Tax Strategy Problem
Pedro Bourbone is the founder and owner of a highly successful small business and, over
the past several years, has accumulated a significant amount of personal wealth. His portfolio
of stocks and bonds is worth nearly $5,000,000 and generates income from dividends
and interest of nearly $250,000 per year. With his salary from the business and his
dividends and interest, Pedro has taxable income of approximately $600,000 per year
and is clearly in the top individual marginal tax bracket. Pedro is married and has three
children, ages 16, 14, and 12. Neither his wife nor his children are employed and have no
income. Pedro has come to you as his CPA to discuss ways to reduce his individual tax
liability as well as to discuss the potential estate tax upon his death. You mention the possibility
of making gifts each year to his children. Explain how annual gifts to his children
will reduce both his income during lifetime and his estate tax at death.
John Gemstone, a wealthy client, has recently been audited by the IRS. The agent has
questioned the following deduction items on Mr. Gemstone’s tax return for the year under
review:
• A $10,000 loss deduction on the rental of his beach cottage.
• A $20,000 charitable contribution deduction for the donation of a painting to a local
art museum. The agent has questioned whether the painting is overvalued.
• A $15,000 loss deduction from the operation of a cattle breeding ranch. The agent is
concerned that the ranch is not a legitimate business (i.e., is a hobby).
Your supervisor has requested that you represent Mr. Gemstone in his discussions with
the IRS.
a. What additional questions should you ask Mr. Gemstone in an attempt to substantiate
the deductibility of the above items?
b. What tax research procedures might be applied to build the best possible case for your
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