Consider the following information and determine what is the tax effect of this issue. Prepare a 1-2 page research memo supporting your conclusion. You must include citations of tax law as support and all citations must be in proper form.

Keystone, Inc. operates a delicatessen/bakery in Philadelphia, PA that specializes in mobile food catering for events and gatherings within the tri-state area. The owner of the company provides to you the following information regarding the pending lawsuit:

Keystones Lawsuit Announcement

To: Keystone Management From: Patty Driver, Chairperson and CEO

Date: January 1, 2016

MEMORANDUM

Keystone, Inc. reported today that a $100,000 jury verdict has been rendered in a lawsuit due to an employee accident, Davenport v. Keystone. The verdict was apportioned 75% to Keystone and 25% to Collier Rental Company. Keystone management is extremely disappointed in this verdict, which it does not believe is supported by the facts or the law, and stated that it will pursue all available options, including post-trial motions and appeal.

In a tragic accident the plaintiff permanently injured her arm; the accident was caused when the plaintiff slipped and fell into a piece of Keystone equipment while on the job. The particular piece of equipment, rented from Collier Rental Company, has been used previously and by the previous business owner with no other similar incident and is still being used by the same facility in the same place today. Keystone Chairman and CEO Patty Driver stated: This piece of equipment has been in continuous operation for over 10 years in the same facility, with no incidents reported other than this one event. We strongly believe that Keystone was not negligent and is in no way responsible for this tragic accident. We will vigorously pursue all avenues to attain a reversal of this verdict.

It is difficult to express the sense of injustice that management and employees of our company feel about the unfairness of this award and the strength of our belief that this accident was not the fault of our company or our equipment. The trial is one more example of a tort system run amok and why more and more U.S. manufacturers find it difficult to operate in the U.S. Keystone makes products exclusively in the USA and has a number of U.S. employees. We intend to exercise all legal remedies to get the verdict overturned.

The piece of equipment in question is located in a Keystone kitchen and rented from Collier Rental Company. The employee spilled water on the floor due to an overflowing sink, slipped on the floor and fell into the kitchen equipment. This is not a design flaw it is a terribly unfortunate result of plaintiffs poor judgment which had the disastrous result for which all of us feel great sympathy. The fact remains that this was not faulty equipment and not the responsibility of Keystone.

It is difficult to understand the jurys decision regarding the amount of the verdict even if Keystone were in some way responsible for the accident which we are not. We believe the trial was flawed beginning with the initial decision to allow plaintiff to use as counsel a firm that had represented Keystone in the past and which should have been disqualified as plaintiff counsel as well as the fact that the judge excluded testimony from the only eye witness. We intend to continue to defend ourselves vigorously. Looking forward, we have faith that our post-trial motions and appeals will result in a reduction or reversal of the verdict.

It is important to me and the entire Keystone management team that the truth be told and that our shareholders know that their company is reputable and honest in its dealings and that our products are the finest in the world safe and effective. To Ms. Davenport, we express great sympathy and admire her courage in dealing with the tragedy that resulted from this accident. But it was an accident not a Keystone product that was at fault.

Aftermath of Davenport

Keystone management in consultation with counsel is analyzing the impact of the verdict on the Company and its financial condition. We have been able to determine that Keystones available insurance coverage for this claim is currently $45,000. Further, a $3,000 attorney fee for litigation for the month ended December 31, 2015 relates to the Davenport liability matter; the bill was received but not booked.

Keystone needs advice on financial reporting for the lawsuit award, as well as its tax ramifications. Management is concerned that if this award stands, Keystone may not have enough cash to support operations.