Kim Rhode is a university graduate who was a pre-veterinarian major with a CIS minor. She is a six- time Olympian from 1996 through 2016 and has won three gold medals, one silver and two bronze medals in sheet and trap events. In order to cope with the stress of Olympic Games, she developed an interest in designing action video games. She is certified by The Video Game Institute, an internationally recognized institution. Kim was recently hired by On Target Productions, Inc.

On Target Productions, Inc. treats one of its computer programmers, Kim Rhode, as an independent contractor. Kim Rhode’s one-year contract with On Target provides her with office space, secretarial support, a computer, and software. Kim sets her own hours, but typically works 60 hours per week at On Target. Kim will not be receiving compensation from any other source during the contract period. The contract calls for Kim to develop six computer games for the pre-teen and teenage market. The contract requires Kim to program all six games herself (rather than hiring anyone else to program). Kim has full discretion as to the type of games. For example, at Kim’s discretion, one or more games could be related to a sport, show violence, have educational value, etc. Every two months, Kim is expected to complete a game and give it to On Target management for review, testing, production & distribution. On Target does not have the power to discharge Kim unless two or more program due dates are missed. On Target believes that Kim is motivated to perform well in order to obtain future contracts with On Target. However, there is no legal obligation for On Target to offer future contracts or for Kim to accept them.

If Kim’s software is commercially successful (i.e. many copies are sold), Kim will receive a significant royalty. During the 1-year development period, On Target pays Kim a $3,000 monthly “advance.” Yet, Kim could be earning at least $5,000 per month in salary as an employee of one of On Target’s competitors. The advances will be subtracted from Kim’s future royalties on the software. If there are no future royalties (i.e. the software does not sell) or if the royalties are not large enough to fully absorb the advances, Kim is still allowed to keep the advances. Kim does not have to repay On Target for any advances under any conditions.

 

Part 1 -

Tax research question #1 – Is Kim an employee or an independent contractor for Federal employment tax purposes?

 

Perform the necessary tax research, write a memorandum to the tax file supporting your decision and then advise On Target Productions in a client letter as to your research findings and recommendation. See Exhibit #2.9 on page 2-27 for a sample Tax File Memorandum and Exhibit 2.10 on page 2-28 for a sample Client Letter.

Partial List of Resources –

Revenue Ruling 1987-41, 1987-1 CB 296

IRS Publication 15

Part 2 –

Assume Kim is providing services to a California employer would Kim be an employee or independent contractor for California employment tax purposes?

Perform the necessary tax research and write a Tax File Memorandum supporting your decision.

Partial List of Resources –

California Assembly Bill 5

ABC Test

Tax Research Problem #2 – Monkee Business 

Mickey Dolenz owns the copyrights to several classic The Monkees’ songs. In 2019, he became aware that Columbia Records was selling several of his songs without his permission. He sues Columbia seeking $1,000,000 in damages. In 2020, the court awards Mickey $500,000 in compensatory damages, $50,000 in prejudgment interest, post-judgment interest to the date of payment, and court costs. Columbia is aware that Dolenz is likely to appeal the judgment and offers to settle for $600,000 with no payment of post-judgment interest or court costs. On the advice of his attorney, Dolenz rejects the settlement offer.

On December 29, 2020, Dolenz receives a check for $600,000 from Columbia. An accompanying letter notes that the payment is in full settlement of the order of the court. Dolenz believes that the payment is in full settlement of the order of the court. Dolenz believes that if he cashes the check, he will forfeit his right to appeal the judgment, the post-judgment interest and court costs. He immediately returns the check to Columbia via overnight mail, stating in a letter that his appeal rights are not exhausted, and he is returning the check until such time as the issue is settled. Columbia re-mails the check on December 31, 2020. Included with the check is a letter advising Dolenz that Columbia intends to deduct the $600,000 in 2020 and that the funds ae available for his unrestricted use. On January 15, 2021, Dolenz files an appeal seeking an increase in the damage award. The next day he deposits Columbia’s check into his business account. On June 5, 2021, the Appeals Court rejects Dolenz’s appeal for higher damages. Dolenz is a cash basis taxpayer. In what year should he report the payment of $600,000 as income.

Perform the necessary tax research and write a memorandum to the tax file and advise Dolenz in a client letter as to your research findings and in what year he should include the $600,000 in income.  See Exhibit #2.9 on pages 2-27 for a sample Tax File Memorandum and Exhibit 2.10 on page 2-28 for a sample Client Letter.

Answer rating: 100% (QA)

Section 530 of the Revenue Act of 1978 section 530 generally allows a taxpayer to treat a worker as ... View the full answer