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Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08 00& ( 020 S,*tion 61 61 Reg. 1.61-1(a) & 2(d)(1) 61(a)( ) 61(a)( ) 61(a)(')

C$% & ' INTRO TO FEDERAL INCO E TA! I% "RO)LE #ross In*o+, -#I. / 0 120,000 $ 25,000.00 cash $ 250,000.00 checks $ 10,000.00 landscaping $ 19,000.00 bank interest $ 1,000.00 di!idends "net capital gain# $ 15,000.00 selling st$ck pr$%it "l$ng ter& capital gain# $ '20,000.00 A234st,2 #ross In*o+, -A#I. / 0 210,000 A#I / #I ' A5o6, th, lin, 2,24*tions -ATLD. $ (60,000.00) (ages paid t$ ($rkers $ (20,000.00) b)siness e*penses $ (10,000.00) bldg. depreciati$n $ (90,000.00) $ '20,000.00 ,$ 2'0,000.00 ),lo7 th, lin, 2,24*tions -)TLD. / 0 19,800 $ 1,000.00 in!est&ent acc$)nt e*pense $ 1+,000.00 $ ',+00.00 $ +,000.00 $ 9,000.00 $ '9,+00.00 &$rtgage interest pr$pert. ta*es state inc$&e ta*es charitable d$nati$n

162(a) 162(a) 16+

212 16' 16/(a)(2) 16/(a)(') 1 0 6

28 Floor on It,+i9,2 D,24*tions $ 2'0,000.00 0,* .02 21 $ /,600.00 2$&e &$rtgage, state inc$&e ta*, pr$pert. ta* & charitable d$nati$n 3 s)b4ect t$ 21 $ '9,+00.00 5678 $ (1,000.00) in!est&ent acc$)nt e*pense s)b4ect t$ $ '+,+00.00 18 O6,rall Li+itation on It,+i9,2 D,24*tions $ 2'0,000.00 0,$(160,000.00) in%lati$n ad4)sted 9applicable a&$)nt: $ 0,000.00 $!er ite&i;ed ded)cti$n li&itati$n * .0' '1 li&itati$n $ 2,100.00 Total D,24*tions / 0 1:,;00

6+

<age 1 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

$ '+,+00.00 5678 &in)s 21 %l$$r $ (2,100.00) '1 li&itati$n 0 1:,;00%00 ",rsonal E<,+ptions / 0 &1,:00 $ ',/00.00 standard e*e&pti$n * / 2 pers$nal e*e&pti$n %$r &arried c$)ple = 2 >)ali%.ing children 0 &1,:00%00 Ta<a5l, In*o+, -TI. / =A#I ' D,24*tions ' E<,+ptions> / 0 &;9,;00 $ 2'0,000.00 0,$ ('6, 00.00) t$tal ded)cti$ns $ (1',600.00) t$tal e*e&pti$ns 0 &;9,;00%00 Ta< Rat,s $ 1 9, 00.00 $(12+,500.00) $ 51,200.00 * .2+ $ 1/,''6.50 $ 2/,9 2.50 $ '9,'0+.50 ta*able inc$&e ta* rate $n 4$int ret)rn (? ta*able inc$&e $% $1 9, 00 a&$)nt $!er $12+,500 ta*ed at 2+1 1 a&t ta*ed $!er $1 9, 00 ta* rate base preli&inar. ta* liabilit.

151

N,t Capital #ain -NC#. $ 1 9, 00.00 ta*able inc$&e $ (16,000.00) @A, ($ 1,000 di!idends = $ 15,000 selling st$ck) $ 16',000.00 $(12+,500.00) ta* rate $n 4$int ret)rn (? ta*able inc$&e $% $1 9, 00 $ '5,200.00 * .2+ 1 a&t ta*ed $!er $1 9, 00 $ 9,+56.00 $ 2/,9 2.50 ta* rate base $ '/,+2+.50 $ 2,/00.00 @,A 1 ta* rate ($ 16,000 * 151 B 2,/00) 0 1;,228%?0 II% O@ER@IEW A% A )ri,f $istorA of F,2,ral In*o+, Ta< 1662 0&end&ent t$ the CD A$nst. in 191' )% Th, Ta< "ra*ti*, C% R,sol4tion of Ta< Iss4,s Thro4gh th, B42i*ial "ro*,ss &% Trial Co4rts A$&&En $% the -RD asserts a de%icienc. in inc$&e ta*, the 6< &a.F Re%)se t$ pa. the ta* & petiti$n the 6a* A$)rt %$r a redeter&inati$n $% the de%icienc.G $r

1(h)

<age 2 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

<a. the de%icienc., %ile an ad&inistrati!e clai& %$r re%)nd, & )p$n denial $% the clai&, s)e %$r re%)nd in %ederal district c$)rt $r the CD A$)rt $% Hederal Alai&s ' cts ha!e $riginal 4)ris. in %ederal ta* casesF 6a* A$)rt, CD8A & CD A$)rt $% Hederal Alai&s. a% Th, Ta< Co4rt A$)rt %$r redeter&inati$n $% a de%icienc. (?$ pa.ing the asserted de%icienc. %irst. A$nstit)ti$nal stat)s (gi!en b. 6a* Re%$r& 0ct $% 1969) )nder 0rt. 1, + Al. 9 $% the A$nst., s$ that it is n$( a part $% the 4)dicial branch. ,i!es 6a* A$)rt the p$(er t$ p)nish %$r c$nte&pt & t$ iss)e (rits t$ en%$rce its decisi$ns 6ried (?$ 4)r. b. $ne 4)dge 5% F,2,ral Distri*t Co4rts CD8A ha!e 4)ris. in an. ta* case seeking a re%)nd $% ta*, regardless $% the a&t. in!$l!ed. Ia. be tried be%$re 4)ries 6he 6< &)st bring ta* acti$ns against the CD in the district in (hich the 6< resides, in the district in (hich it has its principal place $% b)siness. 0 6< cann$t litigate a ta* acti$n in the %ederal district c$)rts (?$ %irst pa.ing the a&t. in disp)te & then c$&&encing a re%)nd acti$n. *% Th, Cnit,2 Stat,s Co4rt of F,2,ral Clai+s At. $% Hederal Alai&s has 4)ri. $!er all ta* s)its against the CD regardless $% a&t. @$ J)r. trial. Khere $ne resides &akes n$ di%%erence At. $% Hederal clai&s has n$ 4)ris. t$ hear de%icienc. cases. 2% App,als -n Golsen, the 6a* At. re!ersed itsel% & ann$)nced that it ($)ld %$ll$( a decisi$n $% the %ederal ct. t$ (hich an appeal %r$& a 6a* At. decisi$n ($)ld be &ade, i% the %ederal appeals ct. decisi$n (ere s>)arel. $n p$int.

1% S,l,*tion of For4+ II% ANALDSIS A% )asi* E4,stions A22r,ss,2 5A an In*o+, Ta< SAst,+ What ite&s $% ec$n$&ic inc$&e $r gain (ill be incl)dable in ,-L What ite&s $% e*pense (ill be all$(able ded)cti$nsL When is an a&$)nt incl)ded in inc$&eL When is the 6< entitled t$ clai& a ded)cti$n %$r an a&$)nt that is clearl. ded)ctibleL Who is the 6< M who is g$ing t$ be ta*ed $n ite&s $% inc$&eL Khat is the character $% the ite&s $% inc$&e $r the ded)cti$nsL )% E6al4ating r% F rs% Ta<paA,rGs Ta< Lia5ilitA Khat is the applicable ta* rateL Khat is the ta* rate applied t$ M that is, (hat is the ta* baseL &% #ross In*o+, A$)rt ha!e %ashi$ned the 9assign&ent $% inc$&e: d$ctrine t$ pre!ent inc$&e shi%ting. <age ' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

0 cash &eth$d 6< incl)des inc$&e $nl. (hen it is actually $r constructively recEd. Dee /51(a)G Reg. 1.1//6-1(c)(1)(i). 61(a)(') gain deri!ed %r$& dealing in pr$pert. (i.e. st$ck) Ia*i&)& rate $n 9net capital gain: M a necessar. c$&p$nent $% (hich is l$ng-ter& capital gain M is less than the &a*i&)& rate $n $rdinar. inc$&e. 1(h). 8i!idends incl)ded in inc$&e )nder 61(a)( ). A)rrent la(, di!idends are incl)ded in c$&p)tati$n $% net capital gain, & are ta*ed at the pre%erential rate acc$rded net capital gain, rather than at $rdinar. inc$&e rates as high as '51. 1(h)(11). 2% A234st,2 gross in*o+, 62 de%ines ad4)sted ,- as ,- less certain ded)cti$ns. 62 si&pl. de%ines 0,-G it is not a deduction granting provision! In general, only those deductions listed in 62 are taken into account in computing AGI 6h)s, there are 2 categ$ries $% ded)cti$ns. 1) c$&prised $% ded)cti$ns a 6< &a. c$nsider in deter&ining his $r her 0,-G the. are re%erred t$ as 9above the line: ded)cti$ns 2) c$nsists $% th$se ded)cti$ns a 6< &a. take int$ acc$)nt $nl. a%ter the 0,- has been deter&inedG there are re%erred t$ as 9below the line: ded)cti$ns. -nteri& &eas)re $% ta*able inc$&e 1% D,24*tions Khen .$) ha!e an e*pense .$) belie!e is ded)ctible, ICD6 %ind a speci%ic A$de a)th$ri;ing it. -n!esting in st$cks & b$nds & $ther(ise &anaging $neEs in!est&ents has been held n$t t$ c$nstit)te a trade $r b)siness (?in the &eaning 162. !iggins v" #omm$n, '12 C.D. 212 (19/1). Nnacted 212 (hich speci%icall. pr$!ides a ded)cti$n %$r e*penses paid $r inc)rred d)ring the ta*able .ear 9%$r the pr$d)cti$n $r c$llecti$n $% inc$&e.: 6h)s, the &anage&ent %ee (ill be ded)ctible as an in!est&ent acti!it. e*pense )nder 212. H% Cal*4lating A234st,2 #ross In*o+, ?% Ta<a5l, In*o+,

a% 67: the 2% Floor on Miscellaneous Itemized Deductions. Aertain ite&i;ed ded)cti$n &a. n$t be ded)cted e*cept t$ the e*tent that in the aggregate s)ch ded)cti$ns e*ceed 21 $% the 6<Es 0,-. 3 s)b4ect t$ the 21 r)leF ded)cti$ns %$r h$&e &$rtgage interest, state inc$&e ta*, real pr$pert. ta*, & charitable c$ntrib)ti$ns. 6 (b). 5% 68: Overall Limitation on Itemized Deductions <r$!ides that $ther(ise all$(able ite&i;ed ded)cti$ns are red)ced b. '1 $% the a&$)nt b. (hich the 6<Es 0,- e*ceeds an in%lati$n-ad4)sted 9applicable a&$)nt: ($r, i% lesser, the red)cti$n is +01 $% $ther(ise all$(able ite&i;ed ded)cti$ns). *% ersonal !"em#tions 151(a) pr$!ides that there (ill be a ded)cti$n %$r pers$nal e*e&pti$ns. 151(d)(1) sets the e*e&pti$n a&$)nt, in general at $2,000, ad4)sted %$r in%lati$n a%ter 19+9 as set %$rth in 151(d)(/), %$r 200 the in%lati$n-ad4)sted pers$nal e*e&pti$n is $',/00. <age / $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

@)&ber $% e*e&pti$ns pr$!ided %$r )nder 152, Reg. 1.151-1(b). :% Ta< Rat, 0ppr$priate ta* rate )nder 1. 1(a) M (i) list 6 di%%erent ta* rates #redits. 21-5' '1 the credit (?h$lding ta*es paid thr$)gh the .ear b. the e&pl$.ers $n behal% $% the e&pl$.ees. Aredit !. ded)cti$n 0 credit red)ces $neEs ta* $n a d$llar %$r d$llar basis, (hereas a ded)cti$n red)ces ta*able inc$&e, th)s pr$!iding a red)cti$n in ta* that is dependent $n the ta* bracket $% the indi!id)al.

III% CLASS NOTES 6a* t$ raise re!en)e ' 5ig p$lic. c$nsiderati$n (e )sed t$ talk ab$)t ta*ati$n Hairness <e$ple disagree ab$)t (hatEs %air Heasibilit. Kant ta* t$ be eas. t$ ad&inister (g$!Et & indi!id)al %iling) N%%icienc. (n$n dist$rti$n) ? @e)tralit. 6he p$int $% ta*es is t$ raise $ n$t change pe$pleEs beha!i$r 6hings Rate 5ase M (hat .$) ta* (i.e. (ind$(s, pr$pert. ta* M assessed !al)e $n .$)r h$&e) Rate * 5ase B (hat ta* is D$cial sec)rit. ta* M base B (ages N*cise ta* M $n $ne narr$( thing Kh. 6a* -nc$&eL &$re inc$&e, the better $%% the. are & &$re able t$ pa. ta* Khat is inc$&eL <$(er t$ c$ns)&e -nc$&e ta* is ta*ing the p$(er t$ c$ns)&e M the $ .$) ha!e t$ c$ns)&e & the $ .$) ha!e .$) c$)ld c$ns)&e (? (sa!ings) NET INCO E ' in*o+, ta< is a ta< on n,t in*o+, All inflo7 -gross r,*,ipts. ' *ost of ,arning th, inflo7 / 7,alth a6aila5l, for *ons4+ption KhatEs le%t $!er %r$& the c$st $% getting that inc$&e (c$st $% earning &$ne.) 0ll in%l$( ,- M e!er.thing that happens t$ &e that &akes &e better $%% (ec$n$&ic) i.e. b)siness $(ner M p.&ts c$&ing in, (ages g$ing $)t, bills $n b)siness TA!A)LE INCO E < RATES / TA! LIA)ILITD 61 M ,- (adding st)%% )p) 1 %% - incl)si$ns $% , 102 %% M e*cl)si$ns $% ,- (i.e. gi%t) -% & (hen .$) can take a ded)cti$nL 62 M 0,- (s)btracti$ns), tell .$) when t$ take a ta* ded)cti$n 0678 M ded)cti$ns c$&e $)t $% , 6' M ta*able inc$&e (s)btracti$ns) 5678 M li&itati$ns $n it <age 5 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

ite&i;ed $r standard o 21 %l$$r & $!erall li&its '1 o -te&i;ed - 6 & 6+ Authori%e .$) t$ take a ded)cti$n 162 %%, 212 @$n ded)ctible things o 261 %% o 262 M c$ns)&pti$n e*penses (i.e., %$$d, cl$thes, l$dging) o 26' M capital e*pendit)res (take deprecati$n $!er ti&e) RATES ( I& special treat&ent $% capital gains (recei!e a l$(er ta* rate than $rdinar. inc$&e) characteri;ati$n iss)e (certain kinds $% inc$&e gets ta*ed di%%erentl.) )s)al inc$&e, reg)larl. paid l$ng ter& capital gains 1, ' TA! LIA)ILITD CREDITS s)btract credits %r$& ta* liabilit. e&pl$.er (ithh$lding $% ta* ta* d)e $r re%)nd di%%erence b?t credit & ded)cti$n ded)cti$ns s)btracted %r$& inc$&e credits s)btracted %r$& .$)r ta* liabilit. 02& ( 0?1

C$%2 ' #ROSS INCO EJ CONCE"TS F LI ITATIONS I% "RO)LE

ar*,lla #ROSS INCO E / S,*tion $ 5,000 salar. 61 $ 5,000 .ear end b$n)s $ /50 !al)e $% $ak desk ($500 %air &arket !al)e - $50 paid) M l$$ks like a bargain deal b)t l$$k at relati$nship b?t e&pl$.er & e&pl$.ee Reg. 1.61-2(d)(2) ),lo7 th, lin, 2,24*tions -)TLD. / $ 15,000 %ederal inc$&e ta*es (ithheld $ 5,500 s$cial sec)rit. ta*es $ /,500 state inc$&e ta*es Not Ta<a5l, $ 2,500 $ 5,000 $ 10,000 $ 2,500 ski retreat c$sts rei&b)rsed b. %ir& 3 ta*able b?c &andat$r. & disting)ished b. IcAann M %$rced c$ns)&pti$n & IcAann can be seen as a b$n)s %$r sales r$)nd class tickets t$ -tal. %r$& %re>)ent %l.er &iles legal %ees %$r h$&e (represented hersel%) i&p)ted inc$&e greenh$)se t$ thank %$r legal ser!ices gi%t e*change (n$t incl)ded) <age 6 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN it*h OR 1 OR 2 OR ' OR / OR 5

FEDERAL INCO E TA! I

S"RIN# 08

b).s st$ck %$r $1,000 M st$ck g$es )p t$ $1,500 st$ck g$es t$ $2,000, 0 $%%ers t$ b). st$ck g$es t$ $2,500, I b$rr$(s $2,000 (? st$ck as c$llateral st$ck g$es t$ $',000, Hire destr$.s st$ck certi%icates, POQ replaces, I repa.s debt st$ck g$es t$ $',500 & I gi!es st$ck t$ a credit$r in p.&t %$r debt $% $',500 - $1k basis B $2.5k

3 reali;ati$n e!ent 3 reali;ati$n e!ent 3 reali;ati$n e!ent 3 reali;ati$n e!ent B reali;ati$n e!ent 1001

0&$)nt Reali;ed B s)& reali;ed = &arket @A, B $2,500 -nc$&e %r$& discharge $% a debt II% O@ER@IEW A% Th, S,ar*h for a D,finition of In*o+, A$ngress, in de%ining 9,-,: intended t$ e*ert 9the %)ll &eas)re $% its ta*ing p$(er.:

)% In*o+, R,ali9,2 in AnA For+ Der!ice 0nn$)nce&ent 2002-1+, 2002-1 A.5. 621 stated 9it ($)ld n$t assert that an. 6< has )nderstated his %ederal ta* liabilit. b. reas$n $% the receipt $r pers$nal )se $% %re>)ent %l.er &iles R attrib)table t$ the 6<Es b)siness $r $%%icial tra!el.: 6h)s, a 6< (h$ acc)&)lates %re>)ent %l.er &iles as a res)lt $% b)siness tra!el paid %$r b. her e&pl$.er, is n$t re>)ired t$ rep$rt an. ,- as a res)lt $% receipt $% the %re>)ent %l.er &iles $r her )se $% th$se &iles %$r pers$n tra!el. C% R,ali9ation, I+p4t,2 In*o+, F )argain "4r*has,s &% $ealization $e%uirement. Reali;ati$n e!ents are n$t li&ited t$ cash sales. ,ain $r l$ss as being reali;ed %r$& the c$n!ersi$n $% pr$pert. int$ cash $r %r$& the e*change $% pr$pert. %$r $ther pr$pert. di%%ering &ateriall. either in kind $r in e*tent. Reg 1.1001-1(a). Cnder 1001F an e*change $% pr$pert. gi!es rise t$ a reali;ati$n e!ent s$ l$ng as the e*changed pr$perties are 9&ateriall. di%%erent: M that is, s$ l$ng as the. e&b$d. legall. distinct entitle&ents. Class Not,s Reali;ati$n r)le M in general .$) d$nEt get ta* 4)st $n the %l)ct)ati$n in the !al)e $% .$)r pr$pert.. Khat c$)nts as a reali;ati$n e!entL

EISNER 6% ACO )ER 028 F& : Irs. I $(ned st$ck in Dtandard Sil $% A0. Dhe & $ther shareh$lders recEd a 501 st$ck di!idend in the %$r& $% additi$nal c$rp$rate st$ck rather than a cash di!idend. Cnder Re!. 0ct $% 1916, the st$ck di!idend (as ta*able. '&$at: D)p. At. held that n$ gain & n$ inc$&e had been reali;ed b. reas$n $% the st$ck di!idend & A$ngress had n$ p$(er t$ ta* it )nder the A$nst. Reali;ati$n is a c$nst. re>)ire&ent. @$(, br$ad c$nsens)s that reali;ati$n is n$t a c$nstit)ti$nall.-re>)ired prere>)isite t$ ta*ati$n. <age $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

COTTA#E SA@IN#S ASSGN 6% CO GN, H99 C%S% at ?:: 028 Issue: Khether a sa!ings and l$an ass$ciati$n 9reali;ed: l$sses $n the e*change $% its interest in $ne gr$)p $% h$&e &$rtgage l$ans %$r interests in a di%%erent gr$)p $% h$&e &$rtgage l$ans. '&$at: 5egan b. a%%ir&ing the c$ncept $% reali;ati$n is %$)nded $n ad&inistrati!e c$n!enience. 6he l$sses had in %act been reali;ed b?c, based $n the reg)lati$ns )nder 1001, an e*change $% pr$pert. gi!es rise t$ a reali;ati$n e!ent s$ l$ng as the e*changed pr$perties are 9&ateriall. di%%erent: M that is, s$ l$ng as the. e&b$d. legall. distinct entitle&ents. 5?c the participati$n interest e*changed deri!ed %r$& l$ans that (ere &ade t$ di%%erent $blig$rs & sec)red b. di%%erent h$&esG the e*change interests did e&b$d. legall. distinct entitle&ents. A$ttage Da!ings reali;ed its l$ses at the p$int $% e*change. 2% Im#uted Income -&p)ted inc$&e is n$t ta*ed, e!en th$)gh the -RA c$ntains n$ speci%ic e*cl)si$n t$ that e%%ect. 2 categ$riesF -&p)ted inc$&e %r$& ser!ices & i&p)ted inc$&e %r$& pr$pert. 2$&e $(ner !. renters Nc$n$&ic bene%it arising %r$& sel%-help, ie, %r$& per%$r&ing ser!ices %$r $nesel%, $neEs %a&il. $r $thers. 7a(.ers dra%ting their $(n (ills, &$(ing .$)r $(n la(n, etc R T)esti$ns related t$ i&p)ted inc$&e arise in practice are th$se ass$ciated (? sel%-e&pl$.&ent $r e&pl$.&ent acti!itiesF &orris v" #omm$n (192+) M the !al)e $% %ar& pr$d)cts c$ns)&ed b. the $(ner (as n$t inc$&e. 1% (ar)ain urchases. Kh. are barter t* ta*ableL b?c then there ($)ld be %e(er cash t* ,eneral barter principle M &arket !al)e %$r the bartered g$$d $r ser!ice 0ss)&e p)rchase an asset at a bargain price (HIU $% the asset is greater than the price .$) paid %$r it) M .$) ha!e an accessi$n t$ (ealth, sh$)ld it be incl)ded in ,-L @S 'ellar v" #omm$n M bargain p)rchases generall. d$ n$t c$nstit)te ,- b?c ad&inistrati!el. )n($rkable, spec)lati!e t$ %ig)re $)t &a. be &ini&al. <r$pert. t* as c$&pensati$n %$r ser!ice in an a&$)nt less than HIU, the di%%erence b?t the HIU & the a&t pd. is ,- . Reg. 1.61-2(d)(2)(i). 8eter&ining (hether a bargain ele&ent is present $r (hether it represents c$&pensati$n %$r ser!ice is, $n $ccasi$n, s$&e(hat &$re di%%ic)lt, i.e. %ringe bene%its 1'2. 5e care%)l n$t t$ &isappl. the reali;ati$n re>)ire&ent in c$nnecti$n (? a c$&pensat$r. bargain p)rchase that c$nstit)tes ,-. 0ss)&eF an e&pl$.er t* t$ an e&pl$.ee, as c$&pensati$n, st$ck ($rth $500 %$r $100 pa.&ent. Reg. 1.612(d)(2)(i) pr$!ides that e&pl$.ee has ,- $% $/00. K$)ld be inc$rrect t$ arg)e the e&pl$.ee had n$ inc$&e b?c the $/00 gain had n$t been reali;ed & ($)ld n$t be reali;ed )ntil the e&pl$.ee disp$sed $% the st$ck. 6he $/00 di%%erence si&pl. d$es n$t c$nstit)te appreciati$n in the st$ckEs !al)e (hile in the hands $% the e&pl$.ee. 6he pr$pert. (as gi!en t$ the e&pl$.ee as c$&pensati$n & it is the HIU $% that pr$pert. that &)st be )sed in $rder t$ &eas)re the c$&pensat$r. ele&ent in the t*.

CO GN 6% #LENS$AW #LASS CO% -&9??. 011 F& : ,lensha( ,lass A$. &an)%act)rers glass b$ttles & c$ntainers. -t (as engaged in pr$tracted litigati$n (? 2art%$r-N&pire A$., (hich &an)%act)res &achiner. )sed b. ,. , s$)ght e*e&plar. da&ages <age + $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

%$r %ra)d & treble da&ages %$r in4)r. t$ its b)siness b. reas$n $% 2Es !i$lati$n %ederal antitr)st la(s. 8ec. 19/ , parties c$ncl)ded a settle&ent in (hich 2 paid , app*. $+00k. 6$tal $'2/k represented p.&t $% p)niti!e da&ages %$r %ra)d & antitr)st !i$lati$ns. , did n$t rep$rt this p$rti$n $% the settle&ent as inc$&e %$r the ta* .ear in!$l!ed. A$&&En deter&ined de%icienc. clai&ing as ta*able the entire s)& less $nl. ded)ctible legal %ees. 6a* At & At. $% 0ppeals r)led in %a!$r $% the 6<. Issue: Khether $ recEd as e*e&plar. da&ages %$r %ra)d $r as the p)niti!e 2?' p$rti$n $% a treble-da&age antitr)st rec$!er. &)st be rep$rted b. a 6< as ,- )nder 22(a) $% the -RA 19'9. $ule: 22(a) M 9gains $r pr$%its and inc$&e deri!ed %r$& an. s$)rce (hate!er: '&$at: 6his lang)age (as )sed b. A$ngress t$ e*ert in this %ield 9the %)ll &eas)re $% its ta*ing p$(er:. 2ere (e ha!e instances $% )ndeniable accessi$ns t$ (ealth, clearl. reali;ed, & $!er (hich the 6<s ha!e c$&plete d$&ini$n. 6he &ere %act that the p.&ts (ere e*tracted %r$& the (r$ngd$ers as p)nish&ent %$r )nla(%)l c$nd)ct cann$t detract %r$& their character as ta*able inc$&e t$ the recipients. Rec$!eries are ta*able t$ the e*tent that the. c$&pensate %$r da&ages act)all. inc)rred. -t ($)ld be an an$&al. that c$)ld n$t be 4)sti%ied in absence $% clear c$ngressi$nal intent t$ sa. that rec$!er. %$r act)al da&ages is ta*able b)t n$t the additi$nal a&$)nt e*tracted as p)nish&ent %$r the sa&e c$nd)ct (hich ca)sed the in4)r.. <)niti!e da&ages d$ n$t c$&e )nder an. pr$!isi$n (hich e*e&pts it %r$& inc$&e. (eversed" CESARINI 6% C%S% -N%D% Ohio &9:9. 01: F& : Vs are h)sband & (i%e. -n 195 , Vs p)rchased a )sed pian$ at an a)cti$n sale %$r app*. $15, in 196/ (hile cleaning the pian$, Vs disc$!ered s)& $% $/,/6 in $ld c)rrenc.. Vs e*changed $ld c)rrenc. %$r a ne( at a bank & rep$rted the s)& $% $/,/6 $n 196/ 4$int ta* ret)rn as $rdinar. inc$&e %r$& $ther s$)rces. Sct. 1965, Vs %iled a&ended ret)rn eli&inating the $/,/6 %r$& ,- c$&p)tati$n & re>)esting a re%)nd $% $+'6.51 c$ntending it (as err$ne$)sl. $!erpaid. Jan. 1966 A$&&En re4ected re%)nd clai&. Issue: Khether the $/,/6 sh$)ld in incl)ded in ,$ule: 61(a) M ,- &eans all inc$&e %r$& (hate!er s$)rce deri!ed, incl)ding b)t n$t li&ited t$ the %$ll$(ing ite&sF (1) M (15) list 15 ite&s speci%icall. incl)ded & <art -- $% s)bchapter 5 $% 195/ A$de list ite&s e*pressl. incl)ded in ,-. <art --- deals (? ite&s speci%icall. e*cl)ded %r$& ,-. '&$at: 6he %$)nd $ in c$ntenti$n is n$t listed in the incl)ded $r e*cl)ded parts W ret)rn t$ 9all inc$&e %r$& (hate!er s$)rce: lang)age $% 61(a) & n$t li&ited t$. D)p. At. has held br$ad lang)age in $rder %$r A$ngress t$ e*ert its %)ll ta*ing p$(er )nder 16th 0&end. -RD Re!. R)ling 61, 195'-1 A5 1 M the %inder $% treas)re tr$!e is in receipt $% ta*able inc$&e. Vs arg)e $ %alls )nder either / (incl)ding the !al)e $% pri;es & a(ard in ,-) & 102 (e*e&pting the !al)e $% gi%ts recEd %r$& ,-). / added b?c pri;es &ight $ther(ise c$nstr)ed as n$n-ta*able gi%ts, & since n$ (as passed e*pressl. ta*ing treas)re-tr$!e, it is W a gi%t )nder 102. 6his ign$res the stat)t$r. sche&e (hereb. inc$&e %r$& all s$)rces is ta*ed )nless the 6< can p$int t$ an e*press e*e&pti$n. $ (as n$t red)ced t$ )ndisp)ted p$ssessi$n )ntil act)al disc$!er. in 196/, th)s ta*able d)ring that .ear and n$t the .ear the pian$ (as b$)ght. OLD COLOND TRCST CO "AND 6% CO GN -&929. 019 F& : <et. e*ec)t$rs $% the (ill $% K. J)ne 1925, be%$re KEs death, the A$&&En n$ti%ied hi& b. &ail $% the deter&inati$n $% a de%icienc. in inc$&e %$r the .ears 1919 & 1920. 0ppeals (as taken t$ 5d. S% 0ppeals. 5d. H$)nd a de%icienc. %$r K in 1919 %$r X$ 0+k & 1920 X$'50k. K ($rked %$r 0KA, (hich passed res$l)ti$n t$ pa. %$r KEs %ederal ta* in 1919 & 1920. Issue: Khether a 6<, ha!ing ind)ced a 'rd pers$n t$ pa. his inc$&e ta* $r ha!ing ac>)iesced in s)ch pa.&ent as &ade in discharge $% an $bligati$n t$ hi&, &a. a!$id the &aking $% a ret)rn there$% & the pa.&ent $% a c$rresp$nding ta*L @S '&$at: <a.&ent $% the ta* b. the e&pl$.ers (as in c$nsiderati$n $% the ser!ice rendered b. the e&pl$.ee & (as a gain deri!ed b. the e&pl$.ees %r$& his lab$r. 6he discharge b. a 'rd pers$n $% an $bligati$n t$ <age 9 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

hi& is e>)i!alent t$ receipt b. the pers$n ta*ed. 6he ta*es (ere paid )p$n a !al)able c$nsiderati$n, the ser!ices rendered b. the e&pl$.ees, & as part $% c$&pensati$n. <.&t $% ta*es -D inc$&e t$ the e&pl$.ee. RE@ENCE RCLIN# ;9(2H, &9;9(& C%)% :0 0H& *ituation +: -n ret)rn %$r pers$nal legal ser!ice per%$r&ed b. a la(.er %$r a h$)sepainter, h$)sepainter painted the la(.erEs pers$nal residence. 5$th &e&bers $% barter cl)b. *ituation 2: 0n indi!id)al (h$ $(ned an apt. bldg recEd a ($rk $% art created b. a pr$%essi$nal artist in ret)rn %$r the rent-%ree )se $% an apt %$r 6 &$s. b. the artist. La,: 61(a) and Reg. 1.61-2 relating t$ c$&pensati$n ser!ices. 1.61-2(d)(1) pr$!ides that i% ser!ices are pd %$r $ther than in $, the HIU $% the pr$pert. $r ser!ices taken in p.&t &)st be incl)ded in inc$&e. -% ser!ices rendered at a stip)lated price, s)ch prices (ill be pres)&ed the HIU $% the c$&pensati$n recEd in the absence $% e!idence t$ the c$ntrar.. 'oldin) +: HIU $% the ser!ices recEd b. the la(.er & h$)sepainter are incl)dable in their ,- )nder 61. 'oldin) 2: HIU $% the !al)e $% the art & the 6 &$s. %air rental !al)e $% the apt. are incl)dable in ,- - 61. *CANN 6% C%S% -F,2% Cir% &981. 0H2 F& : IEs residents $% Dhre!ep$rt &ade a r$)nd trip t$ 7as Uegas in 19 ' %$r the p)rp$se $% attending a se&inar b. Irs. IEs e&pl$.er, D. 0ll tra!eling & $ther e*penses $% the IEs in c$nnecti$n (? the attendance at the se&inar (ere paid b. D. -n 19 ' 4$int inc$&e ta* ret)rn, the IEs did n$t incl)de an. e*penses pd. b. D in regards t$ this trip in their ,-. -RD decided the HIU $% the trip sh$)ld ha!e been incl)ded in their ,- and iss)ed a de%icienc. n$tice. IEs paid, then %iled s)it %$r re%)nd. Issue: Khether, as deter&ined b. the -RD, the IEs sh$)ld ha!e incl)de in their 19 ' inc$&e ta* ret)rn, as p$rt $% their ,-, an a&t based )p$n the c$st t$ D $% de%ra.ing their tra!el & $ther e*penses %$r the trip. $ule: 9all inc$&e %r$& (hate!er s$)rce deri!ed.: '&$at: 6a* all gains e*cept th$se speci%icall. e*cl)ded (hich incl)des an. ec$n$&ic $r %inancial bene%it c$n%erred as c$&pensati$n. Reg. 1.61-1(a) ,- &a. incl)de &$ne., pr$pert., ser!ices, &eals, acc$&&$dati$ns, $r st$ck, $r &a. be in an. $ther %$r&. 6h)s, in a sit)ati$n (here an e&pl$.er pa.s an e&pl$.eeEs e*penses $n a trip that is a re(ard %$r ser!ices rendered b. the e&pl$.ee, the !al)e $% the re(ard &)st be regarded as inc$&e. De&inar B ec$n$&ic bene%it t$ IEs & re(ard t$ Irs. I, De&inar is $pti$nal & n$t re>)ired W the re(ard (as clearl. c$&pensati$n %$r ser!ices rendered & B ,- & (hen ser!ices are paid %$r in a %$r& $ther than $, the HIU is )sed. Reg. 1.61-2(d)(1). "ELLAR 6% CO GN -T%C% &9??. 0H? F& : <et. entered int$ a Y (? a c$nstr)cti$n A$. %$r the erecti$n $% a d(elling $n land pre!i$)sl. p)rchased b. pet. 0ct)al c$st (as s)bstantiall. &$re then the %i*ed price in the Y (e*tras re>)ested b. pet. & err$rs $n part $% the YE$r). HIU at ti&e $% c$&pleti$n (as &ateriall. in e*cess $% the price %i*ed in the agree&ent, b)t &ateriall. less than the c$st $% the c$nstr)cti$n. Issue: Khether $r n$t the e*cess $% the HIU $r the pr$pert. (e*cl)ding land) $!er c$st c$nstit)ted inc$&e t$ the <etiti$ners. $ule: ,eneral r)le M the p)rchase $% pr$pert. %$r less than its !al)e d$es n$t, $% itsel%, gi!e rise t$ the reali;ati$n $% ta*able inc$&e (reali;ati$n n$r&all. arises & is ta*ed )p$n sale $r $ther dip$siti$n). '&$at: @$ ta*able inc$&e res)lts %r$& the p)rchase $% pr$pert. ass)&ing that the t* is $ne at ar&Es length & that the relati$nship $% the parties d$es n$t intr$d)ce int$ the t* $ther ele&ents indicating that the t* is n$t si&pl. a p)rchase b)t in!$l!es an e*change $% $ther c$nsiderati$ns (str$ng e!idence t$ reb)t the pres)&pti$n). 0c>)isiti$ns $% pr$pert. &a. res)lt in ta*able inc$&e (here the. d$nEt represent p)rchases $r (here s$&e $ther p)rp$se is c$ns)&&ated b. the ac>)isiti$n $% the pr$pert., i.e., pr$pert. ac>)ired in c$nnecti$n (?a 9bargain p)rchase: &a. represent c$&pensati$n (here the seller & the p)rchaser bear a <age 10 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

relati$nship $% e&pl$.er & e&pl$.ee, $r a di!idend distrib)ti$n, $r a gi%t. -n the instant case, n$ e&pl$.ere&pl$.ee relati$nship t$ in%er di%%erential (as c$&pensati$n, n$ di!idend, n$t reali;ed. ROCO 6% CO GN -T%C% 2001. 0H8 F& : 8e%icienc. in petitEs 199 inc$&e ta*. <et. s)ed @OCIA in a >)i ta& acti$n )nder Halse Alai&s 0ct clai&ing @OC had s)b&itted %alse in%$. t$ the CD (hich res)lted in a s)bstantial $!erp.&t $% Hederal %)nds. CD pd pet. $1,56+,0+ in 199 as his share $% the settle&ent pr$ceeds. Issue: (1) Khether the $ pa.&ent that pet. recEd %r$& the CD in 199 is incl)dable in ,-L OND (2) Khether the pet. is liable %$r the acc)rac.-related penalt. )nder 6662(a) %$r 199 L OND '&$at: 6he >)i ta& p.&t t$ pet. (as the e>)i!alent $% a re(ard %$r petEs e%%$rts t$ $btain rep.&t t$ the CD $% $!ercharges b. @OCIA. Re(ards are generall. incl)dable in ,-. 1.61-2(a). ,- incl)des all inc$&e %r$& (hate!er s$)rce deri!ed )nless e*cl)ded b. la(. -RA pr$!ides n$ e*cl)si$n %$r ,- %$r pr$ceeds recEd b. a realt$r in a >)i ta& pr$ceeding. @either >)i ta& p.&ts n$r p)niti!e da&ages are intended t$ c$&pensate the recipient %$r act)al da&ages. <)niti!e da&ages are incl)dable in ,-. III% CLASS NOTES 6r)st 0cc$)nting c$ncept add pr$pert. t$ the acc$)nt ha!e a tr)stee &anager, (h$ gi!es inc$&e t$ benes Hact$r p.&ts appr$ach basic appr$ach taken in Nisner !. Iac$&ber inc$&e is gain %r$& the )se $% lab$r & capital c$&bined capital gain is inc$&e 0ccreti$ns t$ (ealth i% &. (ealth increase -E& better $%% general $nl. ta* gains t$ (ealth A$ttage Da!ings 0ssEn !. A$&&En M reali;ati$n r)le, the c$ncept $% reali;ati$n is %$)nded $n ad&inistrati!e c$n!enience. 6$$ hard t$ !al)e pr$pert. e!er. .ear BI S #ENERAL RCLE #I iss4, did s$&ething &ake s$&e$ne better $%%, i% it d$es then l$$k %$r a stat)t$r. $r c$)rt e*cl)si$n in general the de%initi$n $% inc$&e is e*pansi!e, )nless - can %ind a stat)t$r. e*cl)si$n ($r reali;ati$n r)le) Sther h& $pp$site (hen .$) talk ab$)t ded)cti$ns M need a speci%ic pr$!isi$n C$% 1 ' T$E EFFECT OF AN O)LI#ATION TO RE"AD I%"RO)LE S &% Dte!e -a. OR1 M Rep$rt $25,000 (clai& $% right d$ctrine A5 60) -5. OR2 M ded)cti$n %$r $5k rep.&t )nder 1'/1 2% Dte!e -a. OR1 M Rep$rt $25,000 $n ta*es (illegal %)nds) -5. OR2 M ded)cti$n %$r $5k rep.&t )nder 1'/1 1% Ye!in -a. 3 ,- in the .r recEd M 0?? ' 0;8

c$&pare t$ @0S (A5 6') A5 61 )ee -ndianap$lis <$(er (A5 6+) <age 11 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

H% Ye!in )ee -a. 8ec. 1 M Y signs Y t$ (rite b$$k &. RecEd $10k in ad!ance r$.alties 2. Y g)arantees 1,000 c$pies at $25 $r has t$ repa. the di%%erence it sells sh$rt -5. J)l. 1 M &an)script &)st be deli!ered -*. -s ad!ance r$.alties incl)de in ,-L OND M c$ntingent 3 $bligati$n )ee KND6<0A (A5 5) II%O@ER@IEW A% Loans 7$ans are n$t ,-. 0 l$an 3 an 9accessi$n t$ (ealth: $r increase the 6<Es net ($rth b?c the l$an pr$ceeds are acc$&panied b. an e>)al & $%%setting liabilit.F the b$rr$(er has an $bligati$n t$ repa. the l$an, & it is this rep.&t $bligati$n that negates treat&ent $% a l$an as inc$&e. Rep.&t is n$t a ded)ctible e*pense. 6he lender has n$ ded)cti$n (hen the l$an is &adeG rep.&t is &erel. a rec$!er. $% capital %$r hi&. 0 %ail)re t$ repa. a l$an &a. generate ta* c$nse>)ences, i.e. 'rd part. repa.s the l$an $n behal% $% the b$rr$(er (b)t c$)ld represent a gi%t t$ the b$rr$(er and n$t gi!e rise t$ liabilit.). D)pp$seF a c$rp. &akes s)bstantial cash disb)rse&ents t$ a shareh$lder, per&its the shareh$lder t$ )se the c$rpEs credit card %$r pers$nal p)rchases, & pa.s %ederal & state ta* liabilit. $(ed b. the D2. &orrison v" #omm$n held the p.&ts & disb)rse&ent (ere l$ansF the c$)rt %$)nd that the c$rp. had en$)gh %)nds t$ &ake the l$an, the D2 had en$)gh inc$&e t$ repa. the l$ans, & there (as e!idence the D2 had in %act &ade l$an rep.&ts, incl)ding interest.

KARNS "RI E F FANCD FOOD 6% CO GN F& : 6< s$)ght %inancial assistance %r$& D)per Rite %$r certain capital i&pr$!e&ents. D)per Rite re>)ired the 6< t$ (a) enter int$ a (ritten s)ppl. agree&ent re>)iring 6< t$ p)rchase ann)all. a certain a&t D)per RiteEs pr$d)cts & (b) t$ e*ec)te a pr$&iss$r. n$te pa.able t$ D)per Rite in the a&t $% the ad!ance, alth$)gh D)per Rite intended that the c)st$&erEs $bligati$n t$ repa. the %)nds that it ad!ance ($)ld arise $nl. i% the c)st$&er &ateriall. breached the s)ppl. agree&ent. 7$an is %$rgi!en i% 6< d$es n$t breach the agree&ent. 6< incl)ded $250k as $ther s$)rce $% inc$&e %$r the %$ll$(ing .ears & did n$t incl)de the 1.5I in the .ear recEd. '&$at: 6he deter&inati$n $% (hether a t* $% %)nds c$nstit)tes a l$an is a >)esti$n $% %act M in $rder %$r the %)nds t$ c$nstit)te a l$an, at the ti&e the %)nds are t* there &)st be an )nc$nditi$nal $bligati$n (i.e. an $bligati$n that is n$t s)b4ect t$ a c$nditi$n precedent) $n the part $% the trans%eree t$ repa., & an )nc$nditi$nal intenti$n $n the part $% the trans%er$r t$ sec)re rep.&t $% s)ch %)nds. 6he 6< did n$t ha!e an )nc$nditi$nal $bligati$n t$ &ake each $% the ann)al p.&ts set %$rth in the pr$&iss$r. n$te W At. c$ncl)ded that $1.5I recEd b. the 6<, a c$rp. $perating a gr$cer. st$res, %$r& the principal s)pplier, D)per Rite H$$ds, did n$t c$nstit)te a l$an and (as incl)dable as ,-. )% Clai+ of Right Khat is the pr$per ta* treat&ent $% $ ($r $ther pr$pert.) recEd s)b4ect t$ a contingent rep.&t $bligati$nL -.e., %$)nd l$st (allet, b)t la( all$(s s$&e$ne t$ clai& the $ (?in 2 .ears. Alai& $% Right 8$ctrineF -% a 6< recei!es earnings )nder a clai& $% right & (?$ restricti$n as t$ its disp$siti$n, he has recEd inc$&e (hich he is re>)ired t$ ret)rn "that is, t$ rep$rt $n his ta* ret)rn#, e!en th$)gh he &a. still <age 12 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

be clai&ed that he is n$t entitled t$ retain the $, & e!en th$)gh he &a. still be ad4)dged liable t$ rest$re its e>)i!alent. $ recEd )nder a clai& $% right, (?$ restricti$n as t$ disp$siti$n, is inc$&eG the c$ntingent rep.&t $bligati$n d$es n$t all$( the receipt t$ be treated as a l$an. $ recEd & sel% i&p$ses !$l)ntar. restricti$n t$ be a!ailable %$r rep.&t )p$n settle&ent $% the disp)te n$t inc$&e, att.. recEd ad!ance b. clients and canEt )se %)nds, att.. is n$t in receipt $% inc$&e (hen recEd. H)nds $!er (hich the 6< acts $nl. as a c$nd)it are n$t recEd )nder a clai& $% right. C% Ill,gal In*o+, 7$ng clear gains %r$& an illegal b)siness &a. be ta*ed. *) v" )ullivan (192 ). +ames v" *) M D)p. At. held e&be;;led %)nds incl)dable in ,- (RC7N 6S80O). Gilbert v. #omm$n (19 1) M 6< &ade )na)th$ri;ed (?dra(als $% c$rp$rate %)nds & pleaded g)ilt. t$ state & %ederal charges. 2nd Air. 2eld 6< did n$t reali;e inc$&e )nder the +ames test $n %)nd (?dra(n %r$& a c$rp. (here the 6< %)ll. intended t$ repa. the&, e*pected (? a reas$nable certaint. t$ be able t$ repa. the&, belie!ed the (?dra(als ($)ld be appr$!ed b. the c$rp., & &ade a pr$&pt assign&ent $% assets s)%%icient t$ sec)re the a&t. $(ed. At. %$)nd it t$ be in the nat)re $% a l$an. 0s +ames s)ggests, & the Der!ice c$ncedes, rep.&t $% illegal inc$&e entitles the 6< t$ a ded)cti$n. Re!. R)l. 65-25/. At. re4ected arg)&ent that the c$nsens)al rec$gniti$n $% indebtedness $% an e&be;;ler (?in the sa&e ta* .ear trans%$r&ed the t* int$ a l$an. ,reimer v" #omm$n M 6< c$n!icted $% $btaining l$ans )nder %alse pretenses a&$)nting t$ %ra)d. 8espite this, the ct %$)nd the t*s (ere l$ans since the 6< had al(a.s regarded & treated the $bligati$ns as b$na %ide debt the. intended t$ repa.. -n c$ntrast, (here a c$nsistent pattern $% %ra)d)lent dealing de&$nstrates an absence $% intent t$ repa., &erel. labeling the %)nds $btained as l$ans (ill n$t a!$id ,-. D% D,posits Reg)lati$ns pr$!ide that rent paid in ad!ance generall. c$nstit)tes ,- in the .ear it is recEd regardless $% the peri$d c$!ered $r the 6<Es &eth$d $% acc$)nting. Reg. 1.61-+(b). 0d!ance p.&t $% inc$&e is still inc$&e.

NORT$ A ERICAN OIL CONSOLIDATED 6% )CRNET -&912. 0:1 F& : 1916 M s$)ght $ %$r pr$%its $% that .ear, 191 M @0S ($n at trial & $ paid, CD appeals, 1920 @0S (ins appeal, 1922, D)p. At. dis&isses. -nc$&e paid & earned %r$& 1916 had been entered $n the b$$ks $% the c$. as inc$&e & incl)ded in an a&ended ret)rn %$r that .ear %iled in 191+. Issue: Khether the s)& $% X$1 1Y recEd b. the @0S in 191 , (as ta*able t$ it as inc$&e $% that .ear. $ule: -% a 6< recei!es earnings )nder a clai& $% right & (?$ restricti$n as t$ its disp$siti$n, he has recEd inc$&e (hich he is re>)ired t$ ret)rn "that is, t$ rep$rt $n his ta* ret)rn#, e!en th$)gh it &a. still be clai&ed that he is n$t entitled t$ retain the $, & e!en th$)gh he &a. ha!e t$ pa. it back. '&$at: (1) inc$&e earned in 1916 & i&p$)nded b. the recei!er in the .ear (as n$t ta*able t$ hi&, b?c he (as the recei!er $% $nl. a part $% the pr$perties $perated b. the c$&pan.. (2) @et pr$%its (ere n$t ta*able t$ the c$&pan. as inc$&e $% 1916 b?c ne!er recEd it in 1916, n$ c$nstr)cti!e receipt $% the pr$%its, n$ right t$ de&and the recei!er pa. the c$. the $. 191 c$. beca&e entitled t$ recei!e the $. (') @et pr$%its earned b. the pr$pert. in 1916 (ere n$t inc$&e $% 1922 M .ear (hich litigati$n (as %inall. %inished. 5eca&e inc$&e <age 1' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

$% the c$. in 191 (hen it %irst beca&e entitled the& & (hen the. act)all. recEd the&. (i% l$st in 1922 & had t$ repa. ($)ld be entitled t$ a ded)cti$n in 1922, b)t ha!e incl)de as inc$&e in 191 ). -O.!*: Khen .$) get $ & thereEs n$ )nderstanding that .$) ha!e t$ pa. the $ back, thatEs inc$&e t$ .$). BA ES 6% C%S% -&9:&. 0:? F& : Cni$n $%%icial (h$, (? an$ther pers$n, e&be;;led %)nds %r$& 1951-195/ %r$& e&pl$.er )ni$n & ins)rance c$. Hailed t$ rep$rt as inc$&e. Issue: Khether e&be;;led %)nds are t$ be incl)ded in the 9,-: $% the e&be;;ler in the .ear in (hich the %)nds are &isappr$priated )nder 61(a) $% the -RA $% 195/. $ule: Khen a 6< ac>)ires earnings, la(%)ll. $r )nla(%)ll., (?$ the c$nsens)al rec$gniti$n, e*press $r i&plied, $% an $bligati$n t$ repa. & (?$ restricti$n as t$ their disp$siti$n, he has recEd inc$&e (hich he is re>)ired t$ ret)rn, e!en th$)gh it &a. still be clai&ed that he is n$t entitled t$ retain the $, & e!en th$)gh he &a. still be ad4)dged liable t$ rest$re its e>)i!alent. '&$at: 7a(%)l & )nla(%)l gains are c$&prehended (?in the ter& 9,-.: 7a(%)l (as ad&itted in 1916 (hen 6a* stat)te a&ended M intent $% A$ngress t$ deri!e inc$&e ta* %r$& b$th legal & illegal s$)rces. <re&ise that the p)rp$se $% A$ngress (as t$ )se the %)ll &eas)re $% its ta*ing p$(er M liberal c$nstr)cti$n t$ br$ad &eaning $% ter& 9,-:. 6< has c$&&and $!er the pr$pert. ta*ed M the act)al bene%it (hich the ta* is pd. Dh$)ld be treated si&ilarl. t$ s$&e$ne (h$ recei!es inc$&e (i.e. b$n)s) &istakenl. & still has t$ rep$rt as ,- (gets ded)cti$n (hen repd, e&be;;ler als$ gets this). CO GN 6% INDIANA"OLIS "OWER F LI#$T CO% -&990. 0:8 F& : -<7 A$. re>)ired certain $% its c)st$&ers t$ &ake dep$sits as a c$nditi$n $% pr$!iding electricit.. Khen a c)st$&er ter&inated its electric ser!ice, it c$)ld either pa. the entire bill & recei!e the dep$sit, $r appl. the dep$sit t$ the %inal bill. 6he p$(er c$&pan. did n$t incl)de the dep$sits in ,- (hen recEd, & -RD arg)ed that the. (ere inc$&e in that .ear. Issue: Kere the dep$sits incl)dable in 6<Es ,- as ad!ance p.&ts %$r electricit., $r e*cl)dable as dep$sitsL '&$at: 6he a&t dep$sited b. the electric c)st$&ers (ere dep$sits & there%$re (ere e*cl)ded %r$& ,- $% -<7. 6hese a&ts (ere &$st like a l$an %r$& the c)st$&er t$ -<7 (hich c$)ld be applied t$ the p)rchase $% electricit. at ter&inati$n $% ser!ice. -<7Es abilit. t$ retain the dep$sit depended $n 2 e!ents $)tside its c$ntr$l, i.e. cancellati$n $% ser!ice b. c)st$&er & decisi$n t$ appl. the dep$sit t$ %inal bill. WEST"AC "ACIFIC FOOD 6% CO GN -9th Cir% 200:. 0;? F& : Iade / Ys t$ b). in!ent$r. & recEd cash in ad!ance. Issue: Khether cash pd in ad!ance b. a (h$lesaler t$ a retailer, in e*change %$r a !$l)&e c$&&it&ent, is ,- $r (hether ad!ance trade disc$)nts c$nstit)te ,-L @S '&$at: Aash ad!ances in e*change %$r !$l)&e p)rchase c$&&it&ents, s)b4ect t$ pr$ rata rep.&t i% the !$l)&e c$&&it&ents are n$t &et, are n$t inc$&e (hen recEd. Sne &a. ha!e 9c$&plete d$&ini$n: $!er $ b)t it d$es n$t bec$&e inc$&e )ntil it is an 9accessi$n t$ (ealth.: 6hat is (h. b$rr$(ed $ is n$t inc$&e, e!en th$)gh the b$rr$(er has 9c$&plete d$&ini$n: $!er the cash. 5?c $% this rep.&t $bligati$n, the l$an pr$ceeds d$ n$t >)ali%. as inc$&e t$ the 6<. III%CLASS NOTES N%%ect $% a legal $bligati$n M $bligati$n t$ repa. c$)nter balances the receipt $% &$ne. 2006 5 b$rr$(s $10Y %r$& 7 .ear $% the l$an n$ incl)si$n %$r 5 & n$ ded)cti$n %$r 7 200 5 pa.s $10Y t$ 7 .ear $% the rep.&t $% the l$an, n$ ded)cti$n %$r 5 & n$ incl)si$n %$r 7 8i%%erences b?t dep$sit ? prepa.&ent legal right t$ recei!e dep$sit back, b)t &a. ch$$se t$ p)t it t$(ards last &$nth <age 1/ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I


Th, ,ff,*t of an O5ligation to R,paA

S"RIN# 08

Transa*tion 7$an 8ep$sit

D,s*ription 0ccessi$n t$ (ealth (ith a c$nsens)al $bligati$n t$ repa. 0ccessi$n t$ (ealth (ith a c$nsens)al $bligati$n t$ repa. ( 6ND6F (h$ c$ntr$ls $ 0ccessi$n t$ (ealth (ith a c$ntingent $bligati$n t$ repa. 0ccessi$n t$ (ealth (ith a legal (b)t n$t c$nsens)al) $bligati$n t$ repa. 0ccessi$n t$ (ealth (ith a legal (b)t n$t c$nsens)al) $bligati$n t$ repa. 9Aash back: (ith $bligati$n t$ pa. @$ incl)si$n @$ incl)si$n

Ta<ation

Receipt )nder a clai& $% right N&be;;le&ent

-ncl)si$n -ncl)si$n

N*t$rti$n 0d!ance disc$)nt

-ncl)si$n @$ incl)si$n

Loan -no in*l4sion. ((((((( R,paA+,nt -no 2,24*tion.

C$% H ' #AINS DERI@ED FRO I%"RO)LE S

DEALIN# IN "RO"ERTD

0;9 ' 92

&% Dpec)lat$r b$)ght 100-acre desert land 10 .rs ag$ %$r $250,000. -a. D$ld l$t %$r $1,000,000 &. 1,000,000 - $250,000 (basis in land) B $ 50,000 incl)ded in ,-5. D)bdi!ides the 100-acre parcel int$ 5, 20 acre l$ts & sells each %$r $/00,000 &. 5asis in each l$t B $250,000 ? 5 B $50,000 2. /00,000 M 50,000 B '50,000 * 5 B 1, 50,000 incl)ded in ,a% /00,000 * 5 B 2,000,000 - $250,000 B $1, 50,000 2% I p)rchased s)&&er h$&e %$r $500,000. Csed $100,000 $% $(n %)nds & b$rr$(ed $ther $/00,000. -a. 5asis B $500k 1012 &. I p)rchased h$&e )nder Y (here she pd Deller $100,000 d$(n & agreed t$ pa. the balance $% $/00,000 (pl)s interest $n the )npd balance) $!er the ne*t 10 .rs. a% I has sa&e basis $% $500,000 b?c basis B c$st and I still has $bligati$n t$ repa.. -5. I red)ced l$an %r$& $/00,000 t$ $'00,000 M h$( (ill e%%ect basis in h$)seL 8$esnEt -*. I red)ced balance t$ $'00,000 re%inanced & b$rr$(ed an additi$nal $200,000 (l$an B $500,000). &. I )sed $50,000 t$ re&$del the s)&&er h$&e 1016 2. I )sed $100,000 t$ p)rchase a tract $% land she (ill h$ld %$r in!est&ent 1. I )sed $50,000 $% the l$an t$ pa. %$r a N)r$pean !acati$n. H. Khat is IEs basis in s)&&er h$&eL a% $500k $riginal basis = $50k (re&$del) B $550k ?. Khat is IEs basis in tract $% land p)rchasedL <age 15 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

a% $100k -2. I s$ld it %$r cash $'50k & p)rchaser ass)&ed the $/50k &$rtgage B $+00k &. $+00k (a&t. reali;ed B $/50k ass)&pti$n $% &$rtgage = $'50k cash) - $550 (basis a%ter re&$deling) B $250k gain 2. <)rchaser takes basis $% $+00k 1% A $(es 7 $10k in legal %ees. 7 accepts HIU $5.5k $% painting %$r A. A still $(es $/.5k t$ 7. 5 .rs later 7 sells AEs painting %$r $10k. -a. 7 has t$ pa. ,- $% $5.5k $n receipt $% painting %$r ser!ices. -5. 7 has t$ pa. ,- $% $/.5k (hen sells painting (basis $% $5.5k - $10k B gain) -*. A can ded)ct $100 in &aterials as b)siness e*pense, b)t n$ ded)cti$n %$r ti&e. 162 H% Y t* t$ < 5 acre tract $% land in e*change %$r 1 acre lake%r$nt pr$pert.. Y had an ad4)sted basis $% $150k in tract $% land that (as ($rth $/50k at the ti&e $% e*change. < had a $50k ad4)sted basis in land ha!ing HIU $/50k at ti&e $% e*change. -a. Khat ta* c$nse>)ences %$r Y & < $n e*changeL &. Y B $/50k (HIU) - $150k (5asis) B $'00k ,ain in e*change $% land a% 5asis Y B $/50k HIU $% pr$pert. recEd 2. < B $/50k - $50k B $/00k ,ain in e*change $% land a% 5asis < B $/50k HIU $% pr$pert. recEd -5. HIU $% YEs land B $500k, HIU <Es land B $50k = < gi!es Y $50k cash &. Y B $/50k (HIU $% pr$pert. recEd) - $150k B $'00k = $50k cash B $'50k gain in land e*change a% 5asis Y B $/50k HIU pr$pert. recEd %r$& < 2. < B $500k (HIU $% pr$pert. recEd) - $50k (basis) - $50k cash B $/00k gain in e*change $% land a% 5asis < B $/00k (gain $% pr$pert. gi!en) = $50k (cash pd) = $50k basis B $500k (HIU $% pr$pert. recEd %r$& Y) -*. HIU $% YEs land B $500k, HIU <Es land B $50k = < ass)&es $50k &$rtgage $n YEs land &. <Es 5asis in land B $500k (HIU) - $550k (s$ld land %$r) B $50k gain 2. Y B $/50k HIU $% pr$pert. recEd II%O@ER@IEW 61(a)(') speci%ies that ,- incl)des gains deri!ed %r$& dealings in pr$pert.. Reg. 1.61-6(a) pr$!ides that gain is the e*cess $% the a&t reali;ed $!er the )n-rec$!ered c$st $r $ther basis %$r the pr$pert. s$ld $r e*changed. Dpeci%ic r)les %$r c$&p)ting the a&t $% gain $r l$ss are c$ntained in 1001 0d4)sted basis 1001(b) pr$!ides that the a&t reali;ed $n the sale $r $ther disp$siti$n $% pr$pert. e>)als the $ recEd pl)s the HIU $% an. $ther pr$pert. recEd. 1011(a) pr$!ides the ad4)sted basis is e>)al t$ the basis deter&ined )nder 1012 ($r $ther appr$priate ) ad4)sted as pr$!ided in 1016. 1012 basis e>)al c$st e*cept as $ther(ise pr$!ided. A$sts c$&&$nl. )nderst$$d de%initi$n, i.e. an a&t pd %$r an ite&. 1016 re>)ires a 6< t$ ad4)st her basis in pr$pert. t$ re%lect an. rec$!er. $% her in!est&ent $r an. additi$nal in!est&ent &ade in the pr$pert.. 0d4)sted basis re%lects the i&pact e!ents $cc)rring s)bse>)ent t$ $neEs ac>)isiti$n $% pr$pert. &a. ha!e $n the a&t $% $neEs in!est&ent in the pr$pert.. 0 6< &a. rec$!er ta*-%ree her in!est&ent (capital) in pr$pert. be%$re being charged (? inc$&e %r$& a disp$siti$n $% the pr$pert.. 61(a)( ) di!idends B ,-. <age 16 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

8i!idends are !ie(ed as earnings $n $r pr$%it %r$& $neEs in!est&ent, &)ch the (a. rent (61(a)(5)) represents earnings $n $neEs pr$pert. $r interest (61(a)(/)) represents earning $n $neEs &$ne.. A% Ta< Cost )asis ( Reg. 1.61-2(d)(2)(i) )% I+pa*t of Lia5iliti,s &% I+pa*t on )asis 6he a&t $% a 6<Es initial basis $r in!est&ent in pr$pert. is clear (hen n$ liabilities enc)&ber the pr$pert. & the 6< pa.s cash %$r the pr$pert.. #omm$n v" -u.ts (19+') b?c $% the $bligati$n t$ repa. (i.e. l$an ? &$rtgage), the 6< is entitled t$ incl)de the a&t $% the l$an in c$&p)ting his basis in the pr$pert.G the l$an )nder 1012 is part $% the 6<Es c$st $% the pr$pert. M th)s (hether %)nds are b$rr$(ed $r cash the basis in the land is the sa&e. Khere n$ pers$nal liabilit. is ass$ciated (? the b$rr$(ing, the b$rr$(ing is c$nsidered n$nrec$)rse. #rane v" #omm$n (19/ ) n$nrec$)rse and rec$)rse debt sh$)ld be acc$rded the sa&e treat&ent. 2% I+pa*t on A+o4nt R,ali9,2 8eter&inati$n $% the a&t reali;ed b. a Deller is like(ise n$t straight%$r(ard (hen the pr$pert. s$ld is enc)&bered b. liabilities %$r (hich the p)rchaser directl. $r indirectl. bec$&es resp$nsible. ,ain $r 7$ss B the di%%erence b?t his a&t reali;ed & the ad4)sted basis $% the h$&e. Reg. 1.1001-2(a)(1) Rec$)rse liabilities inc)rred b. a 6< in the ac>)isiti$n $% pr$pert. are incl)ded n the 6<Es basis in that pr$pert.G and Rec$)rse liabilities $% a seller, ass)&ed b. a p)rchaser, are incl)ded in the sellerEs a&t. reali;ed. C% )asis of "rop,rtA A*L4ir,2 in Ta<a5l, E<*hang, 6he c$st basis $% pr$pert. recEd in a ta*able e*change is the HIU $% the pr$pert. recEd in the e*change.

"$ILADEL"$IA "ARK A CSE ENT CO% 6% CNITED STATES, &2: F% S4pp% &8H -Clai+s &9?H. F& : 2ad 50 .ear %ranchise agree&ent (? cit. t$ )se %$r a&)se&ent park. 6raded bridge b)ilt (? cit. t$ e*tend agree&ent 10 .ears. Issue: Khat is the c$st basis $% pr$pert. recEd in a ta*able e*changeL 6he HIU !al)e $% pr$pert. recEd. $ule: 1012 the basis $% s)ch pr$pert. (ill be the c$st $% s)ch pr$pert.. '&$at: 6he gain $r l$ss sh$)ld ha!e been rec$gni;ed, & the c$st basis )nder 1012, $% the 10-tr e*tensti$n $% the %ranchise (as the c$st t$ the 6<. 6he c$st is the HIU $% the pr$pert. recEd based )p$n the the$r. that the ter& 9c$st: is a ta* c$ncept & &)st be c$nsidered in light $% the designed interrelati$nship $% the gain & l$ss & basis pr$!isi$ns $% the A$de & the pri&e r$le that the basis $% pr$pert. pla.s in deter&ining ta* liabilit.. 6he c$st basis $% the pr$pert. recEd in a ta*able e*change is the HIU !al)e $% the pr$pert. recEd in the e*change. -% the !al)e $% the e*tended %ranchise cann$t be deter&ined (? reas$nable acc)rac., it ($)ld be reas$nable & %air t$ ass)&e that the !al)e $% the 5ridge (as e>)al t$ the 10-.ear e*tensi$n. -% the !al)e $% the e*tended %ranchise $r bridge cann$t be ascertained (? a reas$nable degree $% acc)rac., the 6< is entitled t$ carr. $!er the )ndepreciated c$st $% the bridge as the c$st basis $% the e*tended %ranchise. C$% ? ' #IFTS, )EECESTS F IN$ERITANCE I%"RO)LE S <age 1 $% + 091 ' &&H

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

&% Oes, Aar$l recei!es cash gi%ts %r$& e&pl$.er, ass$ciates & client. 2 /(b) 2% Aar$l, $10k c$&pensati$n & incl)dable in ,-, $15k &a.be gi%t 102(a) 1% @$ liabilit., trans%erred basis 1015(a) -a. R$b takes A basis $% $60k, (hen sells ($)ld ha!e liabilit. & pa. ta*es H% 7$$ks like c$&pensati$n %r$& e&pl$.er t$ e&pl$.ee, s$ R$b &$st likel. (ill ha!e t$ incl)de $150k in ,102(c)(1) ?% ,i%t, R ass)&es 5Es basis $% $60k, $/5k (HIU) - $'0k B $15k l$ss 1015(a) -a. -% s$ld %$r $55k, n$ l$ss, n$ gain -5. -% at the ti&e $% gi%t, HIU is bel$( d$n$rs basis W he takes HIU as basis t$ c$&p)te a l$ss -*. -H at the ti&e $% gi%t, HIU is bel$( d$n$rs basis W then he sells %$r &$re than HIU basis, then he canEt take a gain. -2. -% he sells it %$r &$re than d$n$rEs $riginal basis, then )ses $riginal basis as his $(n & has gain. :% 5 has gain $% $15k & R$b has a basis $% $ 5k (R$b n$ ta* c$nse>)ence) ;% 5 basis is $60k - $ 5k B $15k gain -a. R has a basis $% $ 5k ((hich e!er is greater the basis $% the d$n$r, $60k $r a&t pd, $ 5k) 8% R takes HIU basis $% l$t at ti&e $% her death B $150k 101/ 9% $60k basis (hen gi%ted t$ grand%ather, he takes that basis -a. $60k basis (hen he died & 5Es basis 101/(e) -5. $150k basis %$r R. II%O@ER@IEW A% What is E<*l42,2 5A I &02M &% Th, Nat4r, of #ift 102 e*cl)des gi%ts as (ell as pr$pert. ac>)ired %r$& a decedent thr$)gh be>)est, de!ise $r inheritance. 6hresh$ld >)esti$n )nder 102 is (hether that (hich is recEd can be characteri;ed as gi%t, be>)est, de!ise $r inheritance. 6he &$ti!e $% the d$n$r is critical in characteri;ing receipts as gi%ts )nder 102. #omm$n v" /uberstein. 102(a) denies e*cl)si$n %$r a&ts t* b. an e&pl$.er t$, $r %$r the bene%it $%, an e&pl$.ee. 7i&its gi%ts &ade b. b)siness 2/ (b) disall$(s a ded)cti$n %$r gi%ts t$ indi!id)als in e*cess $% $25. 102(c)(1) negates gi%t stat)s %$r t* %r$& e&pl$.ers t$ e&pl$.ees. 2% Th, Nat4r, of a ),L4,st or Inh,ritan*, 6hresh$ld >)esti$nF is the cash $r pr$pert. recEd a be>)est, de!ise $r inheritance, $r is it c$&pensati$n $r s$&e $ther %$r& $% ta*able ite&L 0eyth v" !oey (19'+) deter&ined that pr$pert. recEd b. an heir %r$& the estate $% his ancest$r is ac>)ired b. inheritance, and th)s e*cl)dable, (hen it is distrib)ted )nder an agree&ent settling a c$ntest b. the heir $% the !alidit. $% the decedentEs (ill. 1% Stat4torA Li+itations on th, E<*l4sion ( I &02-5. 102(b) pr$!ides 2 li&itati$ns $n the e*cl)si$n 6he inc$&e %r$& pr$pert. e*cl)ded as a gi%t, be>)est, de!ise, & inheritance is n$t e*cl)ded. 102b1 102(b)(2) denies an e*cl)si$n t$ gi%ts, (hether &ade d)ring li%e $r at death, $% inc$&e %r$& pr$pert..

<age 1+ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

)% )asis of "rop,rtA R,*,i6,2 5A #ift, ),L4,st or Inh,ritan*, &% #ifts of Appr,*iat,2 "rop,rtA 1015(a) M recei!ers basis is re%erred t$ as a 9s)bstit)ted basis: $r a 9trans%erred basis.: 6rans%erred basis r)le shi%ts the ta* b)rden ass$ciated (? the appreciated !al)e $% the gi%t %r$& the gi!er t$ the recei!er, i.e. gi%t $% st$ck b$)ght at $200 then (hen gi!en !al)e is $/00. -a.t v" 1owers (1929) M %ather ga!e st$ck t$ da)ghter that had increase in !al)e d)ring the ti&e the %ather $(ned the&. 6he da)ghter then s$ld the st$ck. Dhe (as ta*able $n appreciati$n that $cc)rred d)ring the peri$d her %ather $(ned the st$ck. -n e%%ect, -a.t c$n%ir&s that an$ther li&itati$n e*ists (? respect t$ the general e*cl)si$n r)le %$r gi%ts, ie, the appreciati$n inherent in gi%ts &a. )lti&atel. be ta*ed t$ the d$nee. 2% #ifts of "rop,rtA ' )asis in E<*,ss of Fair arN,t @al4, Khile per&itting the )se $% gi%ts t$ shi%t inc$&e, shi%ting $% l$sses sh$)ld be pr$hibited. 1% )asis of "rop,rtA R,*,i6,2 5A ),L4,st or Inh,ritan*, 101/(a)(1) steps )p ($r steps d$(n) the basis $% pr$pert. ac>)ired %r$& a decedent t$ the HIU $% the pr$pert. at the ti&e $% decedentEs death. -n the case $% appreciated pr$pert., 101/ pr$!ides ta* a&nest. %$r the gain inherent in the pr$pert. at the ti&e $% a pers$nEs death. 6he de!isee $r heir recei!ing the 9stepped-)p basis: can sell the pr$pert. %$r its !al)e as $% the decedentEs death & n$t reali;e an. gain. Snl. appreciati$n $cc)rring a%ter the decedentEs death is s)b4ect t$ ta*. 101/(a) applies t$ pr$pert. $(ned b. the decedent at the ti&e $% his death (hich is t* b. the decedentEs (ill $r p)rs)ant t$ the intestate s)ccessi$n la(s $% a 4)ris. 0@8 pr$pert. ac>)ired thr$)gh $ther &eans, e.g., 4$int tenanc. $r c$&&)nit. pr$pert.. 101/(b). 101/(b)(6) M &akes 101/ applicable t$ a s)r!i!ing sp$)seEs $ne hal% share $% c$&&)nit. pr$pert. 9i% at least $ne-hal% $% the (h$le $% the c$&&)nit. interest in s)ch pr$pert. (as incl)dable in deter&ining the !al)e $% the decedentEs gr$ss estate: %$r %ederal estate ta* p)rp$ses. C% "art(#ift, "art(Sal, Reg. 1.1001-1(e) states that the seller-d$n$r has gain t$ the e*tent that the a&t reali;ed e*ceeds the ad4)sted basis $% the pr$pert. M als$ n$ l$ss is rec$gni;ed $n s)ch a t*. Reg. 1.1015-/ pr$!ides the d$neeEs basis (ill be the greater $% the a&t the d$nee pd %$r the pr$pert. $r the ad4)sted basis $% the d$n$r (a liabilit. ass)&ed b. the d$nee (ill be treated as an a&t pd). a special r)le li&its the d$neeEs basis, %$r p)rp$ses $% c$&p)ting l$ss, t$ the HIU $% the pr$pert. at the ti&e $% the t* t$ the d$nee.

CO GN 6% DC)ERSTEIN, 1:1 C%S% 2;8 -&9:0. &0H F& : 8 b)siness relati$nship (? I. 8 ga!e I s$&e p$ssible c)st$&ers. I ga!e 8 a Aadillac as a gi%t. I ded)cted the !al)e $% the car a b)siness e*pense $n its c$rp$rate inc$&e ta* ret)rn. 8 did n$t incl)de the !al)e $% the car in ,- %$r 1951, dee&ing it a gi%t. A$&&En asserted a de%icienc. %$r the car. Issue: Kas the car a gi%t (?in the &eaning $% the ta* c$deL '&$at: 0 !$l)ntar. e*ec)ted t* $% pr$pert. b. $n t$ an$ther, (?$ an. c$nsiderati$n $r c$&pensati$n, th$)gh a c$&&$n-la( gi%t, is n$t necessaril. a 9gi%t: (?in the &eaning $% the stat)te. 6he &ere absence $% a legal $r &$ral $bligati$n t$ &ake s)ch a p.&t d$es n$t establish it is a gi%t. 2ld #olony -rust" 0 gi%t <age 19 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

pr$ceeds %r$& a detached and disinterested gener$sit. $)t $% a%%ect, respect, ad&irati$n, charit. $r like i&p)lses. Khat c$ntr$ls is the intenti$n (? (hich p.&t, h$(e!er !$l)ntar., has been &ade. 6he ta*ing stat)te d$es n$t &ake n$nded)ctibilit. b. the trans%er$r a c$nditi$n $n the 9gi%t: e*cl)si$nG n$r d$es it dra( an. distincti$n b?t trans%ers b. c$rp. & indi!id)als, as t$ the a!ailabilit. $% the 9gi%t: e*cl)si$n t$ the trans%eree. 8ecisi$ns &)st be based $n the applicati$n $% %act-%inding trib)nalEs e*perience (? the &ainsprings $% h)&an c$nd)ct t$ the t$talit. $% the %acts $% each case. H$)nd it (as n$t a gi%t b)t rec$&pense & ind)ce&ent %$r ser!ices decided b. the trier $% %act & is )pheld. WOLDER 6% CO GN, H91 F%22 :08 -&9;H. &0; F& : 6a* At. held the HIU $% the st$ck & cash recEd )nder the clientEs (ill c$nstit)ted ta*able inc$&e. Issue: Khether an att. c$ntracting t$ & per%$r&ing li%eti&e legal ser!ices %$r a client recei!es inc$&e (hen the client, p)rs)ant t$ the Y, be>)eaths a s)bstantial s)& t$ the att.. in lie) $% the p.&t $% %ees d)ring the clientEs li%eti&e is ta*able inc$&e. $ule: 6est (hether in act)alit. the gi%t is a b$na %ide gi%t $r si&pl. a &eth$d %$r pa.ing c$&pensati$n. '&$at: 6he >)esti$n is res$l!ed b. e*a&ining the intent $% the parties, the reas$ns %$r the t*, & the parties per%$r&ance in acc$rdance (? their intenti$ns. 6* (as inc$&e & s)b4ect t$ ta*ati$n. OLK 6% CNITED STATES, ?1: F%22 8;: -&9;:. &09 F& : 6rial ct held 9t$kes: (ere gi%ts. 6$kes are placed in a c$&&$n %)nd & di!ided a&$ng the dealers. Issue: Khether $, called 9t$kes: in the rele!ant trade, recEd b. the 6<, a craps dealer e&pl$.ed b. 7as Uegas casin$s, c$nstit)ted ta*able inc$&e $r gi%ts (?in the &eaning $% 102(a). '&$at: 6rib)te t$ the g$ds $% %$rt)ne (hich it is h$ped (ill be ret)rned b$)nte$)sl. s$$n can $nl. be described as an in!$l!ed and intensel. interested (n$t detached $r disinterested gener$sit.). 6he reg)larit. $% the %l$(, the e>)al di!isi$n $% the receipts, & the dail. a&t recEd indicate that a dealer acting reas$nabl. ($)ld c$&e t$ regard s)ch receipts as a %$r& $% c$&pensati$n %$r his ser!ices. 6$kes, like tips, are ta*able. #OODWIN 6% CNITED STATES, :; F%12 &H9 -&99?. &&2 F& : , is past$r $% Ah)rch. Ie&bers &ade gi%ts t$ ,, at Ahrist&as & later $n ' 9special $ccasi$n: da.s each .ear beginning in 1966. 0t %irst, %)rnit)re & ($rks $% art, then cash. 5. 19+ , reg)lar pr$ced)re de!el$ped %$r &aking these gi%ts. ,Es did n$t rep$rt these gi%ts as ta*able inc$&e. A$&&En assessed de%icienc. %$r the .ears 19+ -+9 based )p$n the esti&ated )nrep$rted gi%ts. Issue: 0re these special $ccasi$n gi%ts ta*ableL OND, c$&pensati$n n$t gi%ts. '&$at: Hr$& an $b4ecti!e perspecti!e, the critical %act in this case is that the special $ccasi$n gi%ts (ere &ade b. the c$ngregati$n as a (h$le, rather than b. indi!id)al Ah)rch &e&bers. ,athered b. c$ngregati$n leaders in r$)tini;ed & str)ct)red &anner, indi!id)al &e&ber c$ntrib)ted an$n.&$)sl., & the reg)larl. sched)led p.&ts (ere &ade t$ , $n behal% $% the entire c$ngregati$n. 6he c$ngregati$n, c$llecti!el., kne( that (?$ these s)bstantial, $n-g$ing cash p.&ts, the Ah)rch likel. c$)ld n$t retain the ser!ices $% a p$p)lar & s)ccess%)l &inister at the relati!el. l$( salar. it (as pa.ing. Reg)lar, si;able p.&ts &ade b. pers$n t$ (h$& the 6< pr$!ides ser!ices are c)st$&aril. regarded as a %$r& $% c$&pensati$n & th)s ta*able. C$% 9 ' DISC$AR#E OF INDE)TEDNESS I%"RO)LE S &:1 ' &80

&% 8 b$rr$(ed $5k, pd $'k, n$t ins$l!ent, lender %$rga!e balance $% the l$an. Khat ta* c$nse>)encesL -a. 7$cal bank - $2k ta*able -5. 8Es e&pl$.er - $2k ta*able (l$$ks like c$&pensati$n) 10+, 61(a)(12) -*. 8Es br$ther - $2k 3 ta*able, l$$ks like gi%t. 102 2% Ye!in <age 20 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-a. @$ discharge $% indebtedness inc$&e, red)cti$n in the debt, $r settle&ent B red)cti$n in debt. -5. $9k discharge $% indebtedness inc$&e -*. @$ inc$&e $% discharge $% indebtedness b?c gi%t. &. Ye!inEs parent pr$d)ced a n$te t$ a lender a% Y b$rr$(s $20k 5% Y pa.s back $11k *% Ye!inEs parents gi%ts hi& $9k, then pa.s back $9k &$re 2% 2$( &)ch inc$&e sh$)ld Y reali;eL i% @$ne b?c the gi%t (ent straight t$ the discharge $% debt ii% 2e reali;es n$ inc$&e here ,% N*a&ple 2F Y b$rr$(ers $20k i% Ye!in pa.s $1k ii% 7ender sells l$an t$ parents %$r $10k iii% <arents %$rgi!es the $19k (a&$)nt $% the debt b$)ght) <arents gi%t $19k i6% Ye!in & <arents pa. $11k $n a $20k debt 6% Ye!in is bene%ited b. $9k & &)st be incl)ded as inc$&e -2. H$rgi!eness $% a debt d$es n$t generate inc$&e i% the p.&t $% the debt ($)ld ha!e been ded)ctible &. 10+(e)(2) -,. Ye!in entered int$ a Y (? 0 t$ p)rchase a bldg t$ h$)se his b)siness %$r $150k $!er '0.rs in &$s. install&ents. 5ldgEs !al)e decreased signi%icantl.. Y still $(ed $1'0k, bldg. HIU B $115k. 0 agrees t$ red)ce balanced $(ed )nder the Y t$ $150k. &. 10+(e)(5) M treated as red)cti$n, n$t discharge $% indebtedness inc$&e. 1% 5ill b$rr$(ed $ 5k %r$& J. J accepted a tract $% )ni&pr$!ed land %r$& 5 %$r the debt. 5 p)rchased the land %$r $20k & HIU B $60k (hen J recEd it. 5 still $(es $50k t$ 'rd parties & $25k g)arant$r $% s$nEs l$an. <ers$nal pr$pert. $% $55k. -a. 2$( &)ch discharge $% indebtedness inc$&e &)st 5 rep$rt as a res)lt $% the settle&ent $% the debt $(ed t$ JL 7iabilities 0ssets $ 5k debt t$ J $60k land (bases $20k) $50k debt t$ $thers $55k $ther pr$pert. $25k g)arant$r $% s$n l$an 7iabilit. B $125k $r $150k 0ssets B $115k &erkel v" #omm$n, i% its &$re likel. than n$t that he (ill ha!e t$ pa. $n a g)arantee, than the. can incl)de the l$an as a liabilit.. 8eter&ine h$( &)ch is incl)ded $ 5k debt t$ J - $60k land B $15k discharge $% indebtedness 7iabilit., $125k M 0ssets, $115k B -$10k (ins$l!enc. pri$r t$ t*) 6rans%ers land t$ J)d. 7iabilities B $50k ? 0ssets B $55k B @et Ual)e $% $5k (has t$ be incl)ded in ,-). 10+(a)(1)(5) M ,- d$es n$t incl)de 10+(a)(') 6$tal a&$)nt $% discharge debt - $15k, li&ited b. the a&$)nt in (hich the 6< is ins$l!ent ($10k). -ns$l!ent be%$re t*L $10k M can $nl. e*cl)de this a&$)nt, has t$ incl)de the $5k (b?c s$l!ent a%ter t*). 8ischarge $% indebtedness, t$ the e*tent .$) d$nEt ha!e t$ repa. it is incl)dable, )nder 61(a)(12) N*cept 10+ sa.s that s$&e discharge $% indebtedness is e*cl)dable. <age 21 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

Hig)re $)t h$( land t* ($rks 5 $(es $ 5k 6* land (? a basis $% $20k & HIU B $60k 5 is in essence pa.ing $60k $n his debt KhatEs his a&$)nt reali;edL $60k 5 has a gain $% $/0k (HIU $60k - $20k base) $15k inc$&e as a res)lt $% cancellati$n $% debt &. Do,s h, ha6, oth,r in*o+,M a% 8i%%erence b?t the a&$)nt reali;ed & the bases i% 0&$)nt reali;ed B $60k ii% 5ases $n land B $20k iii% -nc$&e reali;ed ? gain $% B $/0k (HIU $60k - $20k) -5. What 5asis 7ill B taN, in th, lan2 sh, r,*G2 fro+ )M &. Cnder 'hiladelphia 3 HIU is the bases B $60k H% LloA2J lia5iliti,s ,<*,,2,2 ass,ts, r,*G2 &0K for toothpast, *o++,r*ial% LloA2 still insol6,nt% -a. What ar, th, ta< *ons,L4,n*,s of L r,*,i6ing &0KM &. 61(a)(1) 2. -ncl)ded in ,-5. Do,s Ao4r ans7,r *hang, if L o7,2 &0K to th, pro24*,r of th, *o++,r*ial F th, pro24*,r *an*,l,2 th, 2,5t in li,4 of paAing &0K to L% &. @$, b?c (asnEt a discharge $% debt, (as a pa.&ent $% debt 2. Aredit$r did n$t %$rgi!e the debtG 7 paid the debt b. ($rking. a% Aredit$r pa.s 7 %$r ($rking, 7 pa.s credit$r %$r debt. II%O@ER@IEW 8$es the %$rgi!eness $% all $r part $% the l$an generate inc$&eL 1owers v" ,erbaugh 4mpire #o" (1926) M ct c$nsidered (hether a 6< (h$ b$rr$(ed $ repa.able in ,er&an &arks reali;ed inc$&e (hen the 6< repd the l$an (? greatl. de!al)ed &arks. At. %$)nd that b?c the b$rr$(ed $ (as entirel. l$st in a b)siness !ent)re, rep.&t $% the l$an (? de!al)ed &arks $nl. red)ced the 6<Es l$ss. 6he &ere di&in)ti$n $% l$ss is n$t gain, pr$%it $r inc$&e. A$&pare *) v" ,irby" 6< reali;es gain (hen a debt is discharged b?c a%ter the discharge the 6< has %e(er liabilities t$ $%%set her assets. 6he 6<Es e*isting assets, (hich $ther(ise ($)ld ha!e g$ne t$(ard repa.ing the debt, are %reed. 61(a)(12), pr$!iding inc$&e %$r& discharge $% indebtedness c$nstit)tes inc$&e. 10+ e*cl)si$n %r$& ,- (hen discharge $% indebtedness $cc)rs in certain listed circ)&stances, bankr)ptc. $r ins$l!enc.. A% Sp,*ifi* R4l,s #o6,rning E<*l4sion &% Dis*harg, of In2,5t,2n,ss Wh,n Ta<paA,r Is Insol6,nt 4isner v" &acomber, the discharge $% debt 9did n$t res)lt in the debt$r ac>)iring s$&ething $% e*changeable !al)e in additi$n t$ (hat he had be%$re. 6here is a red)cti$n $r e*ting)ish&ent $% liabilities (?$ an. increase in assets. 6here is an absence $% s)ch gain $r pr$%it as is re>)ired t$ c$&e (?in the accepted de%initi$n $% inc$&e. -% 6< ins$l!ent b$th be%$re & a%ter the discharge $% cancellati$n $% a debt, n$ inc$&e res)lted. 0akeland Grovery #o" v" #omm$n (19' ) M held debt$r reali;ed inc$&e t$ the e*tent that the discharge $% indebtedness &ade the debt$r s$l!ent. <age 22 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-ns$l!enc. e*cepti$nF @$ inc$&e arises %r$& discharge $% indebtedness i% the debt$r is ins$l!ent b$th be%$re & a%ter the t*G & i% the t* lea!es the debt$r (? assets (h$se !al)e e*ceeds re&aining liabilities, inc$&e is reali;ed $nl. t$ that e*tent. 10+ e*cept as pr$!ided, there is n$ ins$l!enc. e*cepti$n %r$& the general r)le that ,- incl)des inc$&e %r$& the discharge $% indebtedness. Dpeci%icall. pr$!ides n$ ,- i% the discharge $cc)rs in a bankr)ptc. case $r i% the discharge $cc)rs (hen the 6< is ins$l!ent. 10+(a)(') li&its the ins$l!enc. e*cl)si$n t$ the a&t b. (hich the 6< is ins$l!ent. 10+(d)(') de%ines ins$l!ent t$ &ean the e*cess $% liabilities $!er the HIU $% assets. 8eter&inati$n $% this e*cess is deter&ined $n the basis $% 6<Es assets & liabilities i&&ediatel. be%$re the discharge. &erkel v" #omm$n (199 ) M t$ clai& the bene%it $% the ins$l!enc. e*cl)si$n, the 6< &)st pr$!e (? respect t$ an. $bligati$n clai&ed t$ be a liabilit., that, as $% the ins$l!enc. calc)lati$n date, it is &$re pr$bable than n$t that he (ill be called )p$n t$ pa. the $bligati$n in the a&t. clai&ed. 10+(a)(1)(5) de&$nstrates A$ngress intended %$r $nl. th$se liabilities in the a&t that act)all. $%%set assets t$ be c$nsidered in calc)lating ins$l!enc. %$r p)rp$se $% the inc$&e ta*. 10+(b) re>)ires that certain ta* attrib)tes $% the 6< be red)ced. 2% Disp4t,2 or Cont,st,2 D,5ts -% a&t $% debt is disp)ted, settle&ent $% the a&t d$es n$t c$nstit)te a discharge $% indebtedness. 'reslar v" #omm$n M c$ntested liabilit. rests $n the pre&ise that i% the 6< disp)tes the $riginal a&t in g$$d %aith, a s)bse>)ent settle&ent $% that disp)te is treated as the a&t $% debt %$r ta* p)rp$ses. 5arin v. #omm$n M 6< inc)rred a $',/'5,000 ga&bling debt (hich he disp)ted $n the basis that the debt (as )nen%$rceable )nder state la(. 6< & casin$ settled disp)te %$r $500,000. Khen a debt is )nen%$rceable, the a&t $% the debt is in disp)te. 6he settle&ent $% the debt is treated as the a&t $% the debt %$r ta* p)rp$ses. 5?c Qarin pd the $500k, there (as n$ discharge $% indebtedness inc$&e. 'reslar critici;ed & 4arnshaw v" #omm$n (2002) agreed h$lding that a 6< (h$ settled a credit card disp)te (? the iss)ing bank had discharge $% indebtedness inc$&e e&phasi;ing that a signi%icant part $% the debt $(ed b. the 6< (as )nc$ntested & li>)idated. 8ischarge $% liabilit. %$r an. $% s)ch debt W c$nstit)ted discharge $% indebtedness inc$&e. 1% "4r*has,( on,A D,5t R,24*tion for Sol6,nt D,5tors 10+(e)(5) M retr$acti!e red)cti$n in p)rchase price 3 discharge $% indebtedness inc$&e. H% A*L4isition of In2,5t,2n,ss 5A ",rson R,lat,2 to D,5tor 10+(e)(/) speci%icall. pr$!ides that, i% a pers$n related t$ a debt$r ac>)ires the indebtedness, the ac>)isiti$n shall be treated as an ac>)isiti$n b. the debt$r. ?% Dis*harg, of D,24*ti5l, D,5t 10+(e)(2) pr$!ides that %$rgi!eness $% a debt d$es n$t generate inc$&e i% the p.&t $% the debt ($)ld ha!e been ded)ctible. Rati$naleF i% discharge $% indebtedness inc$&e (ere t$ be i&p)ted t$ the tenant, the tenant ($)ld be entitled a ded)cti$n %$r the past d)e rent (hich ($)ld c$&pletel. $%%set the discharge $% indebtedness inc$&e. )% Dis*harg, of In2,5t,2n,ss as #ift, Co+p,nsation, Et*% <age 2' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

#omm$n v" +acobson (19/9) M ct c$nsidered (hether a discharge $% indebtedness c$)ld be c$nsidered an e*cl)dable gi%t )nder 102(a) & its predecess$rs c$ncl)ding the gi%t e*cl)si$n (as n$t applicable (here a debt$r p)rchased his $(n $bligati$ns at a disc$)nt. Sther circ)&stances the cancellati$n $% indebtedness can be e*cl)dable as a gi%t. i.e. parents lends $ t$ a child then %$rgi!es the debt, the %$rgi!eness $% the debt ($)ld likel. be c$nsidered a gi%t e*cl)dable )nder 102(a). Sther circ)&stances the %$rgi!eness &a. represent a %$r& $% c$&pensati$n & sh$)ld n$t be c$nsidered discharge $% indebtedness (?in the &eaning $% 61(a)(12).

CNITED STATES 6% KIR)D LC )ER CO%, 28H C%S% & -&91&. &;H F& : J)l. 192', V iss)ed its $(n b$nds %$r (hich it recEd their par !al)e. 7ater, in sa&e .ear, p)rchased in the $pen &arket s$&e $% the sa&e b$nds at less than par. Issue: Khether the di%%erence in prices (s$ld then b$)ght) is a ta*able gain $r inc$&e $% the V %$r 192'. '&$at: -% the c$rp. p)rchases & retires an. $% s)ch b$nds at a price less than the iss)ing price $r %ace !al)e, the e*cess $% the iss)ing price $r %ace !al)e $!er the p)rchase price is gain $r inc$&e %$r the ta*able .ear. RE@ENCE RCLIN# 8H(&;:, &98H(2 C%)% 1H &;H F& : Y %$r g$$ds. D shipped &$st $% g$$ds b)t n$t all. 6<, b).er, had an $)tstanding acct pa.able t$ D %$r the g$$ds act)all. shipped. <arties settled. 6< agreed t$ pa. part $% the $ $)tstanding indebtedness and the re&aining (as %$rgi!en b. D in ret)rn %$r e*ec)ting a release $% the breach $% Y. Issue: -s the a&t $(ed b. a 6<, that is %$rgi!en b. a seller in ret)rn %$r a release $% a Y c$)nterclai&, inc$&e %r$& discharge $% indebtedness p)rs)ant t$ 61(a)(12) & s)b4ect t$ e*cl)si$n )nder 10+L $ule: 61(a)(12) ,- incl)des inc$&e %r$& discharge $% indebtedness. '&$at: Reg. 1.61-12(a) pr$!ides that a 6< &a. reali;e inc$&e b. the p.&t $% $bligati$ns at less than their %ace !al)e. Dee als$ ,riby. -% a cancellati$n $% indebtedness is si&pl. the &edi)& $% %$r p.&t $% s$&e $ther %$r& $% inc$&e 10+ d$es n$t appl.. -n this sit)ati$n, the settle&ent sh$)ld be anal.;ed as i% the 6< act)all. recEd c$&pensati$n %$r da&ages arising $)t $% the sellerEs breach $% Y & then pd the %)ll a&t $% the acc$)nt pa.able. 6he a&t recEd b. the 6< %$r breach $% the Y is $rdinar. inc$&e b?c the %acts de&$nstrate that the 6< (as rei&b)rsed %$r l$st pr$%its & inc$&e. 6he a&t n$t pd b. the 6< t$ the seller (as the &edi)& thr$)gh (hich inc$&e %r$& the da&ages %$r breach ar$se and this a&t is t$ be treated as a p.&t %$r l$st pr$%its rather than a discharge $% indebtedness )nder 61(a)(12). #E$L 6% CO GN, ?0 F%12 &2 -&99?. &;: F& : 6he 6< b$rr$(ed $ %r$& <A0. I$rtgages $n 21+ acre %a&il. %ar& (ere gi!en t$ <A0 t$ sec)re the rec$)rse l$an. 8ec. 19++, 6< (ere ins$l!ent & )nable t$ &ake p.&ts $n the l$an, balance $% $152,260. 8ec. 6< c$n!e.ed 60 acres $% %ar& land t$ the <A0 in partial satis%acti$n $% the debt. 6< basis in the 60 acres (as $1/,'+/ & the. (ere credited $'9,000 t$(ards their l$an, the HIU $% the land. Jan, 6< c$n!e. 1/1 acres t$ <A0 in partial satis%acti$n $% the debt. 6<Es basis (as $'2,000 & had HIU $% $ , 25. 6< als$ pd $6,12' in cash t$ <A0 t$ be applied t$ their l$an & <A0 %$rga!e the rest $% the l$an $29,/12. 6< (ere ins$l!ent be%$re & a%ter the discharge $% indebtedness. A$&&En %$)nd de%icienc.. 6a* ct %$)nd in %a!$r $% A$&&En, 6< appealed. '&$at: $29,/12 e*cl)ded as inc$&e $% discharge $% indebtedness. 6he 6<Es t* b. deeds in lie) $% %$recl$s)re $% their land t$ <A0 in partial satis%acti$n $% the rec$)rse debt (ere pr$perl. c$nsidered sales $r e*changes %$r p)rp$ses $% 1001. 6he a&t reali;ed %r$& a sale $r $ther disp$siti$n $% pr$pert. incl)des the a&t $% liabilities %r$& (hich the trans%er$r is discharged as a res)lt $% the sale $r disp$siti$n. Reg. 1.10012(a)(1). Uia the land t*, the. (ere gi!en credit t$(ard an $)tstanding rec$)rse l$an t$ the e*tent $% the landEs HIU. -t is clear that the t* $% land e&pl$.ed t$ pa. back a l$an, &)st be treated the sa&e as <age 2/ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

recei!ing $ %r$& a sale. 6he land (as pr$perl. c$nsidered gains deri!ed %r$& dealings in pr$pert. t$ the e*tent the HIU in the land e*ceeded the 6<sE basis in said land. III%CLASS NOTES 5asic pre&ise $% inc$&e %r$& cancellati$n $% debt 8$nEt incl)de l$ans b?c .$) ha!e t$ repa. it -% .$) d$nEt ha!e t$ repa., ha!e t$ incl)de it as inc$&e <r$ble& 2A D)&&ing )p H)nda&ental idea behind it 6ake $)t a l$an, .$) d$nEt ha!e t$ incl)de it in inc$&e b?c (e ass)&e .$) (ill ha!e t$ pa. it back -% credit$r discharges the debt, .$) ha!e t$ incl)de the a&$)nt in (hich the debt (as %$rgi!en 10+ M in certain instances, (ill all$( .$) n$t t$ incl)de the a&$)nt %r$& discharge $% indebtedness 8ed)cti$n e*cepti$n -ns$l!enc. e*cepti$n M a&$)nt e*cl)ded t$ the e*tent that .$) are ins$l!ent. C$% && ' FRIN#E )ENEFITS I%"RO)LE S 20; ' 211

&% Willia+ ( Cni6,rsitA pr,si2,ntJ salarA O ho4sing for fa+ilA -ho4s, sp,*ifi*allA 5o4ght 5A Cni6,rsitA to ho4s, itGs pr,si2,nts -a. I &&9-a.-2. ' ho4sing has to 5, on th, 54sin,ss pr,+is,s% &. 8$es he d$ b)siness thereL i.e., entertain, ha!e st)dents $!er 2. 0rg)e that the h$&e is act)all. the b)siness pre&ises. 1. Khether the h$)se is pr$!ided %$r the c$n!enience $% the e&pl$.er. H. Khether his d)ties re>)ire a &$&ents n$tice. ?. Khether he pa.s an. rent %$r the h$)se. :. Reg. 1.119-1(b)(') M had t$ li!e there t$ take the 4$b, re>)ire&ent $% e&pl$.&ent -5. Ca5in 90 +ins% a7aA &. -ncl)dable, d$esnEt see& t$ &eet the test 2. Ia. &ake hi& better able t$ d$ his 4$bs, b)t its n$t e&pl$.er pr$!ided l$dging )nder the r)les. -*. W tra6,ls ,<t,nsi6,lA in his *apa*itA of pr,si2,nt F g,ts fr,L4,nt flA,r +il,s% Ar, th,s, fr,L4,nt flA,r +il,s F th, trips taN,n on th,+ in*l42a5l,% &. @$. 0nn$)nce&ent, %re>)ent %l.er &iles n$t incl)dable )nless c$n!erted t$ cash. 2% K,n got a fr,, 7,,N pass to a h,alth *l45, th,n 2,*i2,2 to 3oin% AnA in*o+, as a r,s4lt of th, r,*,ipt of th, fr,, passM -a. @$. ,i!ing $)t %ree pass %$r the bene%it $% the health cl)b. &. /uberstein detached and disinterested gener$sit. M @S n$t a gi%t. 2. /e minimis M %ree sa&pleL 1. Gotcher M tr.ing t$ l)re in ne( c)st$&ers. 1% Walt,r ' la7 fir+ has 4n7ritt,n poli*A that asso*iat,s +4st staA in th, ,6,ning% Fir+ gi6,s 0&? to asso*iat,s 7orNing at night to ,at at a n,ar5A r,sta4rant% -a. 0re .$) &ade better $%% b. itL OND -5. Aan K e*cl)deL <age 25 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

&. 119 M e&pl$.er pr$!ided %$$d, gi!en cash n$t &eal 2. 1'2 M n$t n$-additi$nal-c$st ser!ice, n$t >)ali%ied e&pl$.ee disc$)nt, ($rking c$nditi$n %ringe bene%its, de minimis %ringe bene%its, n$t >)ali%ied transp$rtati$n %ringe -*. K skips dinner & keeps the $15 %$r his $ther e*penses M n$t incl)ded, b?c d$nEt (ant t$ ha!e t$ keep check $r de minimis %ringed bene%its. -2. Aa%eteria $n pre&ises (hich pr$!ides %ree s)per t$ each ass$ciate ($rking the e!enings -,. Aa%eteria $n pre&ises, %ree &eals thr$)gh$)t the da. t$ all ass$ciates. &. Reg. 1.119-1(a)(2)(i) M &eals %)rnished b. an e&pl$.er (?$ charge t$ the e&pl$.ee (ill be regarded as %)rnished %$r the c$n!enience $% the e&pl$.er i% s)ch &eals are %)rnished %$r a s)bstantial n$n-c$&pensat$r. b)siness reas$n $% the e&pl$.er. 2. 119(b)(/) M all &eals %)rnished $n the b)siness pre&ises $% an e&pl$.er t$ s)ch e&pl$.erEs e&pl$.ees shall be treated as %)rnished %$r the c$n!enience $% the e&pl$.er, i% (?$ regard t$ this paragraph, &$re than hal% $% the e&pl$.ees t$ (h$& s)ch &eals are %)rnished $n s)ch pre&ises are %)rnished s)ch &eals %$r the c$n!enience $% the e&pl$.er. 1. 1'2(e)(2) M treat&ent $% certain eating %acilities M the $perati$n b. an e&pl$.er $% an. eating %acilit. %$r e&pl$.ees shall be treated as a de &ini&s %ringe i% M s)ch %acilit. is l$cated $n $r near the b)siness pre&ises $% the e&pl$.er, and re!en)e deri!ed %r$& s)ch %acilit. n$r&all. e>)als $r e*ceeds the direct $perating c$sts $% s)ch %acilit.. H% $otAir, In*% -a. No(a22itional(*ost, fr,, foo2 F +,al P+,r,lA in*i2,ntalQ *osts ' nothing in*l42,2 as in*o+, &. 1'2(b)(1) M 6he ser!ice &)st be $ne $%%ered %$r sale t$ c)st$&ers in the $rdinar. c$)rse $% b)siness & the ser!ice be $%%ered in the line $% b)siness $% the e&pl$.er in (hich the e&pl$.ee is per%$r&ing ser!ices. 6his line $% b)siness re>)ire&ent is best e*plained b. the %$ll$(ing e*cerpt %r$& the legislati!e h*. a% Reg. 1.1'2-/(a)(1)(i!) pr$!ides that the per%$r&ance $% s)bstantial ser!ices directl. bene%iting &$re than $ne line $% b)siness is treated as the per%$r&ance $% s)bstantial ser!ices in all s)ch lines $% b)siness. 2. 1'2(b)(2) pr$!ides that the e&pl$.er inc)r n$ s)bstantial additi$nal c$st (incl)ding %$rg$ne re!en)e). a% Reg. 1.1'2-2(c) states that per&itting airline e&pl$.ees t$ take pers$nal %lights at n$ charge & t$ recei!e reser!ed seats res)lts in %$rg$ne re!en)e & t?% e&pl$.ees recei!ing the %ree %lights are n$t eligible %$r the n$-additi$nal-c$st e*cl)si$n. 5% 1'2(b)(2) als$ pr$!ides that (hether an e&pl$.er inc)rs an. s)bstantial additi$nal c$st be deter&ined (?$ regard t$ an. a&$)nt (hich an e&pl$.ee &ight be re>)ired t$ pa.. *% Reg. 1.1'2-2(a)(5)(ii) M t$ the e%%ect that the c$st $% ser!ices 9&erel. incidental: t$ the pri&ar. ser!ice rendered are generall. n$t s)bstantial. 2% Reg)lati$ns, a%ter listing se!eral 9e*cess capacit. ser!ices: that >)ali%. as n$-additi$nal-c$st ser!ices, speci%icall. state that n$n-e*cess capacit. ser!ices, (hich d$ n$t s$ >)ali%., &a. n$netheless be %)ll. $r partiall. e*cl)ded %r$& inc$&e )nder the 9>)ali%ied e&pl$.ee disc$)nt: r)les disc)ssed bel$(. Reg. 1.1'2-2(a)(2). 1. 1'2(4)(1) pr$hibits discri&inati$n in %a!$r $% highl. c$&pensated e&pl$.ees, a ter& (hich, as de%ined in /1/(>), can incl)de $%%icers & $(ners. a% )ee Reg. 1.1'2-+(a)(2) pr$!ides $nl. the &e&bers $% the highl. c$&pensated gr$)p, rather than all e&pl$.ees recei!ing bene%its, (ill be s)b4ect t$ ta*. 5% 1'2(h) de%ines e&pl$.ee t$ incl)de $neEs sp$)se & dependent children as (ell as certain retired & disabled e&pl$.ees & the s)r!i!ing sp$)se $% a decease e&pl$.ee. i% 1'2(h)(') pr$!ides a special r)le treating the )se $% air transp$rtati$n b. the parent $% an e&pl$.ee as )se b. the e&pl$.ee <age 26 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

ii% 1'2(4)(5) (hich pr$!ides %a!$rable treat&ent %$r a%%iliates $% airlines. -5. I &12-*. -E4alifi,2 ,+ploA,, 2is*o4nt. ( E<*l4sion li+it,2 to 208 of th, pri*, at 7hi*h th, s,r6i*,s ar, 5,ing off,r,2% &. Airlin, ti*N,ts ( 201 $% 1,000 B $200 e*cl)ded, ha!e t$ incl)deF a% $1,000 (c$st $% tickets) M $200 (a&t. e*cl)ded) B $+00 - $500 (a&t 7 <d.) B 0100 for airlin, ti*N,ts i% Reg. 1.1'2-'(e) (p. 950) 2. $ot,l Roo+ ( 51 capacit. M n$-additi$nal-c$st ser!ice. DheEs a la(.er, pr$!ides ser!ices t$ b$th line $% b)siness, i% &ade a reser!ati$n c$)ld be e&pl$.ee disc$)nt, h?e n$ l$ss re!en)e %$rg$ne M i% n$t n$-additi$nal-c$st ser!ice then, e&pl$.ee disc$)ntF a% 201 $% $1,200 B $2/0 e*cl)ded, ha!e t$ incl)deF i% $1,200 (c$st $% h$tel r$$&) M $2/0 (a&t. e*cl)ded) B $960 M 600 (a&t 7 pd.) B 01:0 for hot,l roo+% 5% 1'2(c) li&its the a&$)nt $% disc$)nt (hich (ill be e*cl)dable & pr$!ides separate li&itati$ns %$r pr$pert. & %$r ser!ices. i% 6he e*cl)si$n %$r e&pl$.ee disc$)nts $n ser!ices is li&ited t$ 201 $% the price at (hich the ser!ices are being $%%ered b. the e&pl$.er t$ c)st$&ers. 5. c$ntrast, the e*cl)si$n %$r e&pl$.ee disc$)nts $n pr$pert. is li&ited t$ the e&pl$.erEs gr$ss pr$%it percentage, (hich is the e*cess $% the aggregate sales price %$r the pr$pert. s$ld b. the e&pl$.er $!er the aggregate c$st $% s)ch pr$pert. t$ the e&pl$.er, di!ided b. the aggregate sales price. -*. I &12-*.-&.-a. ' th, gross profit p,r*,ntag, of th, pri*, at 7hi*h th, prop,rtA is 5,ing off,r,2 5A th, ,+ploA,r to *4sto+,rs% &. 0ggregate A$st M ,r$ss pr$%it 1 (s)pp$se 20 c$st is $600) B /01 (1000-600 B /00?1000) a% 7inda paid $500 M incl)de $100 e*cess disc$)nt 2. I&12 is ,<*l4sion 4p to 0H00 5ra*,l,t fr,,% a% Dells it %$r $ 00 (and has t$ rec$gni;e $100 gain %r$& the disc$)nted a&t) 5% 5ases %$r $1,000 and can take a $'00 l$ss -2. Is a 2o+,sti* partn,r in*l42,2 in th, 2,finition of ,+ploA,,M &. @S, 6a* c$de d$es n$t incl)de d$&estic sp$)ses in the de%initi$n $% sp$)se $r e&pl$.ee. a% 6 has t$ incl)de $/50 (the c$st $% the %light) & $250 (c$st $% the h$tel) as inc$&e. 2. -% .es, then airline ticket e*cl)ded %r$& inc$&e b?c in n$-additi$nal-c$st bene%it b?c he %le( standb. a% 6he 2$tel ($)ld beF 201 $% $500 B $100 (e*cl)ded %r$& inc$&e) 5% $500 (h$tel bill) - $100 (a&t. e*cl)ded) B $/00 - $250 (a&t. R pd.) B 0&?0 for hot,l in*l42,2 1. 1'2(h) de%ines e&pl$.ee t$ incl)de $neEs sp$)se & dependent children as (ell as certain retired & disabled e&pl$.ees & the s)r!i!ing sp$)se $% a decease e&pl$.ee. H. 1'2(h)(') pr$!ides a special r)le treating the )se $% air transp$rtati$n b. the parent $% an e&pl$.ee as )se b. the e&pl$.ee -,. Do not n,,2 to in*l42, it% I &12-i. pro6i2,s sp,*ial r4l, a4thori9ing r,*ipro*al agr,,+,nts 5?t e&pl$.ers in the sa&e line $% b)siness, th)s enabling the e&pl$.ers t$ pr$!ide ta*-%ree bene%its t$ $ne an$therEs e&pl$.ees. D)ch recipr$cal agree&ents &)st be in (riting & the e&pl$.ers &a. n$t inc)r an. s)bstantial additi$nal c$sts (incl)ding %$rg$ne re!en)es) in pr$!iding s)ch ser!ices. 1'2(4)(5) (hich pr$!ides %a!$rable treat&ent %$r a%%iliates $% airlines. -f. I &12-a.-1. ,<*l42,s th,s, so(*all,2 P7orNing *on2ition fring, 5,n,fits%Q

<age 2 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

&. Reg. 1.1'2-5(a)(1)(!) - Aash p.&ts t$ an e&pl$.ee d$ n$t >)ali%. as ($rking c$nditi$n %ringes )nless the e&pl$.ee is re>)ired t$ )se the p.&ts %$r e*penses inc)rred in a speci%ic $r prearranged >)ali%.ing acti!it., !eri%. s)ch )se, & ret)rn an. e*cess t$ the e&pl$.er. 2. Reg. 1.1'2-5(b) M deter&ines the ($rking c$nditi$n %ringe p$rti$n $% !ehicle )sage, (here an e&pl$.ee )ses an e&pl$.er-pr$!ided !ehicle %$r b)siness & pers$nal p)rp$ses. 1. Reg. 1.1'2-5(n) M c$ns)&er pr$d)ct testing, that is the )se b. e&pl$.ees $% e&pl$.er&an)%act)red c$ns)&er g$$ds, s)ch as cars, %$r testing & e!al)ati$n $)tside the e&pl$.erEs $%%iceZdelineate the re>)ire&ents %$r s)ch e&pl$.ee )se t$ >)ali%. as a ($rking c$nditi$n %ringe bene%it. ?% POQ pr$!ides %ree parking. 6he %ir& pa.s $150?&$nth %$r each parking space. 6$ each %ir& &e&ber (h$ )ses p)blic transit ser!ice, the %ir&s pa.s $ 5?&$ (the c$st $% a &$nthl. transit pass). -a. 1'2(a)(5) e*cl)des %r$& inc$&e 9>)ali%ied transp$rtati$n %ringe: bene%its. -5. 1'2(%)(1) - 0 >)ali%ied transp$rtati$n %ringe bene%its isF &. transp$rtati$n in a c$&&)ter high(a. !ehicle in c$nnecti$n (? tra!el b?t the e&pl$.eeEs residence & place $% e&pl$.&entG 2. a transit passG 1. >)ali%ied parking -*. 1'2(%)(') M cash rei&b)rse&ents %$r these ite&s are als$ e*cl)dable -2. 1'2(%)(2), (6) M the e*cl)si$n is s)b4ect t$ speci%ied d$llar li&itati$ns (hich are ad4)sted %$r in%lati$n. II%O@ER@IEW 61(a)(1) pr$!ides that, a&$ng $ther things, ,- incl)des 9%ringe bene%its.: Reg)lati$n 1.61-1(a) pr$!ides the %$r& $% receipt d$esnEt &atter & 9inc$&e &a. be reali;ed R in the %$r& $% ser!ices, &eals, acc$&&$dati$ns, st$ck $r $ther pr$pert., as (ell as in cash.: #omm$n v" )mith, the c$ncept $% ,- is intended 9t$ incl)de in ta*able inc$&e an. ec$n$&ic $r %inancial bene%it c$n%erred $n the e&pl$.ee as c$&pensati$n, (hate!er the %$r& $r &$de in (hich it is e%%ected. HR-@,N 5N@NH-6D 6he la( regarding the ta* treat&ent $% %ringe bene%its is t$ be %$)nd in a patch($rk $% legislati!e, 4)dicial & ad&inistrati!e r)les. A% ,als F Lo2ging 2* $% piece&eal ta* treat&ent $% %ringe bene%its 1919 r)ling that &eals & l$dging %$r sea&en ab$ard ships (ere e*cl)ded 1920 r)ling that e*e&pted 9s)pper $ paid b. an e&pl$.er t$ an e&pl$.ee, (h$ !$l)ntaril. per%$r&s e*tra lab$r %$r his e&pl$.er a%ter reg)lar b)siness h$)rs. A$n!enience $% e&pl$.er d$ctrineF e*cl)si$ns (ere pre&ised $n the n$ti$n that the bene%its gi!en e&pl$.ees (ere %$r the c$n!enience $% the e&pl$.er. 0d$pted b. the 6reas)r. & c$)rts as pr$!iding the standard %$r deter&ining (hether e&pl$.erpr$!ided &eals & l$dging (ere e*cl)dable. Re>)ired 6<s t$ establish that bene%its acc$rded the& as e&pl$.ees (ere gr$)nd in b)siness necessit.. N&pl$.ees $% h$spitals s)b4ect t$ i&&ediate ser!ice $n de&and at an. ti&e d)ring 2/ h$)rs peri$d & are re>)ired t$ accept >)arters & &eals at the h$spital t$ be a!ailable. 1enaglia M the %act that the 6<Es presence in the h$tel (as necessar. 4)sti%ied e*cl)ding %r$& inc$&e the &eals & l$dging pr$!ided hi&. <age 2+ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

1950, the Der!ice t$$k the p$siti$n that, i% the e&pl$.er characteri;ed a bene%it as c$&pensati$n, the bene%it ($)ld be treated as inc$&e regardless $% the %act that the bene%it (as pr$!ided %$r the c$n!enience $% the e&pl$.er. D$&e c$)rts re4ected this p$siti$n (hile $thers e&braced it. Res)lted in si&ilarl. sit)ated 6<s t$ be treated di%%erentl. depending $n (hich standard )sed. 195/, A$ngress added 119 t$ res$l!e the pr$ble&s. Reg. 1.119-1(b)(') pr$!idesF 9c$nditi$n $% e&pl$.&ent &eans that "the e&pl$.ee# be re>)ired t$ accept the l$dging in $rder t$ enable hi& pr$perl. t$ per%$r& the d)ties $% his e&pl$.&ent. 7$dging (ill be regarded as %)rnished t$ enable the e&pl$.ee pr$perl. t$ per%$r& the d)ties $% his e&pl$.&ent (hen, %$r e*a&ple, the l$dging is %)rnished beca)se the e&pl$.ee c$)ld n$t per%$r& the ser!ices re>)ired $% hi& )nless he is %)rnished s)ch l$dging.: -s the N*cl)si$n J)sti%iableL Hact re&ains the pers$nal needs $% the e&pl$.ee are satis%ied. 8issent in 1enaglia, perhaps the !al)e $% the bene%it t$ the e&pl$.ee sh$)ld be treated as inc$&e. 6an (osen v" #omm$n reas$ned 9"t#h$)gh there (as an ele&ent $% gain t$ the e&pl$.ee, in that he recei!ed s)bsistence & >)arters (hich $ther(ise he ($)ld ha!e had t$ s)ppl. %$r hi&sel%, he had n$thing he c$)ld take, appr$priate, )se & e*pend acc$rding t$ his $(n dictates, b)t rather, the ends $% the e&pl$.erEs b)siness d$&inated & c$ntr$lled, 4)st as in the %)rnishing $% a place t$ ($rk & in the s)ppl.ing $% the t$$ls & &achiner. (ith (hich t$ ($rk. 6he %act that certain pers$nal (ants & needs $% the e&pl$.ee (ere satis%ied (as plainl. sec$ndar. & incidental t$ the e&pl$.&ent.: R)ling 59-/09, (hich ($)ld ha!e triggered additi$nal inc$&e t$ an e&pl$.ee %$r the !al)e $% bene%its pr$!ided t$ &e&bers $% his %a&il.. 6his r)ling (as (ithdra(n the %$ll$(ing .ear & A$ngress in 19 +, a&ended 119 t$ e*cl)de &eals & l$dging pr$!ided t$ an e&pl$.eeEs sp$)se & dependents. #aratan v" #omm$n, the Der!ice c$ntended that $(ner-e&pl$.ees $% a %ar&ing c$rp$rati$n c$)ld n$t e*cl)de the !al)e $% the li!ing acc$&&$dati$ns pr$!ided the& b?c the. had %ailed t$ establish that the. (ere re>)ired t$ accept the l$dging as a c$nditi$n $% their e&pl$.&ent. 6a* A$)rt agreed, n$ting that, since there (as a!ailable h$)sing in a residential area 10 &ins. %r$& the %ar&, it (as n$t necessar. t$ the per%$r&ance $% their d)ties that the 6<s li!e in the h$)sing pr$!ided b. their c$rp$rati$n. 9th Airc)it At, in re!ersing, relied $n Reg. 1.119-1(b). <)rs)ant t$ the reg)lati$n, it (as en$)gh %$r 6<s t$ establish that he (as re>)ired t$ be a!ailable %$r d)t. at all ti&es. 9-t is n$t necessar. t$ sh$( that the d)ties ($)ld be i&p$ssible t$ per%$r& (?$ s)ch l$dging being a!ailable.: 6he a!ailabilit. $% nearb. h$)sing (as there%$re irrele!ant. #omm$n v" ,owalski, the D)p. At. c$nsidered (hether cash p.&ts &ade t$ state p$lice tr$$pers as &eals all$(ances (ere e*cl)dable )nder 119. 6he At. c$ncl)ded that case p.&ts (ere n$t e*cl)dable )nder the (hich, acc$rding t$ the At., e*cl)ded $nl. &eals in kind. Sccasi$nal s)per $ is e*cl)dable as a de minimis %ringe bene%it )nder 1'2(a)(/). )% Fring, ),n,fits F S,*tion &12 0 n$n-e*ha)sti!e list $% s$-called 9stat)t$r. %ringe bene%its: ($)ld incl)de e&pl$.ee gr$)p ter& li%e ins)rance )nder $50,000 ( 9)G e&pl$.er-pr$!ided accident & health bene%its ( 105, 106(a))G and dependent car assistance pr$gra&s ( 129). T)ali%ied retire&ent plans ( /01 et" se7") c$nstit)te a partic)larl. signi%icant %ringe bene%it %$r &an. e&pl$.ees. <age 29 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

2$st $% n$n-stat)t$r. e&pl$.er-pr$!ided %ringe bene%its e*isted (ign$red b. the Der!ice $r treated as n$nta*able. 1921, Der!ice r)le that 9pers$nal transp$rtati$n passes iss)ed b. a railr$ad c$&pan. t$ its e&pl$.ees & their %a&ilies R are c$nsidered gi%ts & the !al)e d$es n$t c$nstit)te ta*able inc$&e t$ the e&pl$.ees.: 19+/, A$ngress enacted the %irst c$&prehensi!e treat&ent $% %ringe bene%it. 1'2. 1'2 rec$gni;es categ$ries $% e*cl)dable bene%itsF @$-additi$nal-c$st ser!iceG T)ali%ied e&pl$.ee disc$)ntG K$rking c$nditi$n %ringeG /e minimis %ringeG T)ali%ied transp$rtati$n %ringeG T)ali%ied &$!ing e*pense rei&b)rse&entG and T)ali%ied retire&ent planning ser!ices. &% No(A22itional(Cost S,r6i*, A$ngress rec$gni;ed that c$&panies engaged in the airline, railr$ad, $r h$tel b)siness $%ten ha!e e*cess capacit. (e"g", e*tra seats $n a sched)led airline %light) (hich (ill re&ain )n)sed %$r lack $% pa.ing c)st$&ers). 5?c n$ c$st inc)rred b. the e&pl$.er in all$(ing an e&pl$.ee t$ $cc)p. an e&pt. seat, A$ngress $pted t$ e*cl)de %r$& inc$&e the entire !al)e $% s)ch ser!ices, s)b4ect t$ a n)&ber $% restricti$ns. / Re>)ire&ents 1. 1'2(b)(1) - 6he ser!ice &)st be $ne $%%ered %$r sale t$ c)st$&ers in the $rdinar. c$)rse $% b)siness. I"e", an e&pl$.ee $% a c$rp$rati$n has pers$nal b)siness in NA & the c$&pan. all$(s the e&pl$.ee t$ $cc)p. an $ther(ise e&pt. seat $n the c$rp$rate 4et (hich is being %l$(n t$ NA %$r b)siness reas$ns, this bene%it %ails the 9%$r sale t$ c)st$&ers: standard 2. 1'2(b)(1) M the ser!ice be $%%ered in the line $% b)siness $% the e&pl$.er in (hich the e&pl$.ee is per%$r&ing ser!ices. 6his line $% b)siness re>)ire&ent is best e*plained b. the %$ll$(ing e*cerpt %r$& the legislati!e h*. 0n e&pl$.er (hich pr$!ides airline ser!ices & h$tel ser!ices t$ the general p)blic is c$nsidered t$ c$nsist $% 2 separate lines $% b)siness. 0n e&pl$.ee $% the airline b)siness &a. n$t e*cl)de the !al)e $% %ree h$tel r$$&s pr$!ided b. the h$tel b)siness $% the e&pl$.er & !ice !ersa. -% the. c$)ld d$ this, it ($)ld disad!antage s&all b)siness abilit. t$ c$&pete. Khat ab$)t an acc$)ntant that pr$!ides ser!ices t$ b$th lines $% b)sinessL Reg. 1.1'2-/(a)(1)(i!) pr$!ides that the per%$r&ance $% s)bstantial ser!ices directl. bene%iting &$re than $ne line $% b)siness is treated as the per%$r&ance $% s)bstantial ser!ices in all s)ch lines $% b)siness. '. 1'2(b)(2) pr$!ides that the e&pl$.er inc)r n$ s)bstantial additi$nal c$st (incl)ding %$rg$ne re!en)e). Reg. 1.1'2-2(a)(5) pr$!ides 9%$r p)rp$ses $% deter&ining (hether an. re!en)e is %$rg$ne, it is ass)&ed that the e&pl$.ee ($)ld n$t ha!e p)rchased the ser!ice )nless it (ere a!ailable t$ the e&pl$.ee at the act)al price charged t$ the e&pl$.ee. Reg. 1.1'2-2(c) states that per&itting airline e&pl$.ees t$ take pers$nal %lights at n$ charge & t$ recei!e reser!ed seats res)lts in %$rg$ne re!en)e & t?% e&pl$.ees recei!ing the %ree %lights are n$t eligible %$r the n$-additi$nal-c$st e*cl)si$n. <age '0 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

1'2(b)(2) als$ pr$!ides that (hether an e&pl$.er inc)rs an. s)bstantial additi$nal c$st be deter&ined (?$ regard t$ an. a&$)nt (hich an e&pl$.ee &ight be re>)ired t$ pa.. 6h)s, e&pl$.ee pa.&ent 3 ser!e t$ trans%$r& an e&pl$.er-pr$!ided ser!ice int$ a 9n$additi$nal-c$st: ser!ice, alth$)gh s)ch p.&t &a. $b!i$)sl. be >)ite rele!ant in &eas)ring the inc$&e, i% an., the e&pl$.ee recei!es %r$& the e&pl$.erEs pr$!isi$n $% the ser!ice. Hinall., the stat)e re%ers t$ 9s)bstantial: additi$nal c$sts. I"e", are the h$)sekeeping c$sts ass$ciated (? &aintenance $% h$t r$$&s 9s)bstantial: additi$nal c$sts t$ the $(ner $% a h$tel chain (h$ per&its e&pl$.ees t$ )se r$$&s (hich $ther(ise ($)ld re&ain !acantL o Reg. 1.1'2-2(a)(5)(ii) M t$ the e%%ect that the c$st $% ser!ices 9&erel. incidental: t$ the pri&ar. ser!ice rendered are generall. n$t s)bstantial. Reg)lati$ns, a%ter listing se!eral 9e*cess capacit. ser!ices: that >)ali%. as n$-additi$nal-c$st ser!ices, speci%icall. state that n$n-e*cess capacit. ser!ices, (hich d$ n$t s$ >)ali%., &a. n$netheless be %)ll. $r partiall. e*cl)ded %r$& inc$&e )nder the 9>)ali%ied e&pl$.ee disc$)nt: r)les disc)ssed bel$(. Reg. 1.1'2-2(a)(2). /. 1'2(4)(1) pr$hibits discri&inati$n in %a!$r $% highl. c$&pensated e&pl$.ees, a ter& (hich, as de%ined in /1/(>), can incl)de $%%icers & $(ners. )ee Reg. 1.1'2-+(a)(2) pr$!ides $nl. the &e&bers $% the highl. c$&pensated gr$)p, rather than all e&pl$.ees recei!ing bene%its, (ill be s)b4ect t$ ta*. 1'2(i) pr$!ides special r)le a)th$ri;ing recipr$cal agree&ents b?t e&pl$.ers in the sa&e line $% b)siness, th)s enabling the e&pl$.ers t$ pr$!ide ta*-%ree bene%its t$ $ne an$therEs e&pl$.ees. D)ch recipr$cal agree&ents &)st be in (riting & the e&pl$.ers &a. n$t inc)r an. s)bstantial additi$nal c$sts (incl)ding %$rg$ne re!en)es) in pr$!iding s)ch ser!ices. 1'2(h) de%ines e&pl$.ee t$ incl)de $neEs sp$)se & dependent children as (ell as certain retired & disabled e&pl$.ees & the s)r!i!ing sp$)se $% a decease e&pl$.ee. 1'2(h)(') pr$!ides a special r)le treating the )se $% air transp$rtati$n b. the parent $% an e&pl$.ee as )se b. the e&pl$.ee 1'2(4)(5) (hich pr$!ides %a!$rable treat&ent %$r a%%iliates $% airlines. #harley v" #omm$n, the 6< arg)ed 1'2(a)(1) e*cl)ded %r$& inc$&e a&$)nts he recei!ed %$r %re>)ent %l.er &iles (hich he c$n!erted t$ cash. 6he c$)rt n$ted that the 6<Es c$&pan. did n$t $%%er %re>)ent %l.er &iles %$r sale t$ c)st$&ers in the $rdinar. c$)rse $% its b)siness. 6he c$)rt c$ncl)ded that either the tra!el credit arrange&ent represented additi$nal c$&pensati$n t$ the 6< %r$& his c$&pan. $r the 6< had si&pl. s$ld his %re>)ent %l.er &iles in (hich he had a ;er$ basis. Cnder either anal.sis, the a&$)nt credit t$ his pers$nal tra!el %)nd c$nstit)tes ,-. Der!ice ann$)nced that the -R0 (ill n$t assert that an. 6< has )nderstated his %ederal ta* liabilit. b. reas$n $% the receipt $% pers$nal )se $% %re>)ent %l.er &iles. 6his relie% d$es n$t appl. t$ bene%its that are c$n!erted t$ cash, $r t$ c$&pensati$n paid in the %$r& $% s)ch bene%its, $r t$ bene%its )sed %$r ta* a!$idance p)rp$ses. 2% E4alifi,2 E+ploA,, Dis*o4nt N*cl)si$n %$r >)ali%ied e&pl$.ee disc$)nts re%lects rec$gniti$n $% l$ng-standing practice $% b)sinesses t$ pr$!ide disc$)nts t$ their e&pl$.ees $n the sa&e g$$ds & ser!ices the. sell t$ the general p)blic. 0rgs in %a!$rF Dti&)lates a c$&pan.Es sales t$ a nat)ral gr$)p $% c)st$&ers (increase $!erall sales & pr$%its)

<age '1 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

Dti&)lati$n $% sales t$ the general p)blic (e&pl$.ee ed)cated ab$)t the &erchandise the e&pl$.er sells W e&pl$.ees &ake &$re e%%ecti!e sales, &$ral is higher, &$re l$.al ad!$cates, e%%ecti!e &eans $% ad!ertising the e&pl$.ers g$$ds). 1'2(c) li&its the a&$)nt $% disc$)nt (hich (ill be e*cl)dable & pr$!ides separate li&itati$ns %$r pr$pert. & %$r ser!ices. 6he e*cl)si$n %$r e&pl$.ee disc$)nts $n ser!ices is li&ited t$ 201 $% the price at (hich the ser!ices are being $%%ered b. the e&pl$.er t$ c)st$&ers. 5. c$ntrast, the e*cl)si$n %$r e&pl$.ee disc$)nts $n pr$pert. is li&ited t$ the e&pl$.erEs gr$ss pr$%it percentage, (hich is the e*cess $% the aggregate sales price %$r the pr$pert. s$ld b. the e&pl$.er $!er the aggregate c$st $% s)ch pr$pert. t$ the e&pl$.er, di!ided b. the aggregate sales price. 1'2(c)(/) de%ines 9>)ali%ied pr$pert. $r ser!ices.: 6he de%initi$n c$ntains the sa&e 9%$r sale t$ c)st$&ers: and 9line $% b)siness: re>s. $% 1'2(b). 6he real pr$pert. & pers$nal pr$pert. held %$r in!est&ent d$ n$t >)ali%. %$r the 1'2(c) e*cl)si$n. I"e", the e*cl)si$n ($)ld n$t appl. t$ e&pl$.ee p)rchases $% st$cks $r b$nds, g$ld c$ins $r residential & c$&&ercial real estate. -n i&p$sing this li&itati$n, A$ngress (as c$ncerned that s)ch pr$pert. c$)ld t.picall. be s$ld b. e&pl$.ees 9at cl$se t$ the sa&e price at (hich the e&pl$.er sells the pr$pert. t$ its n$n-e&pl$.ee c)st$&ers.: 1'2(c) the sc$pe $% the ter& $% e&pl$.ee is the sa&e as that in 1'2(b), and the antidiscri&inati$n r)les applicable t$ the n$-additi$nal-c$st ser!ice e*cl)si$n are als$ applicable t$ the >)ali%ied e&pl$.ee disc$)nt e*cl)si$n. @$teF the recipr$cal agree&ent r)les $% 1'2(i) are n$t applicable t$ >)ali%ied e&pl$.ee disc$)nts. 1% WorNing Con2ition Fring, ),n,fits N&pl$.ers pr$!ide e&pl$.ee (? all $% the t$$ls, $%%ice space, & s)pplies an e&pl$.ee needs. D)ch pr$pert. & ser!ices are s$ cl$sel. c$nnected t$ 4$b per%$r&ance that (ere the e&pl$.ee, rather than the e&pl$.er, t$ pa. %$r the&, the e&pl$.ee ($)ld be entitled t$ ded)ct their c$st as b)siness e*pense W (hen the. are pr$!ided b. the e&pl$.er, the. 3 c$nsidered c$&pensati$n t$ the e&pl$.ee. 1'2(a)(') e*cl)des these s$-called 9($rking c$nditi$n %ringe bene%its.: Reg. 1.1'2-5(a)(1)(!) - Aash p.&ts t$ an e&pl$.ee d$ n$t >)ali%. as ($rking c$nditi$n %ringes )nless the e&pl$.ee is re>)ired t$ )se the p.&ts %$r e*penses inc)rred in a speci%ic $r pre-arranged >)ali%.ing acti!it., !eri%. s)ch )se, & ret)rn an. e*cess t$ the e&pl$.er. Reg. 1.1'2-5(b) M pr$!ided %$r deter&ining the ($rking c$nditi$n %ringe p$rti$n $% !ehicle )sage, (here an e&pl$.ee )ses an e&pl$.er-pr$!ided !ehicle %$r b$th b)siness & pers$nal p)rp$ses. Reg. 1.1'2-5(n) M c$ns)&er pr$d)ct testing, that is the )se b. e&pl$.ees $% e&pl$.er&an)%act)red c$ns)&er g$$ds, s)ch as cars, %$r testing & e!al)ati$n $)tside the e&pl$.erEs $%%ice Z delineate the re>)ire&ents %$r s)ch e&pl$.ee )se t$ >)ali%. as a ($rking c$nditi$n %ringe bene%it. Re!. R)l. 92-69, 1992-2 A.5. 51, the Der!ice c$ncl)ded e&pl$.er-pr$!ided $)tplace&ent ser!ices (ere e*cl)dable b. e&pl$.ees as ($rking c$nditi$n %ringe bene%its. -% an e&pl$.er deri!es a s)bstantial b)siness bene%it %r$& the pr$!isi$n $% s)ch $)tplace&ent ser!ices that is distinct %r$& the bene%it it ($)ld deri!e %r$& the &ere p.&t $% additi$nal c$&pensati$n, ie, pr$&$ting a p$siti!e c$rp$rate i&age, &aintaining e&pl$.ee &$rale, & a!$iding (r$ng%)l ter&inati$n s)its, the ser!ice &a. generall. be treated as a ($rking c$nditi$n %ringe. -ownsend Industries v" *nited )tates, '/2 H.'d +90 (+th Air. 200'), the c$)rt held the per-e&pl$.ee c$st $% the 6<Es ann)al %ishing trip c$nstit)ted a ($rking c$nditi$n %ringe bene%it e*cl)dable %r$& e&pl$.ee inc$&e & ded)ctible t$ the e&pl$.er as a b)siness e*pense. H$ll$(ing ann)al 2-da. &tg., 6< sp$ns$red a /-da., e*pense-paid %ishing trip t$ a res$rt in Aanada. <age '2 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

0ll the trips (ere !$l)ntaril., 9nearl. all e&pl$.ees %elt an $bligati$n t$ attend.: 6esti&$n. regarding the b)siness disc)ssi$ns that t$$k place a&$ng th$se attending. At %$)nd 96$(nsend had a realistic e*pectati$n t$ gain c$ncrete %)t)re bene%its %r$& the trip based $n its kn$(ledge $% its $(n s&all c$&pan., its kn$(ledge $% the )tilit. $% interpers$nal interacti$ns that pr$babl. ($)ld n$t $cc)r b)t %$r the trip, & its kn$(ledge $% its $(n past e*perience.: H% De Minimis Fring, ),n,fits Re%lecting a c$ngressi$nal desire %$r ad&inistrati!e c$n!enience, 1'2(a)(/) e*cl)des de minimis %ringe bene%its, de%ined in 1'2(e). @$te the e&phasis place $n 9%re>)enc.: as a %act$r %$r deter&ining (hether a bene%it is de minimis. @$te als$ that, )nlike the n$-additi$nal-c$st ser!ice, >)ali%ied e&pl$.ee disc$)nt, & ($rking c$nditi$n %ringe bene%it r)le, the de minimis e*cepti$n d$es n$t necessitate an e&pl$.er-e&pl$.ee relati$nship b?t the pr$!ider & recipient. W bene%its recei!ed b. a direct$r $% a c$rp$rati$n &a. c$nstit)te e*cl)dable de minimis %ringes. Reg. 1.1'2-6(d)(2) - special r)les %$r e*cl)ding &eals & $ccasi$nal &eal $ as de minimis %ringes. Reg. 1.1'2-6(e) lists a !ariet. $% c$&&$n bene%its that d$ $r d$ n$t >)ali%. as de minimis. Reg. 1.1'2-6(c) de minimis %ringe bene%it stat)s is e*plicitl. denied t$ an. cash $r cash e>)i!alent bene%its, $ther than th$se all$(ed b. the special r)les. ?% E4alifi,2 Transportation Fring, 1'2(a)(5) e*cl)des %r$& inc$&e 9>)ali%ied transp$rtati$n %ringe: bene%its. 1'2(%)(1) - 0 >)ali%ied transp$rtati$n %ringe bene%its isF (1) transp$rtati$n in a c$&&)ter high(a. !ehicle in c$nnecti$n (? tra!el b?t the e&pl$.eeEs residence & place $% e&pl$.&entG (2) a transit passG (') >)ali%ied parking. 1'2(%)(') M cash rei&b)rse&ents %$r these ite&s are als$ e*cl)dable. 1'2(%)(2), (6) M the e*cl)si$n is s)b4ect t$ speci%ied d$llar li&itati$ns ad4)sted %$r in%lati$n. :% On("r,+is,s #A+s F Oth,r Athl,ti* Fa*iliti,s 1'2(4)(/) M A$ngressi$nal c$ncern %$r e&pl$.ee health (hich %$r $n-pre&ises athletic %acilities pr$!ided b. the e&pl$.er. 1'2(4)(/)(5)(iii) - N*cl)si$n applicable $nl. i% the )se $% s)ch %acilities is li&ited t$ e&pl$.ees, their sp$)ses & their dependent children. C% @al4ation Hringe bene%its n$t e*cl)ded %r$& inc$&e )nder 1'2 $r an$ther $% the A$de, are, s)b4ect t$ ta* p)rs)ant t$ 61(a)(1). Reg. 1.61-21(b)(1) - 6he &eas)re $% inc$&e is the %air &arket !al)e $% the %ringe bene%it, less an. e*cl)dable p$rti$n $% the %ringe bene%it & an. a&$)nt paid b. the recipient. Dpecial, & e*tensi!e, !al)ati$n r)les are pr$!ided, h?e, (? respect t$ e&pl$.er-pr$!ided !ehicles, cha)%%e)r ser!ices, c$&&ercial & n$n-c$&&ercial air tra!el, & eating %acilities. Reg. 1.61-21(a)(/) - 6he reg)lati$ns e*plicitl. ta* the !al)e $% %ringe bene%it t$ the e&pl$.ee, e!en th$)gh the bene%it &a. act)all. be recei!ed b. s$&e$ne else. GN, 1: )%T%A% 818 -&91;. 221 <age '' $% +

)ENA#LIA 6% CO

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

F& : <et., h)sband & (i%e, residing in 2$n$l)l), 2a(aii. 6he pet. has since 1926 & incl)ding the ta* .ears in >)esti$n, been e&pl$.ed as the &anager in %)ll charge $% the se!eral h$tels in 2$n$l)l) $(ned & $perated b. 2a(aiian 2$tels. <et. (as c$nstantl. $n d)t. & %$r the pr$per per%$r&ance $% his d)ties & entirel. %$r the c$n!enience $% his e&pl$.er, he & his (i%e $cc)pied a s)ite $% r$$&s in the h$tel & recEd their &eals %r$& the h$tel. Dalar. ne!er incl)ded &eals & l$dging & e&pl$.er & e&pl$.ee regarded the& as c$&pensati$n. A$&&En added $ ,+/5 each .ear t$ the pet. ,- as 9c$&pensati$n recEd %r$& 2a(aiian 2$tels: h$lding this is the 9%air &arket !al)e $% r$$&s & &eals %)rnished b. the e&pl$.er: and that the r$$&s & &eals (ere n$t in %act s)pplied 9&erel. as a c$n!enience t$ the h$tels.: Issue: (1) Khether the &eals & l$dging ha!e t$ be incl)ded in ,-L (2) 2$( &)ch has t$ be incl)dedL '&$at: 6here re&ains n$ r$$& %$r d$)bt that the petEs residence at the h$tel (as n$t b. (a. $% c$&pensati$n %$r her ser!ices, n$t %$r his pers$nal c$n!enience, c$&%$rt $% pleas)re, b)t s$lel. b?c he c$)ld n$t $ther(ise per%$r& his ser!ices re>)ired $% hi&. 2is d)t. (as c$ntin)$)s & re>)ired his presence at a &$&entEs call. Cnder s)ch circ)&stances, the !al)e $% the &eals & l$dging is n$t inc$&e t$ the e&pl$.ee e!en th$)gh it &a. reli!e hi& $% an e*pense (hich he ($)ld $ther(ise bear. Dissent: 6he arrange&ent as t$ li!ing >)arters & &eals (as $% &)t)al bene%it, & t$ the e*tent it bene%ited pet. it (as c$&pensati$n in additi$n t$ his cash salar., & ta*able t$ hi& as inc$&e. A$)ld incl)de the HIU ($ ,+/5) $r h$( &)ch he bene%ited ($',600). CNITED STATES 6% #OTC$ER, H0& F%22 &&8 -&9:8. 22? F& : ,Es t$$k a 12 da. e*pense-paid trip t$ ,er&an. t$ t$)r the U$lks(agen %acilities there. Cp$n ret)rning , b$)ght 251 interest in Nc$n$&. I$t$rs. 6$da. he is <res. $% NI & $(ns 501 $% the dealership. 6he. did n$ incl)de the trip as ,-. A$&&En deter&ined the. reali;ed inc$&e, had a ta* de%icienc., ,Es paid, then %iled s)it %$r a re%)nd. 6he district c$)rt held that the c$st $% the trip (as n$ inc$&e, $r in the alternati!e, (as inc$&e & ded)ctible as an $rdinar. & necessar. b)siness e*pense. Issue: (1) Khether the all e*pense paid trip t$ ,er&an. has t$ be incl)ded in ,- & h$( &)ch incl)dableL '&$at: 0%%ir& district c$)rtEs deter&inati$n that the c$st $% the trip (as n$t inc$&e t$ Ir. , ($6+6.15), b)t Irs. ,Es e*pense ($6+6.15) c$nstit)ted inc$&e & (ere n$t ded)ctible. 2 distinct re>)ire&ents %$r ec$n$&ic gain t$ the 6<F 6here &)st be an ec$n$&ic gain, & this gain &)st pri&aril. bene%it the 6< pers$nall.. -n s$&e cases, as in the case $% an e*pense-pd trip, there is n$ direct ec$n$&ic gain, b)t there is an indirect ec$n$&ic gain inas&)ch as a bene%it had been recEd (?$ a c$rresp$nding di&in)ti$n in (ealth. 6he acti!ities in ,er&an. s)pp$rt the c$ncl)si$n that the trip (as $riented t$ b)siness. 6he d$&inant p)rp$se $% the trip is the critical in>)ir. & s$&e pleas)rable %eat)res (ill n$t negate the %inding $% an $!erall b)siness p)rp$se. STATE ENT )D DONALD C% LC)CIK, ASSISTANT -ne>)it. & Nc$n$&ic -ne%%icienc. Aa)se 5. N*e&pting Hringe 5ene%its %r$& 6a* Hairness re>)ires that 6<s (? e>)al inc$&e be treated e>)all. %$r inc$&e ta* p)rp$ses & (hen %ringes are e*e&pted %r$& ta*, 6<s (? e>)al inc$&es pa. )ne>)al ta*es. STAFF OF T$E BOINT CO ITTEE ON INTERNAL RE@ENCE TA!ATION, E!A INATION OF "RESIDENT NI!ONGS TA! RETCRNS FOR &9:9(;2 -&9;H. F& : Hriends & %a&il. $% <res. ha!e tra!eled in the aircra%t (?$ <res. D$&e %lights in c$nnecti$n (? the per%$r&ance $% $%%icial d)ties. Issue: (1) Khether the %ree )se $% g$!Et transp$rtati$n b. the <resEs %a&il. created inc$&e s)b4ect t$ %ederal ta*. (2) i% .es, then (h$ sh$)ld be ta*edL '&$at: 0)th$rities rec$gni;e it is n$t necessar. that the indi!id)al 6< hi&sel% recei!e the direct bene%it $% the )se $% the %acilit. $r the p.&t $% the e*penses b. the e&pl$.er. <res. has reali;ed ta*able inc$&e (here <age '/ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

&e&bers $% his %a&il. $r his %riends had %ree )se $% ,$!Et transp$rtati$n %$r pers$nal e*c)rsi$ns $r (here it has n$t been established that the. (ere $n ,$!Et b)siness. HIU $% the pr$pert. $r ser!ices taken in p.&t &)st be incl)ded in inc$&e & c$st $% 1st class c$&&ercial %lights (ill be )sed. III%CLASS NOTES 2 5ig 0nal.tical -ss)esF -ncl)si$n Hact$r pa.&ent 0ccreti$ns M is the 6< better $%%L ,eneral r)le that %ringe bene%its are incl)de, )nless there is a speci%ic e*cl)si$n (119) Ual)e Res$l)ti$n M A$de (illF -ncl)de HIUG SR 1.61-2(d) 6$tall. e*cl)de C$% 10 ' ANNCAL ACCOCNTIN# I%"RO)LE S ;&; ' ;1?

&% Nllen - 1'/1 -a. OR1F 6a*able inc$&e $100Y (incl)ding $5k b$n)s) ta*ed at '01 - '0,000 ta* c$nse>)ence &. -n n$t incl)ded, $96k * 0.' B 2+,+00 - $'0k - $1,200 ta* added b?c incl)ded -5. OR2F 05A i&pr$perl. calc)lated NEs b$n)s, sh$)ld ha!e been $1k, N ret)rned e*cess $/k, ta*able inc$&e $60k, ta*ed at 201 B12,000 - ded)cti$n sa!es $+00 in ta*es. &. $6/,000 * .2 B 12,+00 M ded)cti$n sa!es $+00 -*. the ta* c$st $% the $riginal incl)si$n is ($rth &$re than the ded)cti$n -2. 1'/1(a)(5) pr$!ides instead ((hen it is &$re !al)able than a ded)cti$n) is a ta* decrease, in e%%ect a ta* credit, against the c)rrent .ears liabilit. in an a&t e>)al t$ the added ta* $ccasi$ned b. the pri$r .earEs incl)si$n inc$&e. -,. N has a ta* credit $% $1.2k in OR2 2% Nllen - 1'/1 ($)ld n$t appl. b?c $2k n$t greater than $'k. -a. Ret)rns hal% in .ear 2 and the $ther hal% in .ear '. &. OR2 M ($)ld $nl. be able t$ ha!e [ ta* ded)cti$n - $/00 2. OR' M ($)ld $nl. be able t$ ha!e [ ta* ded)cti$n - $/00 -5. 1'/1(a)(') the a&$)nt $% s)ch ded)cti$n e*ceeds $'k. -*. 0ccr)al &eth$d instead $% cash &eth$dL &. Dtill get ded)cti$n )nder 7e(is h$lding, ($)ld take %)ll ded)cti$n 1% OR 1F b$n)s $50k ? OR 'F -RD deter&ines NEs OR1 c$&pensati$n e*ceeded 9reas$nable: c$&pensati$n b. $50k, & denies 05A a OR1 ded)cti$n %$r the $50k b$n)s M c$rp. cann$t ded)ct b?c e*ceeded reas$nable c$&pensati$n. -a. 05A & N enter int$ an agree&ent that N ret)rn an. c$&pensati$n denied b. -RD, & N repa.s in OR' &. N still had a right t$ it n$ change in c$nse>)ence -5. Khat i% the agree&ent (as entered int$ d)ring OR2L -*. <ri$r t$ the pa.&ent $% OR1 b$n)sL H% OR1F 201 ta* bracket, 6 rep$rted ,- $% $'0k & ite&i;ed ded)cti$ns $% $1/k (incl)ded ded)cti$n )nder 1 0 $% $10k %$r real estate gi!en t$ charit.). Dtandard ded)cti$n is $5k. -a. Real estate re!erts t$ 6 in OR/, still $10k. 2$( &)ch ,- &)st 6 rep$rt. <age '5 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-5. I)st she rep$rt an. inc$&e in .ear /L Oes. 111 applies M ta* bene%it r)le. &. 0ppl. ta* bene%it (hen (e all$( s$&e$ne t$ ha!e a ded)cti$n $ne .ear & a %)nda&entall. inc$nsistent e!ent happens (pr$pert. re!erts back t$ her). 2. 2$( &)chL a% 111 M $9k, h$( &)ch a bene%it did she get in OR1L 5% ,- B $'0k, ded)cti$ns $1/k B ta*able inc$&e = e*cepti$ns B $16k *% Khat (ere her ta*able inc$&e ($)ld ha!e been had she n$t gi!en the pr$pert. a(a. i% ,-B$'0k, standard ded)cti$n (ite&i;ed (as $/k s$ sheEll take standard)B $5k, 6a*able inc$&e = e*e&pti$ns B $25k 2% $25k - $16k B $9k, 6erriEs charitable c$ntrib)ti$n red)ced her ta*able inc$&e b. $9k, s$ that is all she &)st incl)de in OR/. -*. 0ss)&e then in '01 ta* bracket. -2. D)pp$se the !al)e in OR/ (as $5k $r $15k. ?% ,e$rge M last OR ded)cted $1k in c)lti!ati$n e*penses attrib)table t$ plants he ga!e a(a. t$ a l$cal garden cl)b (hen he (ent $)t $% b)siness last .ear. 0ls$ ded)ctible $250 %$r sta&ps & $100 %$r stati$ner. that re&ained $n hand (hen he (ent $)t $% b)siness. 6$$k the sta&ps h$&e & discarded the stati$ner.. Khat ta* res)lts this .earL -a. $1k (c)lti!ating e*penses), $250k & $100 (%$r stati$ner.) B $1.1k in b)siness e*penses. -5. 6$$k ded)cti$ns based $n )sing the& %$r his b)siness -*. Cnder !illsboro - the 6< has t$ )nd)e the ded)cti$n in a later .ear i% there is an.thing %)nda&entall. inc$nsistent (? the ded)cti$n in the earlier .ear. Dtill all$(ed t$ take the ded)cti$nL &. 6he sta&ps M OR1 t$$k ded)cti$n, sh$)ld )nd)e the ded)cti$n b?c )sing %$r pers$nal )se in OR2 2. 6he stati$ner. M OR1 t$$k ded)cti$n, 3 ha!e t$ )nd)e the ded)cti$n b?c n$t )sing %$r pers$nal )se & the c$st $% d$ing b)siness. 1. 6he plants M OR1 t$$k ded)cti$n, ga!e the plants a(a., b$)ght the& (? the intenti$n $% selling, b)t ga!e the& a(a. instead (hen he (ent $)t $% b)siness 3 need t$ )nd)e the ded)cti$n. :% 05A A$rp$rati$n - 1 2, carr. net l$ss back 2 .ears & %$r(ard 20 .ears. -a. OR1F ta*able inc$&e $% $10k. -5. OR2F ta*able inc$&e $% $10k. -*. OR'F ta*able inc$&e $% $5k M carr. the $60 back M net l$ss $% $55 ($0 ta*able inc$&e) -2. OR/F ta*able inc$&e $% $20k M carr. the $55 back M net l$ss $% $'5 ($0 ta*able inc$&e) -,. OR5F ,- inc$&e $% $/0k & its all$(able e*penses $% $100k (net l$ss $% $60k). -f. OR6F ta*able inc$&e $% $5k M carr. $'5 net l$ss %$r(ard (net l$ss $% $'0k) ($0 ta*able inc$&e). -g. OR F ta*able inc$&e $% $'0k, $50k all$(able e*penses. &. Aarr. net l$ss $% $'0k %$r(ard (net l$ss $% $50k) ($0 ta*able inc$&e). -h. OR+F ta*able inc$&e $10k M carr. $50k %$r(ard (net l$ss $% $/0k) ($0 ta*able inc$&e). -i. OR9F ta*able inc$&e $10k M carr. $/0k %$r(ard (net l$ss $% $'0k) ($0 ta*able inc$&e). -3. OR10F ta*able inc$&e $10k M carr. $'0k %$r(ard (net l$ss $% $20k) ($0 ta*able inc$&e). -N. OR11F ta*able inc$&e $10k M carr. $20k %$r(ard (net l$ss $% $10k) ($0 ta*able inc$&e). -l. OR12F ta*able inc$&e $10k M carr. $10k %$r(ard (net l$ss $% $0k) ($0 ta*able inc$&e). -+. OR1'F ta*able inc$&e $10k M n$ net l$ss t$ carr. %$r(ard %r$& this p$int $n. -n. M OR20F ta*able inc$&e is $10k?.r. II%O@ER@IEW //1 general r)le that 6<s are t$ &ake an ann)al acc$)nting $% their ta*able inc$&e. A% R,storing A+o4nts R,*,i6,2 Cn2,r Clai+ of Right <age '6 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

a&$)nts recEd )nder a clai& $% right, (?$ restricti$n as t$ disp$siti$n, c$nstit)te inc$&e. 2$( sh$)ld the rest$rati$n )nder a clai& $% right be taken int$ acc$)nt *nited )tates v" 0ewis M 6< recEd an i&pr$perl. c$&p)ted b$n)s in 19// (hich he rep$rted as inc$&e that .ear, & (hich he repaid t$ his e&pl$.er in 19/6. 6he g$!Et p$siti$n (as that the repa.&ent sh$)ld be taken as a ded)cti$n in 19/6 rather than per&it a rec$&p)tati$n $% the 19// ta*. 6he ta8 increase that res)lts %r$& incl)ding in inc$&e an a&$)nt recEd )nder a clai& $% right (ill n$t al(a.s be the sa&e as the ta8 savings res)lting %r$& ded)cting its rep.&t in a later .ear. 1'/1 M the 6< (h$ &eets the re>)ire&ents $% 1'/1(a)(1)-(') is directed t$ c$&p)te ta* liabilit. )nder the appr$ach that pr$d)ces the &$re %a!$rable ta* res)lt. 1'/1(a)(5) pr$!ides ((hen it is &$re !al)able than a ded)cti$n) is a ta* decrease, in e%%ect a ta* credit, against the c)rrent .earEs ta* liabilit. in an a&$)nt e>)al t$ the added ta* $ccasi$ned b. the pri$r .earEs incl)si$n in inc$&e. 6his secti$n ser!es the %)ncti$n $% an a&ended ret)rn (?$ in %act a)th$ri;ing $ne. Re>)ire&ents $% 1'/1 1'/1(a)(') M &in$r a&$)nts are barred %r$& treat&ent b. $'k thresh$ld re>)ire&ent. 1'/1(a)(1) M it is necessar. that the rest$red ite& ha!e been incl)ded in inc$&e %$r a pri$r .ear b?c it 9appeared: the 6< had an )nrestricted right t$ the inc$&e. 6here is n$ 9appearance: $% s)ch a right (? respect t$ e&be;;led %)nds, & repa.&ent is th)s $)tside the . 9appeared: re%ers t$ a 9se&blance $% an )nrestricted right in the .ear recEd as disting)ished %r$& an )nchallengeable right ((hich is &$re than an \apparentE right) & %r$& abs$l)tel. n$ right at all ((hich is lees than an \apparentE right). 1'/1(a) d$es n$t appl. t$ the repa.&ent $% %)nds recEd as the res)lt $% the 6<Es 9&ere err$r,: $r t$ the repa.&ent, 9d)e t$ a s)bse>)ent e!ent,: $% %)nds recEd )nder 9abs$l)te right.: /ominion (esource v" *nited )tates 1'/1(a)(2) re>)ires the 6< t$ establish that he did n$t ha!e an )nrestricted right t$ the a&$)nt recEd in the pri$r .ear. 6h)s !$l)ntar. repa.&ents d$ n$t c$&e (?in 1'/1. 'ike v" #omm$n M att.. s$ld st$ck $pti$ns. 2is right t$ retain the pr$%its (as disp)ted, & he paid the pr$%its t$ the c$&pan., n$t b?c he ad&itted liabilit. $r (as c$&pelled t$ d$ s$, b)t b?c he %eared c$ntr$!ers. $!er the &atter ($)ld endanger his pr$%essi$nal career. 6a* At. held 6< %ailed t$ establish that he (as n$t entitled t$ retain the pr$%its, as re>)ired b. 1'/1(a)(2)G b)t the c$)rt %)rther held the p.&t (as all$(able as a 162 ded)cti$n. 1arrett v" #omm$n M the 6a* A$)rt held that the 6<, a st$ckbr$ker, (as entitled t$ a credit )nder 1'/1(a)(5) %$r a&ts. paid in 19+/ t$ settle ci!il s)its arising $)t $% his p)rchase & sale $% certain st$ck $pti$ns in 19+1. 6he 19+1 sale generated a sh$rt-ter& capital gain $% $1+ k, (hich the 6< rep$rted, b)t had als$ led t$ ci!il s)its & pr$ceedings b. DNA t$ re!$ke 6<Es br$kerage license. Dettled the s)it b. repa.ing part $% the pr$%its %r$& the saleG the DNA pr$ceedings (ere dr$pped. -n appl.ing 1'/1(a)(5) the c$)rt re4ected the A$&&EnEs arg)&ent that the rep.&t (as !$l)ntar. & held that the g$$d %aith, ar&Es length settle&ent $% the disp)te had the sa&e e%%ect as a 4)dg&ent in establishing the %act & a&t. $% 6<Es legal $bligati$n %$r rep.&t. & establishing that he did n$t ha!e an 9)nrestricted right: t$ the a&t. (hen he recEd it. 'arks v" *nited )tates M 1arrett re4ected b. this c$)rt - s$ld b)siness & rep$rt pr$%it as inc$&e. Dettled %ra)d-related litigati$n arising $)t $% the sale, &ade rep.&t, & s$)ght t$ appl. 1'/1 t$ the rep.&t. 8istrict ct. held the settle&ent did n$t eli&inate the g$!Et $pp$rt)nit. t$ de&$nstrate, i% s)ch (ere the case, that the pre!i$)sl.-rep$rted inc$&e had been $btained b. %ra)d, & that 1'/1 ($)ld t?% be <age ' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

inapplicable t$ the rep.&t $n the gr$)nds the 6< had n$t 9appeared t$ ha!e an )nrestricted right: t$ the inc$&e, as re>)ired b. 1'/1(a)(1). Wang v" #omm$n M intern %$r br$kerage h$)se s$ld insider in%$r&ati$n. DNA initiated ci!il & cri&inal pr$ceedings against 6< (h$ settled the ci!il acti$n b. p.&t $% $125k t$ a restit)ti$n %)nd. A$)rt re4ect the 6<Es e%%$rt t$ appl. 1'/1 t$ the p.&t, $n the gr$)nds the stat)te did n$t appl. (here there (as n$ clai& $% right t$ the illegal %)nds. 1arrett (as disting)ished $n the basis that its %$c)s had been $n (hether the rep.&t (as !$l)ntar., n$t $n (hether the inc$&e had been recEd )nder clai& $% right $r the appearance $% an )nrestricted right t$ inc$&e. )% Th, Ta< ),n,fit R4l, J)diciall.-de!el$ped - 2 aspects t$ the r)le (hen a 6< rec$!ers a pre!i$)sl. ded)cted a&$)ntF 9-ncl)si$nar. aspect: M pr$!ides that rec$!er. c$nstit)tes ,-F the ded)cti$n ga!e rise t$ a ta* bene%it that, in light $% later e!ents, t)rned $)t t$ be )n(arranted, & the 6< in e%%ect gi!es back the ta* bene%it b. incl)ding the rec$!ered a&$)nt in inc$&e. 9N*cl)si$nar. aspect: M pr$!ides t$ the e*tend a pre!i$)sl. ded)cted a&$)nt did n$t pr$d)ce a ta* sa!ings, its rec$!er (ill n$t c$nstit)te inc$&e. 111(a) C% N,t Op,rating Loss,s 1 2 pr$!ides that a l$ss in 1 .r &a. be )sed t$ $%%set inc$&e in an$ther .r s$ the l$ss is n$t (asted. 1 2(c) de%ines net $perating l$ss as the e*cess $% ded)cti$ns all$(ed $!er ,-.

)CRNET 6% SANFORD F )ROOKS CO%, 282 C%S% 1?9 -&91&. ;2; F& : 191'-1915 c$&pan. c$ntracted %$r dredging the 8ela(are Ri!er b. CD. Resp. added t$ ,- %$r each .ear %r$& 191'-1916 %$r pa.&ents &ade )nder the Y & ded)cted its e*penses pd. in per%$r&ing the Y. 6$tal e*penses e*ceeded the p.&ts recEd b. $1 6k & ta* ret)rns %$r 191', 1915, & 1916 sh$(ed net l$sses. 191/ sh$(ed net inc$&e. -n 1915 ($rk )nder Y (as aband$ned, & in 1916 a s)it (as br$)ght t$ rec$!er %$r breach $% (arrant. $% the character $% the &aterial t$ be dredged. J)dg&ent %$r the clai&ant (as a%%ir&ed in 1920. <et. recEd $ (hich incl)ded the $1 6k b. (hich its e*penses )nder the Y had e*ceeded receipts & accr)ed interest. Resp. %ailed t$ incl)de these a&ts in its ta* ret)rns %$r 1920, A$&&En &ade the de%icienc. based $n the additi$n $% b$th ite& t$ ,- %$r that .ear. 6he At. $% 0pps. held that $nl. the ite& $% interest (as pr$perl. incl)ded that the $1 6k (as ret)rn $% l$sses s)%%ered b. resp. in earlier .ears & hence (as (r$ngl. assessed as inc$&e. Issue: Khether the gain $r pr$%it (hich is the s)b4ect $% the ta* &a. be ascertained $n the basis $% %i*ed acc$)nting peri$ds, $r (hether, it can $nl. be net pr$%it ascertained $n the basis $% partic)lar t*s $% the 6< (hen the. are br$)ght t$ a c$ncl)si$n. '&$at: Rec$!er. &ade b. resp. in 1920 (as ,- %$r that .ear. 6he $ (as deri!ed %r$& a Y entered int$ in the c$)rse $% b)siness $perati$ns %$r pr$%it. D)ch receiptEs %$r& the c$nd)ct $% b)siness are t$ be incl)ded in the 6<Es ret)rn as part $% ,-, regardless $% (hether the partic)lar t* res)lts in net pr$%ts, s)%%icientl. appears in 21'(a) & %r$& the character $% ded)cti$ns all$(ed. 6th 0&end ad$pted t$ enable g$!Et t$ ta*. -t is the essence $% an. s.ste& $% ta*ati$n that it sh$)ld pr$d)ce re!en)e ascertainable, & pa.able t$ the g$!Et, at reg)lar inter!als. Snl. b. s)ch a s.ste& is it practicable t$ pr$d)ce a reg)lar %l$( $% inc$&e & appl. &eth$ds $% acc$)nting. ALICE "$ELAN SCLLI@AN COR"% 6% CS, 18& F%22 199 -&9:;. ;29 F& : 6he g$!Et %iled a &$ti$n %$r s)&&ar. 4)dg&ent in an acti$n b. V c$rp. t$ rec$!er an alleged $!erpa.&ent in its inc$&e ta* d)ring a .ear that 2 parcels $% realt. (ere ret)rned t$ V a%ter the. had been d$nated and clai&ed as a charitable c$ntrib)ti$n ded)cti$n. 6he A$&&En disagreed (? the c$rpEs <age '+ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

characteri;ati$n $% the rec$!er. as a n$n-ta*able ret)rn $% capital, !ie(ing the t* instead as gi!ing rise t$ ta*able inc$&e W ad4)sting the c$rpEs inc$&e b. the t$tal $% the charitable c$ntrib)ti$n ded)cti$ns pre!i$)sl. clai&ed and all$(ed. 6he g$!Et %iled a &$ti$n %$r DJ & the c$)rt granted the &$ti$n. Issue: Khether the gain attrib)table t$ the rec$!er (as t$ be ta*ed at the rate applicable at the ti&e the ded)cti$n (as %irst clai&ed $r (hether the pr$per rate (as that in e%%ect at the ti&e $% rec$!er.. '&$at: 'erry v" *) (195+) dissenting, it (as rec$gni;ed that a ret)rn t$ the d$n$r $% a pri$r charitable c$ntrib)ti$n ga!e rise t$ inc$&e t$ the e*tent $% the ded)cti$n pre!i$)sl. all$(ed. 6he principle is (ell ingrained in $)r ta* la( that the ret)rn $r rec$!er. $% pr$pert. that (as $nce the s)b4ect $% an inc$&e ta* ded)cti$n &)st be treated as inc$&e in the .ear $% its rec$!er.. 7i&itati$n $n the principleF ta*-bene%it r)le (hich per&its the e*cl)si$n $% the rec$!ered ite& %r$& inc$&e as l$ng as its initial )se as a ded)cti$n did n$t pr$!ide a ta* sa!ing. 5?A the c$rp. $btained a %)ll ta* bene%it %r$& its earlier ded)cti$ns, th$se ded)cti$ns (ere pr$perl. classi%ied as inc$&e )p$n rec$)p&ent and &)st ha!e been ta*ed as s)ch. $ILLS)ORO NATIONAL )ANK 6% CO GN, H:0 C%S% 1;0 -&981. ;1& F& : 2 cases c$ns$lidated (here petiti$ners appealed the decisi$ns $% the CD At. $% 0pp. %$r the th Air. RN the applicabilit. $% the ta* bene%it r)le t$ the rep.&t t$ shareh$lders $% ta*es %$r (hich the. (ere liable b)t that (ere $riginall. paid b. the c$rps & t$ the distrib)ti$n $% e*pensed assets in a c$rp$rate li>)idati$n. Issue: Khat is the applicabilit. $% the ta* bene%it r)le t$ 2 c$rp$rate ta* sit)ati$nsF (1) the repa.&ent t$ the shareh$lders $% ta*es %$r (hich the. (ere liable b)t that (ere $riginall. paid b. the c$rp$rati$nG and (2) the distrib)ti$n $% e*pensed assets in a c$rp$rate li>)idati$n. '&$at: 6he At. held that the ta* bene%it r)le re>)ired the rec$gniti$n $% inc$&e in the case c$ncerning the li>)idati$n b)t n$t in the case c$ncerning the ta* re%)nd. (2) -n the li>)idati$n case, the At. re!ersed the decisi$n $% the l$(er At. and held that the li>)idating c$rp. &)st incl)de in inc$&e the a&$)nt $% the )n(arranted ded)cti$n b?c 26 C.D.A.D. ''6 did n$t pre!ent the applicati$n $% the ta* bene%it r)le. 6he At. re&anded %$r a deter&inati$n $% the pr$per increase in ta*able inc$&e. (1) -n the case c$ncerning the ta* re%)nd, the At. si&pl. re!ersed b?c a redeter&inati$n (as s$)ght in the 6a* At. 6he At. re!ersed the decisi$n $% the l$(er At. and held that the ded)ctible di!idend (as per&itted (hen the &$ne., th$)gh initiall. paid int$ the state treas)r., )lti&atel. reached the shareh$lder. C$ &2 ' )CSINESS F "ROFIT SEEKIN# E!"ENSES I%"RO)LE S 2H& ( 2;:

&% Aase. -a. 8ed)ct salar. & b$n)s pd t$ 5L &. 162(a)(1) 2. Hact$rs %$r reas$nable c$&pensati$n (p. 25/) 1. 5$n)s - 162(h) -5. (a) change, i% AEs b)siness (ere inc$rp. & A is s$le shareh$lder $% the c$rp. 2% Hinn -a. $25k ded)ctibleL A$n(a. 6(itt. M carr.ing $n trade b)siness -5. $20k ded)ctibleL Oes, c$)ld be part $% his i&age. 1% Dall. & Da& - Nach inc)r air%are e*penses $% $500, h$tel charges $% $600, & res)&e (riting sa&ple preparati$n $100. Dall. recei!es & accepts a 4$b $%%er. -a. Dall. M clerking in a 4)dicial clerkship, s$ she ($)ld be carr.ing $n a b)siness trade (c)rrentl. carr.ing $n the trade $r b)siness she is c)rrentl. seeking a 4$b). &. <)rp$se t$ seek e&pl$.&ent $r pers$nalL N&pl$.&ent M are the e*penses related t$ seeking e&pl$.&ent in the trade ? b)siness the. are alread. inL .es 2. 8e%initel. res)&e e*penses, (hat ab$)t h$tel & %light. <age '9 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

a% Dightseeing d$esnEt &atter b?c (as pri&aril. l$$king %$r a 4$b. -5. @O 7a( %ir& pa.s Dall.Es transp$rtati$n & h$tel c$st. &. Re!. R)ling 5-120 M (?$ indicating (hether the inter!ie(ee (as engaged in a trade $r b)siness, held the rei&b)rse&ent recEd b. an inter!ie(ee (as n$t ,-. -*. Da& debatable. H% IarkEs t! cl$thes ded)ctibleL -a. @$, $b4ecti!e test, i% the cl$thes can be ($rn %$r general )se than canEt ded)ct the c$st $% the cl$thes (pg. 256) M Re!. R)ling 0-/ /. ?% <hil - 195 -a. Khen <hil is spending $19k in e*penses is he alread. carr.ing $n a trade ? b)siness M i% .$) are starting s$&ething )p, are .$) carr.ing $n a trade $r b)sinessL @S -5. 5)t i% had alread. been carr.ing $n a trade $r b)siness (start )p e*penses, )nless .$) c$)ld ded)ct th$se e*penses i% the b)siness (as alread. his (as in $perati$n). -*. 195 M all$(ed t$ ded)ct )p t$ $5k $% these e*penses, & phases $)t $nce the t$tal start )p c$st reaches $50k. :% Uic -a. Kall Dtreet 4$)rnal ded)ctible )nder 212 (he has a p$rt%$li$ $% st$cks & b$nds helps hi& keep )p $n the &arket). -5. $25 %$r the c$p. $% the g)ide t$ ta* %ree b$nds, d$nEt get t$ ded)ct e*penses that is n$t incl)ded in ,- ? ta* %ree inc$&e -*. $500 ne(sletter M like the Kall Dtreet 4$)rnal & ded)ctible )nder 212 -2. Da%e dep$sit b$* M h$lds st$ck certi%icates, b$nds & $ther i&p$rtant papers - 212 -,. $/00 t$ prepare ta* ret)rn - 212(') in c$nnecti$n t$ the deter&inati$n $% ta*. -f. $250 M .es 212 (la(.er is gi!ing ta* ad!ice). II%O@ER@IEW Dt)d. $% ded)cti$ns @et inc$&e, can s)btract the c$sts $% earning ,7egislati!e grace, inclined t$(ard e*cl)si$n (n$t all$(ed t$ take the ded)cti$n) )nless can %ind s$&ething in the stat)te that speci%icall. all$(s .$) t$ take the ded)cti$n. 162 b)siness ded)cti$n 212 pr$%it seeking ded)cti$n 9net inc$&e: rather than ,- sh$)ld be s)b4ect t$ ta*G & e*penses necessar. t$ the earning $% ite&s $% ,$)ght t$ be all$(ed as ded)cti$ns 262(a) M pers$nal e*penses (e*penses n$t (?in the b)siness $r pr$%it-seeking classi%icati$n) generall. are n$t ded)ctible in deter&ining the net inc$&e s)b4ect t$ ta*. D$&e e*pendit)res are regarded as 9capital e*pendit)res: b?c the. (ere &ade t$ $btain an asset lasting %$r s$&e s)bstantial $r inde%inite pd. $% ti&e. ,enerall., n$t ded)cted in %)ll at the ti&e $% the e*pendit)re (incre&ents $!er s$&e peri$d $% ti&e) 8ra( lines b?t b)siness ? pr$%it seeking e*penses & pers$nal e*penses. A% )4sin,ss D,24*tions ( I &:2 -RD ta*es gain, pr$%it, $r net inc$&e M n$t gr$ss receipts. Reg. 1.61-'(a) interprets 61(a)(2) lang)age as 9,- deri!ed %r$& b)siness: t$ &ean 9the t$tal sales, less the c$st $% g$$ds s$ld.: 162 establishes re>)ire&ents %$r the ded)cti$n $% c$sts ass$ciated (? b)sinessF <age /0 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

6he c$st &)st be an 9e*pense: 6he e*pense &)st be 9$rdinar.: -t &)st be 9necessar.: -t &)st be 9paid $r inc)rred d)ring the ta*able .ear: -t &)st be paid $r inc)rred in 9carr.ing $n: a 9trade $r b)siness.: &% Th, E<p,ns, 4st ), POr2inarAQ

a% Is th, E<p,ns, POr2inarAQ Welch v" !elvering M $rdinar. re>)ires that a c$st be c)st$&ar. $r e*pected in the li%e $% the b)siness. Khat is c)st$&ar. $r e*pected in b)sinessL Srdinar. is disting)ished %r$& capital e*pendit)res s)ch as rep)tati$n (g$$d(ill) $r learning.

BENKINS 6% CO GN -&981. 2H? F& : A$)rt all$(ed c$)ntr. s$ng(riter & singer (stage na&e A$n(a. 6(itt., t$ ded)ct as a b)siness e*pense a&ts. he repaid t$ in!est$rs in his de%)nct %ast %$$d !ent)re, 6(itt. 5)rger. Issue: Khether 1 pers$n (6(itt.) &a. ded)ct the e*penses $% an$ther pers$n (6(itt. 5)rger). et /r): <et. arg)ed he had n$ liabilit. & &ade p.&ts grat)it$)sl. $)t $% a sense $% &$ral $bligati$n. N*pendit)res are ded)ctible )nder 162 b?c the p.&ts (ere &ade pri&aril. (? a b)siness &$ti!e (t$ pr$tect his singer?s$ng(riter rep)tati$n) & there is s)%%icient c$nnecti$n b?t the p.&ts & 6<Es trade $r b)siness. '&$at: -n $rder t$ deter&ine (hether the disall$(ed e*pendit)res are ded)ctible b. petiti$ner )nder 162 (e &)st (1) ascertain the p)rp$se $r &$ti!e $% the 6< in &aking the p.&ts and (2) deter&ine (hether there is a s)%%icient c$nnecti$n b?t the e*pendit)res & the 6<Es trade $r b)siness. I$ral $bligati$n d$es n$t precl)de ded)ctibilit. as l$ng as it is n$t the satis%acti$n $% the &$ral $bligati$n (as n$t the pri&ar. &$ti!ati$n %$r the e*pendit)res. At. %$)nd the pri&ar. &$ti!e %$r the ded)cti$n (as pr$tecting his pers$nal b)siness rep)tati$n W At. c$ncl)ded their (as a pr$*i&ate relati$nship b?t the p.&ts &ade t$ the h$lderEs debent)res & petiti$ners trade $r b)siness as a c$)ntr. &)sic singer s$ as t$ render th$se p.&ts. an $rdinar. & necessar. e*pense $% that b)siness. De#ut0 v. Du#on) (19/0) M $rdinar. has the c$nn$tati$n $% n$r&al, )s)al $r c)st$&ar.. 0n e*pense &a. be $rdinar. th$)gh it happens b)t $nce in the 6<Es li%eti&e, b)t the t* (hich gi!es rise t$ it &)st be $% c$&&$n $r %re>)ent $cc)rrence in the t.pe $% b)siness in!$l!ed. 1oedel v. 2omm3n (19'9) M 6a* 5d c$ncl)ded that pre&i)&s paid b. a sec)rities %ir& $n a li%e ins)rance p$lic. c$!ering <res. R$$se!elt (ere n$t ded)ctible. A$)rt d$)bted that $ther b)siness acc)st$&ed t$ b).ing ins)rance in c$nnecti$n (? their b)siness ($)ld )se %)nds t$ p)rchase an ins)rance p$lic. $% the nat)re ac>)ired b. the %ir&. -s the %act that an e*pendit)re is )nprecedented en$)gh t$ %ind it n$t $rdinar. & n$t ded)ctibleL 1illian v. 2omm3n (19+6) M the 6<, an artist (? a h* $% &ental & e&$ti$nal pr$ble&s, created a &a4$r dist)rbance $n an airline (hile %l.ing t$ Ie&phis t$ lect)re & teach. -ndicted )nder %ederal cri&inal stat)tes & s)ed b. a passenger (h$ he in4)red. 2e s$)ght t$ ded)ct as b)siness e*penseF (1) the legal %ees inc)rred in de%ending the cri&inal acti$n and (2) the settle&ent paid t$ the in4)red passenger. 6a* A$)rt disall$(ed the ded)cti$ns reas$ning that the artists & teachers (hile tra!eling $n b)siness d$ n$t generall. engage in c$nd)ct like the 6<EsG 6he c$sts inc)rred (ere n$t part $% the 6<Es transp$rtati$n c$sts and 2is acti$ns did n$t %)rther his trade $r b)siness. <age /1 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

W his c$sts (ere n$t 9$rdinar.: (?in the &eaning $% 162. Dancer v. 2omm3n (19+0) M the At. all$(ed a ded)cti$n %$r the c$sts a 6< inc)rred in settling a negligence acti$n arising %r$& an car accident (hich $cc)rred (hile he (as tra!eling $n b)siness. 6he c$)rt n$tedF the e*pendit)re in the instant case did n$t %)rther petiti$nerEs b)siness in an. ec$n$&ic senseG n$r is it the t.pe $% e*pendit)re that &an. b)sinesses are called )p$n t$ pa.. @either %act$r lessens the direct relati$nship b?t the e*pendit)re & the b)siness. Aar tra!el b. the petiti$ner (as an integral part $% his b)siness. A$sts inc)rred as a res)lt $% s)ch an incident are 4)st as &)ch a part $% $!erall b)siness e*penses as the c$st $% %)el. 5% Is th, E<p,ns, PN,*,ssarAQ Welch, c$)rt interpreted 9necessar.: t$ &ean 9appr$priate & help%)l: & indicated it ($)ld be sl$( t$ 9$!erride: the 4)dg&ent $% a b)siness pers$n RN the necessit. $% an. c$sts inc)rred. alo /lto .o,n 4 2ountr0 5illa)e6 Inc. v. 2omm3n (9th Air. 19 ) M re!ersed a 6a* At decisi$n h$lding c$sts inc)rred in &aintaining an airplane $n a standb. basis (ere n$t $rdinar. & necessar.. 6he At %$)nd e!idence the 6<s $%%ered RN the need %$r a plane $n standb. t$ be inc$nsistent (? 6<Es act)all. c$nd)cted b)siness & 6<s did n$t )se the airplane (? s)%%icient %re>)enc. t$ 4)sti%. the e*pense $% &aintaining it $n a per&anent standb. as $rdinar. & necessar. %$r the c$nd)ct $% their b)siness. 9th Air. n$ted the i&&ediate a!ailabilit. $% the plane, arising %r$& its standb. basis, led t$ a sa!ing $% al&$st $1I in interest $n a l$an, $r that n$t ha!ing the plane $n standb. ($)ld res)lt in dela.s in getting <al$ 0lt$ pers$nnel back h$&e %r$& their b)siness trips, $r that chartering a plan & keeping it $n standb. ($)ld be &)ch &$re e*pensi!e than 6<sE arrange&ent W the %acts indicate ha!ing a plane $n standb. (as appr$priate & help%)l t$ the b)siness, & it (as a resp$nse $ne ($)ld n$r&all. e*pect a b)siness in 6< circ)&stance t$ &ake. 6he e*pense (as th)s b$th necessar. & $rdinar.. 6he deter&inati$n $% (hether an e*pense is necessar. is a %act)al deter&inati$n. 'enr0 v. 2omm3n (1961) M the 6<, a ta* la(.er & acc$)ntant, p)rchased a .acht $n (hich he %le( a red, (hite & bl)e pennant (? the n)&erals 10/0 $n it. 6< clai&ed the )se $% .acht ser!ed t$ pr$&$te his b)siness b. pr$!iding the 6< c$ntacts in the .achting circles, thereb. p$tentiall. increasing his client base. At re4ected clai&, )nder the circ)&stancesG he (as entitled t$ ded)ct the c$sts $% ins)ring & &aintaining the .acht. 6he c$)rt speci%icall. c$ncl)ded the 6< had n$t established the .acht (as 9necessar.: %$r 6<Es trade $r b)siness. 6he 6< is $rdinaril. the best 4)dge $n the &atter & (e ($)ld hesitate t$ s)bstit)te $)r $(n discreti$n %$r his (? regard t$ (hether an e*pendit)re is \appr$priate & help%)lE in the p)rp$ses $% his b)siness. 6he e*pendit)res &a. (ell ha!e been &ade t$ %)rther ends (hich are pri&aril. pers$nal, this $rdinar. c$nstraint d$es n$t pre!ailG petiti$ner &)st sh$( a%%ir&ati!el. that his e*penses (ere \necessar.E t$ the c$nd)ct $% his pr$%essi$ns. 6he clai&ed e*penses, (hen c$nsidered in relati$n t$ the %ees (hich petiti$ner attrib)tes t$ .achting, are in$rdinate & d$ n$t indicate the re>)isite pr$*i&ate relati$nship b?t his sp$rting acti!ities & his b)siness. N!idence d$es n$t sh$( h$( an. speci%ic %ee res)lted %r$& his $perating a .acht. Do77e v. 2omm3n (9th Air. 2000) M ta* c$)rt re4ected a c$rp$rati$nEs atte&pt t$ ded)ct the c$st $% landscaping ar$)nd the pers$nal residence $% its s$le shareh$lders. 6he c$rp. engaged in the b)siness $% i&p$rting & gr$(ing %l$(er b)lbs, (hich it s$ld t$ c)t %l$(er pr$ced)res. 2?e, %$)nd the c$rp. did n$t lease the 8$bbeEs residence l$cated $n the %ar&. Khen a c$rp. &akes an e*pendit)re that pri&aril. bene%its the c$rp. shareh$lders & $nl. tangentiall. bene%its the c$rp. b)siness, the a&$)nt $% the e*pendit)re &a. be ta*ed t$ the shareh$lder as a c$nstr)cti!e di!idend & is n$t ded)ctible )nder 162. $easona7le salaries. Dalaries & $ther c$&pensati$n are a&$ng the &$st c$&&$n e*penses inc)rred b. an. b)siness. 162(a)(1) pr$!ides $nl. reas$nable salaries &a. be ded)cted. 6he ele&ent $% reas$nableness is inherent in the phrase 9$rdinar. & necessar..: <age /2 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

Khere parties are related, shi%ting inc$&e %r$& $ne part. t$ the $ther &a. be ad!antage$)s. A$rp. separate ta*able entit., pr$%its generated b. the c$rp. are ta*ed t$ it & pr$%its distrib)ted as di!idends b. the c$rp. are ta*ed t$ the shareh$lders. 8$)ble ta* can be eli&inated i% the c$rp. can s)ccess%)ll. characteri;e its distrib)ti$ns t$ shareh$lders $r their %a&il. &e&bers as ded)ctible salaries $r c$&pensati$nG hence, the te&ptati$n t$ disg)ise di!idends as ded)ctible (ages. !lliots6 Inc. v. 2omm3n (9th Air. 19+') M the reas$nableness $% c$&pensati$n paid t$ a share-h$ldere&pl$.ee, partic)larl. a s$le shareh$lder, sh$)ld be e!al)ated %r$& the perspecti!e $% a h.p$thetical independent in!est$rF (hether an inacti!e, independent in!est$r ($)ld be (illing t$ c$&pensate the e&pl$.ee as he (as c$&pensated. A$)rts ha!e )ses c$&binati$n $% %act$rs as rele!ant t$ the deter&inati$n $% reas$nablenessF (a) the p$siti$n held b. the e&pl$.eeG (b) h$)rs ($rked & d)ties per%$r&edG (c) the general i&p$rtance $% the e&pl$.ee t$ the s)ccess $% the c$&pan.G (d) a c$&paris$n $% past d)ties & salar. (? c)rrent resp$nsibilities & c$&pensati$nG (e) a c$&paris$n $% the e&pl$.eeEs (%) the si;e $% the c$., the c$&ple*ities $% the c$.Es b)siness & the general ec$n$&ic c$nditi$nsG (g) the e*istence $% a p$tentiall. e*pl$itable relati$nship b?t the ta*pa.ing c$. & its e&pl$.eesG& (h) e*istence $% a b$n)s s.ste& that distrib)tes all $r nearl. all $% the pre-ta* earnings $% the c$. @$ single %act$r is deter&inati!eG rather, the e&pl$.&ent sit)ati$n &)st be !ie(ed as a (h$le. -ndirect &arket test M i% the rate $% ret)rn is e*tre&el. high, it (ill be di%%ic)lt t$ pr$!e that the &anager is being $!erpaid. Menards Inc. v. 2omm3n (200/) M -RD arg)ed that the c$&pensati$n paid b. the 6< t$ its ANS (as n$t reas$nable & t?% disall$(ed part $% the ded)cti$n clai&ed b. the c$&pan. )nder 162. 6he 6<, $ne $% the nati$nEs t$p retail h$&e i&pr$!e&ent chains, paid its pre; & ANS $20.6I %$r the .ear & b$n)s e>)al t$ 51 $% the 6<Es net inc$&e be%$re ta*es. 6a* At. c$ncl)ded that )nder the independent in!est$r test, the c$&pensati$n paid the ANS ($)ld be pres)&ed t$ be reas$nable in !ie( $% the rate $% ret)rn $n in!est&ent generated b. the 6<, b)t reb)tted (hen c$nsidering h$( si&ilarl. sit)ated b)siness paid ANS salaries. 2% PCarrAing On a Tra2, or )4sin,ssQ a% What Constit4t,s a PTra2, or a )4sin,ssMQ 6$ be engaged in a trade $r b)siness, the 6< &)st be in!$l!ed in the acti!it. (? c$ntin)it. & reg)larit. & the 6<Es pri&ar. p)rp$se %$r engaging in the acti!it. &)st be %$r inc$&e $r pr$%it. Reg. 1.1+'-2(a) lists the %$ll$(ing %act$rs %$r deter&ining (hether an acti!it. is engaged in %$r pr$%itF 6he &anner in (hich the 6< carries $n the trade $r b)sinessG 6he e*pertise $% the 6< $r his $r her ad!isersG 6he ti&e & e%%$rt e*pended b. the 6< in carr.ing $n the acti!it.G 6he e*pectati$n that assets )sed in the acti!it. &a. appreciate in !al)eG 6he s)ccess $% the 6< in carr.ing $n $ther si&ilar $r dissi&ilar acti!itiesG 6he 6<Es h* $% inc$&e $r l$sses (? respect t$ the acti!it.G 6he a&t $% $ccasi$nal pr$%its, i% an., (hich are earnedG 6he %inancial stat)s $% the 6<G Nle&ents $% pers$nal pleas)re $r recreati$n. @$ single %act$r is deter&inati!e. Reg 1.1+'-2(b) <age /' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

5% Th, PCarrAing OnQ R,L4ir,+,nt 8e!el$p&ent $% ne( b)siness in!$l!es 2 stages be%$re the trade $r b)siness bec$&es $perati$nalF -n the in!estigat$r. stage, a pers$n &a. re!ie( !ari$)s kinds $% b)siness be%$re deciding t$ ac>)ire $r t$ enter int$ a speci%ic b)siness. Fran8 v. 2omm3n (195') M 6< (h$ s$)ght t$ p)rchase & $perate a ne(spaper $r radi$ stati$n. 6< )lti&atel. p)rchased a ne(spaper, b)t &ade n)&er$)s trips t$ cities t$ in!estigate p$ssible p)rchases inc)rring tra!el & legal e*penses. 6hese e*penses 3 ded)ctible )nder 162 b?c n$t related t$ the c$nd)ct $% the b)siness that the. (ere engaged in b)t (ere preparat$r. t$ l$cating a b)siness !ent)re $% their $(n. 6he e*pense $% in!estigating & l$$king %$r a ne( b)siness & trips prapart$r. t$ entering a b)siness are n$t ded)ctible as $rdinar. & necessar. b)siness e*pense inc)rred in carr.ing $n a trade $r b)siness. 7egislati!e h* $% 195, address s$ called start )p e*pensesF 5)siness in!estigat$r. e*penses generall. are n$nded)ctible regardless $% (hether the. are inc)rred b. an e*isting b)siness in relati$n t$ an$ther b)siness $r b. a 6< (h$ is n$t in an. b)siness (can ded)ct e*pense inc)rred %r$& in!estigati$ns int$ ac>)iring a speci%ic b)siness). Dec$nd stage $cc)rs a%ter the 6< has decided t$ ac>)ire $r establish a speci%ic b)siness & c$&&ences preparati$ns %$r its $perati$n. $ichmond .elevision 2or#. v. 9.*. (1965) M 6< s$)ght t$ ded)ct certain pers$nnel training e*penses inc)rred pri$r t$ recei!ing the HAA license necessar. t$ $perate. At. held e!en th$)gh 6< has &ade a %ir& decisi$n t$ enter int$ b)siness & $!er a c$nsiderable pd $r ti&e speng $ in preparati$n %$r entering that b)siness, he still has n$t engaged in carr.ing $n an. trade $r b)siness (?in the intend&ent $% 162(a) )ntil s)ch ti&e as the b)siness has beg)n t$ %)ncti$n as a g$ing c$ncern & per%$r&ed th$se acti!ities %$r (hich it (as $rgani;ed. Dtart-)p c$sts pr$!ide bene%its l$ng be.$nd the c)rrent ta* .ear & t?%, sh$)ld n$t be c)rrentl. ded)ctible. D)ch e*penses are anal$g$)s t$ the c$sts inc)rred in ac>)iring an e*isting b)siness, $r bldgs. & e>)ip&ent %$r an e*isting b)siness. 0ls$ pre!ents 6< %r$& ded)cting pers$nal e*penses. *% I &9? F th, A4thori9ation of C,rtain "r,(Op,rational or Start(Cp Costs 195 per&itted 6< t$ elect t$ a&$rti;e b)siness start-)p e*pendit)res $!er a pd $% n$t less than 60 &$s. 200/ a&ended 195 t$ all$( a 6< t$ ded)ct )p t$ $5k $% start-)p e*pendit)res in the ta*able .r in (hich the acti!e trade $r b)siness begins. 6he $5k a&t is red)ced b)t n$t bel$( 0 b. the a&t t$ start-)p e*pendit)res e*ceed $50k. 6he re&ainder $% start-)p e*pendit)res are a&$rti;ed $!er a 1+0-&$ pd beginning (? the &$nth in (hich the acti!e trade $r b)siness begins. @$teF t$ clai& a c)rrent ded)cti$n %$r $r t$ a&$rti;e start-)p e*pendit)res )nder 195, $ne &)st act)all. engage in the trade $r b)siness. N*pendit)res eligible %$r a&$rti;ati$n &)st satis%. 2 re>sF 6he e*pendit)re &)st be pd $r inc)rred in c$nnecti$n (? creating, $r in!estigating the creati$n $r ac>)isiti$n $%, a trade $r b)siness entered int$ b. the 6<. 6he e*pendit)re in!$l!ed &)st be $ne (hich ($)ld be all$(able as a ded)cti$n %$r the ta*able .r in (hich it is paid $r inc)rred i% it (ere paid $r inc)rred in c$nnecti$n (? the e*pansi$n $% a trade $r b)siness in the sa&e %iled as that entered int$ b. the 6<. 2% Appli*ation of th, PCarrAing OnQ R,L4ir,+,nt to E+ploA,,s <age // $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

6he cts & ser!ice agree that a 6< &a. be in the trade $r b)siness $% being an e&pl$.ee & an e&pl$.ee can ha!e &$re than 1 trade $r b)siness. 8ed)ctible e&pl$.ee b)siness e*penses (i.e. res)&e c$sts, p$stage) are generall. 5678 & s)b4ect t$ the 21 %l$$r i&p$sed b. 6 . 6he sc$pe $% the e&pl$.eeEs c)rrent trade $r b)siness is $b!i$)sl. critical in e!al)ating the ded)ctibilit. $% c$sts inc)rred in seeking ne( e&pl$.&ent. rimuth v. 2omm3n M 6< (as the secretar.-treas)re %$r a s&all c$rp. <aid a %ee t$ an e&pl$.&ent agenc. t$ assist hi& in %ind a ne( 4$b (? increase resp$nsibilities & (? a larger c$rp. At %$)nd the 6< (as carr.ing $n the trade $r b)siness $% being a c$rp$rate e*ec)ti!e & c$ncl)ded the e&pl$.&ent agenc. e*pense (as ded)ctible. 2remona v% 2omm3n (19 2) M 6< (as held t$ be in the trade $r b)siness $% being an ad&inistrat$r, & 4$b c$)nseling %ees he inc)rred t$ i&pr$!e his 4$b $pp$rt)nities in that b)siness (ere ded)ctible e!en th$)gh 6< did n$t s)cceed in $btaining ne( e&pl$.&ent. At re4ected the A$&&En arg)&ent that e&pl$.&ent-seeking c$sts (ere $nl. ded)ctible i% ne( e&pl$.&ent (as act)all. sec)red. $oc8e:eller v% 2omm3n (19+5) M c$)nsel %$r R$cke%ellerEs estate s$)ght t$ establish that @R, in seeking the U< $% the CD %$ll$(ing the resignati$n $% <res. @i*$n (as &erel. c$ntin)ing t$ engage in the sa&e trade $r b)siness in (hich he had been in!$l!ed in %$r .ears. 8espite the estateEs arg)&ents t$ the c$ntrar., the 2d Air. H$)nd that REs tasks & acti!ities as U< (ere n$t the sa&e as th$se ass$ciated (? the $ther p$siti$ns he had held. 6he c$sts he inc)rred in seeking the U< W 3 ded)ctible. Furner v% 2omm3n (196+) M a teacher (h$ t$$k a lea!e %r$& teaching %$r a .ear t$ $btain a &asterEs degree in her %ield (as held t$ be 9carr.ing $n: her trade $r b)siness %$r the .ear, th)s all$(ing her ed)cati$nal e*penses t$ be ded)cted. 6$ take ad!antage $% the hiat)s principle, a 6< &)st establish that d)ring the hiat)s he intended t$ res)&e the sa&e trade $r b)siness. )% I 2&2 D,24*tions 0ll$(s %$r a ded)cti$n %$r the $rdinar. & necessar. e*penses $% pr$d)cing $r c$llecting inc$&e, &aintaining pr$pert. held %$r the pr$d)cti$n $% inc$&e, $r deter&ining, c$llecting $r re%)nding an. ta*. @$ ded)cti$n all$(able %$r e*pendit)res all$cable t$ ta*-e*e&pt inc$&e. Reg. 1.212-1(e) 9rank v" #omm$n M b$)ght ne(spaper b)siness M cann$t ded)ct e*penses )nder 212 M neither are the tra!el & legal e*penses inc)rred b. the pets. -n their atte&pt t$ %ind a b)siness ded)ctible )nder 212, (hich all$(s the ded)cti$n $% e*penses inc)rred in the pr$d)cti$n $r c$llecti$n $% inc$&e $r in the &anage&ent, c$nser!ati$n, $r &aintenance $r pr$pert. held %$r the pr$d)cti$n $% inc$&e.

WELC$ 6% $EL@ERIN# -&911. 2:? F& : K (as an e*ec. (? a bankr)pt c$. (hen he beca&e a c$&&issi$n agent in the sa&e line $% b)siness as his %$r&er c$., he !$l)ntaril. pd s$&e $% the c$.Es )npd debts t$ establish g$$d relati$ns (? c)st$&ers. Issue: Ia. K ded)ct debt p.&ts as $rdinar. b)siness e*pensesL '&$at: 6hese p.&ts 3 ded)ctible b?c the. are n$t $rdinar. e*penses. 0n $rdinar. e*pense is $n that is c$&&$n & accepted (?in an ind)str., e!en i% )nc$&&$n %$r a partic)lar 6<. -t is e*tre&el. rare in b)siness %$r an indi!id)al t$ )ndertake the p.&t $% an )nen%$rceable debt, & W the p.&t (as n$t $rdinar. & W 3 ded)ctible. $I##INS 6% CO GN -&9H&. 2:; F& : 2 has e*tensi!e in!est&ents in real estate, b$nds & st$cks, de!$ted c$nsiderable ti&e t$ &anaging the& & hired $thers t$ assist hi& in $%%ices rented %$r that p)rp$se. 6he &eth$d %$r handling his a%%airs <age /5 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

)nder e*a&inati$n had been e&pl$.ed b. pet. %$r '0= .rs. H$r 19'2 & 19'', he clai&ed salaries & e*penses incident t$ l$$king a%ter his pr$perties as ded)ctible )nder 2'(a). A$&&En re%)sed ded)cti$ns. 6a* 5$ard held that these acti!ities 3 carr.ing $n a b)siness. '&$at: 6$ deter&ine (hether the acti!ities $% a 6< are 9carr.ing $n a b)siness: re>)ires an e*a&inati$n $% the %acts in each case. <et. &erel. kept rec$rds & c$llected interest & di!idends %r$& his sec)rities, thr$)gh &anagerial attenti$n %$r his in!est&ents. @$ &atter h$( lg the estate $r h$( c$ntin)$)s?e*tended the ($rk re>)ired &a. be, s)ch %acts are n$t s)%%icient as a &atter $% la( t$ per&it the cts t$ re!erse the decisi$n. CO GN 6% #ROETRIN#ER -&98;. 2:8 F& : 19 + resp. de!$ted 60-+0 hrs ?(k (agering $n d$g races. @$ $ther e&pl$.&ent & tried t$ &ake a li!ing d$ing s)ch. ,r$ss (innings $% $ 0k $n bets $% $ 2k %$r a net ga&bling l$ss $% $2k. Rep$rted his l$ss $n 19 + ta* ret)rn, he didnEt )tili;e it in c$&p)ting his 0,- $r clai& it as a ded)cti$n. 6a* At held he (as in the trade $r b)siness $% ga&bling. '&$at: (1) the stat)t$r. ($rds $% 9trade $r b)siness: is br$ad & c$&prehensi!e & (2) that, h?e, e*penses incident t$ caring %$r $neEs $(n in!est&ents, e!en th$)gh that endea!$r is %)ll-ti&e, are n$t ded)ctible as pd $r inc)rred in carr.ing $n a trade $r b)sinessG (') that the $pp$site c$ncl)si$n &a. %$ll$( %$r an acti!e trader. SSS t$ be engaged in a trade $r b)siness, the 6< &)st be in!$l!ed in the acti!it. (? c$ntin)it. & reg)larit. & that the 6<Es pri&ar. p)rp$se %$r engaging in the acti!it. &)st be %$r inc$&e $r pr$%it. -% $neEs ga&bling acti!it. is p)rs)ed %)ll ti&e, in g$$d %aith, & (? reg)larit., t$ the pr$d)cti$n $% inc$&e %$r a li!elih$$d, & is n$t a &ere h$bb., it is a trade $r b)siness (?in the &eaning $% the stat)tes (? (hich (e are here c$ncerned. RE@% RCLIN# ;?(&20 2;2 Khether a&ts pd in seeking ne( e&pl$.&ent are ded)ctible )nder 162 $r 212. N*penses inc)rred in seeking ne( e&pl$.&ent in the D0IN trade $r b)siness are ded)cti$n )nder 162 i% directl. c$nnected (? s)ch trade $r b)siness as deter&ined b. the %acts & circ)&stances. 3 ded)ctible i% an indi!id)al is seeking e&pl$.&ent in a @NK trade $r b)siness. 3 ded)ctible )nder 212 (hich applies $nl. t$ e*penses inc)rred (? respect t$ an e*isting pr$%itseeking endea!$r n$t >)ali%.ing as a trade $r b)siness. 6ra!el e*penses are ded)ctible i% the pri&ar. p)rp$se %$r the trip is t$ seek ne( e&pl$.&ent. "E@SNER 6% CO GN -&980. 2;1 F& : 6< &anager $% ($&enEs cl$thing st$re, OD7. 2as t$ (ear the cl$thes as part $% her 4$b. 6< d$es n$t (ear the& at h$&e, & $nl. %$r ($rk. Al$thes can be ($rn at $ther ti&es than %$r 4)st ($rk. Issue: Khether the 6< can ded)ct as $rdinar. & necessar. b)siness e*pense the c$st $% p)rchasing & &aintaining OD7 cl$thes & access$ries ($rn b. the 6< in her e&pl$.&entL $ule: 6he c$st $% cl$thing is ded)ctible as a b)siness e*pense $nl. i%F (1) the cl$thing is $% a t.pe speci%icall. re>)ired as a c$nditi$n $% e&pl$.&ent, (2) it is n$t adaptable t$ general )sage as $rdinar. cl$thingG and (') it is n$t s$ ($rn. /onnely v" #omm$n (1959). '&$at: 6< &eets re>)ire&ent (1) and ('). 2?e, 3 (2). At. )ses an $b4ecti!e test (here n$ re%erence is &ade t$ the indi!id)al 6<Es li%est.le $r pers$nal taste M instead adaptabilit. %$r pers$nal $r general )se depends )p$n (hat is generall. accepted %$r $rdinar. street (ear W cl$thes can be adapted W cl$thes 3 ded)ctible. III%CLASS NOTES @et inc$&e ta* (pr$%its M the c$st t$ &ake the &$ne.) -s it a capital e*pendit)re $r a repair $% rep)tati$nL <age /6 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08 2;; ' 108

C$ &1 ' CA"ITAL E!"ENDITCRES I%"RO)LE S

&% Janet &ade e*pendit)res this .ear %$r a resta)rant she $(ned. N*pense $r capital e*pendit)reL -a. $10,000 t$ repaint the e*teri$r $% the resta)rant. Reg. 162-/, repairs $r &aintenance, (hich d$ n$t &ateriall. add t$ !al)e $r appreciabl. pr$l$ng )se%)l li%e, are ded)ctibleG replace&ents $r i&pr$!e&ents, $n the c$ntrar., are n$t & &)st be capitali;ed. D,24*ti5l, as &aintenance. -5. $12,000 t$ %i* da&age t$ the ne( r$$% ca)sed b. a tree %alling. D,24*ti5l, Reg. 162-/, repair. -*. $'0,000 %$r c$&pletel. re(iring & repl)&bing the resta)rant & re&$deling the interi$r. 0ss)&e ($rk (as d$ne i&&ediatel. a%ter JanetEs p)rchase $% the resta)rant. &. 0 - $10k ($)ld *apitali9, 2. 5 - $12k ($)ld 2,24*ti5l, as repair e*pense 1. Re!. R)ling 2001-/F d$ing a c$&plete re%)rbish&ent, than e*penses that $ther(ise ($)ld ha!e be ded)ctible ($)ld ha!e t$ be *apitali9,2. -2. $'k %$r ad!ertising c$ns)ltant Reg. 162-/(a)(1) M :abisco v" #omm$n (29') - 2,24*ti5l, &. $ k %$r ne(spaper, radi$ & tele!isi$n - 2,24*ti5l, 2. $/k %$r a ne( sign $)tside the resta)rant M *apitali9,2 b?c i&pr$!e&ent 1. $1k t$ re&$!e & discard the $ld sign that the ne( replaced M 2,24*ti5l, Re!. 2000- (2+5) -,. $5k %$r a ne( $!er %$r the resta)rant - *apitali9,2 &. installati$n M part $% the $!en and getting it r$lling M *apitali9,2 2. 1 .r &aintenance M 2,24*ti5l, Reg. 1.26'(a)-(/)(%) -f. $'k ann)al pre&i)& %$r %ire, the%t & liabilit. ins. pd. at the end $% the .ear 1 & c$!ered the 12 &$nth peri$d %r$& Heb. 1 $% ne*t .ear 2 t$ Jan. '1 $% the .ear '. &. &0H: of stat4t, ' 2o,s not ,<t,n2 5,Aon2 th, a% Earli,r of i% &2 +onths aft,r &st 2at, on 7hi*h T" r,ali9,s th, right -F,5% &st of A,ar 1. ii% En2 of th, ta<a5l, A,ar, follo7ing th, A,ar of paA+,nt -D,*% 1& A,ar 2. 5% D,*% 1& is ,arli,r, th, ins4ran*, lasts till F,5% &st of A,ar 1 T *apital ,<p,n2it4r,% 2. 8$nEt (ant pe$ple b).ing p$licies in 200+ %$r 2020. 1. AanEt take a ded)cti$n (capitali;ed) %$r a pa.&ent in .ear 1 %$r a p$lic. lasting .ear 2 thr) '. H. 5)t can take a ded)cti$n i% &ake pa.&ent in .ear 2 %$r a p$lic. lasting .ear 2 thr) '. -g. $2k %$r .earsE (r$th $% cleaning s)pplies %$r the resta)rant. Reg. 1.162-' c$st $% &aterials, 6< carries incidentals $n hand - 2,24*ti5l, -h. $6k in legal %ees in s)ccess%)ll. de%ending a la(s)it br$)ght b. a %$r&er che% $% the resta)rant (h$ had ($rked there / .rs., & (h$ clai&ed he had an agree&ent %$r ] $(nership interest in the resta)rant, pl)s ] $% resta)rant pr$%its in the past / .ears. &. 8e%ending title ($(nership) M 1.26'(a)-2(c) (10'5 stat)te b$$k) M *apitali9,2 2. 7a(s)it %$r pr$%its - )outhland (oyalty #o" v" *")" (2+5) M 2,24*ti5l, -i. $'.5k in lease p.&ts $n a %ire sprinkler s.ste& %r$& A$. 6he s.ste& speci%icall. designed %$r the resta)rant. ' .r. lease re>)ired Janet t$ &ake lease p.&ts $% $'.5k?.r. at the end $% the least $pti$n Y t$ b). s.ste& %$r $100. -3. $10k %$r 5-.ear lease $% ad4acent land t$ be )sed %$r c)st$&er parking. &. $1k b$n)s t$ her assistant 2% Janet -a. Dtart )p c$sts ? in!estigati$n -5. -% alread. in the line b)siness $% r)nning a health cl)b, i% $pening 2nd 12 &$nth r)le <age / $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

II%O@ER@IEW Khen .$) b). an asset, .$) can rec$!er the assetEs c$st in a %e( (a.sF -&&ediate 8ed)cti$nF c$sts $% assets that are )sed )p in $ne .ear can be ded)cted i&&ediatel. (b)siness e*pense). 8)ring 7i%e $% 0ssetF .$) can rec$!er the c$st $% the asset as it is )sed )p. 8epreciati$nF tangible assets 0&$rti;ati$nF intangible assets 0nn)ities Cp$n 8isp$siti$nF can $nl. rec$!er the c$st $% the asset (hen .$) sell it (it isnEt capitali;ed beca)se it d$esnEt (ear $)t). Dt$ck 7and A% D,24*ti5l, E<p,ns, or Capital E<p,n2it4r, -CE.M I$st i&p$rtant e*cepti$n %$)nd in 26' (hich denies ded)cti$ns %$r ANs. 8isall$(ance applies t$ e*pendit)res that 9add t$ !al)e, $r s)bstantiall. pr$l$ng the )se%)l li%e: $% pr$pert., SR 9adapt pr$pert. t$ a ne( & di%%erent )se.: 3 incidental repairs & &aintenance AN pr$!ides a bene%it that persists, c$ntrib)tes t$ generating inc$&e $!er a pd $% .rs, its !al)e is n$t c$ns)&ed $r dissipated (?in the c)rrent .r. AS8NF 161F (arns that 162 ded)cti$ns are s)b4ect t$ e*cepti$ns 26'F denies ded)cti$ns %$r capital e*pendit)res 0 ded)cti$n is denied %$r the c$st $% ne( b)ildings $r %$r per&anent i&pr$!e&ents $r better&ents increasing the !al)e $% the pr$pert., and %$r rest$rati$n c$sts %$r (hich an all$(ance is &ade. 6RN0DCRO RN,C706-S@DF Reg. 1.26'(b)F disall$(ance $% ded)cti$ns applies t$ e*pendit)res that add t$ !al)e $r s)bstantiall. pr$l$ng the )se%)l li%e $% pr$pert. b)t n$t t$ incidental repairs and &aintenance. 6he &atching $% c)rrent e*pendit)res (ith %)t)re bene%its is at the heart $% the capitali;ati$n re>)ire&ent. -t is the c$ncern (ith &atching inc$&e and related e*penses that )nderlies the capitali;ati$n re>)ire&ent. KSS6N@F I06A2-@, M Iatch e*pense t$ the inc$&e it pr$d)ces 0AACR0AO M O$) get t$ ded)ct s$&ething (hen .$) )se s$&ething )p. O$) (ant t$ &ake s)re .$) represent inc$&e acc)ratel.. 2ence, it is n$t acc)rate t$ ded)ct s$&ething in %)ll (hen .$) )se it )p $!er ti&e. K2O 8S KN A0RNL 6-I-@,F -% - ded)ct the e*pense earlier, - red)ce &. ta*es in that .ear, and can p)t &. &$ne. in the bank and &ake interest $n it. -% - ded)ct in later .ears and capitali;e &. e*pense, - (ill n$t red)ce &. ta*es as &)ch, - (ill ha!e less &$ne. and - (ill end )p getting less interest $n &. &$ne. - p)t in the bank. 6here%$re, the g$!ern&ent &akes &$ne. (hen - capitali;e and - &ake &$ne. (hen - ded)ct all at $nce^ 2ence, ta*pa.ers like t$ take the ded)cti$ns as earl. as p$ssible. NP0I<7NF S!en W lasts se!eral .ears M &)st capitali;e <age /+ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-ngredients W )sed )p right a(a. M can ded)ct YNO TCND6-S@F 2SK 7S@, -D K206 -EI 5CO-@, ,S-@, 6S 70D6L )% D,fining Capital E<p,n2it4r, ' I-DO 2O I-DO 2O v. 2omm3n (1992) M 9the decisi!e distincti$ns b?t c)rrent e*penses & ANs are th$se $% degree & n$t $% kind:
@S 8N8CA6-S@ 077SKN8 D4ration an2 Signifi*an*, T,stJ Wh,r, ,<p,n2it4r,s g,n,rat, FCTCRE )ENEFITS that ar, SI#NIFICANT, th,A +4st 5, *apitali9,2%

8ed)cti$ns are speci%icall. en)&erated & th)s s)b4ect t$ disall$(ance in %a!$r $% capitali;ati$n @$nded)ctible capital e*pendit)res are n$t e*ha)sti!el. en)&erated in the c$de & 26' ser!es as a general &eans $% disting)ishing ANs %r$& c)rrent e*penses. 6h)s ded)cti$ns strictl. c$nstr)ed & all$(ed $nl. as there is a clear pr$!isi$n there%$re. 2eld c$ns)lting & legal %ees inc)rred b. a c$. in deciding (hether the accept an$ther c$.Es %riendl. take$!er bid pr$!ided a l$ng ter& bene%it & W had t$ be capitali;ed. Lincoln *avin)s 4 Loan /ss3n (19 1) M established separate & distinct test %$r deter&ining (hether e*pendit)res had t$ be capitali;ed. 2ad t$ capitali;e 9additi$nal pre&i)&: b?c it created a 9separate & distinct asset.: At %$)nd Lincoln *avin)s t$ &ean that a 6<Es e*pendit)re that ser!es t$ create a separate & distinct asset sh$)ld be capitali;ed )nder 26' M it 3 %$ll$( that only e*pendit)res (hich create $r enhance a separate & distinct asset are t$ be capitali;ed. H$c)sed $n (hether the e*pendit)res at iss)e generated %)t)re bene%its & (hether th$se bene%its (ere signi%icant.
*tale0 Manu:acturin) 2o. v. 2omm3n -&99;., p2:8 8N8CA6-S@ 077SKN8 E<p,ns,s in*4rr,2 in 2,f,n2ing 54sin,ss fro+ hostil, taN,o6,rs ar, 2,24*ti5l,%

9* Frei)ht,a0s 2or#. v. 2omm3n (2001) M l$ng-ha)l %reight tr)cking c$. re>)ired t$ p)rchase large n)&ber $% per&its & licenses .earl..

8N8CA6-S@ 077SKN8 E<p,ns,s that ar, fi<,2 on,(A,ar, or2inarA, n,*,ssarA an2 r,*4rring 54sin,ss ,<p,ns,s 7ill 5, tr,at,2 as 2,24*ti5l, ,<p,ns,s -,6,n if th,A *o6,r t7o ta< A,ars.%

Sne .r ite&s (here the bene%it (ill ne!er e*tend be.$nd that ter&, that are $rdinar., necessar. & rec)rring e*penses %$r the b)siness in >)esti$n B ded)ctible e*penses )nder 162(a). C% S,l,*t,2 Cat,gori,s of Capital E<p,n2it4r,s &% Cost of A*L4isition F Costs In*4rr,2 in ",rf,*ting F D,f,n2ing Titl, Khen 6< p)rchases tangible pr$p. (i.e. bldgs, &achine, !ehicle) $r intangible pr$p. (c$p.right, patent, interest in a c$rp. $r partnership) asset creates a c$ntin)ing, l$ng ter& bene%it & &)st be capitali;ed. 6< takes basis as B t$ c$st. <)rchasing 6itle <age /9 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

0c>)isiti$n c$sts c$nstit)te capital e*pendit)res beca)se the asset pr$d)ces a l$ng ter& bene%it (e.g. p)rchasing title t$ a b)ilding, &achine, !ehicle, c$p.right, patent, etc.). 8e%ending 6itle A$sts inc)rred in de%ending title $% pr$pert. are capitali;ed (e.g. legal %ees inc)rred in resisting e%%$rts t$ cancel trade&ark $r in a trade&ark in%ringe&ent acti$n). 6his incl)des c$sts inc)rred in per%ecting a recentl.-ac>)ired title and c$sts inc)rred in the de%ense $% a pre-e*isting title. Oet, (hen the disp)te relates t$ inc$&e %r$& the title, it has been held ded)ctible (e.g. rec$!ering r$.alties). 8isp$sing 0ssets 8isp$siti$n c$sts are t$ be treated as capital e*pendit)res e*cept that c$sts are ded)ctible (hen the asset is &erel. retired and discarded (e.g. re&$!ing teleph$ne p$lls in $rder t$ install ne( $nes -ded)ctible e*pense). 2omm3n v. Idaho o,er 2o., CD D)pre&e A$)rt (19 /), p2+0 A$sts that $rdinaril. &a. be c)rrentl. ded)ctible ((ages, rent) &a. take $n a di%%erent stat)s (hen the. are part $% an ac>)isiti$n c$st $% c$nstr)cted pr$pert.. H$r e*a&ple, i% .$) hire a carpenter t$ b)ild a tree h$)se that .$) plan t$ rent $)t, his (age is a capital e*pendit)re t$ .$). A$&pan.?ta*pa.er can ded)ct %$r their $(n e>)ip&ent. 5)t .$) $nl. get ded)cti$n %$r )sing things )p. 2ere, .$) are t)rning e>)ip&ent int$ the %acilities. 6he. n$( ha!e a ne( plant %r$& )sing the e>)ip&ent )p^ O$) &)st capitali;e i% .$) create s$&ething that lasts (n$t 4)st i% .$) b). s$&ething that lasts). @$r&al and r$)tine c$sts are @S6 capitali;ed. 0n e*pendit)re &)st be capitali;ed t$ the e*tent that it (1) creates?enhances separate?distinct asset (2) pr$d)ces signi%icant %)t)re bene%it (') is related t$ ac>)isiti$n $% capital asset. RNUN@CN RC7-@, 99-2', p291 N*pendit)res inc)rred in the c$)rse $% a general search %$r, $r in!estigati$n $%, an acti!e trade $r b)siness in $rder t$ deter&ine (hether t$ enter a ne( b)siness and (hich ne( b)siness t$ enter ($ther than c$sts inc)rred t$ ac>)ire capital assets that are )sed in the search $r in!estigati$n) >)ali%. as in!estigat$r. c$sts that are eligible %$r a&$rti;ati$n as start-)p e*pendit)res )nder 195. 2$(e!er, e*pendit)res inc)rred in the atte&pt t$ ac>)ire a speci%ic b)siness d$ n$t >)ali%. as start)p e*pendit)res beca)se the. are ac>)isiti$n c$sts )nder 26' and hence are capitali;ed. HactsF c$rp$rati$n C hired an in!est&ent banker t$ e!al)ate the p$ssibilit. $% ac>)iring a trade $r b)siness )nrelated t$ C_s e*isting b)siness. 2$ldingF (1) c$nd)cting research and e!al)ating p)blicl. a!ailable %inancial in%$ B in!estigat$r. c$sts, beca)se the. are )sed in deciding (hether t$ enter a b)siness. 5C6 (2) c$sts related t$ appraisals $% UEs assets and re!ie( $% UEs b$$ks B ac>)isiti$n c$sts?capital e*pendit)res beca)se the. are inc)rred $nce the decisi$n t$ ac>)ire a speci%ic b)siness (as &ade. @$teF 0 ta*pa.er inc)rring c$sts t$ in!estigate the e*pansi$n $% an e*isting b)siness generall. can ded)ct th$se c$sts )nder 162. 2% R,pair or I+pro6,+,nt Reg. 1.162-/, 1.26'(a)-1(b)F Repairs that d$nEt &ateriall. add t$ !al)e $r appreciabl. pr$l$ng )se%)l li%e are ded)ctible. Midland !m#ire ac8in) 2om#an0 v. 2omm3r (1950), p2+5 Khen an )ne*pected da&age t$ a b)ilding $cc)rs, a repair that rest$res the b)ilding t$ its state be%$re the da&age is ded)ctible, as l$ng as it d$es n$t add !al)e $r appreciabl. pr$l$ng the li%e $% the pr$pert.. <age 50 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

Khen the repairs &erel. ser!e t$ keep the pr$pert. in an $perating c$nditi$n $!er its pr$bable )se%)l li%e %$r the p)rp$se %$r (hich it (as )sed, it is c)rrentl. ded)ctible. HactsF Sil $% nearb. re%iner. starts leaking int$ base&ent $% Iidland. 6he re%iner. (as b)ilt a%ter IidlandEs b)siness began. Iidland $il pr$$%s the base&ent and then ded)cts the c$sts. A$&&Er arg)es it is a capital e*pense. 2$ldingF e*pendit)res %$r lining base&ent (alls and %l$$r (ere repairs and th)s ded)ctible as $rdinar. and necessar. b)siness e*penses. RN<0-R Iidland (as r)nning b)siness and )ne*pected e!ent pre!ented r)nning b)siness 6$$k acti$n t$ bring itsel% back t$ p$siti$n be%$re e!ent -% the. had p)t c$ncrete lining in base&ent be%$re starting b)siness i&pr$!e&ent, A0<-607-QN -% the. had kn$(n ab$)t the p$ssibilit. $% $il leaking (hen b)ilt and began b)siness i&pr$!e&ent )nder It. I$rris sh$)ld ha!e %i*ed this in the %irst place n$t a repair n$t an 9)ne*pected e!ent: A0<-607-QN Mt. Morris Drive;In .heatre 2o. v. 2omm3r <+=>>?6 #288 Khen there is (1) n$ s)dden catastr$phic l$ss ca)sed b. a ph.sical %a)lt )ndetected b. the ta*pa.er and (2) there is n$ )n%$reseeable e*ternal %act$r ` changes &ade in resp$nse t$ the %$reseeable da&age are i&pr$!e&ents and n$t repairs. 2ence, the. &)st be capitali;ed. HactsF 6< b).s pr$pert. %$r $)td$$r theatre kn$(ing a drainage s.ste& ($)ld ha!e t$ be installed. 0%ter la(s)it, he c$nstr)cts drainage s.ste& b)t asserts the c$sts ass$ciated are %)ll. ded)ctible. 2$ldingF -t is a capital e*pendit)re b?c (1) there (as n$ 9)n%$reseen: circ)&stance (hich $cc)rred hereG (2) it (as $b!i$)s (hen the ta*pa.er b$)ght the land that a drainage s.ste& ($)ld ha!e t$ be c$nstr)ctedG (') this (as n$t rest$rati$n $% assetG rather it (as ac>)isiti$n and c$nstr)cti$n $% an asset (ne( drainage s.ste&) that is n$t entitled t$ ded)cti$n. $evenue $ulin) 2@@+;A6 #2=A 0-RAR0H6 I0-@6N@0@AN ASD6D -% the replace&ents are a relati!el. &in$r p$rti$n $% the ph.sical str)ct)re $% the asset, s)ch that the asset as a (h$le has n$t gained &ateriall. in !al)e $r )se%)l li%e, the c$sts &a. be ded)cted. 5)t, i% a &a4$r c$&p$nent $r a s)bstantial str)ct)ral part $% the asset is replaced and, as a res)lt, the asset as a (h$le has increased in !al)e, li%e, e*pectanc. $r )se, then the c$st $% the replace&ent &)st be capitali;ed. Khere an e*pendit)re is &ade as part $% a general plan $% rehabilitati$n, &$derni;ati$n, and i&pr$!e&ent $% the pr$pert., the e*pendit)re &)st be capitali;ed. Sne Oear R)le $% 6h)&bF c$sts $% repairs sh$)ld be capitali;ed i% the. bring ab$)t ac>)isiti$n $% asset ha!ing peri$d $% )se%)l li%e in e*cess $% $ne .ear. 6his is a &ere g)idep$st and n$t an abs$l)te r)le (Kehrli). ,eneral <lan $% Rehabilitati$n R)leF e*pendit)re that is part $% a 9general plan: $% rehabilitati$n, &$derni;ati$n, and i&pr$!e&ent $% the pr$pert., &)st be capitali;ed, e!en th$)gh, standing al$ne, the ite& &a. appr$priatel. be classi%ied as $ne $% repair. Khether s)ch a plan e*ists is a >)esti$n $% %act deter&ined b. l$$king at p)rp$se, nat)re, e*tent, and !al)e $% ($rk d$ne (Kehrli). Nn!ir$n&ental Alean)pF Decti$n 19+ pr$!ides that c$sts inc)rred t$ c$ntr$l ha;ard$)s s)bstances (en!ir$n&ental clean)p c$sts) &a. be ded)cted. <age 51 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

N&pl$.ee 6rainingF (ill generall. be ded)ctible b)siness e*penses, b)t it &)st be capitali;ed in )n)s)al circ)&stances (here training pr$!ides bene%its signi%icantl. be.$nd th$se traditi$nall. ass$ciated (ith training in the $rdinar. c$)rse $% b)siness. 1% Intangi5l, Ass,ts Aapitali;ati$n $% a&ts pd t$ ac>)ire $r create an intangible, t$ 9%acilitate: the ac>)isiti$n $r creati$n $% an intangible, $r t$ create $r enhance a separate & distinct asset. S(nership interests in partnerships, c$rp$rati$ns $r $ther entities, debt instr)&ents, $pti$ns t$ pr$!ide $r ac>)ire pr$pert., leases, patents $r c$p.rights, etcR A$st $% creating intangibles &)st be capitali;ed. H% E<pansion Costs A$sts ass$ciated (ith establishing a %ranchise (ere held t$ be ded)ctible. Re!en)e R)ling 99-2'F a ta*pa.er inc)rring c$sts t$ in!estigate the e*pansi$n $% an e*isting b)siness generall. c$)ld ded)ct th$se c$sts )nder 162. 5riarcli%%F the &ere abilit. t$ sell in ne( &arkets and t$ ne( c)st$&ers, (ith$)t &$re, d$es n$t res)lt in signi%icant %)t)re bene%its and c$sts ass$ciated (ith it d$ n$t ha!e t$ be capitali;ed. 8$(n-Di;ingF De!erance pa.&ents are ded)ctible beca)se these pa.&ents principall. relate t$ pre!i$)sl. rendered ser!ices $% th$se e&pl$.ees (Re!. R)ling 9/- ). ?% A26,rtising E<p,ns,s 0d!ertising e*penses &a. $%ten pr$!ide bene%its that c$ntin)e (ell be.$nd the c)rrent ta*able .ear, b)t the. generall. are ded)ctible. Snl. in )n)s)al circ)&stances &)st the c$st $% ad!ertising be capitali;ed. H$r p)rp$ses $% $btaining a ded)cti$n, n$ distincti$n sh$)ld be &ade bet(een de!el$ping and e*ec)ting ad!ertise&ent ca&paigns. (RJR @abisc$). -% the ad!ertising takes the %$r& $% a ph.sical asset, the c$st &)st generall. be capitali;ed and rec$!ered $!er the li%e $% the asset. D% "4r*has, or L,as, 162(a)(')F speci%icall. a)th$ri;es the ded)cti$n $% rental pa.&ents (ith respect t$ pr$pert. )sed in a trade $r b)siness b)t $nl. i% the ta*pa.er d$es n$t take title and has n$ e>)it. in the pr$pert.. 6here &a. be an iss)e, h?e, as t$ (hether ac>)isiti$n c$sts are being disg)ised in ter&s $% 9rental: c$sts. 109 ' 1?0

C$ &H ' DE"RECIATION I%"RO)LE S

&% 7)*)r. 2$tel -a. 6ract $% land M n$n-depreciable, land d$es n$t %all in !al)e. Reg. 1.16 -(a)(1)-2 &. Hilling )p a h$le $n the land M &a. be seen as an i&pr$!e&ent $n the land & can depreciate the !al)e $% the c$st $% the (h$le -5. Hences & c$ncrete side(alks $n the gr$)nds $% the h$tel. &. 7and i&pr$!e&ent Re!. R)ling +6-56 (A5 '/') -*. 7andscaping, incl)ding shr)bber. & trees &. 7and i&pr$!e&ent Re!. R)ling +6-56 (A5 '/') -2. Ual)able anti>)e %)rnishing & carpets, dac$r $% the p)blic spaces thr$)gh $)t the h$tel &. 16 M depreciable b?c (ear & tear in p)blic places & itEs a part $% the b)siness <age 52 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-,. 7andscape paintings %$r each $% the g)est r$$&s. &. Re!. R)ling 6+-2'2 M s)b4ect t$ (ear & tear it sh$)ld be depreciable 2% 7i; -a. $200Y &. Oear 1 B $/0k B $160 2. Oear 2 B $6/ B $96 1. Oear ' B $96 basis H. Oear - $0 -5. N>)ip&ent in .ear ' i% she sells it $n 8ece&ber '1 $% that .earL &. ,et [ .ear c$n!enti$n M 19.21 $% $200, $'+./k, $19.2k 2. 0d4)sted basis - $96k - $19.2k B 6.+k -*. Iid->)arter c$n!enti$n -2. Cnder 1 9 she gets t$ e*pense $150,000 $% the $200k, & )nder 16+ she gets t$ take depreciati$n $% the re&aining $ 5k. 1% Nrik M e*cl)ded %r$& 19 -a. 1 c$&p$nent the rent - $2k?&$ ded)ctible )nder 162(a) as b)siness e*pense -5. $10k, b$n)s %$r leasing the pr$pert. H% <ete p)rchase & placed in ser!ice an apart&ent bldg. %$r $1.5I, $500k all$cated t$ the land & $1I t$ the bldg itsel%. <aid $500k d$(n $n the pr$pert. and pa.ing balance $!er 20 .ears. -a. 1 9(d)(1) M pr$pert. can be e*pensed i% (a) & (b) are &et. 6angible pr$pert. - 12/5 pr$pert. -5. Oear $% p)rchase M residential rental pr$pert., table 6, $1I * 2.+ 91 B $2+, 90 &. H$ll$(ing .ear M $1I * '.6'61 B $'6,'60 CLASS NOTES 6$ %ind the right table Rec$!er. peri$d 0ppr$priate &eth$d $% depreciati$n 0pplicable c$n!enti$n Residential rental pr$pert. )ses straight line &eth$d M 16+(b) 2 .5 .ears 16+(d) (applicable c$n!enti$n) &id &$nth c$n!enti$n II%O@ER@IEW 6he decrease in pr$pert.Es !al)e sh$)ld be a ded)ctible c$st $% pr$d)cing inc$&e. 8epreciati$n represents (1) the .earEs red)cti$n $% the )nderl.ing asset thr$)gh (ear and tear and (2) a ret)rn t$ the ta*pa.er $% his in!est&ent in the inc$&e-pr$d)cing pr$pert. $!er the .ears in (hich depreciati$n is all$(ed. A% D,pr,*iation &% D,pr,*ia5l, "rop,rtA 16 F 8e%ines the depreciati$n ded)cti$n as a reas$nable all$(ance %$r the e*ha)sti$n, (ear and tear, and $bs$lescence (1) $% pr$pert. )sed in the trade $r b)siness $r (2) $% pr$pert. held %$r the pr$d)cti$n $% inc$&e. Sne &a. n$t clai& a depreciati$n ded)cti$n %$r a pers$nal residence as it is n$t )sed %$r a trade $r b)siness. 7and, st$ck, and $ther assets that d$ n$t decline in !al)e predictabl. are n$t depreciable. Re!en)e R)ling +9-25 (19+9) <age 5' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

<r$pert. )sed 4)st %$r de&$nstrati$n p)rp$ses &a. be depreciated, b)t pr$pert. held pri&aril. %$r the sale t$ c)st$&ers (9in!ent$ries $r st$ck in trade:) &a. n$t be depreciated. Dee Reg. 1.16 (a)-2. HactsF 6he ta*pa.er te&p$raril. )sed ne( h$)ses %$r &$dels t$ sh$( c)st$&ers. 6he. generated n$ inc$&e and (ere e!ent)all. intended t$ be s$ld. 2e (anted t$ depreciate the (ear and tear $% th$se h$)ses. 6he c$)rt said n$. 2% R,*o6,rA ",rio2 ' Th, Cs,f4l Lif, Con*,pt length $% )se%)l li%e re>)ires asset-b.-asset deter&inati$n A$rrelati$n e*ists bet(een the )se%)l li%e $% an asset and the si;e $% ann)al depreciati$n ded)cti$n 6reas)r. pr$!ides g)idelines %$r )se%)l li!es $% speci%ic assets and classes $% assets 16+ 0ccelerated A$st Rec$!er. D.ste& 9n$nresidential real pr$pert.: '9 .ears 16+(c) 9residential rental pr$pert.: 2 .5 .ears 16+(c) 9$ther pr$pert.: 9class li%e: $% assets 16+(e) 8escribes classes ' .rF race h$rse &$re than 2 .rs $ld 5 .rF a)t$&$bile, light general p)rp$se tr)ck, c$&p)ter based ph$ne s(itch, c$&p)ters, c$p.ing e>)ip&ent, 12/5 pr$pert. )sed %$r research and e*peri&entati$n .rF 9catchall class: %$r an. pr$pert. (ith$)t an assigned class o $%%ice %)rnit)re, %i*t)res, e>)ip&ent als$ 10 .r and 15.r classes -DDCNF I)st a ta*pa.er still establish that an asset has a deter&inable )se%)l li%e in $rder %$r the asset t$ be depreciableL disagree&ent bt( Der!ice and c$)rts *eli) v. 2ommissioner (hether a depreciati$n ded)cti$n all$(able %$r cars held in 9pristine c$nditi$n: and e*hibited %$r a %ee in ta*pa.erEs trade $r b)sinessL Oes %ail)re t$ sh$( )se%)l li!es $% cars is irrele!ant li%e as sh$( cars sh$rter than $rdinar. )se%)l li%e, th)s s)%%ered $bs$lescence 9(ere @S6 &)se)& pieces $% indeter&inable )se%)l li%e: 1% D,pr,*iation ,tho2s Dtraight line depreciati$n A$st $% asset ? n)&ber $% .ears in rec$!er. peri$d B depreciati$n all$(ance %$r .ear N*a&pleF 0pt. bldg $2 5,000 residential rental pr$pert.F 2 .5 .rs )se%)l li%e ass)&e sal!age !al)e $% $0 Nntitled t$ ded)ct 1001?2 .5 $r '.61 $% $2 5,000 $r $10,000 per .ear a%ter 2 .5 .rs (ill ha!e ded)cted entire c$st $% b)ilding <age 5/ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

'.61 is the straight line rate $% depreciati$n Reg)lati$n 1.16 (b)-1 Cnder straight line &eth$d c$st $% pr$pert. ($r $ther basis) 7NDD esti&ated sal!age !al)e is ded)ctible in e>)al a&$)nts $!er the peri$d $% esti&ated )se%)l li%e $% the pr$pert. 16+(b)(/) all$(s sal!age !al)e t$ be treated as ;er$ 0ccelerated 8epreciati$n 8eclining balance &eth$d per&its larger depreciati$n ded)cti$ns in earl. .ears 9%r$nt l$aded: ded)cti$ns greater %i*ed rate $% depreciati$n is applied 5)t t$ the c$st less the depreciati$n ded)cti$ns clai&ed %$r pri$r .ears. Reg, .16 (b)-2(a) I$st c$&&$n &eth$ds d$)ble declining balance $r 2001 1501 declining balance 8$)ble 8eclining 5alance N*F <)rchase $'0,000 &achine %$r b)siness )se%)l li%e 5 .rs Dtraight line rate 1001 ? 5 B 201 rate $% depreciati$n d$)ble depreciati$n all$(s t(ice the rate /01 16+ (b)(1) 8$)ble declining balance )sed %$r ', 5, -.ear pr$pert. b)t 6< shall shi%t t$ straight line in the .ear that &eth$d ($)ld pr$d)ce the larger ded)cti$n 16+(g)(2) and (g)( ) all$( 6< t$ elect t$ )se straight line &eth$d and ded)ct $!er a l$nger ti&e seld$& d$ne 16+(b)(') Dtraight line &eth$d %$r residential rental pr$pert. and n$nresidential real pr$pert. alternati!e )nder 16+(g)(2) &a. be elected t$ length peri$d $% ti&e $!er (hich ded)cti$ns are clai&ed H% Con6,ntions Rec$!er. peri$d d)ring (hich depreciati$n &a. be clai&ed begins (hen pr$pert. is placed in ser!ice Reg. 1./6-'(d)(1)(ii) <laced in Der!ice 9placed in a c$nditi$n $r state $% readiness and a!ailabilit. %$r the speci%icall. designed %)ncti$n: Real pr$pert. placed in ser!ice d)ring an. &$nth dee&ed placed in ser!ice &id-p$int $% s)ch &$nth ta*pa.er pr$-rate ann)al rate $% depreciati$n ded)cti$n $!er the n)&ber $% &$nths pr$pert. (as in ser!ice @S6NF @$ depreciati$n ded)cti$n all$(ed %$r pr$pert. p)t int$ ser!ice and s$ld (ithin the sa&e ta*able .ear. 1.16+(d)-1(b)(')(ii) 2al%-Oear A$n!enti$n all $ther classes $% pr$pert. <age 55 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

0n. pr$pert. placed int$ ser!ice ($r disp$sed $% ) d)ring ta* .ear is dee&ed placed in ser!ice ($r disp$sed $%) $n the &id-p$int $% the ta* .ear 16+(d)(1) and (/)(0) @S6NF -% pr$pert. placed in ser!ice d)ring the last ' &$nths $% the .ear that ha!e an aggregate basis greater than /01 $% the aggregate base $% all pr$perties placed in ser!ice that .ear &id->)arter c$n!enti$n applies Re!en)e <r$ced)re + -5 tables inc$rp$rating c$n!enti$ns )% Co+p4ting th, D,pr,*iation D,24*tion 16+(a) 8epreciati$n %$r tangible pr$pert. 8epreciati$n deter&ined )sing applicable depreciati$n &eth$d applicable rec$!er. peri$d applicable c$n!enti$n 5egin (ith basis generall. c$st N*. $100,000 DCU 2)&&er p)rchased in 200/ %$r b)siness )se basis %$r %irst .ear is c$st $100k Rec$!er. peri$dF 16+(e)(')F a)t$&$biles and light tr)cks 5 .ear pr$pert. 16+(c)(1)F rec$!er. peri$d %$r 5-.ear pr$pert. is 5 .ears 5 .r rec$!er. peri$d 8epreciati$n &eth$dF 16+(b)(1)F 2001 declining balance r)le )sed %$r 5.r pr$pert. 2001 A$n!enti$nF generall. applicable c$n!enti$n %$r 5-.r pr$pert. is hal%-.ear c$n!enti$n 7$cate table in Re!. <r$ced)re + -5 depreciati$n rateF 201 %irst .ear Oear 1F basis P depreciati$n rate B depreciati$n ded)cti$n o $100k P 201 B $20,000 Oear 2F $100,000('21) B $'2,000 o )se table t$ get rate Nntire depreciati$n ded)cti$n (ill be clai&ed $!er 6 .ears. @S6NF 6able is n$t a p)rist applicati$n $% d$)ble declining balance principle, b)t &akes the pr$cess si&pler %$r 6<s C% A+orti9ation of Intangi5l,s ( I &9; -t all$(s ta*pa.ers t$ a&$rti;e certain intangibles ratabl. $!er a 15 .ear peri$d. -t all$(s %$r the a&$rti;ati$n $% g$$d(ill and g$ing c$ncern !al)e. D% R,lationship )Ut )asis F D,pr,*iation 5asis &)st be ad4)sted t$ re%lect the depreciati$n a&$)nt^ I &0&:-a.-2.J pr$!ides %$r the ad4)st&ent $% basis %$r the a&$)nt all$(able %$r depreciati$n. <age 56 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

I b).s a !i$lin %$r 100Y. Dhe depreciates all $% it $!er the .ear catchall peri$d. 2er basis is n$( ;er$. -% she sells it %$r 100Y, she reali;es a gain $% $100Y beca)se her basis is ;er$. 6here%$re, she &)st pa. ta*es $n that a&$)nt. I b).s a b)ilding %$r $200,000, )ses it %$r b)siness $!er 10 .ears, then sells it %$r $150,000. 0ss)&e she c$)ld depreciate $ 5,000 %$r the b)ilding. 6here%$re, her ad4)sted basis ($)ld be $125,000 (200Y M 5Y). 0cc$rding t$ 1001, her gain ($)ld be $25Y (150Y-125Y), e!en th$)gh she s$ld the pr$pert. %$r less than she paid %$r it. Kh. d$es she reali;e gainL 5?c she )sed the pr$pert. %$r 10 .ears t$ earn inc$&e (ith her b)siness. E% I &;9 ' E<p,nsing Tangi5l, ",rsonal "rop,rtA -C) 121.

F% Th, R,lationship of D,5t to D,pr,*iation Kith respect t$ basis, it &akes n$ di%%erence (hether the p)rchase $% pr$pert. is (ith a l$an $r n$t. -t &akes n$ di%%erence (hether the &$ne. is b$rr$(ed %r$& a 'rd pers$n $r the seller $% the e>)ip&ent. D$, .$) can b$rr$( 50Y t$ b). e>)ip&ent %$r a b)siness and depreciate the e>)ip&ent )sing 50Y as the basis %$r depreciati$n. 6his all$(s the ta*pa.er t$ clai& depreciati$n ded)cti$ns (ith$)t inc)rring an. $)t $% p$cket e*penses^ 12? 12? 11H 118 119

RE@ENCE RCLIN# :8(212 SI ON 6% CO LIDDLE 6% CO GN -22 Cir% &99?. GN -12 Cir% &99?.

RE@ENCE RCLIN# 89(2? RE@ENCE RCLIN# 8;(?: CLASS NOTES ' 5ig -ss)es M <$licies behind depreciati$n pr$!isi$ns 0cc)ratel. representing inc$&e M A$ngress has decided in $rder t$ sp)r ec$n$&ic gr$(th the. (ill all$( 6<s t$ depreciate pr$pert. &$re rapidl. than it act)all. d$es depreciate Ianage the &acr$-ec$n$&. I$re >)ickl. .$) can depreciate &$re ret)rn $n in!est&ent Iake it si&pler %$r pe$ple t$ %ig)re $)t h$( &)ch the depreciate M c)t d$(n the ad&inistrati!e e*pense 0cc)ratel. re%lect $% l$sing inc$&e Alassi%icati$n A)rrent e*pendit)res than &)st be capitali;ed A)rrent e*pendit)res that can be ded)cted Real& $% depreciable pr$pert. 16+ M peri$ds $% depreciati$n 16+(c) M applicable peri$d $% depreciati$n '.r pr$pert. is depreciated $!er ' .ears 16+(e) A5 '/2, '/' M class li!es (Re!. R)ling + -56)

<age 5 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

0pplicati$n Dtraight line !. d$)ble declining balance 1?& ' 1;?

C$ &? ' LOSSES F )AD DE)TS I%"RO)LE S

&% 8an b$)ght tr)ck %$r $/0k, t$$k $1/k depreciati$n ded)cti$n -a. 8ed)ct l$ss he inc)rred $n the saleL Oes 165(c)(1), take ad4)sted basis ($/0k - $1/./k) B 25.6k, s$ld %$r $2/k B $1.6k ded)ctible l$sses -5. Csed as a pers$nal !ehicle n$t %$r b)siness M Reg. 1.262-1(b)(/) (pg 10'/), n$t ded)ctible &. 5r$ader p$int, ded)cti$ns are a &atter $% legislati!e grace and canEt ded)ct )nless .$) can %ind a secti$n that sa.s it is ded)ctible -*. 8 -2. 8 2% 5rittnie 1% Aal!in H% Iar. -a. 8 -5. 8 ?% 0)nt Iabel :% <eter M n$t a b)siness bad debt, n$t in the trade $r b)siness $% &aking l$ans. -a. Khat &)st <eter pr$!e t$ clai& a ded)cti$nL &. 5$na %ide debt M (ritten pr$&iss$r. n$te, &arket rate $% interest, g$ne thr$)gh the %$r&alities 2. @$n-b)siness bad debt - n$n-b)siness debt, has t$ be (h$ll. ($rthless 166(d)(1)(5) 1. -s ded)ctible against $rdinar. inc$&eL Oes, c$nsidered a sh$rt ter& capital l$ss 166 ;% ,l$ria CLASS NOTES ,eneral r)le M l$sses inc)rred in pr$%it seeking are ded)ctible 7$ss inc)rs in pers$nal li%eL 165 (A) M l$sses inc)rred in a trade $r b)siness, l$ss inc)rred in t* %$r pr$%it II%O@ER@IEW A% Loss,s 165(a) a)th$ri;es a ded)cti$n %$r an. )nc$&pensated l$ss s)stained d)ring the .ear. 165(c) restricts the l$ss ded)cti$n %$r indi!id)als t$ trade $r b)siness l$sses, l$sses in pr$%it-seeking transacti$ns, and cas)alt. $r the%t l$sses. 165(c)(') M %$r pers$nal l$sses res)lting %r$& a cas)alt. $r the%t (Ahapter 2/) M n$t reall. c$ncerned &% Th, )4sin,ss or "rofit R,L4ir,+,nt for In2i6i24als 165(c)(1) and (c)(2) re>)ire an indi!id)alEs l$sses t$ be inc)rred in a b)siness $r pr$%it-seeking t* i% the. are t$ be ded)ctible. Dell h$)se %$r less than (hen she b$)ght M l$ssL @S M Dee Reg. 1.165-9(a) 0cti!ities that c$nstit)te a trade $r b)siness %$r the p)rp$se $% 162 appl. <age 5+ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

5)siness l$sses ded)cted 067 7$sses $n pr$%it seeking t* are 567 ded)cti$ns )nless the. res)lt %r$& the sale $% pr$pert. @et $perating l$ss r)les $% 1 2 %a!$r b)siness l$sses $!er in!est&ent $r $ther n$nb)siness l$sses in the c$&p)tati$n $% net $perating l$ss carr.backs & carr.%$r(ards. 165(c)(2) M t* entered int$ %$r pr$%it: M n$t en$)gh that at the ti&e $% a sale a 6< (as h$ping t$ &ake a pr$%it. <ers$nal-)se pr$pert. &a. be c$n!erted int$ inc$&e-pr$d)cing pr$p. D$ as t$ >)ali%. %$r a 165 ded)cti$n. -e,com7e v. 2omm3n (19 0) - 16 & 212 ded)cti$ns (depreciati$n & &aintenance) (ere denied (here the 6<s $%%ered their %$r&er residence %$r sale b)t n$t %$r rent. Khere the pr$%it s$)ght b. the 6< represents $nl. the appreciati$n (hich t$$k place d)ring the pd the 6< $cc)pied the pr$p., the pr$p. Kill n$ be dee&ed t$ ha!e been 9held %$r the pr$d)cti$n $% inc$&e.: 6he placing $% the pr$p. Sn the &arket %$r i&&ediate sale, at $r sh$rtl. a%ter the ti&e $% its aband$n&ent as a residence, (ill $rdinaril. be str$ng e!idence that the 6< is n$t h$ld the pr$pert. %$r p$stc$n!ersi$n appreciati$n !al)e R -H a 6< blie!es that the !al)e $% the pr$p. Ia. appreciate & decides t$ h$ld it %$r& s$&e pd. in $rder t$ reali;e a gain in e*cess his in!est&ent B pr$p. held %$r the pr$d)cti$n $% inc$&e. 2o,les M Der!ice c$nceded that an $%%er t$ rent (as s)%%icient t$ satis%. the 9held %$r the pr$d)cti$n $% inc$&e: standard $% 16 & 212. 6<Es pri&ar. p)rp$se (ill be c$ntr$lling. 1evirtz v. 2omm3n (19/1) M 6< b$)ght land intending t$ b)ild apt h$)ses, b)t instead b)ilt a h$)se, capable $% c$n!ersi$n t$ apts & $cc)pied it. Uacated the pr$p. and tried )ns)ccess%)ll. t$ sell $r rent. At. denied l$ss ded)cti$n, h$lding she aband$ned her $riginal pr$%it &$ti!e & that the p$ssibilit. $% %)t)re b)siness )se (as 9clearl. s)bsidiar.: t$ her pers$nal )se. <r$p. )sed %$r pers$nal p)rp$ses & at $ther ti&es %$r b)siness $r pr$%it-seeking p)rp$ses, all$cati$n $% a l$ss b?t the (n$nded)ctible - 262) pers$nal )se & (ded)ctible) b)siness $r pr$%it seeking )se is all$(able. Dee RNU. RC7. 2-111 (A5 '56) & Reg. 1.165-9(b)(2), 1.165-9(c). 165(b), 6< 3 all$(ed a l$ss ded)cti$n in e*cess $% the 6<Es basis. 2% Wh,n is a Loss S4stain,2M Re>)ire a l$ss 9be e!idence b. cl$sed & c$&pleted t*, %i*ed b. identi%iable e!ents.: Reg. 1.165-1(b) 0 l$ss is all$(ed %$r 9sec)rities,: as de%ined b. 165(g)(2), (hen the. bec$&e 9($rthless: 9e*tensi!e: shrinkage $% !al)e is @S6 s)%%icient %$r this p)rp$se. Reg. 1.165-/(a). 6511(d) M e*tends the n$r&al '-.r DS7 t$ .rs %$r re%)nd clai&s based $n 165. 6he $bs$lescence $r per&anent aband$n&ent $% pr$pert. &a. als$ gi!e rise t$ a l$ss ded)cti$n. Reg. 1.165-2 relating t$ $bs$lete n$n-depreciable pr$pert.. Reg. 1.16 (a)-+(a)(/) relating t$ aband$n&ent $% depreciable pr$pert.. 6he%t l$sses are treated as s)stained in the .r the the%t l$ss is disc$!ered. 165(e). 1% A+o4nt of th, D,24*tion 165(b) li&its the a&t $% the l$ss ded)cti$n t$ the ad4)sted basis $% the pr$pert. in >)esti$n. 6$ the e*tent a 6< recei!es ins. $r $ther c$&p., the l$ss is $%%set & the ded)cti$n red)ced. 165(a) -% there is a 9reas$nable pr$spect $% rec$!er.: the l$ss is n$t treated as s)stained )ntil the &atter $% rei&b)rse&ent is deter&ined (? 9reas$nable certaint..: Reg. 1.165-1(d)(2) & 1.165-1(d)('). H% Disallo7,2 Loss,s <age 59 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

26 (a)(1) disall$(ing l$sses $n 9related part.: sales $r e*changes 1091 den.ing l$sses $n 9(ash sales: $% st$ck $r sec)rities. )% )a2 D,5ts 166 all$(s a ded)cti$n %$r debts bec$&ing ($rthless (?in the ta*able .r 3 dra( a distincti$n b?t c$rp$rate & indi!id)al 6< 8$es dra( a line b?t b)siness & n$nb)siness bad debts, a &atter addressed bel$(. Khere a debt is e!idenced b. a 9sec)rit.: the r)les $% 165 g$!ern & 166 3 appl.. &% )ona Fi2, D,5t R,L4ir,+,nt 166 applicable $nl. i% 9b$na %ide debt: e*ists. 6here &)st be a debt$r-credit$r relati$nship based $n a !alid, en%$rceable $bligati$n t$ pa. a %i*ed $r deter&inable s)& $% &$ne.. Dee Reg. 1.166-1(c) 2% Worthl,ssn,ss I)st be a 9bad: debt H$rgi!eness $r cancellati$n $% the debt &a. c$nstit)te a gi%t rather than e!idence $% ($rthlessness, & n$ ded)cti$n (ill be all$(able. 8ebt &a. be cancelled %$r b)siness reas$ns. @$ ded)cti$n all$(ed b. 166 i% the debt (as n$t ($rthless, 5C6, i% the pr$!isi$ns $% 162 are $ther(ise satis%ied, a ded)cti$n (ill be all$(able )nder that . Re>)ire c$nsiderati$n $% 9all pertinent e!idence: (? regard t$ the deter&inati$n $% ($rthlessness. 6511 pr$!ides .r DS7 %$r re%)nd clai&s )nder 166. 1% )4sin,ss or Non(54sin,ss D,5ts 166(b) M disting)ishes b?t b)siness & n$n-b)siness debts 5)siness debts are ded)ctible )nder 166(a)(1) in the .r the. bec$&e (h$ll. ($rthless. <artiall. ($rthless b)siness debts ded)ctible - 166(a)(2), )p t$ the a&t. charged $%% (?in the .r. @$n-b)siness debts 0re ded)ctible $nl. )p$n bec$&ing (h$ll. ($rthless. (uchanan v. 9* (1996) M the i&p$rtance $% s)ch t$tal ($rthlessness M e!en i% a &$dest %racti$n $% the n$n-b)siness debt can be rec$!ered, the debt is n$t ($rthless %$r the p)rp$ses $% 166 & n$ ded)cti$n is a!ailable. N!en i% c$&pletel. ($rthless, are ded)ctible $nl. as sh$rt ter& capital l$sses, rather than as $rdinar. l$sses as is the case (? b)siness bad debts. 166(d)(1). 166(d)(2) de%ines n$n-b)siness bad debt as 9a debt $ther than a debt created $r ac>)ired in c$nnecti$n (? 6<Es b)siness, $r a debt the l$ss %r$& the ($rthlessness $% (hich is inc)rred in the 6<Es b)siness. Bhi##le v. 2omm3n (196') M At. held that a c$ntr$lling shareh$lderEs $rgani;ati$nal, pr$&$ti$nal & &anagerial ser!ices t$ a c$rp. did n$t ca)se l$ans t$ the c$rp. t$ be classi%ied as b)siness debtF (hen the $nl. ret)rn is that $% an in!est$r (i.e. 3 e&pl$.ee), the 6< has n$t satis%ied his b)rden $% de&$nstrating that he is engaged in a trade $r b)siness since in!esting is n$t a trade $r b)siness & the ret)rn t$ the 6< legall. arises n$t %r$& his $(n trade $r b)siness b)t %r$& that $% the c$rp. N&pl$.ee, h?e, is engaged in the b)siness as an e&pl$.ee. )ee Reg. 62(a)(1) <age 60 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-% e&pl$.ee can de&$nstrate that a l$an t$ $neEs e&pl$.er is in e%%ect re>)ired t$ ens)re c$ntin)ed e&pl$.&ent, the l$an is a b)siness debt arising $)t $% the trade $r b)siness $% being an e&pl$.ee. .rent v. 2omm3n (1961). 6he l$an &)st bear a pr$*i&ate relati$nship t$ the 6<Es trade $r b)siness. Reg.1.166-5(b). Khen l$an pr$&pted b. b$th in!est&ent & b)siness reas$ns, At has held the b)siness &$ti!e &)st be the d$&inant %$r the debt t$ be characteri;ed as a b)siness debt. 9* v. 1eneres. H% A+o4nt D,24*ti5l, 0&t. $% a bad debt ded)cti$n is the debtEs ad4)sted basis. 166(b). Reg. 1.166-1(e) M pr$!ides that n$ bad debt ded)cti$n is all$(ed )nless s)ch a&ts ha!e been incl)ded in inc$&e, (hich ($)ld n$t be the case (? the cash &eth$d 6<. -n per%$r&ing ser!ices (?$ c$&pensati$n, the 6<Es net ($rth is )nchangedG i% n$ inc$&e (as rec$gni;ed, n$ l$ss is appr$priate. -% inc$&e rec$gni;ed, as in the case $% an accr)al &eth$d 6<, a ded)cti$n is all$(ed. ?% #4arant,,s 7$sses arising $)t $% l$an g)arantees are treated as l$sses %r$& bad debts, & are classi%ied as b)siness $r n$n-b)siness debts based $n their c$nnecti$n (? the 6<Es trade $r b)siness. Reg. 1.166-9. C% )a2 D,5ts F Loss,sJ Th, Int,rplaA )Ut II &:: F &:? -n!est&ent related l$sses are s)b4ect t$ capital l$ss treat&ent i% the. %all )nder 166. -% the l$ss in >)esti$n is a pers$nal $ne, 165 denies a ded)cti$n (e*cept %$r cas)alt. & the%t l$sses), (here 166 at least all$(s a sh$rt-ter& capital l$ss. 8istincti$n b?t 166 & 165 is b?t b)siness & n$n-b)siness debts. <re!aling !ie(F <ers$nal bad debts are ded)ctible, ass)&ing the debt is b$na %ide, despite the absence $% an. b)siness $r pr$%it seeking &$ti!ati$n $n the part $% the lender. 165 & 166 are &)t)all. e*cl)si!e & (here b$th pr$!isi$ns are applicable in a gi!en sit)ati$n, 166 g$!erns.

COWLES 6% CO GN -&9;0. 1:1 F& : A ac>)ired real pr$p. & )sed as residence %r$& 195+-196/. 196/ YEd (? real estate br$kers t$ sell the h$&e & kEd (? $ther br$kers t$ rent &?$r sell the h$&e. <r$p. re&ained $n the &arket till 1966. 2 $%%ers %$r rental (ere recEd, re4ected & (?dra(n. A$st basis at the ti&e $% the listing (? br$kers (as $'/, /5. HIU $% pr$p. (as $'/,500 M $%%ered %$r sale at $'5,500. Issue: -s the ded)ctibilit. $% a l$ss s)%%ered b. A $n the sale $% pr$p. (hich had been their pers$nal residenceL (Snl. i% c$n!erted M @S6 in this case) 0nd Khether the l$ss (hich A s)%%ered (as s)stained in a 9t* entered int$ %$r pr$%it: (?in the &eaning $% 165(c)(2)L @S '&$at: S%%er t$ rent is n$t s)%%icient t$ 4)sti%. h$lding that it is held %$r the pr$d)cti$n $% inc$&e (?in the &eaning $% 212 & 16 W $%%ers t$ sell & rent are ins)%%icient t$ pr$!ide the necessar. %$)ndati$n %$r the ded)cti$n $% a l$ss inc)rred in a 9t* entered int$ %$r pr$%it,: as re>)ired b. 165(c)(2). RE@ENCE RCLIN# 200H(?8 1:H Issue: Ia. a 6< ded)ct the c$st $% ac>)iring & de!el$ping creati!e pr$pert. as a l$ss )nder 165(a) in the sit)ati$ns bel$(L <age 61 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

*ituation + M P p)rchases e*cl)si!e right %$r the re&ainder $% the c$p.right ter& t$ script. 200/ P (ill n$t set script %$r pr$d)cti$n, & (rites $%% the c$st $% ac>)iring & de!el$ping script. P retains all rights t$ the script inde%initel.. V 2,24*ti5l, *ituation 2 M 200', P p)rchase li&ited e*pl$itati$n rights t$ )se screenpla. b in the pr$d)cti$n $% &$ti$n pict)re. 6er&s $% p)rchase agree&ent, all $% PEs right e*pire i% screenpla. b -s n$t set %$r pr$d)cti$n (?in %$)r .ears %$r& the date $% the agree&ent. @$t set %$r pr$d)cti$n, PEs rights e*pire. P (rites $%% in 2006. onlA 2,24*ti5l, in 200; 7h,n rights ,<pir,% *ituation C M 200', P p)rchases &$ti$n pict)re rights c, %r$& 0. 6er&s $% Y, i% P d$es n$t set the& %$r pr$d)cti$n (?in 2 .rs 0 has an $pti$n t$ reac>)ire the &$ti$n pict)re. P 3 set %$r &$ti$n, 0 3 reac>)ire the &$ti$n, P retains &$ti$n pict)re rights c inde%initel.. V 2,24*ti5l,% $ule: 1.165-1(b) M t$ be all$(able %$r a ded)cti$n )nder 165(a), a l$ss &)st be e!idenced b. a cl$sed & c$&pleted t*, %i*ed b. an identi%iable e!ent, e*cept as pr$!ided in 165(h) & 1.165-11, act)all. s)stained in the ta*able .r. 1.165-1(d)(1) pr$!ides a l$ss is treated as s)stained d)ring the ta*able .ear in (hich the l$ss $cc)rs, as e!idence b. a cl$sed & c$&pleted t*, & %i*ed b. a R. '&$at: 0 6< &a. n$t ded)ct the c$sts $% ac>)iring & de!el$ping creati!e pr$pert. as a l$ss )nder 165(a) i% the 6< d$es n$t establish an intenti$n t$ aband$n the pr$pert. & an a%%ir&ati!e act $% aband$n&ent, $r identi%iable e!ent(s) e!idencing a cl$sed & c$&pleted t* establishing ($rthlessness. C%S% 6% #ENERES -&9;&. 1:9 F& : 8ebt held b. c$rp. $(ed t$ shareh$lder-e&pl$.er beca&e ($rthless in 1962. Issue: Khether, %$r the shareh$lder-e&pl$.ee, that ($rthless $bligati$n (as a b)siness $r n$n-b)siness bad debt (?in the &eaning & reach $% 166(a) & (d). $ule: I)st be d$&inant b)siness &$ti!ati$n. '&$at: 6)rns $n the pr$*i&ate relati$n. -s it a d$&inant b)siness &$ti!ati$n $r a signi%icant. C$ &: ' TRA@EL E!"ENSES I%"RO)LE S &% 8ick -a. @$, this is c$&&)ting and 3 ded)ctible )nder 262 -5. D)b)rbia $r s)rr$)nding areas, c$sts t$ !isit clients M Oes, te&p. ($rk l$cati$ns inside $r $)tside $% &etr$ area. &. Hr$& h$&e t$ client, t$ ($rk B can ded)ct e!er.thing 2. -% h$&e, t$ ($rk then client B canEt ded)ct h$&e t$ ($rk, b)t can ded)ct ($rk t$ client. -*. 8ri!e %r$& h$&e t$ client in either s)b)rbia $r an$ther t$(n, &a. 8 ded)ct c$stsL Oes &. 8i%%erent i% 8Es $%%ice (ere in his h$&e rather than being l$cated else(hereL @$. -2. Oes. -,. 8ed)ct &ealsL M @$ b?c n$t spending $!ernight. 2% Nlaine 1% 0le*is H% 8an ?% Iarc$ II%O@ER@IEW A% Co++4ting <age 62 $% + 1;; ' H0H

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

6he ch$ice $% (here $ne li!es is generall. pers$nal. A$&&)ting c$sts are !ie(ed as pers$nal in nat)re & n$nded)ctible )nder 262. A$&&En !. Hl$(ers (19/6) M D)p. At. denied a ded)cti$n %$r tra!el e*penses t$ a 6< (h$ li!ed in Jacks$n, ID, b)t (h$ ($rked in I$bile, 07, he c$)ld d$ &$st $% his ($rk in Jacks$n, b)t (anted t$ ded)ct the e*pense (hen he had t$ ($rk in I$bile. (ationale; t$ be ded)ctible, a tra!el e*pense &)st satis%. ' ele&entsF it &)st be reas$nable & necessar.G it &)st be inc)rred a(a. %r$& h$&eG & &)st be inc)rred in p)rs)it $% b)siness. )% Oth,r Transportation E<p,ns,s 6aking a ta*i t$ &eet a client, %l.ing t$ an$ther cit. t$ arg)e a case, etc. are all ded)ctible. Khere the pri&ar. p)rp$se %$r the tra!el is b)siness, .$) can ded)ct the transp$rtati$n c$sts (hich are b)siness related. Sn the $ther hand, (hen the trip is pri&aril. pers$nal in nat)re, the transp$rtati$n e*penses (and $ther tra!eling e*penses) are n$t ded)ctible, alth$)gh an. e*penses inc)rred (hile at the destinati$n that are all$cable t$ the ta*pa.erEs trade $r b)siness are ded)ctible. Dee Reg. 1.162-2(b)(1).
R,6,n4, R4ling 99(; p. '+1

Starting point "rin*ipal pla*, R,g4lar 7orN of 54sin,ss lo*ation

D,stination T,+porarA 7orN T,+porarA 7orN lo*ation insi2, lo*ation o4tsi2, +,tro ar,a +,tro ar,a 8ed)ctible 8ed)ctible

R,g4lar WorN (sa&e) Lo*ation or "rin*ipal "la*, of )4sin,ss -Oth,r than R,si2,n*,. $o+, offi*,

8ed)ctible

(sa&e) M i.e. h$&e 8ed)ctible is principal place $% b)siness -tEs a c$&&)te. @$t ded)ctible. -tEs a c$&&)te. @$t ded)ctible.

8ed)ctible

8ed)ctible

R,si2,n*, / r,g4lar 7orN lo*ation, 54t not a ho+, offi*,

8ed)ctible

8ed)ctible i% 6< has an$ther reg)lar ($rk l$cati$n $ther than h$&e. Sther(ise, n$t ded)ctible.

R,si2,n*, is not a -tEs a c$&&)te. r,g4lar 7orN @$t ded)ctible. lo*ation or a ho+, offi*,

-tEs a c$&&)te. @$t ded)ctible.

8ed)ctible

8ed)ctible i% ta*pa.er has an$ther reg)lar ($rk l$cati$n $ther than h$&e. Sther(ise, n$t ded)ctible.

T,+porarA WorN Lo*ationJ realisticall. e*pected t$ last (and d$es in %act last) %$r 1 .ear $r less. $o+, Offi*,F an $%%ice in the ta*pa.erEs residence that satis%ies the principal place $% b)siness re>)ire&ents $% 2+00(c)(1)(0).

<age 6' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

C% E<p,ns,s for ,als F Lo2ging Whil, in Tra6,l Stat4s S!ernight R)le ? Dleep $r Rest R)leF -% the ta*pa.ers cann$t c$&plete the r$)nd trip (ith$)t st$pping the per%$r&ance $% their d)ties t$ $btain s)bstantial rest $r sleep, then the. &a. ded)ct the c$st $% their &eals and l$dging. -% .$)Ere g$ne l$ng en$)gh s$ that .$) need t$ take ti&e t$ rest ` a(a. %r$& h$&e %$r ta* p)rp$ses. 9* v. 2orrell (196 ), A5 ' - 6he 6<, a tra!eling sales&an, (anted t$ ded)ct the c$st $% his &eals as a tra!el e*pense )nder 162(a). 2e c$)ldnEt b?c his trips re>)ired neither sleep n$r rest and hence (as a pers$nal li!ing e*pense )nder 262. -% a 6<Es b)siness tra!el re>)ires hi& t$ spend the night a(a. %r$& h$&e (i.e., re>)iring hi& t$ sleep $r rest), then he can ded)ct &eals as a tra!el e*pense. 2hriste0 v. 9.* - At held that state tr$$pers c$)ld ded)ct their &eals at resta)rants beca)se the. re&ained $n d)t. thr$)gh$)t their &eals and (ere %re>)entl. interr)pted d)ring &eals. 6he ded)cti$n %$r l$dging rec$gni;es that a ta*pa.er $n a b)siness trip inc)rs d)plicate e*penses in &aintaining an apart&ent $r h$&e at his principal place $% ($rk and inc)rring additi$nal e*pense in sec)ring l$dging in s$&e $ther cit. (hile $n b)siness. D% PA7aA fro+ $o+,Q $o7ertson v. 2omm3n (1999) - 92$&e: &eans the !icinit. $% the ta*pa.erEs principal place $% b)siness and n$t (here his pers$nal residence is l$cated. 6h)s a 6<Es h$&e %$r p)rp$ses $% 162 is that place (here he per%$r&s his &$st i&p$rtant %)ncti$ns $r spends &$st $% his ($rking ti&e. $osens#an v. 2omm3n (19 1) - 92$&e: &eans $neEs act)al residence M this places an e&phasis $n the b)siness necessit. $% inc)rring tra!el e*penses. 2ence, (hen the ta*pa.er has n$ per&anent residence, he has n$ 9h$&e: t$ be 9a(a. %r$&: and there%$re cann$t clai& a ded)cti$n %$r tra!eling e*penses. 'enderson v. 2omm3r (199+) - 0 6< $nl. has a ta* h$&e M and can clai& a ded)cti$n %$r being a(a. %r$& that h$&e M (hen it appears that he inc)rs s)bstantial, c$ntin)$)s li!ing e*penses at a per&anent place $% residence (in $rder t$ pre!ent the ta*pa.er %r$& d)plicating li!ing e*penses). 6hree Hact$rs t$ be c$nsideredF 5)siness c$nnecti$n t$ the l$cale $% the clai&ed h$&e. 6he d)plicati!e nat)re $% the ta*pa.erEs li!ing e*penses (hile tra!eling and at the clai&ed h$&e. <ers$nal attach&ents t$ the clai&ed h$&e. HF 6< ($rked %$r a 8isne. ice sh$(. 2e tra!eled &$st $% the .r & (hen t$)r (as d$ne, he ret)rned t$ his parentEs h$&e in 5$ise. 8idnEt pa. rent at their h$)se, b)t &ail there, his d$g there, etc. 2F (1) 2e had n$ b)siness reas$n t$ ret)rn t$ 5$ise M it (as a pers$nal ch$ice t$ li!e there, as his ($rk re>)ired hi& t$ tra!el acr$ss the c$)ntr. and n$t t$ li!e in 5$ise. (2) 2e did n$t ha!e s)bstantial, c$ntin)ing li!ing e*penses in 5$ise that (ere d)plicated b. his tra!el e*penses, as he paid n$ rent t$ his parents. 5?c he d$esnEt ha!e a ta* h$&e, he (as ne!er 9a(a. %r$& h$&e: & 3 ded)ct his tra!el e*penses )nder 162. 6e&p$rar. J$bsF ,enerall., a ta*pa.er that ($rks at a te&p$rar. 4$b is c$nsidered t$ be in 9tra!el stat)s: and tra!el e*penses paid $r inc)rred in c$nnecti$n (ith the te&p$rar. assign&ent a(a. %r$& h$&e are ded)ctible. 162(a)(2)F a ta*pa.er shall n$t be treated as te&p$raril. a(a. %r$& h$&e d)ring an. peri$d $% e&pl$.&ent i% s)ch peri$d e*ceeds $ne .ear. 0 seas$nal 4$b t$ (hich an e&pl$.ee reg)larl. ret)rns, .ear a%ter .ear, is regarded as being per&anent rather than te&p$rar. e&pl$.&ent. E% Tra6,l E<p,ns,s of Spo4s, <age 6/ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

2 /(&)(')F 0 ta*pa.er &a. n$t ded)ct e*penses %$r a sp$)se $r dependent )nless (1) the sp$)se?dependent is a b$na %ide e&pl$.ee $% the ta*pa.er, (2) the tra!el $% the sp$)se?dependent is %$r a b$na %ide b)siness p)rp$se, and (') the sp$)se?dependent c$)ld $ther(ise ded)ct the e*pense. N&pl$.er paid e*penses %$r sp$)sal tra!el &a. be treated b. the e&pl$.er as ded)ctible c$&pensati$n t$ the e&pl$.ee )nder 2 /(e)(2). -% n$t s$ treated, a n$nded)ctible e&pl$.er-paid e*pense is pres)&abl. a ($rking c$nditi$n %ringe bene%it ( 1'2). F% R,i+54rs,2 E+ploA,, E<p,ns,s -t is c$&&$n %$r e&pl$.ees t$ be rei&b)rsed b. their e&pl$.ers %$r tra!el e*penses inc)rred %$r b)siness p)rp$ses, b)t the. can be ded)cted 067 $nl. i% the rei&b)rsed e*penses that satis%. 62(c). T)ali%ied Rei&b)rse&ent 0rrange&ents (0cc$)ntable <lans) 6he rei&b)rse&ent arrange&ent &)st pr$!ide rei&b)rse&ents, ad!ances $r all$(ance $nl. %$r ded)ctible b)siness e*penses (9b)siness c$nnecti$n: re>)ire&ent). Dee Reg. 1.62-2(d)(1). 6he e*pense &)st be pr$perl. s)bstantiated. Reg. 1.62-2(e)(1). 6he rei&b)rse&ent arrange&ent &)st re>)ire the e&pl$.ee t$ ret)rn (ithin a reas$nable ti&e an. a&$)nt in e*cess $% the s)bstantiated e*penses. #% )4sin,ss(R,lat,2 ,als Ieals &a. >)ali%. and be ded)ctible as $rdinar. and necessar. e*penses )nder 162(a) e!en (hen the 6< is n$t a(a. %r$& h$&e. 2 /(a)F sti%% s)bstantiati$n re>)ire&ents %$r the ded)cti$n $% &eal e*penses 2 /(k)F ta*pa.er is re>)ired t$ be present at a &eal %$r (hich an e*pense ded)cti$n is s$)ght. 2 /(n)F li&its the &eal e*pense ded)cti$n t$ 501 $% its c$st. $% Li+itations on For,ign Tra6,l ,enerall., tra!el $)tside $% the CD is s)b4ect t$ the sa&e standards as d$&estic tra!els. 2 /(h)(1)F (hen a ta*pa.er tra!els $)tside $% @$rth 0&erica t$ attend a b)siness c$n!enti$n, certain %acts &)st be c$nsidered (hen deter&ining i% it (as a reas$nable b)siness e*pense. I% R,lationship to I 2&2 Ieals and l$dging e*penses c$)ld be ded)cted )nder 212 (ded)cti$ns %$r in!est&ent e*penses) s)b4ect t$ the sa&e r)les as &eals and l$dging e*penses )nder 162. H$r e*a&ple, a ta*pa.er c$)ld ded)ct e*penses in tra!eling t$ pr$pert. (hich he (as h$lding %$r in!est&ent. 2 /(h)( )F denies a ded)cti$n )nder 212 %$r e*penses all$cable t$ a c$n!enti$n, se&inar, $r si&ilar &eeting. B% S45stantiation R,L4ir,+,nts -n additi$n t$ the re>)ire&ents $% 162 and 212, ta*pa.ers &)st &eet the s)bstantiati$n re>)ire&ents i&p$sed b. 2 /(d).

C%S% 6% CORRELL -&9:;. 192 F& : 6<, a tra!eling sales&an, (anted t$ ded)ct the c$st $% his &eals as a tra!el e*pense )nder 162(a). '&$at: 2e c$)ldnEt b?c his trips re>)ired neither sleep n$r rest and hence (as a pers$nal li!ing e*pense )nder 262. -% a 6<Es b)siness tra!el re>)ires hi& t$ spend the night a(a. %r$& h$&e (i.e., re>)iring hi& t$ sleep $r rest), then he can ded)ct &eals as a tra!el e*pense. <age 65 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN RE@ENCE RCLIN# 99(; Dee chart ab$!e

FEDERAL INCO E TA! I

S"RIN# 08 19:

$ENDERSON 6% CO GN -&998. H00 F& : 6< ($rked %$r a 8isne. ice sh$(. 2e tra!eled &$st $% the .r & (hen t$)r (as d$ne, he ret)rned t$ his parentEs h$&e in 5$ise. 8idnEt pa. rent at their h$)se, b)t &ail there, his d$g there, etc. Issue: $ule: 0 6< $nl. has a ta* h$&e M and can clai& a ded)cti$n %$r being a(a. %r$& that h$&e M (hen it appears that he inc)rs s)bstantial, c$ntin)$)s li!ing e*penses at a per&anent place $% residence (in $rder t$ pre!ent the ta*pa.er %r$& d)plicating li!ing e*penses). 6hree Hact$rs t$ be c$nsideredF 5)siness c$nnecti$n t$ the l$cale $% the clai&ed h$&e. 6he d)plicati!e nat)re $% the ta*pa.erEs li!ing e*penses (hile tra!eling and at the clai&ed h$&e. <ers$nal attach&ents t$ the clai&ed h$&e. '&$at: (1) 2e had n$ b)siness reas$n t$ ret)rn t$ 5$ise M it (as a pers$nal ch$ice t$ li!e there, as his ($rk re>)ired hi& t$ tra!el acr$ss the c$)ntr. and n$t t$ li!e in 5$ise. (2) 2e did n$t ha!e s)bstantial, c$ntin)ing li!ing e*penses in 5$ise that (ere d)plicated b. his tra!el e*penses, as he paid n$ rent t$ his parents. 5?c he d$esnEt ha!e a ta* h$&e, he (as ne!er 9a(a. %r$& h$&e: & 3 ded)ct his tra!el e*penses )nder 162. C$ 22 ' T$E INTEREST DEDCCTION I%"RO)LE S ?&& ' ?28

&% Ye!in -a. $'k interest $n a bank l$an )sed t$ pa. $perating e*penses - $162 ded)ctible, $rdinar. c$)rse $% r)nning .$)r b)siness, $16'(h)(2) "pg. 150# -5. $500 interest $n l$an %$r a car %$r pers$nal )se - &$1,000 interest $n credit cards M n$t ded)ctible d$esnEt %all )nder $16'(h)(2)(a)-(%) -*. Y pd interest $n a bank l$an )sed t$ pa. his da)ghterEs c$llege t)iti$n - ded)ctible &. 221(d)(1) M >)ali%ied ed)cati$nal l$an, n$t indebtedness t$ an. pers$n is related t$ the 6< )nder 26 (c)(/) M %a&il. $% an indi!id)al (ill incl)de br$ther, sister, sp$)se, ancest$rs & lineal descendents, direct descendent 2. 6aken %r$& br$ther 3 ded)ctible 1. 6aken %r$& )ncle B ded)ctible -2. <repaid 5 .rs $% interest $25k $% an install&ent c$ntract, entered int$ (hen he p)rchased land $n (hich he intends t$ c$nstr)ct a bldg. %$r his sh$e b)siness &. /61(g)(1) M interest represents the charge %$r the peri$d )sed. i.e., can ded)ct in the .ear t$ (hich the interest paid ($)ld relate t$ M (ill be capitali;ed $!er 5 .ears. 2. Aapitali;e and all$cate it $!er the ter& %$r (hich it (as paid. -,. Y pd. $1k interest $n l$an )sed t$ p)rchase st$ck. Y recEd $'00 in interest inc$&e & $/00 in di!idends %r$& $ther st$ck he $(ns. $50 %$r a s)bscripti$n t$ -n!est$rs Keekl. &aga;ine. 2% <atrick -a. 8 -5. 8 -*. 8 -2. 8 1% A70DD @S6ND <age 66 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

-a. Oear 1 &. J b$rr$(s $++k b 251 2. J b$rr$(s $100k b 101 -5. Oear 2 &. J pa.s $110k, $++k principal, $22k interest 2. J pa.s $110k, $100k principal, $10k interest -*. Oear 10 &. J sells %$r $1'0k, gain B $1'0k - $++k "principal paid ? ad4)sted basis# B $/2k 2. J sells %$r $1'0k, gain B $1'0k - $100k "principal paid ? ad4)sted basis# B $'0k -2. 2.p$thetical &. Dkating rink $(ner, b)siness decided t$ a !acati$n 2. Kants a sec)red l$an, pledge skating rink as c$llateral, ded)ctible, n$ b?c n$t b)siness e*pense 1. <ledges a pers$nal h$&e, h$&e e>)it. indebtness is ded)ctible II%O@ER@IEW A% What is Int,r,stM Re!. R)ling 69-1++, interest de%ined as the a&$)nt $ne has c$ntracted pa. %$r the )se $% b$rr$(ed &$ne., and as the c$&pensati$n paid %$r the )se $r %$rbearance $% &$ne.. 0 neg$tiated b$n)s $r pre&i)& paid b. a b$rr$(er t$ a lender in $rder t$ $btain a l$an has been held t$ be interest %$r ta* p)rp$ses. S!er dra%t charges n$t interest <a.&ent $r accr)al &)st be incidental t$ an )nc$nditi$nal & legall. en%$rceable $bligati$n $% the 6< I)st be c$&pensati$n %$r the )se $r %$rbearance $% $ per se & n$t a pa.&ent %$r speci%ic ser!ices (hich the lender per%$r&s in c$nnecti$n (? the b$rr$(erEs acc$)nt. 7$ans &ade b. shareh$lders -% treated as debts, the a&$)nts repaid b. the c$rp. t$ the shareh$lders (? respect t$ the debt (ill c$nstit)te a c$&binati$n $% principal and interest, (? the interest being ded)ctible b. the c$rp$rati$n. -% the 9l$an: is in s)bstance a capital c$ntrib)ti$n, a&$)nts paid t$ the shareh$lder are n$t interest b)t (ill likel. be treated as di!idends. 8i!idends paid t$ shareh$lder are n$t ded)ctible b. the c$rp$rati$n. )% D,24*tion of ",rsonal Int,r,st 19+6 6a* 0ct li&ited ded)cti$n $% pers$nal interest 16'(h)(1) -nc$&e B the a&$)nt .$) c$ns)&e = the change in !al)e $% .$)r pr$pert. 8$esnEt belie!e pers$nal interest is c$ns)&pti$n N*cl)ded h$&e &$rtgage interest C% In6,st+,nt Int,r,st D% Ti+ing Iss4,s an2 Li+itations &% I H:&-g. 2% I 2:1A 1% "aA+,nt Iss4,s DA@ISON @% CO F& : GN -&998. ?22 <age 6 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN Issue: $ule: '&$at: C$ 28 ' CAS$ I%"RO)LE S &% 2% 1% H% ?% :% ;% 8% Iike Iike Iike Iike Iike 0ngela 7)igi 2ank -a. 8 -5. 8

FEDERAL INCO E TA! I

S"RIN# 08

ET$OD ACCOCNTIN#

:1? ' :;H

II%O@ER@IEW A% In*o+, 4n2,r th, Cash ,tho2 @eed t$ kn$( (h$ t$ id an ite& as a ded)cti$n and K2N@ ite& &)st be rep$rted as inc$&e $r taken as a ded)cti$n 9in (hat ta* .ear is s$&ething inc$&e: 9cash receipts and disb)rse&ents: (cash) &eth$d & 9accr)al: &eth$ds &% In #,n,ral //6(c)(1) a)th$ri;es the )se $% the cash &eth$d s$ l$ng as it clearl. re%lects the 6<s inc$&e Re>)ires 6< t$ rep$rt cash (and inc$&e in $ther %$r&s) as recEd & t$ ded)ct e*penses as the. are pd. <ri&ar. iss)esF 8e%erred pa.&ent )nder cash &eth$d, c$nstr)cti!e receipt, cash e>)i!alenc. & ec$n$&ic bene%it 2% Constr4*ti6, R,*,ipt 6< can dela. in s$&e sit)ati$ns dela. receipt $% inc$&e t$ red)ce ta*es %$r a gi!en .ear. Reg. 1.//6-1(c)(1)(i) de%ines cash &eth$d M generall., )nder the cash receipts & disb)rse&ents &eth$d in the c$&p)tati$n $% ta*able inc$&e, all ite&s (hich c$nstit)te ,- ((hether in the %$r& $% cash, pr$pert., $r ser!ices) are t$ be incl)ded %$r the ta*able .r in (hich act)all. $r constructively recEd. A$nstr)cti!e Receipt e*plained in Reg 1./51-2(a)F -nc$&e alth$)gh n$t act)all. red)ced t$ a 6<Es p$ssessi$n is c$nstr)cti!e recEd b. hi& in the ta*able .ear d)ring (hich it is credited t$ his acc$)nt, set a part. %$r hi&, $r $ther(ise &ade a!ailable s$ that he &a. dra( )p$n it at an. ti&e, $r s$ that he c$)ld ha!e dra(n )p$n it d)ring the ta*able .ear i% n$tice $% intenti$n t$ (?d had been gi!en. 2?N, inc$&e is n$t c$nstr)cti!el. recEd i% the 6<Es c$ntr$l $% its receipt is s)b4ect t$ s)bstantial li&itati$n $r restricti$n. 6< 3 t)rn his back $n inc$&e $r, the cash &eth$d 6< (h$ has c$ntr$l $!er his act)al receipt $% inc$&e &)st rep$rt it, regardless $% (hether he has act)al ph.sical p$ssessi$n $% it. <age 6+ $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

a% Sp,*ifi* Fa*tors Aff,*ting Appli*ation of Constr4*ti6, R,*,ipt Do*trin, 2 re>)ire&ents &)st be satis%ied be%$re c$nstr)cti!e receipt is applicableF 6he a&$)nt &)st be a!ailable t$ the 6<G and 6he 6<Es c$ntr$l $!er the receipt &)st n$t be s)b4ect t$ s)bstantial restricti$ns $r li&itati$ns. !ornung v" #omm$n (196 ) M the basis $% AR is essentiall. )n%ettered c$ntr$l b. the recipient $!er the date $% act)al receipt. 1a8ter v" #omm$n (19+ ) M alth$)gh n$ti$n $% AR blends a %act)al deter&inati$n $% (hat act)all. happened & a legal assess&ent $% its assess&ent $% its signi%icance, (e ha!e held that a %inding $% AR is a %inding $% %act. Aan $nl. be set aside i% clearl. err$ne$)s. Hact$rs c$)rts c$nsider rele!ant in e!al)ating (hether the 6< had 9)n%ettered c$ntr$l $!er the date $% act)al receipt: $% inc$&eF /istanceF 6<Es ge$graphic pr$*i&it. t$ the l$cati$n (here an ite& $% inc$&e is being &ade a!ailable t$ the 6<. !ornung M %$$tball pla.er l$cated in K-, ($n a car l$cated in @O dealership (hich (as cl$sed %$r the (eekend. 7ikel. c$)ld n$t take p$ssessi$n $% the car be%$re Jan. 1 & W 3 AR. 'aul v. #omm$n (1992) M ($n l$tter. in 19+ , recEd check %$r $ in 19++. AR in 19++. 8ate (hen $ recEd, date itEs &ailed 3 deter&ine the .ear $% ta*ati$n. ,nowledgeF n$ kn$(ledge $% a!ailabilit. W 3 AR /avis v" #omm$n (19 +) M the <$stal Der!ice atte&pted t$ deli!er a certi%ied letter c$ntaining a se!erance p.&t check t$ the 6< $n 8ec. '1, 19 /. 6he 6< (as n$t h$&e t$ sign the ret)rn receipt necessar. t$ recei!e the letter. 6<, (h$ (as n$t e*pecting the se!erance check )ntil s$&eti&e in the ne( .ear, recEd n$tice $% the atte&pted deli!er. $n 8ec. '1, b)t $nl. a%ter the <S had cl$sed. At. %$)nd 6< did n$t kn$( the check (as a!ailable t$ her in 19 /, th)s 3 AR. #ontractual arrangementsF 6< 3 AR )p$n re%)sing a p.&t n$t .et d)e Renter pa.s rent d)e %$r Jan 1st. in 8ec. landl$rd n$t re>)ired t$ accept it be%$re that ti&e 3 AR. 7andl$rd 3 re>)ired t$ %$rg$ c$ntract)al rights (lease, etc R) 9or.eitures or other penaltiesF -&p$se a penalt. i% $ is (?d %r$& certain certi%icate acc$)nts be%$re &at)rit.. <enalt. %$r earl. (?d &ight c$nstit)te a s)%%icient restricti$n t$ negate AR Reg. 1./51-2(a)(1)-(/) pr$!ides e*a&ples $% circ)&stance s)nder (hich restricti$ns $n bank acc$)nts (ill n$t negate the applicati$n $% the AR d$ctrine. Reg. 1./51-2(a)(2) M pr$!ides there (ill be n$ AR $% interest $n a certi%icate $% dep$sit $r $ther dep$sit arrange&ent 9i% an a&t e>)al t$ ' &$nths interest &)st be %$r%eited )p$n (?d $r rede&pti$n be%$re &at)rit.: $% dep$sit arrange&ents $% $ne .ear $r less. Re!. R)ling +0-'00 (19+0) M pr$!ides an e*a&ple $% a restricti$n s)bstantial en$)gh t$ bar a %inding $% AR. Ye. e&pl$.eeEs recEd st$ck appreciati$n rights (D0Rs) %r$& the c$rp. 0n e&pl$.ee c$)ld e*ercise M i.e. cash in M D0RD si&pl. b. gi!ing (ritten n$ti%icati$n t$ the c$rp. 6he e&pl$.ee ($)ld then recei!e a cash p.&t e>)al t$ the di%%erence b?t the !al)e $% the c$rpEs st$ck $n the date the D0R (as e*ercised & the !al)e $% the st$ck $n the date the D0R (as granted. 6he e&pl$.ee 3 AR $% inc$&e as the st$ck appreciated in !al)e, pri$r t$ the e*ercise $% the D0R. 9H$r%eit)re $% a !al)able right (the right t$ bene%it %r$& %)rther appreciati$n $% st$ck (?$ risking an. capital) is a s)bstantial li&itati$n that precl)des AR $% inc$&e.: 6he !al)able right (as l$st & the li&itati$n (as re&$!ed $nce the e&pl$.ee e*ercised the D0R, & at the p$int the e&pl$.ee rec$gni;ed the inc$&e. (elationship o. the -' to the payorF <age 69 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

<r$ble&s in c$nte*t $% cl$sel. held c$rps. in (hich $(ners are als$ the c$rp. e&pl$.ees & $%%icers. !yland v" #omm$n (19 9) M re4ected the 6<Es e%%$rt t$ in!$ke the AR d$ctrine based $n his +51 $(nership interest in his c$rp., i% c$ntr$l $% the c$rp. b. the $(ner-$%%icer (ere en$)gh t$ establish AR $% )npaid salaries, the distincti$n b?t shareh$lders & their c$rp. ($)ld be !itiated. A$rp. e&pl$.ee-$(ner that is n$t paid salar. d)ring the .ear, (ill n$t be dee&ed AR $% the salar. 4)st b?c she has c$ntr$l $!er the c$rp. 6here &)st be s$&e c$rp$rate acti$n t$ set aside $r $ther(ise &ake the salar. a!ailable t$ the shareh$lder-e&pl$.ee. D-N &)st ha!e s$&e a)th$rit. t$ dra( a check t$ hersel% $n the c$rp. acc$)nts. Re!. R)ling 2-'1 (19 2) s)ch %acts, t$gether (? the %act the c$rp. (as able t$ &ake the salar. p.&t, (ere s)%%icient t$ 4)sti%. a %inding $% AR. <oung /oor #o" v" #omm$n (196') M 6A held that a li&itati$n in a c$rp. res$l)ti$n (? respect t$ b$n)s p.&ts t$ c$ntr$lling shareh$lders c$nstit)ted a s)bstantial restricti$n $r li&itati$n )nder Reg. 1./51-2(a). 1asila v" #omm$n (1961) M 6A si&ilarl. c$ncl)ded a (ritten e&pl$.&ent Y speci%.ing that a b$n)s ($)ld n$t be pd. )ntil the .r %$ll$(ing its c$&p)tati$n pre!ented a c$ntr$lling shareh$lder e&pl$.ee %r$& ha!ing an )nrestricted right t$ de&and p.&t. $% the b$n)s pri$r t$ the date set %$r p.&t. 5% Sp,*ifi* E<*,ptions to Constr4*ti6, R,*,ipt R4l,s Der!ice has r)led that a 6< (h$ re%)ses a pri;e is n$t re>)ired t$ rep$rt it as inc$&e. Re!. R)l. 5 -' /, 195 -2 (6< 3 de%erring receipt $% inc$&e, b)t %$reg$ing %$r the right t$ recei!e it.) 125 9ca%eteria plans: b. (hich an e&pl$.ee &a. ch$$se b?t receipt $% case $r receipt $% e*cl)dable %ringe bene%its (6< is t)rning his back $n). 5)t 125, a)th$ri;es an e*cl)si$n )nder th$se circ)&stances, the e&pl$.ee arg)abl. ($)ld be in AR $% inc$&e. 1% Cash EL4i6al,n*A Do*trin, Reg. 1-61-1(a) M ,- incl)des inc$&e in an. %$r&, (hether in &$ne., pr$pert. $r ser!ices. N*a&plesF 6 per%$r&s ser!ices %$r I. I, in lie) $% cash gi!es 6 $ne $% the %$ll$(ingF 0n a)t$&$bile ($rth $5k M incl)dable in ,- M Reg. 1.61-1(a) Dt$ck in -5I ($rth $5k M incl)dable in ,- - Reg. 1.61-1(a) -5I bear b$nd ($rth $5k M incl)dable in ,- as the HIU at the ti&e $% receipt - Reg. 1.61-2(d)(/) <r$&iss$r. n$te in (hich I agrees t$ pa. 6 $5k Receipts $% intangibles (ie b$nds & IEs n$te)M cts ha!e in!$ked the 9cash e>)i!alenc. d$ctrine: Aertain intangibles ha!e s$ clear a !al)e & are s$ readil. &arketable that a cash &eth$d 6< recei!ing the& sh$)ld n$t be entitled t$ de%er rep$rting inc$&e. 7etter ackn$(ledging I $(es 6 $5k %$r ser!ices SR an $ral pr$&ise t$ pa. 6 $5k M Reg. 1.61-1(a) H)nda&ental di%%erence b?t cash acc$)nting & accr)al acc$)nting is that an accr)al &eth$d 6< &)st incl)de in inc$&e (hen it is earned e!en i% the 6< has recEd n$thing. Aash &eth$d 6< incl)des inc$&e $nl. )p$n receipt. 6 3 incl)de in inc$&e these b?c n$ AR 3 bargained-%$r-c$nsiderati$n Billiams v. 2omm3n (195 ) A5 6// M 6< per%$r&ed ser!ices %$r client, (h$ ga!e the 6< a pr$&iss$r. n$te pa.able app*. + &$s. later. @$te )nsec)red & b$re n$ interest. 0t the ti&e client ga!e 6< the n$te, he had n$ %)nds in (hich t$ pa. it. 6< tried t$ sell n$te t$ banks, b)t %ailed. At. %$)nd n$te 3 incl)dable <age 0 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

in inc$&e b?c the n$te had been gi!e $nl. as sec)rit. %$r $r as e!idence $% the indebtedness & n$t as p.&t. 0ls$, b?c n$te b$re n$ interest & (as n$t &arketable W had n$ HIU. $ev. $ul. 68;6@66 +=68;2 M a de%erred-p.&t $bligati$n (hich is 9readil. &arketable & i&&ediatel. c$n!ertible t$ cash: is pr$perl. incl)dable $n receipt )nder the cash &eth$d t$ the e*tent $% its HIU. 2ash e%uivalenc0 and the treatment o: chec8s. Dahler v. 2omm3n (1952) M 6< recEd a c$&&issi$n check %$r $!er $/.'k $n 8ec. '1, 19/6 a%ter banking hrs. 6he 6< cashed the check $n Jan. 2, 19/ . 6A c$ncl)ded it &ade n$ di%%erence that it (as i&p$ssible t$ cash the check in 19/6, n$ting (here ser!ices are pd %$r $ther than b. $, the a&t t$ be incl)ded as inc$&e is the HIU $% the pr$pert. taken in p.&t. Cnless s$&e $ther c$nditi$n, ie check is n$t h$n$red, it &)st be incl)ded in inc$&e as th$)gh cash had been recEd. <$sted dated check %$r Jan. 2nd, recEd at .ears in (ill n$t be incl)ded )ntil $ is a!ailable. H% Th, E*ono+i* ),n,fit Do*trin, 2omm3n v. *mith (19/5) M rec$gni;ed that an ec$n$&ic bene%it $r %inancial bene%it c$n%erred )p$n an e&pl$.ee as c$&pensati$n (as incl)ded in inc$&e. *#roull v. 2omm3n (1952) M ct %$)nd that an a&t irre!$cabl. placed in tr)st %$r the bene%it $% an e&pl$.ee c$nstit)ted inc$&e t$ the e&pl$.ee in that .r, e!en th$)gh the $ (as n$t pa.able t$ the e&pl$.ee )ntil s)bse>)ent .rs. 6A e&phasi;ed the a&t (as %i*ed & irre!$cabl. pd $)t %$r the s$le bene%it $% the e&pl$.ee. 0pplied &$stl. t$ e&pl$.ee c$&pensati$n c$nte*t & (? respect t$ pri;es & a(ards held in escr$( $r tr)st-t.pe arrange&ents. Minor v. 9* (19+5) M the ec$n$&ic bene%it d$ctrine pr$!ides an alternate &eth$d $% deter&ining (hen a 6< recei!es ta*able bene%it. 0n e&pl$.erEs pr$&ise t$ pa. de%erred c$&pensati$n in the %)t)re &a. itsel% c$nstit)te a ta*able ec$n$&ic bene%it i% the c)rrent !al)e $% the e&pl$.erEs pr$&ise can be gi!en an appraised !al)e M applicable $nl. i% the e&pl$.erEs pr$&ise is capable $% !al)ati$n B (here the e&pl$.er &akes a c$ntrib)ti$n t$ an e&pl$.eeEs de%erred c$&pensati$n plan (hich is n$n-%$r%eitable, %)ll. !ested in the e&pl$.ee & sec)red against the e&pl$.erEs credit$rs b. a tr)st arrange&ent. $ev. $ul. 62;7A6 +=62;+ M 6< a(arded pri;e $ in a c$ntest. A$ntest sp$ns$r placed $ in a n$n-interestbearing escr$( acct (? the a&t t$ be pd t$ 6< $!er a 2 .r pd. 6< 3 ha!e t$ incl)de the %)ll $ in inc$&e i&&ediatel. b)t $nl. the disc$)nted !al)e $% the p.&ts & as p.&ts recEd the !al)e (as incl)ded in ,-. 8$ctrine B ,- incl)des an. ec$n$&ic bene%it c$n%erred )p$n a 6< t$ the e*tent the bene%it has an ascertainable HIU. ?% D,f,rr,2 Co+p,nsation Arrang,+,nts Dpeci%ic de%erral arrange&ents all$(able M >)ali%ied pensi$n & pr$%it sharing plans @$n->)ali%ied de%erred c$&pensati$n arrange&entsF 0n. electi!e $r n$n-electi!e plan, agree&ent, &eth$d, $r arrange&ent b?t an e&pl$.er & an e&pl$.ee ($r ser!ice recipient & ser!ice pr$!ider) t$ pa. the e&pl$.ee c$&pensati$n s$&e ti&e in the %)t)re. @T8 c$&pensati$n plans d$ n$t a%%$rd e&pl$.ers & e&pl$.ees the ta* bene%its ass$ciated (? >)ali%ied plans b?c the. d$ n$t satis%. all the re>s. $% -RA /01(a). N*a&plesF Dalar. $r b$n)s de%erral arrange&ents -% $ set aside %r$& e&pl$.erEs credit$rs %$r the e*cl)si!e bene%it $% e&pl$.ee than incl)dable as ,-. Ia. be %$r&al $r in%$r&al & need n$t be in (riting. Khen are de%erred a&ts incl)ded in e&pl$.eeEs ,-L Khen e&pl$.ee has AR M that is 6< has c$ntr$l $!er the receipt $% the de%erred a&ts & that c$ntr$l 3 s)b4ect t$ s)bstantial restricti$ns $r li&itati$ns. <age 1 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

,i!e e&pl$.ees credit cards, debit cards $r check b$$ks t$ access the %)nds 0ll$( e&pl$.ees t$ b$rr$( against the %)nds Nc$n$&ic 5ene%it M i% an indi!id)al recei!es an. ec$n$&ic $r %inancial bene%it $r pr$pert. as c$&pensati$n %$r ser!ices, the !al)e $% the bene%it $r pr$pert. is c)rrentl. incl)dable in ,-. N&pl$.ee &)st incl)de in ,-, the !al)e $% assets that ha!e been )nc$nditi$nall. & irre!$cabl. t* as c$&pensati$n int$ a %)nd %$r the e&pl$.eeEs s$le bene%it, i% the e&pl$.ee has a n$n%$r%eitable interest in the %)nd. Khen are de%erred a&ts ded)ctible t$ the e&pl$.erL +'(h) & /0/(a)(5) M a&ts are ded)ctible b. the e&pl$.er (hen the a&t is incl)dible in the e&pl$.eeEs inc$&e. -nterest?earnings credited t$ a&ts de%erred )nder n$n>)ali%ied de%erred c$&pensati$n plans 3 >)ali%. as interest ded)ctible )nder 16' M b)t represents additi$nal de%erred c$&pensati$n )nder /0/(a)(5) /090 (A5 650) :% Lott,rA "ri9,s /51(h) all$(s states t$ $%%er pri;e (inners the $pti$n $% recei!ing a single cash p.&t $% an. l$tter. pri;e $ther(ise pa.able $!er at least 10 .rs., $pti$n &)st be e*ercised (?in 60 da.s $% the 6<Es entitle&ent t$ the pri;e. 6< 3 in AR $% (h$le (innings i% elect t$ ha!e it pd $!er a peri$d $% ti&e. Nc$n$&ic bene%it d$ctrine 3 applicable b?c states d$ n$t )s)all. irre!$cabl. set aside the %)nds. ;% "r,paA+,nts 6< &)st rep$rt the prep.&ts (hen recEd. Reg. 1.61-+(b) re>)ires prep.&ts $% rent t$ be incl)ded in the .r $% receipt 9regardless $% the pd c$!ered $% the &eth$d $% acc$)nting e&pl$.ed b. the 6<.: <rep.&ts $% ded)ctible e*penses b. cash &eth$d 6< 3 ded)ctible in %)ll )% D,24*tions Cn2,r th, Cash ,tho2 &% In #,n,ral Cnder cash &eth$d ded)ctible e*penses are ded)ctible (hen pd. Reg. 1.//6-1(c)(1)(i)G 1./61-1(a)(1) 8ed)cti$ns are all$(ed %$r pa.&ents $nl. (hen 9act)all. &ade,: %$r e*pendit)res $nl. 9(hen paid.: 6h)s, there is n$ c$)nterpart $n the ded)cti$n side $% the Aash Ieth$d 8$ctrine t$ c$nstr)cti!e receipt (ith respect t$ inc$&e. N*F <)t $ in escr$( acct %$r ta*es $n h$)se 3 ded)ctible )ntil ta*es are pd %r$& escr$( acct. Khat is <a.&entL <a.&ent in cash, pr$pert., b$rr$(ed %)nds 0 check is pa.&ent (hen it is deli!ered. <a.&ent b. a credit card c$nstit)tes pa.&ent at the ti&e the charge is &ade, and n$t (hen the ta*pa.er pa.s the bank. Khat is @S6 <a.&entL 6rans%erring H)nds t$ an agent 8ep$sit $% %)nds b. a cash-basis ta*pa.er as an $%%er in c$&pr$&ise $% a disp)ted a&$)nt is n$t pa.&ent )ntil the $%%er is accepted. -ss)ance $% a <r$&iss$r. @$te 6he n$te &a. ne!er be paid and i% it is n$t paid, the ta*pa.er has parted (ith n$thing &$re than his pr$&ise t$ pa.. (Dee 2el!ering !. <rice). <age 2 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

2% Cash ,tho2 "r,paA+,nts -% a cash-&eth$d ta*pa.er pa.s a ded)ctible e*pense n$(, he &a. take an i&&ediate ded)cti$n, (hich &akes sense %r$& an ec$n$&ic standp$int i% the !al)e $% the earlier ded)cti$n e*ceeds the c$st $% &aking the prepa.&ent. 5C6, the ded)cti$n ti&ing r)les $% /61 are s)b4ect t$ the capital e*pendit)re r)les $% 26'. 6h)s, a c)rrent ded)cti$n &a. be denied i% it is a capital e*pendit)re. 1r0n7er) v. 2omm3nF '-part test (ith respect t$ the ded)ctibilit. $% prepaid rentalsF (1) the e*pendit)re &)st c$nstit)te an act)al pa.&ent rather than a dep$sit, (2) it &)st be &ade %$r a s)bstantial b)siness reas$n (and n$t 4)st t$ accelerate a ta* ded)cti$n), and (') it &)st ca)se n$ &aterial dist$rti$n $% inc$&e. Eaninovich v. 2omm3n (19+0) p. 6' - Cnder the $ne-.ear r)le, an e*pendit)re is treated as a capital e*pendit)re i% it creates an asset that has a )se%)l li%e $% &$re than $ne .ear. -% it has a )se%)l li%e $% less than $ne .ear, it &a. be ded)ctible n$(, e!en i% the )se%)l li%e e*tends $!er t($ ta*able .ears. $ol2ingJ 8ec. 19 ' prepa.&ent $% rent %$r a peri$d bet(een 12? ' and 12? / (as ded)ctible in 19 ' and n$t 19 /. :?;

RE@ENCE RCLIN# :0(1& -&9:0. F& : Issue: $ule: '&$at: A ES 6% CO F& : Issue: $ule: '&$at: COWDEN 6% CO F& : Issue: $ule: '&$at: GN -&999.

::2

GN -&9:&.

:::

RE@ENCE RCLIN# ;8(19 -&9;8. F& : Issue: $ule: '&$at: RANINO@IC$ 6% CO F& : Issue: $ule: '&$at: GN -&980.

::9

:;&

<age ' $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08 ;1; ' ;H;, ;:0 ' ;:9, ;;; ' ;91

C$ 1& ' CA"ITAL #AINS F LOSSES

I%"RO)LE S A% D,finitions of Capital Ass,t &% 6err. -a. Dedan recEd %r$& &an)%act)rer & placed in sales sh$(r$$&. N*cl)ded as capital gain )nder 1221(a)(1) M pr$pert. held %$r the sale t$ c)st$&ers -5. Uan )sed t$ transp$rt c)st$&ers t$ and %r$& its ser!ice depart&ent. N*cl)ded 1221(a)(2) -*. @e( stati$n (ag$n )sed as %a&il. car M Aapital asset -2. 7and & bldg. $(ns & )ses in the car dealership. @$, e*cl)ded )nder 1221(a)(2) -,. <r$&iss$r. n$te 6err. recEd $n the sale $% the ad4acent !acant land he p)rchased as an in!est&ent. Oes, held %$r pr$%it $r %$r in!est&ent M Aapital asset -f. <r$&iss$r. n$te H recEd $n the sale $% a tr)ck M @$, n$te recei!able e*cl)ded )nder 1221(a)(/) & tr)ck (as e*cl)ded )nder 1221(a)(1) -g. 6 & IEs h$&e M capital asset -h. 0 painting IEs &$ther painted & ga!e t$ I sh$rtl. be%$re &$ther diedG gi%t, e*cl)ded )nder ca)se I takes her &$therEs basis, 1221(a)(')(c) &. 2nd painting I recEd )p$n &$&Es death M basis deter&ined b. HIU n$t $n the pers$n (h$ created it, capital asset -i. 6 & IEs st$ck in Hriendl. Aar 8ealership M capital asset -3. A$&p)ter %$r&erl. $(ned & )sed in the dealership, b)t (hich 6 & I n$( $(n & )se t$ &anage in!est&ents M capital asset 2% 8ennis M p)rchased intending t$ resell it, Reg. 1.12' -1, s)bdi!ided the land, &akes it l$$k &$re like a b)siness, did n$t c$ntact the realt$r M e*cl)ded )nder 1221(a)(1) 1% Dte!e H% 8an ?% Iarc$ C% is*,llan,o4s Capital #ain U Loss Iss4,s &% Dhar$n a% @$t hedging 5% 2% 8$nEt d)e 1% $2k capital l$ss, basis $% $2500 %$r re&aining 50 shares, 1.65(g)(1) (pg. 162) M the l$ss res)lting be treated as a l$ss $% a capital asset M capital l$ss. H$r a t$tal $/500 in capital l$sses H% Iiddlet$(n <r$%. H$re&anEs e*a& II%CLASS NOTES 8e%initi$n $% Aapital ,ain $r 7$ss - 1222(10), (11) @et capital l$ss M &eans the e*cess $% the l$sses %r$& sales $r e*changes $% capital assets $!er the s)& all$(ed )nder 1221. -n the case $% a c$rp., %$r the p)rp$se $% deter&ining l$sses )nder this paragraph, a&$)nts (hich are sh$rt-ter& capital l$sses )nder 1212 shall be e*cl)ded. @et capital gains M &eans the e*cess $% the net l$ng-ter& capital gain %$r the ta*able .ear $!er the net sh$rt-ter& capital l$ss %$r s)ch .ear. 6reat&ent $% Aapital 7$sses - 1211(b), 165(%) <age / $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

1211(b) M 7i&itati$n $n capital l$sses M (b) $ther 6<s. M in the case $% a 6< $ther than a c$rp., l$sses %r$& sales $r e*changes $% capital assets shall be all$(ed $nl. t$ the e*tent $% the gains %r$& s)ch sales $r e*changes, pl)s (i% s)ch l$sses e*ceed s)ch gains) the l$(er $% M $',000 ($1,500 in the case $% a &arried indi!id)al %iling a separate ret)rn)G $r 6he e*cess $% s)ch l$sses $!er s)ch gains. 165(%) M Aapital l$sses. M 7$sses %r$& sales $r e*changes $% capital assets shall be all$(ed $nl. t$ the e*tent all$(ed in 1211, 1212 6reat&ent $% Aapital ,ains - 1(h), 1222(11) 1(h) M &a*i&)& capital gains rate. (1) -n general. M i% a 6< has a net capital gain %$r an. ta*able .ear, the ta* i&p$sed b. this %$r s)ch ta*able .ear shall n$t e*ceed the s)& $% M etc R 1222(11) M see ab$!e Kh.L Hairness M b)nching, ec$n$&ic ine%%icienc. @$t let ta* deter selling $% st$cks 8e%initi$n $% a 9Aapital 0sset: - 1221(a) Dtat)t$r. N*cl)si$ns - 1221(a)(1)-(+) (1) in!ent$r. (2) pr$pert. s)b4ect t$ the all$(ance %$r depreciati$n in 16 , $r real pr$pert. )sed in his trade $r b)siness (') J)dicial N*cl)si$ns M Arkansas 1est, !ort 8e%initi$n $% 9Dale $r N*change: M ,enan

III%O@ER@IEW A% $istori*al O6,r6i,7 ,ains %r$& the sale $% assets like st$ck c$nstit)te inc$&e. 0ckn$(ledged that special ta* treat&ent %$r the gain rec$gni;ed $n the disp$siti$n $% certain assets (as 4)sti%ied. -n the Re!. 0ct $% 1921, A$ngress pr$!ided pre%erential ta* treat&ent %$r the gains (re%erred t$ as capital gains) %r$& the sale $r e*change $% a class $% assets A$ngress characteri;ed as capital assets. Aapital asset M pr$pert. ac>)ired and held b. the 6< %$r pr$%it $r in!est&ent %$r &$re than 2 .ears ((hether $r n$t c$nnected (? his trade $r b)siness), b)t d$es n$t incl)de st$ck in trade $% the 6< $r $ther pr$pert. $% a kind (hich ($)ld pr$perl. be incl)ded in the in!ent$r. $% the 6< i% $n hand at the cl$se $% the ta*able .ear. &% "r,f,r,ntial Tr,at+,nt for Long T,r+ Capital #ain ,ains %r$& the sale $% st$ck c$nstit)te inc$&e Merchants Land .rust 2o. v. *mietan8a (1921) M appreciati$n $n st$ck (as inc$&e s)b4ect t$ ta* (hen the appreciati$n (as reali;ed thr$)gh the sale $% st$ck. Re!. 0ct $% 1921 M A$ngress pr$!ided pre%erential ta* treat&ent %$r the gains (capital gains) %r$& the sale $r e*change $% a class $% assets (capital assets). Aapital asset M pr$pert. ac>)ired & held b). the 6< %$r pr$%it $r in!est&ent %$r &$re than 2 .rs ((hether c$nnected t$ trade $r b)siness $r n$t), b)t d$es n$t incl)de st$ck in trade $% the 6< $r $ther pr$pert. incl)ded in the in!ent$r. $% 6< i% $n hand at the cl$se $% the ta*able .r. <age 5 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

2% Li+itation on th, D,24*tion of Capital Loss,s Aapital l$sses c$)ld $nl. be ded)cted t$ the e*tent $% capital gains Cp t$ $2k $% an. e*cess $% capital l$sses $!er gains c$)ld als$ be ded)cted 0n. capital l$ss n$t ded)ctible b?c $% the li&itati$n (ere carried $!er t$ the %$ll$(ing .rs )ntil )sed. N*cess capital ded)cti$n has been raised t$ $'k. 1% B4stifi*ation for "r,f,r,ntial Capital #ain Tr,at+,nt <r$p$nent arg)&entsF A$ntend the gain reali;ed $n the sale $r e*change $% a capital asset is $%ten largel. d)e t$ in%lati$n & d$es n$t represent an. real increase in !al)e $% the asset. I$bilit. $% capital c$)ld be i&paired i% capital gains (ere ta*ed like an. $ther inc$&e. 6a*ing capital gains at the sa&e rate as $ther inc$&e is a disincenti!e t$ sa!ings. Spp$nents arg)&entsF D)ch treat&ent creates the need %$r c$&ple* stat)t$r. pr$!isi$ns designed t$ pre!ent 6< %r$& c$n!erting $rdinar. inc$&e int$ capital gains. Re>)ires cts & ser!ice t$ deter&ine (hether a partic)lar gain is a capital gain $r $rdinar. inc$&e. <r$ble&s idEd b. pr$p$nents $% s)ch treat&ent c$)ld be better addressed thr$)gh $ther &eans. )% STO" ' BC " TO D -C) ;?9. C% DONGT DCE

D% D,finition of Capital Ass,t <r$pert. ac>)ired and held b. the ta*pa.er ((hether $r n$t c$nnected (ith his trade $r b)siness) is a capital asset, NPAN<6 %$r the %$ll$(ingF &% I &22&-a.-&.J In6,ntorA, Sto*N in Tra2,, F "rop,rtA $,l2 "ri+arilA for Sal, to C4sto+,rs in th, Or2inarA Co4rs, of Th, Ta<paA,rGs Tra2, or )4sin,ss @S pre%erential capital gains treat&ent $% in!ent$r. t.pe ite&s 9pri&aril. %$r sale: re>)ired $nl. that the 6<Es p)rp$se t$ sell be s)bstantial. (iedenharn $ealt0 v. 9* (19 6) M At c$nsidered the %$ll$(ing %act$rs in deter&ining the character $% gains %r$& the sale $% s)bdi!ided landF %re>)enc. & s)bstantialit. $% salesG i&pr$!e&ents &ade t$ the landG 6<Es s$licitati$n & ad!ertising e%%$rtsG & )tili;ati$n $% real estate br$kers & agents. I$st i&p$rtant %act$rs (ere %re>)enc. & s)bstantialit. $% sales 2% I &22&-a.-2.J "rop,rtA Cs,2 in th, Ta<paA,rGs Tra2, or )4sin,ss NPA7C8ND %r$& capital asset stat)s pr$pert. )sed in the ta*pa.erEs trade $r b)siness that is either depreciable pr$pert. SR real pr$pert. 1221(a)(2) pr$pert. held %$r &$re than 1 .r special treat&ent )nder 12'1 as 9>)asi-capital asset: 1% I &22&-a.-1.J CopArights, Lit,rarA, 4si*al or Artisti* Co+position, Et*% @S6 capital asset i% held b. 6< (h$ pers$nal e%%$rts created the pr$pert. SR Kh$se basis (as deter&ined in (h$le $r in part. b. re%erence t$ the basis $% the pr$pert. in the hands $% a pers$n (h$se e%%$rts created the pr$pert. H% I &22&-a.-H.J A**o4nts R,*,i6a5l, for S,r6i*,s R,n2,r,2 or In6,ntorA(TAp, Ass,ts Sol2 <age 6 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN @S6 capital asset

FEDERAL INCO E TA! I

S"RIN# 08

?% I &22&-a.-?.J C,rtain "45li*ations of th, CS #o6Gt @S6 capital asset li&its ded)cti$ns %$r gi%ts $% g$!Et p)blicati$ns t$ libraries etc. 6a*pa.er cann$t get charitable ded)cti$n greater than basis in ite& :% I &22&-a.-8.J S4ppli,s Cs,2 or Cons4+,2 in th, Ta<paA,rGs Tra2, or )4sin,ss @S6 capital assets ;% B42i*iallA Esta5lish,2 Li+its on Capital Ass,t Chara*t,ri9ation 2orn roducts $e:inin) 2o. v. 2omm3n (1955) - sale $% c$rn %)t)res b. c$rn %ar&er @S6 capital assets A$rn %)t)res t$ cl$se t$ b)siness $% c$rn %ar&ers D)bse>)entl. )sed b. ta*pa.ers t$ 0US-8 characteri;ati$n $% st$ck l$sses as capital l$sses /r8ansas (est A$)rt re4ected &$ti!ati$n test t$ deter&ine capital asset 2ene"6 Inc. v. 9* (199+) M s)rr$gates $r s)bstit)tes %$r in!ent$r. 9&)st bear a cl$se relati$nship t$ act)al in!ent$r. and can d$ s$ i% the. are cl$sel. related t$ the ta*pa.erEs in!ent$r.-p)rchase s.ste&: A$rn %)t)res gains and l$sses in c$rn %)t)res, ($)ld be the sa&e as gains and l$sses $n act)al in!ent$r. ($)ld ha!e been Dale $% right t$ c$llect %)t)re di!idends $n st$ck @S6 capital gain /zar -ut 2om#an0 v. 2omm3n (1991) M an asset is n$t e*cepted %r$& capital-asset treat&ent si&pl. b?c the asset is ac>)ired (? a b)siness p)rp$se. 6$ >)ali%. )nder the 9)sed in: e*cepti$n, an asset &)st be 9)sed in: the 6<Es b)siness, and an asset that has n$ &eaning%)l ass$ciati$n (? the 6<Es b)siness $perati$ns a%ter it is ac>)ired cann$t reas$nabl. %all (?in the plain ($rds $% the stat)te. 'ort v. 2omm3n - 0 pa.&ent in lie) $% $rdinar. inc$&e is $rdinar. inc$&e. O$) canEt take $rdinar. inc$&e and change it int$ capital gain b. accelerating the pa.&ent (b. pa.ing in $ne l)&p s)&p). N*a&pleF D p)blisher, b).s st$ck in 05A ne(sprint c$ t$ ens)re s)ppl. $% paper & sells 05A at a l$ss Aharacteri;e l$ss A$rn pr$d)cts? 0rkansas 5est c$rn %)t)res e*cl)ded as in!ent$r. 0rkansas re4ected &$ti!ati$n test t$ deter&ine capital asset A0<-607 7SDD @$ st$ck p)rchase agrees t$ p)rchase certain a&$)nt $% ne(sprint each .ear peri$dicall. assigns right t$ s$&e $% the ne(sprint t$ $ther p)blishing c$&panies Aharacteri;e pa.&ents recei!ed %$r these assign&ents like c$rn %)t)res right t$ ne(sprint is like in!ent$r. o @S6 a A0<-607 asset, assign&ent gi!es rise t$ $rdinar. inc$&e <age $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

E% Th, Sal, or E<*hang, R,L4ir,+,nt <)rs)ant t$ 1222, $nl. gains $r l$sses res)lting %r$& the sale $r e*change $% capital assets (ill be treated as capital gains and l$sses. 9sales and e*changesF:B be>)ests, %$r%eit)re, in!$l)ntar. %$r%eit)re. F% STO" ' BC " to C) ;;;

ARKANSAS )EST COR"% 6% CO GN -&988. ;;; F& : 05 di!ersi%ied h$lding c$. 196+ ac>)ired 651 st$ck in @5A. 5?t 69- / 05 tripled c $% shares. 0R5 s$ld b)lk $% st$ck in 19 5 & clai&ed a ded)cti$n %$r $rdinar. l$ss res)lting %r$& the sale $% st$ck. Issue: Khether capital st$ck held b. 0rkansas 5est is a 9capital asset: as de%ined in 1221 regardless $% (hether the st$ck (as p)rchased & held %$r a b)siness p)rp$se $% %$r an in!est&ent p)rp$se. '&$at: 6he br$ad de%initi$n $% the ter& capital asset e*plicitl. &akes irrele!ant an. c$nsiderati$n $% the pr$pert.Es c$nnecti$n (? the 6<Es b)siness. 5ank st$ck %alls (?in literal de%initi$n $% capital asset )nder 1221 & is $)tside the classes $r pr$pert. e*cl)ded %$r& capital-asset stat)s, the l$ss arising %r$& the sale $% the st$ck is a capital l$ss. $ORT 6% CO GN -&9H&. ;82 F& : <et. ac>)ired pr$pert. b. de!ise. 0greed t$ cancel a lease in c$nsiderati$n %$r p.&t $% $1/0k. <et. 3 incl)de a&t in ,-, b)t rep$rted l$ss (c$st $% lease M c$nsiderati$n B l$ss clai&ed). Issue: (1) Khether the a&t pet. recEd as c$nsiderati$n %$r cancellati$n $% a lease $r realt. in @OA (as $rdinar. ,- as de%ined in 22(a)L (2) Khether pet. s)stained a l$ss thr$)gh cancellati$n $% the lease (hich is rec$gni;ed in 2'(')L '&$at: 0&t recEd b. pet. %$r cancellati$n $% the lease &)st be incl)ded in ,- in its entiret.. A$nsiderati$n %$r the cancellati$n $% the lease (as n$t a ret)rn $% capital. Aancellati$n $% the lease & c$nsiderati$n e*change, relin>)ished right t$ the re&ainder $% the lease. DA@IS 6% CO GN -2002. ;8H F& : K$n l$tter., assigned part $% the (innings a(a.. Issue: Khether the a&t that pet. recEd in e*change %$r the assign&ent $% their right t$ recei!e a p$rti$n $% certain %)t)re ann)al l$tter. p.&ts is $rdinar. inc$&e $r capital gainL '&$at: Srdinar. inc$&e. KENAN 6% CO F& : Issue: $ule: '&$at: GN -&9H0. ;90

C$ 1H ' ASSI#N ENT OF INCO E I%"RO)LE S &% Iartha <lan 1 - DheEs assigning inc$&e %r$& ($rk $r ser!ices, is ta*ed t$ the earner, I is ta*ed. <lan 2 -a.

8&1 ' 81;

<age + $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN -5. <lan ' -a. 8 -5. 8 -*. 8 -2. 8 <lan /F II%O@ER@IEW

FEDERAL INCO E TA! I

S"RIN# 08

A% Th, "rogr,ssi6, Rat, Str4*t4r, K2S has inc$&e is i&p$rtant beca)seF (1) -ndi!id)als are !ie(ed as the ta*pa.ing )nitG (2) Kith$)t sa%eg)ards, the higher bracket ta*pa.er c$)ld shi%t inc$&e t$ a l$( bracket ta*pa.er. ,eneral r)lesF -nc$&e is ta*ed t$ the ta*pa.er (h$ c$ntr$ls the earnings $% the inc$&e a!$id shi%ting inc$&e t$ children -nc$&e %r$& pr$pert. is ta*ed t$ the $ne (h$ $(ns the pr$pert. directing rent t$ be paid t$ child, pr$pert.-$(ner parent is still ta*ed $n rental inc$&e )% D,6,lop+,nt of R4l,s Li+iting In*o+,(Shifting -nc$&e is ta*ed t$ the ta*pa.er that c$ntr$ls the earning $% the inc$&e. Lucas v. !arl6 9.*. (19'0) - -nc$&e (ill be ta*ed t$ the earner $% inc$&e. Kith ser!ices, the per%$r&er $% ser!ices is ta*ed. HactsF 6he Narls had a c$ntract, (hereb. Irs. Narl had a 501 interest in Ir. NarlEs inc$&e. 6he h)sband had c$ntr$l $!er the inc$&e and sh$)ld there%$re be ta*ed $n it. +'F Khen s$&e$ne d$es ($rk and a pa.&ent is &ade t$ an.b$d. (ith regards t$ that ($rk, the pers$n (h$ act)all. d$es the ($rk is ta*ed $n that inc$&e. 5et(een 2el!ering !. N)bank ((hich held that .$) canEt trans%er de%erred c$&pensati$n) and 7)cas !. Narl (.$) canEt trans%er (ages), it is al&$st i&p$ssible t$ trans%er inc$&e. 'elverin) v. 'orst (19/0) - -nc$&e %r$& pr$pert. is ta*ed t$ the $ne (h$ $(ns the pr$pert.. N*a&ple, the landl$rd-parent directing that rent be pd t$ her child is still ta*ed $n that rental inc$&e. HactsF 6he 6< had a b$nd that had a c$)p$n $n it. 2e ga!e the c$)p$n t$ his s$n, (h$ cashed the b$nd at the bank. At. held that the 6< &)st pa., b?c it (as his pr$pert.. <r$pert. ta*ed t$ the $(ner. C% Appli*ation of th, Assign+,nt of In*o+, R4l,s Dochans80 v. 2omm3n (1996) M 6< as a part. $% di!$rce settle&ent, agreed t$ pa. t$ his (i%e a p$rti$n $% an. c$ntingent %ee t$ (hich be beca&e entitled as a res)lt $% representing a client in a &ed &alpractice s)it. -nc$&e is ta*able t$ the pers$n (h$ earns it & an anticipat$r. assign&ent $% pers$nal ser!ices (ill n$t ser!e t$ shi%t the ta* liabilit.. 6he c$ntingent %ee represented c$&pensati$n t$ 6< %$r ser!ices rendered. 6< t* $nl. the right t$ recei!e a p$rti$n $% the inc$&e t$ his (i%e. 2omm3n v. 1iannini (19/2) M 6<, <res. $% c$rp., in%$r&ed c$rp. b$ard that he ($)ld re%)se t$ accept an. inc$&e %r$& the c$rp. %$r his ser!ices d)ring the re&ainder $% the .r & s)ggested the c$rp. )se the $ %$r s$&e ($rth(hile ca)se. <r$pert. (hich is ren$)nced (ie. aband$ned) cann$t be di!erted $r assigned b. the ren$)ncer, & cann$t be ta*ed )p$n the the$r. that it (as recEd. At. held %$r 6< n$ting that the 6< did n$t direct the c$rp. t$ gi!e the $ t$ an. speci%ic $rg. <age 9 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

D% In*o+,(Shifting WUin Fa+ili,s F )Ut R,lat,2 "arti,s 1(g) M Yiddie 6a* M ta* )nearned inc$&e $% certain children at the t$pe &arginal rates $% their parents.

LCCAS 6% EARL -&910. 821 F& : 6he Narls had a c$ntract, (hereb. Irs. Narl had a 501 interest in Ir. NarlEs inc$&e. 6he h)sband had c$ntr$l $!er the inc$&e and sh$)ld there%$re be ta*ed $n it. Issue: Khether resp. N, c$)ld be ta*ed %$r the (h$le $% the salar. & att.. %ees earned b. hi& in the .ears 1920 & 1921, $r sh$)ld be ta*ed %$r $nl. hal% $% the& in !ie( $% the Y (? his (i%e. '&$at: -nc$&e (ill be ta*ed t$ the earner $% inc$&e. Kith ser!ices, the per%$r&er $% ser!ices is ta*ed. +' Khen s$&e$ne d$es ($rk and a pa.&ent is &ade t$ an.b$d. (ith regards t$ that ($rk, the pers$n (h$ act)all. d$es the ($rk is ta*ed $n that inc$&e. $EL@ERIN# 6% $ORST -&9H0. 82H F& : 6he 6< had a b$nd that had a c$)p$n $n it. 2e ga!e the c$)p$n t$ his s$n, (h$ cashed the b$nd at the bank. At. held that the 6< &)st pa., b?c it (as his pr$pert.. <r$pert. ta*ed t$ the $(ner. Issue: Khether the gi%t, d)ring the d$n$rEs ta*able .r, $% interest c$)p$ns detached %r$& the b$nds, deli!ered t$ the d$nee & later tin the .r pd at &at)rit., is the reali;ati$n $% inc$&e ta*able t$ the d$n$rL '&$at: -nc$&e %r$& pr$pert. is ta*ed t$ the $ne (h$ $(ns the pr$pert.. N*a&ple, the landl$rd-parent directing that rent be pd t$ her child is still ta*ed $n that rental inc$&e. $EL@ERIN# 6% EC)ANK -&9H0. 82; '&$at: 5et(een 2el!ering !. N)bank ((hich held that .$) canEt trans%er de%erred c$&pensati$n) and 7)cas !. Narl
(.$) canEt trans%er (ages), it is al&$st i&p$ssible t$ trans%er inc$&e.

SAL@ATORE 6% CO GN -&9;0. 829 F& : D Ys t$ sell gas stati$n t$ 6e*ac$. -nstead $% selling her (h$le stake t$ 6e*ac$ and gi!ing her children [ $%
the $, D then gives her children [ $% her stake in it. 6he. then s$ld their [ stake and the ($&an s$ld her stake.

Issue: Khether D is ta*able $n all $r $nl. [ $% the gain reali;ed $n the sale $% certain real pr$pert. in 196'. '&$at: ,ain ta*able t$ $(ner $% pr$p. -n $ther ($rds, a 6< cann$t shi%t inc$&e t$ 0, (h$ is in a l$(er ta*
bracket, b. gi!ing pr$p. t$ hi&, & he (ill then sell it t$ 5. -% 0 pd n$thing $r e!en a n$&inal a&$)nt %$r the pr$pert. and is $nl. a c$nd)it t$ pass title, then the gain %r$& the sale is attrib)ted t$ the ta*pa.er. 9s)bstance $!er %$r&:

ACCELERATION OF INCO EJ -% the sa&e inc$&e (ill be ta*ed at a higher rate in O2 than it is in O1, there is an incenti!e t$ %ind a (a. t$ accelerate %)t)re inc$&e int$ the present ta* peri$d, and it &a. bec$&e necessar., %$r ta* p)rp$ses, t$ deter&ine (hether and (hen the 6< has reali;ed inc$&e. STRANA$AN 6% CO GN -&9;1. 812 F& : 6he 6< assigned his s$n anticipated st$ck di!idends and the s$n paid his %ather %$r the&. 6he s$n pd the
%ather t$ recei!e %)t)re inc$&e %r$& the di!idends. 6he s$n t$$k a risk, b?c it (asnEt g)aranteed that heEd recei!e the sa&e $r &$re $ %r$& the t*. 6his is W 3 an in!alid t*, b?c there (as ec$n$&ic reas$n t$ it W the agree&ent is !alid.

'&$at: -t is a !alid t* (hen 0 pa.s g$$d & s)%%icient c$nsiderati$n t$ the 6< %$r pr$p. in $rder %$r the 6< t$ accelerate his inc$&e int$ an earlier .ear, as l$ng as there is a legiti&ate ec$n$&ic reas$n %$r it & it is a legiti&ate sale. AD 6% CO GN -&98H. 81? F& : I ga!e pr$p. t$ a tr)st, then rented the pr$p. %$r his b)siness %r$& the tr)st. I (ants t$ ded)ct the rental p.&ts )nder this 9gi%t-leaseback: as a b)siness e*pense. At held this (as an irre!$cable t* $% pr$p., <age +0 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

the 6< retained %e( c$ntr$ls $!er the pr$p., the tr)st bene%its d$ n$t g$ t$ the 6<, & the tr)stee is independent. 5?c the ele&ents $% the test (ere &et, the rental p.&ts &a. be ded)cted as a b)siness e*pense. '&$at: Cnder 162(a)('), the t* $% a s)%%icient pr$p. interest )nder a ,-H6-7N0DN50AY 4)sti%ies the ta*ati$n $% d$nees and the ded)cti$n $% rental p.&ts as $rdinar. & necessar. b)siness e*penses b. the d$n$r. -n a ,-H6-7N0DN50AY sit)ati$n, the s)%%icienc. $% the pr$p. interest t* &)st be assessed )sing the %$ll$(ing %act$rsF 1.6he d)rati$n $% the trans%er. 2.6he c$ntr$ls retained b. the d$n$r. '.6he )se $% the gi%t pr$pert. %$r the bene%it $% the d$n$r. 0@8 /.6he independence $% the tr)stee. C$ 1? ' T$E KIDDIE TA! I%"RO)LE S &% 2% 1% H% J)ni$r J)ni$r J)ni$r J)ni$r 819 ' 8H1

II%O@ER@IEW -nc$&e %r$& ser!ice be ta*ed t$ the ser!ice-per%$r&er -nc$&e %r$& pr$p. 5e ta*ed t$ the pr$pert. $(ner. -nc$&e %r$& pr$p. Aan be shi%ted b. t* $(nership $% pr$p. 1(g) M Yiddie 6a* D)bstantiall. eli&inates the bene%its $% inc$&e-shi%ting t$ a child s)b4ect t$ the ta*. 6$ ta* the 9net )nearned inc$&e: $% a c$!ered child at the t$p &arginal ta* rate $% his $r her parents. Dtill ta*ed t$ the child & n$t parents, b)t at parents ta* rate i% higher than childs N*tends be.$nd child-parent relati$nship t$ $ther relati!es 7i&itati$ns $n Dc$pe $% 1(g) 0pplies t$ a child )nder age 1+ 1(g)(2)(0) 0pplies t$ a child i% (1) the child has attained the age $% 1+ b. the end $% the ta* .r b)t is n$t .et 19 $r a child is %)ll-ti&e st)dent )nder the age $% 2/G 1(g)(2)(0)(ii)(-) & 152(c)(')G an2 6he childEs earned inc$&e d$es n$t e*ceed [ $% the a&t. $% the childEs s)pp$rt. 1(g)(2)(0)(ii)(--). 3 appl. i% child has n$ li!ing parent 3 appl. t$ a &arried child (h$ %iles a 4$int ret)rn. 1(g)(2)(5),(A). 152(d)(2) pr$!ides that i% a dependenc. ded)cti$n (? respect t$ an indi!id)al is all$(able t$ an$ther 6<, that indi!id)al &a. n$t clai& a pers$nal e*e&pti$n $n his $r her $(n ta* ret)rn. 6hat indi!id)alEs standard ded)cti$n &a. n$t e*ceed the greater $% an in%lati$n-ad4)sted $500 $r the s)& $% $250 & s)ch indi!id)alEs earned inc$&e. 6'(c)(5). 0 c$!ered child (h$ is all$(able as a dependent $n the ret)rn $% $ne $r b$th parents, (ill %ind that $n her $(n ret)rn she &a. n$t clai& the pers$n e*e&pti$n $r the basic standard ded)cti$n, b)t (ill instead take the li&ited standard ded)cti$n $% 6'(c)(5). 0ss)&ing 1(g) applies, the ta* i&p$sed $n the child is the greater $% 2 a&tsF 6he ta* i&p$sed (?$ regard t$ 1(g) (this ($)ld be the greater a&t (hen the child is in a higher ta* bracket than the parents)G SR 6he s)& $%F <age +1 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

6he n$r&al ta* that ($)ld be i&p$sed i% the childEs ta*able inc$&e (ere red)ced b. net )nearned inc$&eG and 6he childEs share $% the 9all$cable parental ta*.: 1(g)(1). @et )nearned inc$&e B )nearned inc$&e M the s)& $% 2 a&tsF 6he li&ited standard ded)cti$n $% 6'(c)(5)(0)G an2 0 sec$nd 6'(c)(5)(0) ded)cti$n, $r the all$(able ite&i;ed ded)cti$ns directl. c$nnected (? the )nearned inc$&e, (hiche!er is greater. 1(g)(/)(0). 0ll$cable parental ta* is generated b. ta*ing at the parental &arginal rate, all $% the net )nearned inc$&e $% all children $% the parent t$ (h$& 1(g) applies. 1(g)( ) M parental electi$n t$ incl)de )nearned inc$&e $% a c$!ered child in the parental ret)rn. AhildEs ,- &)st be $nl. %r$& interest & di!idends & &)st be &$re than the li&ited standard ded)cti$n $% 6'(c)(5)(0), b)t less than 10* that a&t. 8?9 ' 881

C$ 1; ' TA! CONSEECENCES OF DI@ORCE I%"RO)LE S &% Hrank & I$reen 2% Hrank & I$reen -a. 8 -5. 8 -*. 8 -2. 8 1% Hrank & I$reen -a. OR2 pa.s $60k M &. O1 M " ( dO2 - 15ke = 15k ) ? 2# = 15k 2. $60k M " ( d /+k = 15k e = 15k ) ? 2# = 15k 1. $60k M " ( ''k = 1+k ) ? 2 # = 15 H. $60k M " 51k ? 2# = 15 B &9%? -5. OR' pa.s $/+k &. O2 M (O' = 15k) 2. /+k M (1+k = 15k) B &?N -*. OR/ pa.s $1+k B -2. OR5 pa.s $12k H% Hrank & I$reen -a. 8 -5. 8 -*. 8 -2. 8 ?% Hrank & I$reen -a. 8 -5. 8 -*. 8 -2. 8 -,. 8 :% Hrank & I$reen -a. 8 -5. 8

<age +2 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN -*. 8

FEDERAL INCO E TA! I

S"RIN# 08

II%O@ER@IEW A% Ali+onAJ #,n,ral R,L4ir,+,nt 1 0li&$n. ali&$n. incl)ded in -@ASIN pa.&ents $% ali&$n. are 8N8CA6-57N b. pa.$r 1(b) R)les $% deter&ining ali&$n. pa.&ents &)st be cash pr$pert. $r ser!ices d$ n$t >)ali%. as ali&$n. &)st be recEd b. 9$r $n behal% $%: the sp$)se. 1b10 &)st be )nder a (ritten agree&ent-- 1(b)(2) describes n$t designated b. parties as n$t being incl)dable n$t li!ing in sa&e h$)seh$ld n$ liabilit. %$r pa.&ent a%ter death 1(c) Ahild s)pp$rt @S6 incl)dable $r ded)ctible 1(%) Rec$&p)tati$n (here e*cess %r$nt-l$ading $% ali&$n. pa.&ents recapt)re r)le t$ pr$hibit ta* a!$idance b. disg)ising ali&$n. as pr$pert. settle&ents -% pa.&ents in the three .ears a%ter di!$rceF N>)ati$nF 8a!is trans%er $% appreciated pr$pert. t$ sp$)se at di!$rce reali;ati$n e!entL @S 10/1 6rans%er $% pr$pert. bet(een sp$)ses $r incident t$ di!$rce n$ gain $r l$ss shall be rec$gni;ed $n a trans%er $% pr$pert. %r$& an indi!id)al t$ a sp$)se $r a %$r&er sp$)se, b)t $nl. i% the trans%er is incident t$ di!$rce trans%er treated as gi%tG trans%eree has trans%er$rEs basis incident t$ di!$rce $cc)rs (ithin 1 .r a%ter date $% &arriage ceases $r is related t$ the cessati$n $% the &arriage Be77 v. 2omm3n (1990)- 1(b)(1)(8) O8erson v. 2omm3n (200/) - 1(b)(1)(8) )% Chil2 S4pport 1(c) M @S6 incl)dable $r ded)ctible 0 pa.&ent %i*ed as child s)pp$rt b. the di!$rce $r separati$n instr)&ent is @S6 ali&$n.. Cnder 6e&p. Reg. 1. 1-16(c), a pa.&ent (hich is clearl. ass$ciated (ith a c$ntingenc. related t$ a child is child s)pp$rt and n$t ali&$n.. 1(c)(2) l$$ks like child s)pp$rt n$t ali&$n. red)cti$n $% ali&$n. relating t$ an e!ent dealing (ith child t)rning 1+, &arr.ing, d.ing, lea!ing sch$$l etc. SR a ti&e (hich clearl. can be ass$ciated (ith a c$ntingenc. $% the kind in (0)

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Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

N*a&pleF 0li&$n. (as t$ st$p (ithin 6 &$nths $% the child t)rning 1+. 5)t, beca)se that this (as &ere c$incidence and the date (as deter&ined independentl. $% the birthda., it (as n$t child s)pp$rt and it (as treated as ali&$n.. NP0I<7NF Ahild is (hen parents di!$rce. 2 pa.s K $2000?&$nth. Khen child is 1/, pa.&ent is red)ced t$ $1000. Khen child is 1+, pa.&ent is red)ced t$ 0. 6he $1000 red)cti$n %r$& (hen the child is 1/ t$ (hen he is 1+ is child s)pp$rt as it is c$ntingent $n the childEs age and is n$t in the 6th p$stseparati$n .ear. 6he share $% the pa.&ent that is red)ced $n a c$ntingenc. $% the child (ill ne!er be ali&$n.. D$, $nl. $1000 $% the $2000 %r$& (hen the child (as t$ 1/ is ded)ctible. 6he $ther is child s)pp$rt. 6he &$ne. paid %r$& (hen the child is 1/ M 1+ is n$t ded)ctible at all, as itEs child s)pp$rt. C% E<*,ss Front(Loa2ing 1(%)F Recapt)re pr$!isi$n -% t$$ &)ch ali&$n. (as incl)ded $r ded)cted in a pri$r .ear, it is recapt)red in a s)bse>)ent .ear. 6he ta* treat&ent is then re!ersed. 6he pa.ee &a. take a ded)cti$n $% the e*cess a&$)nt and the pa.$r &)st incl)de that e*cess a&$)nt as inc$&e. H$r&)laF O1 ali&$n. M "d(O2 0li&$n. M O2 N*cess) = O' 0li&$n.e ? 2# = 15Y B a&$)nt thatEs recapt)red %$r 1st p$st-separati$n .ear. O2 ali&$n. M (O' ali&$n. = 15Y) B a&$)nt recapt)red %$r 2nd p$st separati$n .ear. 0dd the& t$gether, and .$) get the a&$)nt that &)st be recapt)red. D% Ali+onA Tr4sts 6+2 M the inc$&e %r$& an ali&$n. tr)st is ta*ed t$ the bene%iciar. $% the tr)st. E% D,p,n2,n*A E<,+ption -n the case $% a child $% di!$rced $r separated parents, the parent (ith c)st$d. $% the child %$r the greater part $% the .ear (ill $rdinaril. be entitled t$ the dependenc. e*e&pti$n %$r the child, pr$!ided that the parents t$gether are entitled t$ the e*e&pti$n. 152(e). 152(e)F 6he c)st$dial parent recei!es the e*e&pti$n e!en th$)gh the n$nc)st$dial parent &a. ha!e pr$!ided &$re s)pp$rt than the c)st$dial parent. 152(e)(1). 6he n$nc)st$dial parent is $rdinaril. all$(ed the e*e&pti$n $nl. (here the c)st$dial parent has released the clai& t$ the e*e&pti$n in (riting. 152(e)(2). Sne $% the general inc$&e, age, $r stat)s tests $% 151(c) &)st als$ be satis%ied be%$re the c)st$dial parent is entitled t$ the e*e&pti$n. F% Filing Stat4s 0 c)st$dial parent (ith head $% h$)seh$ld stat)s d$es n$t l$se it b. !irt)e $% releasing the clai& t$ the dependenc. e*e&pti$n. 2(b). #% "rop,rtA Transf,rs ( I&0H& 9.*. v. Davis - the 6<Es t* $% his appreciated pr$p. t$ his e*-(i%e, p)rs)ant t$ their pr$pert. settle&ent agree&ent, in ret)rn %$r her release $% her &arital rights, pr$d)ced rec$gni;ed ta*able gain t$ the h)sband. 6he (i%e, in t)rn, t$$k the HIU $% the pr$pert.. 5asicall., the h)sband had t$ pa. inc$&e $n gi!ing the (i%e the pr$pert. %$r &$re than his basis in e*change %$r her relin>)ishing her &arital rights.

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Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

0 s)es 5. 0 (ins $105Y. -nstead $% pa.ing cash, 5 gi!es 0 st$ck. 6he st$ckEs basis is $50Y and the HIU is $105Y. 6his is treated as th$)gh 5 s$ld the st$ck %$r $105Y, paid it t$ 0, & then b$)ght the shares %$r $105Y. 5 has a $55Y gain, 0 has $105Y inc$&e and a basis $% $105Y in the st$ck. 62-D @S 7S@,NR 0<<7-ND 6S I0RR-N8 ASC<7ND M 10/1. -% this (as a di!$rce pr$ceeding, 0Es basis ($)ld be 5Es basis ($50Y) and neither 0 n$r 5 ($)ld rec$gni;e a gain^ )CT, 8a!is (as regarded as inappr$priate in &arriage and di!$rce cases M the b)ilt-)p gain in the pr$pert. (as n$t being trans%erred $)tside the t($-sp$)se c$&&)nit., & W the h)sband sh$)ldnEt ha!e t$ pa. ta*es $n the gain. D$ 10/1 (as added and created an NPAN<6-S@ t$ the general r)le $% 8a!is. 10/1F @$ gain $r l$ss is rec$gni;ed $n a pr$pert. trans%er bet(een sp$)ses incident t$ di!$rce. 10/1(a),(b)F the trans%er bet(een sp$)ses is treated as a gi%t, (ith the trans%eree taking the trans%er$rEs basis, and @S6 the HIU, as (as the case in 8a!is. 0pplies t$ b$th di!$rce c$)ples and &arried c$)ples trans%erring pr$pert.. Dince neither gain n$r l$ss is rec$gni;ed, and the trans%er$rEs basis carries $!er t$ the trans%eree, the parties e%%ecti!el. deter&ine (h$ bears the %)t)re ta* b)rden in appreciated part. and (h$ recei!es the %)t)re ta* bene%it $n pr$pert. (ith a !al)e less than its basis. NP0I<7NF 1015(a)F @SRI07 RC7N K? ,-H6DF 8S@SR W 8S@NN st$ck (? basis $% $1Y & HIU $% 500Y. -% sells it at a gain (%$r &$re than $1000), basis (ill be the d$n$rEs basis. -% he sells it %$r a l$ss (%$r less than 500), his basis (ill be the HIU. D$, i% he sells it %$r $1500, heEll ha!e a 500 gain. -% he sells it %$r '00, heEll ha!e a $200 l$ss. -% he sells it %$r $ 00 (in b?t), n$ gain $r a l$ss. 10/1F 2CD50@8 W K-HN st$ck (? basis $% $1000. K takes the 2Es basis. 2ence, i% she sells it %$r $1500, she has a 500 gain. -% she sells it %$r 00, she has a '00 l$ss. -% she sells it %$r '00, sheEll ha!e a 00 l$ss. D$ it is !er. di%%erent than the n$r&al sit)ati$n (ith gi%ts^ $% Sp,*ial R4l,s R,gar2ing ",rsonal R,si2,n*, ( I &2& Dee 121(d)(')(0),(5) %$r r)les regarding the sale $% the pers$nal residence in di!$rce c$nte*ts. I% L,gal E<p,ns,s Dee CD !. ,il&$re

RE@% RCL% 2002(22 8;? -nterest in n$nstat)t$r. st$ck $pti$ns & n$n>)ali%ied de%erred c$&pensati$n are pr$pert. (?in the &eaning $% 10/1. 10/1 c$n%ers n$nrec$gniti$n treat&ent $n an. gain that the 6< &ight $ther(ise reali;e (hen 6< t* these inters t$t his %$r&er sp$)se. 0ssign&ent $% inc$&e d$ctrine 3 appl.. CS 6% #IL ORE (196') 8;8 Facts: 0 6< arg)ed that b?c his (i%eEs di!$rce clai&s ($)ld h)rt his b)siness, his litigati$n c$sts c$)ld be ded)cted as b)siness e*penses. 5)t, )nder the Srigin $% the Alai& 6est, e!en th$)gh a sp$)seEs clai&s &a. a%%ect a ta*pa.erEs b)siness, i% it ar$se %r$& pers$nal reas$ns, then the litigati$n c$sts in de%ending th$se clai&s are n$t ded)ctible. $ule: 7egal e*penses &a. be ded)cted t$ de%end clai&s that arise $)t $% b)siness, b)t n$t th$se that arise $)t $% pers$nal reas$ns (di!$rce). '&$at: 6he Srigin $% the Alai& 6estF 6he $rigin and character $% the clai& (ith respect t$ (hich an e*pense has inc)rred, rather than its p$tential c$nse>)ences )p$n the %$rt)nes $% the ta*pa.er, is the c$ntr$lling test $% (hether the e*pense (as b)siness $r pers$nal and hence (hether it is ded)ctible $r n$t )nder 212. Cnder the $rigin-$%-the-clai& test, legal e*penses in c$n4)ncti$n (ith a di!$rce (ill generall. be n$nded)ctible. 2?e, s)b4ect t$ the 21 %l$$r r)le $% 6 , the c$st $% ta* planning ad!ice is generall. <age +5 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

regarded as ded)ctible, as are the legal e*penses attrib)table t$ a&$)nts incl)dable in inc$&e as ali&$n.. Reg. 1.262-1(b)( ). R,6,n4, R4ling :;(H20 882 -% (1) a h)sband and (i%e h$ld pr$pert. as 4$int tenants and 4$intl. $(e &$ne. $n a &$rtgage, and (2) p)rs)ant t$ di!$rce agree&ents, (') the h)sband pa.s the &$rtgage and the (i%e $(es n$thing, the (i%e recei!ed inc$&e )nder 2ld #olony -rust as she (as relie!ed $% her debt. "RE@IOCS E!A &% 0 M can $nl. ded)ct .$)r basis in a bad debt, n$ ded)cti$n b?c n$ basis in the bad debt. -a. @$ bad debt ded)cti$n is all$(ed )nless s)ch a&ts ha!e been incl)ded in inc$&e, (hich ($)ld n$t be the case (? the cash &eth$d 6<. 2% N M c$nstr)cti!e receipt 1% 8 M J)d. cann$t rec$gni;e a gain $r l$ss b?c itEs a gi%t. 1.102-L H% 8 M $120,000 1.1001-1(e) M C$ ? ?% 5 M %ringe bene%it, A2 11 M >)ali%ied e&pl$.ee disc$)nt 201 e*cl)dable has t$ incl)de $200 in ,-. :% 5 M ded)ctible !. capital ? depreciati$n ;% N - 1'/1, ded)cti$n $'000 $r $'500 credit, take the best $ne. 8% 5 M A2 16 9% 5 M appl. 12 &$nth r)le M A2 1' - 10/6 &0% 0 - 1015(a) M the d$nees generall. takes the d$ners basis e*cept i% that the &&% skip &2% skip &1% skip &H% skip &?% 8 M basis r)le %$r pr$pert. le%t in a (ill, HIU at the date $% death B $1.5k &:% 5 M Re!. R)ling 99&;% 5 M 165(b) &8% skip &9% 8 20% A M ta* bene%it r)le in 111 2&% 0 22% 8 21% 5 2H% 8 2?% 5 2:% N 2;% N 28% 5 102(c)(1) 29% 0 10% 5 M clai& $% right 1&% 5 12% skip 11% 8 1H% A 1?% 0 1:% 8, c$ntested debt d$ctrine & p)rchased $ debt red)cti$n <age +6 $% +

Tara Short, Class of 2009 Spring 2008 WOOTEN

FEDERAL INCO E TA! I

S"RIN# 08

1;% 8 18% 8 19% 5 M 1 9, l$$k at %irst pg. 125,000 &a* - $+0k (ent $!er H0% 8 M 10+(') M t$ the e*tent .$) are ins$l!ent H&% 8 H2% 8 H1% 8 HH% 8 - 1(%) H?% A H:% 0 M kn$( di%%erence b?t 0678 & 5678 H;% 0 H8% 5 - assign&ent $% inc$&e, inc$&e %r$& ser!ices is ta*ed t$ the earner H9% N ?0% A

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