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Copyright 2010© Deloitte Development LLC All Rights Reserved.
2010 Deloitte Tax Case Study Competition
[12:00:00, 12:00:01, 12:00:02. We open to dramatic music and the intense “tick tick”
of a distant clock echoed by the “pluh-plunk” of a fiercely beating heart.]
Noon Thursday. As the noon bells rang around Washington, D.C., Mark Bailey, Chief
of Staff of the Joint Committee on Taxation (JCT), looked around the hearing room at the
expectant faces of the waiting House Ways & Means Committee meeting attendees.
Bailey’s calm expression masked his inner turmoil.
In the Longworth House Office Building hearing room, Mark was waiting for the
Chairman to call the meeting to order. Those in attendance: members and staff of the
House Ways and Means Committee, a few Senate Finance Committee observers, and the
legions of JCT staffers. The agenda: to quickly move forward on the President’s urgent
request for prompt action on the Economic Recovery and Stabilization Act of 2010
(ERSA). Friday afternoon. Congress would recess for an extended period, and many
believed financial markets would react adversely to Congressional inaction. Mark
shuddered involuntarily and thought, ―I can‘t imagine what will happen if this bill isn‘t
reported before the recess.‖
The door opened almost soundlessly. Mark looked up, hopeful that Lynda Armstrong, the
Chairman of the House Ways and Means Committee, had arrived, along with a few other
expected late-comers. Instead, a clerk entered, grim-faced. He whispered in Bailey’s ear,
―Chairman Armstrong has been injured in an automobile accident on her way back to
the Capitol.‖
Before Mark had time to react, a disheveled young Congressman entered the room and
placed his briefcase on the table next to Mark. Jason Bauer had been described by the
media as ―a rogue Congressman from a low-population state.‖ Jason has an accounting
degree from [your school] and a law degree from Harvard. He had been the youngest
senior partner in the largest and most reputable law firm in his home state. Jason is
handsome and strong – he had been a self-defense instructor in the Marines. Mark looked
at Jason. In spite of Jason’s present bedraggled appearance, Mark thought, ―Jason
deserves his reputation for intelligence and ethics. We aren‘t dealing with ‗politics as
usual‘ when Jason is involved.‖
Jason gingerly touched a bandage on his forehead and addressed Mark quietly,
―Chairman Armstrong and I met with Treasury and White House officials this morning to
settle on details for this bill. On our way back here, our car was hit broad-side on
Pennsylvania Avenue. I was not really injured, but Lynda took the brunt of it. I pray
she….‖ Jason’s voice trailed off at the thought he could not speak. He grimaced at the
pain from a rib that had been broken in the accident.
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Jason took a shallow and painful breath and spoke to the assembled group. ―Chairman
Armstrong is not able to be here this afternoon. This morning, we worked with the White
House and Treasury to iron out provisions for a bill that should pass the House quickly,‖
he said. With a determined voice, Jason growled, slowly enunciating each word, ―Let‘s
get this legislation passed.‖
[12:24:00, 12:24:01, 12:24:02 tick tick]. 12:24 p.m. – 3:30 p.m. In a live report from
the New York Stock Exchange, Kristine Abdallah of the Flix Global Network (FGN)
reported, ―News today is grim from all parts of the globe. Trading was suspended early
in the afternoon as wide-scale, programmed sell-offs triggered a steep drop in the
market.‖ She continued in her slight British accent, explaining that the sell-offs were
largely caused by: 1) disturbing economic reports from China and Europe, 2) weak
earnings reports from key U.S. corporations, 3) uncertainty regarding Congress’s ability
to pass critical tax legislation, and 4) news that Chairman Armstrong had been in a
serious accident. She continued, ―So far, there is no news of the Chairman‘s condition
from Mercy & Kindness Hospital in Washington, D.C.‖
Meanwhile, in the Longworth Building, the Ways and Means Committee’s second
ranking Member, Congressman Dan Rostco, acting as Chairman, asked Congressman
Jason Bauer to lead the Committee through consideration of the bill. Jason took the helm
during one of the worst economic crises of our time. With Mark Bailey, Dan Rostco, and
the rest of the Committee, Jason spent the afternoon reviewing tax strategies to foster
capital investment and create jobs in the U.S. The Committee also reviewed several
corporate financial statements (including statements for Technologica Industries, Inc.)
and finalized provisions designed to make corporate earnings reports more
understandable to the average reader. [Poetic license note: Note that jurisdiction over
financial accounting does not reside in Ways & Means and that the Joint Committee Staff
would have prepared statistical analyses rather than reviewing specific case summaries.
We‘re using case summaries because they are more interesting. ]
[3:30:00, 3:30:01, 3:30:02 pluh plunk]. 3:30 p.m. - 6:00 p.m. Kristine Abdallah found
herself once again in front of the cameras. With great intensity, she reported, ―In
breaking news, we have learned that Chairman Armstrong‘s prognosis is uncertain. She
remains in intensive care.‖ The market reopened for the last half-hour of trading but
dipped further on this and other news reports.
[6:00:00, 6:00:01, 6:00:02 tick tick].6:00 p.m. – 9:00 p.m. After the markets closed for
the day at 4:00 p.m., FGN raced Kristine to a private plane destined for Washington, D.C.
At 6:00 p.m., from the Rotunda of the Capitol Building, she reported, ―In Chairman
Armstrong‘s absence, the economic stability of our country rests on the shoulders of a
relative newcomer to Washington, Congressman Jason Bauer, who was part of Chairman
Armstrong‘s negotiations with the White House earlier in the day.‖ On screen, the
network superimposed a video of a bleeding Jason holding his chest as he escaped
Armstrong’s mangled vehicle. The video had been captured by a tourist who happened to
be filming Washington sights as the crash occurred.
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At the same time, in the Committee meeting, Mark Bailey was presenting statistics that
had been gathered by the Joint Committee on Taxation in the months leading up to the
current session. While the rest of the world was in shock at the news events of the day,
Jason, Mark, and the Committee calmly turned their focus to issues facing individual
taxpayers.
Mark announced: ―The Joint Committee Staff has compiled statistics and interviewed
numerous taxpayers around the country to determine the impact of existing and proposed
tax law changes. We present the case of Mathew and Kayla Summer to illustrate some of
the tax issues we are examining tonight.‖
Jason moderated a discussion on the impact of allowing tax rate reductions to expire as
scheduled at the end of the year. The discussion became heated when the topic turned to
whether or not the Alternative Minimum Tax should be repealed.
[9:00:00, 9:00:01, 9:00:02 pluh plunk]. 9:00 p.m. – 12:00 midnight. Now in scrubs,
Kristine Aballah announced, in a loud whisper, ―We are reporting live from Mercy &
Kindness Hospital. We have just learned that Chairman Lynda Armstrong has been
upgraded to ‗serious‘ condition, although she remains in intensive care. She reportedly
gained consciousness and said, ‗I have to vote.‘ Then she drifted off into a peaceful
slumber.‖
Back at the Capitol, the Committee turned its attention to small business owners. Mark
Bailey led the discussion, stating, ―Let‘s look now at the situation faced by D&K Flavors,
Inc. This is a regional ‗lemonade stand‘ that has been in business for about 15 years.‖
He reviewed some of the tax issues the company had faced in recent years, including
capital losses and net operating losses. Mark continued, ―Much of the company‘s
business office work is being done by subcontractors rather than employees because of
the high costs of hiring someone in a permanent position.‖ This report launched a debate
over proposed changes to the treatment of net operating losses and capital losses, as well
as expiring provisions benefiting small businesses.
Tempers flared when the discussion turned to hiring incentives. At one point, Jason found
himself in a verbal war with Congressman Rostco, a former union-official-turned-
politician. Dan wanted to eliminate a proposed ―New Employee Hiring Credit‖ in order
to ―pay‖ for a provision that would allow employees to claim an above-the-line deduction
for union dues. Jason almost shouted at his colleague, ―We need to reduce an employer‘s
cost of hiring – not increase it! You will make it more expensive to hire employees.
People need jobs!‖ Congressman Rostco shouted back, ―People need protection from
greedy employers, so we need to help them be able to afford the cost of joining a union!‖
[12:00:00, 12:00:01, 12:00:02 tick tick]. Midnight – 1:00 a.m. After the flare up with
Dan, Jason suggested that the Committee break for an hour, noting, ―I probably should
see someone about my ribs.‖
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Jason called his driver and said, ―Bring the car, and call Mercy and tell them we‘re on
the way.‖ He headed out of the room, hoping to avoid the lobbyists waiting in the wing
known as ―The Gulch,‖ but the pain from his rib cage slowed him down. Their cries
seemed to echo from all corners of the hallway, ―Congressman Bauer, Congressman
Bauer!‖ Jason was soon surrounded by representatives from various companies. To
Jason, their message seemed to be, ―Our industry will fail and this country will implode if
you don‘t pass this provision for us.‖
Jason’s aide, Megan, came to his side and helped Jason escape the throng. Jason
collapsed into the back of the waiting car. Megan spoke kindly, ―Mercy has been alerted,
and doctors are waiting. They know you need to be back within the hour.‖
When they arrived at the hospital, they were directed to a private entrance near the
Intensive Care wing. An intern had surreptitiously notified Kristine Abdallah of their
arrival, so they were greeted by news cameras. ―Congressman Bauer,‖ Kristine spoke,
trying to gain an interview, ―What is the status of the recovery bill? The country needs to
know.‖
Jason managed a tired smile and said, ―Our committee will be back to work in an hour.
We are highly optimistic that we will produce a bill that will pass before the recess.‖ He
collapsed onto a waiting gurney and was whisked through the doors into Intensive Care.
[1:00:00, 1:00:01, 1:00:02 pluh plunk]. 1:00 a.m. to 4:00 a.m. Jason was bandaged and
walked to Chairman Armstrong’s bedside. She touched Jason’s arm, smiled weakly and
said, ―Thank you for taking over, Jason. Please make sure I get out of here in time to
vote.‖ Jason replied gently but with resolve in his voice, ―Yes, Madame Chairman. We
will need your vote if you can be there.‖
Jason arrived at the meeting room in Longworth, called the Committee to order, and
turned to Mark Bailey who continued his presentation: ―We have just a few corporate
provisions on the table. One proposed change would allow more favorable utilization of
net operating losses from acquired entities. This will reduce the cost of corporate
acquisitions of subsidiaries and will facilitate corporate growth. The President wants a
revenue-neutral bill, so we‘ll have to find a way to pay for this.‖
This discussion proceeded relatively smoothly, and the parties quickly reached a
consensus – at least on the corporate provisions. There was an uneasy silence in the room
as Mark conferred with Dan and Jason. Dan announced: ―After conferring with Members
on this side—the majority party ,we may not have the votes to report this bill, unless our
friends on the other side will join us.‖
No one moved to alter any of the compromise provisions. Jason looked sternly from face
to face, but everyone in the room avoided eye contact with him. Jason scratched out a
note and sent it around the table to Congressman Rostco. Mark broke the tension by
announcing that the Committee would stand in recess until 9:00 A.M.
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[4:00:00, 4:00:01, 4:00:02 tick tick]. 4:00 a.m. to 7:00 a.m. Jason dodged the waiting
press by walking through tunnels under the Capitol to exit on the Senate side. He quickly
maneuvered across Constitution Avenue to McKinney’s Irish Pub. ―It‘s a good thing this
place never closes,‖ he thought to himself. He looked into a couple of dark booths and
quickly found Congressman Rostco. He sat down and asked, ―What do you think it will
take to get the votes to report this bill?‖
Dan scratched a few notes on a bar napkin and passed it to Jason. Jason nodded and
answered, ―We‘re going to have to close a couple of loopholes to offset that revenue
loss.‖ Their conversation continued for hours. As the sun rose over the Capitol,
Congressmen Bauer and Rostco scribbled their compromise agreements on the back of a
few bar napkins over a pitcher of beer. The pair painstakingly addressed each issue,
mentally calculated votes, and made note of phone calls they would have to make and
deals on which they would have to ―shake hands.‖ As the Capitol was waking, Jason
stood and said, ―I doubt it is quite revenue-neutral, but I think we have it. Let‘s go see the
President.‖
[7:00:00, 7:00:01, 7:00:02 pluh plunk] 7:00 a.m. to 9:00 a.m. The President was
waiting in the Oval Office when Jason and Dan were escorted into the room. During the
car ride, Jason’s aide, Megan, had transferred their calculations to a yellow legal pad,
which they now presented to the President. The President sighed and said ―We can‘t go
forward with another spending bill. This has to be revenue-neutral. Could it be time for a
small, corporate rate increase?‖ Dan responded, ―There is no way a rate increase will
pass the House in this economy.‖ Jason looked concerned, then glanced at each of them
and smiled, saying,―I have an idea.‖ He scratched out a few lines on the pad, and the
President and Dan smiled. ―I think we have a bill!‖
[9:00:00, 9:00:01, 9:00:02 tick tick] 9:00 a.m. to 11:00 a.m. From outside the Capitol
Building, Kristine Abdallah reported, ―The market opened ‗down‘ again today on reports
that the Ways and Means Committee has been unable to craft a recovery bill. At this
moment, the Committee is reconvening for a last effort at an agreement.‖
Just then, a car passed, and Kristine noticed Lynda Armstrong’s driver through the tinted
glass. Kristine stood straighter and smiled as she said, ―Chairman Armstrong has just
arrived at the Capitol. Perhaps there is hope for a bill this morning.‖
[11:00:00, 11:00:01, 11:00:02 tick tick] 11:00 a.m. to 12:00 noon. Soon after the
Chairman’s arrival, the Committee members emerged from their meeting with a report
that the bill had been approved. The Majority Leader indicated that the Rules Committee
would meet promptly on the bill and that Members should anticipate a vote that evening.
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The bill was passed just as the bells in the city announced the noon hour. Kristine ended
her long day with a closing report, ―On news that the House is prepared to pass sweeping
tax reform, the market is beginning a slow climb and has recovered the day‘s early
losses. Senate leaders expressed confidence that the bill will pass the Senate shortly
before the upcoming recess. The President has indicated that he will sign the legislation.
We tried to get a report from the leader of this effort, Jason Bauer, but word on the street
is that he has gone home to sleep.‖
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REQUIREMENTS
NOTE: Assume that tax law currently in effect (Fall 2010) applies during the time
indicated in the requirement. Unless otherwise indicated, assume each requirement is
independent of the other requirements.
NOTE: Your analysis is as important as your final conclusion. Do not “copy and paste”
your answers ―in bulk‖ from the Code and Regulations. Support your answers, but use
your own words to evaluate the situation. Limit quotes to the most relevant sentence or
two. Show your calculations.
NOTE: Be sure to check each requirement to determine whether or not you are required
to complete it. Some requirements are for graduate students only, some are for
undergraduate students, and some are for both groups.
Requirement 1. Undergraduate students only. What is the authority allowing the U.S.
Congress to impose taxes? How is tax legislation initiated, adopted, and passed? At the
beginning of our story, where are we in the tax legislation process?
Requirement 2. Graduate students only. How is tax legislation initiated, adopted and
passed? What is the Joint Committee on Taxation (JCT)? What is the Joint Committee
Staff? What is the role of the JCT and the Joint Committee Staff in the tax legislation
process? As related to our story, describe some of the services that the Joint Committee
Staff would have provided to the Ways & Means Committee.
Requirement 3. Graduate and undergraduate students. What are some of the
different types of ―primary authority,‖ and where does each type originate? What do we
mean when we talk about the ―weight of authority‖ and why is it important? What is the
difference between IRS general (also called interpretive) regulations and IRS legislative
regulations? Provide a general ranking of the weights of 1) tax legislation (as passed by
the U.S. Congress), 2) general regulations, 3) legislative regulations, 4) Tax Court
decisions, and 5) U.S. Supreme Court decisions?
Requirement 4. Graduate and undergraduate students. Describe five or six broad
categories of public policy objectives that are reflected in the tax law. Describe at least
one provision of the Internal Revenue Code that is designed to provide incentives for
each of the following: 1) capital investment, 2) U.S. manufacturing activities, and 3)
personal savings. Provide citations and describe the intended effect of the provision.
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Requirement 5. Graduate and undergraduate students. Review the Accounting
Policies and Income Tax notes for the Technologica Enterprises, Inc. (TEI) financial
statements. Also refer to the excerpt from the Thor Power Tool, Inc. Supreme Court
ruling. For each accounting method indicated in Note 1, describe the book-tax differences
that TEI must take into account in preparing its current year tax return, and provide
citations for the tax provision(s) governing treatment on the return. Identify whether each
item would be considered a permanent difference or a temporary difference for purposes
of Accounting Standard Codification (ASC) 740 (Financial Accounting Standard #109).
Requirement 6. Graduate and undergraduate students. Review the Mathew and
Kayla Summer scenario summarized by the Joint Committee on Taxation. What are the
tax consequences of the short sale of their principle residence? Describe the results and
show your calculations.
Requirement 7. Graduate and undergraduate students. What is the alternative
minimum tax (AMT) and what is its purpose? In 2009, how was the AMT calculated for
a married couple filing a joint tax return? In answering this question, review Mathew and
Kayla Summer’s 2009 tax return and Form 6251. Describe the calculation in detail and
provide citations and use terminology described in the Code. Relate the various
definitions in the AMT calculation to the descriptions on Form 6251. What tax law
changes will affect the 2010 (and later) calculation of AMT?
Requirement 8. Graduate and undergraduate students. In 2009, how much was the
Summers’ alternative minimum tax liability? Why were they subject to alternative
minimum tax? Can this AMT amount be recovered in a later year as a minimum tax
credit (MTC)? If Mathew had remained with the same company, what could he have
done to reduce his family’s exposure to AMT?
Requirement 9. Graduate and undergraduate students. Review Mathew and Kayla’s
2009 tax return once again. How were their various categories of income and losses
taxed? What happens to the 2009 net capital loss? Based on existing tax law, how would
the Summers’ tax liability change if this tax return was being prepared for 2011?
Requirement 10. Undergraduate students only. Refer to the D&K Flavors, Inc.
discussion of employees versus independent contractors. Where in the Code do you find
definitions of ―employees‖? From the employer’s perspective, what is the difference in
treatment of an employee versus an independent contractor? For purposes of ―Federal
withholding from wages‖ requirements, what criteria are used to determine whether
someone is an employee versus an independent contractor? If an employer can hire
someone as either 1) an employee or 2) an independent contractor (at the same base pay
rate), which status do you think the employer is more likely to select and why?
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Requirement 11. Graduate students only. Refer to the D&K Flavors, Inc. discussion of
employees versus independent contractors. For purposes of ―Federal withholding from
wages‖ requirements, what criteria are used to determine whether someone is an
employee versus an independent contractor? In recent years, expectations have increased
significantly regarding the employer’s need to ―take care of‖ employees. In general
terms, describe four general types of costs outlined in the Code (other than salaries and
wages) that an employer might incur with respect to ―employees.‖ Which of these items
are generally provided to independent contractors? What are some of the tax incentives
for hiring employees that are provided for in the Code? Assume an employer can hire
someone as either an employee at a given salary or an independent contractor for 110%
of that amount. Do you think these hiring incentives are adequate to ensure the employer
hires the person as an employee? Why or why not?
Requirement 12. Graduate and undergraduate students. Review the scenario and
financial information for D&K Flavors, Inc. How are the capital gains and losses treated
for each taxable year? What is the amount of any capital loss carryforward that remains at
the end of 2010? In what year or years will the loss expire? Estimate the amount of any
tax savings arising from utilization of the capital losses through 2010. Assume D&K
remains a Subchapter C corporation in 2010.
Requirement 13. Graduate and undergraduate students. In its calendar year tax
return for 2010, can D&K utilize a net operating loss carryforward from any earlier year?
What are the options D&K would have considered in each of the respective years for
utilizing the NOLs for 2006, 2008, and 2009? If D&K had wanted to receive the greatest
possible tax refunds for those years, which option would you have recommended? If any
NOLs remain at the end of 2010, when will they expire? Assume the relevant Code
section has not been amended since 2006 in any way that would affect your answer (i.e.,
what you see in the Code is what you use). Assume D&K remains a Subchapter C
corporation in 2010. Also assume D&K did not elect to forego the NOL carryback.
Requirement 14. Undergraduate students only. D&K is considering electing to be
treated as a Subchapter S corporation. In general terms, describe the advantages and
disadvantages of operating any business as a Subchapter S corporation vs. a Subchapter C
corporation.
Requirement 15. Graduate and undergraduate students. If D&K elected to be treated
as a Subchapter S corporation, what is the earliest date the election could be effective?
What complications could arise in the S election process and how should they be
addressed? What complications could arise on an ongoing basis? If D&K had unutilized
net operating losses or capital losses at the time the S election became effective, how
would they be treated? Why would it not be advisable for D&K to convert to LLC status?
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Requirement 16. Graduate students only. Assume D&K’s shareholders agreed to the
merger with Beverly Beverages, Inc. effective January 1, 2011. Also assume D&K had a
net operating loss carryforward of $1,000,000 available for the 2011 calendar year (and
no capital loss carryforward). [These are not the actual amounts you should have
calculated for Requirements 12 and 13.] Describe the limitations that apply to Beverly
Beverage’s ability to utilize D&K’s net operating loss carryforwards in 2011 and future
years. In 2011, if Beverly’s income for the year was $2,000,000, how much could the
merged entity claim as a net operating loss carryforward? Assume the long-term tax
exempt rate is 4%.
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The Constitution of the United States
Adopted September 17, 1787
As Amended
www.archives.gov
We the People of the United States, in order to form a more
perfect Union, establish justice, insure domestic tranquility, provide for the common
defense, promote the general welfare, and secure the blessings of liberty to ourselves and
our posterity, do ordain and establish this Constitution for the United States of America.
ARTICLE I.
Section 1. All legislative powers herein granted shall be vested in a Congress of the United States,
which shall consist of a Senate and House of Representatives.
Section 2. The House of Representatives shall be composed of Members chosen every second year
by the people of the several States, and the Electors in each State shall have the
qualifications requisite for Electors of the most numerous branch of the State
Legislature….
Section 3. The Senate of the United States shall be composed of two Senators from each State,
chosen by the Legislature thereof for six years; and each Senator shall have one vote….
Section 7. All bills for raising revenue shall originate in the House of Representatives; but the
Senate may propose or concur with amendments as on other bills.
Section 8. The Congress shall have power to lay and collect taxes, duties, imposts and excises, to
pay the debts and provide for the common defense and general welfare of the United
States; but all duties, imposts and excises shall be uniform throughout the United States;
Section 9. .... No capitation, or other direct, tax shall be laid, unless in proportion to the census or
enumeration herein before directed to be taken. [Modified by Amendment XVI below]
AMENDMENT XVI
Passed by Congress July 2, 1909. Ratified February 3, 1913.
Note: Article I, section 9, of the Constitution was modified by amendment 16.
The Congress shall have power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among the several States, and without regard to
any census or enumeration.
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The Joint Committee on Taxation
Excerpts from the Committee Web Site (Page 1 of 3)
www.jct.gov
The Joint Committee on Taxation is a nonpartisan
committee of the United States Congress, originally
established under the Revenue Act of 1926. The Joint
Committee operates with an experienced professional staff of Ph.D. economists,
attorneys, and accountants, who assist Members of the majority and minority parties in
both houses of Congress on tax legislation.
The Joint Committee is chaired on a rotating basis by the Chairman of the Senate Finance
Committee and the Chairman of the House Ways and Means Committee. During the first
Session of each Congress the House has the Chair and the Senate has the vice-chair;
during the second session the roles are reversed.
The Joint Committee Staff is closely involved with every aspect of the tax legislative
process, including:
Assisting Congressional tax-writing committees and Members of Congress with
development and analysis of legislative proposals;
Preparing official revenue estimates of all tax legislation considered by the
Congress;
Drafting legislative histories for tax-related bills; and
Investigating various aspects of the Federal tax system.
The Joint Committee is established under the Internal Revenue Code of 1986. The Joint
Committee formally consists of ten Members of Congress: five from the Senate
Committee on Finance (there are three from the majority and two from the minority); and
five Members from the House Committee on Ways and Means (also three from the
majority and two from the minority).
The Joint Committee Staff is closely involved in every aspect of the tax legislative
process. Among other things, the Joint Committee Staff (1) prepares hearing pamphlets,
committee reports, and conference reports (statements of managers), (2) assists in the
drafting of statutory language, (3) assists Members of Congress with the development
and analysis of legislative proposals, (4) assists Members of Congress in addressing
constituent issues and problems, (5) prepares revenue estimates of all revenue legislation
considered by the Congress, (6) reviews proposed large income tax refunds, and (7)
initiates investigations of various aspects of the Federal tax system. These staff activities
are described in greater detail below.
Committee hearings. Early in the legislative process, both the House Ways and Means
Committee and the Senate Finance Committee often hold hearings on tax legislative
proposals…. Joint Committee Staff members are present at hearings to answer questions
that Members, their staffs, and tax-writing committee staffs may have.
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The Joint Committee on Taxation
Excerpts from the Committee Web Site (Page 2 of 3)
www.jct.gov
Preparation of bills. The Joint Committee Staff assists all Members in preparing bills for
introduction. This assistance includes development and analysis of proposals, assistance
in preparation of a statutory draft, and preparation of a description of the bill….
Preparation for Ways and Means Committee markup. The Joint Committee Staff
works very closely with the Chairman of the Ways and Means Committee and his staff in
preparing for committee markup of tax legislation….
Ways and Means Committee markup. When the Ways and Means Committee begins a
markup, the Chief of Staff of the Joint Committee usually sits at the witness table and
describes the legislative proposals before the committee…. The Joint Committee Staff
may also answer questions about the tax policy and administrative aspects of proposals
under consideration. As amendments are adopted in markup, the Joint Committee Staff
analyzes the revenue impact of those amendments, and keeps a running total of the
revenue effects of the committee's actions.
House Floor consideration. When tax legislation is considered on the floor [of the
House], Joint Committee Staff members are available to answer questions about the
content of the bill and possible amendments.
Senate Finance Committee markup. Markup in the Senate Finance Committee is
similar to markup in the Ways and Means Committee… [Two exceptions are not relevant
to this case.]
Senate Floor consideration. Joint Committee Staff assists Senators and their staffs in the
preparation of possible floor amendments….
Preparation for Conference. After the House has passed a bill, and while the bill is
being considered on the Senate floor, the Joint Committee Staff prepares for conference.
The Joint Committee Staff prepares side-by-side revenue tables for all provisions in both
bills as well as a side-by-side document describing all the provisions in both bills. The
Joint Committee Staff meets with Members of the conference committee …to analyze the
effects of proposals….
Conference Committee. At the start of the conference, the Chief of Staff of the Joint
Committee generally describes the content of the two bills. The staff meets with the
conferees, particularly the two Chairmen of the tax-writing committees, to assist them in
developing possible compromise proposals on matters before the conference. In addition,
the Joint Committee Staff assists the staffs of the Ways and Means and Finance
Committees in developing offers from one side to the other.
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The Joint Committee on Taxation
Information from the Committee Web Site (Page 3 of 3)
www.jct.gov
Conference Committee (continued). While assisting in the conference negotiations, the
Joint Committee Staff assists in drafting the statutory language that will implement the
decisions of the conferees and estimates the revenue consequences of the various
compromise proposals. The Joint Committee Staff also has the primary responsibility for
writing the explanatory statement-of-managers portion of the conference report.
Conclusion of Conference. Once the conferees have completed their work and the Joint
Committee Staff has prepared both the statement of managers and the final revenue table,
the staff assists the Chairmen and the tax-writing committee staffs in preparation of
explanatory materials of the conferees' decisions.… The staff also assists in answering
questions on the floors of both the House and Senate that arise in the consideration of the
conference report.
Consultation with the Administration. The Joint Committee Staff consults with
Treasury and IRS personnel throughout the legislative process….
Meetings with outside parties. Throughout the entire legislative process, meetings are
held with outside parties that may be affected by the legislation being considered….
15
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TECHNOLOGICA ENTERPRISES, INC.
Excerpts From Annual Report Financial Statements
Year Ended September 30, 2010
[Fictional report]
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES
Technologica Enterprises, Inc. (TEI) designs, produces, manufactures, and sells several
forms of software. The accompanying financial statements have been prepared under the
accrual method of accounting in conformity with U.S. generally accepted accounting
principles (GAAP).
Allowance for Doubtful Accounts Receivable. An allowance for doubtful accounts is
determined based upon historical experience, an aging of accounts receivable balances,
and specific review (as needed) of certain larger receivables.
Worker’s Compensation Reserves. The estimated cost of worker’s compensation
liabilities is established each year based on employee hours worked. Liability balances
are evaluated at least annually and adjusted as needed.
Inventories. Inventories are stated at the lower of cost (computed using the first-in, first-
out method) or market. Write-downs are reflected for obsolescence, impairment, or lack
of salability resulting from excess quantities on hand.
Property, Plant, and Equipment. Property and equipment is stated at cost. Properties
are depreciated using the straight-line method. The estimated useful lives of property and
equipment are generally as follows: computer equipment, three years; furniture and
fixtures, three years; and buildings, 15 years. Land is not depreciated.
Intangible Assets. TEI does not amortize self-developed intangible assets with indefinite
useful lives. Such asset values are tested for impairment at least once per year. An
impairment of $X,XXX was reported during the current year. Acquired intangible assets
with definite lives are amortized over periods ranging from three to 10 years.
Software Development Costs. Research and development costs are expensed as
incurred. [NOTE: Assume no R&D credits are available for tax purposes.]
NOTE 10 – INCOME TAXES
The provision for income taxes is computed using the asset and liability method under
ASC 740 (FAS 109). The tax provision is $X,XXX …. <section omitted>.
Differences between the statutory federal income tax rate of 35% and the effective rate
reflected in the financial statements arose from domestic production deductions,
impairment of certain intangible assets, and state income taxes.
16
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Excerpt from
THOR POWER TOOL CO. v. COMM.
99 S. Ct. 773, 01/16/1979
(Page 1 of 2)
Judge: Mr. Justice BLACKMUN delivered the opinion of the Court.
This case, as it comes to us, presents two federal income tax issues. One has to do with
inventory accounting. The other relates to <not relevant for this case study>.
The Inventory Issue. In 1964, petitioner Thor Power Tool Co. (hereinafter sometimes
referred to as the ―taxpayer‖), in accord with ―generally accepted accounting principles,‖
wrote down what it regarded as excess inventory to Thor's own estimate of the net
realizable value of the excess goods. Despite this write-down, Thor continued to hold the
goods for sale at original prices. It offset the write-down against 1964 sales…. The
Commissioner of Internal Revenue, maintaining that the write-down did not serve to
reflect income clearly for tax purposes, disallowed the offset….
<Several pages omitted> A presumptive equivalency between tax and financial
accounting would create insurmountable difficulties of tax administration. Accountants
long have recognized that ―generally accepted accounting principles‖ are far from being a
canonical set of rules that will ensure identical accounting treatment of identical
transactions. ―Generally accepted accounting principles,‖ rather, tolerate a range of
―reasonable‖ treatments, leaving the choice among alternatives to management. Such,
indeed, is precisely the case here. Variances of this sort may be tolerable in financial
reporting, but they are questionable in a tax system designed to ensure as far as possible
that similarly situated taxpayers pay the same tax. If management's election among
―acceptable‖ options were dispositive for tax purposes, a firm, indeed, could decide
unilaterally—within limits dictated only by its accountants—the tax it wished to pay.
Such unilateral decisions would not just make the Code inequitable; they would make it
unenforceable.
Thor complains that a decision adverse to it poses a dilemma. According to the taxpayer,
it would be virtually impossible for it to offer objective evidence of its ―excess‖
inventory's lower value, since the goods cannot be sold at reduced prices …. The
taxpayer thus sees itself presented with ―an unattractive Hobson's choice: either the
unsalable inventory must be carried for years at its cost instead of net realizable value,
thereby overstating taxable income by such overvaluation until it is scrapped, or the
excess inventory must be scrapped prematurely to the detriment of the manufacturer and
its customers.‖
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Excerpt from
THOR POWER TOOL CO. v. COMM.
99 S. Ct. 773, 01/16/1979
(Page 2 of 2)
If this is indeed the dilemma that confronts Thor, it is in reality the same choice that
every taxpayer who has a paper loss must face. It can realize its loss now and garner its
tax benefit, or it can defer realization, and its deduction, hoping for better luck later.
Thor, quite simply, has suffered no present loss. It deliberately manufactured its ―excess‖
spare parts because it judged that the marginal cost of unsalable inventory would be
lower than the cost of retooling machinery should demand surpass expectations. This was
a rational business judgment and, not unpredictably, Thor now has inventory it believes it
cannot sell. Thor, of course, is not so confident of its prediction as to be willing to scrap
the ―excess‖ parts now; it wants to keep them on hand, just in case. This, too, is a rational
judgment, but there is no reason why the Treasury should subsidize Thor's hedging of its
bets. There is also no reason why Thor should be entitled, for tax purposes, to have its
cake and to eat it, too.
<Several pages omitted related to the second tax issue.>
The judgment of the Court of Appeals is affirmed.
It is so ordered.
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The Joint Committee on Taxation
Summary of Tax Situation of Mathew and Kayla Summers
Prepared for the Committee on Ways & Means Meeting on the
Economic Recovery and Stabilization Act of 2010 (ERSA)
[Fictional report]
The following narrative describes some of the economic issues faced by U.S. taxpayers.
[Note: For actual Committee mark-ups, the JCT reports would typically be statistical
rather than specific. In addition, the Committee would not review a taxpayer‘s return in
open session.]
Mathew Summers had been employed as a salesman by the same company for 20 years,
but he was ―downsized‖ near the end of 2009. As a normal part of his work, Mathew
incurred substantial unreimbursed expenses for business travel, meals, and entertainment.
Kayla Summers, (Mathew’s wife), runs a successful home-based business. The Summers
have two children, 10-year-old twins, Drew and Emma.
2009 Taxes. In 2009, the family was subject to alternative minimum tax (AMT), and
realized substantial losses from sales of personal investments. The family also realized
substantial income from investments.
2010 Short Sale of Personal Residence. In 2005 Mathew and Kayla each had especially
good earnings years. They fell for ―the dream‖ and purchased an upscale home they later
realized they couldn’t support financially. The real estate market took a steep downturn in
their area. Where they had previously enjoyed substantial equity in their home, they now
found themselves ―upside down‖ – with negative equity.
They had paid $900,000 for their home, with an initial mortgage balance of $850,000. At
the top of the market in 2007, they refinanced the property for $950,000 when it was
valued at $1 million and when the initial debt had been reduced to $825,000. They used
$75,000 of the additional debt proceeds for Mathew’s new car, and the remaining
$50,000 for improvements to the home. The debt was secured by the property and by the
personal guarantees of Mathew and Kayla (recourse debt).
After Mathew lost his job, the Summers felt they could not afford to continue to make the
payments and still pay the private school tuition for the twins. Early in 2010, they
decided to walk away from their home. They found an affordable rental property, and
worked with the bank to ―short sell‖ their residence. The buyer agreed to pay $700,000
for the property (equal to its fair market value, per an appraisal). At the time of the short
sale, the remaining balance on the mortgage was $900,000.
Current Situation. Recently, Mathew found a great-paying job. After a couple of years,
the family believes their credit will be restored and they will be able to purchase another
home.
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Copyright 2010© Deloitte Development LLC All Rights Reserved.
Joint Committee on Taxation
JCX-79-08, page 14
Emergency Economic Stabilization Act of 2008, PL 110-343, 10/3/2008
C. Exclude Discharges of Acquisition Indebtedness on Principal
Residences from Gross Income
(sec. 303 of the bill and sec. 108 of the Code)
(Page 1 of 2)
Present Law
In general
Gross income includes income that is realized by a debtor from the discharge of
indebtedness, subject to certain exceptions for debtors in Title 11 bankruptcy cases,
insolvent debtors, certain student loans, certain farm indebtedness, and certain real
property business indebtedness (§§ 61(a)(12) and 108). In cases involving discharges of
indebtedness that are excluded from gross income under the exceptions to the general
rule, taxpayers generally reduce certain tax attributes, including basis in property, by the
amount of the discharge of indebtedness….
For all taxpayers, the amount of discharge of indebtedness generally is equal to the
difference between the adjusted issue price of the debt being cancelled and the amount
used to satisfy the debt….
Qualified principal residence indebtedness
An exclusion from gross income is provided for any discharge of indebtedness income by
reason of a discharge (in whole or in part) of qualified principal residence indebtedness.
Qualified principal residence indebtedness means acquisition indebtedness (within the
meaning of §163(h)(3)(B) , except that the dollar limitation is $2,000,000) with respect to
the taxpayer's principal residence. Acquisition indebtedness with respect to a principal
residence generally means indebtedness which is incurred in the acquisition, construction,
or substantial improvement of the principal residence of the individual and is secured by
the residence. It also includes refinancing of such indebtedness to the extent the amount
of the indebtedness resulting from such refinancing does not exceed the amount of the
refinanced indebtedness. For these purposes, the term ―principal residence‖ has the same
meaning as under §121 of the Code.
20
Copyright 2010© Deloitte Development LLC All Rights Reserved.
Joint Committee on Taxation
JCX-79-08, page 14
Emergency Economic Stabilization Act of 2008, PL 110-343, 10/3/2008
C. Exclude Discharges of Acquisition Indebtedness on Principal
Residences from Gross Income
(sec. 303 of the bill and sec. 108 of the Code)
(Page 2 of 2)
If, immediately before the discharge, only a portion of a discharged indebtedness is
qualified principal residence indebtedness, the exclusion applies only to so much of the
amount discharged as exceeds the portion of the debt which is not qualified principal
residence indebtedness. Thus, assume that a principal residence is secured by an
indebtedness of $1 million, of which $800,000 is qualified principal residence
indebtedness. If the residence is sold for $700,000 and $300,000 debt is discharged, then
only $100,000 of the amount discharged may be excluded from gross income under the
qualified principal residence indebtedness exclusion.
Explanation of Provision
The provision extends for three additional years the exclusion from gross income for
discharges of qualified principal residence indebtedness.
Effective Date
The provision is effective for discharges of indebtedness on or after January 1, 2010, and
before January 1, 2013.
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The Joint Committee on Taxation
Summary of Tax and Financial Situation of D&K Flavors, Inc.
Prepared for the Committee on Ways & Means Meeting on the
Economic Recovery and Stabilization Act of 2010 (ERSA)
[Fictional report]
The following narrative describes some of the economic issues faced by U.S. small
businesses. [Note: For actual committee mark-ups, the JCT reports would typically be
statistical rather than specific.]
D&K Flavors, Inc. is a regional ―lemonade stand.‖ The company sells flavored
lemonades, teas, and baked goods in several ―warm climate‖ states. Business increased
exponentially for its first 10 years of operations. In the last few years, though, the
company has struggled as a result of too-rapid expansion and ―souring‖ economic
conditions. [Lemonade, sour… couldn’t resist!] On this page, we discuss the general
issues facing D&K. Additional information is provided on the following pages.
Current ownership. D&K is a Subchapter C corporation that files its tax returns using
the accrual method of accounting and a calendar taxable year. It was formed by
Demetrius and Kanisha Thomas about 15 years ago. Six years ago, the company held a
local stock offering to raise funds for expansion. There are now about 100 shareholders.
Employees and independent contractors. The ―lemonade stands,‖ themselves, are
manned by employees. However, much of the company’s business office work is done by
independent contractors. The company has had a hiring freeze because it feels it simply
cannot afford the costs – above and beyond salary costs – that relate to hiring a new
employee. After the Hiring Incentives to Restore Employment Act (the HIRE Act) was
passed (March 2010), D&K hired several new employees and indicated it intended to
retain several employees the company had planned to terminate. However, per Demetrius
Thomas, ―It is just plain expensive to hire people these days.‖ [NOTE: Act Section 102
of the HIRE Act follows the D&K discussion. This section affects the Code, but it did not
amend the Code.]
Significant tax and business matters. In the past few years, D&K has incurred capital
losses and net operating losses that have not been fully utilized. In spite of the losses,
D&K’s assets are substantially appreciated. Details related to D&K’s stock ownership,
recent tax matters, asset valuation, and plans for the future are shown on the following
pages.
35
Copyright 2010© Deloitte Development LLC All Rights Reserved.
The Joint Committee on Taxation
Summary of Tax and Financial Situation of D&K Flavors, Inc.
Prepared for the Committee on Ways & Means Meeting on the
Economic Recovery and Stabilization Act of 2010 (ERSA)
[Fictional report]
D&K Flavors, Inc. Ownership Chart
Shareholder Entity Type Percent owned
Demetrius Thomas Individual 20%
Kenesha Thomas Individual 20%
Sunny Sippers, LLC Limited liability company 10%
Donald Thomas Trust Trust 5%
Gerald Thomas Trust Trust 5%
20 shareholders Married individuals (10
couples)
10%
80 shareholders Individuals 30%
Demetrius and Kenesha Thomas are a married couple and the founders of D&K. Their
minor children are Donald and Gerald Thomas. A trust for the benefit of each child owns
5% of the D&K shares. Sunny Sippers, LLC is owned by Kenesha’s brothers, Darius and
Timothy. The LLC was formed solely to own the shares of D&K.
In addition to the family members described above, there are 100 additional shareholders.
Eighty of the shareholders are individuals who are not related to one another. Twenty of
the shareholders are families in which D&K stock is held in the names of both a husband
and a wife (in other words, 10 couples represent 20 of the D&K shareholders).
D&K Flavors, Inc. Summary of Recent Income, Expenses, Gains, Losses, and Taxes
Revenues Expenses Net Income
(Loss)*
Net Capital
Gain/Loss
Federal Tax
Liability
2010
(forecasted)
18,000,000 17,800,000 200,000 20,000 69,050
2009 18,500,000 19,000,000 (500,000) (20,000) -0-
2008 19,000,000 19,600,000 (600,000) 30,000 -0-
2007 20,500,000 20,400,000 100,000 (60,000) 22,250
2006 20,000,000 20,200,000 (200,000) 10,000 -0-
2005 19,500,000 19,000,000 500,000 20,000 176,800
2004 19,000,000 18,000,000 1,000,000 -0- 340,000
2003 18,500,000 18,450,000 50,000 -0- 7,500
* Net Income (Loss) is the amount before considering any Net Capital Gain / Loss.
36
Copyright 2010© Deloitte Development LLC All Rights Reserved.
The Joint Committee on Taxation
Summary of Tax and Financial Situation of D&K Flavors, Inc.
Prepared for the Committee on Ways & Means Meeting on the
Economic Recovery and Stabilization Act of 2010 (ERSA)
[Fictional report]
D&K Flavors, Inc. Asset Basis and Fair Market Value
The fair market values and bases of the assets of D&K Flavors, Inc. are forecasted to be
as follows as of December 31, 2010:
Assets Fair Market Value Tax Basis
Cash and cash equivalents $100,000 $100,000
Accounts receivable (net) 200,000 200,000
Inventory (net) 700,000 500,000
Personal property 3,000,000 4,000,000
Accumulated depreciation (2,800,000)
Real property 4,000,000 4,000,000
Accumulated depreciation (1,000,000)
Goodwill 2,000,000 -0-
Total assets $10,000,000 $5,000,000
Liabilities and Equity Fair Market Value Tax Basis
Accounts payable $1,000,000 $1,000,000
Long-term debt 3,000,000 3,000,000
Total liabilities $4,000,000 $4,000,000
Equity 6,000,000 1,000,000
Total liabilities and equity $10,000,000 $5,000,000
D&K’s accumulated earnings and profits are forecasted to be $1.2 million on
December 31, 2010.
37
Copyright 2010© Deloitte Development LLC All Rights Reserved.
The Joint Committee on Taxation
Summary of Tax and Financial Situation of D&K Flavors, Inc.
Prepared for the Committee on Ways & Means Meeting on the
Economic Recovery and Stabilization Act of 2010 (ERSA)
[Fictional report]
Plans for future operations. D&K is considering two options for ―the next 15 years.‖
The business will either convert to pass-thru entity status, or it will merge with Beverly
Beverages, Inc. These options are described below.
Option 1. Subchapter S election or conversion to an LLC. The first option is that
D&K will convert to some sort of ―pass-thru‖ entity and focus on conducting existing
operations more efficiently. D&K has expressed an interest in electing to be treated as a
Subchapter S corporation or converting into a Limited Liability Company (LLC) to
ensure profits are ―single taxed‖ rather than being ―double taxed.‖ If they follow this
approach, the entity’s philosophy will be that ―smaller is smarter,‖ and that the
company’s income potential will be greater if the focus is on making existing locations
more efficient.
Option 2. Potential merger with Beverly Beverages, Inc. Earlier this year, D&K was
approached by Beverly Beverages, Inc. with the idea of merging the corporations
effective January 1, 2011. After initially disregarding this idea, Demetrius and Kenesha
recently contacted the officers of Beverly to find out more information. In this option,
Demetrius will be retained as a Vice President of operations and will work with Beverly
to help expand the operations of the new-and-improved entity.
In the proposed transaction, the shareholders of D&K would receive shares of Beverly
Beverages, Inc. valued at $6 million in exchange for their shares in D&K. [Beverly is
valued at approximately $18 million; the new entity will be valued at approximately $24
million].
After the shares are transferred to Beverly, D&K would be liquidated, and D&K’s assets
would be transferred to Beverly. [NOTE: Although not necessarily the most likely
scenario in the ―real world,‖ assume this would be a ―straight merger‖ under
§368(a)(1)(A) rather than a triangular merger. After the merger, only one entity will exist.
(In other words, this is not a scenario in which a consolidated tax return would be filed)s]
After the merger, the D&K shareholders would each own one-fourth of the percentage
owned in D&K (e.g., Demetrius and Kenesha each owned 20% in D&K; they would each
own 5% of Beverly Beverages, Inc. Other shareholders interests would be reduced
accordingly).
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Hiring Incentives to Restore Employment Act
Act Sections Not Amending Code:
Sec. 102. BUSINESS CREDIT FOR RETENTION OF CERTAIN
NEWLY HIRED INDIVIDUALS IN 2010.
(a) In General. In the case of any taxable year ending after the date of the enactment of
this Act, the current year business credit determined under section 38(b) of the Internal
Revenue Code of 1986 for such taxable year shall be increased by an amount equal to the
product of-
(1) $1,000, and
(2) the number of retained workers with respect to which subsection (b)(2) is
first satisfied during such taxable year.
(b) Retained Worker. For purposes of this section, the term ―retained worker‖ means any
qualified individual (as defined in section 3111(d)(3) of the Internal Revenue Code of
1986)--
(1) who was employed by the taxpayer on any date during the taxable year,
(2) who was so employed by the taxpayer for a period of not less than 52
consecutive weeks, and
(3) whose wages for such employment during the last 26 weeks of such period
equaled at least 80 percent of such wages for the first 26 weeks of such
period.
(c) Limitation on Carrybacks. No portion of the unused business credit under section 38
of the Internal Revenue Code of 1986 for any taxable year which is attributable to the
increase in the current year business credit under this section may be carried to a taxable
year beginning before the date of the enactment of this section.