To: Mr. John Smith and Mrs. Jane Smith
From: Sarah Gong
Date: November 25, 2012
RE: 2011 Tax Strategy
Dear John and Jane,
Thank you for the opportunity to work on your behalf for tax preparation this year. Per our previous discussion, I have prepared this memo as a preliminary work on this year’s tax strategy. The three main sections are constructed according to inquiries made by each of you individually and, then, to conclude on the options available for you both and my recommendation.
1. John Smith tax issues
a) The $300,000 of attorney’s fee should be included in gross income and subject to federal and state tax. The Internal Revenue Code Section 61 (IRC 61, 26 U.S.C. § 61) defines gross income as all income from whatever source derived. Section 61 also lists examples of items that are taxable under the Code, which includes "Compensation for services, including fees, commissions, fringe benefits, and similar items"1. The $300,000 belongs to this income category.
Since you’ve been working on the case for over two years, you can split the $300,000 and allocate them into the years you’ve been actually working on the case. By doing that, you can lower your annual gross income, and you may be able to put yourself in a lower tax rate bracket. b) The $25,000 is paid upfront by your client to cover the expenses. Although the payment is to cover your business expense, it should still be considered as a type of compensation for your services. The $25,000 should be added to gross income. However, same as the service fee $300,000, you should be able to allocate them into the years you’ve been working on the case. Meanwhile, when you report your business expenses on the tax returns, if the total expense is less than $25,000, you will end up with more taxable income; if the total expense is exactly $25,000, no impact on your taxable income;
