Hank Moody, an executive for ahealthcare company in Dallas, TX, has approached our firm, TheComet Group, due to recent interaction with the IRS. Over the pastfew years, Hank acquired and renovated several properties in theDallas area, ultimately intending to lease them for use by varioustenants. Hank is the sole owner of these properties. Hank’sdaughter, Becca, began her freshman year at the University of Texasat Dallas in the Fall of 2018. Hank hopes to use the income fromthese properties to pay for Becca’s college tuition, as well as herliving expenses.

In December 2017, Hank successfullyleased his first property. The lease began on January 1, 2018, andthe tenants made their first rental payment that same day. Thecontract stated that the lease is for one year (i.e., it ends onDecember 31, 2018) and specified that the tenants would pay rent of$1,000 on the first day of each month. Thus, the total rentcollected from the tenants for 2018 was $12,000. The tenants paidtheir rent each month on time.

Hank had discussed his intentions touse the income from the rental property to fund Becca’s educationwith his friends. One of them suggested that Hank have the tenantspay rent directly to Becca so that she, rather than Hank, wouldearn the income and be responsible for paying tax on it. His friendreasoned that, because Becca only has a part-time job, she wouldpay tax on the rental income at a lower rate than Hank, which wouldallow the income to cover more of the cost of her education. Hankwas delighted to receive this advice from his friend, and heimplemented it. The rental contract specified that the tenants sendtheir payments directly to Becca Moody. The tenants complied withthe terms of the contract, and Becca cashed their checks each monthand used the money to pay for her education expenses. Beccareported $12,000 of rental income on her 2018 tax return and paidthe appropriate tax.  

After examining Hank’s 2018 taxreturn, the IRS issued a deficiency assessment claiming that the$12,000 of rental income reported by Becca constituted income toHank, and thus, should be included in Hank’s income under I.R.C.Section 61(a)(5). Hank has requested our assistance because hedisagrees with the IRS’s position and believes that he is notrequired to include the income in his gross income given that therental payments were paid directly to Becca. How should we adviseHank?

Assignment:

1) Look up and review the following authorities:

I.R.C. Section 61(a)

Treas. Reg. Section 1.61-1(a)

Lucas v. Earl, 281 U.S. 11 (1930)   

1. State the primary issue or issues that the clientswants analyzed and answered?

2. Summerize the law and provide an analysis of the lawas it appears to the facts of the case. (hint: summarize therelevant legal authorities that may pertain to the issue andanalyze the clients facts in the light of the guidence youprovide.)

Facts:

For the given case first, we should understand the differencebetween tax avoidance and tax evasion. Tax avoidance is legallyexploiting the tax system to reduce current or future taxliabilities by means not intended by parliament. It often involvesartificial transactions that are contrived to produce a taxadvantage whereas, tax evasion is to escape paying taxes illegally.This is usually where a person misrepresents or conceals the truestate of their affairs to tax authorities. It’s a dishonest taxreporting system. Here one of Hank’s friend advised him thattenants pay directly to Becca for avoiding higher tax liabilitiesof Hank but as in the given problem the property from which suchincome arise belongs wholly to Hank, so the total income should betaxable in the hands of Hank. Therefore, the said advice of Hank’sfriend leads to tax evasion instead of tax avoidance. So, the claimof IRS is absolutely right. Here Mr. Hank can only appeal forconsideration of his mistake.   

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