worth $1.2 million and her basis in the building is $900,000. She also owns Xerox stock worth $30,000 with a basis of $45,000. May owns a small beach cottage worth $120,000 with a basis of $20,000. May lives in the cottage one month of the year and rents it out for as much as possible during the remainder of the year. May wants to purchase an apartment from Kristy so she can move into the city, but she doesn't want to have to sell her cottage in a taxable transaction. Kristy is willing to trade one apartment unit worth $100,000 plus stock worth $20,000 in exchange for the beach cottage. Assume that the apartment building, Xerox stock and cottage are all long-term capital assets.
 

(1) Given these facts, what issues would you need to resolve to determine whether this transaction qualifies as a like-kind exchange under §1031 for both Kristy and May?
 

(2) If the transaction qualifies as a like-kind exchange for Kristy and for May, what will be their federal income tax consequences from the transaction?
 

(3) What are Kristy's federal income tax consequences if this is a taxable transaction to her (if §1031 does not apply)?
 

B. In 1993, a driver of one of the P & P Diaper Service's trucks negligently struck and injured Maria. In settlement of Maria's compensatory damage claim, P & P offered a lump sum cash payment of $200,000. Maria

agreed to the total amount but insisted that P & P pay the amount in cash to her attorney, who she directed to purchase an annuity in her (Maria's) name with herself as the beneficiary. P & P gave the cash to the attorney,

who paid Shamrock Annuity Company $200,000 in return for Shamrock's promise to pay Maria $50,000 per year for the rest of her life. (Maria has a life expectancy of 10 years.) On December 31, 1993, Maria will receive her

first check for $50,000 from Shamrock. Assuming that the damages paid by P & P were for "personal injuries'' what are the tax consequences to Maria in 1993 as a result of these transactions?
 

C. Sam uses a wheelchair for mobility after breaking his back in a car accident. In 1993, he paid $140,000 for a two-story house that required significant modification to make it wheelchair accessible. In the same year, he spent the following amounts on modifications: (1) $20,000 for a lift to get from the first to the second floor, (2) $5,000 to replace the concrete sidewalk and steps in the front of the house with a concrete ramp, (3) $10,000 to remove carpeting and install wooden floors in several rooms, (4) $5,000 to make various modifications in the kitchen and bathroom to make it easier to reach the stove, sinks, toilet and shower, and (5) $3,000 to plaster and paint the modified areas. In 1993, Sam's adjusted gross income will be $60,000. Will these expenses be deductible as medical expenses? If not, what effect will they have, if any, for federal income tax purposes? Which tax treatment do you think Sam would prefer and why?
 

D. Airport Taxi operates a holiday program it calls SoberCab in which it offers free rides (up to a maximum drive of 20 miles) to people who are too drunk to drive during "the holiday season" (between Christmas and January

2). Fingerhut Companies, Inc. (a mail-order sales company) this year will provide the financing for the operation--it will reimburse Airport Taxi for the cost of operating the program. Volunteers will answer the phones. What

are the tax consequences of this arrangement for Fingerhut and the free riders? Assume Fingerhut will be taxed as an individual.
 

E. George's Microbrewery annually earns gross receipts of $400,000 and spends about $30,000 in advertising its established products. However, when it introduces a new line of beer, it will spend an additional $20,000 on advertising in the first year to get the new line off to a good start. According to the materials and principles covered in the readings and class discussions, should these advertising expenses be treated as current or capital expenses? Explain.
 

III. (20%)
 

Write no more than 3 pages on the following question.
 

Choose one of the following positions and defend it using the tax policy criteria we discussed in class:
 

(1) the new §1202 exclusion for gain recognized on the disposition of certain small business stock (or something like it) should be expanded to cover capital gain from all long-term investments providing new financing to businesses;
 

(2) the new §1202 exclusion for gain recognized on the disposition of certain small business stock should be eliminated altogether.
 

Here are all the details about §1202 that you will need to take into account for the purposes of this question: New §1202 will allow a 50% exclusion of gain realized on the disposition of stock in certain small Subchapter C corporations (income from which is taxable at both the corporate and shareholder level) if the stock was acquired by issue from the corporation and has been held for more than 5 years.