Requirements
Suppose your client, Client A, is an unmarried individual U.S. taxpayer living in New York City. She informs you that she recently entered into a settlement agreement with her investment advisor. The investment advisor has paid Client A $150,000. The payment is attributable to investment losses caused by the investment advisor's alleged failure to follow the asset allocation directions from Client A. Specifically; Client A instructed her advisor to change the investment objective for her account from "all equity" to "current income." The advisor understood these instructions to mean reallocate her portfolio from equity to income gradually over time, rather than an immediate sell off and restructuring. Client A claims that her intention was to do an immediate sell off and restructuring. Hence, a dispute arose with respect to the correct interpretation of her instructions and the decline in market value of the equity position over the length of time it took her advisor to gradually sell (restructure) her equity portfolio to income. Client A says this could have been avoided had the change in asset allocation been implemented immediately the way she wanted. In the interests of both parties in settling the dispute without admission of fault by either party, the investment advisor agreed to pay Client A $150,000.
Client A (the payee) wants to know the following:
· Is this settlement payment taxable for federal income tax purposes?
And
· If so, what is the character of the payment? Is it a reduction of tax basis of investment assets, ordinary income, or short or long-term capital gain income?
In addition, research and address what the income tax consequences are to the investment advisor (the payor) in making the settlement payment. Is the payment deductible, and if so, what is the character of the deduction?
Hint: Recall that income tax consequences in general are symmetrical; meaning that if one taxpayer for a given transaction has to report income, then the other taxpayer to the transaction generally has a deduction.
Prepare a tax research memorandum to answer the questions raised by your client. State any assumptions you make. Your written memorandum should be no approximately six pages in length. Recall that proper format and content are of equal importance. Refer to the Sample Tax Memorandum for guidance on the proper format. This assignment will be graded using the rubric below.