Problem 7-35 (LO. 3, 4) On July 24 of the current year, Sam Smith was involved…
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Question “Problem 7-35 (LO. 3, 4) On July 24 of the current year, Sam Smith was involved…”
Answer
Hoffman, Maloney, Raabe, and Young,
CPAs
5191 Natorp Boulevard
Mason, OH 45040
January 27,
2021
Mr. Sam Smith
450 Colonel’s Way
Warrensburg MO 64093
Dear Mr. Smith,
This letter informs you about the tax and cashflow consequences of filing a claims with your insurance company to recover damages to your business-use car.
You will get a $2,000 taxable gain if you file an insurance claim.
Insurance Recovery $ 12,000
Less than $10,000
or decline in FMV of $12,000 (10000)
Gain $ 2,000
This will result in a net cash flow equal to $11,300. It is calculated as follows:
$12,000 insurance reimbursement
Less Tax on Gain (35% x $2,000 (700
Net cashflow $11,300
You will not be liable for any tax if you do not file an insurance claim. However, a $10,000 deductible will apply to your loss. This will reduce your tax liability by $3500 (35% x 10,000).
The net cash gain from filing an insurance claim for reimbursement would be $7800 (between $11,300 and $3,500).
If you have any questions or would like more information, please get in touch with me.
Sincerely,
John J. Jones, CPA
Partner
TAX FILE
January 27, 2021
From: John J. Jones
Subject: Sam Smith’s tax consequences if he doesn’t file an insurance claim to get reimbursement for damages to his car.
Sam will be able to recoup $2,000 if he files an insurance claim.
Insurance Recovery $ 12,000
Less than $10,000: Lesser adjusted basis or
FMV decline of $12,000 (10000)
Gain $ 2,000
This will result in a net cash flow equal to $11,300. It is calculated as follows:
$12,000 in insurance reimbursement
Less: Tax on gains (35% x $2,000 (700)
Net cash flow $11,300
Sam will not be liable for any tax if he files no insurance claim. Instead, a $10,000 deductible will apply to Sam. This will reduce Sam’s tax liability by $3500 (35% x 10,000).
I wrote to Sam to point out that filing an insurance reimbursement claim would net a cash benefit of $7,800 (between $11,300 and $3,500).
Conclusion
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