On July 24 of the current year, Sam Smith was involved in an accident with his business use automobile. Sam had purchased the car for $30,000. The automobile had a fair market value of $20,000 before the accident and $8,000 immediately after the accident. Sam had taken $20,000 depreciation on the car. The car is insured for the fair market value of any loss. Because of Sam's history, he is afraid that if he submitted a claim, his policy will be cancelled. Therefore, he is considering not filing a claim. Sam believes the tax loss deduction will help mitigate the loss of the insurance reimbursement. Sam's current marginal tax rate is 35%.
Write a letter to Sam that contains your advise with respect to the tax and cash-flow consequences of filing a claim for the insurance reimbursement for the damage to his car. Also prepare a memo for the tax files.