Introduction
Tax research memorandum is prepared after an extensive research on tax related cases. The research focuses on reviewing various tax laws within a given jurisdiction. The tax laws are then interpreted and applied in the context of a client. Basically, the tax research memorandum is used to document and communicate the findings of a tax research. Documenting the relevant tax authorities and rationale is important especially during audits and for future reference. A tax memorandum should be made up of two key parts these are the main text and the support documents. This paper seeks to prepare tax research memorandum for two cases. Also, it will discuss the concept of passive loss limitation.
Tax research memorandum for Peaceful Pastures Funeral Home Inc.
IRS Audit Notice
The company received an IRS audit notice concerning the reporting of prepaid income under Peaceful’s program.
Facts
Peaceful Pastures Funeral Home Inc. provides a full line of funeral services to its customers. Besides, the company retails goods related to those services. The company experienced a decline in the volume of sales to the escalating cost of the goods and services it provides. The increased costs made customers to select cheaper products. Besides, the company also noted that some customers were unable to pay bills while others paid their bills late. The company came up with a program that would solve the problem of reduced sales. The program allowed customers to prepay for the products to be offered at a later date. The amounts prepaid are refundable upon the request of the purchaser. Peaceful currently uses the accrual basis of accounting. This implies that revenues are recognized as income once the goods or services are delivered.
Issue
Should Peaceful Pastures Funeral Home include the prepaid income in the year in which it is received or can the company include this income in the year in which the services are offered?
Conclusion
Peaceful should not report the income earned under the advance payment program as gross income in the year when it is received. The company should report the income in the year when the services are provided because the nature of the contracts gives the customers absolute control on whether and when the refunds should be made. Such prepayments act as security and not a prepayment of income since they are refundable.
Analysis
In the case of Commissioner of Internal Revenue v. Indianapolis Power & Light Company Code Sec (s) 61 and Perry Funeral Home, Inc. v. Commissioner, TC memo 2003-340, Code Sec (s) 451, the court ruled that refundable deposits where the contracts contained open-ended cancellation and refund right are refundable deposits and not advance payment. Therefore, the company does not have complete control over the funds. The case Perry Funeral Home, Inc. v. Commissioner, TC memo 2003-340, Code Sec (s) 451 was ruled based on the precedence set by Justice Blackmun in the case of Commissioner of Internal Revenue v. Indianapolis Power & Light Company Code Sec (s) 61. The facts in the case of Perry Funeral Home, Inc. v. Commissioner, TC memo 2003-340, Code Sec (s) 451 are consistent with the facts in the scenario of Peaceful Pastures Funeral Home Inc. In the scenario of Peaceful, the customers can request for refund of the prepaid amount any time until the services are rendered. This shows that Peaceful has no control over the prepaid amount. The company does not have the assurance that the amount prepaid will be future income. Thus, such prepayments should be recorded as income in the year when the services are offered.
Tax research memorandum for MegaCorp, Inc.
IRS Audit Notice
The company received an IRS audit notice concerning the accounting treatment of $5 million paid to Ideas, Inc. on behalf of Little Inc. for legal damages.
Facts
MegaCorp, Inc. acquired Little, Inc. As a consideration, MegaCorp, Inc. took over the assets and a portion of the liabilities of Little, Inc. Further, MegaCorp, Inc. was supposed to pay for anticipated damages arising from litigation. MegaCorp, Inc. agreed to be legally responsible for the outcome of the judgment. After judgment was passed on the lawsuit, the company paid $5 million for the damages. The transaction was recorded in the books of account as an ordinary expenditure. The company supported this entry with the provision under section 162.
Issue
Can MegaCorp, Inc. deduct the $5 million payment as a business expense considering that they incurred the expense in the processing of purchasing Little, Inc.?
Conclusion
MegaCorp, Inc. should not deduct the $5 million as a business expense. The money was incurred in the process of acquiring Little, Inc. Thus, the judgement payment should be capitalized.
Analysis
Section 162a employed by the company allows for the deduction of conventional and essential expenses that are incurred in the daily operations of the business. Some of the expenses that can be allowed based on this section are a realistic amount of salaries, travelling expenses, and rentals. Based on this section, the payment for damages during acquisition does not fall under the category of day to day operations of the business. On the other hand, section 263a does not allow deductions that relate to constructions of a new structure and renovations that are lasting in nature or renovations that raise the worth of a structure. Apart from section 162 and 263, there are several cases ruled that have similar facts. For instance, in Indopco, Inc. v. Commissioner, Code Sec (s) 162 and Illinois Tool Works Inc. et al. v. Commissioner, Code Sec(s) 162 the jury ruled that the amount paid for litigation in the process of acquiring certain assets of another company should be capitalized. This judgement was based on the fact that such litigation charges are not ordinary business expenses. The facts in the case of MegaCorp, Inc. are similar to those of Illinois Tool Works Inc. et al. v. Commissioner, Code Sec(s) 162. Thus, MegaCorp, Inc. should not deduct the $5 million as a business expense. The amount should be capitalized. As a general rule, a financial commitment that relates to buying of a capital asset is a non-deductible capital expenditure. Such expenses are not allowable deductions and should be capitalized with other costs of the capital assets.
Research essay – passive loss limitation
The Internal Revenue Services (IRS) outlines the rules that may restrict the amount of losses that can be deducted from an income generating activity. Publicly traded partnerships (PTPs) pass tax liabilities to partners when distributions are made. These distributions are not recorded as taxable income. In the case of a publicly traded partnership, the income or losses should be separated from a passive activity. A passive partner does not participate substantially in the partnership trade (Smith, Raabe & Maloney, 2013). The passive loss limitation restricts the ability of a passive partner to subtract losses from the activity. However, the limitation does not apply in the case of a partnership business that trades in securities. The subsequent section will discuss the benefits and disclaimers of a number of PTPs.
Access Midstream
In the prospectus, the company focuses on its size. The size of the company is large and it shows that it is stable and promises high returns in the future. This can be appealing to investors. On the other hand, the disclaimer states that “the information in the prospectus includes forward-looking statements which are subject to known and unknown risks and uncertainties that could cause actual results to differ materially. We refer you to the discussion of risk factors that could affect future operating or financial performance” (Access Midstream, 2013, p. 1).
Limestone oil
In the prospectus, the company explains how it will find opportunities for drilling oil and gas easily. Further, the company explains the experience of investing in oil and gas industry using the example of Mike May. In the disclaimer, the company states that “all oil and gas investments are financially risky and may result in complete loss of all money. There are no guarantees, no safety and no security in oil and gas investments” (Limestone Oil, 2013, p. 1).
Legacy Reserves LP
In the prospectus, the company attributes their growth to acquisition and development of producing oil and natural gas properties. The prospectus outlines that an investor will gain from the acquisition since the assets are long lived and will generate revenue over a long period (Legacy reserves LP, 2012, p. 1). As a disclaimer, the company states that their operations are characterized by seasonal rates of production and the ability of the company to distribute profits depends on economic findings (Legacy reserves LP, 2012, p. 9).
References
Access Midstream. (2013). About us. Web.
Legacy reserves LP. (2012). 2012 annual report. Web.
Limestone Oil. (2013). How to evaluate oil and gas drilling investments. Web.
Smith, J., Raabe, W., & Maloney, D. (2013). Taxation of business entities. USA: South- Western Cengage Learning.