Question

Jerry always wanted to run his own manufacturing business. Jerry needed a special machine that cost $40,000. After all of the other startup expenses, Jerry only had $30,000 remaining to purchase this machine. Jerry’s good friend Mike came to the rescue and loaned him $10,000 to help Jerry buy the machine. The loan was a simple loan with a balloon payment of $11,000 at the end of two years. This represents approximately a 5% annual interest rate, which was the going market rate at the time the loan was made.

Jerry’s business was going well, however it required him to put in many long hours. Jerry noticed that an apartment building that was close to his warehouse had a vacancy. Jerry thought it would be nice to drive to work instead of commute through traffic, so he decided to move closer to the warehouse. Before moving, he decided to have a garage sale to get rid of the things at his old place. The garage sale was a hit! Jerry didn’t know he was sitting on such a gold mine. In total, Jerry made $15,000 from selling his items at the garage sale.

With business going well, and the unanticipated cash flow from the garage sale, Jerry decided to pay back his loan in full to Mike, ahead of schedule. When Jerry offered the check to Mike for $11,000, Mike said, “You know what Jerry? You’re my friend. I wasn’t expecting the money back. I know you would help me out if I needed it. I’m just happy that I was blessed to be in a position where I could help you pursue your dreams.”

Jerry was extremely grateful. As a gesture of thanks, and because Jerry had been working so much that he and Mike hadn’t hung out much lately, Jerry took Mike out to a fancy dinner followed by VIP concert to Mike’s favorite band. In all, the night cost Jerry about $1,500, but Jerry didn’t mind. After all, he just saved $11,000 for not having to pay Mike back for the loan, plus, Jerry figured he would just deduct the costs of dinner and the concert as a business expense.

Jerry comes into your office seeking tax advise. Identify any tax issues that arise through Jerry’s story. Also identify any relevant section of the Code, case law, or tax court memorandums that will help you resolve these issues.

Answer 1

Answer) Jerry has incurred expense of $ 1,500 in providing treat to his friend Mike. However, the expenses incurred cannot be considered as business expense, since the same is not incurred for running and operating the business. By incurring the expenses, there is no gain to the business as Mike has already told Jerry that he will not take the money back. Thus, there is no relation between the dinner and Mike's decision for not taking back the loan.

Jerry decision to show the expense as business expense is incorrect and the same will get disallowed as per the provision of relevant act. Thus, Jerry should treat the expense as personal expense not as business expense, otherwise Jerry may also be liable for interest and penalty for incorrect claiming of excess expenditure and delay in payment of tax on the same.