Federal Income Taxation
Week 3 Project
David S. Pesi
DeVry University
November 16, 2014
TAX FILE MEMORANDUM
FROM David S. Pesi
SUBJECT Peaceful Pastures Funeral Home, Inc. Audit
Today I spoke with Peaceful Pastures Funeral Home, Inc. to discuss the IRS audit notice they received in regards to their reported income. They inquired as to whether the amounts prepaid under Peaceful’s program constitutes prepaid income that must be included in Peaceful’s income in the year in which it was received.
FACTS Peaceful is an accrual basis taxpayer; they provide a full line of funeral services and sell related goods as well. Over the years, their cost of goods sold increased and customers haven’t been able to afford their services. For this reason, they came up with an approach where customers are able to prepay for their funeral goods and services. Under the contract, the payments are refundable at any time until the goods and services are provided. Peaceful doesn’t report payments received in advance as income until the year in which the services are provided.
ISSUE Should the prepaid income be included in the year in which it was received or in the year when the services are provided?
CONCLUSION Peaceful shouldn’t have to report prepaid income in the year received, they should report income when the services are provided.
ANALYSIS According to Comm. v. Indianapolis Power and Co & Light Co., (65 AFTR 2d 90-394) the opinion was delivered that stated that the main purpose of prepayments was to serve as security rather than prepayment of income. According to commissioner, “The key is whether the taxpayer has some guarantee that he/she will be allowed to keep the money.” Based on a very similar case Perry Funeral Home, Inc. v. Commissioner, TC Memo 2003-340, Code Sec (s) 451 amounts constituting advance payments for goods and services are includable in gross income in the year received “only upon the provision of the subject goods and services.”(Perry). Under Peaceful’s contract, payments are refundable if the purchaser requests any time until the goods and services are provided. Peaceful has no guarantee at all that they will be able to keep the money.
In my opinion and based on the research that I have concluded, the prepayments are to lock the prices in and to make sure customers are not charged higher prices when the cost of goods sold increases. Also, these prepayments aren’t guaranteed that Peaceful will get to keep it since they give refunds any time until the services are rendered at customers’ request and therefore shouldn’t be included in taxable income.
November 16, 2014
TAX FILE MEMORANDUM
FROM David S. Pesi
SUBJECT MegaCorp, Inc. Audit
Today I spoke with MegaCorp, Inc. to discuss the IRS audit notice received in regards to the
$5 million in damages paid to Ideas, Inc.
FACTS MegaCorp purchased all the assets of Little, Inc. Also, MegaCorp acquired some of Little’s Inc. liabilities, which included an alleged patent violation by Ideas Inc. MegaCorp agreed to the legal responsibility for any judgment that Little’s Inc. would have to pay Ideas Inc.
ISSUE Was the IRS correct in reclassifying the payment as a capital expenditure under 263 and to disallow the deduction?
CONCLUSION MegaCorp isn’t entitled to the deduction and should add the judgment payment to the basis of acquiring Little’s, Inc.
ANALYSIS Section 162(a) of the Internal Revenue Code allows the deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." Section 263 of the Code allows no deduction for a capital expenditure, an “amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate”. In Illinois Tool Works Inc. et al v. Commissioner, the court opinion stated, “Generally, the payment of a liability of a preceding owner of property by the person acquiring such
