Essay on Accounting: John Smith Tax Issue

Words: 965
Pages: 4

John Smith tax issue:
1a). How is the $300,000 treated for purposes of federal income tax? The $300,000 that John Smith received would be treated as income. According to the IRS, income is classified as “earned income includes all the taxable income and wages you get from working,” such as:
• wages, salaries, tips, and other taxable employee pay;
• union strike benefits;
• long-term disability benefits received prior to minimum retirement age;
• net earnings from self-employment, such as own or operate a business; and
• gross income received as statutory employee.
John Smith will be taxed on his income of $300,000 regardless if he received the amount as a lump sum or in annuity. The constructive receipt doctrine states that “…
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The IRC Section 1031 states, “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” Since John and Jane is only buying another property (personal property/home, and not for business purposes) they would be able to treat this transaction as an exchange rather than a buy or sell transaction. John and Jane will only be taxed if there is a gain on their transaction.
Source:
http://www.texas1031.com/reg/sec1031.htm

2c). Does Jane have a business or hobby? Why is this distinction important? Jane would have to distinguish herself if what she does at home (jewelry making) is a business or hobby. Publication 535 of the IRS helps in answering her question if she is operating a business or just a hobby.
1. Does the time and effort put into the activity indicate an intention to make a profit?
2. Does the taxpayer depend on the income from the activity?
3. Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
4. Does the activity make a profit in some years?
If yes is answered to all four questions, then yes, indeed Jane have a business rather than a hobby. It is important