Problem - Write a formal research paper to Ed (Facts, Issues, Rule of Law, Analysis, and Conclusion). For authority, only use primary sources such as code sections, regulations, revenue rulings, revenue procedures, cases etc. Do not cite as authority IRS instructions, IRS publications or RIA explanations or any other editorial literature.
Ed P., a partner in the CPA firm where you work, is meeting with a potentially new client, Arthur A., to do tax planning. Arthur is an engineer who works as a full time employee for Orange, Inc. and receives a substantial salary from them. In addition to working as an employee, he is also engaged in computer consulting and sports memorabilia collection. He has been collecting and selling sports memorabilia for over 5 years and has always sustained substantial losses from the activity. In prior years, he would sometimes report the computer consulting business and the sports memorabilia activity on one Form 1040, Schedule C. In either case, he would utilize the entire loss from the sports memorabilia to offset his other income.
Arthur only maintains one bank account which he uses to deposit his paychecks and cash receipts from his computer consulting business and sales from his sports memorabilia collection. He also pays all personal and business expenses from this account. Due to poor bookkeeping, Arthur is unable to properly allocate income and expenses between his different activities; however, he gave Ed a list of expenses which included auto expenses, commissions, depreciation, legal and professional services, rent, supplies, travel, meals and entertainment, utilities, advertising and cost of goods sold. Ed asked Arthur for documents to support his deductions and purchases, and Arthur handed Ed several unorganized binders with thousands of pages of documents. Arthur said that he does not maintain any inventory system for his sports memorabilia activity.
Arthur said that he does want to make the sports memorabilia activity profitable; however, Ed cannot see how he has implemented anything to accomplish this. Arthur said that he has a business plan, but he is unable to produce it to Ed. Arthur never prepared budgets, income statements, balance sheets, forecasts, or any other financial statement for the sports memorabilia activity. Arthur claims that he is only losing money because major league baseball players are using steroids, thus, reducing the value of the sports cards. Arthur claimed that he was growing his business by continuing to purchase new sports memorabilia. He never sought professional guidance regarding sports memorabilia because he claims that he is an expert in the field because he has a book that contains the prices for sport cards.
Arthur said that he could make millions from the appreciation of the sports memorabilia inventory. He said that a 1902 H. W. sport card was sold in 2001 for $1.1 million. Ed asked Arthur if he owns it now, and Arthur replied that he never owned it. He was just using that as example to demonstrate how valuable some sport cards could be. Arthur never insured his sports memorabilia collection.
Ed asked Arthur how much time he devotes to his sports memorabilia activity. Arthur said that he spend 15 hours a day, 7 days a week. Ed just remained silent when he heard this.
How Ed should handle the sports memorabilia activity. He is asking you to research the tax ramifications of the aforementioned. Do not discuss late filing penalties or accuracy-related penalties.