Professional Documents
Culture Documents
I. Introduction
4 Main Units:
1. Gross Income
2. Deductions
3. Characterization of Income (Capital Gain or Loss)
4. Computations and Credits
Sources of Tax Law
-The code, the cases, and administrative materials.
Administrative Materials
i. Treasury Regulations
1.
The Secretary of the Treasury is given general authority to prescribe all
needful rules and regulations for the enforcement of the Internal Revenue Code.
This is a lawful delegation of subordinate legislative authority.
2.
Ultimately, the judiciary has the right to determine whether the
regulations promulgated by the executive (the Treasury) conform to the statute
enacted by the legislature.
3.
Most regulations are sustained so long as they reflect a consistent, long
standing interpretation by the Treasury or if they comport with notions of sound
policy and reason.
ii. Revenue Rulings
1.
On application from a taxpayer, the Secretary of the Treasury may
answer a specific question concerning the taxpayers liability.
2.
These responses, dubbed Revenue Rulings, do not carry the force and
effect of regulations, but they do provide precedent for use in the disposition of
similar cases.
3.
iii. Private Letter Rulings: Not binding and can be requested but have to pay They are
published.
Tax Court Decision
Secondary Tax Resources: Lexis and Westlaw, BNA Tax Management Portfolios, RIA
Checkpoint, Legal Tax Software
Code 61 defines gross income as all income from whatever source derived.
61. Gross Income Defined
(a) General Definiotn.Except as otherwise provided in this subtitle, gross income
means all income from whatever source derived, including (but not limited to)
the following items:
(1) Compensation for services, including fees, commissions, fringe benefits,
and similar items;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Alimony and separate maintenance payments;
(9) Annuities;
(10) Income from life insurance and endowment contracts;
(11) Pensions;
(12) Income from discharge of indebtedness;
(13) Distributive share of partnership gross income;
(14) Income in respect of a decedent; and
(15) Income from an interest in an estate or trust.
**Examples: -Scholarships are mostly not considered gross income. Life insurance
proceeds arent considered gross income.
-Pulitzer Prize is considered gross income.
-10k gratuitous gifts are not gross income.
Reg. 1.61-1 Gross Income.
(a) General Definition. Gross income means all income from whatever source
derived, unless excluded by law. Gross income includes income realized in any
form, whether in money, property, or services. Income may be realized, therefore,
in the form of services, meals, accommodations, stock, or other property, as well
as in cash. Section 61 lists the more common items of gross income for purposes
of illustrationGross income, however, is not limited to the items so
enumerated.
Reg. 1.61-2. Compensation for services, including fees, commissions, and similar
items.
(a) In General
(1) Wages, salaries, commissions paid salesmen, compensation for services on the
basis of a percentage of profits, commissions on insurance premiums, tips,
bonuses including Christmas bonuses), termination or severance pay, rewards,
jury fees, marriage fees and other contributions received by a clergyman for
services, pay of persons in the military or naval forces of the United States,
retired pay of employees, pensions, and retirement of allowances are income
to the recipients unless excluded by law. . . .
Reg. 1.61-2. Compensation for services, including fees, commissions, and similar
items.
(d) Compensation paid other than in cash
(1) In General. Except as otherwise provided in paragraph (d)(6)(i) of this
section (relating to certain property transferred after June 30, 1969), if services are
paid for in property, the fair market value of the property taken in payment must
be included in income as compensation. If services are paid for in exchange for
other services, the fair market value of such other services taken in payment must
be included in income as compensation. If the services are rendered at a stipulated
price, such price will be presumed to be the fair market value of the compensation
received in the absence of evidence to the contrary. . . .
Reg. 1.61-14. Miscellaneous items of gross income.
(a) In General. In addition to the items enumerated in section 61(a), there are many
other kinds of gross income. For example, punitive damages such as treble
damages under the antitrust laws and exemplary damages for fraud are gross
income. Another persons payment of the taxpayers income taxes constitutes
gross income to the taxpayer unless excluded by law. Illegal gains constitute gross
income. Treasure trove, to the extent of its value in Untied States currency,
constitutes gross income for the taxable year in which it is reduced to undisputed
possession.
Cersarini v. US
Facts: The Ceasarinis bought a used piano for $15.00, and they found $4,467 of cash
stashed inside. The filed the cash as income and paid more than $800 in taxes on it. They
later filed an amended return and demanded a refund of that $800+. They argued that
found money should not be taxed as income.
-Ps arguments: 1. The found money is not includable in gross income under Sec 61.
2. Even if it was gross income, it was due and owing the year the piano
was purchased and the SOL are up.
3. If it was gross income it was entitled to capital gains treatment.
-Court said no refund and no capital gains treatment. Rule 61 says gross income means
all income from whatever source derived including but not limited 15 items. Basically, all
income is taxable unless you can point to an exemption and Ps have failed to point to an
exemption.
-P also argues that found money must be construed as a gift. Court shoots it down.
-Ps and Ds miss regulation that that includes treasure trove as gross income.
-Addressing the SOL argument, the court looks to Ohio law to determine when the
money was reduced to undisputed possession. In this case it was reduced only upon
discovery.
CLASS NOTES:
*Everything is income unless otherwise excluded. Regulation 1.61-14 says treasure trove
is included in income. But when does it become taxable? When you discover it and claim
it as your own.
TAKEAWAY: Is treasure trove income? Yes, treasure trove or windfall income is taxable.
Old Colony Trust Co. v. Commissioner
Facts: Company passed resolution that stated the company would pay all the income
taxes for its President and other officers. The Company paid $681,169.88 in taxes for him
for 1918 and $351,179.27 in 1919. The Board of Tax Appeals determined that these
amounts constituted additional income for the years 1919 and 1920.
Issue: If an employer pays the income taxes of an employee, does the payment of the
taxes constitute taxable income?
Held: Yes it is taxable income. The payment of the tax by the employers was in
consideration of the services rendered by the employee and was a gain derived by the
employee from his labor. Doesnt matter that it was paid directly to the government. The
discharge by a third person of an obligation to him is equivalent to receipt by the person
taxed.
-Wasnt a gift either, and cant address the tax on a tax argument because the Treasury
had not yet imposed another tax.
CLASS NOTES:
-Taking the tax burden off of the president is still another form of compensation/ a benefit
in exchange for services. IT IS NOT A GIFT in this situation.
-Look to the context of the payment of someones taxes, if for services then its income
and taxable, if just a gift then its not.
Facts: -Two cases were consolidated. First case, The parties settled and Glenshaw
received $800,000. Of that, $324,529.94 represented punitive damages. Glenshaw did not
report that amount as income.
-Second case, William Goldman sued Loews Inc. for violations of antitrust law and
sought treble damages. William Goldman received $375,000 in treble damages but
claimed $250,000 of that represented punitive damages and did not report it as income.
Issue: Did punitive damages constitute taxable income?
Held: Yes. All damages are taxable income. The Court defined income as all undeniable
accessions to wealth, clearly realized, and over which the taxpayers have complete
dominion. The Court rejected the defendants arguments that the income wasnt taxable
because it was not associated with capital or labor. While those designations are typical
sources of income, income is not limited to those avenues. Generally, the Court gives a
liberal construction to the broad phrasing in the code definition, in recognition of the
intention of Congress to tax all gains except those specifically exempted.
CLASS NOTES:
-Punitive damages are taxable income. Loss profit damages are taxable. Scope of 61 is
very broad.
-Default rule: Presume its included unless you can show that it is out.
-Current law explicitly says that punitive damages are taxable.
Charley v. Commissioner
Facts: For company travel, Charley would bill the client for roundtrip, firstclass airfare
then instruct his travel agent to buy a coach ticket. Charley used frequent flyer miles to
upgrade to first class, but he pocketed the difference between the billed price and the
purchase price in a personal travel account. In 1988, this account accrued more than $3k
in travel credit. The tax court levied a deficiency for that amount.
Issue: Whether tax credits converted to cash in a personal travel account established by
an employer constitute gross income to the employee?
Held: Yes. Travel credits were, at base, additional compensation. Alternatively, one
could characterize the transaction as a disposition of property and gross income include
gains derived from dealings is property.
CLASS NOTES:
-Guy was wealthier after the transaction before and still apart of his job. Not explicitly
excluded so still taxable.
-Normal frequent fly miles for ordinary travelers wont be taxed. Consider it more like a
rebate.
*Notes on page 52.
Loans:
*Are loans considered income? Not income because you have to pay it back.
They are offset by an obligation to pay.
Illegal Ascensions to Wealth:
*Are taxable gross income.
Problems pg. 1-2 54
1. Would the results to the taxpayers in the Cesarini case be different if instead of
discovering $4,467 in old currency in the piano, they discovered that the piano, a
Steinway, was the first Steinway piano ever built and is worth $500,000? There is
a difference when you find something is changing value. Wont be taxed on it until
you have a recognition event. (Sold it or something). Dont tax the property when
the value changes.
2. Winner attends the opening of a new department store. All persons attending
are given free raffle tickets for a watch worth $200. Disregarding any possible
application of IRC section 74, must Winner include anything within gross income
when she wins the watch in the raffle? It is taxable as a prize. Prizes and awards
are taxable income. Not a gift.
-Per the IRS, both of these payments amount to income taxable to the lawyer/landlord
at the fair market value.
-The applicable section of the Internal Revenue Code. . . and the Income Tax Regulations
are 61(a) and 1.61-2, relating to compensation for services.
CLASS NOTES:
Barter:
Does Barter create income? Yes and you look to the fair market value. Still as if you paid
money for the trade or service.
*Section 1.61-2(d)(1) of the regulations provides that if services are paid for other than in
money, the fair market value of the property or services taken in payment must be
included in income. If the services were rendered at a stipulated price, such price will be
presumed to be the fair market value of the compensation received in the absence of
evidence to the contrary.
*But what if you do your own work, working for yourself? Not taxable. Can do services
for yourself wont be taxable.
Dean v. Commissioner
-Personal use of business property create income? Yes.
- Deans transferred their home to a closelyheld corporation so that it could serve as
collateral on a loan to the corporation, but they remained in the home rentfree. IRS
sought taxes on the fair market rental value of the home.
-Court of Appeals affirmed the Tax Court ruling that the Deans were liable to the IRS for
taxes on the rental value of the home. The corporation was paying the rent for the Deans.
CLASS NOTES:
-How is it different from living in your own home? It is being owned by the corporation
so youre receiving compensation, free use of corporate property.
Problem 1 pg. 57
Vegy grows vegetables in her garden. Does Vegy have gross income when:
(a)
(b)
Vegy and her family consume $100 worth of vegetables? No. Can enjoy your own
property.
(c)
Vegy sells vegetables for $100? Yes. She has exchanged products for money.
(d)
Vegy exchanges $100 worth of vegetables for $100 worth of tuna ,which Charlie
caught? Yes that is recognition of income for both of them. It was barter.
B. GIFTS
-Exclude gifts because we assume they have already paid taxes on it. (Just one
reason).
102. Gifts and inheritances
(a) General rule.Gross income does not include the value of property acquired by
gift, bequest, devise, or inheritance.
(b) Income.Subsection (a) shall not exclude from gross income
(1) The income for any property referred to in subsection (a); (Example: Stock is
tax free but the dividends are taxable) or
(2) Where the gift, bequest, devise, or inheritance is of income form property, the
amount of such income. (Example: Given the dividends from stock for next 10
years, is still taxable).
(c) (1)- Gifts and Inheritances. Employee Gifts. In General.Subsection (a) shall
not exclude form gross income any amount transferred by or for an employer to,
or for the benefit of, an employee.
(a) General Rule. Property received as a gift, or received under a will or under
statutes of descent and distribution, is not includible in gross income, although the
income from such property is includible in gross income. An amount of principal
paid under a marriage settlement is a gift. However, see Section 71 and the
regulations thereunder for rules relating to alimony or allowances paid upon
divorce or separation. Section 102 does not apply to prizes and awards (see
section 74 and 1.74-1) nor to scholarships and fellowship grants (see section
117 and the regulations thereunder)
(b) Income from gifts and inheritances. The income from any property received as
a gift, or under a will or statue of descent and distribution shall not be excluded
form gross income under paragraph (a) of this section.
102- an exclusion- Gross income does not include the value of property acquired by gift,
bequest, devise or inheritance. These are specifically excluded from income.
-Not Excluded:
Problem pg. 69
2. At the Heads Eye Casino is Vegas, Lucky Louie gives the matre d a $50 tip to
assure a good table, and gives the croupier a toke after a good night with the
cubes. Does either the matre d or the croupier have gross income? Yes.
Intending to give them money in return for something. Tips are not gifts.
BONUS: Professor received an extra copy of a textbook as an unsolicited mailing
from publisher who wanted to recommend the book to students. The professor
gave the book to a student. Is the book income to the student? Was the textbook
income to the professor? The book is not income to the student. It is a gift.
-Yes? Because it was give to the professor hoping he would help them sell
it. However, could argue it has no fair market value.
Employee Gifts
**A transfer from an employer is very rarely a gift
102(c) Denial of exclusion from income for employee gifts*
274(b) Disallowance of deduction for business or profit-making activities for gifts that
exceed $25*
**Disallowance of deduction for business or profit making activities for gifts that exceed
$25.
(1) Limitations.No deductions shall be allowed under section 162 or section 212
for any expense for gifts made directly or indirectly to any individual to the extent
that such expense, when added to prior expenses of the taxpayer for gifts made to
such individual during the same taxable year, exceeds $25. For purposes of this
section, the term gift means any item excludable form gross income of the
recipient under section 102 which is not excludable from his gross income under
any other provision of this chapter, but such term does not include
(A) An item having a cost to the taxpayer not in excess of $4.00 on which the
name of the taxpayer is clearly and permanently imprinted and which is one
of a number of identical items distributed generally by the taxpayer, or
(B) A sign, display rack, or other promotional material to be used on the
business premises of the recipient.
(2) Special rules.
(A) In the case of a gift by a partnership, the limitation contained in paragraph (1)
shall apply to the partnership as well as to each member thereof.
(B) For purposes of paragraph (1), a husband and wife shall be treated as one
taxpayer.
**In general, 102(a) does not apply to the employer-employee relationship. Any
purported gift between them is taxed.
However, there are exceptions:
1. 74(c), certain Achievement Awards are excluded
2. 132(e), Traditional Retirement Gifts
74(c) Prizes and Awards: Exception for certain employee achievement awards.
(1) In General.Gross income shall not include the value of an employee
achievement award (as defined in section 274(j)) received by the taxpayer if the
cost to the employer of the employee achievement award does not exceed the
amount allowable as a deduction to the employer for the cost of the employee
achievement award.
(2) Excess deduction award.If the cost to the employer of the employee
achievement award received by the taxpayer exceeds the amount allowable as a
deduction to the employer, then gross income includes the greater of
(A) An amount equal to the portion of the cost to the employer of the award that is
not allowable as a deduction to the employer (but in excess of the value of the
award), or
(B) The amount by which the value of the award exceeds the amount allowable as
a deduction to the employer.
Lyeth v. Hoey- Even if there is a settlement or controversy, the inheritance is free from
tax.
Facts: Woman died, and Petitioner is her grandson. She left four children as heirs;
petitioner and his brother are children of a deceased daughter. Deceased left more than
$3M in trust to benefit Christian Science. During probate, heirs objected that there was a
lack of testamentary capacity and undue influence. In settlement, Petitioner received $80
in cash and shares of a corporation valued at $141,484. The Commissioner treated this as
income and denied petitioners request for a refund.
Issue: Is the property he received taxable income when it is the result of a compromise
agreement to a will contest?
The United States Supreme Court held that the bequest should not be treated as income,
relying on his status as an heir. The Court rejected the arguments that the value was
taxable because it resulted from a court judgment and that the value was taxable because
it did not correlate to the amount bequeathed to the petitioner in her previous will.
Wolder v. Commissioner
Facts: Wolder, an attorney, entered into an agreement with a wealthy client whereby he
would provide a lifetime of legal services free of charge in return for a bequest of 500
shares of common stock in the clients will. The client ultimately left Wolder more than
$15k in cash and 750 shares of stock. Wolder argues that, because of the source, this is
not income. Tax Court found to the contrary.
Issue: Whether a will bequest that functioned as postponed payment for legal services
was taxable income?
Held: Yes. Applied Duberstein, is it a ona fide gift or a method for paying compensation?
Look at the intent. Woman chose to compensate the attorney through a bequest for his
legal services. Just because it was a bequest does hide the fact the she was intending to
compensate him. Congress intended to tax income comprehensively.
**Just because it is in a will doesnt mean that its gratuitous. Look beyond face of
document. Look to why is it there? Gratuitous, tax-free. If compensation, not tax free.
Problems pg. 77
1. Consider whether it is likely that 102 applies in the following circumstances
a) Father leaves Daughter $20,000 in his will. Inheritance. Tax-free.
b) Father dies intestate and Daughter receives $20,000 worth of real estate as
his heir. Still inheritance, hasnt received income from the gift yet. Tax-free.
c) Father leaves several family members out of his will and Daughter and
others attack the will. As a result of the settlement of the controversy
Daughter receives $20,000. Look at the Lyeth v. Hoey case. Still applies. Taxfree.
d) Father leaves Daughter $20,000 in his will stating that the amount is in
appreciation of Daughter's long and devoted services to him. Still probably
tax-free. In appreciation No real services.
e) Father leaves Daughter $20,000 pursuant to a written agreement under
which Daughter agreed to care for Father in his declining years Formal
agreement. Intended to compensate for services. Not tax-free.
f) Same agreement as in (e) above except that Father died intestate and
Daughter successfully enforced her $20,000 claim under the agreement
against the estate Still taxable.
g) Same as (f) above except that Daughter settles her $20,000 claim for a
$10,000 payment. Same outcome. Taxable income.
h) ) Father appointed Daughter executrix of his estate and Fathers will
provided Daughter was to receive $20,000 for services as executrix. Taxable
as services rendered.
i) Father appointed Daughter executrix of his estate and made a $20,000
bequest to her in lieu of all compensation or commissions to which she would
otherwise be entitled as executrix. Still taxable, because you have to do the
service to receive the payment.
2. Boyfriend who has a mental problem with marriage agrees with Taxpayer
that he will leave her everything at his death in return for her staying with
him without marriage. She does, he doesnt, she sues his estate on a theory
of quantum meruit and settles her claim. Is her settlement excludable under
section 102? No. Still compensation for a service. Theres a contract, not a
gratuitous transfer.
3. If the Wolder case arose today, would 102(c) apply to resolve the issue?
Employer-employee relationship? Probably not.
-If an employee benefit is not specifically excluded from gross income, its value
must be included in gross income.
132. Certain fringe benefits.
(a) Exclusion from gross income.Gross income shall not include any fringe
benefit which qualifies as a(1) No-additional-cost service,
(2) Qualified employee discount,
(3) Working condition fringe,
(4) De minimis fringe,
(5) Qualified transportation fringe,
(6) Qualified moving expense reimbursement,
(7)Qualified retirement planning services
I.R.C. 132(b), NoAdditionalCost Services
-Service offered in employers line of business to employee, so long as employer occurs
no additional cost in providing the service, are tax-free.
-Same line of business.
-Offered broadly (nondiscrimination standard).
-Not displacing paying customers
Common Examples
1. Hotels often allow employees free use of unused hotel rooms.
2. Airlines often allow employees to fly standby for free.
Same Line of Business: Has to be the same line if business.
Displacement Ruleu-e of such benefits cannot displace nonemployee
customers (i.e. the hotel cant turn away customers and still give the
employee a room for free; the airline cant bump a passenger to allow the
employee to fly free).
Reciprocal Agreementstwo companies in the same line of business can
have written reciprocal agreements to allow employees of both companies to
use the services of the other taxfree as long as theres no substantial cost in
doing so.
Nondiscrimination Rulebenefits must be provided to a wide crosssection
of employees, not just the highly compensated ones.
I.R.C. 132(c), Qualified Employee Discounts
Discounts on Goodsan employee purchasing goods sold by her employer can
exclude a discount up to the employers gross profit percentage. [(aggregate sales
price aggregate sales cost)/aggregate sales cost].
Gross profit percentage shall be determined on the basis of--(i) all property
offered to customers in the ordinary course of the line of business of the employer
in which the employee is performing services (or a reasonable classification of
property
Problem 1 pg. 87
Consider whether and to what extent the fringe benefits listed below may be
excluded from gross income and, where possible, support your conclusions with
statutory authority
a) Hotel Chain: Excluded under No-additional-cost service. Imposes no
substantial additional cost on the employer since there are other empty
rooms; AND is offered for sale in the ordinary course of business in which the
employee works.
b) Paying Guest Kicked Out: Doesnt qualify if you have foregone revenue.
Reg 132.2(a)(2) says that excess capacity services like hotels are treated as no
additional cost services. BUT here there is no excess capacity? BUT I say it is
still excluded assuming there is no substantial cost to the employer for kicking
the guest out.
c) Bill Rebated: Still excluded. Reg 1.132-2(a)(3) says the exclusion also applies
if the benefit is provided through a partial or total cash rebate of an amount
paid for the service.
d) Spouse and kids use room: Still excluded. Discount and no additional cost
fringes extend to spouses and children.
e) Reciprocal Agreement: Excluded. Two companies in the same line of business
can have written reciprocal agreements to allow employees of both companies
to use the services of the other taxfree as long as theres no substantial cost
in doing so.
f) Special Discount For Officers Not Excluded. Violates the non-discrimination
rule. Probably not since they are substantially the same terms.
g) Shipping Worker in Conglomerate: Not excluded. It violates the same line of
business rule. If he worked for both as an accountant or something it would
be excluded.
h) Controller of Conglomerate: Excluded since as a controller for both lines of
business, he performs substantial services that directly benefit both lines of
business.
(iv) Performance of services that directly benefit more than one line of
business (A) In general. An employee who performs substantial services that
directly benefit more than one line of business of an employer is treated as
performing substantial services in all such line of business.
subparagraph are met, the exclusion shall apply irrespective of whether under an
employment contract or a statute fixing the terms of employment such meals are
furnished as compensation.
(2) Meals furnished without a charge. (i) Meals furnished by an employer without
charge to the employee will be regarded as furnished for the convenience of the employer
if such meals are furnished for a substantial noncompensatory business reason of the
employer
(b) Lodging. The value of lodging furnished to an employee by the employer shall be
excluded from the employee's gross income if three tests are met:
(1) The lodging is furnished on the business premises of the employer,
(2) The lodging is furnished for the convenience of the employer, and
(3) The employee is required to accept such lodging as a condition of his employment.
(c) Business premises of the employer--(1) In general. For purposes of this section, the
term business premises of the employer generally means the place of employment of
the employee. For example, meals and lodging furnished in the employer's home to a
domestic servant would constitute meals and lodging furnished on the business premises
of the employer. Similarly, meals furnished to cowhands while herding their employer's
cattle on leased land would be regarded as furnished on the business premises of the
employer
Herbert G. Hatt
-Hatt married the president and majority stockholder of a corporation that operated a
funeral home. Pursuant to an antenuptial agreement, he became the majority stockholder,
president, and general manager.
-Hatt moved into the apartment located in funeral home building where he would
answerer telephone calls when the office was closed and meet with customers after hours,
which was customary for funeral homes in the area.
-Government said that Hatt was taxable on the apartments fair rental value.
-Government argued that Hatt wasnt required to accept the lodging as a condition of his
employment since there were people already available 24 hours AND that the lodging
wasnt furnished for the convenience of the employer since he could control what was at
their convenience.
-Court said the market value of the rent was excludable and that the condition and
convenience tests were basically similar.
-Court noted that the funeral business requires someone to be available 24 hours a day
and every other funeral home had someone there 24 hours a day. The ambulance crews
CHAPTER 5 AWARDS
A. PRIZES: With very limited exceptions, prizes and awards are includable in
gross income.
74. Prizes and Awards
(a) General Rule.Except as otherwise provided in this section or in section 117
(relating to qualified scholarships), gross income includes amounts received as
prizes and awards.
(b) Exception for certain prizes and awards transferred to charities.
Gross income does not include amounts received as prizes and awards made
primarily in recognition of religious, charitable, scientific, educational, artistic,
literary, or civic achievement, but only if
(1) The recipient was selected without any action on his part to enter the contest
or proceeding;
(2) The recipient is not required to render substantial future services as a
condition to receiving the prize or award; and
(3) The prize or award is transferred by the payor to a governmental unit or
organization described in paragraph (1) or (2) of section 170(c) pursuant to a
designation made by the recipient.
(c) Exception for certain employee achievement awards.
EXCEPTIONS:
Problems pg. 98
1. Each year national sportswriters get together and select the single most outstanding
amateur athlete in the country and award that person a check for $5,000. Michael, a
talented swimmer, has been selected for this years award. The award is giving with the
stipulation that the winner deliver a 15 minute acceptance speech at an awards banquet.
(A) Tuition and fees required for the enrollment or attendance of a student
at an educational organization described in section 170(b)(1)(A)(ii), and
(B) Fees, books, supplies, and equipment required for courses of instruction
at such an educational organization. **Room and board isnt included.
(c) Limitation.
(1) In general.Except as provided in paragraph (2), subsections (a) and (d)
shall not apply to that portion of any amount received which represents
payment for teaching, research, or other services by the student required as a
condition for receiving the qualified scholarship or qualified tuition reduction.
(2) Exceptions.Paragraph (1) shall not apply to any amount received by an
individual under
(A) The National Health Service Corps Scholarship Program under section
338A(g)(1)(A) of the Public Health Service Act, or
(B) The Armed Forces Health Professions Scholarship and Financial
Assistance program under subchapter I of chapter 105 of title 10,
United States Code.
(d) Qualified tuition reduction.
(1) In general.Gross income shall not include any qualified tuition reduction.
(2) Qualified tuition reduction.For purposes of this subsection, the term
qualified tuition reduction means the amount of any reduction in tuition
provided to an employee of an organization described in section 170(b)(1)(A)
(ii) for the education (below the graduate level) at such organization (or
another organization described in section 170(b)(1)(A)(ii)) of
(A) Such employee, or
(B) Any person treated as an employee (or whose use is treated as an
employee use) under the rules of section 132(h).
(3) Reduction must not discriminate in favor of highly compensated, etc.
Paragraph (1) shall apply with respect to any qualified tuition reduction
provided with respect to any highly compensated employee only if such
reduction is available on substantially the same terms to each member of a
group of employees which is defined under a reasonable classification set up
by the employer which does not discriminate in favor of highly compensated
employees (within the meaning of section 414(q)).
(4) Repealed
(5) Special rules for teaching and research assistants.In the case of the
education of an individual who is a graduate student at an educational
organization described in section 170(b)(1)(A)(ii) and who is engaged in
teaching or research activities for such organization, paragraph (2) shall be
applied as if it did not contain the phrase (below the graduate level).
127
(a) Exclusion from gross income.--
(1) In general.--Gross income of an employee does not include amounts paid or expenses
incurred by the employer for educational assistance to the employee if the assistance is
furnished pursuant to a program which is described in subsection (b).
(2) $5,250 maximum exclusion.--If, but for this paragraph, this section would exclude
from gross income more than $5,250 of educational assistance furnished to an individual
during a calendar year, this section shall apply only to the first $5,250 of such assistance
so furnished.
(b) Educational assistance program.-(1) In general.--For purposes of this section an educational assistance program is a
separate written plan of an employer for the exclusive benefit of his employees to provide
such employees with educational assistance. The program must meet the requirements of
paragraphs (2) through (6) of this subsection
Section 117(a) excludes from gross income amounts received as a qualified scholarship
by a degree candidate at an educational organization. The principal requirements of the
exclusion are found in the definition of a qualified scholarship, which is defined as any
amount received as a scholarship or fellowship grant that in accordance with the grant is
used for qualified tuition and related expenses. Those expenses encompass tuition and
enrollment fees at the educational organization as well as fees, books, supplies and
equipment required for courses of instruction. There is no exclusion for amounts which
cover personal living expenses, such as meals and lodging, or for travel and research.
Section 117(d) allows a qualified tuition reduction to be excluded from gross income in
the case of education below the graduate level or at the graduate level if the graduate
student is engaged in teaching or research activities. There is a non-discrimination
requirement.
Note: Although a qualified tuition reduction is eligible for an exclusion from grossincome, to the extent that the reduction represents payment for research, teaching, or
other services required of the student to receive the reduction, the qualified tuition
reduction is required to be included in gross income.
Section 127 permits an employee to exclude up to $5,250 from gross income for amounts
paid by the employer for educational assistance at the undergraduate or graduate level of
education, provided the education assistance programs meets certain requirements related
primarily to non-discrimination in favor of highly compensated employees. Education
assistance under Section 127 includes tuition, books, supplies and an employer provided
educational course, but it does not include assistance for courses involving sports, games,
or hobbies.
Problems pg. 100-101
1. Student working toward an A.B. degree is awarded a scholarship of $15,000 for full
tuition and for room and board during the academic year. The tuition, including the cost
of books, is $10,000, and the room and board costs $5,000. As a scholarship recipient,
Student is required to do about 300 hours of research for the professor to whom he is
assigned. Non-scholarship students, if hired, receive $10.00 per hour for such work.
a.) What tax consequences to Student? 10k could be excluded. The other 5k is taxable.
What about the 3k excluded?
b.) What tax consequences to Student if all students are required to do 300 hours or
research for faculty? Same?
c.) What result if Student is not required to do any research but receives the $15,000 as
an athletic scholarship? Excluded. 10k is excludable, 5k for room and board is included.
d.) ) What tax consequences to Student if Student receives only a tuition scholarship
worth $9,000 (no books) because Students spouse is an employee at a neighboring
educations institution and the tuition scholarship is part of a nondiscriminatory plan
between several institutions applicable to all employees of such institutions? Excluded
under 117(d).
2. Secretary, in a large tax law firm, receives a $10,000 stipend from her firm to assist her
while on a leave of absence to obtain a college degree. The stipend is part of a firm plan
under which all recipients are required to return to the firm following their educational
leave.
a.) What tax consequences to Secretary? Exclude up to 5,250 even though its still
considered compensation for future services. The rest is included in gross income since
its basically compensation for services.
b.) ) What tax consequences to Secretary if she is not required to return to the firm
after competing her degree? 5,250 still excluded, the excess is still probably considered
compensation so that would be included.
c.) What are the tax consequences to Secretary if she is not an employee, but instead
receives the stipend as a prize in an essay contest? As long as it is tied to tuition and
related fees, its excluded.
A. DETERMINATION OF BASIS
-Cost basis: Most common and the default. Its just what you paid for it.
-Transfer basis- When your basis is derived from someone elses basis.
Gift: Donees basis is donors basis. Except for measuring loss, it becomes
the lower between fmv and the donors basis.
Transfer between Spouses:
-Date of Death Basis (Decedent)
-Basis may also be adjusted.
1. COST AS BASIS
*Unless another rule applies, the initial basis of property is its cost to the taxpayer.
Gross income does not include income (other than rent) derived by a lessor of real
property on the termination of a lease, representing the value of such property attributable
to buildings erected or other improvements made by the lessee.
(a) General rule.The adjusted basis for determining the gain or loss from the sale
or other disposition of property, whenever acquired, shall be the basis . . . adjusted
as provided in section 1016.
1012. Basis of propertycost
(a) In general.The basis of property shall be the cost of such property, except as
otherwise provided . . . .(What you paid for it)
Treasury Regulation 1.1012-1 Basis of Property
(a) General Rule. In general, the basis of property is the cost thereof. The cost is the
amount paid for such property in cash or other property. This general rule is
subject to exceptions stated in subchapter O, C, K and P.
1016. Adjustments to basis
(a)General rule.Proper adjustments in respect of the property shall in all cases be
made
(1) for expenditures, receipts, losses, or other items, properly chargeable to capital
account, but no such adjustment shall be made
(A) for taxes or other carrying charges described in section 266, or
(B) for expenditures described in section 173(relating to circulation expenditures),
For which deduction has been taken by the taxpayer in determining taxable income for
the taxable year or prior taxable years.
depreciation deductions based on the cost of the extension and a loss upon abandonment
of the franchise.
*Real issue is basically how the cost basis of property is determined in a taxable
exchange. Court said that the cost basis is the fair market value of property received.
Issue: May the taxpayer use the fair market value of the franchise extension (as of the
date of the exchange) as the cost basis?
Held: The taxpayer was entitled to fair market value of the franchise extension (on the
date of the exchange for the bridge) as the cost basis. The Court remanded the case for
further consideration of what that fair market value actually was.
*The fair market value of what you received determines how much gain you should be
taxed on.
CLASS NOTES:
*If exchanging property, presumed that its equal value. So if something is hard to value
and you atleast know the value of the other, you can determine it.
Problem 2 on page 107
2. In an arms-length exchange, Sharp exchanges some land with a cost basis of
$6,000 and a value of $9,000 with Dull for some non-publicly traded stock which
Dull owns and in which Dull has a basis of $8,000 and is worth $10,000 at the time of
the exchange.
a.) Consider Sharp and Dulls gains on the exchange and their respective cost bases
in the assets that they receive. Sharps amount realized 10k- sharps basis of 6k = has
a gain of 4k. Dull has amount realized of 9k- Dulls basis of 8k =gain of 1k. Sharp
cost basis is 10k and Dulls cost basis is 9k? OR
b.) What results in (a), above, if the value of Dulls stock cannot be determined
with any reasonable certainty? Assume that the fair market values are equal. So
Sharp would now have a 3k gain. Amount realized of 9k Basis of 6k= 3k.
(a) Gifts after December 31, 1920.If the property was acquired by gift after
December 31, 1920, the basis shall be the same as it would be in the hands of the
donor or the last preceding owner by whom it was not acquired by gift, except
that if such basis (adjusted for the period before the date of the gift as provided in
section 1016) is greater than the fair market value of the property at the time of
the gift, then for the purpose of determining gain or loss the basis shall be such
fair market value. If the facts necessary to determine the basis in the hands of the
donor or the last preceding owner are unknown to the donee, the Secretary shall,
if possible, obtain such facts from such donor or last preceding owner, or any
other person cognizant thereof. If the Secretary finds it impossible to obtain such
facts, the basis in the hands of such donor or last preceding owner shall be the fair
market value of such property as found by the Secretary as of the date or
approximate date at which, according to the best information that the Secretary is
able to obtain, such property was acquired by such donor or last preceding owner.
Treasury Reg. 1.1015-1 Basis for property acquired by gift after December 31,
1920.
(a) General Rule.
(1) In the case of property acquired by gift after December 31, 1920 (whether by
a transfer in trust or otherwise), the basis of the property for the purpose of
determining gain is the same as it would be in the hands of the donor or the
last preceding owner by whom it was not acquired by gift. The same rule
applies in determining loss unless the basis (adjusted for the period prior to
the date of gift in accordance with sections 1016 and 1017) is greater than the
fair market value of the property at the time of the gift. In such cases, the basis
for determining loss is the fair market value at het time of the gift.
(2) The provisions in subparagraph (1) of this paragraph may be illustrated by the
following example.
Example: A acquires by gift income-producing property, which has an adjusted
basis of $100,000 at the date of gift. The fair market value of the property at the
date of gift is $90,000. A later sells the property for $95,000. In such cases, there
is neither gain nor loss. The basis for determining loss is $90,000; therefore, there
is no loss. Furthermore, there is no gain, since the basis for determining gain in is
$100,000.
Section 1015(a), Property Acquired by Gift
i. Generally, for property acquired by gift, basis is the same as it would be in the
hands of the donor.
ii.
If the property has a fair market value less than basis (its taken a loss), basis is
the fair market value.
Taft v. Bowers, U.S. Supreme Court (1929)
Father gave shares of stock to daughter in 1921 and 1922. She sold them in 1923 for
more than their fair market value at the time the gift was made. The I.R.S. demanded
income tax on the difference between the cost to the donor and the price received by the
daughter. She paid the tax and then demanded a refund.
*She thought the cost basis should be determined by the fair market value of the stock
when it was given to her, and not when he originally bought it.
Held: The Court Affirmed and held that she should be taxed on the gain based on the
value of the stock when acquired by the donor.
*When she accepted the gift, she assumed the position of the owner.
The Court noted that Taft took the gift knowing the law and she benefited from the
increase in value.
Further, when the stock was sold she did not receive only gain in value, but it included
the original amount as paid by her donor father.
FaridEsSultaneh v. Commissioner,
Man and woman had an agreement that she would promise to marry him in exchange for
shares of stock.
Sulataneh and Kresge were eventually divorced. Sultaneh then sold 12,000 shares of the
S.S. Kresge stock for $230,802.36.
-The Commissioner of Internal Revenue characterized the stock as a gift and thereby
counted the donors basis for determining the gains.
-Wife contended that the stock was not a gift; it was consideration in a contract.
Therefore, the basis should be calculated from the date of her acquisition. The Tax Court
found for the Commr.
HOLDING: The stock was not a gift and thus, the basis at the time acquired by Miss
Sultaneh should be used.
*She gave consideration for the stock, a promise to marry so no gift. Costs basis is the
date she acquired the stock.
*A transfer that is designated as a gift under gift tax law doesnt necessarily mean it is to
be treated as a gift income-tax wise.
CLASS NOTES:
Sale = Cost Basis Rule
Gift= Transfer Basis Rule
(a) General rule.No gain or loss shall be recognized on a transfer of property from
an individual to (or in trust for the benefit of)
(1) A spouse, or
(2) A former spouse, but only if the transfer is incident to the divorce.
(b) Transfer treated as a gift; transferee has transferors basis.In the case of
any transfer of property described in subsection (a)
(1) For purposes of this subtitle, the property shall be treated as acquired by the
transferee by gift, and
(2) The basis of the transferee in the property shall be the adjusted basis of the
transferor.
(c) Incident to divorce.For purposes of subsection (a)(2), a transfer of property is
incident to the divorce if such transfer
(1) Occurs within 1 year after the date on which the marriage ceases, or
(2) Is related to the cessation of the marriage.
d.) ) What results in (a)-(c) above, if the property had declined in value to
$30,000 and Andree sold it to Steffi for $30,000? Non-recognition of gain or
loss.
e.) ) What results (gains, losses, and bases) to Andre and Steffi if Steffi transfers
other property with a basis of $50,000 and value of $70,000 (other than cash)
to Andre in return for his property? No gains or losses. Andres basis would be
50k in the property.
on the decedents death AND if the property (or proceeds therefrom) passes from
the decedent back to the donor or the donors spouse, the basis in the property is
the adjusted basis of the property in the hands of the decedent immediately before
the death.
The Section 1014 basis rule is an important element in estate planning. It means that,
although appreciated property is fully subjected to the estate tax, the appreciation itself
entirely escapes the income tax. Thus, elderly people with substantially appreciated
property often choose not to sell such property in order to avoid income taxation and are
said to be locked-in to their positions.
*Relief of indebtedness is included in your amount realized and allow you to take a
depreciation deduction.
International Freighting Corp. v. Commissioner
-The taxpayer in this case is a corporation. The corporation had a bonus plan in which it
would pay their employees shares of common stock of their parent company.
-In 1936, the corporation gave out bonuses in shares of stock, which cost the corporation
about 16k but had a market value of 24k.
-Corporation took a 24k deduction on account of the bonuses paid but the Commissioner
reduced the deduction to 16k arguing that the basis for determining the amount is the cost
of the property and not the fair market value.
- Commissioner argued that if Taxpayer were entitled to a deduction in the amount of
$24k, then Taxpayer realized a gain that should be reported as taxable profit. The Tax
Court held that the Taxpayer was entitled to the full deduction and that the profit should
count as gross income.
-**Court of appeals affirmed the tax courts ruling, holding that the market value was the
stock was properly deductible and that the transfer to the employees resulted in a taxable
gain.
-***There was a taxable gain on the difference between the market value of the shares
and the actual cost of the shares.
-**The delivery of shares was a disposition for valid consideration, but resulted in a
taxable gain.
((Amount realized was the fmv of the stock.
-The Commissioner of Internal Revenue determined that Crane realized a net taxable gain
of $23,767.03. The Commissioners theory was that the property sold was not equity in
the building; it was the physical property. Per the Commissioner, the basis reduced based
on the deductions she took, and as a result, the basis was less than the mortgage
liability. The difference between the liability and the basis$23,767.03constituted a
gain when she sold the property and the liability
HOLDING: -Supreme Court agreed with the Commissioner held that the proper basis
was the value of the property, adjusted by deductions, but undiminished by the mortgage.
The Court looked at the meaning of property and concluded that it included the physical
thing that is subject to ownership or the aggregate of the owners rights to control and
dispose of it.
Seller received benefit by relief of mortgage indebtedness
Rule: A person who sells property with by a nonrecourse mortgage, must include the
unpaid balance of the mortgage in when computing the amount realized.
This case stands for the idea that non-recourse liability will occupy the same posture for
tax purposes as full recourse liability does.
Basically, a taxpayer is treated as having realized proceeds from the elimination of a debt
even if that taxpayer had no personal liability for the debt.
**RELIEF of indebtness is
**This case basically asks whether the Crane ruling applies when the unpaid amount of a
nonrecourse mortgage exceeds the fair market value of the property sold. Court said it
did.
Held: Supreme Court rule in favor of IR.
*When a taxpayer sells or disposes of property, he is required to include the outstanding
amount of the obligation as part of the amount realized.
It isnt relevant that this was a non-recourse loan or that the loan was in excess of the fair
market value of the property at the time.
-Its just as if the buyer gave them the full 1.8 to fulfill their obligation.
Problems 1,2 pg. 135-136
1.) Mortgagor purchases a parcel of land from Seller for $100,000. Mortgagor borrows
$80,000 from Bank and pays that amount and an additional $20,000 of cash to seller
giving Bank a nonrecourse mortgage on the land. The land is the security for the
mortgage which bears an adequate interest rate.
a.) What is Mortgagors cost basis in the land? 100k
b.) Does Mortgagor have income when she takes out a second nonrecourse
mortgage after the property has appreciated to $300,000? No. Loans arent
considered income. Still has an obligation to repay.
c.) What is Mortgagors basis in the land if the $100,000 or mortgage proceeds
are used to improve the land? 200k. Example of how you can adjust basis.
d.) What is Mortgagors basis in the land if the $100,000 or mortgage proceeds
are used to purchase stock and bonds worth $100,000? 100k basis in the land.
Other 100k not used to improve the land.
e.) What result under the facts of (d) above if when the principal amount of the
two mortgages is still $180,000 and the land is still worth $300,000, Mortgagor
sells the property subject to both mortgages to Purchaser for $120,000 of cash?
What is Purchasers cost basis in the land? The amount realized will be 300k for
the mortgagor with a 200 gain. Purchasers basis would only be 300k (120 cash,
and 180 in mortgages is what he put into it).
2.) Investor purchased three acres of land, each acre worth $100,000 for $300,000.
Investor sold one of the acres in year one for $140,000 and a second in year two for
$160,000. The total amount realized by Investor was $300,000 which is not in excess of
her total purchase price. Does Investor have any gain or loss on the sales? It would be a
gain. Basis in each parcel would be 100k. 40k gain on the first, and 60k gain on the
second.
I.R.C. 101(a)(2), Transfer for valuable consideration.--In the case of a transfer for a
valuable consideration, by assignment or otherwise, of a life insurance contract or any
interest therein, the amount excluded from gross income by paragraph (1) shall not
exceed an amount equal to the sum of the actual value of such consideration and the
premiums and other amounts subsequently paid by the transferee. The preceding sentence
shall not apply in the case of such a transfer-(A) if such contract or interest therein has a basis for determining gain or loss in
the hands of a transferee determined in whole or in part by reference to such basis
of such contract or interest therein in the hands of the transferor, or
(B) if such transfer is to the insured, to a partner of the insured, to a partnership in
which the insured is a partner, or to a corporation in which the insured is a
shareholder or officer.
The term other amounts in the first sentence of this paragraph includes interest paid or
accrued by the transferee on indebtedness with respect to such contract or any interest
therein if such interest paid or accrued is not allowable as a deduction by reason of
section 264(a)(4).
CLASS NOTES: Most of the time insurance proceeds of gratuitous transfer are not
taxable, but if you sold it or treated it like an investment, then it is taxable.
But, often times it becomes necessary to tap the life insurance before you die. If you are
chronically or terminally ill, you may be unable to work, but still have substantial
expenses. To deal with this, Congress has put special rules into the Code for accelerated
death benefits.
(d) Payment of life insurance proceeds at a date later than death.-(1) General rule.--The amounts held by an insurer with respect to any beneficiary
shall be prorated over the period or periods with respect to which such
payments are to be made. There shall be excluded from the gross income of such
beneficiary in the taxable year received any amount determined by such proration.
Gross income includes, to the extent not excluded by the preceding sentence,
amounts received under agreements to which this subsection applies.
(2) Amount held by an insurer.--An amount held by an insurer with respect to
any beneficiary shall mean an amount to which subsection (a) applies which is-(A) held by any insurer under an agreement provided for in the life
insurance contract, whether as an option or otherwise, to pay such amount
on a date or dates later than the death of the insured, and
(B) equal to the value of such agreement to such beneficiary
(i) as of the date of death of the insured (as if any option exercised
under the life insurance contract were exercised at such time), and
(ii) as discounted on the basis of the interest rate used by the
insurer in calculating payments under the agreement and mortality
tables prescribed by the Secretary.
(3) Application of subsection.--This subsection shall not apply to any amount to
which subsection (c) is applicable.
I.R.C. 101(g), Accelerated Death Benefitsbenefits received from a life insurance
policy on the life of a terminally ill or chronically ill insured person are treated as paid
by reason of the death of the insured under 101(a)(1), and as a consequence are
excluded from gross income.
I.
II.
Another issue to consider is that of insureds who take money before death, who receive
amounts in excess of the policy value.
i.
ii.
If one takes a cash surrender during life, the insured will realize an amount in
excess of the basis, which is taxable gain unprotected by these exclusions.
If a beneficiary takes fixed monthly payments for life, these may also cause the
realization of an amount in excess of basis. If this is the case, one must turn to the
mortality tables to calculate the taxable amount.
Viatical Settlements
I.R.C. 101(g)(2), Viatical SettlementsAny amount one receives from a viatical
settlement is considered to be by reason of death, and therefore not taxable.
DIRUSSO KEY POINTS
Generally, life insurance proceeds paid by reason of the death of the insured are excluded
from gross income.
Transfers during life of an insurance policy do not benefit from this exclusion and may
trigger taxable gain, except in the case of Viatical settlements for terminally ill or
chronically ill people.
Interest payments on insurance proceeds remain taxable.
Insurance proceeds paid out over time are excluded only.
Problems pg. 140
1. Insured died in the current year owning a policy of insurance that would pay
Beneficiary $100,000 but under which several alternatives were available to beneficiary.
a. What result if Beneficiary simply accepts the $100,000 in cash? Excludable.
Treat just like a gift.
b. What result in (a), above, if Beneficiary instead leaves all the proceeds with
the company and they pay her $6,000 interest in the current year? 6k interest is
not excludable.
c. What result if Insureds daughter is beneficiary of the policy and in accordance
with an option that she elects, the company pays her $12,000 in the current year?
Assume that such payments will be made annually for her life and hat she has a
25-year life expectancy. Use a ratio for policies paid overtime. 4k each year is tax
free. (100k/25). The rest is subject to tax.
d. What result in (c) above if Insureds daughter lives beyond her 25-year life
expectancy and receives $12,000 in the twenty-sixth year? Still going to be taxed
on the 8k and not the 4k.
3.
Insured purchases a single-premium $100,000 life insurance policy on her life for
a cost of $40,000. Consider the income tax consequences to Insured and the
purchaser of the policy in each of the following alternative situations
a. Insured sells the policy to her Child for its $60,000 fair market value and on
Insureds death the $100,000 of proceeds are paid to Child. Taxable on the 40k.
100k-60k. Not a gift but a transfer. Insurer would pay tax on 20k. (60-40)
b. Insured sells the policy to her Spouse for its $60,000 fair market value and on
Insureds death the $100,000 of proceeds are paid to Spouse. Spouse gets a
transfer basis of 40k. No gain recognized.
c. Insured is certified by her physician as terminally ill and she sells the policy for
its $80,000 fair market value to Viatical Settlement Provider who collects the
$100,000 of proceeds on Insureds death? Excludable because shes terminally
ill. Viatical settlement provider basis would be 80k.
B. ANNUITY PAYMENTS
-Generally, only the portion of an annuity payment that reflects the return of the initial
capital investment is excluded from gross income. The portion that reflects earnings
from that investment is included.
-Once you get your entire investment back, everything else is subject to tax. : If you die
before you get all your basis back, you may deduct what remains of your basis in that
year.
-Different from life insurance.
Exclusion Ratio: Same as life insurance
Problem 1 pg. 145
1. In the current year, T purchases a single life annuity with no refund feature for
$48,000. Under the contract T is to receive $3,000 per year for life. T has a 24-year life
expectancy.
a. To what extent, if at all, is T taxable on the $3,000 received in the first
year? Exclusion Ratio: 3k*24= 72k is expected return. We put 48k in. So
what is 48/72 reduces to 2/3. So two thirds is excluded and only taxed on
one third, so he will be taxed on 1k per year, other 2k is excluded.
b.
If the law remains the same and T is still alive, how will T be taxed on the
$3,000 received in the thirtieth year of the annuity payments? Will be
taxed on all of it (different from life insurance).
d. To what extent are T and Ts spouse taxable on the $3,000 received in the
current year if at a cost of $76,500 they purchase a joint and survivorship
annuity to pay $3,000 per year as long as either lives and they have a joint
life expectancy of 34 years? 3k*34: 102k. Ends up giving you a
exclusion ratio. 2,250 is excluded. So 750 is taxable.
given credit at the casino. So, he was losing on credit. The casino brought an action
against Zarin to recover the debt. Zarin protested, claiming that under New Jersey law, he
did not owe the debt. They settled for $500,000. The I.R.S. attempted to collect the
balance of the debt as income from the forgiveness of debt.
Held: No income. The settlement is governed by the contested liability doctrine. Under
which a taxpayer, who in good faith, disputes the amount of the debt, may treat the
settlement value as the amount of debt for tax purposes. Since Zarin was deemed to have
owed $500,000, and because he paid the $500,000 debt, there were no adverse tax
consequences to Zarin.
CLASS NOTES: Did not find a financial gain because theres no relief from indebtedness
since it was not a legally enforceable debt.
**Special Rule applies to bankruptcy. In certain proceedings you wont recognize the
relief of indebtedness as taxable income.
(f) Student loans.-(1) In general.--In the case of an individual, gross income does not include any amount
which (but for this subsection) would be includible in gross income by reason of the
discharge (in whole or in part) of any student loan if such discharge was pursuant to a
provision of such loan under which all or part of the indebtedness of the individual would
be discharged if the individual worked for a certain period of time in certain professions
for any of a broad class of employers.
(2) Student loan.--For purposes of this subsection, the term student loan means any
loan to an individual to assist the individual in attending an educational organization
described in section 170(b)(1)(A)(ii) made by
(3) Exception for discharges on account of services performed for certain lenders.
(4) Payments under National Health Service Corps Loan Repayment Program and
certain State loan repayment programs
Revenue Ruling 2008-34
Facts: C, attended law school and has student loan debt. The loan documents do not
specify whether any of the indebtedness would be forgiven if C worked in a particular
profession for a specified period of time. Cs law school offers a Loan Repayment
Assistance Program (LRAP) to help reduce the student loan debt of graduates who
engage in public service. To qualify a graduate must work in a law-related public service
position for a tax-exempt charitable organization or a governmental unit.
Law:
Under Section 61(a)(1) gross income includes income from the discharge of
indebtedness.
Section 108(f)(1) provides that in the case of an individual, gross income does not
include any amount from the discharge of any student loan if the discharge was
pursuant to a provision of such loan under which all or part of the indebtedness
would be discharge if the individual worked for a certain period of time in a
certain profession for any of a broad class of employers.
Section 108(f)(2) defines student loan to include any loan to an individual to
assist the individual in attending an educational organization. This includes loans
made by the educational institution which are designed to encourage its students
to serve in occupations with unmet needs or in areas with unmet needs, where the
services provided by the student are for or under the direction of a non-profit or
governmental organization. A public service requirement is a part of this type of
loan.
Analysis: The terms of Cs LARP provides for loan forgiveness only if C works for a
certain minimum period of time in a qualifying law-related public service position. This
comports with the requirements of 108(f)(1). Additionally, the law schools LARP is
designed to encourage its students to engage in public service in occupations and areas of
unmet needs, meeting the definition of student loan in 108(f)(2).
Holding: The terms of the loan made under the LARP satisfy the requirements of
108(f)(1), and the LARP loan is a student loan within the meaning of 108(f)(2).
(Lets defer our concern for Nephew.) What result to Decedents estate? Debt is
discharged so 5k of taxable income to the estate because the SOL had run.
(b) What result to the estate in (a) above (with Decedent still in cold storage) if instead
Friend simply permitted the statute to run stating that she felt sorry for Decedents
widow, the residuary beneficiary of his estate? No relief of indebtedness comes off as a
gift. Looks like discharge but it is a gift.
(c) Now, what result to Nephew if Decedents will provided that his estate not collect
Nephews debt to the estate? Not taxable because its a bequest.
**Gratuitous transfers for relief of indebtedness are not taxable income.**
(b) What result to Debtor under the facts of (a) above if instead Debtor transferred some
land worth $8,500 with a basis of $2,000 to Plaintiff to satisfy the obligation? What is
Plaintiffs basis in the land? 6,500 of taxable income. Ps basis is 8,500.
(c) Plaintiffs suit was based on a breach of a business contract and Plaintiff recovered
$8,000 for lost profits and also recovered $16,000 of punitive damages. 24k is taxable.
Punitive damages are always taxable.
(d) Plaintiffs suit was based on a claim of injury to the goodwill of Plaintiffs business
arising from a breach of a business contract. Plaintiff had a $4,000 basis for the goodwill.
The goodwill was worth $10,000 at the time of the breach of contract.
(1) What result to Plaintiff if the suit is settled for $10,000 in a situation where the
goodwill was totally destroyed? 6k taxable and 4k of return of capital.
(2) What result if Plaintiff recovered $4,000 because the goodwill was partially
destroyed and worth only $6,000 after the breach of contract? Just return of capital for
the first 4k.
(3) What result if Plaintiff recovers only $3,000 because the goodwill was worth $7,000
after the breach of contract? 3k is
C. Damages and other Recoveries for Personal Injuries
- Certain damages that reflect payment for physical injuries or physical sickness may be
excluded from taxable income.
I.R.C. 104(a): ) In general.--Except in the case of amounts attributable to (and not in
excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for
any prior taxable year, gross income does not include
I.R.C. 104(a)(1), Workers Compensation Excludesbenefits paid to an employees
survivors under state WC acts and similar statutes in the case of jobrelated death.
Does Not Excludebenefits paid to the employee for jobrelated injuries; non
occupational benefits, such as amounts paid for disability during employment but not
caused by injury or sickness.
104(a)(2), Tort Damages Excludesdamages incurred on account of personal physical
injuries or physical sickness; damages incurred emotional distress to the extent those
damages required medical care; does not exclude other ED damages.
Does Not Excludedamages for nonphysical injuries, such as defamation, First
Amendment rights, and sex and age discrimination.
Settlement AgreementsIf the parties settle, the Tax Court will follow the express
allocation of compensatory and punitive damages in the settlement agreement for tax
purposes if the agreement is reached in an adversarial context, at arms length, and in
good faith. Trial Judgmentthe court will use the values demanded in the complaint to
establish the ration of nontaxable compensatory damages to taxable punitive damages.
the nature of the injury and not to the period the employee is absent from work, the
amount is excludable from gross income.
**Only briefly discussed** Section 106(a)Section 106(a) excludes from an
employees gross income an employers contributions to accident and health plans set up
to pay compensation to employees for injuries or sickness. The exclusion under Section
106(a) relates, not to amounts paid to employees who are sick or injured, but to amounts
paid by employers for insurance premiums or into funded plans to set up benefits for
employees in case of future sickness or injuries. Fringe-BenefitSection 106(a)
provides a tax-free fringe benefit.
Tax Policy: Provides an economic incentive for employers to provide health insurance
for employees.
Alimony Recapture
***WONTBE ASKED TO DO ON MIDTERM
When front-loaded alimony payments reflect a disguised property settlement, alimony
recapture functions to reverse the effect of payor deduction and payee inclusion by
assigning the payee a deduction and the payor inclusion.
The amount recaptured, which occurs in the third taxable year of the payments is the sum
of the YEAR 2 RECAPTURE and the YEAR 1 RECAPTURE, where:
YEAR 2 RECAPTURE = YEAR 2 PAYMENTS YEAR 3 PAYMENTS - $15,000
YEAR 1 RECAPTURE = [(YEAR 2 PAYMENTS YEAR 2 RECAPTURE) + YEAR 1
PAYMENTS]/2 - $15,000.
Problem 1 pg 184-185
1. Determine whether the following payments are accorded alimony or separate
maintenance status and therefore are includible in the recipients gross income under
71(a) and deductible by the payor under 215(a). Unless otherwise stated, Madonna and
Guy are divorced and payments are called for by the divorce decree.
(a) The divorce decree directs Madonna to make payments of $10,000 per year to Guy
for his life or until he remarries. Madonna makes a $10,000 cash payment to Guy in the
current year. Gets the alimony status.
(b) Same as (a) above except that Madonna, finding herself short on cash during the
year, transfers her $10,000 promissory note to Guy. Not cash so doesnt get the status.
(c) Same as (b) above except that instead of transferring her promissory note to Guy,
Madonna transfers a piece of art work, having a fair market value of $10,000. Not cash
so doesnt get the alimony status.
(d) Same as (a) above except that in addition the decree provide that the payments are
nondeductible by Madonna and are excludible from Guys gross income. No alimony
status because they chose non-alimony treated,
(e) Would it make any difference in (d) above if you learned that Madonna anticipated
that she would have little or no taxable income in the immediate future, making the 215
I.T 4001
-Life insurance premiums are includable by wife and deductible by husdband. Example
of indirect payment that is still treated as alimony.
(b) Mortgage payments of $1,000 per month on their family home which is transferred
outright to Nicole in the divorce proceedings. Qualifies because it is made for her
benefit.
(c) Mortgage payments of $1,000 per month as well as real estate taxes and upkeep
expenses on the house where Nicole is living which is owned by Tom. Doesnt qualify
as alimony. Not just for the benefit of the spouse, also for the benefit of himself.
B. Property Settlements-Property settlements, being transfers between spouses in connection with a divorce,
should be tax-neutral.
Section 1041, Transfers Incident to Divorce (or between Spouses)with respect to
any transfer of property between married persons or once-married persons, any gain is
not recognized. Basis carries over from one party to the other party.
Section 1041 provides a clear non-recognition rule for gains and losses with respect to
any transfer of property between married persons and also between formerly married
persons.
Caveat: However, in regards to transactions between formerly married persons, 1041
only applies when the transfer is incident to divorce.
Section 1041(c), Transfers Incident to DivorceA transfer of property is incident to
divorce if the transfer
(1) Occurs within 1 year after the date on which the marriage ceases, or
(2) Is related to the cessation of the marriage.
Note: If the transfer occurs within 1 year after the marriage ceases, it is automatically
assumed to be incident to divorce, if it occurs after, then it must be related to the
cessation of the marriage.
Young v. Commissioner, 4th Cir. (2001)
Mr. & Mrs. Young were divorced in 1988. They entered into a Settlement Agreement in
1989 which provided that Mrs. Young was to be delivered a promissory note secured by a
deed of trust on 71 acres of property that belonged to Mr. Young under the terms of the
agreement. In 1990, Mr. Young defaulted on his obligation on the note. Mrs. Young
brought a state court action to collect. In 1991, Mrs. Young was awarded a judgment. Mr.
Young only paid a portion of the judgment, so Mrs. Young commenced steps to execute
the judgment. However, before execution of the judgment Mr. and Mrs. Young entered
into a Settlement Agreement under which Mr. Young would transfer 59 acres to Mrs.
Young. Mr. Young retained an option to repurchase. Mr. Young assigned the option to a
third party, who exercised it and bought the property for $2.2 million.
The Issue: What are the tax consequences.
1. Of the transfer between Mr. Young and Mrs. Young?
Even though it is beyond the one year safe harbor, this is clearly a transaction
incident to divorce. The sole reason for the 1992 Settlement was to resolve
disputes that arose from the divorce and subsequent property settlement, therefore
it was related to the cessation of the marriage. This was a 1041 tax neutral
transaction.
2. Of the transaction between Mrs. Young & the Third Party?
Taxable event, income to Mrs. Young.
Notes:
There is no income involved, not to the payee spouse, not to the child. There is no
deduction for the payor spouse.
If any amount specified in a divorce settlement agreement will be reduced on a
child attaining a specific age, marrying, dying, etc., the amount of the reduction
will be treated as an amount fixed for the support of a child, and the balance will
be treated as alimony.
Problems 1. Pg. 198
1. Kris and Kim enter into a written support agreement, which is incorporated into their
divorce decree at the time of their divorce. They have one child who is in Kims custody.
Discuss the tax consequences in the following alternative situations:
(a) The agreement requires Kris to pay Kim $10,000 per year and it provides that $4,000
of the $10,000 is for the support of their child. -6k is treated as alimony. The 4k is tax
neutral.
(b) The agreement requires Kris to pay Kim $10,000 per year, but when their child
reaches age twenty-one, dies, or marries prior to reaching twenty-one, the amount is to be
reduced to $6,000 per year. -6k is alimony, 4k is tax neutral.
(c) The agreement requires Kris to pay Kim $10,000 per year but that the payments will
be reduced to $8,000 per year on January 1, 2008 and to $6,000 per year on January 1,
2012. Kris and Kim have two children: Daughter (born June 17, 1990) and Son (born
March 5, 1993). The amount being reduced is child support, so 4k. The base amount of
6k is alimony.
(d) What result in (a) above if Kris pays Kim only $5,000 of the $10,000 obligation in
the current year? -4k is child support, the balance to alimony, the other 5k is unpaid
alimony.
2. ALIMONY PAYMENTS MADE BY A THIRD PARTY
Annuity payments
Payments from an annuity, even an annuity purchased in connection with a divorce, are
taxable as discussed earlier.
Alimony Trusts
Income from alimony trusts is includable in the income of the payee. No need to deduct
from the income of the payor, because the income was excluded to begin with.
3. DIVORCE
Rules relating to inclusion and deductibility of alimony payments apply only
when there is a divorce. State law generally determines the legal status of parties
as married, separated, or divorced
Applies only once every two years, unless an exception applies allowing fractional
exclusion.
Problems pg. 210
1. Determine the amount of gain that Taxpayers (a married couple filing a joint return)
must include in gross income in the following situations:
(a) Taxpayers sold their principal residence for $600,000. They had purchased the
residence several years ago for $200,000 and living in it over those years. -They have a
gain of 400k and there is a 500k exclusion since they are married. So they arent taxed on
it.
(b) Taxpayers in (a) above purchased another principal residence for $600,000 and sold it
2 years later for $1 million. Same (a). They met the two-year requirement.
(c) What result in (b) above if the second sale occurred 1 years later? 400k gain and is
taxable because they havent lived there long enough, and no exception applies.
(d) [Skip]
(e) What result in (a) above if the residence was Taxpayers summer home, which they
used three months of the year? 400k gain and is taxable. Only applies to the primary
residence.
(f) What result if Taxpayer who met the ownership and use requirements is a single
taxpayer who just sold a principal residence for $400,000 and it had an adjusted basis of
$190,000 after Taxpayer validly took $10,000 of post-1997 depreciation deductions on
the residence, which served as an office in Taxpayers home? -10k is income, but can
exclude the 200k. **Check the answer
Resident is present in a foreign country or countries for at least 330 days during a
period of twelve consecutive months.
Foreign Housing Costs: Section 911 provides an exclusion for amounts paid as
reimbursement of foreign housing expenses if the expenses are paid by the taxpayers
employer. Alternatively, if a taxpayers housing costs are not paid by their employer, they
may take a deduction for a certain limited amount of those expenses.
-Housing expenses include reasonable amounts paid for housing, including utilities.
C. Exclusions And Other Tax Benefits Related To Costs of Higher Education
The code includes a collection of tax benefits for costs of higher education, including:
117 scholarship exclusion
108(f) student loan forgiveness exclusion
162 limited educational expense deduction
132 education as working condition fringe
221 interest deduction for education loans
222 deduction for certain tuition expenses
25A Hope Scholarship and Lifetime Learning Credits
135 exclusion of bond income used for education
529 tax-advantaged college savings plans *Wont have to know for midterm
530 Coverdell educational savings accounts *Wont have to know for midterm.
Section 530 Coverdell Education Savings Accounts **dont have to know for
exam**
(e) Same as (a) above except that Spouses have a modified adjusted gross income of
$100,000 for the year.
If Spouses have a modified adjusted gross income of $100,000, the credit is fully phased
out. 25A(d)(1) and (2). If the modified adjusted gross income had been $92,000, the
$2,000 potential credit would be reduced to $800, because $12,000/$20,000 or 60% of
the
credit
would
be
disallowed
under
25A(d)(1)
and
(2).
(f) What result in (a) above if, before credits, the Spouses has $3,000 of tax liability
and $3,000 of withholding from wages which qualifies for a potentially refundable
credit under 31?
As in problem 1(a), above, Spouses would qualify for a $2,000 25A credit. The credit
would reduce tax liability to $1,000 and result in a $2,000 refund under refundable 31.
See footnote 11 on page 213 of the Text.
(g) Same as (a) above, except that Spouse is also in college. Spouse is in the third
year of college and pays $5,000 in tuition and $500 for books.
Spouse would qualify for a $2,500 (American Opportunity Tax) credit $2,000 plus 25%
of $2,000. 25A(i)(1). Spouse would potentially qualify for the Lifetime Learning
credit but it would be only $2,000 and so the $2,500 credit would be preferable. If
25A(i) did not apply, there would only be a $2,000 credit.
The Lifetime Learning credit is a per taxpayer (not a per student) credit. ( 25A(c)(1))
and since both spouses are "the taxpayer" on a joint return, the results should be the same
as in (a), above, a $2,000 credit. Cf. 25A(d)(3) where "the taxpayer" would be the two
spouses filing a joint return; however, compare Reg. 1.151-1(b) where two personal
exemptions are allowed for the spouses filing a joint return.
(h) Same as (a) above, except that after Law Student graduates, Spouse, who has
not previously attended college, quits work and enters a vocational school as defined
in 25A(f)(2). Spouse pays $10,000 in tuition and Lawyer earns $75,000.
Spouses tuition would qualify for a $2,500 (American Opportunity Tax) credit.
25A(i).
If 25A(i) did not apply, Spouse's tuition would still qualify for a Hope Scholarship
credit since the costs are incurred within the first two years of Spouse's education.
25A(b)(2)(C). $1,500 of Spouse's first $2,000 will qualify for a Hope Scholarship credit.
25A(b)(1).
Federal Taxes and State Activities
The doctrine of intergovernmental immunity has bearing on the history and structure of
taxes imposed by the states on activities of the federal government and, to a more limited
extent, on taxes imposed by the federal government on activities by states.
Interest paid on state-issued (or municipality-issued) bonds is exempt from federal taxes
under certain circumstances.
*After midterm
Ch. 14 Business Deductions
A. INTRODUCTION
-Rather than assessing a tax against gross income, taxpayers are permitted to
deduct certain costs.
Taxpayers may report qualifying business deductions and thereby reduce the
amount of income that is subject to tax.
1. Ordinary.
2. Necessary.
3. A current expense (and not an investment that must be capitalized).
4. Paid or incurred in the taxable year.
5. For carrying on the trade or business.
[P.S. this is only the beginning the expense might otherwise be disallowed or
limited.]
to the current costs of operation; whereas a capital expense benefits many years into the
future. Capital assets cannot be deducted, rather they are depreciated. So, when you
purchase a building, it is not an ordinary expense, it is a capital expenditure, as it benefits
the corporation many years into the future. Therefore, the initial purchase is not an
ordinary expense, however the amortization in subsequent years can be deducted
(depreciation.).
The Big Take Away from Welch Necessary = Appropriate & Helpful.
Ordinary = Current Cost of Operation.
2. EXPENSES
-To be deductible, the cost must be a current expense as opposed to an investment that
must be capitalized.
-When a cost is capitalized, the cost may be recoverable upon sale or disposition of the
asset (by increasing basis and lowering gain) or through depreciation deductions.
-From a taxpayers perspective, a deduction is preferable to capitalizing, because now is
better than later. Expense is now and capitalization is later.
Section 263(a), Capital ExpendituresA taxpayer may not deduct any amount paid for
new buildings or permanent improvements or betterments made to increase the value of
any property.
a.
b.
c.
d.
Commissioner argued that the expenses were indeed necessary, but were not ordinary;
rather, the Commissioner contended that the expenses were a capital investment.
Held: The expenses were both necessary and ordinary. No expansion or improvement of
the property occurred. The basement functioned exactly the same way, both before and
after the addition of the seal. This was a mere repair, and therefore ordinary.
Amounts Paid to Acquire or Create Intangible Property
INDOPCO, Inc. v. Commissioner, United States Supreme Court (1992)
Unilever approached INDOPCO about a friendly takeover. INDOPCO hired an
investment banker and lawyer to appraise and guide the process. INDOPCO paid $2.25M
to the banker, $500K to the lawyers, and $150K in related expenses. The company
deducted the $2.25M as a business expense, subsequently the Commissioner asserted a
deficiency. INDOPCO counterclaimed, asserting that, in addition to the $2.25M, they
should also be able to take a deduction on the $500K and the $150K.
Result: This was a non-deductible capital expenditure. The transaction produced
significant benefits to INDOPCO that extended beyond the tax year in question.
-It had long-term value. Is it useful in the current year or something that adds value over
time?
Big Question: Is it now or is it later?
Problem 1 pg. 310
Landlord incurs the following expenses during the current year on a ten-unit apartment
complex. Is each expenditure a currently deductible repair on a capital expenditure?
a. $500 for painting three rooms of one of the apartments. Deductible
repair. Routine maintenance to keep in its normal working condition.
b. $4,000 for replacing the roof over an apartment. The roof had suffered
termite damage. Depends on how much of the roof. If its the whole
roof, then probably a capital expenditure. If it was just a portion then
probably a deductible repair.
c. $1,000 for patching the entire asphalt parking lot area. Probably a
normal repair to patch the parking lot area.
d. $3,000 for adding a carport to an apartment. Capitalization, it
improves the property as a whole. It adds value.
e. $100 for advertising for a tenant to occupy an empty apartment.
Advertising is an exception to the rule. They are consistently
deductible.
3. CARRYING ON BUSINESS
In order for the costs to be deductible, they must be incurred in the participation of the
business, and not just costs incurred in investigating participation in a new business.
Morton Frank v. Commissioner, Tax Court (1953)
Frank, a career newspaper man, sought to purchase a newspaper to run. They traveled
around the country (Pennsylvania, Ohio, Indiana, Michigan, Minnesota, Wisconsin,
Oklahoma, New Mexico, California, Texas, and Arizona). They eventually settled in
Phoenix, Arizona were Frank worked as an employee of the Arizona Times. He still
wished to purchase a newspaper, so he continued to make trips to find a paper to
purchase. Eventually, he purchased the Canton Repository. Mr. Frank deducted his travel,
telephone and other expenses expended in finding a paper to purchase.
Held: They cant take these deductions under 162(a), 162(a) requires carrying on a
trade or business, and Frank was spending money to find a trade or business, he was not
carrying on so there can be no deduction taken under 162(a).
START-UP COSTS:
General Rule: No deduction for startup costs, unless they are listed in 195.
Section 195, Start-Up Expenditures
a. 195 permits a taxpayer to elect to deduct up to $5,000 of start-up expenditures
in the year in which the business begins, reduced by the amount of start-up
expenditures that exceed $50,000 (thus phased out at $55,000).
b. The remaining start-up costs are amortized over a period of not less than 180
months from the month in which the business begins.
c. One must actually be successful in entering a trade or business to elect 195.
d. Start-up expenditures are only those incurred with respect to:
a. Investigating creation/acquisition of active trade or business;
b. Creating an active trade or business; or
c. Activities engaged in for profit before the day on which the active trade or
business begins, in anticipation of such activity becoming an active trade
or business.
e. The expenditures must be of the type that would be allowable as a deduction if
paid or incurred by an existing trade or business.
Problems on pg. 317
1. Determine the deductibility under 162 and 195 of expenses incurred in the following
situations:
(a) Tycoon, a doctor, unexpectedly inherited a sizeable amount of money from an
eccentric millionaire. Tycoon decided to invest a part of her fortune in the development
of industrial properties and she incurred expenses in making a preliminary investigation.
Not deductible under 162 because she is not actively carrying on business and she is
only looking into it. However, could be a start up expense under 195.
(b) The facts are the same as in (a) above, except that Tycoon, rather than having been a
doctor, was a successful developer of residential and shopping center properties.
Deductible under 162 because he is already carrying on the business.
(c) The facts are the same as in (b) above, except that Tycoon, desiring to diversify her
investments, incurs expenses in investigating the possibility of purchasing a professional
sports team. Not deductible under 162, sports teams are different than real property. but
maybe under 195.
(d) The facts are the same as in (c) above and Tycoon purchases a sports team. However,
after two years Tycoons fortunes turn sour and she sells the team at a loss. What
happens to the deferred investigation expenses? Yes under 195?
(3) In any event the allowance for the compensation paid may not exceed what is
reasonable under all the circumstances
NOTES: If really isnt payment for services then its not deductible. The form of
compensation is not decisive to determine if it is reasonable or not. Doesnt matter what
you call it. Are they disguised dividends? Contingent compensation is closely looked at
by IRS to make sure not disguised dividends.
Exacto Spring Corporation v. Commissioner, 7th Circuit (1999)In 1993 and 1994,
Exacto paid CEO $1.3M and $1.0M respectively. The company deducted these amounts
from its income tax returns. The IRS challenged the deductions, finding that CEOs
reasonable salary would have been only $381K and $400K respectively. The Tax Court
agreed that the salary was excessive, but reduced it only to $900K and $700K
respectively.
Held: CEOs salary was sufficiently related to the rate of return he generated. Judge
Posner embraced an independent investor test.
Independent Investor Test: An executives salary is reasonable so long as it is
reasonably related to the rate of return (adjusted for risk) that the executive can generate.
If the Commissioner can prove that a salary is inflated by dividends or that it does not
compensate for services, then it can nullify the deduction.
Harolds Club v. Commissioner, 9th Circuit (1965)From 1952-1956 Harolds Club, a
Nevada casino, paid Smith annual salaries ranging from $350k to $560k. Smiths sons
owned Harolds, and Smith was the brains of the operation. Profits during the period
ranged from $1.3M to $2M, and the sons received a salary of less than $100k.
Holding: The salary was unreasonable, the evidence failed to support the existence of a
free bargain between Smith and the owners (his sons). Smith was the father and head of
the family and he dominated both the business and the relationship with the sons. The
Court found that the control, which led to the absence of a free bargain, nullified the
deductions.
Section 162(m): Congress has imposed a $1 Million dollar ceiling on the amount of
compensation that a publicly held corporation may deduct in any year as remuneration
for services performed by a covered employee.
Problem 1 pg. 330
1.
Employee is the majority shareholder (248 of 250 outstanding shares) and
president of Corporation. Shortly after Corporation was incorporated, its Directors
The meal is not lavish or extravagant and the taxpayer (or employee of the
taxpayer) attends the meal.
(Theres more fine print and detail too, but these are the high points.)
Uniforms
Deductions relating to employee uniforms qualify only if:
The uniform is not adaptable to general use (can take the place of regular
clothing).
Advertising
-Generally, advertising expenses of a business are deducible in the year in which they are
incurred or paid (even if the benefits extend over time).
However, an expenditure related to advertising may also be a capital expenditure, which
is not deductible. Example: The purchase of property or the construction of a billboard or
advertising sign is a non-deductible capital expenditure.
Dues
-Generally, dues paid to organizations directly related to ones business are deductible.
Examples: ABA, BBA etc
Lobbying Expenses
Generally, lobbying expenses are NOT deductible as a business expense.
Lobbying expenses include costs such as those incurred in influencing legislation,
participation in political campaigns, influencing the public with respect to elections or
legislative matters, or direct communications attempting to influence executive branch
officials.
*Exceptions: The limitation does not apply to (1) influencing legislation at the local level,
(2) in-house lobbying expenses of up to $2,000 per year, or (3) lobbying expenses
incurred by professional lobbyists directly on behalf of another person.
(3) $100 in newspaper ads to acquire a job as a property manager in his spare time. Not
deductible because not related to current trade or business.
(4) $200 in union dues. Deductible.
(5) $50 in political contributions to his local legislator who he hopes will push
legislation beneficial to airline pilots. Local mean state? So probably deductible.
(6) $500 in fees to a local gym to keep in physical shape for flying. Not deductible.
What is the total or Pilots deductible 162 expenses? $480.
2. BUSINESS LOSSES
Qualifying business losses may be deductible. Section 165(c)(1) permits the deduction
by an individual of any loss incurred in a trade or business.
Many other kinds of losses are disallowed may be experienced by the taxpayer, but not
recognized for tax purposes.
165. Losses (a) General rule.--There shall be allowed as a deduction any loss
sustained during the taxable year and not compensated for by insurance or otherwise.
(b) Amount of deduction.--For purposes of subsection (a), the basis for determining the
amount of the deduction for any loss shall be the adjusted basis provided in section 1011
for determining the loss from the sale or other disposition of property.
(c) Limitation on losses of individuals.--In the case of an individual, the deduction
under subsection (a) shall be limited to-(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered into for profit, though not connected
with a trade or business; and
(3) except as provided in subsection (h), losses of property not connected with a
trade or business or a transaction entered into for profit, if such losses arise from
fire, storm, shipwreck, or other casualty, or from theft
280B. Demolition of structures: In the case of the demolition of any structure--
(1) no deduction otherwise allowable under this chapter shall be allowed to the owner or
lessee of such structure for-(A) any amount expended for such demolition, or
(B) any loss sustained on account of such demolition; and
(2) amounts described in paragraph (1) shall be treated as properly chargeable to capital
account with respect to the land on which the demolished structure was located.
Problem pg. 368
1. Taxpayer has an automobile used exclusively in Taxpayers business, which was
purchased for $40,000 and, as a result of depreciation deductions, has an adjusted basis of
$22,000. When the automobile was worth $30,000, it was totally destroyed in an
accident and Taxpayer received $15,000 of insurance proceeds.
(a) What is Taxpayers deductible loss under Section 165? Car was used in trade or
business. Adjusted Basis (22k)-15k=7kLoss.
(b) What result in (a) above if the automobile had not been totally destroyed but was
worth $10,000 after the accident? Choose the lower of basis or change in value. The
change in value was 20k which is lower than the adjusted basis, so go with the lower of
20k. So 20k-15k=5k
(c) What is Taxpayers adjusted basis in the automobile in (b) above if Taxpayer incurs
$17,000 fixing the automobile? 2k basis increased by 17k basis son basis is now 19k.
*LEFT OFF HERE, CONCETATE ON E1.
E. DEPRECIATION
**Only responsible for the basic introduction.**
1. INTRODUCTION
Certain assets that are not eligible for current business deductions may
instead be eligible for depreciation deductions.
Depreciation Basics:
Useful Life: Assets are depreciated over the time they are expected to last
(or some time period estimated to be such or deliberately underestimated
to allow faster recovery of investment).
167. Depreciation
(a) General rule.--There shall be allowed as a depreciation deduction a
reasonable allowance for the exhaustion, wear and tear (including a reasonable
allowance for obsolescence)-(1) of property used in the trade or business, or
(2) of property held for the production of income.
(c) Basis for depreciation.-(1) In general.--The basis on which exhaustion, wear and tear, and
obsolescence are to be allowed in respect of any property shall be the adjusted
basis provided in section 1011, for the purpose of determining the gain on the sale
or other disposition of such property.
(2) Special rule for property subject to lease.--If any property is
acquired subject to a lease-(A) no portion of the adjusted basis shall be allocated to the leasehold
interest, and
(B) the entire adjusted basis shall be taken into account in determining the
depreciation deduction (if any) with respect to the property subject to the
lease.
Section 1016: Depreciation lowers your basis.
Sharp v. US
FACTS: Sharp and Sharp were business partners who bought an airplane costing
about $54k.
They used the plane 74% of the time for personal use, and 26% of the time
for business use.
For a few years, Sharp and Sharp claimed a deduction on their taxes for
depreciation of the airplane.
Finally, they sold the airplane for $35.3k. When they filed their taxes, they claimed a loss
on the sale. The IRS disagreed and found that they had made a gain on the sale.
Sharp and Sharp argued that their adjusted basis in the plane was $54k $13.7k = $40.5k. Since they sold the airplane for only $35.3k, they lost
$5k.
So, the business part of the airplane was only worth 26% of the
$54k, or about $14.2k. When you subtract out the $13.7k of
depreciation, the adjusted basis of the business part of the airplane
was only $500.
When they sold the airplane, the business part was sold for $35k x
26% = $9300.
Since gains or losses on the personal use part of the airplane are
not deductible, the partnership owes taxes on a gain or $8800.
The Trial Court found for the IRS. Sharp and Sharp appealed.
The Trial Court found that Sharp's logic would result in non-uniformity
between taxes owed on properties used exclusively for business, and those
used for a combination of business and personal uses.
Simon v. Commissioner
The Simons, Petitioners, purchased two violin bows made in the 19th century by Francois
Tourte, a renowned bow maker. They were purchased in 1985 and were virtually unused
at that time. A violin bow will play out eventually and no longer be useful. However,
the Tourte bows retain value as collectors items. The bows at issue were appraised in
1990 at $45,000 and $35,000. At that time they had deteriorated since their purchase by
Petitioners. Petitioners paid $30,000 and $21,500 for the bows. Petitioners used the bows
for their trade as musicians and in 1989, the tax year at issue, they played in four concerts
per week. They claimed depreciation on the bows in the amount of $6,300 and $4,515.
The Tax Court allowed the deductions, and the Commissioner appealed.
Holding for Petitioners and finding that the bows did not have to have a determinable
useful life to qualify for a depreciation deduction, and were deductible.
The Court of Appeals found that the test is whether property will suffer exhaustion, wear
and tear, or obsolescence in its use by a business. The Court points out that the law was
intended by Congress to encourage economic in business property. The Commissioner
argued that businesses could use the law to purchase wasteful antiques. However, the
Court found that the test articulate should prevent abuse by businesses because it requires
demonstrable wear and tear in it business.
CLASS NOTES: Must have a property that is subject to wear and tear.
(a) If Company owns trucks that are used during the year exclusively in constructing a
new storage plant for the Company, is Company allowed a depreciation deduction for the
trucks during the year? Consider what tax alternative there might be and then see
Commissioner v. Idaho Power Co.
-No depreciation because they exclusively used in only construction. You capitalized
construction costs.
(b) Are interest on loans connected with property and taxes on the property which are
paid during the construction period currently deductible? See 263A.
-*Check answer. No depreciation
Meyer J. Fleischman v. Commissioner, Tax Court (1966)Meyer and his wife Joan had
an ante-nuptial agreement, under which upon divorce Meyer would pay Joan $5k to
release all claims to Meyers property. Joan filed for divorce seeking division of property.
While the suit was pending, she filed a separate action to invalidate the ante-nuptial
agreement. Meyer prevailed on the invalidation suit, and the divorce settled.
Procedure: Meyer did not deduct the expenses of the divorce proceedings (good, cause
they are not deductible, they are personal expenses) but he did deduct expenses for
defending the invalidation suit. The Commissioner asserted a deficiency.
Held: No deduction can be allowed here. The invalidation suit arose entirely from a
personal issue. A suit against a taxpayer must be directly connected with or proximately
result from his business before it is a business/profit-making expense.
CLASS NOTES: Personal costs are not deductible.
Problems 1,3 pg. 425
1. Speculator buys 100 shares of Sound Company stock for $3,000, paying her broker a
commission of $50 on the purchase. Fourteen months later she sells the shares for $4,000
paying a commission of $60 on the sale.
a.) She would like to treat $110 paid as commissions as 212 expenses. Why? Can
she? Not deductible because the commissions are part of the cost.
b.) What result in (a) above if instead she sells the shares for $2500 paying a $45
commission on the sale? See 165(c)(2). Doesnt matter that it was a gain or loss
so same answer.
c.) Speculator owned only one-tenth of one percent of the Sound Company stock
(worth $3000) but being an eager investor during the time she owned the stock,
she incurred $500 of transportation, meals, and lodging expenses in traveling
1000 miles to New York City to attend Sounds annual shareholder meeting. May
she deduct her travel under 212(2)? No it is not ordinary for someone with such a
small stake in the company to do. Not deductible.
d.) What result in (c) above if instead Speculator owned 10% of the total
outstanding Sound stock, worth $300,000? It is deductible, he could influence
the company with that significant amount.
e.) What result to Speculator if she incurred the expense in (c) above to attend a
seminar on investments? Not deductible. Educational expenses are personal.
f.) Speculator owns 10% of Sounds stock worth $300,000 and she incurs $10,000
in legal fees and personal costs investigating the operation of the business after
the business has some serious set-backs. Is the $10,000 deductible? Maybe.
Probably need more facts. Is it likely to produce more return? Ordinary and
necessary?
3. Planner consults his attorneys with respect to his estate plan. They decide to make
various inter vivos gifts and draft his will. To what extent, if any, are Planners legal fees
deductible under 212(3)? Legal fees are deductible for determining tax consequences but
not deductible to not to anything unrelated to tax.
Horrman was entitled to the deductions for depreciation, because the property was
held for the production of income. His efforts to rent the property, albeit
unsuccessful, were sufficient.
(ii)
(iii)
Horrman was entitled to a deduction for the expenses incurred in maintaining and
conserving the property for production of income. The improvements he made
were designed to make the property more attractive to potential renters.
Horrman was not entitled to a deduction for the loss on the sale of the property
because no facts supported a shift from (1) his holding the property for the
production of income to (2) a transaction entered into for profit. Simply putting
the house on the market doesnt support the designation; he had the ability to pull
it off the market at any time. A more substantial, definitive event would be
required.
Lowry v. United States, District Court for the District of New Hampshire (1974)
Lowry put up his vacation home for sale and unsuccessfully attempted to rent it while it
remained on the market for several years. Lowry deducted the expenses of caring for and
maintaining the residence. The Service disallowed the deduction and levied a deficiency.
Lawry paid and sued for a refund.
Held: Refund granted, Lowry was entitled to the deduction. The Court held that the facts
supported that Lowry abandoned the home as a residence and transformed the property
into one held for the production of income. The statute permitting a deduction for the care
and maintenance of such property does not require that it actually produce any income,
rather, it requires a factual determination of how the owners regarded and treated the
property. In this case, the court found that it was clear that Lowry was holding the
property for the production of profit.
*Can convert personal property to profit seeking property.
B. INTEREST
-To what extent are payments of interest deductible? Sometimes but not always.
IRC 163. INTEREST
(a) General rule.--There shall be allowed as a deduction all interest paid or accrued
within the taxable year on indebtedness.
(h) Disallowance of deduction for personal interest.-(1) In general.--In the case of a taxpayer other than a corporation, no deduction
shall be allowed under this chapter for personal interest paid or accrued during the
taxable year.
(2) Personal interest. --For purposes of this subsection, the term personal
interest means any interest allowable as a deduction under this chapter other than
(What is deductible:)
(A) interest paid or accrued on indebtedness properly allocable to a trade
or business (other than the trade or business of performing services as an
employee),
(B) any investment interest (within the meaning of subsection (d) ),
(C) any interest which is taken into account under section 469 in
computing income or loss from a passive activity of the taxpayer,
(D) any qualified residence interest (within the meaning of paragraph (3)),
*This is the biggie. Whether you own a house or not.
(E) any interest payable under section 6601 on any unpaid portion of the
tax imposed by section 2001 for the period during which an extension of
time for payment of such tax is in effect under section 6163, and
(F) any interest allowable as a deduction under section 221 (relating to
interest on educational loans).
(3) Qualified residence interest.--For purposes of this subsection--
loaned money; The payment must not be for specific services that the lender performs in
connection with the borrower's account; It is sufficient that the payment is a "prerequisite
to obtaining borrowed capital.
For example, for gift term loans, the value of the constructive interest is the amount
loaned less the present value of the principal (and all actual interest payments to be made,
if any).
For gift demand loans, the value of the constructive interest is the difference between the
interest paid, if any, and the amount that would have been paid under the AFR that year.
7872 does not apply to gift loans or compensation-related loans that are cumulatively
under $10,000. It also does limits constructive interest to net investment income for
loans cumulatively under $100,000.
Soppy v. Commissioner
- The Tax Court has held that unmarried co-owners of two personal residences were not
each allowed to deduct interest on $1.1 million of acquisition and home-equity
indebtedness because the debt limitations are residence based, rather than taxpayer based.
CLASS NOTES: Per-residence basis, not per taxpayer basis.
(a) The purchase price and fair market value of the home is $350,000. Taxpayers obtain a
mortgage for $250,000 of the purchase price. They can deduct all of it. It can go up to
1million.
(b) The facts are the same as in (a), above, except that in 2 years Taxpayers have reduced
the outstanding principal balance of the mortgage to $200,000 and the fair market value
of the residence has increased to $400,000. In the later year, Taxpayers take out a 2nd
mortgage for $100,000 secured by their residence to add a 4th bedroom and a den to the
residence. Yes, either under home equity or acquisition.
(c) The facts are the same as (b), above, except that Taxpayers use the proceeds of the
$100,000 mortgage to buy a Ferrari. Yes, under the home equity indebtedness. You can
buy whatever you want.
4. Single taxpayer, T, who graduated from law school, pays $3,000 of interest in the
current year on qualified educational loans.
(a) If T has $40,000 of modified adjusted gross income in the current year, what amount
of interest can T deduct? -2,500.
(b) Same as (a), above, except T has $56,000 of modified adjusted gross income in the
current year. Phase out. Exceeded by 6k over 15k, which is 2/5. So you lose 2/5 of it but
you can keep 3/5 of it.
(c) Same as (a), above, except T is married and T and Spouse file a joint return and have
$140,000 of modified adjusted gross income in the current year. None. No deduction.
Exceeds the phase out.
(d) Same as (c), above, except that T and Spouse delay paying the $3,000 of interest
(along with a $300 penalty) from the current year to succeeding year when their modified
adjusted gross income is $80,000 (because Spouse ceases working) and when no other
interest payments are made. Only 2,500 is deductible. Can choose to defer, and have a
deduction the year you qualify. *Check.
(e) Same as (a), above, except that F, Ts father makes the $3,000 payment. It is
deductible if there is a parent paying on the behalf of them.
C. TAXES
- To what extent are payments of taxes deductible?
164. Taxes (a) General rule.--Except as otherwise provided in this section, the
following taxes shall be allowed as a deduction for the taxable year within which paid or
accrued:
Cramer v. Commissioner
That's like an installment plan, where Osborn was to pay Cramer monthly
payments and also pay the property taxes.
Osborn was a deadbeat who didn't pay. Eventually, Cramer paid the property taxes
herself and foreclosed the property.
Later that same year, Cramer sold the house to someone else for no gain.
At the same time, Cramer's mother was sick, so Cramer was looking after her
house and paying the property taxes there as well.
Also at the same time, Cramer had bought herself a new house, and was paying
the property taxes there as well.
When Cramer filed her taxes, she deducted the amounts paid in property taxes on
all three residences.
The IRS argued that only the property taxes paid on Cramer's new house
were deductible.
The Tax Court found that the property tax Cramer paid for her Mom's
house was not deductible.
Since the house wasn't owned by Cramer, and she wasn't liable to
pay the taxes, she couldn't claim the deduction even though she
was the one who paid the taxes.
The Court found that the property tax Cramer paid for the house she sold
to Osborn was partially deductible.
In this case, the Court determined that Cramer owned the property for 48 out of the 365
days of the tax year in question, so she is allowed to deduct 48/365th of the amount she
paid in property taxes on that house.
CLASS NOTES: To take the deductions you have to be legally obliged to pay the taxes.
Problems pg. 469
1. Which of the following taxes would be deductible as such under 164?
(a) A state sales tax imposed at a single rate on sellers but required to be separately stated
and paid by purchasers to sellers, applicable to retail sales of any property except food,
clothing, and medicine. It is impossible for us to know at this point in time.
(b) A state real property tax of $1,000 for which A became liable as owner of Blackacre
on January 1st but which B agreed to pay half of when he acquired Blackacre from A on
July 1st. Only deduct the $500. Half to each.
(c) A state income tax. Deductible.
(d) The federal income tax. Not deductible.
(e) A state gasoline tax imposed on customers. Not Deductible.
3. Son who is still in college owns substantial securities. Father, when paying his own
intangibles tax to state X, pays the intangibles tax due by Son.
(a) May Father deduct the tax paid? No. Father has to be legally obliged.
4. Dr. Medic employs Charles to work for her as receptionist. She pays Charles salary
but withholds X dollars to which she adds Y dollars all of which she pays to the federal
government under the Federal Insurance Contributions Act (for social security).
(a) Can Dr. Medic deduct amount X? Amount Y? X + Y? Yes. Cost of doing business.
(b) Is Charles entitled to a deduction for the payments? No. Cant deduct payroll taxes
from federal income taxes.
D. BAD DEBTS, CHARITABLE CONTRIBUTIONS, AND CASUALTY AND THEFT LOSSES
-Will cover more later.
Any loss from an activity to which this section applies not allowed under this section for
the taxable year shall be treated as a deduction allocable to such activity in the first
succeeding taxable year.
(b) Amounts considered at risk
(1) In general
For purposes of this section, a taxpayer shall be considered at risk for an activity with
respect to amounts including
(A)the amount of money and the adjusted basis of other property contributed by
the taxpayer to the activity, and
(B)amounts borrowed with respect to such activity (as determined under
paragraph (2)).
(2) Borrowed amounts
For purposes of this section, a taxpayer shall be considered at risk with respect to
amounts borrowed for use in an activity to the extent that he
(A) is personally liable for the repayment of such amounts, or
(B) has pledged property, other than property used in such activity, as security for
such borrowed amount (to the extent of the net fair market value of the taxpayers
interest in such property).
No property shall be taken into account as security if such property is directly or
indirectly financed by indebtedness, which is secured by property described in paragraph
(1).
(3) Certain borrowed amounts excluded
(A) In general
Except to the extent provided in regulations, for purposes of paragraph (1)(B),
amounts borrowed shall not be considered to be at risk with respect to an activity
if such amounts are borrowed from any person who has an interest in such activity
or from a related person to a person (other than the taxpayer) having such an
interest. **Has to actually be recourse liability, not just disguised.
(d) Definition of loss
For purposes of this section, the term loss means the excess of the deductions allowable
under this chapter for the taxable year (determined without regard to the first sentence of
subsection (a)) and allocable to an activity to which this section applies over the income
received or accrued by the taxpayer during the taxable year from such activity
(determined without regard to subsection (e)(1)(A)).
..
c. The facts are the same as in (a) except that in the third year of operations when the
farm broke even, Taxpayer converted his personal liability of $400,000 to a non-recourse
loan. Recapture applies. So has to recapture 10k of income.
d. The facts are the same as in (b) except that Taxpayer pays off $10,000 of the
nonrecourse loan in year two. Increase in amount at risk by paying off principal of the
nonrecourse loan. 160k at risk, and 160k worth of deduction. So no recapture.
e. The facts are the same as in (b) except that the farm breaks even in year three and
Taxpayer pays off $10,000 of the non-recourse loan in year three. Can re-deduct it late
because he put more at risk.
*Add notes:
CLASS NOTES:
IRC 183: Disallowance of hobby activities. But can still deduct things like property
taxes. You can deduct only the losses up to the extent of your gains.
-Determining whether it is an activity entered into for profit is a question of fact. Use an
objective test. Presumption it is if it has a history of being profitable.
Treas. Reg. 1.183-3 Activity not engaged in for profit defined.
Relevant Factors: 9 of them. See notes.
Engdahl v. Commissioner
-Retired orthodontist and wife decided to enter the horse-breeding business after
consulting with trainers, vets, and other people within the business. They purchased a
ranch to board the horses and worked 35 to 55 hours a week caring for the horses and
working on the ranch. They maintained books and records of their horse operation. From
1964- 1975 they had operating losses from 1964 through 1975. Eventually they ended the
business and sold the ranch.
-They deducted substantial losses for 1971, 1972, and 1973. The losses were not allowed
based because the hose breeding operation was considered not to be an activity engaged
in for profit.
Holding: It was an activity engaged in for profit. Court looks at the 9 factors listed by the
regs. They include the manner in which the taxpayer carried on the activity; the expertise
of the taxpayer or his advisers; the financial success or failures of the activity; the
financial statues of the taxpayer.
*Triggered if you are renting a vacation home, and the home office limitation.
Exceptions: Allows for deductions for home office if it is used exclusively and on a
regular basis as his principal place of business. Portion of the home has to be used.
IRC 280A. Disallowance of certain expenses in connection with business use of
home, rental of vacation homes, etc.
- (a) General rule.--Except as otherwise provided in this section, in the case of a
taxpayer who is an individual or an S corporation, no deduction otherwise allowable
under this chapter shall be allowed with respect to the use of a dwelling unit which is
used by the taxpayer during the taxable year as a residence.
(b) Exception for interest, taxes, casualty losses, etc.--Subsection (a) shall not apply to
any deduction allowable to the taxpayer without regard to its connection with his trade or
business (or with his income-producing activity).
(c) Exceptions for certain business or rental use; limitation on deductions for such
use.-(1) Certain business use.--Subsection (a) shall not apply to any item to the extent
such item is allocable to a portion of the dwelling unit which is exclusively used
on a regular basis-(A) as the principal place of business for any trade or business of the
taxpayer,
(B) as a place of business which is used by patients, clients, or customers
in meeting or dealing with the taxpayer in the normal course of his trade or
business, or
(C) in the case of a separate structure which is not attached to the dwelling
unit, in connection with the taxpayer's trade or business.
In the case of an employee, the preceding sentence shall apply only if the exclusive use
referred to in the preceding sentence is for the convenience of his employer. For purposes
of subparagraph (A), the term principal place of business includes a place of business
which is used by the taxpayer for the administrative or management activities of any
trade or business of the taxpayer if there is no other fixed location of such trade or
business where the taxpayer conducts substantial administrative or management activities
of such trade or business.
(c) Exceptions for certain business or rental use; limitation on deductions for such
use.
(2) Certain storage use
(3) Rental use.--Subsection (a) shall not apply to any item which is attributable to the
rental of the dwelling unit or portion thereof (determined after the application of
subsection (e)).
(4) Use in providing day care services
(5) Limitation on deductions.--In the case of a use described in paragraph (1), (2), or
(4), and in the case of a use described in paragraph (3) where the dwelling unit is used by
the taxpayer during the taxable year as a residence, the deductions allowed under this
chapter for the taxable year by reason of being attributed to such use shall not exceed the
excess of-(A) the gross income derived from such use for the taxable year, over
(B) the sum of--
(i) the deductions allocable to such use which are allowable under this chapter for the
taxable year whether or not such unit (or portion thereof) was so used, and
(ii) the deductions allocable to the trade or business (or rental activity) in which such use
occurs (but which are not allocable to such use) for such taxable year.
Any amount not allowable as a deduction under this chapter by reason of the preceding
sentence shall be taken into account as a deduction (allocable to such use) under this
chapter for the succeeding taxable year. Any amount taken into account for any taxable
year under the preceding sentence shall be subject to the limitation of the 1st sentence of
this paragraph whether or not the dwelling unit is used as a residence during such taxable
year.
c)
d)
2.
3.
B.
C.
D.
E.
F.
(3)
minimum of 10% ownership
b) $25,000 offset is reduced by 50% of the gross income of the t/p
exceeding $100,000.
Portfolio income is defined as interest dividends and royalties 469(e)(1)(A)
Separates active portfolio passive income
Cannot use passive losses to offset active or portfolio income (Except after
disposition)
Must carry forward to offset passive gains in subsequent years
Losses are allowed in the following order:
1.
Income from that activity for the year
2.
Over any net income or gain from all other passive activities
3.
Against active activity or portfolio activity on disposition (See 1d)
G.
If a passive activity has a loss in one year then
becomes an active activity in the next with a gain, the
passive loss can offset the active (passive) gain.
(c) Same as (a) above except that in the succeeding year the movie limited partnership
makes a gain of $90,000 as a result of a successful move, Alligator Allee. -50,000 of
loss offsets the 90,000 gain, so only 40,000 in gain needs to be recognized.
(d) Same as (a) above, except that Lawyer sells her movie limited partnership interest at
the beginning of the succeeding year at a gain. Can deduct the prior losses against the
gain from the sale of the interest.
2. (a) In the current year Grocer purchases a grocery store and spends 35 hours per week
operating it to the exclusion of all other business and investment activities. Grocers loss
from the grocery store business is $50,000. How much of his loss is deductible? All of
the 50,000 is deductible because it is a passive activity. Material participation.
(b) Same as (a) above except Grocer is only irregularly involved in the operation of the
grocery store. Intermittently, Grocer makes significant management decision. Have to
decide whether he is materially participating. Book says that an active but only
intermittent role in management doesnt establish material participation. So probably
passive. Probably not enough,
(c) Same as (a) above except that Grocer who is retired purchases the grocery store and
hires a manager who has carte blanche power to make all business decisions. Passive
activity. Outsourced all you material participation.
(d) Grocer, upset with the $50,000 loss in (a) above, fires manager at the end of the year
and in the succeeding year, Grocer manages the store on a full-time basis and in that year
makes a $60,000 profit. What tax consequences to Grocer for the succeeding year?
Passive activity was converted into active activity. The 50,000 loss from the prior passive
year is carried over and offsets the 60,000 gain in the now active year. So 10,000 of
taxable income.
F. ILLEGALITY OF IMPROPRIETY
Certain expenses that might otherwise be deductible may be denied on public policy
grounds; such as that incurring the expense was illegal or improper.
IRC 162. Trade or business expenses (c) Illegal bribes, kickbacks, and other
payments.-(1) Illegal payments to government officials or employees.--No deduction shall be
allowed under subsection (a) for any payment made, directly or indirectly, to an official
or employee of any government, or of any agency or instrumentality of any government,
if the payment constitutes an illegal bribe or kickback or, if the payment is to an official
or employee of a foreign government, the payment is unlawful under the Foreign Corrupt
Practices Act of 1977
(2) Other illegal payments.--No deduction shall be allowed under subsection (a) for any
payment (other than a payment described in paragraph (1)) made, directly or indirectly, to
any person, if the payment constitutes an illegal bribe, illegal kickback, or other illegal
payment under any law of the United States, or under any law of a State (but only if such
State law is generally enforced), which subjects the payor to a criminal penalty or the loss
of license or privilege to engage in a trade or business
(3) Kickbacks, rebates, and bribes under medicare and Medicaid
(f) Fines and penalties.--No deduction shall be allowed under subsection (a) for any fine
or similar penalty
Commissioner v. Tellier
-Taxpayer was in the business of buying and selling securities. Was later charged and
found guilty for violating the 1933 Securities Act 1933 and mail fraud statute.
-Incurred about $23,000 in legal fees and claimed a deduction.
-Commissioner conceded that the payments were business expenses and were ordinary
and necessary. However, disallowed the deduction on the ground of public policy.
-HELD: Supreme Court disagreed with the Tax Court and said the deductions should be
allowed. The Court noted that criminals are still expected to pay taxes on income from
criminal activities. So it would only be fair to allow them to claim the same deductions as
would normally apply to legal activities
- Only in extremely limited circumstances has the Court upheld a disallowance, and this
did not fall under that category.
-No public policy is offended when a person hires an attorney to help him defend himself
against serious charges.
**ATL are most valuable deductions, and BTL are second tier.
IRC 62: Defines Adjusted Gross Income and lists the above the line deductions:
(1) Trade and business deductions.--The deductions allowed by this chapter (other than
by part VII of this subchapter) which are attributable to a trade or business carried on by
the taxpayer, if such trade or business does not consist of the performance of services by
the taxpayer as an employee.
*If your employed they are not ATL deductions, they are BTL deductions.
Ex.) Bar dues for solo practitioner are ATL deductions.
(2) Certain trade and business deductions of employees [excluding unreimbursed
employee business expenses]
(3) Losses from sale or exchange of property.--The deductions allowed by part VI (sec.
161 and following) as losses from the sale or exchange of property.
(4) Deductions attributable to rents and royalties.--The deductions allowed by part VI
(sec. 161 and following), by section 212 (relating to expenses for production of income),
and by section 611 (relating to depletion) which are attributable to property held for the
production of rents or royalties.
(5) Certain deductions of life tenants and income beneficiaries of property
(6) Pension, profit-sharing, and annuity plans of self-employed individuals.--In the
case of an individual who is an employee within the meaning of section 401(c)(1), the
deduction allowed by section 404.
other equipment, and supplementary materials used by the eligible educator in the
classroom.
(f) Employee makes payments for medical expenses and charitable contributions and for
taxes on her residence and interest on a note secured by a mortgage on the residence. BTL
deductions. Traditional itemized deductions.
(g) Same as (f), above, except that the taxes and interest relate to a residence that
Employee rents to Tenant. If directly related to rental income the ATL, otherwise it
would be BTL.
(h) Employee has a loss on the sale of some stock that he held for investment. ATL
(i) Employee deducts $1,000 of interest on student loans. ATL
(j) Employer, whose business is unincorporated, pays his state income taxes. BTL. Not a
business tax, his personal income tax.
(k) Employer pays accountant $400 to prepare his federal income tax return, $150 of
which is allocable to preparing the schedule related to the income from his sole
proprietorship business. Costs specifically related to business ($400) is ATL, and the
personal tax would be BTL.
(l) Single pays ex-spouse $6,000 in alimony. Is this within the common thread of 62
deductions? ATL.
(m) Employee incurs properly deductible moving expenses. ATL.
(n) Employee is an elementary school teacher who buys $350 worth of classroom
materials in the current year. ATL, up to $250. Congress hasnt acted yet for this year
though.
B. MOVING EXPENSES
-Taxpayers are permitted, as an ATL deduction, to deduct certain moving expenses. For
new places of employment. Cant be for the search of work.
IRC 217. Moving expenses
(a) Deduction allowed.--There shall be allowed as a deduction moving expenses paid or
incurred during the taxable year in connection with the commencement of work by the
taxpayer as an employee or as a self-employed individual at a new principal place of
work.
(c) Conditions for allowance.--No deduction shall be allowed under this section unless-(1) the taxpayer's new principal place of work--
(A) is at least 50 miles farther from his former residence than was his
former principal place of work, or
(B) if he had no former principal place of work, is at least 50 miles from
his former residence, and
(2) either-(A) during the 12-month period immediately following his arrival in the
general location of his new principal place of work, the taxpayer is a fulltime employee, in such general location, during at least 39 weeks, or
(B) during the 24-month period immediately following his arrival in the
general location of his new principal place of work, the taxpayer is a fulltime employee or performs services as a self-employed individual on a
full-time basis, in such general location, during at least 78 weeks, of which
not less than 39 weeks are during the 12-month period referred to in
subparagraph (A).
For purposes of paragraph (1), the distance between two points shall be the shortest of
the more commonly traveled routes between such two points.
$100 in lodging and $200 in meals in conjunction with transporting the family?
Everything but the meals so $650.
(g) Is there any difference in the result in (f) above if Lawyers spouse also takes a job in
Town Y and meets the necessary time and distance requirements? No doesnt make any
difference at all as long as either spouse qualifies.
(h) If Lawyers firm reimburses Lawyer for $850 of his expenses in the year they are
incurred, what tax consequence will the reimbursement have? $650 is deductible, but
$200 doesnt qualify.
-Gerard's daughter had cystic fibrosis, which meant it was dangerous for her to
be exposed to dry, dusty air. On the recommendation of her doctor, Gerard
installed an air-conditioning system costing $1300 to make his daughter feel
better.
When he filed his taxes, Gerard deducted the $1300. The IRS denied the
deduction. Gerard appealed. Gerard argued that the $1300 was deductible under
26 U.S.C. 213, which allows for deductions for expenses related to medical care.
The IRS argued that this wasn't a medical expense, it was an improvement to
Gerard's house, and that's a non-deductible capital expenditure.
HELD: The Tax Court split the difference. The Tax Court found that the air
conditioner was an expenditure for medical care, and so was covered within the
scope of 213. However, the Court also found that 26 U.S.C. 263(a)(1) does not
allow deductions for any amount paid for permanent improvements or betterments
made to increase the value of any property.
In this case, the Court found that the air conditioner increased the value of
Gerard's property by $800. Therefore, Gerard was only allowed to deduct $1300$800 = $500.
deductible and the health insurance. So total is $10,500, can only deduct the amount it
exceeds the 10% of her AGI so the answer is $500.
(b) Would it make better sense and, if so, be possible under the present statute to allow a
deduction of $1,200 per year for the air conditioning expenditure, assuming the system
has a 5-year life? No. Make it harder to break that 10% qualifier.
(c) If in the current year Homeowner incurs maintenance expenses of $300 on the air
conditioning system can that be taken into account as a medical expense? Would a $150
deduction for those expenses be more supportable assuming, of course, Daughter is still
there and still asthmatic? What about an estimate that $400 of the years electricity bill is
attributed to running the air conditioning system? Maintaining the equipment is still a
medical cost.
The amount allowed as a deduction for a taxpayer whose AGI does not
exceed $65K ($130K in case of joint returns is $4,000.
The amount allowed for a taxpayer whose AGI is between $65K and
$80K ($130K and $160K in case of a joint return) is $2,000.
For taxpayers over $80k (or $160k in case of a joint return), ZERO.
(c) Same as (a), above, except that Law Student is married filing a joint return and Law
Student and Spouse have $140,000 of adjusted gross income prior to consideration of
222.
E. PERSONAL AND DEPENDENCY EXEMPTIONS
-Taxpayers are generally entitled to a personal exemption for the self, the spouse, and
qualifying dependents, so long as those exemptions are not claimed by another taxpayer.
-Almost every taxpayer is allowed an exemption for himself. If another taxpayer claims
the individual as a dependent, the individual is denied a personal exemption.
-Husband and wife filing a joint tax return count as taxpayers and can get two personal
exemptions. If they dont file a joint return, a spouse may claim an allowance for the
other spouse only if the other has no gross income and is not a dependent of any other
taxpayer.
-Personal Exemption Amount is 4k.
-Also allows exemptions for dependents.
The Dependent: Qualifying Child or Qualifying Relative
152 (a) In general.--For purposes of this subtitle, the term dependent means-(1) a qualifying child, or
(2) a qualifying relative.
Phaseout: Personal exemptions are phased out for wealthier people. Lose 2% of the 4k
for each 2,500 you are over the applicable amount. Its a gradual phase-out.
Qualifying Child:
In general, to be a taxpayers qualifying child, a person must satisfy four tests:
Relationship the taxpayers child or stepchild (whether by blood or adoption), foster
child, sibling or stepsibling, or a descendant of one of these.
Residence has the same principal residence as the taxpayer for more than half the tax
year. Exceptions apply, in certain cases, for children of divorced or separated parents,
kidnapped children, temporary absences, and for children who were born or died during
the year.
Age must be under the age of 19 at the end of the tax year, or under the age of 24 if a
full-time student for at least five months of the year, or be permanently and totally
disabled at any time during the year.
Support did not provide more than one-half of his/her own support for the year.
(from http://www.irs.gov/uac/A-%E2%80%9CQualifying-Child%E2%80%9D)
Qualifying Relative
Four criteria must be met for a person to be your qualifying relative.
1.
2.
The persons gross income for the year must be less than $3,900,
and
4.
The taxpayer generally must provide more than half of a person's total support
during.
(d) What difference in results under the facts of (c), above, if Taxpayers deductible
interest is $4,000 rather than $1,000? It would make the itemized deduction higher
The value of services cannot be deducted, although some costs incurred in connection
with volunteering may be (mileage etc).
A transfer for partial consideration may result in a part-gift, part-sale transaction.
Quid pro quo received by the donor must be netted out, except for certain de minimus
benefits.
Substantiation of donations is required. Have to provide evidence of donation made.
Partial Interests in Property
-Only certain partial interests in property qualify for the charitable deduction.
A netting process (more on this later) is required to determine the balance of long-term
and short-term capital gain and loss.
IRC 1. Tax imposed
(c) Unmarried individuals (other than surviving spouses and heads of households).-There is hereby imposed on the taxable income of every individual (other than a
surviving spouse as defined in section 2(a) or the head of a household as defined in
section 2(b)) who is not a married individual (as defined in section 7703) a tax
determined in accordance with the following table:
****LOOK UP RATES
-- If taxpayers ordinary income tax rate is 25% - 39.6% (28%, 31%, or 36%)
20%
There are a few other exceptions where capital gains may be taxed at rates greater than
20%:
The portion of any unrecaptured section 1250 gain from selling section 1250 real
property is taxed at a maximum 25% rate
The taxable part of a gain from selling section 1202 qualified small business stock is
taxed at a maximum 28% rate.
Net capital gains from selling collectibles (like coins or art) are taxed at a maximum 28%
rate.
B.
1. T, a single taxpayer, has a salary of $50,000 in the current year. T also has the
following transactions all involving the sale of capital assets: (1) a gain of $15,000 on a
collectible held for 2 years; and (2) a gain of $20,000 on stock held for 1 year and 3
months.
(a) Determine the amount of Ts net capital gain. Overall capital gain is $35,000.
(b) At what rate will the components of Ts net capital gain be taxed? Collectible is
28% and stock is 20%
(c) Assuming there is a flat 30% tax on ordinary income and disregarding any deductions
(including the standard deduction and personal exemption), what is Ts tax liability in the
current year? *Check.
2. S, a single taxpayer, has a salary of $500,000 in the current year. S also has the
following transactions involving the sale of capital assets: (1) a gain of $120,000 on stock
held for 1 year and 3 months and (2) a loss of $20,000 on stock held for 3 years. Assume
there is a flat 30% tax on ordinary income and disregarding any deductions (including the
standard deduction and personal exemption), what is Ss tax liability under Section 1 in
the current year?
His salary of $500K will subject to the 30% tax, so that would be $150,000.
His capital gains would be $100K and they would be subject to 20% capital against rate,
so that would be $20,000.
Which would bring his total tax liability to $170,000.
C. CAPITAL LOSSES
-Capital losses may be used to offset capital gains. To the extent capital losses exceed
capital gains, $3000 may be deducted against ordinary income, and the balance may be
carried forward into future years until gain arises to offset the loss (or until death).
IRC 1211. Limitation on capital losses
(b) Other taxpayers.--In the case of a taxpayer other than a corporation, losses from
sales or exchanges of capital assets shall be allowed only to the extent of the gains from
such sales or exchanges, plus (if such losses exceed such gains) the lower of-(1) $3,000 ($1,500 in the case of a married individual filing a separate return), or
(2) the excess of such losses over such gains.
Problem pg. 651
1.
Here are two questions on capital losses incurred in the current year. The figure
for taxable income given in column A reflects a single taxpayers taxable income for each
of two years without regard to his capital gains and losses. Note that in computing gross
income (as adjusted) on the return no gains will be included, since capital losses exceed
capital gains and the 1211(b) excess amount will be a reduction.
Taxable Income
1. $10,000
2. $10,000
LTCG
$2,000
$2,000
LTCL
$6,000
$10,000
STCG
$2,600
$2,000
STCL
$1,000
$4,000
For each year separately, without regard to computations for other years, determine the
amount of the taxpayers capital loss that is allowed as a deduction from ordinary income
under 1211 (b)(1) or (2) and the amount and character of his capital loss carryover, if any,
under 1212(b).
ANSWER:
Taxable Income
1. $10,000
LTCG
$2,000
LTCL
$6,000
$2,600
STCG
$1,000
STCL
Taxable Income
2. $10,000
LTCG
$2,000
LTCL
$10,000
STCG
$2,000
STCL
$4,000
Taxpayer can deduct capital losses from ordinary income up to the SMALLER of the
actual loss and $3000.
Here, $10000>$3000, so T can deduct $3000 from his $10,000 ordinary income.
The $7000 in unused loss is net capital loss carryover and can be used next year (at the
rate of $3000 + gain offset).
-Maudlin bought 160 acres of land in New Mexico with the intention of using it
for cattle grazing. But then he decided a cattle ranch was a bad investment, so he
did nothing with the land. The land was way outside the city limits, and wasn't
very valuable for building houses.
Years later, the town had grown and the land was now inside the city limits. The
city built some roads on the land, and charged Maudlin for the service. To pay the
bill, Maudlin split up the land into lots and started selling them off to people who
wanted to build houses. As soon as Maudlin sold enough lots to cover the cost of
the roads, he stopped actively marketing the lots. But over the next 10 years,
unsolicited offers came in and he eventually sold off most of the lots, making a
good profit.
He claimed that the lots he sold were a long-time capital asset (26 U.S.C. 1221)
and paid taxes on the profits at that rate. The IRS denied Maudlin's claim and
found that the profit was ordinary income (now 26 U.S.C. 61(a)), which is taxed
at a higher rate. Maudlin appealed. Maudlin argued that his profits shouldn't be
considered ordinary income unless he was in the trade or business of selling real
estate, but he wasn't, he was only trying to get rid of this land he didn't want
anymore.
The Tax Court found that Maudlin was in the "trade or business" of selling real estate,
therefore the profits were ordinary income.
The Appellate Court found that there is no rule of thumb for when property sales
amount to a trade or business. Evidence the courts should consider includes:
In this case, the Court found that the evidence weighed in favor of Maudlin being
engaged in a trade or business.
Malat v. Riddell
-Malat was a participant in a joint venture that bought some land. They were
originally going to build some apartments to rent or houses to sell, but they had
some problems with financing and zoning, so they eventually gave up and just
sold off the land. When Malat filed his taxes, he claimed that the profits from the
land sale were a long-time capital asset (26 U.S.C. 1221) and paid taxes on the
profits at that rate. The IRS denied Malat's claim and found that the profit was
ordinary income (now 26 U.S.C. 61(a)), which is taxed at a higher rate. Malat
appealed.
Malat argued that the land was primarily to be used for building
apartments, so he was in the "trade or business" of renting apartments, He
was not in the trade or business of selling real estate.
The IRS argued that Malat was in the trade or business of selling property,
and so any profits he made were ordinary income.
The Trial Court found for the IRS. Malat appealed. The Appellate Court affirmed.
Malat appealed. The US Supreme Court remanded.
The Court found that the word "primarily" should be read to mean "of first
importance" or "principally. The IRS had been arguing that "primarily"
should be read to mean "substantially."
The Court sent the case back to the Trial Court using the proper definition of "primarily."
Bingham died and her will left Wise $5M to be paid on her 40th birthday, which
was payable in either cash or securities (aka stocks and bonds). Bingham's
trustees paid Wise partially in cash and partially in securities.
The securities had been purchased by Bingham years earlier and had
significantly appreciated in value between the time Bingham died and
when Wise received the inheritance.
The IRS ordered the trustees to pay $367k in taxes on the securities as a capital
gain.
The IRS argued that if the trustees had sold the securities and given the cash to Wise,
then the sale would have been a realized gain and thus taxable.
The trustees argued that the securities were an inheritance and should not be
taxable because they had not been sold and no gain was realized.
Basically the trustees were saying that there was no realized gain until Wise sold
the securities. They argued that this was more like an exchange of property. If
Bingham had given Wise a house in her will, the estate would not be responsible
for paying taxes on the increased value of the house.
The Tax Court found for the IRS. The trustees appealed.
The Appellate Court looked to the relevant section of the tax code (then 26
U.S.C. 117, now 26 U.S.C. 1222) and found that capital gain is realized
whenever there is a "sale or exchange."
In this case, the Court found that there was an "exchange" when the
securities were transferred to Wise. Therefore, the gain was realized.
The Court found that since Bingham's will offered the trustees a choice of paying Wise in
cash or securities, it was not the same as if Bingham had made a bequest of property.
Hudson v. Commissioner
-Harahan won a lawsuit against Cole and was awarded $75k. However Cole
didn't pay. Eventually Harahan sold her interest in the Cole judgment to Hudson
and Taylor for $11k. Hudson and Taylor then negotiated with Cole and settled the
judgment for $21k. When they filed their taxes, Hudson and Taylor reported their
profit on the deal (~$5k each) as a long-term capital gain. The IRS denied the
claim. Hudson and Taylor appealed.
The IRS argued that it was not a long-term capital gain but instead was
ordinary income (which was taxed at a higher rate).
Hudson and Taylor argued that the judgment was a capital asset, and the
settlement was a "sale or judgment of a capital asset" which met the
definition of the relevant section of the tax code (then 26 U.S.C. 117,
now 26 U.S.C. 1222).
The Tax Court found that the judgment was not 'property' but just a debt.
Hudson and Taylor did not recover the money as the result of any sale or
exchange but only as a collection of settlement of the judgment.
The Court found that since the settlement of a debt is not a "sale or exchange," then the
tax code provisions related to capital gains are inapplicable and the profits are to be
treated as ordinary income.
CLAS NOTES: Distribution of the judgment funds is ordinary income.
Problem 1 pg. 666
1. Creditor purchased an individual Debtors $5,000 interest bearing note from a
third party as an investment at a cost of $4,000 in 1996 (see 1271(a)(1) and (b)(1)
(A)). Several years later, Debtor pays off the principal of the note using General
Motors stock which Debtor purchased several years ago at a cost of $2,000 which
is now worth $5,000. What are the tax consequences to Creditor and Debtor?
For the debtor, he purchased the stock for $2,000, therefore that is his basis, he
has an amount realized of $5,000 because that is the amount he owed on the note.
Therefore, he has a capital gain of $3,000 because the stock would be considered
a capital asset.
For the creditor, purchased the note obligation for $4,000 therefore that is his
basis, his amount realized is $5,000 because that is the value of the stock used to
satisfy the note obligation. Therefore he will report $1,000 to income because this
would not be considered a capital asset.
Note: 1271(a)(1), effective in 1997, provides that Amounts received by the holder on
retirement of any debt instrument shall be considered as amounts received in exchange
therefor. 1271(b)(1(A) provides that 1271 does not apply to pre-June 1997 obligations.
(d) T told Ts broker to purchase 100 shares of stock on December 29th of year 1 at a time
when its price was $50 per share. The stock was delivered to T on January 3rd of year 2
when it was selling for $52 per share. T told Ts broker to sell the stock on December 30th
of year two when it sold for $60 per share, and it was delivered to Buyer on January 4th of
year 3 when it was selling for $63 per share. You use the trade dates. The date purchased
(Dec. 29th at $50 per share) and the date sold (Dec 30th at $60 per share). Since it was for
longer than one year, he has a long term capital gain of $1,000.
(e) Same as (d), above, except that the value of the stock on December 30th of year 2 was
$45 per share and on January 4th of year 3 was $48 per share. Still use the date they were
sold, however now there would be a long term capital loss of ($500).
(f) Ts father bought 100 shares of stock on January 10th of year 1 at $30 per share. On
March 10th of year 1 when they were worth $40 per share he gave them to T who sold
them on January 15th of year 2 for $60 per share. Gifts. 3k LTC gain. Can stack the
holding periods on top of each other.
(g) Ts father purchased 1,000 shares of stock for $10 per share several years ago. The
stock was worth $50 per share on March 1st of year 1, the date of Fathers death. The
stock was distributed to T by the ex ecutor on January 5th of year 2 and T sold it for $60
per share on January 15th of year 2. Can stack the holding periods on top. So LTC gain.
10k LTC gain.
(h) Same as (g), above, except that T was executor of Ts fathers estate and as such T
sold the stock on January 15th of year 2 for $60 per share to pay the estates
administration expenses. Still a LTC gain.
Ch. 27 Computations
A. TAX RATES
Once taxable income has been determined (by subtracting appropriate deductions and
exemptions from gross income), the taxpayer must apply the appropriate tax rate for
his/her/their filing status to determine tentative tax liability.
Classifications of Taxpayers
An individual taxpayer is classified into one of the following statuses:
1.
2.
3.
Unmarried Individual
4.
Threshold amount is $250,000 for married filing jointly, $125,00 for married filing
separately, $200,000 for single, and $200,000 for head of household.
The Kiddie Tax
- The net unearned income of a child (under age 18 or a supported student under age 24)
that exceeds $1,000 (in 2015, $2,100) is taxed at the parents marginal tax rate.
married but filing separately. It might also be informative to point out that, under 1(e),
an estate or trust with
$223,050 of taxable income would be liable for $86,685.60 of taxes.
Over $199,175 but not over $225,000: $53,884.25 + 35% of excess over $199,175.
So $53,884.25 + 35% [$223,050 - $199,175] = $53,884.25 + 35% [$23,875] =
$53,884.25 + $8,356.25 = $62,240.50.
2. Husband and Wife, both under 65 and with good eyesight, have 2 dependent
children. In the year 2013, whose rate schedules appear above, the file a joint return.
They have no 62 deductions. Using the rate tables and assuming the exemption
amount is $2,000 and the standard deduction for marrieds filing jointly is $6,000,
compute their tax liability before credits if:
(a) They have $100,000 of gross income, $2,000 in state property taxes, and $5,500 in
miscellaneous employee business expenses.
Husband and Wife have taxable income of $86,000. That amount of taxable income is
computed as follows:
Gross income $100,000
- 62 deductions - 0
Adjusted Gross Income $100,000
- Standard deduction - 6,000
- Personal exemptions - 8,000
Equals taxable income of $ 86,000
They would use the standard deduction of $6,000 (see 63(c)(2)(A)), as it exceeds their
total itemized deductions of $5,500, the total of the miscellaneous itemized deductions of
$5,500 which are subject to a $2,000 (2% of adjusted gross income, see 67(a)) floor
netting $3,500 plus the $2,000 of itemized deductions which are not subject to the 2%
floor (see 67(b)(2) and 164(a)(1)). The personal exemptions amount is 4 x $2,000 or
$8,000.
Husband and Wife have $13,357.50 of tax liability computed under 1(a) as follows:
$9,982.50 plus $3,375 (25% of $13,500) equals $13,357.50.
(b) They have $100,000 of gross income, $3,000 in state property taxes, and $7,000 in
miscellaneous employee business expenses.
Husband and Wife have taxable income of $84,000. That amount of taxable income is
computed as follows:
31
38
Withholding credit
Credits potentially qualifying for the
general business credit
$ 1,000
24,000
90,000
54.
What items are included in gross income (excluding capital gain property)? At
what value?
55.
56.
57.
What are each of Xs itemized deductions and what is the total of Xs itemized
deductions? You should take into account the 2% limitation of Section 67, if any.
58.
Assume the standard deduction for married taxpayers filing jointly is $10,000.
Should X take the itemized deductions or the standard deduction? (Whichever one is
bigger)
59.
How much can X deduct for personal exemptions, assuming each exemption is
$5,000?
60.
What is Xs net taxable income? (AGI ITEMIZED/STD DEDUCTION
EXEMPTIONS)
61.
Using the table in the edited code section below, for married couples filing jointly,
what is the tax on Xs net taxable income?
Over $250,000
62.
Considering your answers for 26-35, and assuming a capital gain tax rate of 20%,
what is the tax on Xs net capital gain (assuming the holding period is long-term)?
63.
62.
Considering your answers for 46-49, what credits should be deducted, and at what
value?
65.
Considering all of the above, what should Xs final tax bill be?