Question

You have a client who wants to claim a deduction or loss that may be questioned by the Internal Revenue Service (IRS).

• Explain two specific deductions or losses that would most likely result in an IRS audit.
• Outline at least two strategies to avoid a tax audit for a client who wishes to take the specific deductions or losses.
• Support your proposal with specific recommendations.
• Obtain a Form 1040 income tax return.
  • Clearly identify the section of the Form 1040 that applies to the deduction or loss, and why.

Under Sec. 267, current deductions may not be taken for certain transactions between related parties.

• Determine who is considered a member of a taxpayer's family under the related party transaction rules of Sec. 267.
• Identify two other relationships that are considered related parties for purposes of Sec. 267.
• Be sure to explain why these other relationships are included in the definition within your response.

Answer 1

a. An individual's spouse, brothers and sisters, ancestors, and lineal descendants are considered members of the taxpayer's family for purposes of Sec. 267.

b. The term "related parties" under Sec. 267(b) includes (1) an individual and a corporation in which the individual owns more than 50% of the value of the outstanding stock, (2) various relationships between grantors, beneficiaries, and fiduciaries of a trust, a corporation and a partnership if the same persons own more than 50% in value of the stock of the corporation and more than 50% of the partnership, and two corporations if the same persons own more than 50% in value of both corporations and at least one of the corporations is an S corporation. These relationships are included because the taxpayer may be able to exert control or influence which may keep transactions between the parties from being completely at arm's length.