Tax Research Memo

TO: File FROM: Albert Smith RE: Fly Jones (tax year 2003)

Facts

Fly Jones, a U.S. citizen and our client, plays point guard for  a professional basketball team, the Wyoming Wildcats. To  discourage laziness and mental errors, Fly and his teammates  formed the Slammin-Jammin Club on August 30, 2002.  Membership in the club was voluntary, but every Wildcat desired to join and did so.

Each time someone on the opposing team blocked a shot  during a regular season game, the Wildcat who was  “slammed and jammed” paid a $100 fine to the club. When a  Wildcat was responsible for a turnover (e.g., having the ball  stolen), he paid a $50 fine. Good performance (e.g., blocking the shot of or stealing the ball from an opposing player) did not reduce fines otherwise payable. At the end of the season, the club had collected approximately $40,000.

According to club rules determined at the season�s beginning, one-tenth of the fines was used to fund a barbecue for the players and their families on March 15, 2003. (Fly did not  attend the barbecue because his grandmother�s funeral was  the same day.) The rest of the funds, again according to  previously-determined club rules, was given to the American  Red Cross. The Red Cross knew nothing about the  contribution until it was actually donated on May 12, 2003.  One month later, the American Red Cross sent individual letters of thanks and receipts to each member of the club.  The donation amount on each receipt was based on a report  the club�s treasurer prepared. 

Of the $40,000, Fly contributed $2,200 to the Slammin- Jammin Club in 2002 and $2,800 in 2003. Fly itemizes his  deductions. He files jointly, and his adjusted gross income is  about $117,000.

Issue and Conclusion 1

Is Fly entitled to a deduction for fines he paid to the Slammin- Jammin Club? 1

Yes, Fly can deduct some of his fines as charitable  contributions. 2

Analysis 1

The fines paid to the Slammin-Jammin Club are not  deductible as business expenses since, under �162(a), they  are not ordinary and necessary. 3  To be ordinary, Welch v. Helvering (S.Ct., 1933) 4  requires that the fines be  commonplace among other taxpayers who find themselves in  comparable situations. 5  Forming a club to which members  pay fines for mental errors and laxity is not commonplace among professional basketball players. 6  To be necessary, the players must reasonably expect the fines to be appropriate  and helpful according to Welch. 7  Whether the pressure of fines can reasonably be expected to increase performance is  debatable. But since the payment is not ordinary, Fly cannot  deduct his fines under �162. 8  

Fly Jones , 2003

However, Fly can deduct some portion of his fines as a  charitable donation if in the nature of a contribution or gift  under �170(c). 9  CIR v. Duberstein (S.Ct., 1960) 10 clarifies the  meaning of the term “gift.” In this decision, the taxpayer  periodically gave names of potential customers to a business  associate. The associate was so appreciative that he gave the  taxpayer a Cadillac. The taxpayer protested that he had not  intended to be compensated. But the associate persisted, and the taxpayer relented. 11  In holding that the Cadillac was  gross income to the taxpayer, the court observed that a  donor�s intent to make a gift is the key factor establishing a  transfer as a gift. 12  Similarly, Fly intended to make a gift of  his contributions to the club. Fly voluntarily joined the club  and was aware from the beginning that the bulk of fines  would be paid to the American Red Cross. 13  Thus, Fly�s  contributions were in the nature of gifts.

Fly can deduct some portion of his fines even though paid  through the Slammin-Jammin Club. In Rev. Rul. 55-192,14  the members of a social club deducted a portion of their  membership dues that were distributed to a qualified charity  later. Thus, to claim deductions, individuals are not  necessarily required to donate money or property directly to  qualified charitable organizations. 15  Fly can deduct the  contributions he made to the American Red Cross through  the Slammin-Jammin Club. 16

Issue and Conclusion 2

What portion of Fly�s $5,000 fines can he deduct as a  charitable contribution? 17

Fly can deduct $4,500 (90% of his $5,000 fines) as a  charitable contribution. 18

Analysis 2

To determine the deduction for each individual, the total  $40,000 contribution must be allocated among the players. 19 The taxpayer in Wilson v. CIR (TCM, 1952) 20  attempted to deduct charitable contributions that his mother, the taxpayer�s dependent, made. Even though the taxpayer gave the  contributed funds to his mother prior to their donation to  charity, the court held that a deduction is available only to the  individual making the donation. 21  In the same way, the  charitable contribution the Slammin-Jammin Club made must  be allocated only among the individuals paying the fines. Each individual�s contribution is limited to his actual fines.Wilson 22 suggests that a proportional allocation method must be used  to determine the charitable contribution of each club  member. 23  In contrast to the taxpayer�s mother inWilson,  the club is not a separate taxable person or entity and, thus,  can be ignored as a type of conduit. In other words, the  individual club members are the actual donors (requiring  some allocation method), not the club. 24  Based on the  treasurer�s report, Fly�s allocable portion of fines paid is  $5,000. 25

Fly Jones , 2003

Fly cannot deduct the portion of fines paid for which he  receives tangible benefits. 26  Rev. Rul. 76-232 27  involved amounts donated to a tax-exempt organization that  conducted weekend marriage seminars. The ruling allows a  deduction only to the extent the amount donated exceeds the  value of benefits and privileges received in return (i.e., free or  discounted seminar attendance). 28  Fly donated $5,000 but  received benefits in return valued at $500 (i.e., the  barbecue). Thus, his deductible contribution is only $4,500.

Nonattendance at the barbecue does not affect the  deduction. 29  Rev. Rul. 67-246,30 dealt with admission fees  to charitable fund raisers such as balls, fairs, bazaars,  banquets, and athletic events. The ruling allowed the taxpayer to deduct only the excess of donations over the value of  benefits received in return. The ruling stated that the  deduction is not increased when the taxpayer decides not to  accept the available benefits (e.g., through non- attendance). 31  The fact that Fly did not attend the barbecue  has no effect on (i.e., does not increase) his charitable  deduction. Since only 90% of the fines collected is  contributed to the American Red Cross, the amount  attributable to the barbecue reduces Fly�s deduction. Thus,  10% of Fly�s contribution to the club or $500 is a  nondeductible personal expense. The remaining $4,500 is deductible as a charitable contribution.  32

Issue and Conclusion 3

When can Fly deduct his $4,500 charitable contribution to  the American Red Cross? 33

Fly can deduct his $4,500 contribution in 2003, the year  the funds are given to the American Red Cross. 34

Analysis 3

Under �170(a)(1), contributions individuals make are  deductible in the year paid. Reg. �1.170A-1(b) states that a  contribution is ordinarily considered paid at the time delivery  occurs. However, the regulation does not address to whom  the delivery must be made. 35

Fly Jones, 2003 In Rev. Rul. 55-192,36 70% of membership dues paid to a  social club were earmarked for designated charities.  Members paid dues to the club�s treasurer, whom the  charities previously authorized to act as their collecting agent.  Members could deduct 70% of their contributions during the  taxable year in which they paid their dues. However, if the  charities had not authorized the treasurer to act as collecting  agent, members could not deduct their contributions until the  taxable year in which the treasurer forwarded such funds to  the charities. 37  Thus, the taxable year in which Fly can  deduct his $4,500 depends on whether the club has a duly- authorized collecting agent, the year when �fines� are paid,  and the year when 90% of the fines are transferred to the  American Red Cross. 38  

The Slammin-Jammin Club is not an authorized agent of the  American Red Cross since the latter did not know of the  contribution until it was actually received. Thus, payments  made to the club are deductible in the year the club transfers  the payment to the American Red Cross. Though Fly paid some of his fines in 2002 and some in 2003, his $4,500  deduction falls entirely in 2003. 39

1. Issues in research memos should be written in the context of the client’s facts. For example, the taxpayer’s name is used in the issue. In contrast, the issue in a judicial brief should be written in more general terms.

2.  A one-sentence conclusion should immediately follow each issue. Research memos are easier to understand and follow when the reviewer knows the conclusion before reading the analysis.

3. Often, a good strategy is to begin an issue’s analysis with the relevant Code section.

4. When the case is attached, the only relevant information is the court and year. The traditional cite, consisting of the volume, reporter series, and page number, is unnecessary information that clutters the research memo.

5. This statement is the rule of law. At times, providing only a judicial decision’s rule of law is sufficient, especially for well-known landmark cases with broadly-applicable holdings. In contrast, other judicial decisions cited in this research memo are briefly discussed to establish their relevance to the client’s facts. Generally, you should discuss each judicial decision or ruling briefly to show its relevance; the example here is an exception to this usual procedure.

6. This sentence applies the Welch v. Helvering’s rule of law to the client’s facts. An explicit application of law to facts is very important in a research memo.

7. Subsequent references to a judicial decision within the same issue need only include a summary reference consisting of the taxpayer’s name.

8. The �162 possibility is addressed first since, if allowed, the deduction would be for adjusted gross income (AGI). Deduction for AGI is a more favorable outcome for many taxpayers than an itemized deduction, which the next paragraph addresses.

9.  Often, a good strategy is to begin an issue’s analysis with the relevant Code section.

10. When the case is attached, the only relevant information is the court and year. The traditional cite, consisting of the volume, reporter series, and page number, is unnecessary information that clutters the research memo.

11. Sufficient facts are provided about Duberstein to establish the decision’s relevance to the client’s facts. Establishing that the fact pattern in the judicial decision is analogous to the client’s facts is very important in a research memo. The same is true of IRS rulings.

12. The rule of law follows the brief discussion of the judicial decision’s facts.

13.  The explicit application of the law to the client’s facts is very important.

14. When the ruling is attached, the only relevant information is the ruling’s year and number. The traditional cite, which includes the volume, reference to the Cumulative Bulletin, and page number, provides unnecessary information that clutters the research memo.

15. Sufficient facts are provided about Rev. Rul. 55-192 to establish the ruling’s relevance to the client’s facts. Establishing that the fact pattern in the ruling is analogous to the client’s facts is very important in a research memo. The same is true of judicial decisions.

16. The explicit application of the law to the client’s facts is very important.

17. Issues in research memos should be written in the context of the client’s facts. For example, the dollar amount of the fines is used in the issue. Note that issues 1 and 2 could be combined as follows: “How much can Fly deduct for the $5,000 fines he paid to the Slammin-Jammin Club?” Combining the two issues might be appropriate when the analysis of each is very short or involves substantial overlap.

18. A one-sentence conclusion should immediately follow each issue. Research memos are easier to understand and follow when the reviewer knows the conclusion before reading the analysis.

19. Sometimes an issue requires that several subpoints be addressed (e.g., that total contributions must be allocated). In this situation, a short conclusion at the beginning of each subpoint is an organization strategy that can increase readability.

20. When the case is attached, the only relevant information is the court and year. The traditional cite, consisting of the volume, reporter series, and page number, is unnecessary information that clutters the research memo.

21. Sufficient facts are provided about Wilson to establish the decision’s relevance to the client’s facts. Establishing that the fact pattern in the judicial decision is analogous to the client’s facts is very important in a research memo. The same is true of IRS rulings.

22. Subsequent references to a judicial decision within the same issue need only include a summary reference consisting of the taxpayer’s name.

23. The explicit application of the law to the client’s facts is very important. As a Tax Court memorandum decision, other sources (besides and perhaps better thanWilson) could have been cited to establish the general principle that only the payor of an expense or donation is entitled to a deduction. The mere fact thatWilson involved a charitable contribution, like our client’s, does not necessarily mean that it is the best source to cite for such a general principle.

24. These two sentences simply clarify a difference between Wilson and our client’s facts that is irrelevant.

25. The explicit application of the law to the client’s facts is very important.

26. Sometimes an issue requires that several subpoints be addressed (e.g., no deduction for benefits received). In this situation, a short conclusion at the beginning of each subpoint is an organization strategy that can increase readability.

27.  When the ruling is attached, the only relevant information is the ruling’s year and number. The traditional cite, which includes the volume, reference to the Cumulative Bulletin, and page number, provides unnecessary information that clutters the research memo.

28. Sufficient facts are provided about Rev. Rul. 76-232 to establish the ruling’s relevance to the client’s facts. Establishing that the fact pattern in the ruling is analogous to the client’s facts is very important in a research memo. The same is true of judicial decisions.

29. Sometimes an issue requires that several subpoints be addressed (e.g., nonattendance is irrelevant). In this situation, a short conclusion at the beginning of each subpoint is an organization strategy that can increase readability.

30. When the ruling is attached, the only relevant information is the ruling’s year and number. The traditional cite, which includes the volume, reference to the Cumulative Bulletin, and page number, provides unnecessary information that clutters the research memo.

31. Sufficient facts are provided about Rev. Rul. 55-192 to establish the ruling’s relevance to the client’s facts. Establishing that the fact pattern in the ruling is analogous to the client’s facts is very important in a research memo. The same is true of judicial decisions.

32. The explicit application of the law to the client’s facts is very important. The tax law often does not provide explicit allocation rules for every conceivable situation. Taxpayers often allocate items on the basis of common sense or sound logic. In other words, citing primary authority is not always necessary for allocation issues.

33. Issues in research memos should be written in the context of the client’s facts. For example, the dollar amount of the contribution (as established in issue 2), the client’s name, and the donee’s name are used in this issue.

34. A one-sentence conclusion should immediately follow each issue. Research memos are easier to understand and follow when the reviewer knows the conclusion before reading the analysis.

35. Often, a good strategy is to begin an issue’s analysis with the relevant Code section. If a regulation adds further insight, discuss its contribution next. In this issue, the regulation provides some clarification but is insufficient to resolve the issue and reach a conclusion.

36. When the ruling is attached, the only relevant information is the ruling’s year and number. The traditional cite, which includes the volume, reference to the Cumulative Bulletin, and page number, provides unnecessary information that clutters the research memo.

37. Sufficient facts are provided about Rev. Rul. 55-192 to establish the ruling’s relevance to the client’s facts. Establishing that the fact pattern in the ruling is analogous to the client’s facts is very important in a research memo. The same is true of judicial decisions.

38. Sometimes a statement summarizing the relevant factors, such as this one, is helpful before applying the law to the client’s facts. The more complex the law, the more likely a summary statement will be helpful.

39. The explicit application of the law to the client’s facts is very important.