This is a TAX QUESTION - FEDERAL TAX RESEARCH 10TH EDITION. AUTHOR: ROBY SAWYERS. VBID: 9781305850323

QUESTION 77 - CHAPTER 7 (TO ANSWER QUESTION USE FORMAT AS ILLUSTRATED ON EXHIBIT 11-5: Client File Illustration BELOW)

Case to be answered:

Charles Nobel works as a television talk show host for Broadcast Inc. In 2013, Charles generated substantial income from his employment. His wages from Broadcast were approximately $100,000 in 2013. The show is taped four days per week and taping lasts only a few hours each day. The crew of writers and Charless ability to effortlessly read the teleprompter provide Charles with an extremely well-paid job for approximately 20 hours work per week. This leaves Charles with time away from work that most U.S. employees would find enviable. In 2013, Charles found a way to use that extra time by becoming, in his words, a professional slot machine gambler. On approximately 50 days in 2013, Charles played the slots in casinos in and around southern California. He managed to generate slot machine winnings of $102,000 in 2013; that is, his total winning payouts from slots were $102,000. However, during those same 50 days, Charles lost $116,000. Because of the level of play and money spent at the casinos, Charles was probably one of the top 1 percent or 2 percent of gamblers in all of southern California. In fact, he was frequently invited to slot machine tournaments based on his gambling and celebrity status. Charles also kept meticulous records of his gambling endeavors. He had detailed books and records that tracked the amounts played each day, the amounts won and lost, and various other expenses incurred. It seemed clear that Charles took his gambling very seriously. In previous years, Charles had played the slots less frequently but had managed to generate net gambling winnings (his wins exceeded his losses) and truly believed he could make money playing slots professionally. On his 2013 tax return (Schedule C of Form 1040Profit or Loss from Business), Charles reported the following: Gross income $102,000 Car and truck expenses (2,323) Supplies (212) Travel (400) Other expenses: Gambling losses (116,000) Telephone expenses (65) Net loss $(17,000) Prepare a tax research memorandum to the files that provides your opinion on the proper treatment of Charless gambling activities as it relates to calculating his taxable income (i.e., what is the taxable income or loss from Charless gambling).

For the purposes of this memo, you may assume that his gambling activities rise to the level of a trade or business. You may also assume that all Charless expenses are ordinary and necessary business expenses that are fully supported and directly related to his gambling business.

EXHIBIT 11-5 SAMPLE TO BE USED ON ANSWERING QUESTION: Client File Illustration

FILE MEMO

December 10, 20XX

Sawyers, Raabe, Whittenburg and Gill CPAs Newport, RI

Relevant Facts

On the morning of their wedding, Frieda gave to Harold $400,000 of appreciated stock, pursuant to a prenuptial agreement. Friedas basis in the stock was $150,000. In exchange for these securities, Harold surrendered all other marital rights and claims to Friedas assets, under the terms of the agreement.

Specific Issues 1. What are the gift tax consequences of this exchange? 2. What are the income tax consequences of this exchange?

Conclusions 1. Frieda incurs no gift tax liability as the agreement is executed and implemented. 2. Neither Frieda nor Harold recognizes taxable income as a result of the exchange. Asset basis carries over to Harold, the new owner of the securities.

Support

Issue One

Donative intent on the part of the donor is not an essential element in the application of the gift tax. Reg. 25.2511-1(g)(1). The Supreme Court has held that prenuptial transfers in relinquishment of marital rights are not adequate and full consideration in money or moneys worth for the transfer of property, within the meaning of I.R.C. 2512(b) (Merrill v. Fahs, 324 U.S. 308 (1945); Comm. v. Wemyss, 324 U.S. 303 (1945); Reg. 25.2512-8). Although the transaction resulted in a gift, no gift tax is imposed due to the application of the annual exclusion and the unlimited gift tax marital deduction (I.R.C. 2503(b) and 2523; Rev. Rul. 69-347, 1969-1 C.B. 227). I.R.C. 2501 imposes a tax on the transfer of property by gift; the gift tax is not imposed, though, upon the receipt of property by the donee. Rather, it is the transfer itself that triggers the tax. Since the prenuptial agreement here is enforceable by state law only when consummated by marriage, the transfer has not taken place until after the marriage occurs. Thus, the transfer appears to be eligible for the gift tax marital deduction, regardless of the timing of the transfer relative to the marriage ceremony on the wedding day. Even if the securities had been physically transferred to Harold prior to the completion of the ceremonies, the agreement was only enforceable after the couple was married. The IRS likely would not need or attempt to establish the exact moments of both (1) the transfer of the securities, and (2) the consummation of the marriage (Archbold, 42 B.T.A. 453 (1940, Acq. in result only).

Issue Two

Neither Harold nor Frieda recognizes any gross income upon Harolds release of his marital rights. Gross income does not include the value of property that is acquired by gift (I.R.C. 102(a); Reg. 1.102-1(a); Rev. Rul. 79-312, 1979-2 C.B. 29; Rev. Rul. 67-221, 1967-2 C.B. 63; Howard v. C.I.R., 447 F.2d 152 (CA-5, 1971)). In the typical gift situation, the donee takes the donors income tax basis in the transferred property. I.R.C. 1015(a) and 1041(a)(1).

Actions to Be Taken

Prepare letter, review results with client.

Place copy of prenuptial agreement in the client file.

Preparer: Karen J. Boucher

Reviewer: Lynne E. Schoenfeldt

Client Letter

Sawyers, Raabe, Whittenburg and Gill CPAs Newport, RI

December 10, 20XX

Harold and Frieda van Briske

2000 Fox Point Heights

Whitefish Bay, RI 02899

Dear Harold and Frieda,

Thank you again for requesting my advice concerning the tax treatment of a gift of appreciated stock related to your prenuptial agreement. I am happy to report that the transaction will not result in the imposition of any federal gift or income tax for either of you. My understanding of the facts as you described them to me on the phone are as follows. On the morning of your wedding, Frieda gave to Harold $400,000 of appreciated stock, pursuant to a prenuptial agreement. Friedas basis in the stock was $150,000. Under the terms of the agreement, in exchange for these securities, Harold surrendered all other marital rights and claims to Friedas assets.

My research has uncovered a series of court cases concluding that an agreement such as yours is not supported by full and adequate consideration, and, therefore, that it is to be treated as a gift. Although you did not intend for your property transfer to be a gift, the intent of the parties in such agreements does not control for federal gift tax purposes. Fortunately, however, the treatment of your transaction as a gift will not result in the imposition of federal gift tax or income tax. Federal income tax is not imposed upon the transfer because gross income is not recognized by either the donor or donee when a gift is made. Although a gift has occurred, no gift tax is due, because the unlimited gift tax marital deduction neutralizes the transfer. My conclusion is based on the facts that you have provided me and on the applicable income tax laws in effect as of the date of this letter.

We can discuss any questions that you have early next year when we meet to begin the process of preparing your tax return for the year.

Sincerely,

Karen J. Boucher, CPA, JD, MST Sawyers, Raabe, Whittenburg and Gill CPAs