I blind mark the tax memo so please only include your RED ID for the author of the memo. If you really want to use a name then please use “Jane Smith” irrespective of whether you are male or female. Please ensure you use the tax research database, CCH AnswerConnect to help you research the issues to be addressed in the tax memo. Please look at the examples for the correct format for a tax memo.
Background:
Mission Bay Privy Berkshire, Inc. (“MBPB”) is an S corporation. MBPB had been a C corporation prior to making the S
election. MBPB is a calendar year taxpayer and uses the cash basis accounting method for income tax purposes. MBPB
has two shareholders, Tyrone Smith (“Tyrone”) and his sister Zuri Smith (“Zuri”), who also work in the business. They
know they need to pay themselves a reasonable salary and pay themselves $100,000 each every year. The business
withholds and pays the necessary FICA taxes and files all the appropriate payroll tax returns reflecting these
compensation payments of $100,000 to each shareholder, including providing the Form W-2 to each shareholder by
January 31 of the following year. Each year in the annual Board meeting the compensation to be paid to the two
shareholders, who are also officers, are documented as $100,000p.a. The business is quite cyclical for cash flow so
excess fund are invested and earn dividend interest income for the periods when there is excess cash to ensure there are
sufficient cash reserves for the periods of low cash flow. There are no expenses associated with the investment income.
As the entity is an S corporation they understand if they each have sufficient basis in the shares in the S corporation then
they can receive tax free distributions from the S corporation and will not be subject to income tax on the distribution.
At the end of 2022 the basis for the S corporation was $250,000 for each shareholder.
MBPB still has Earnings & Profits (“E&P”) from when it was a C corporation in the amount of $400,000. These were the
gross receipts and the passive income for:
2020: Gross receipts of $700,000; Investment income of $177,000
2021: Gross receipts of $800,000; Investment income of $207,000
2022: Gross receipts of $1,200,000; Investment income of $302,000
Their prior CPA ensured the S corporation paid the Excess Passive Income Tax for the tax years 2020, 2021 and 2022.
Each of those years both Tyrone and Zuri would each take a distribution of $85,000 each and the distribution would be
tax free as there was sufficient basis for each of them in their S corporation. Their prior CPA passed away in early 2023
and had prepared the Form 1120-S before he died and his widow provided the tax forms to them.
For 2023 they hired a new CPA. For 2023, they again documented in the minutes of MBPB the intention to make a
distribution to both shareholders of $150,000 each and paid the shareholders the amount of the distribution on July 31,
2023. This was consistent with what they had done for 2020, 2021 and 2022. When they went to collect the tax return
for 2023 the CPA had prepared a Form 1120 and provided Forms 1099-DIV to each shareholder. Tyrone and Zuri are
upset as they were expecting a Form 1120-S and certainly did not expect to pay income tax on the distribution. The CPA
explained that as a result of three years where the S corporation had net passive income exceeding 25% of the gross
receipts, and the S corporation had E&P that the S election had automatically terminated on January 1, 2023 and as the
payment had been made the Form 1099-DIV was required.
Tyrone was very upset by this result and fired the new CPA on the spot. MBPB needs advice for the following, and
requires primary authorities to support the answer:
1.
2.
3.
4.
Was there a termination of the S corporation effective January 1, 2023?
If so, what are the rules and is there a way to avoid the termination of the S election?
Is it possible to have the $150,000 paid to each of the shareholders reclassified as compensation for the 2023
tax year?
Is it possible to have the $150,000 paid to each of the shareholders reclassified as a catch-up payment in 2023
for prior years since there is more available cash?
You research should consider the following (but it is not an exhaustive list):
IRC § 162
Regs §1.162-7(a)
IRC § 1362(d)(3)
© 2024. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of copyright will be
subject to prosecution and considered Academic Dishonesty
Regs §1.1368-1(f)(3)
IRS Letter Ruling 201710013
Paula Construction Co., 58 T.C. 1055 (1972), aff’d, 474 F.2d 1345 (5th Cir. 1973)
International Capital Holding Corp., T.C. Memo. 2002-109
Universal Manufacturing Co., T.C. Memo. 1994-367
Eberl’s Claim Service Inc., T.C. Memo. 1999-211, aff’d, 249 F.3d 994 (10th Cir. 2001)
Your responsibility:
Prepare a tax research memo addressing all the questions that has been raised. Please note that if the tax memo is not
in the required format and/or contains very little analysis of primary authorities you will receive a zero (0) for the
assignment.
You will need to support your conclusion using primary sources of tax law. Your textbook is NOT primary authority nor
are IRS Publications. Please refer to Chapter 2 for primary authorities. CCH AnswerConnect is not a primary authority,
nor is Google Scholar nor are any other websites you may access. The primary authorities are legislative, administrative
and judicial. You may use secondary authorities to assist you with identification and understanding the primary
authorities, such as CCH AnswerConnect but your memo should only contain primary authorities.
You must use proper citation form in your memo (see Chapter 2 for help with citation form). The form for this
communication should be professional and in the form of a tax research memo (examples posted on Canvas and a
similar example in your textbook). You will see that citations are within the text of the document in the example. Once a
court case has been cited in full, it can be referred to using simply the name in italics.
Please use your own words and do not quote large amounts from the primary authorities. If the reader wants to see the
wording of the primary authorities you have provided the citation for the reader to go and look at the wording from the
primary authorities.
This memo should be whatever length you feel is appropriate to resolve the issues. We do NOT use a bibliography or list
of references in a tax research memo. We do not include Background in a tax memo. The Background is provided so you
can identify the facts.
You are required to INDIVIDUALLY prepare this document. Please upload your memo to Canvas before the due date
and time. TurnitIn will be used to check for plagiarism. Late assignments are not accepted.
The grading rubric for Tax memos is posted in Canvas. For this assignment, points are distributed as follows:
Aspects of the memo
Content – facts and issue(s)
Content – analysis
Content – conclusion
Organization
Audience
Style
Mechanics
Referencing
Total
Points
16
30
14
8
8
8
8
8
100
© 2024. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of copyright will be
subject to prosecution and considered Academic Dishonesty
October 17, 2021
To:
Client file
Facts
1. The name of the US client is George’s Software, Inc. (“George’s”)
2. The business, George’s, is an S corporation
3. The corporation is a calendar year end, cash basis taxpayer
4. George’s recently redeemed 23% of the shares from a shareholder Robyn Harley
(“Harley”)
5. As part of the transaction George’s and Harley entered into a Covenant Not to Compete
(“CNC”)
6. The CNC is for a period of one year and is in relation to customer contracts and
relationships
Issues
1. Which code section of the Internal Revenue Code covers the deductibility of a CNC for
George’s?
2. What is the normal period for deducting the costs of a CNC for federal income tax
purposes?
3. Is it possible to deduct the costs in accordance with the term (one year in this case) of the
CNC?
Conclusions
1. §197 of the Internal Revenue Code covers the deductibility of a CNC. The CNC is
considered a Code Sec. 197 intangible.
2. A taxpayer can deduct the cost of a CNC over a 15-year period, beginning in the month
the asset is acquired.
3. Since the CNC is a section 197 intangible that is amortizable over fifteen years, it is not
possible to deduct the costs of the CNC over its duration of one year.
© 2021. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part. Violation of copyright will be subject to prosecution and considered Academic Dishonesty
Analysis
Which code section of the Internal Revenue Code covers the deductibility of a CNC for
George’s?
As a general rule, under §197, of the Internal Revenue Code, a taxpayer is entitled to an
amortization deduction of any section 197 intangible asset. A CNC 1 is considered to be an
intangible asset that is deductible over a 15-year period, beginning with the month of the asset’s
acquisition.2 George’s is also holding the asset in connection with a trade for the production of
income, another requirement for an asset to be considered a section 197 intangible.
Furthermore, when dealing with any corporate stock acquisition, it does not matter whether the
corporate stock is substantial or not because it will still be considered a “section 197 intangible”
nonetheless.3
Certainly, there are exceptions to these assets which include: financial interests4, land5, computer
software6, certain interests or rights acquired separately7, and some more discussed further
throughout §197(e). §197(f)(1)(B) also discusses the special rule regarding covenants not to
compete, which is that no event shall be treated as disposable before the disposition of the entire
interest.
What is the normal period for deducting the costs of a CNC for federal income tax purposes?
As discussed before, Internal Revenue Code §197 covers the normal period for deducting the
costs of a CNC for federal income tax purposes. §197(a) states that the deductions are “…ratably
over [a] 15-year period…” The deductions also begin within the month the intangible asset is
obtained by the taxpayer.
In the case, Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal
Revenue, Respondent, Appellee8, the Internal Revenue Service (IRS) changed the amount of
allowed amortization deductions that Recovery Group had reported in their income tax returns
since they allocated the income from their CNC over a two-year period instead of the correct
1
Refer to §197(d)(1)(E)
Refer to §197(a)
3
Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal Revenue, Respondent, Appellee.
652 F.3d 122 (1st Cir. 2011), Affirming the Tax Court, 99 TCM 1324, Dec. 58,184(M), TC Memo. 2010-76.
4
Refer to §197(e)(1)
5
Refer to §197(e)(2)
6
Refer to §197(e)(3)
7
Refer to §197(e)(4)
8
Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal Revenue, Respondent, Appellee.
652 F.3d 122 (1st Cir. 2011), Affirming the Tax Court, 99 TCM 1324, Dec. 58,184(M), TC Memo. 2010-76.
2
© 2021. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation of
15-year period. As a result, the change in the allowed amortization deductions increased
Recovery Group’s income for each year, and thus the amount of each shareholder’s share.
Is it possible to deduct the costs in accordance with the term (one year in this case) of the CNC?
In Recovery Group, Inc. v. Commissioner of Internal Revenue9, the court found in favor of the
Commissioner regarding the length of the amortization period for a CNC. They analyzed the
requirements and rules regarding an intangible asset under section 197.
The court concluded that Recovery Group’s interpretation of §197(d)(1)(E) was incorrect and
that any CNC “…entered into in connection with the acquisition of any corporate stock, even if
not ‘substantial,’ was considered a ‘section 197 intangible’ amortizable over fifteen years.” The
taxpayer must use the correct IRC §197 rules for its intangible asset and it cannot claim any
other type of depreciation or amortization to align with those rules contradicting the possibility
of the costs to be deductible in accordance with the term of the CNC.
9
Recovery Group, Inc., et al., Petitioners, Appellants v. Commissioner of Internal Revenue, Respondent, Appellee.
652 F.3d 122 (1st Cir. 2011), Affirming the Tax Court, 99 TCM 1324, Dec. 58,184(M), TC Memo. 2010-76.
© 2021. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Violation
of copyright will be subject to prosecution and considered Academic Dishonesty
Background:
Your Texas Band, Inc., is a calendar year corporation. The corporation is a Texas corporation that is
based in Dallas, Texas. The band recently sold tickets ($1,000,000) for concerts scheduled in the United
States for next year and the following year. For financial statement purposes, Your Texas Band will
recognize the income from the ticket sales when it performs the concerts. For tax purposes, the
corporation uses the accrual method and would prefer to defer the income from the ticket sales until
after the concerts are performed. This is the first time that it has sold tickets one or two years in
advance. Their manager, Russell Crowe has asked your advice. Write a memo to Mr. Crowe explaining
your findings.
Facts:
• Your Texas Band, Inc., is a calendar year corporation
• The corporation is a Texas corporation
• The band is based in Dallas, Texas
• The band recently sold tickets ($1,000,000) for concerts scheduled in the United States for next
year and the following year.
• For financial statement purposes, Your Texas Band will recognize the income from the ticket
sales when it performs the concerts.
• For income tax purposes, the corporation uses the accrual method.
• The band has never previously sold tickets one or two years in advance.
Issue:
Should Your Texas Band include the income from the advance sales of tickets for concerts scheduled in
future years?
Relevant Authorities:
IRC Sections 451 and 446
Rev. Proc. 2004-34, 2004-1 CB 991.
Artnell Co. v. Comm. (7 Cir., 1968), 68-2 USTC par. 9593, rev’g and rem’g 48 TC 411 (1967).
Tampa Bay Devil Rays, Ltd., 84 TCM 394 (2002).
Schlude v. Comm. (S. Ct., 1963), 63-1 USTC par. 9284, aff’g, rev’g and rem’g (8 Cir., 1962), 62-1 USTC
par. 9137, aff’g 32 TC 1271 (1959).
American Automobile Association v. U.S. (367 US 687), 61-2 USTC par. 9517, aff’g (Ct. Cl., 1960), 601 USTC par. 9301.
Auto. Club of Michigan v. Comm. (353 US 180), 57-1 USTC par. 9593, aff’g (6 Cir., 1956), 56-1 USTC
par. 9296, aff’g 20 TC 1033 (1953).
Conclusion:
Your Texas Band can defer recognition income form the ticket sales until the amounts are earned
(i.e., until the concerts are performed). Thus, the ticket sale income for the concerts will be
recognized in the year of the performance.
Analysis:
The general rule for prepaid service income is to recognize it in the year of receipt. However, Rev. Proc.
2004-34 allows a one-year deferral for prepaid services. Nonetheless, there is judicial authority (Artnell
Co. and Tampa Bay Devil Rays, Ltd.) that indicates that deferring the income until actual performance
more clearly reflects income in this particular setting. The key fact here is that the taxpayer knows
exactly when the performance will take place. If, for example, the prepaid services were for “services on
demand” like dance lessons, consulting services, etc., the most advantageous tax treatment would be a
one-year deferral under Rev. Proc. 2004-34.
There should be detailed analysis for each authority to continue the Analysis.
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