In 2009, Larry and Mary Carpenter inherited $ 100,000 from Larry's uncle. Upon their cousin's recommendation, they invested the entire inheritance with Mr. Smart, principal owner and CEO of Smart & Safe Securities Inc. The returns were averaging between 15% ~ 19%. Needless to say, both Larry and Mary were ecstatic and they have invested more of their personal savings with Smart & Safe Securities Inc.
On March 15, 2014, you received a frantic phone call from Larry. They have heard over the radio that Mr. Smart had misappropriated most of his clients' monies. Over the next couple of weeks, the true story gradually leaked out and you learned that in early June, the FBI had arrested and indicted Mr. Smart for running a Ponzi scheme and that he had stolen at least $100 million of his clients investments.
You quickly pulled out the Carpenter's tax file and reviewed the history of their transactions:
2010 Original investment $100,000
Investment Income reported 5,150
2011 Refinanced home for additional investment 80,000
Investment Income reported 35,150
2012 Distribution in August for vacation 10,000
Investment Income reported 37,020
2013 Investment Income reported 33,450
2014 Distribution in October for new SUV 35,000
Investment Income reported 11,500
2015 January, refinanced home for additional investment 50,000
You calculated that taxes paid on investment income over the years were $ 29,344.
You also noted their AGI and tax liabilities for years 2010 ~ 2014 were as follows:
AGI Tax Liability
2010 $ 75,123 $ 9,766
2011 113,429 17,014
2012 121,015 19,046
2013 114,427 18,521
2014 85,559 8,556
Larry expects his 2015 AGI to be roughly the same as the previous year. He further confides in you that without the investment income from Smart & Safe Securities, he would not be able to pay his home mortgage, and he would be completely broke.
As the Carpenters' CPA, what advise can you offer them? Please be aware that you may never be paid for this service. Nonetheless, you should prepare a technical memorandum for your files