In 1994 Martin Dean was diagnosed with cancer by doctors at University Hospital. He had a malignant tumor in his spleen which was treated by surgically removing the organ. Unknown to Martin, research physicians at the university did biopsy work on the spleen and discovered that it had unique properties that seemed to have hindered the growth of the tumor.Working for about a year, the physicians were able to isolate the properties and used them to develop a treatment that showed great promise in slowing the growth of

some tumors that ordinarily grew quite rapidly.The university obtained a patent and planned to begin exploiting it for profit.

Although they believed that they had no legal obligation to do so under Moore v. Board of Regents, University Hospital officials notified Martin of their work and the part he and his

spleen had played in it.They also agreed to pay him five percent of all profits made by the patented process.At the time they valued Martin’s share at $250,000 based on the expectation that it would return about $30,000 per year to him.To evidence this agreement on January 31, 1996, the university gave Martin a written document titled Document of Profit Share which stated that the University thereby transferred 5% of all profits from exploitation of the patent to Martin or his successors for the life of the patent.

In May of 1996 Martin, who was independently wealthy, gave his daughter, Martha,

a note which read:

“Dear Martha—I have never thought that misfortune--my cancer--could lead to

such good luck.You know that I have no need for this windfall, and I want

you to be able to enjoy it.Therefore, I am hereby assigning to you 1/2 of

my interest in the university’s patent.Happy 30^th Birthday!

Love,

Dad”

From May until October of 1996 the day that he received his monthly check for $2,500 from the university, Martin would send his own check for $1,250 to Martha.Finally, in October, 1996, he got around to notifying the university of his daughter’s interest and the university began sending ½ of every check to Martha.

In February, 1997, Martin was fatally injured in a skiing accident.His will devised all of his property to Martha who became entitled to all of the payments from the university.This turned out even better than she might have imagined because it had then become apparent that the treatment was more useful and therefore more valuable than had been previously thought.Based on the projections for use, the university informed Martha that it now believed that the value of her right to receive the payments was about $500,000.It increased her monthly payments to $4,800 which she received beginning in March, 1997.

In 1998 the university decided that it would rather not have the burden of sending the monthly checks to Martha.Its lawyers contacted her and offered to buy her 5% interest for three annual payments of $200,000 plus the market rate of interest on the deferred payments.Martha liked the idea of having the money all at once and therefore agreed.She assigned and released her interest to the university in exchange for its installment obligation.The university made the agreed payments in a timely fashion.

Prior to his death Martin had amended his 1994 income tax return for the purpose of claiming a deduction for the cost of his surgery.He believed that this was appropriate as a cost of producing income producing property. Had his spleen not been removed, the patent and his interest in it would not have been obtained.

Discuss the tax consequences of these facts to Martin and Martha.Be sure to discuss whether Martin’s claim for a deduction is proper.

In 1994 Bill decided that he had had enough of the grind and politics of the big firm.He worked out a deal with his partners in which he would become supervisor for pro bono work in the firm; he would drop his partner status and become an employee of the firm.The firm had always allowed its members to do this kind of work, and Bill would be in charge of organizing and monitoring various projects undertaken by members of the firm.He could also do projects of his own and use firm associates to assist him.The agreement called for the firm to pay Bill $75,000 per year for the first three years of his work.For the 10 years following that, it would pay him $30,000 per year.This was a considerable reduction in the amount that he had received as a partner, but he had saved much over the years and did not need more.Both the firm and Bill agreed that he would do this work for three years and then retire.Bill then planned to live in part off the continuing payments from the firm.

Shortly after this agreement was signed the firm purchased an annuity from New York Insurance calling for an annuity of $30,000 per year for ten years.These payments were to begin in three years when the payments to Bill after retirement were to start.The policy was issued to the firm, but it provided for an irrevocable beneficiary designation with Bill so designated.

During their marriage Polly had been very active in volunteer work.For many years she did not work for pay outside the home, but starting in 1990 she became a paid legislative lobbyist working on various issues relating to women.She had always loved to cook, and this new position gave her many opportunities to entertain.During the last several years she had many dinner parties to which she invited other lobbyists and some legislators.She kept records of her expenses of these parties.One problem was that several of the parties were held during the legislative session, and it was illegal for legislators to accept benefits in excess of $5.00 from lobbyists during the session.A newspaper story was published describing the Polly’s parties, and several of the legislators were disciplined for having attended.In addition, the legislature sought to suspend Polly’s lobbying privileges.She hired an attorney to resist this suspension.After several hearings the legislative ethics committee dropped its action finding that her violations had been inadvertent. She paid her lawyer $15,000 for his legal services in connection with this matter.

But the adverse publicity took its toll.Polly decided that she wanted to make a change in her life too.But instead of winding down, she decided to do something she had always dreamed of.She would open a restaurant or a catering business.For about a year Polly and Bill took trips to the major restaurant cities of the United States.They went to New York, New Orleans, Chicago, San Francisco and the wine country of California.They kept meticulous records of their flight and ground transportation costs and the costs of their meals and lodging.They spent all of their time on these trips eating at restaurants, talking to chefs and owners and winemakers and generally getting to know more about food and the restaurant business.Polly twice went to one week cooking classes at the Culinary Institute of America in the Napa Valley.The tuition for these classes alone was $4,000, not including her travel expenses.

Time passed and Bill completed his three years in charge of pro bono work at the firm.He retired and began to collect checks from the insurance company.Several days after his retirement from the firm, Bill learned that he was to be awarded the Morris Dees Leadership Award for his pro bono work with prisoners.He traveled to Mobile, Alabama to receive the award at a dinner sponsored by the Southern Poverty Law Center.There he received a plaque worth $100, and a lifetime membership in the Center.This membership entitled him to free use of the Center library and free admission to all of its Continuing Legal Education presentations.All of his expenses for the trip were paid by the Center.

After he had received two months payments on the annuity, Bill decided that he did not need the full amount to live comfortably.He executed an assignment in which he gave one half of his interest in the annuity to his alma mater, Trinity Law School, to fund a scholarship for students showing a particular interest in poverty law.

In the meantime Polly opened a catering business.She did lots of work for some of her lobbyist friends’ entertaining, and enjoyed herself immensely.She loved receiving the praise that her food got even if she was not doing so well financially.She was buying only the best ingredients and equipment, but the market simply would not bear pricing sufficient to make a profit.Nevertheless, she kept trying for several years even though she had net loss from the business every year.

Polly’s hard work and Bill’s new found interest in golf put substantial strains on their relationship, and they finally divorced.Bill agreed to pay $20,000 per year in cash for the first two years, and transfer stock worth $20,000 to Polly in the third year.All of these payments were to cease if Polly died before the final payment.He also agreed to keep in force a life insurance policy on his life with Polly as the beneficiary.On this policy he paid a premium of $5,000 per year.Otherwise, they divided all of their property equally.

Two years after the divorce, Bill died, and Polly collected $150,000 on the life insurance policy.

Discuss fully the tax consequences of these facts to Bill and Polly.Be sure to discuss the timing of Bill’s realization on the compensation arrangement he had with the firm.

In 1997 May Collier lived in Grand Forks, North Dakota, and experienced the terrible flooding of that year.She had operated a kitchen store for several years in space she rented in a downtown building.She sold various items of cooking equipment, dinnerware and cookbooks and also conducted cooking classes at a display kitchen in the back of the store.Her business was quite successful and life was good until the floods came.

When the floods hit she was totally surprised by their magnitude.She had never expected that either her home or her business could be affected by flooding because they were not that close to the river and had not been affected in prior floods of her experience.She had not thought it necessary to have flood insurance.

But it wasn’t the flood that did the major damage to her business.It was the fire that broke out during the flood that destroyed everything she had in the business.Fortunately, this meant that she could recover under her fire insurance policy which paid her $250,000 for her claim.This included $175,000 for her inventory (which had a basis of $160,000), $50,000 for her equipment (which she had purchased for $75,000 and for which she had taken ACRS deductions of $52,000) and $25,000 for her lost business.

She was happy to receive this amount, but decided that she did not have the heart or strength to reopen her business.Besides, it would be a long time before business in Grand Forks would be anywhere close to normal.She decided to put the money into a store that would sell home construction equipment and also do remodeling.She was a very skilled carpenter and was able to give excellent counsel for rebuilding projects.She bought equipment for remodeling for $100,000 and invested another $160,000 on merchandise for the business.

She did not fare so well when it came to her home.It was one of those that sat under water for so long that its structural integrity was severely compromised.It turned out to be a total loss, and she had no insurance coverage for it.She had paid $85,000 for the house in 1980, and it was the only house she had ever owned.She had thought about selling it about a year earlier and had had it appraised.The appraised value was $120,000 at that time.The only recovery she had for the house was $38,000 paid by state and federal disaster funds.

She was despondent over these losses, but did buy a new house on higher ground in Grand Forks in November of 1997.Fortunately she was able to use the disaster funds as part of her $50,000 down payment.The total cost was $125,000, and she financed the balance with a bank loan.

Her other loss was to her car that she used to drive to and from work and otherwise for personal use.She had moved it to higher ground, but not high enough.It was not a total loss, but suffered significant damage of about $2,000.May was fortunate though because like other residents of the town she received a check in that amount from an anonymous donor who had come forward with the offer in the weeks following the flood.All she had to do to collect this amount was to go to city hall and sign a statement that she planned to live in Grand Forks in spite of the flood.Although this gift was intended to be anonymous, a resourceful reporter eventually found out that the benefactor was Hillary Schofield, a wealthy developer who made her fortune promoting real estate development in and around Grand Forks and Fargo.May used the check to pay for the repairs to her car.

May at first went into her new business with enthusiasm, but after a time the devastation and heartbreak she saw was too depressing for her to stand.She decided that she could no longer live in Grand Forks.She had an irrational fear of flooding even during dry periods.In July of 1999 she decided to leave the area.Because the progress in rebuilding had been so slow, housing was at a premium.She was able to sell her new house for $200,000.Her business had boomed and she was able to sell it for $350,000 ($200,000 for her then inventory that had cost $170,000, $80,000 for the equipment that she had depreciatedin the amount of $40,000, and $70,000 for goodwill).

She moved to Montana and bought a house near Missoula for $175,000.It was much bigger than her old house and had a beautiful view of the mountains.She was far above any possibility of flooding.She went to work there as a salesperson in kitchen store.

Shortly after she moved to Missoula, she heard from a friend that the city of Grand Forks was holding an auction the proceeds of which would go to those still suffering from the floods after 2 years.On October 15, 1999, May contributed a painting that her father, a prominent professional artist, had painted in the 1970s.He had devised it to her at his death in 1988 when it was valued in his estate at $30,000.At the time of its contribution to the city auction, the painting was appraised at $60,000, but it sold at the auction for $55,000.May went back to Grand Forks for the auction and herself bought a baseball signed by Kirby Puckett for $1,500.Kirby had always been her favorite baseball player.

What are the income tax consequences to May of these facts?