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Federal Income Tax Outline

Fall 2005
Table of Contents
Table of Contents..........................................................................................................................................................1
Abbreviations in This Outline......................................................................................................................................3
I. Overview of Income Tax Sstem..............................................................................................................................4
A. Sources of Tax !aw..............................................................................................................................................4
". Tax !iti#ation........................................................................................................................................................4
C. Ste$s in Com$utin# Taxable Income..................................................................................................................5
II. %thics.........................................................................................................................................................................5
A. Standards for Tax Attornes...............................................................................................................................5
&. A"A Formal O$inion '5()52............................................................................................................................5
2. I*S Circular 2)0 + "est ,ractices and Other Standards -)& C.F.*. . &0.)/0..............................................5
). Section 112/.......................................................................................................................................................6
". Standards for Tax$aers......................................................................................................................................6
III. The Sco$e of 3ross Income...................................................................................................................................6
A. Cash *ecei$ts4 5oes Source 6atter7.................................................................................................................6
&. 3enerall8 9o.....................................................................................................................................................6
2. Tax(Free *ecover of Ca$ital is Allowed........................................................................................................7
). Statutor %xclusions -Con#ress Sas Source 6atters0..................................................................................7
". Is it taxable if it isn:t cash7..................................................................................................................................9
&. 3enerall8 ;es8 as far as . 1& is concerned......................................................................................................9
2. Two 3reat 9on(Statutor %xclusions of 9on(Cash %conomic "enefits....................................................10
). Statutor %xclusions "ased on the 9on(Cash 9ature of the "enefit.........................................................10
/. 5e Facto Administrative %xclusion + Fre<uent Flier 6iles4 C" 2&)(22&..................................................14
C. Income Inclusions as 6ista=e(Correctin# 5evices.........................................................................................14
&. The Annual Tax Accountin# ,eriod...............................................................................................................14
2. !oans and Cancellation of Indebtedness......................................................................................................14
). The Tax "enefit *ule......................................................................................................................................17
I>. ,ro$ert Transactions..........................................................................................................................................17
A. The *eali?ation 5octrine...................................................................................................................................17
&. %isner v. 6acomber........................................................................................................................................18
2. @nreali?ed A$$reciation8 Stoc= 5ividends vs. Cash 5ividends..................................................................18
). The Constitutional Issue.................................................................................................................................18
". 6ani$ulation of the *eali?ation *ules.............................................................................................................18
&. The Substance of a Sale without *eali?ation of 3ain..................................................................................19
2. The Substance of Continued Ownershi$ with *eali?ation of !oss............................................................19
). ACherr ,ic=in#B + . &2&& Ca$ital !oss !imitations..................................................................................19
C. 9onreco#nition4 C" 212....................................................................................................................................19
&. The conce$t of nonreco#nition.......................................................................................................................19
2. !i=e(Cind %xchan#es4 C" 2D2E F" 220........................................................................................................19
). Involuntar Conversions -. &0))04 C" 2DDE F" 2)D...................................................................................20
/. ,ermanent %xclusion of 3ain on the Sale of a ,rinci$al *esidence..........................................................20
5. Installment Sales................................................................................................................................................21
%. Annuities..............................................................................................................................................................21
F. "asis *ules for ,ro$ert Transferred b 3ift or "e<uest...............................................................................22
&. ,ro$ert Transferred b Inter >ivos 3ift.....................................................................................................22
2. ,ro$ert Transferred at 5eath......................................................................................................................22
). ,art 3ift8 ,art Sale Transactions...................................................................................................................22
3. "asis Allocation4 ,iecemeal Asset 5is$ositions and Other Contexts4 C" 22/..............................................22
I>. ,ersonal 5eductions..............................................................................................................................................23
A. Charitable Contributions -. &D004 C" )51E F" 5&2........................................................................................23
&. The *ationale..................................................................................................................................................23
2. The Amount of the 5eduction........................................................................................................................23
). %li#ible *eci$ients...........................................................................................................................................24
1
/. !imitations on 5eductions and Carrovers.................................................................................................24
5. >ehicle 5onations............................................................................................................................................24
1. Guid ,ro Guo..................................................................................................................................................24
". Interest %x$ense4 C" )1)E F" /20...................................................................................................................25
&. Gualified *esidence Interest..........................................................................................................................25
2. "usiness 5ebt...................................................................................................................................................26
). Investment and ,assive Activit Interest......................................................................................................26
/. %ducational !oan Interest..............................................................................................................................26
C. State and !ocal Taxes4 C" )D5E F" /2'..........................................................................................................26
5. Casualt !osses4 C" )'28 /D0(/D'E F" 500.....................................................................................................27
%. 6edical %x$enses4 C" )''E F" 5&/.................................................................................................................27
F. 6iscellaneous Itemi?ed 5eductions4 C" )2/E F" 52D....................................................................................28
3. *eduction of Itemi?ed 5eductions for Fi#h Income Tax$aers4 C" )25.....................................................28
>. "usiness %x$ense 5eductions................................................................................................................................28
A. Hhat is an AOrdinar and 9ecessarB ex$ense7 + C" /25............................................................................28
&. 9ecessar.........................................................................................................................................................28
2. Ordinar..........................................................................................................................................................28
". Hhat is a ATrade or "usinessB7........................................................................................................................29
C. ,ublic ,olic !imitations...................................................................................................................................29
5. !obbin# %x$enses............................................................................................................................................29
%. *easonable Com$ensation.................................................................................................................................29
F. Travel and %ntertainment..................................................................................................................................30
&. Travel................................................................................................................................................................30
2. %ntertainment.................................................................................................................................................30
3. ,atrollin# the "usiness(,ersonal "orders.......................................................................................................31
&. Fobb !osses...................................................................................................................................................31
2. >acation Fomes...............................................................................................................................................32
). Fome Office.....................................................................................................................................................32
/. %ducation %x$enses........................................................................................................................................32
5. Hor=(*elated Clothin#..................................................................................................................................33
>I. Ca$itali?ation and Cost *ecover.......................................................................................................................33
A. Ca$itali?ation and 5e$reciation4 The "asics..................................................................................................33
". Hhat is 5e$reciable7.........................................................................................................................................33
C. Hhat Costs 6ust "e Ca$itali?ed7....................................................................................................................34
&. Self(,roduced ,ro$ert..................................................................................................................................34
2. I95O,CO........................................................................................................................................................34
). *e$airs.............................................................................................................................................................34
/. %x$enses to Create or 6aintain a "usiness *e$utation..............................................................................34
5. Iob Funtin# %x$enses....................................................................................................................................35
>II. Tax Accountin#....................................................................................................................................................35
A. 3enerall.............................................................................................................................................................35
". Cash 6ethod4 Constructive *ecei$t.................................................................................................................35
C. Accrual 6ethod..................................................................................................................................................35
&. All %vents Test8 Clear *eflection of Income8 and %conomic ,erformance................................................35
2. %arl Cash *ecei$ts of Accrual 6ethod Tax$aers....................................................................................36
>III. Tax ,references..................................................................................................................................................36
A. Tax Shelters.........................................................................................................................................................36
&. ,assive !oss *ules of . /12............................................................................................................................36
2. Iudicial Anti(Abuse 5octrines.......................................................................................................................36
". Alternative 6inimum Tax.................................................................................................................................37
IJ. Taxation and the Famil......................................................................................................................................37
A. Tax Allowances for Famil *es$onsibilities.....................................................................................................37
&. Allowances for Child Care %x$enses.............................................................................................................37
2. Child Tax "enefits 9ot "ased on %x$enditures...........................................................................................38
". Income Tax Treatment of 6arria#e..................................................................................................................38
C. Income Tax Conse<uences of 5ivorce..............................................................................................................38
2
5. %arned Income Tax Credit................................................................................................................................39
J. Identifin# the ,ro$er Tax$aer -Attribution0...................................................................................................39
A. %arned Income...................................................................................................................................................39
". Income from ,ro$ert........................................................................................................................................39
JI. Ca$ital 3ains and !osses.....................................................................................................................................40
A. 6echanics of 9et Ca$ital 3ain Com$utation.................................................................................................40
&. !on# and Short Term Ca$ital 3ains and !osses.........................................................................................40
2. 9ettin# of !on# and Short 3ains and !osses...............................................................................................40
). The Several Ca$ital 3ains *ates...................................................................................................................40
/. 9ettin# the S$ecial *ate Cate#ories..............................................................................................................41
". !imitations on 5eductions of Ca$ital !osses...................................................................................................41
&. *ationale..........................................................................................................................................................41
2. The Ca$ital !oss !imitation *ule.................................................................................................................41
). A "i# %xce$tion for Small "usiness Stoc=....................................................................................................41
/. Ca$ital !oss Carrbac= and Carrover.......................................................................................................41
C. 5efinition of a Ca$ital Asset..............................................................................................................................41
&. ,ro$ert Feld for Sale to Customers............................................................................................................41
2. ,ro$ert @sed in a Trade or "usiness...........................................................................................................42
5. Sale or %xchan#e *e<uirement.........................................................................................................................42
%. Substitutes for Future Ordinar Income.........................................................................................................42
Abbreviations in This Outline
C" + Caseboo=
F" + Fornboo=
, + ,ublication &D
3
I. Overview of Income Tax Sstem
@nit &4 C" $$ &(28 2D()2 -s=i$ chart on 2'(220 and Introduction -F" $$ &('0
A. Sources of Tax !aw
The Internal Revenue Code u!"ect to an# contraint i$%oed !# the &.'. Contitution.
Re(ulation %ro$ul(ated !# the Treaur# )e%art$ent. In o$e cae* Con(re ha dele(ated to the
Treaur# the authorit# to eta!lih u!tantive rule +,le(ilative re(ulation-. rather than $erel# to
inter%ret the Code +,inter%retive re(ulation-.. I/ a court !elieve that a Code %roviion could reaona!l#
!e inter%reted in $ore than one 0a#* the court 0ill u%hold an# reaona!le re(ulator# inter%retation.
Chevron &.'.A. v. 1atural Reource )e/ene Council* 467 &.'. 837 +1984..
Revenue rulin( and revenue %rocedure %u!lihed !# the IR'.
o A revenue rulin( et /orth the IR'2 vie0 a to ho0 the Code a%%lie to a h#%othetical et o/ /act.
A rulin( doe not have a %reu$%tion o/ validit#. 3o0ever* a ta4%a#er $a# rel# on /actuall#
a%%lica!le ta4%a#er5/avora!le rulin( +unle and until the IR' revo6e the rulin(..
o Revenue %rocedure have the a$e le(al tatu a revenue rulin(* !ut the# ree$!le re(ulation
in /or$at
7etter rulin(. 8or a /ee* a ta4%a#er $a# re9uet a %rivate letter rulin( /ro$ the IR'. The ta4%a#er u!$it
to the IR' a decri%tion o/ the %ro%oed tranaction and the ta4%a#er2 ar(u$ent a to 0h# /avora!le ta4
treat$ent i 0arranted under the a%%lica!le la0. I/ the IR' iue a /avora!le rulin(* the ta4%a#er to 0ho$
the rulin( i iued $a# rel# on it* even i/ the IR' later decide the le(al anal#i i 0ron(. The di//erence
!et0een a revenue rulin( and a letter rulin( i that a ta4%a#er2 reliance on a letter rulin( iued to another
ta4%a#er i not %rotected.
The Treaur# and the IR' rel# on detailed re%ort /ro$ the 3oue and :a# and ;ean Co$$ittee and the
'enate 8inance Co$$ittee in inter%retin( the Code.
<lue!oo6 A/ter the enact$ent o/ $a"or ta4 le(ilation* the 'ta// o/ the =oint Co$$ittee on Ta4ation
uuall# %u!lihe a ,>eneral ?4%lanation- +or ,<lue!oo6-. decri!in( the le(ilation. <lue!oo6 are
lar(el# co$%iled /ro$ the 3oue and 'enate co$$ittee re%ort. 'ince the# are 0ritten a/ter the le(ilation
ha !een enacted* <lue!oo6 are not reall# le(ilative hitor# and the# do not have the authorit# o/ %re5
enact$ent co$$ittee re%ort.
=udicial @%inion
". Tax !iti#ation
There are three "udicial /oru$ in 0hich a ta4%a#er can liti(ateA
1. &.'. )itrict Court /or the ditrict in 0hich the ta4%a#er reide
2. Court o/ 8ederal Clai$ +no "urie.
3. &.'. Ta4 Court
In the )itrict Court and the Court o/ 8ederal clai$* the ta4 %a#er can onl# liti(ate a/ter %a#in( the di%uted ta4 and
uin( /or a re/und. In Ta4 Court* the ta4%a#er can liti(ate 0ithout havin( /irt %aid the ta4. A ta4%a#er invo6e the
"uridiction o/ the Ta4 Court !# /ilin( a %etition 0ithin 90 da# o/ the date o/ a notice o/ de/icienc# iued !# the
IR'.
Ta4 Court i head9uartered in :ahin(ton* ).C. Ta4 Court "ud(e ride circuit throu(hout the countr#* o a ta4%a#er
doe not have to travel to :ahin(ton to %reent her cae. ;ot ta4 o%inion are iued !# a in(le "ud(e !ut
i$%ortant iue can !e u!$itted to a %anel o/ all "ud(e* ittin( en !anc. All Ta4 Court trial are !ench trial +no
"urie.. @%inion are dei(nated a either ,$e$orandu$- or ,re(ular- o%inion. A $e$orandu$ o%inion a%%lie
0ell5eta!lihed la0 to the /act o/ a %articular cae* 0hile a re(ular o%inion involve $ore interetin( le(al iue.
<oth t#%e o/ o%inion have %recedential value* althou(h re(ular o%inion have o$e0hat (reater 0ei(ht* and en
!anc o%inion +identi/ied a ,revie0ed !# the Court-. have %articularl# tron( %recedential value.
The a%%eal /ro$ either the Ta4 Court or a ditrict court i to the &.'. Court o/ A%%eal /or the circuit in 0hich the
ta4%a#er reide. An a%%eal /ro$ the Court o/ 8ederal Clai$ lie 0ith the Court o/ A%%eal /or the 8ederal Circuit.
I/ a ta4%a#er loe a cae !e(un in Ta4 Court* he $ut %a# not onl# the de/icienc#* !ut alo interet runnin( /ro$ the
ori(inal due date o/ the return* at the 8ederal hort5ter$ rate %lu three %ercenta(e %oint. I/ the ta4 %a#er 0in a
4
re/und cae* the (overn$ent 0ill %a# the ta4%a#er !oth the a$ount o/ the over%a#$ent and interet on the
over%a#$ent.
C. Ste$s in Com$utin# Taxable Income
'ee 3< 360
1.. >ro Inco$e
2.. 7eA deduction allo0ed a!ove the line a %rovided !# B 62
3.. CieldA Ad"uted >ro Inco$e +,A>I-.
4.. 7eA The (reater o/ ite$iDed deduction or the tandard deduction
5.. 7eA )eduction /or %eronal and de%endenc# e4e$%tion
6.. CieldA Ta4a!le inco$e
7.. Calculate Ta4
8.. 7eA An# ta4 credit
II. %thics
A. Standards for Tax Attornes
There are three di//erent rule that a ta4 attorne# $ut /ollo0 0hen deter$inin( 0hether to advie a ta4%a#er to ta6e
a %eci/ic %oition on hi returnA +1. an A<A o%inion* +2. a Treaur# Re(ulation* and +3. a tatutor# %roviion.
&. A"A Formal O$inion '5()52
C< 65* 3< 649
@%inion 855352 tate that a la0#er can advie that a client ta6e a %oition on hi or her return a lon( aA +1. the
la0#er ha a (ood /aith !elie/ that the %oition i 0arranted in e4itin( la0 or can !e u%%orted !# a (ood /aith
ar(u$ent /or an e4tenion* $odi/ication* or reveral o/ e4itin( la0E and +2. ,there i o$e realitic %oi!ilit# o/
ucce i/ the $atter i liti(ated.-
The co$$entar# to the o%inion tate that realitic %oi!ilit# o/ ucce hould not !e a %oition havin( onl# a 5F
or 10F li6elihood o/ ucce i/ liti(ated !ut rather a%%ro4i$atin( 1G3. In deter$inin( the chance o/ ucce* the
%ro!a!ilit# o/ an audit cannot !e ta6en into account. 3o0ever* ince the co$$entar# i not %art o/ the actual
o%inion it i unclear ho0 $uch 0ei(ht it hould !e (iven.
Thi o%inion $a6e clear the A<A2 %oition that the attorne# ha a dut# to the client a!ove all ele and the /ilin( o/
a ta4 return $a# !e the /irt te% in a %roce that $a# reult in an adverar# relationhi% !et0een the client and the
IR'.
'u$$ar#A It i o6a# to ta6e a((reive %oition* even one 0ithout u!tantial authorit# and it i o6a# to do o
0ithout dicloure* a lon( a the attorne# !elieve that #ou have !et0een a 10 and 33 %ercent chance o/ ucce +or
(reater..
2. I*S Circular 2)0 + "est ,ractices and Other Standards -)& C.F.*. . &0.)/0
C< 69 and 3< 652
Circular 230 et out the re9uire$ent /or attorne# and other a(ent 0ihin( to %ractice !e/ore the IR'. An attorne#
0ho violate thee re9uire$ent $a# !e /ined* u%ended* or di!arred /ro$ %racticin( !e/ore the IR'.
Circular 230 ue ,realitic %oi!ilit# o/ ucce- !ut de/ine it a at leat a one in three +1G3. chance o/ ucceedin(
on the $erit. An attorne# can rel# on re%reentation o/ /act $ade !# hi client. 3e cannot i(nore in/or$ation
/urnihed to hi$ or actuall# 6no0n !# hi$ and $ut $a6e a reaona!le in9uir# i/ the in/or$ation a%%ear to !e
incorrect or inconitent 0ith other /act or /actual au$%tion.
A %ractitioner $a# not %rovide 0ritten advice to a ta4%a#er thatA +1. i !aed on unreaona!le /actual or le(al
au$%tionE +2. /ail to ta6e into account all relevant /act that the %ractitioner hould 6no0E or +3. conider the
chance o/ audit or the chance that the iue 0ill not !e raied on audit.
5
I/ the %ractitioner 6no0 that third %artie 0ill ue or rel# on thi advice in $ar6etin( or %ro$otin( ta4 helter* the
IR' 0ill a%%l# a hei(htened tandard o/ care.
). Section 112/
a. K250 ,enalt
Thi ection i$%oe a H250 %enalt# on an inco$e ta4 return %re%arer 0ho %re%are a return +or %rovide advice in
connection 0ith the %re%aration o/ a return. that ta6e an undicloed %oition /or 0hich there 0a not a realitic
%oi!ilit# o/ ucce on the $erit. Ade9uate dicloure o/ the %oition 0ill avoid the %enalt# a lon( a the
%oition i not /rivolou. 'i$ilar to Circular 230* a realitic %oi!ilit# o/ ucce i at leat a one5in5three chance o/
%revailin( on the $erit.
Thi %enalt# i %ro!a!l# $ot i(ni/icant /or a %re%arer %re%arin( a hi(h5volu$e o/ lo05/ee ta4 return. The
%re%arer $a# alo !e concerned that a B 6694 %enalt# 0ill tri((er dici%linar# action under Circular 230.
b. K&8000 ,enalt . 112/-b0
I/ the undertate$ent 0a due to 0ill/ul or rec6le conduct* or to an intentional dire(ard o/ rule or re(ulation.
The re(ulation %rovide that a realitic %oi!ilit# o/ ucce i at leat a one in three chance o/ ucce on the $erit
and the chance o/ an audit +or the chance o/ (ettin( cau(ht. cannot !e conidered in $a6in( thi deter$ination.
". Standards for Tax$aers
B 6662 i$%oe a %enalt# on a ta4%a#er 0ho /ile a ta4 return that undertate hi correct ta4 lia!ilit# !# $ore than
the (reater o/ H5*000 or 10 %ercent o/ the correct ta4 lia!ilit#. The %enalt# i 20 %ercent o/ the undertate$ent. An
undertate$ent u!"ect to %enalt# doe not arie /ro$ either +1. an undicloed return %oition /or 0hich the
ta4%a#er had ,u!tantial authorit#*- or +2. a %oition that lac6 u!tantial authorit#* !ut that i ade9uatel# dicloed
and /or 0hich there i a reaona!le !ai. >ood /aith reliance on %ro/eional advice i a reaon /or relie/ under B
6664+c..
III. The Sco$e of 3ross Income
A. Cash *ecei$ts4 5oes Source 6atter7
&. 3enerall8 9o
IRC B 61 de/ine (ro inco$e a ,all inco$e /ro$ 0hatever ource derived.- The tatute (ive 15 e4a$%le* !ut
inco$e i not li$ited to thoe e4a$%le.
Co$$iioner v. >lenha0 >la Co.* 348 &.'. 426 +1955. C< % 77
T0o cae 0ere conolidated in thi cae. @ne cae involved e4e$%lar# da$a(e /or /raud and the other involved
%unitive da$a(e. The iue in thi cae 0a 0hether $one# received a e4e$%lar# da$a(e /or /raud or a the
%unitive %ortion o/ antitrut recover# $ut !e re%orted !# a ta4%a#er under B 61. The Court held that ,Con(re
a%%lied no li$itation a to the ource.- 1ot onl# are the co$%enator# da$a(e ta4a!le !ut o are %unitive
da$a(e. The %unitive da$a(e are ,acceion to 0ealth.-
Cearini v. &nited 'tate* 296 8. 'u%%. 3 +1.). @hio 1969. C< % 81
The ta4%a#er !ou(ht a %iano /or H15 in 1957. In 1964* the ta4%a#er dicovered H4*000 in the %iano. The
ta4%a#er /iled a return clai$in( the dicovered a $one#. The# later /iled an a$ended return e4cludin( the /ound
$one# and clai$in( a re/und. The ta4%a#er ar(ued +1. the /ound $one# 0a not inco$eE +2. i/ it 0a inco$e* it
0a inco$e in 1957 and there/ore the tatute o/ li$itation had runE or +3. i/ it 0a inco$e* it hould !e ta4ed at the
ca%ital (ain rate. The court held that it 0a inco$e in the #ear it 0a /ound and that the conce%t o/ inco$e i !road
enou(h to cover thi.
Trea. Re(. B 1.61514 %rovide that treaure trove i inco$e in the #ear 0hen it i reduced to undi%uted %oeion.
"aseball4 C" 202 + 20/E F" 5D ( 52
:hat are the ta4 i$%lication to a /an 0ho catche a !all 0orth H1*000*000I
8irt* a /an 0ho cau(ht the !all 0ould %ro!a!l# have inco$e o/ H1*000*000. I/ he 0on the lotter# or a %riDe it 0ould
!e ta4ed. I/ the /an catche the !all* i/ he (ive it to o$eone ele +/or intance ;c>0ire.* the /an i e4erciin(
6
control and it ee$ the /an 0ould not onl# !e re%oni!le /or inco$e ta4 !ut /or a (i/t ta4. In IR' Jre Releae
IR598556* the IR' aid there 0ould !e no ta4 i$%lication i/ /an (ave !ac6 the !all +!ut 0hat a!out not (ivin( it
!ac6 !ut (ivin( it to ;c>0ireI.. @ne ar(u$ent a(aint ta4ation i that the !ae!all i li6e el/5created %ro%ert# or
i$%uted inco$e and hould not !e ta4ed until it i old.
2. Tax(Free *ecover of Ca$ital is Allowed
B 61+a.+3. tate that (ro inco$e include ,(ain derived /ro$ dealin( in %ro%ert#.- B 1001+a. de/ine the (ain on
the ale o/ %ro%ert# a the e4ce o/ the a$ount realiDed on the ale over the ad"uted !ai o/ the %ro%ert#. B
1001+!. de/ine a ta4%a#er2 a$ount realiDed on a ale a the cah received !# the ta4%a#er %lu the /air $ar6et
value o/ an# non5cah %ro%ert# received. B 1012 de/ine a ta4%a#er2 !ai in an aet a ,the cot o/ uch %ro%ert#.-
). Statutor %xclusions -Con#ress Sas Source 6atters0
a. 3ifts and "e<uests
Co$$iioner v. )u!ertein* 363 &.'. 278 +1960. C< % 87
B 102 e4clude (i/t /ro$ inco$e. The iue 0a 0hat contitute a (i/t. The Court held that a (i/t i (iven 0ith
,detached and diintereted interet.- The Court ,%unt- holdin( that trial court are !etter at deter$inin( the
,$ain%rin( o/ hu$an conduct.- The Court tated that the /actual /indin( o/ lo0er court 0ill (enerall# !e
u%held.
&nder B 274+!.* !uinee can2t deduct a (i/t a a !uine e4%ene +onl# u% to H25 %er individual.. &nder B
102+c.* an# a$ount (iven to an e$%lo#ee cannot !e e4cluded /ro$ the e$%lo#ee2 inco$e +!ut ee Trea. Re(. B
1.13256+e.+1. 0hich e4clude non5cah lo0 value traditional !irthda# or holida# (i/t a a de $ini$u /rin(e..
3#%oA 3u!and e$%lo# 0i/e. 3 (ive : a !irthda# (i/t. Thi i e4cluda!le !ecaue it i not in the co%e o/
e$%lo#$ent.
b. 5ama#es on Account of ,ersonal ,hsical InLuries -C" 22(&0)0
-i0 3enerall
B 104+a.+2. e4clude /ro$ (ro inco$e ,an# da$a(e +other than %unitive da$a(e. received +0hether !# uit or
a(ree$ent and 0hether a lu$% u$ or a %eriodic %a#$ent. on account o/ %eronal %h#ical in"urie or %h#ical
ic6ne.- The e4cluion a%%lie toA +1. non5%ecuniar# da$a(e /or %ain and u//erin( or lo o/ en"o#$entE +2.
da$a(e /or $edical e4%ene +%at and /uture.E or +3. da$a(e /or lot 0a(e +%at and /uture..
B 104+a.+2. i ver# i$%ortant /or la0#er. Their (oal i to (et their client 0ithin B 104+a.+2.. 8or e4a$%le* #ou ue
/or H6 $illion. Jart o/ thi H6 $illion i %ro!a!l# threat o/ %unitive da$a(e. Cou tart tal6in( ettle$ent. Cou ue
the ettle$ent a(ree$ent a a 0a# to clai/# all the recover# a co$%enator# rather than %unitive.
1
?4a$%leA :hen )enni Rod$an 6ic6ed the ca$era$an* the attorne# /or the ca$era$an 0ould a# that it i
e4cluda!le !ecaue it 0a /or da$a(e. The (overn$ent ar(ued that not all o/ that $one# 0a /or %ain and
u//erin(.
-a0 9on($ecuniar dama#es
8or e4a$%le* i/ a violinit2 hand i in"ured and he recover H1 $illion* the recover# i not ta4ed. There are t0o
reaon /or thi rule. 8irt* the hand i 0orth H1 $illion and thi i i$%l# a recover# o/ ca%ital. 'econd* 0e don2t
6ic6 a %eron 0hen the# are do0n.
There are t0o %ro!le$ 0ith thee "uti/ication. 8irt* /or other %ur%oe* 0e au$e Dero !ai o/ a !od# %art a
%eron can2t ta6e a deduction i/ the# loe the ar$ throu(h their o0n /ault. :e alo have a %ro!le$ o/ ine9ualit#
0here one %eron collect and the other doen2t.
-b0 6edical %x$enses
The %olic# "uti/ication /or e4cluion o/ $edical e4%ene i that the# 0ould !e deducti!le an#0a# under IRC B 213.
In %ractice* ho0ever* B 104+a.+2. %rovide !etter reult than B 213 !ecaue the $edical e4%ene deduction +B 213. i
1
'ee the horn!oo6 /or the e4a$%le on e4ual hara$ent +I don2t 6no0 0hat %a(e..
7
onl# allo0ed /or $edical e4%ene in e4ce o/ 7.5 %ercent o/ the ta4%a#er2 ad"uted (ro inco$e and i not
availa!le i/ the ta4%a#er ta6e the tandard deduction.
-c0 !ost wa#es
Thi e4cluion i hard to "uti/# !ecaue i/ the %eron had not !een in"ured and had earned the 0a(e* the 0a(e
0ould not have !een e4cluda!le. @ne ar(u$ent i the di//icult# in e%aratin( the lot 0a(e da$a(e /ro$ other
da$a(e. Another ar(u$ent i that the e4cluion i a ta4 u!id# /or the tort %lainti//2 contin(ent attorne#2 /ee.
-ii0 The ,hsical InLur *e<uirement
Jrior to 1996* the e4cluion a%%lied to da$a(e on account o/ %eronal in"urie 0hether %h#ical or not. Court had
(reat di//icult# decidin( 0hich non%h#ical in"urie 9uali/ied a %eronal in"urie* da$a(e /or 0hich 0ere
e4cluda!le. In 1996* B 104+a.+2. 0a a$ended and the 0ord %h#ical 0a added. The a$end$ent reduced
con/uion a to 0hat in"urie the ection a%%lied* !ut it i le /air. There i no %olic# reaon 0h# recoverie /or
%h#ical in"urie hould !e e4cluded !ut recoverie /or non%h#ical in"urie hould not !e e4cluded.
-iii0 %motional 5istress
&nder B 104+a.* ,e$otional ditre hall not !e treated a a %h#ical in"ur# or %h#ical ic6ne.- 3o0ever* thi
doe not a%%l# to a$ount not over the a$ount %aid /or $edical care 0hich i attri!uted to the e$otional ditre.
Accordin( to the co$$ittee re%ort* it ee$ that da$a(e /or in"urie 0hich lead to e$otional ditre are
e4cluda!le !ut da$a(e /or e$otional ditre 0hich lead to in"urie i not e4cluda!le.
-iv0 !oss of Consortium and Hron#ful 5eath
The co$$ittee re%ort %eci/icall# a# that lo o/ conortiu$ and 0ron(/ul death are %eci/icall# e4cluda!le.
-v0 Structured Settlements
&nder B 104+a.+2.* %eriodic %a#$ent are e4cluda!le. I/ a %eron receive a lu$% u$ and u!e9uentl# invet the
lu$% u$* the lu$% u$ i e4cluda!le !ut (ain on the invet$ent are not e4cluda!le. 3o0ever* i/ a %eron
ne(otiate a tructured ettle$ent* the %a#or can invet the $one# and the tructured %a#$ent are not ta4a!le.
:h# 0ouldn2t %eo%le ta6e tructured ettle$entI
1. @%%ortunit# cot #ou thin6 #ou can do !etter
2. In real li/e* co$%anie 0ant to %lit the ta4 !ene/it.
c. !ife Insurance
B 101+a. %rovide that (ro inco$e doe not include ,a$ount received KLM under a li/e inurance contract* i/ uch
a$ount are %aid !# reaon o/ the death o/ the inured.-
-i0 T$es of !ife Insurance
There are eentiall# t0o t#%e o/ li/e inurance %olicieA +1. ter$ li/e inuranceE or +2. 0hole li/e inurance.
Ter$ 7i/e InuranceA I %a# each #ear an a$ount 0hich re%reent the chance o/ $e d#in(. I a$ !ettin( that I a$
(oin( to dieE the inurance co$%an# i !ettin( that I a$ (oin( to live. The inurance %olic# onl# cover $e d#in(
0ithin a %eci/ied ter$. ?ach #ear* the inurance %olic# !eco$e $ore e4%enive.
:hole 7i/e InuranceA Thi i a co$!ination o/ ter$ and invet$ent. There i a level %a#$ent. ?ach #ear* I %a# the
a$e a$ount.
&niveral 7i/eA Thi t#%e ha !eco$e ver# %o%ular 0ithin the lat (eneration. There are variou /or$* !ut the#
have in co$$on the /act that u!tantial invet$ent a%ect are co$!ined 0ith a core li/e inurance ele$ent. In the
earl# /or$ o/ thi t#%e* the invet$ent do$inated the li/e inurance a%ect. Con(re i(ni/icantl# cut !ac6 0hen it
added B 7703 to the code. The %ur%oe o/ 0hich 0a to $a6e the %re$iu$ %aid related to the actuarial ri6. Thi
li$it the a!ilit# to create lar(e invet$ent account 0ithin the u$!rella o/ a li/e inurance contract.
-ii0 %xclusion for !ife Insurance ,roceeds
B 101 o/ the Code %rovide that a$ount received a the ,%roceed o/ li/e inurance- are not includi!le in (ro
inco$e.
8
The advanta(e o/ e4cluion o/ li/e inurance death !ene/it have recentl# !een e4tended to cover ituation in
0hich a d#in( %olic#holder receive a %re5death inurance !ene/it. ;an# li/e inurance %olicie %er$it %a#$ent o/
all or a %art o/ the death !ene/it to the inured hi$el/* %rior to death* i/ he i ter$inall# ill. Niatical ettle$ent
%rovider have arien to %urchae or ta6e ai(n$ent o/ an inured2 interet in a li/e inurance %olic# i/ he i
ter$inall# ill. &nder B 101+(.* allo0 uch %a#$ent either /ro$ the inurance co$%an# or /ro$ ale or
ai(n$ent o/ ri(ht to a viatical ettle$ent co$%an# to 9uali/# /or the e4cluion (ranted !# B 101+a. /or li/e
inurance %roceed.
Ja#$ent $ade to chronicall# ill %atient $a# alo !e e4cluded a death !ene/it i/ the %a#$ent are ued to de/ra#
certain lon(5ter$ care e4%ene a li$itation that doe not a%%l# to the ter$inall# ill.
d. Other Source("ased %xclusions for Cash *ecei$ts
@ther i$%ortant e4cluion includeA +1. B 103 e4cluion /or interet on $unici%al !ondE +2. B 121 e4cluion /or (ain
on the ale o/ a %eronal reidenceE +3. B 86 e4cluion /or ocial ecurit# !ene/itE +4. (eneral 0el/are e4cluion
there i no tatutor# !ai !ut i ha lon( !een reco(niDed !# the IR'E +5. B 139 9uali/ied diater relie/ %a#$entE
+6. there are nu$erou other e4cluion %roviion.
". Is it taxable if it isn:t cash7
&. 3enerall8 ;es8 as far as . 1& is concerned
>enerall#* even i/ it in2t cah* it i till ta4a!le. The %ro!le$ i valuation. 8or e4a$%le* i/ #ou received 100
nic6er !ar* ho0 0ould #ou !e ta4edI The IR' $i(ht tr# to value #ou the$ at 60 cent each ince that i 0hat
the# are old /or. Cou could atte$%t to ar(ue that a reaona!le %eron 0ould not !u# 100 nic6er !ar at 60 cent
each* rather the# hould !e valued at the !ul6 %rice.
Roone# v. Co$$iioner* 88 T.C. 523 +1987. C< 110
8our o/ client o/ an accountin( /ir$ !eca$e delin9uent in %a#in( /or ervice. The /ir$ allo0ed their %artner to
receive (ood and ervice /ro$ the client /or /ree. In return* the# reduced the client2 de!t to the %artnerhi% !# an
a$ount e9ual to the %rice nor$all# char(ed /or uch (ood and ervice !# the client to it retail cuto$er. 7ater*
the %artner !eca$e diati/ied 0ith the cro5accountin( arran(e$ent 0ith the client. The# deter$ined that o$e
o/ the (ood received 0ere over%riced and that o$e o/ the ervice 0ere not ati/actoril# %er/or$ed and that
there/ore the value to the$ o/ the (ood and ervice 0a le than the nor$al retail %rice char(ed !# uch client.
The %artner dicounted the retail %rice o/ the (ood and ervice received !# the$ /ro$ the /our client and
reduced the %artnerhi%2 (ro recei%t account !# the a$ount o/ the dicount. The iue !e/ore the court 0a
0hether the /ir$ could dicount the retail %rice o/ (ood and ervice received !# coniderin( the %artner2
u!"ective deter$ination o/ value.
The court held that the /air $ar6et value o/ the (ood and ervice received !# the /ir$ 0a the %rice char(ed !#
the /ir$2 client and not the u!"ective valuation.
1ote that there i till roo$ /or ar(u$ent 0ith o!"ective 8;N. 8or e4a$%le* one %eron $i(ht ue the %rice char(ed
!# O5;art 0hile the other ue 'a6 8i/th Ave.
Revenue Rulin( 575374
An individual 0ho re/ue to acce%t an all5e4%ene %aid vacation tri% he 0on a a %riDe in a contet doe not have to
include the 8;N o/ the tri% in hi inco$e.
The C< %oint out that the %eron ha contructive recei%t and there/ore hould !e ta4ed. I/ a chec6 i handed out on
)ece$!er 31* Cear 1 !ut I don2t %ic6 it u% until =anuar# 2* Cear 2* it i till included in ta4e /or #ear 1 !ecaue I had
contructive recei%t. The C< alo ar(ue that there i no tatutor# !ai /or thi rulin(.
Ar(u$ent /or allo0in( thi rulin(A 0e don2t ta4 %eo%le /or raie the# don2t ta6e* and 0e aren2t ta4ed /or 0or6in(
at the )@= rather than a la0 /ir$. :e have the /reedo$ to have le $one#.
2. Two 3reat 9on(Statutor %xclusions of 9on(Cash %conomic "enefits
9
a. Im$uted Income + $ &&5
I/ I %aint $# o0n houe* I a$ not ta4ed on the 8;N o/ hirin( a %ro/eional %ainter to %aint the houe. 3o0ever* i/
ervice are %aid /or in e4chan(e /or other ervice* the 8;N o/ uch ervice $ut !e included in inco$e. 'ee
Roone# u%ra* ee alo Trea. Re(. B 1.6152+d.+1.. Reaon /or not ta4in( i$%uted inco$eA %rivac# and non5eroion
o/ ta4 !ae +%eo%le 0on2t do it "ut to avoid ta4e li6e the# 0ould i/ 0e e4cluded !artered inco$e..
The %ro!le$ 0ith not ta4in( i$%uted inco$e are evidenced !# the /ollo0in( e4a$%le +ee C< 1175118.A
Cou%le 1A 3 $a6e H80*000 and : $a6e H0 !ecaue he i a ta# out ho$e $o$.

Cou%le 2A 3 $a6e H40*000 and : $a6e H40*000. Cou%le 2 ha to %a# /or da# care* houe cleanin(* and $a#!e
the# eat out $ore* e.(. H16*000.
The %ro!le$ 0ith i$%uted inco$e are +1. e9ualit# and +2. e//icienc#. There i a %ro!le$ 0ith e9ualit# there i no
horiDontal e9uit#. The a$e inco$e end in di//erent reult. Cou%le 1 ha i$%uted inco$e o/ H96*000 0hich i
u!idiDed !# the (overn$ent. 8urther$ore* ta4ation $i(ht lead to e//icienc# %ro!le$. 8or e4a$%le* ee Carla
and Chuc6 +% 118.. Au$e Carla ta6e a "o! /or H30*000* %a# ta4 o/ H12*000* and H20*000 /or child ervice.
'ociet# 0ant her to !e a %u!lic a/et# o//icer !ecaue it value that hi(her than her ta#in( ho$e 0ith her children
+H30*000 v. H20*000. !ut it in2t 0orth it to her.
The IR' ha ruled that ervice $ean in the conte4t o/ !uine. 8or e4a$%le* +C< 119. i/ Oaren and 'andra are
(ood /riend uch that 0hen Oaren (oe on vacation 'andra /eed Oaren2 cat and 0ater Oaren2 la0n and Oaren
doe the a$e 0hen 'andra (oe on vacation* thi 0ould not !e inco$e !ecaue neither i in the !uine o/
0atchin( cat and 0aterin( la0n.
3el%in( out a /riend onl# a%%lie to ervice* it doe not a%%l# to %ro%ert#. 8or e4a$%le +C< 122 Jro!le$ 9. i/ t0o
%ro/eor a(ree to a te$%orar# houe 0a%* there i inco$e to !oth %ro/eor.
b. @nreali?ed A$$reciation + $ &22
&nrealiDed a%%reciation i not included in (ro inco$e. 3o0ever* u%on ale* B 1001* #ou are ta4ed on the (ain.
The uual %olic# e4%lanation /or the e4cluion i that ta4ation o/ unrealiDed a%%reciation 0ould involve tre$endou
%ro!le$ o/ valuation and li9uidit#. Thi i not a %er$anent e4cluion !ut rather a de/erral. Ta4ation i de/erred
until ale +unle the %eron die in 0hich cae B 1014 a%%lie..
Anti5/li% ruleA I/ I ell ecuritie to realiDe a lo* I can2t realiDe the lo i/ I re%urchae the ecuritie 0ithin 30 da#.
In ?iner v. ;aco$!er* 252 &.'. 189 +1920.*
2
the 'u%re$e Court held that the e4cluion o/ unrealiDed a%%reciation
/ro$ (ro inco$e 0a re9uired !# the Contitution. Althou(h the cae han2t !een /or$all# overruled* later
'u%re$e Court o%inion a%%ear to have de$oted it /ro$ contitutional tatu. &nder the current vie0* Con(re ha
the %o0er to ta4 unrealiDed a%%reciation to the e4tent it ee /it. 8or e4a$%le* B 475 re9uire ecuritie deal to
,$ar6 to $ar6et- their ecuritie each #ear.
). Statutor %xclusions "ased on the 9on(Cash 9ature of the "enefit
In (eneral* non5cah econo$ic !ene/it are includa!le in (ro inco$e in the a!ence o/ an e4%licit e4cluion
%roviion.
a. %m$loer(,rovided Fealth Insurance
B 106+a. e4clude /ro$ the (ro inco$e the value o/ e$%lo#er5%rovided health inurance covera(e. B 105+!.*
e4clude /ro$ (ro inco$e the value o/ !ene/it received under e$%lo#er5%rovided health inurance* to the e4tent
the !ene/it contitute rei$!ure$ent o/ $edical e4%ene. I/ an e$%lo#ee %a# throu(h %a#roll deduction* the
a$ount %aid i e4cluded /ro$ (ro inco$e. B 125 %rovide that health inurance covera(e $a# !e o//ered under a
,ca/eteria %lan.- &nder the ca/eteria %lan rule o/ B 125* a ta4%a#er 0ho i o//ered a choice !et0een cah and health
inurance covera(e* and 0ho chooe inurance* 0ill not !e ta4ed under the doctrine o/ contructive recei%t.
2
'ee C< 123
10
The re(ulation tate that the e4cluion onl# a%%lie to health inurance /or the e$%lo#ee* hi %oue* or hi
de%endent a de/ined in B 152. Trea. Re(. B 1.10651. I/ an e$%lo#er %rovide health inurance covera(e /or
un$arried %artner o/ it e$%lo#ee* the value o/ the %artner covera(e cannot !e e4cluded unle the %artner
9uali/ie a a de%endent.
Ta4%a#er 0ho do not have health inurance throu(h their e$%lo#er* B 213 allo0 the$ to clai$ their $edical
e4%ene includin( health inurance %re$iu$ not e4cluded under B 106 a ite$iDed deduction. 3o0ever*
under B 213+a.* $edical e4%ene are deducti!le onl# to the e4tent the# e4ceed 7.5F o/ ad"uted (ro inco$e. Thi
i an e4a$%le o/ ho0 the code %re/er e$%lo#er %rovided !ene/it to i$ilar ite$ %urchaed !# a ta4%a#er 0ith hi
o0n $one#.
b. 3rou$(Term !ife Insurance
B 79 allo0 e$%lo#ee to e4clude the value o/ (rou%5ter$ li/e inurance %rovided !# their e$%lo#er* /or u% to
H50*000 o/ inurance. 7ar(er a$ount o/ inurance can !e %rovided* !ut to the e4tent that the %olic# e4ceed the
H50*000 /ace a$ount %er$itted to !e received ta4 /ree* B 79 %rovide that the e$%lo#ee ha additional 0a(e inco$e
in the a$ount o/ the %re$iu$ %ro%erl# alloca!le to the e4ce covera(e.
c. Scholarshi$s and Other Tax "enefits for Fi#her %ducation %x$enses + C" &)0
)
B 117+a. e4clude /ro$ (ro inco$e ,an# a$ount received a a 9uali/ied cholarhi% !# an individual 0ho i a
candidate /or a de(ree- at a colle(e or univerit#. The e4cluion a%%lie !oth to cah cholarhi% and to
cholarhi% received in56ind +in the /or$ o/ /ree or reduced tuition.. The e4cluion i li$ited to the a$ount o/ the
tudent2 tuition and /ee* and the cot o/ coure5related !oo6* u%%lie* and e9ui%$ent. B 117+c. %rovide that the
e4cluion doe not a%%l# to ,an# a$ount received 0hich re%reent %a#$ent /or teachin(* reearch* or other ervice
!# the tudent re9uired a a condition /or receivin( the 9uali/ied cholarhi%.- I/ a (rant i in the /or$ o/ a
cholarhi% !ut i reall# co$%enation /or ervice* it 0ill !e treated a inco$e.
4
An e4cluion i allo0ed /or a 9uali/ied tuition reduction* 0hich i de/ined a a reduction in tuition %rovided to an
e$%lo#ee o/ an educational intitution /or the education o/ the individual or hi %oue or de%endent +alo availa!le
/or tuition reduction %lan at other educational intitution* e.(. throu(h an e4chan(e %ro(ra$.. B 117+d.+3..

Ar(u$ent /or not ta4in(A ?ducation i ver# i$%ortant and 0e 0ant to encoura(e it.
Ar(u$ent /or ta4in(A I/ #ou 0or6* $a6e the $one#* and %a#* #ou are ta4ed. I/ #ou are luc6# enou(h to (et a
cholarhi%* #ou are not ta4ed.

B 117 i thou(ht to o%erate !iDarrel# in e9uit#. The 3o%e Credit and 7i/eti$e 7earnin( credit 0ere intended to $a6e
it $ore e9uita!le.

Rev. Jroc 76547 C< 1325135
Thi revenue %rocedure (ive (uideline /or deter$inin( 0hether a (rant $ade !# a %rivate /oundation under an
e$%lo#er5related (rant %ro(ra$ to an e$%lo#ee or child o/ an e$%lo#ee i a cholarhi% under B 117+a..
In addition to B 117* Con(re ha enacted the 3o%e 'cholarhi% Credit +B 25A+!.. and the 7i/eti$e 7earnin( Credit
+B 25A+c... The credit are availa!le /or 9uali/ied tuition +de/ined in B 25A+/.. and related e4%ene incurred !# the
ta4%a#er* hi %oue* or hi de%endent. The credit are not re/unda!le +no %a#$ent i/ credit i lar(er than the
ta4%a#er2 lia!ilit#.. Credit $ean a dollar /or dollar reduction +!ut o$eti$e the code %ut a %ercenta(e li$it..
The 3o%e Credit and the 7i/eti$e 7earnin( Credit are %haed out !aed on the ta4%a#er2 $odi/ied ad"uted (ro
inco$e. 8or $arried cou%le /ilin( "ointl#* the credit %hae out /ro$ H87*000 to H107*000. 8or a in(le /iler* the
credit %hae out /ro$ H43*000 to H53*000.
An ar(u$ent in /avor o/ a (overn$ent u!id# /or education i that it i invet$ent in hu$an ca%ital 0hich 0e 0ant
to encoura(e. An ar(u$ent a(aint i that education i a %eronal conu$%tion choice that the ta4%a#er $ade.
3
3< 118
4
&nder Rev. Rule 775263* athletic cholarhi% are not inco$e !ecaue 0hen a athlete i o//ered an athletic
cholarhi%* the# receive a cholarhi% /or the entire #ear* even i/ the# end u% not %la#in( an# %ort.
11
Fo$e Scholarshi$ Credit + C" &)1E F" 1//(1/1E , 2/D(25)
The 3o%e 'cholarhi% credit %rovide a $a4i$u$ credit to the %eron %a#in( the e4%ene o/ H1*500 %er tudent /or
each o/ the tudent2 /irt t0o #ear o/ %otecondar# education. The credit allo0 a 100 %ercent credit %er eli(i!le
tudent /or the /irt H1*000 o/ tuition e4%ene +roo$* !oard* and !oo6 are not covered.. Then it allo0 a 50
%ercent credit /or the econd H1*000 o/ tuition %aid.
5
The tudent $ut !e enrolled at leat on a hal/ ti$e !ai.
'ince it i availa!le on a %er tudent !ai* i/ there are three 9uali/#in( tudent* the 3o%e 'cholarhi% Credit $a# !e
clai$ed /or all three.
!ifetime !earnin# Credit
The i a credit o/ 20F o/ 9uali/ied tuition e4%ene %aid !# the ta4%a#er /or an# #ear the 3o%e Credit i not clai$ed.
The credit i ta6en !# ta6in( 20F o/ the /irt H5*000 o/ tuition %aid !# the ta4%a#er in #ear !e/ore 2003 and the /irt
H10*000 a/ter 2003. The credit i calculated %er ta4%a#er and the a$ount doe not chan(e !aed on the nu$!er o/
tudent in the ta4%a#er2 /a$il#. The 7i/eti$e 7earnin( Credit can !e clai$ed /or an unli$ited nu$!er o/ #ear
and can !e ued /or !oth under(raduate and (raduate tuition and /ee.
. 222 5eduction for Gualified Tuition
B 222 allo0 #ou to deduct rather than clai$in( a credit 0hether thi i !etter than ho%e or li/eti$e de%end on
#our $ar(inal rate. Ta4%a#er can deduct* a!ove the line* a %ortion o/ their ,9uali/ied tuition- +0hich $ean the#
can ta6e thi in addition to the tandard deduction.. 8or #ear !e/ore 2006* ta4%a#er 0ith A>I that doe not e4ceed
H65*000 +H130*000 /or "oint return. $a# deduct u% to H2*000. Puali/ied tuition i the a$e de/inition a /or the
3o%e Credit and the 7i/eti$e 7earnin( Credit. Cou cannot clai$ !oth the deduction and the 3o%e or 7i/eti$e
Credit.

d. Frin#e "enefits -. &)204 C" 205(20'E F" 52(15
An e$%lo#er $a# %rovide /rin(e !ene/it to an e$%lo#ee a co$%enation /or 0or6in( /or the e$%lo#er. &nder the
!road de/inition o/ B 61* the %reu$%tion i that uch !ene/it are inco$e. B 132 %rovide an e4cluion /ro$ (ro
inco$e certain /rin(e !ene/it. A to +1. and +2. !elo0* the# are onl# availa!le to hi(hl# co$%enated e$%lo#ee
onl# i/ o//ered to other e$%lo#ee on a nondicri$inator# !ai +nondicri$inator# $ean co$%enation in thi
conte4t.. B 132+h.+1. %rovide that retired and dia!led e$%lo#ee and urvivin( %oue are treated a e$%lo#ee
/or %ur%oe o/ u!ection +a.+1. and +2.. In addition* %oue and de%endent children are treated a e$%lo#ee
under B 132+h.+2.. Jarent o/ an airline e$%lo#ee are treated a an e$%lo#ee and can (et /ree tand!# tic6et under
B 132+h.+3..
-&0 A no(additional(cost service4 . &)2-b0
Thi i a ervice %rovided !# an e$%lo#er to an e$%lo#ee i/A 1. the ervice i o//ered /or ale to cuto$er in the
ordinar# coure o/ the e$%lo#er2 line o/ !uine in 0hich the e$%lo#ee i %er/or$in( erviceE and 2. the
e$%lo#er incur no u!tantial cot +includin( /ore(one revenue. in %rovidin( the ervice to the e$%lo#ee
+deter$ined 0ithout coniderin( an# a$ount %aid !# the e$%lo#ee /or the ervice.. Alo* e$%lo#er can have
reci%rocal a(ree$ent 0here the e$%lo#er %rovide ervice to each other2 e$%lo#ee i/ the reci%rocal a(ree$ent i
in a 0ritten a(ree$ent and no e$%lo#er incur an# u!tantial additional cot. 'ee B 132+i..
-20 A <ualified em$loee discount4 . &)2-c0
:ith re%ect to a %roduct* the dicount cannot e4ceed the di//erence !et0een the ale %rice o/ the %roduct and the
cot to the e$%lo#er. :ith re%ect to a ervice* the dicount cannot e4ceed 20F o/ the %rice at 0hich the ervice
are o//ered !# the e$%lo#er to cuto$er. I/ the dicount i (reater than thee li$it* onl# the a$ount o/ the
dicount 0hich doe not e4ceed thee li$it i e4cludi!le and the !alance i includi!le in the inco$e o/ the
e$%lo#ee. The %ro%ert# cannot !e real %ro%ert# or %ro%ert# held /or invet$ent. In addition* the dicount $ut !e
on %ro%ert# or ervice o//ered in the ordinar# coure o/ the line o/ !uine o/ the e$%lo#er in 0hich the e$%lo#ee
i %er/or$in( ervice.
-)0 A wor=in# condition frin#e4 . &)2-d0
5
The 50F re9uire the ta4%a#er to have o$e re%oni!ilit# !ut a the horn!oo6 %oint out* there i no incentive /or
the ta4%a#er not to incur the /irt H1*000 and /or the econd H1*000* 50F i %rett# (enerou.
12
Thi i an# %ro%ert# or ervice %rovided to an e$%lo#ee o/ the e$%lo#er to the e4tent that* i/ the e$%lo#ee %aid /or
uch %ro%ert# or ervice* uch %a#$ent 0ould !e allo0a!le a a deduction to the e$%lo#ee under B 162 +ordinar#
and necear# !uine e4%ene. or B 167 +de%reciation..
-/0 A de minimis frin#e4 . &)2-e0
Thi i an# %ro%ert# or ervice the value o/ 0hich i +a/ter ta6in( into account the /re9uenc# 0ith 0hich i$ilar
/rin(e are %rovided !# the e$%lo#er to the e$%lo#er2 e$%lo#ee. o $all a to $a6e accountin( /or it
unreaona!le or ad$initrativel# i$%ractica!le.
An eatin( /acilit# o%erated !# the e$%lo#er 9uali/ie i/ +a. the /acilit# i located near or on the !uine %re$ie o/
the e$%lo#er and +!. the revenue derived /ro$ the /acilit# nor$all# e9ual or e4ceed the direct o%eratin( cot o/
the /acilit#. An e$%lo#ee entitled under B 119 to e4clude the value o/ a $eal +the $eal i /urnihed /or the
convenience o/ the e$%lo#er and /urnihed on the !uine %re$ie. i treated a havin( %aid an a$ount e9ual to
the o%eratin( cot o/ the /acilit# attri!uta!le to the $eal.
-50 A <ualified trans$ortation frin#e4 . &)2-f0
Thi i 9uali/ied %ar6in(* tranit %ae* or tran%ortation in a co$$uter hi(h0a# vehicle +vehicle that eat at leat
7 %eo%le. %rovided !# the e$%lo#er to the e$%lo#ee. A 9uali/ied tran%ortation /rin(e $a# not e4ceed H105 %er
$onth /or the a((re(ate o/ tran%ortation %ae and a$ount %ent on co$$uter hi(h0a# vehicle* and H200 %er
$onth /or 9uali/ied %ar6in(.
e. *estricted ,ro$ert and Stoc= O$tions4 C" 222(2)0
I/ a ta4%a#er %er/or$ ervice and %ro%ert# i tran/erred in connection 0ith %er/or$ance o/ thoe ervice* then
the ta4%a#er i ta4ed under B 83+a. on the /air $ar6et value o/ the %ro%ert# at the ti$e o/ tran/er +reduced !# an#
a$ount %aid !# the ta4%a#er /or the %ro%ert#.. 3o0ever* tran/erred %ro%ert# i not ta4a!le i/ the ta4%a#er2 ri(ht
are not u!tantiall# veted. A ta4%a#er2 ri(ht are not u!tantiall# veted i/ the# are u!"ect to a u!tantial ri6 o/
/or/eiture and are not tran/era!le. I/ u!tantiall# nonveted %ro%ert# later !eco$e veted* the ta4 under B 83+a. i
i$%oed at the ti$e o/ vetin(. The a$ount included in (ro inco$e de%end on the value o/ the %ro%ert# at the
ti$e o/ vetin(. The e$%lo#er2 !uine e4%ene deduction under B 162 i ta6en 0hen the e$%lo#ee include
under B 83. The e$%lo#er i allo0ed a deduction e9ual in a$ount to the e$%lo#ee2 incluion and in the a$e #ear
a the e$%lo#ee2 incluion.
'ection 83+c.+1. de/ine u!tantial ri6 o/ /or/eiture and B 83+c.+2. de/ine tran/era!ilit#. 'ection 83+a. tate that
the %ro%ert# i ta4a!le to the %eron 0ho %er/or$ed the ervice i/ the %ro%ert# i tran/erred in connection 0ith
thoe ervice. Thi $ean that i/ ta4%a#er doe 0or6 /or hi e$%lo#er and the e$%lo#er (ive %ro%ert# to the iter
o/ the ta4%a#er* the ta4%a#er i re%oni!le /or %a#in( the ta4. The a$e reult 0ould !e reached throu(h 7uca v.
?arl C< 733.
&nder B 83+!.* a %eron can elect to include in (ro inco$e in the #ear in 0hich the %ro%ert# i tran/erred.
3o0ever* i/ thi election i $ade and the %ro%ert# i u!e9uentl# /or/eited* the ta4%a#er can2t ta6e a deduction.
The ta4%a#er hould al0a# ta6e the B 83+!. election 0hen the election 0ill tri((er no current inco$e ta4 lia!ilit#
!ecaue the ta4%a#er %urchaed the %ro%ert# /or it /air $ar6et value. 'ee Alve v. Co$$iioner C< 225.
Alve v. Co$$iioner % 225
The ta4%a#er* a %art o/ hi e$%lo#$ent a(ree$ent* %urchaed 40*000 hare o/ toc6 at ten cent %er hare. <oth
the IR' and the ta4%a#er ti%ulated that the hare had a 8;N o/ ten cent %er hare 0hen the ta4%a#er %urchaed
the hare. In addition !oth %artie a(reed that the ta4%a#er did not $a6e a B 83+!. election. The ta4%a#er ar(ued
that B 83+a. doe not a%%l# to %urchae /or 8;N. 3e ar(ued that ,in connection 0ith- $eant that the e$%lo#ee i
receivin( co$%enation /or hi %er/or$ance o/ ervice. The court held that the tatute a%%lie to all %ro%ert#
tran/erred in connection 0ith the %er/or$ance o/ ervice. It i not li$ited to co$%enation. The ta4%a#er alo
ar(ued that thi i a ta4 tra% o/ ta4%a#er 0ho are not 0ell in/or$ed. The ta4 court a# too !ad ,'ection 83+!. i
!ut one e4a$%le o/ a %roviion re9uirin( ta4%a#er to act or u//er le attractive ta4 cone9uence.-
13
'ection 83+e.+3. tate that B 83 doe not a%%l# to tran/er o/ an o%tion 0ithout readil# acertaina!le 8;N and $ot
o%tion do not have a readil# acertaina!le 8;N. 3o0ever* 0hen the ta4%a#er e4ercie the o%tion he 0ill !e ta4ed
under B 83+a.. )i//erent rule a%%l# to incentive toc6 o%tion.
6
/. 5e Facto Administrative %xclusion + Fre<uent Flier 6iles4 C" 2&)(22&
A Technical Advice ;e$orandu$ +,TA;-. i 0ritten to an IR' a(ent in the /ield intructin( the a(ent ho0 to
handle a ituation. 3o0ever a TA; cannot !e cited a %recedent. A TA; i !aicall# an un%u!lihed rulin(.
Ju!lihed rulin( $a# !e cited a %recedent.
In TA; 9547001 C< 213* the ta4%a#er 0a allo0in( it e$%lo#ee to 6ee% /re9uent /lier $ile earned on tri%
%aid /or !# the co$%an#. The TA; ar(ue that the /re9uent /lier $ile are a re!ate a(aint the %rice and there/ore
allo0in( the e$%lo#ee to 6ee% the $ile i a /or$ o/ co$%enation.
In an announce$ent* 2002510 I.R.<. 621 C< 220* the IR' !ac6ed do0n a#in( that ,the recei%t or %eronal ue o/
/re9uent /l#er $ile or other in56ind %ro$otional !ene/it attri!uta!le to the ta4%a#er2 !uine or o//icial travel-
did not (ive rie to ta4 lia!ilit#.
'o$e reaon 0h# thi $i(ht !e the ri(ht an0er includeA valuation %ro!le$ +!ut i thi an# di//erent than other
valuation %ro!le$ 0e /ace.E ad$initration %ro!le$ +it $i(ht !e too e4%enive to 6ee% trac6.E de $ini$u /rin(e
+it doen2t /all under B 132 !ut it i de $ini$u /rin(e in (eneral..
C. Income Inclusions as 6ista=e(Correctin# 5evices
&. The Annual Tax Accountin# ,eriod
The ta4a!le #ear i ar!itraril# =an. 1 to )ec. 31. In <urnet v. 'an/ord Q <roo6 Co.*
7
the Court held that the
(overn$ent re9uire ,revenue acertaina!le* and %a#a!le to KitM* at re(ular interval.- Thi caue ine9uitie. 8or
e4a$%le* i/ a da# trader $a6e H2 $illion on )ece$!er 30 and on =an. 3* he loe H2 $illion* althou(h he ha no net
(ain or lo he till o0e the (overn$ent ta4 on the H2 $illion.
8or !uinee +includin( ole %ro%rietorhi%. there i o$e relie/ throu(h the 1et @%eratin( 7o +1@7. %roviion
o/ B 172* allo0 a ta4%a#er 0ith a 1@7 in one ta4 #ear to ue the 1@7 to o//et %oitive inco$e in other #ear.
8
An
1@7 $a# !e ued to o//et net inco$e in the t0o #ear %recedin( the lo #ear and in the 20 #ear /ollo0in( the lo
#ear. An 1@7 i carried /irt to the earliet %er$ii!le #ear* to the e4tent it e4ceed the inco$e in the earliet #ear*
the e4ce i carried to the /ollo0in( #ear.
Correction o/ Inco$e Ta4 ;ita6eA
There are t0o t#%e o/ $ita6eA
1. Cou lac6ed correct in/or$ation or advice 0hen #ou /iled the ta4 return. To correct thi* #ou /ile an a$ended
return.
2. Thin( turned out di//erentl#. <aed on the 0orld at the ti$e #ou /iled* #ou /iled correctl#. Then the 0orld
chan(ed and #our ta4e !eco$e incorrect. 8or e4a$%le* on )ece$!er 31* #ou receive a chec6 /ro$ #our la0 /ir$
/or H20*000 and a note 0hich a# it i a !onu. Cou include the H20*000 a inco$e. In =anuar#* the /ir$ end out
notice that a $ita6e 0a $ade and the chec6 hould have !een H2*000. Cou have an H18*000 lo /or the #ear in
0hich #ou learned a!out the $ita6e. 'ee C< 143 n.4. ?ven i/ #ou dicovered the $ita6e !e/ore A%ril 15* #ou till
have to declare H20*000 o/ inco$e /or #ear 1 and an H18*000 lo /or #ear 2.
2. !oans and Cancellation of Indebtedness
a. 3eneral *ule
A ta4%a#er doe not have to include $one# !orro0ed $one# in inco$e* !ut the ta4%a#er doe not (et a deduction
/or re%a#in( the loan. The uual "uti/ication i that the ta4%a#er i no 0ealthier than he 0a !e/ore the loan* he
6
I a$ not ure 0hat an incentive toc6 o%tion i. It i not %art o/ thi coure and i onl# included in thi outline to !e
co$%lete.
7
'ee C< 138E 3< 600
8
Oee% in $ind that thi %roviion i /or !uinee onl#* ee B 172+d.
14
received the loan !ut he alo created a lia!ilit# to re%a# the loan.
9
'i$ilarl#* the lender doe not have a deduction on
$a6in( the loan and doe not have inco$e on re%a#$ent. 3o0ever* i/ the loan i dichar(ed* their $i(ht !e inco$e.
B 61+a.+12. au$e that dichar(e o/ inde!tedne i inco$e. B 108 %rovide e4ce%tion 0hich re$ove dichar(e
o/ inde!tedne /ro$ inco$e.
In @ld Colon# Trut v. Co$$iioner 3< 52* a co$%an# %aid there %reident a alar# and in addition a(reed to
%a# the %reident2 inco$e ta4e. The Court held the %a#$ent o/ ta4e !# the co$%an# 0a inco$e to the %reident*
!ecaue the %reident2 0ealth 0a increaed !# the %a#$ent +he didn2t have to %a#..
In Clar6 v. Co$$iioner 3< 123* ta4 counel (ave incorrect advice to the ta4%a#er 0hich reulted in the ta4%a#er
%a#in( H19*000 too $uch in ta4e. The ta4 counel rei$!ured the ta4%a#er. The IR' aerted the rei$!ure$ent
0a inco$e. The ta4%a#er ar(ued that it 0a $erel# a return o/ ca%ital. The court held it 0a not inco$e.
10
The
IR' ha ta6en the %oition that Clar6 a%%lie 0hen ta4%a#er %a# ,$ore than their $ini$u$ %ro%er /ederal inco$e
ta4 lia!ilitie- and are rei$!ured !# a third %art# /or thoe a$ount. The IR' ha ditin(uihed Clar6 /ro$ other
cae 0here the %a#$ent 0a not due to an error $ade on the return itel/ !ut on an o$iion to %rovide advice that
0ould have reduced /ederal inco$e ta4 lia!ilit#. ;ita6e on the return are a return o/ ca%ital !ut $ita6e in
%lannin( are not.
In (eneral* @ld Colon# can !e ditin(uihed /ro$ Clar6 !ecaue in @ld Colon#* the co$%an# %a#in( the ta4%a#er2
inco$e ta4e 0a co$%enator# 0herea in Clar6* the rei$!ure$ent /or ta4e 0a a return o/ ca%ital.
In &nited 'tate v. Oir!# 7u$!er Co. C< 141E 3< 125
Oir!# 7u$!er Co. iued H12 $illion o/ !ond* later that #ear the co$%an# %urchaed !ac6 a%%ro4i$atel# H1
$illion o/ thee !ond /or H862*000.
11
Thu* the co$%an# aved H138*000. The iue 0a 0hether thi H138*000
0a includa!le in Oir!#2 inco$e. The Court held that Oir!# had an acceion to inco$e.
In order to have de!t cancellation* there ha to !e a valid de!t. Rarin v. Co$$iioner C<
The ta4%a#er ran u% H3*435*000 in (a$!lin( de!t at Reort 3otel. Reort /iled uit a(aint the ta4%a#er !ut
eventuall# ettled /or H500*000. The IR' ar(ued that the H3*435*000 0a a loan and the ettle$ent /or H500*000 0a
a cancellation o/ H2*935*000 o/ inde!tedne. The court held the de!t o0ed to Reort 0a unen/orcea!le a a
$atter o/ 1e0 =ere# la0 !ecaue Reort violated Caino Co$$iion rule. Thu the de!t 0a not one /or 0hich
the ta4%a#er 0a lia!le and the cancellation 0a not inco$e. @ne %oi!le ar(u$ent i that i/ it 0an2t a loan* 0h#
0an2t he ta4ed on the $one# 0hen he received itI The court ee$ed to a# that it 0an2t real $one# !ut rather li6e
$ono%ol# $one#.
b. 5efinin# 5ebt Cancellation Income
<rad/ord v. Co$$iioner C< 234
3 had accu$ulated a!out H300*000 in de!t. To $a6e hi /inance loo6 !etter* : a(reed to au$e H205*000 !#
(ivin( a note in her na$e to the !an6 in e4chan(e /or 32 note to the !an6. The !an6 %lit the note into a ecured
note /or H105*000 and an unecured note /or H100*000. 7ater* the !an6* on it !oo6* 0rote H50*000 o// the
unecured note. The !an6 o//ered to ell the H100*000 note /or H50*000. 32 hal/5!rother %urchaed the note /or
H50*000. The ta4 court held that the H50*000 0riteo// 0a a dichar(e o/ :2 inde!tedne. The Court o/ A%%eal
revered. The court held that : never received an# inco$e /ro$ the tranaction. The court co$%ared it to a
reduction in %rice. The %eron that actuall# received the dichar(e o/ inde!tedne 0a 3 and he 0a not !e/ore the
court.
12
9
1ote that there are other %lace in the code 0here a ta4%a#er in2t 0ealthier #et he i till ta4ed* /or e4a$%le
conider 0hat ha%%en 0hen a ta4%a#er ell toc6. 3e i no 0ealthier #et he i till lia!le /or ta4e. 3o0ever* thi
ee$ intuitivel# di//erent !ecaue throu(hout the 0hole tranaction* the ta4%a#er ha $ade inco$e.
10
Their reaonin( 0a that it 0a not derived /ro$ ca%ital* la!or* or !oth* thi reaonin( 0a u!e9uentl# overruled
!# >lenha0 >la* !ut the reult in Clar6 till a%%lie. It 0a $erel# a return o/ ca%ital.
11
Oir!# 0a a!le to re%urchae the !ond /or le than their ori(inal iue %rice !ecaue interet rate had rien in
the econo$#. Riin( interet rate drive !ond %rice do0n !ecaue richer #ield are availa!le throu(hout the
/inancial $ar6et. An invetor could (et $ore $one# /ro$ a hi(her interet !ond o the# ell their lo0 interet
!ond and !u# hi(her interet !ond.
12
Toda#* the IR' 0ould "oin !oth 3 and :.
15
c. Insolvent or "an=ru$t 5ebtor
I/ a de!tor i inolvent and receive a dichar(e /ro$ inde!tedne under the <an6ru%tc# Code* the a$ount o/
inco$e /ro$ dichar(e o/ inde!tedne i e4cluded /ro$ the de!tor2 inco$e. 'ee IRC B 108.
d. 5ebt *elief Associated with the 5is$osition of ,ro$ert + C" &5/
:here the %ro%ert# i %urchaed /or a do0n %a#$ent %lu de!t o!li(ation o/ the %urchaer* the uual rule i that the
!ai i the /ull a$ount o/ the %urchae %rice even thou(h o$e o/ it i not #et %aid. The $ort(a(e %lu an# other
cah or %ro%ert# i included 0hen calculatin( the a$ount realiDed.
In Crane v. Co$$iioner 3< 178 +dicued in Tu/t C< 157.* ta4%a#er had %ro%ert# 0ith a 8;N o/ H262*000
and a $ort(a(e o/ H262*000. The ta4%a#er too6 de%reciation deduction o/ H25*000. The ta4%a#er then old the
%ro%ert# /or H2*500 cah and au$%tion o/ the $ort(a(e. The court held that a nonrecoure $ort(a(e i included in
calculatin( the ta4%a#er2 !ai +e.(. cah %aid /or the %ro%ert# %lu the a$ount o/ the $ort(a(e..
;ort(a(in( %ro%ert# u!e9uent to it ac9uiition doe not increae !ai. :ooda$ Aociate* Inc. v.
Co$$iioner 3< 185. The $ort(a(in( o/ an alread#5held %ro%ert# i not a realiDin( event.
8or e4a$%leA 8i(ure 3< 185
In #ear 1* =anice !ou(ht <lac6acre /or H500*000 cah. In #ear 4* <lac6acre i 0orth H1 $illion. =anice ta6e out a
nonrecoure $ort(a(e o/ H750*000. 'he clai$ that the H250*000 0a inco$e !ut the tatute o/ li$itation ha run.
In #ear 10* he allo0 the !an6 to /orecloe on the %ro%ert#. The court held the $ort(a(e in #ear 4 0a not a
realiDin( event. There/ore* the !ai 0a not increaed. @n the /orcloure* =anice2 !ai 0a H500*000 +the a$ount
he %urchaed it /or. and the a$ount received 0a H750*000 +the a$ount 0hich 0a cancelled in /orecloure. and
there/ore he had a (ain o/ H250*000.
13
In /ootnote 37 o/ Crane* the court declined to conider 0hat 0ould ha%%en i/ at the ti$e o/ the ale o/ the %ro%ert#*
the %ro%ert# had a /air $ar6et value o/ le than the a$ount o/ the $ort(a(e +thi can onl# ha%%en i/ the %ro%ert#
ha declined in value a/ter the $ort(a(e ha !een %ut on it.. Thi 0a an0ered in Tu/t.
Co$$iioner v. Tu/t C< 157E 3< 192
The ta4%a#er o!tained a nonrecoure loan in the a$ount o/ H1.85 $illion to !uild a !uildin(. A/ter the !uildin(
0a !uilt* the ta4%a#er too6 de%reciation 0hich le/t an ad"uted !ai o/ H1.4 $illion. The 8;N o/ the %ro%ert#
dro%%ed to H1.4 $illion. The ta4%a#er old the %ro%ert# to a third %art# 0ho a(reed au$ed the $ort(a(e a the
/ull %a#$ent. The ta4%a#er ar(ued that the a$ount realiDed 0a H1.4 $illion o there 0a no (ain or lo. The IR'
ar(ued that the (ain 0a the a$ount realiDed 0a H1.85 $illion $inu the ad"uted !ai o/ H1.4 $illion reultin( in
a (ain o/ H450*000. The court held the /ull a$ount o/ the nonrecoure $ort(a(e i the a$ount realiDed to the
ta4%a#er on the ale o/ the %ro%ert# even thou(h it i (reater than the 8;N o/ the %ro%ert#. It i ea# to ee thi i
the correct reult. I/ the reult ca$e out the other 0a#* %eo%le could ta6e out an e4ceivel# hi(h $ort(a(e on a
%ro%ert# and de%reciate do0n to the 8;N o/ the %ro%ert# and then ell.
The H450*000 (ain in Tu/t i o/ten called ,%hanto$ (ain- or ,Tu/t (ain.-
In @2Connor2 concurrence to Tu/t* @2Connor 0ould !i/urcate the anal#i. The %ro%ert# 0ould !e treated a !ein(
old at 8;N. There/ore* the (ain realiDed 0ould !e the 8;N ad"uted !ai. The dichar(e o/ inde!tedne 0ould
!e the a$ount o/ the $ort(a(e 8;N. It onl# $atter 0hich /or$ula #ou ue 0hen the de!tor i inolvent.
I/ the loan i recoure* ee Rev. Rul. 90516 C< 166.
S 0a inolvent +B 108+d.+3.. and de/aulted on a recoure loan. S ne(otiated 0ith the !an6 to tran/er the %ro%ert#
to the !an6 and the !an6 releaed S /ro$ lia!ilit#. The 8;N o/ the %ro%ert# 0a 10*000* S2 ad"uted !ai 0a
8*000* and the a$ount due on the de!t 0a 12*000. The rulin( held that 2*000 0a (ain +10*000 8;N 8*000
ad"uted !ai. and 2*000 0a dichar(e o/ inde!tedne 0hich 0ould !e ta4a!le* e4ce%t under B 108+a.+1.+<. the
/ull a$ount o/ S2 dichar(e o/ inde!tedne i e4cluded !ecaue that a$ount doe not e4ceed the a$ount !# 0hich
S 0a inolvent.
13
Thee are (enerall# the /act o/ :ooda$ Aociate 3< 185
16
There/ore* i/ the de!tor i inolvent* @2Connor2 a%%roach i !etter /or the de!tor !ecaue the a$ount a!ove the
8;N i dichar(e o/ inde!tedne 0hich i not ta4a!le under B 108+a.+1.+<.. @2Connor2 a%%roach i onl# ued /or
recoure loan. &nder Tu/t* the a$ount realiDed i not the 8;N !ut rather the a$ount o/ the loan and there i no
dichar(e o/ inde!tedne.
). The Tax "enefit *ule
The ta4 !ene/it rule a%%lie 0here a %eron ta6e a deduction in one #ear and it later !eco$e a%%arent in a later
#ear the %eron hould not have ta6en the deduction* i/ the deduction (enerated a ta4 !ene/it.
In 3ill!oro 1ational <an6 v. Co$$iioner C< 171* the Court held that the %ur%oe o/ the ta4 !ene/it rule i to
create tranactional %arit# 0hich correct a re%orted tranaction 0hich 0a re%orted on the !ai o/ au$%tion that
an event in a u!e9uent #ear %rove to !e erroneou. In the cae* the Court (ive an e4a$%le 0here a ta4%a#er
i(n a 30 da# leae on )ece$!er 15.
14
@n =anuar# 10* a /ire !urn do0n the !uildin(. The ta4 !ene/it rule doe not
a%%l# !ecaue the event i not inconitent 0ith the deduction. Thi i till a !uine e4%ene. 3o0ever* i/ the
ta4%a#er intead o/ uin( it /or hi !uine ued it to houe hi /a$il#* thi 0ould !e inconitent 0ith the !uine
e4%ene deduction and the ta4 !ene/it rule 0ould a%%l#.
Another e4a$%leA Ta4%a#er lend H1*000 to ) in #ear 1. 7ater that #ear* it a%%ear ) 0ill never %a# the de!t* o the
ta4%a#er ta6e a deduction o/ H1*000. In #ear 2* ) une4%ectedl# %a# !ac6 the H1*000. The ta4%a#er ar(ue that the
H1*000 i not inco$e !ecaue it i "ut re%a#$ent o/ a loan +recover# o/ ca%ital.. Thi ar(u$ent 0ould (ive a
%hanto$ deduction +an e4tra H1*000.. &nder the ta4 !ene/it rule* H1*000 i re%orted a inco$e /or #ear 2.
In Roen v. Co$$iioner % 176* the ta4%a#er donated %ro%ert# to a cit#. The# clai$ed a charita!le deduction o/
H51*250. The ne4t #ear* the cit# decided it could not ue the %ro%ert# and returned the %ro%ert# to the ta4%a#er.
The ta4%a#er then donated the %ro%ert# to a ho%ital ta6in( a charita!le deduction o/ H48*000. The ho%ital
returned the %ro%ert# the ne4t #ear. The court held that ince the ta4%a#er too6 a charita!le deduction 0hen the#
tran/erred the %ro%ert#* the ta4 !ene/it rule re9uired the$ to ta6e the %ro%ert# a inco$e 0hen it 0a returned to
the$.
@nce #ou deter$ine that the ta4%a#er have to include the %ro%ert# a inco$e* the 9uetion then !eco$e ho0 $uch
inco$eI
Ta4 co$$entator 0ould a# H51*250 !ecaue the ta4 !ene/it rule i a ta4 correctin( device.
The IR' conceded and the court held that H48*000 hould !e included in inco$e !ecaue that 0a the value o/ the
%ro%ert# the# 0ere receivin( !ac6.
I/ the %ro%ert# increaed to H80*000 !e/ore it 0a (iven !ac6* ta4 co$$entator 0ould till a# H51*250 0hile the
IR' 0ould a# H80*000.
IRC B 111 decri!e the treat$ent o/ deduction and credit i/ recover# i $ade in later #ear.
IRC B 1341 i the o%%oite o/ the ta4 !ene/it rule and a%%lie 0here a %eron receive inco$e under a ,clai$ o/
ri(ht- !ut i later re9uired to re%a# the $one#. 8or an e4a$%le ee % 175 n.6.
I>. ,ro$ert Transactions
:hen %ro%ert# i old or other0ie di%oed o/* there are everal te% that $ut !e /ollo0ed to deter$ine the
ta4a!le (ain. 8irt* there $ut !e realiDation* (enerall# a ale or other di%oition o/ the %ro%ert# /or conideration.
1e4t* co$%ute the (ain or lo realiDed* 0hich i done !# u!tractin( the a$ount realiDed /ro$ the ad"uted !ai o/
the %ro%ert#. The ne4t te% i deter$inin( 0hether the (ain or lo 0ill !e reco(niDed. I/ it i reco(niDed* it 0ill
have i(ni/icance /or the ta4%a#er2 ta4 return. I/ it i not reco(niDed* the (ain or lo 0ill !e de/erred until o$e
later #ear. @nce it i acertained that the (ain or lo 0ill !e reco(niDed* the character o/ the (ain $ut !e
deter$ined 0hether ca%ital or ordinar#.
15
A. The *eali?ation 5octrine
14
Thi i a !uine e4%ene under B 162+a.+3.
15
8or a (ra%hical vie0 o/ thi %roce* ee 3< 150
17
&. %isner v. 6acomber
Inco$e /ro$ %ro%ert# $ut !e realiDed !e/ore it can !e ta4ed. The reaon /or thi includeA valuin( a%%reciation
+althou(h note that the %rice o/ $ar6eta!le ecuritie i ea# to deter$ine and real etate could !e a%%raied. or
ta4%a#er lac6 the $one# to %a# /or the ta4 +in the cae o/ $ar6eta!le ecuritie* the ta4%a#er could ell o// o$e to
%a# the ta4 or i/ it i real etate ta4 %a#er could !orro0 a(aint the %ro%ert#..
<e/ore the a%%reciation in value o/ %ro%ert# can !e ta4ed* there $ut !e a realiDin( event. The %ro%ert# $ut !e
di%oed o/* uuall# old or e4chan(ed /or $one# or other %ro%ert#.
?iner v. ;aco$!er C< 251E 3< 154
Ta4%a#er o0ned 2*200 hare o/ 'tandard @il. The ta4%a#er received 1*100 hare throu(h a toc6 dividend. 8or
each ne0 hare iued* the co$%an# tran/erred H100 +%ar value. /ro$ earned ur%lu to ca%ital account. The iue
0a 0hether the toc6 dividend 0a ta4a!le to the ta4%a#er 0here the tatute %eci/icall# a# toc6 dividend. The
ta4%a#er ar(ued that the tatute violated the Contitution 0hich re9uired direct ta4e to !e a%%ortioned accordin( to
the %o%ulation and that it 0a not inco$e under the 'i4teenth A$end$ent. The court held the toc6 dividend did
not contitute a realiDin( event* a re9uired !# the Contitution. 3ence the tatute 0a uncontitutional. To have
inco$e* the (ain $ut not accrue to ca%ital* !ut it $ut !e evered /ro$ the ca%ital /or the ta4%a#er2 e%arate ue.
3ol$e diented* a#in( that inco$e included the toc6 dividendE there/ore* the toc6 dividend hould !e ta4ed.
<randei ar(ued that i/ the co$%an# had $ade a cah dividend at the a$e ti$e it o//ered toc6 and the ta4%a#er
ued the dividend to !u# the toc6* the ta4%a#er 0ould have !een ta4ed on the dividend. There/ore* the ta4%a#er
hould !e ta4ed on the toc6 dividend.
2. @nreali?ed A$$reciation8 Stoc= 5ividends vs. Cash 5ividends
@ne ar(u$ent that could have !een $ade i that !# ditri!utin( a toc6 dividend* the ta4%a#er in ;aco$!er 0a not
an# 0ealthier +thi 0a "ut cuttin( the a$e %iDDa into $ore lice.. 3o0ever* the a$e could !e aid /or a cah
dividend. In the tatute* Con(re treated toc6 dividend the a$e a cah dividend. To conclude the toc6
dividend 0ere not ta4a!le* the court /ound that the tatute 0a uncontitutional +dealt 0ith in the ne4t ection.. The
reult o/ ;aco$!er ee$ intuitivel# correct. Jro!le$ o/ valuation and li9uidit# "uti/# de/errin( ta4 o/ the
a%%reciation o/ %ro%ert# in the /irt %lace* thee %ro!le$ don2t dia%%ear 0hen the o0nin( o/ toc6 create a toc6
dividend. The hare received in the toc6 dividend have the a$e %ro!le$ 0ith valuation and li9uidit#. A cah
dividend doe not have thee %ro!le$ and can eail# !e ta4ed.
). The Constitutional Issue
That tatute in 9uetion in ;aco$!er clearl# re9uired ta4ation o/ toc6 dividend. The court ue the /ollo0in(
reaonin( to /ind the tatute uncontitutionalA
1. &nle the 'i4teenth A$end$ent a%%lie* a ta4 on toc6 dividend i an uncontitutional una%%ortioned direct ta4
on %eronal %ro%ert#.
2. The 'i4teenth A$end$ent allo0 an una%%ortioned ta4 on ,inco$e.-
3. &nrealiDed a%%reciation i not ,inco$e.-
4. 'toc6 dividend are a /or$ o/ unrealiDed a%%reciation.
5. There/ore* ta4in( toc6 dividend 0ithout a%%ortion$ent i uncontitutional.
The court reaon that unle a (ain i clearl# e%arated /ro$ the ta4%a#er2 ori(inal inveted ca%ital a it i in the
cae o/ a cah dividend the (ain i not inco$e and cannot !e ta4ed !# Con(re 0ithout a%%ortion$ent.
7ater cae have de$oted ;aco$!er /ro$ Contitutional tatu to ad$initrative i$%li/ication +valuation and
li9uidit# %ro!le$ in deter$inin( ta4 on toc6 dividend..
". 6ani$ulation of the *eali?ation *ules
'ection 1001+a. tate that a ta4%a#er realiDe (ain or lo on the ,ale or other di%oition o/ %ro%ert#.- Thi invite
t0o t#%e o/ ta4%a#er $ani%ulationA +1. ta4%a#er 0ant to di%oe o/ a%%reciated %ro%ert# throu(h the econo$ic
e9uivalent o/ a ale 0ithout tri((erin( B 1001+a.E or +2. a ta4%a#er o0n de%reciated %ro%ert# that he 0ant to retain*
technicall# ellin( the %ro%ert# 0hile retainin( the econo$ic e9uivalent o/ o0nerhi%.
18
&. The Substance of a Sale without *eali?ation of 3ain
An e4a$%le o/ a techni9ue ued !# ta4%a#er to ell 0ithout realiDin( (ain 0a the ,hort ale a(aint the !o4.-
Con(re enacted B 1259* 0hich re9uire a ta4%a#er to reco(niDe (ain on the contructive ale o/ an# a%%reciated
%oition in toc6.
An e4a$%le o/ a hort ale a(aint the !o4A
S ha 100*000 hare o/ A<C* Inc.* 0ith 8;N o/ H100 $illion and a !ai o/ H10 $illion. S !orro0 100*000
hare o/ A<C /ro$ <ro6er. S2 !ai in the !orro0ed hare i H100 $illion. S ell the !orro0ed hare /or H100
$illion and %a# no ta4 !ecaue S2 !ai i H100 $illion. S then (ive the !ro6er the 100*000 hare 0hich have a
!ai o/ H10 $illion +%lu a /ee /or the !ro6er2 0or6.. S ha old her hare in A<C 0ithout !ein( ta4ed.
2. The Substance of Continued Ownershi$ with *eali?ation of !oss
Re(. B 1.100151+a. tate that an e4chan(e o/ an aet /or another aet i a realiDation event a lon( a the
e4chan(ed aet di//er $ateriall# in 6ind or e4tent. Con(re enacted B 1091 to %revent a ta4%a#er /ro$ ellin(
toc6 and turnin( around and !u#in( it a(ain +0ah ale.. 'ection 267+a.+1. diallo0 a lo deduction on a ale or
e4chan(e !et0een certain related %artie.
). ACherr ,ic=in#B + . &2&& Ca$ital !oss !imitations
'ection 1211 allo0 an individual to deduct ca%ital loe onl# a(aint ca%ital (ain and H3*000 o/ non5ca%ital (ain.
&nder B 1212* ca%ital loe can !e carried /or0ard to !e ued a(aint ca%ital (ain in later #ear. Thi %roviion
%revent ta4%a#er /ro$ ,cherr#5%ic6in(*- ellin( the toc6 0hich have loe to ta6e a deduction a(aint inco$e
0hile not realiDin( (ain.
C. 9onreco#nition4 C" 212
&. The conce$t of nonreco#nition
There are everal ituation in 0hich a ta4%a#er ha realiDed a (ain or lo* !ut the tranaction 0ill not !e reco(niDed
/or ta4 %ur%oe +at leat not at that ti$e.. The rationale i the ta4%a#er ha $aintained a u!tantiall# continuou
invet$ent* onl# li(htl# altered in /or$. Thi continuit# o/ invet$ent underlie con(reional 0illin(ne to de/er
ta4 reco(nition. 1onreco(nition tranaction includeA +1. B 1031 +li6e 6ind e4chan(e.E +2. B 1033 +involuntar#
converion.E and +3. B 121 +ale o/ a %eronal reidence unli6e the other t0o* thi i not a de/erral o/ ta4ation !ut
rather a %er$anent e4cluion..
a. %lectivit
Thee %roviion a%%l# to !oth (ain and lo ituationE ho0ever* ta4%a#er can uuall# arran(e the tranaction o
a to avoid a%%lica!ilit# o/ nonreco(nition %roviion 0hen thoe %roviion 0ould 0or6 to their diadvanta(e.
3o0ever* o$eti$e the IR' 0ill aert that the nonreco(nition a%%lie to de/er a lo.
b. *ole of "asis
1onreco(nition %roviion are dei(ned to de/er reco(nition o/ (ain* not to /or(ive ta4ation o/ the (ain /orever.
There/ore* the (eneral idea i to $aintain a hitorical !ai in one or $ore o/ the ne0 aet.
2. !i=e(Cind %xchan#es4 C" 2D2E F" 220
I/ a ta4%a#er 0ho hold %ro%ert# ued in !uine or /or invet$ent e4chan(e that %ro%ert# /or %ro%ert# o/ li6e
6ind* no (ain or lo 0ill !e reco(niDed to the ta4%a#er on the tranaction. IRC B 1031. 'ection 1031 onl# a%%lie
to %ro%ert# ued in !uine or held /or invet$ent. Thi leave out %ro%ert# held /or %eronal ue* uch a one2
%eronal reidence or auto$o!ile. 'ection 1031+a.+2. alo %reclude a%%lication to everal cate(orie o/ %ro%ert#
includin(A toc6* !ond* and noteE %artnerhi% interetE and inventor# %ro%ert#. It can !e ar(ued that the %olic#
reaon !ehind thi i that there i no u//icient chan(e in invet$ent to reco(niDe (ain. Jro%ert# 0hich i held
%ri$aril# /or ale i not availa!le /or B 1031 treat$ent.
16
I/ %ro%ert# (iven u% and received i held /or invet$ent !#
the ta4%a#er* the tranaction 0ill count a a li6e56ind e4chan(e /or the ta4%a#er* even i/ the other %art# doe not hold
the %ro%ert# /or !uine or invet$ent.
16
3< (ive e4a$%le o/ cae +ee 3< 221. 0here the ta4%a#er %ut u% a i(n o//erin( the %ro%ert# /or ale !e/ore the
e4chan(e. Court held the i(n di9uali/ied the tranaction /ro$ B 1031. 'ee 1eal T. <a6er ?nter%rie* Inc. v.
Co$$iioner.
19
a. Hhat is an exchan#e7
'ection 1031 re9uire an ,e4chan(e- o/ %ro%ert#E a ,ale- 0ill not 9uali/#. I/ a ta4%a#er receive !oth li6e56ind
%ro%ert# and a $all a$ount o/ $one# /or hi %ro%ert#* he 0ill till !e re(arded a havin( en(a(ed in an ,e4chan(e-
o/ hi %ro%ert#. 3o0ever* i/ $one# /or$ a u!tantial %art o/ the conideration* then it $a# not !e an e4chan(e and
intead a ale.
b. Hhat is !i=e(Cind7
The re(ulation a# that the conce%t o/ li6e56ind re/er to the ,nature and character- o/ the %ro%ert#* and not it it
,(rade or 9ualit#.- 'o$e e4a$%le are in Trea. Re(. B 1.1031+a.51+c.. The re(ulation u((et a cit# %ro%ert#
could !e traded /or a ranch* 0hich u((et that the nature and character o/ real %ro%ert# 0hich can !e e4chan(ed i
!road. The re(ulation u((et that a e4chan(e o/ real %ro%ert# o0ned in /ee /or a leae o/ real %ro%ert# 0ith 30
#ear or $ore to run i an e4chan(e o/ li6e 6ind. Tan(i!le %eronal %ro%ert# ha to !e in the a$e ,aet cla- to !e
li6e56ind. 'ee Trea. Re(. B 1.1031+a.52.
c. Calculatin# "asis in the new $ro$ert
8irt* it i i$%ortant to re$e$!er that (ivin( !oot doe not tri((er reco(nition o/ (ain. Receivin( !oot doe. The
ea# 0a# to calculate !aiA the !ai o/ the nonreco(nition %ro%ert# received 0ill !e e9ual to the 8;N o/ the
nonreco(nition %ro%ert# received le an# unreco(niDed (ain on the %ro%ert# e4chan(ed +unreco(niDed (ain i e9ual
to unreco(niDed (ain !e/ore the tranaction $inu reco(niDed (ain durin( the tranaction..
17
d. Three(Cornered %xchan#es
In Rev. Rulin( 775297* the IR' a%%roved three5cornered e4chan(e. < 0ant to !u# A2 %ro%ert#. A 0ant to
%reerve (ain. A dei(nate %ro%ert# 0hich < %urchae and then A and < e4chan(e %ro%ertie. 8or A* the
tranaction 9uali/ie /or B 1031. B 1031+a.+3. et o$e ti$e li$itation /or three5cornered e4chan(e.
). Involuntar Conversions -. &0))04 C" 2DDE F" 2)D
'ection 1033 %rovide /or the nonreco(nition o/ a cah ale 0hich i /ollo0ed !# a reinvet$ent 0ithin t0o #ear* i/
the cah ale 9uali/ie a an involuntar# converion. 'ection 1033 re9uire the t0o %ro%ertie to !e o/ ,i$ilar or
related in ervice or ue.- Thi tandard ha !een inter%reted a $ore de$andin( than the ,li6e56ind- tandard o/ B
1031. The %olic# "uti/ication i (enerall# continuit# o/ invet$ent 0ith the /act that the ta4%a#er did not
voluntaril# ell hi %ro%ert#. To the e4tent the ta4%a#er doe not reinvet the %roceed o/ the involuntar# converion*
the ta4%a#er i ta4ed.
3#%oA :hat i/ S o0n land 0ith a !ai o/ H250*000 0hich i conde$ned /or %u!lic ue. S receive a
conde$nation a0ard o/ H600*000. S !u# %ro%ert# 0ith 8;N o/ H560*000. S /inance the %urchae 0ith H400*000
cah and a $ort(a(e o/ H160*000. S2 reco(niDed (ain i H40*000. The tatute a# the reco(niDed (ain i the
a$ount realiDed $inu the cot o/ re%lace$ent %ro%ert#.
/. ,ermanent %xclusion of 3ain on the Sale of a ,rinci$al *esidence
The (eneral rule i that lo realiDed /ro$ ale or other di%oition o/ the ta4%a#er2 %eronal5ue %ro%ert# i not
allo0ed. 'ee IRC B 165+c.. A lo on the ale o/ ta4%a#er2 %eronal ue %ro%ert#* uch a a %eronal reidence*
"e0elr#* or a hore* i not allo0ed. 3o0ever* (ain on the ale o/ %eronal5ue %ro%ert# are uuall# ta4ed.
18
'ection 121 i the onl# %er$anent e4cluion o/ realiDed (ain in the code. 'ection 121+a. %rovide that (ro inco$e
doe not include u% to H250*000 o/ (ain +H500*000 /or $arried individual /ilin( a "oint return. on the ale or
e4chan(e or %ro%ert#* i/* durin( the 5 #ear %eriod endin( on the date o/ the ale or e4chan(e* the %ro%ert# ha !een
o0ned and ued !# the ta4%a#er a hi %rinci%al reidence /or %eriod a((re(atin( 2 #ear or $ore. The e4cluion i
not availa!le i/ the individual ha en(a(ed in another ale o/ a %rinci%al reidence reultin( in e4cluion o/ (ain
0ithin the %recedin( t0o #ear.
17
Thi i not ho0 the tatute calculate !ai* /or the 0a# the tatute calculate !ai* ee 3< 228.
18
Thi hould !e dicued ele0here !ut other %roviion 0hich te$%oraril# diallo0 loe are B 267 +diallo0in(
loe on tranaction !et0een related ta4%a#er. and B 1091 +diallo0in( loe /ro$ ,0ah- ale o/ toc6 or
ecuritie..
20
8or a cou%le /ilin( a "oint return* the cou%le $ut $eet the /ollo0in( conditionA
a. ?ither %oue $eet the re9uire$ent o/ o0nin( the %ro%ert# /or t0o #ear out o/ the lat /ive #ear.
!. <oth %oue $eet the re9uire$ent o/ uin( the %ro%ert# a their %rinci%al reidence /or t0o #ear out o/ the lat
/ive #ear.
c. 1either %oue i ineli(i!le /or the e4cluion !ecaue o/ havin( en(a(ed in another ale o/ a %rinci%al reidence
reultin( in e4cluion o/ (ain 0ithin the lat t0o #ear.
I/ the ta4%a#er doe not $eet the o0nerhi% or reidence re9uire$ent a %ro rat a$ount o/ the H250*000 or H500*000
e4cluion i allo0ed i/ the ale or e4chan(e i due to a chan(e in %lace o/ e$%lo#$ent* health* or un/oreeen
circu$tance. To 9uali/# /or thi %ro rata e4cluion* accordin( to Te$%. Re(. B 1.12153T* the %ri$ar# reaon /or
the ale $ut !e e$%lo#$ent* health %ro!le$* or un/oreeen circu$tance. 8actor relevant /or deter$inin(
ta4%a#er2 %ri$ar# reaon includeA +1. the ale and reaon /or the chan(e are %ro4i$ate in ti$e* +2. the uita!ilit#
o/ the %ro%ert# a a %rinci%al reidence $ateriall# chan(e* +3. the ta4%a#er2 /inancial a!ilit# to a//ord the reidence
$ateriall# chan(e* +4. ta4%a#er ued the %ro%ert# a a reidence durin( hi o0nerhi%* +5. circu$tance (ivin( rie
to the ale or e4chan(e 0ere not /oreeea!le* and +6. circu$tance (ivin( rie to the ale or e4chan(e occurred
0hile ta4%a#er ued the %ro%ert# a a %rinci%al reidence. ?4a$%le o/ un/oreeen circu$tance includeA
involuntar# converion o/ the reidence* natural or $an $ade diater* includin( act o/ 0ar* death o/ ta4%a#er or
/a$il# $e$!er* divorce or le(al e%aration* or $ulti%le !irth.
To calculate the %ro rata e4cluionA 8irt calculate the nu$!er o/ $onth the ta4%a#er lived in the houe divided !#
24 $onth +the 2 #ear re9uire$ent.. ;ulti%l# thi ratio !# H250*000 +H500*000 in the cae o/ a "oint return..
I/ one %oue $eet the re9uire$ent !ut the other doen2t* the %oue 0ho $eet the re9uire$ent (et an e4cluion
o/ H250*000 0hich i a((re(ated 0ith the other %oue %ro rata e4cluion a calculated a!ove +au$in( he $eet
the re9uire$ent o/ ellin( /or e$%lo#$ent* health* or un/oreeen circu$tance..
Thi %roviion i (reat /or o$eone 0ho $ove into a ho$e* re$odel it and ell it t0o #ear later /or a (ain 0ithin
the e4cluion a$ount.
Jrior to B 121* there 0a B 1034 0hich 0a not a %er$anent e4cluion !ut rather a de/erral %roviion 0hich allo0ed
no (ain to !e reco(niDed on the ale o/ a %rinci%al reidence i/ a ne0 reidence 0a at leat e9ual in cot to the ale
%rice o/ the old reidence. The %ro!le$ 0ith thi 0a that it encoura(ed %eo%le to !u# $ore e4%enive houe and
loc6ed in 0ealth.
5. Installment Sales
There are everal reaon 0h# a eller $i(ht a(ree to ell %ro%ert# throu(h an intall$ent aleA +1. the !u#er i a
$all !uine ha a lot o/ (ood0ill 0hich i hard to value and a loan 0ould !e too ri6# /or the !an6E +2. the !u#er
doe not have (ood creditE or +3. the eller doen2t $ind ta6in( the %ro%ert# !ac6 i/ the !u#er de/ault.
The iue in intall$ent ale i recover# o/ !ai. There are three o%tion /or recover# o/ !aiA +1. allo0 the
ta4%a#er to recover !ai u% /irt +thi i ta4%a#er /riendl# !ecaue it de/er ta4ation.E +2. allo0 the ta4%a#er to
recover !ai lat +ver# (overn$ent /riendl#.E +3. %ro rata recover#. 'ection 453 allo0 a %ro rata recover# o/ !ai.
'ection 453+c. (ive the /ollo0in( e9uation +S i the ta4a!le a$ount* J i the %a#$ent received that #ear* >R i the
(ain realiDed on the ale* and CJ i the contract %rice.A
S T J+>RGCJ.
'ection 453 a%%lie onl# to %rinci%al %a#$ent* interet %a#$ent are included in the (ro inco$e o/ the eller a
ordinar# inco$e. I/ the note doe not contain tated interet @ri(inal Iue )icount Rule +,@I)-. a%%l#. =ut
6no0 that @I) e4it.
%. Annuities
'i$ilar to intall$ent ale* Con(re ha %rovided a (radual recover# o/ an annuitant2 !ai accordin( to the
,e4cluion ratio- o/ B 72+!.+1.. Thi e9uation i +S i the nonta4a!le a$ountE J i the annuit# %a#$entE I i the
invet$ent in the contractE ? i e4%ected return.A
S T J+IG?.
21
'ection 72+c.+1. a# the invet$ent in the contract e9ual the %re$iu$ %aid !# the ta4%a#er reduced !# an#
a$ount received !# the ta4%a#er !e/ore the annuit# tartin( date and e4cluded /ro$ inco$e. 'ection 72+c.+3.
doen2t de/ine e4%ected return !ut a# that i/ the e4%ected return de%end on the annuitant2 li/e e4%ectanc#* the
e4%ected return i to !e !aed on Treaur# actuarial ta!le.
The e4cluion i li$ited to the invet$ent. A/ter the ta4%a#er recover her invet$ent* he ha to include the entire
annuit# %a#$ent in inco$e. I/ the ta4%a#er die !e/ore her invet$ent i recovered* the a$ount o/ the unrecovered
invet$ent i allo0ed a a deduction in the ta4%a#er2 lat ta4a!le #ear. &nder B 72+!.+3.+C.* thi deduction i
treated a a 1@7 +thi allo0 the ta4%a#er to carr# the lo !ac6 t0o #ear..
F. "asis *ules for ,ro$ert Transferred b 3ift or "e<uest
&. ,ro$ert Transferred b Inter >ivos 3ift
There are three o%tion /or ta4in( a (i/tA +1. treat (i/t a a realiDation event and ta4 (ain* donee 0ould (et %ro%ert#
0ith a !ai at 8;NE +2. carr#5over !ai* donee receive donor2 !ai and i ta4ed on the (ain 0hen the donee
ellE or +3. ta4 the donor 0hen the donee ell on (ain u% to %oint o/ tran/er and ta4 donee on (ain a/ter tran/er.
'ection 1015 tate that the donor2 !ai i carried over to the donee. 3o0ever* i/ 8;N at ti$e o/ tran/er i lo0er
than !ai and the donee eventuall# ell /or a lo* then 8;N at ti$e o/ tran/er i ued a !ai.
The /ollo0in( i a ,notch tranaction-A
) (ive S toc6 0ith a !ai o/ H100 and 8;N o/ H90. S ell the toc6 /or H95. I/ #ou a%%l# (ain rule +(ive S the
carr#5over !ai. the !ai i H100 and there i a lo o/ H5. I/ #ou a%%l# lo rule +(ive S the 8;N at tran/er. the
!ai i H90 and there i a (ain o/ H5. In thi ituation* there i no (ain or lo. 'ee Trea. Re(. B 1.101551+2..
Thi ection doe not a%%l# to tran/er !et0een %oueE B 1041 a%%lie.
2. ,ro$ert Transferred at 5eath
A tran/er at death i not treated a a realiDation event* and B 1014 (ive the tran/eree a !ai e9ual to the %ro%ert#2
value a o/ the decedent2 death. Thi %roviion hurt %eo%le 0ho die une4%ectedl# or 0ith %oor advice +!ai o/
%ro%ert# 0ith a lo i te%%ed do0n to the 8;N..
@ne ar(u$ent i that it $i(ht !e di//icult to deter$ine the !ai o/ %ro%ert# ince the %eron 0ho %ro!a!l# 6ne0 i
no0 dead.
). ,art 3ift8 ,art Sale Transactions
&nder Trea. Re(. B 1.100151+e.* i/ a tran/er o/ %ro%ert# i %art ale and %art (i/t* the tran/eror ha a (ain to the
e4tent the a$ount the tran/eror receive e4ceed hi !ai. 8or intance i/ S ha %ro%ert# 0ith 8;N o/ H400*000
and !ai o/ H60*000 and S tran/er the %ro%ert# to ) /or H100*000* S ha a (ain o/ H40*000 +H100*000 5 H60*000..
)2 !ai 0ould then !e deter$ined !# Trea. Re(. B 1.101554. 8or a !ar(ain ale to a charita!le or(aniDation* ee B
1011+!..
3. "asis Allocation4 ,iecemeal Asset 5is$ositions and Other Contexts4
C" 22/
>a$!le v. Co$$iioner C< 294
The ta4%a#er !ou(ht a %re(nant $are /or H60*000. The /oal the $are carried 0a !elieved to !e ired !# a hore
0hoe #earlin( old /or an avera(e o/ H50*000 each. The ta4%a#er inured the /oal 0ith H20*000 inurance !e/ore
the /oal 0a !orn and H30*000 a/ter the coal 0a !orn. Ta4%a#er old the colt /or H125*000. The ta4%a#er ar(ued
that H30*000 o/ the H60*000 %aid /or the $are 0a /or the colt and there/ore hi !ai in the colt 0a H30*000 +the
ta4%a#er ar(ued that thi 0a a%%ro4i$atel# the tud /ee.. The IR' ar(ued that the entire H60*000 0a /or the $are
and the ta4%a#er had no !ai in the colt. The court held the !ai 0a H20*000 !ecaue that 0a 0hat the a$ount
the ta4%a#er inured the colt.
There are everal 0a# the ta4%a#er could ar(ue that value o/ the /oal +and there/ore !ai allocation. !e/ore !irth +at
the ti$e o/ ta4%a#er2 %urchae o/ the $are.A +1. (et !reeder to eti$ate value o/ the /oalE +2. cot o/ !reedin(
22
+ta4%a#er lot in thi cae.E or +3. $ore than the cot o/ !reedin( !ecaue tud /ee onl# (ive a chance o/ a /oal* here
a /oal e4ited.
>a$!le ho0 the %ro!le$ 0ith !ai allocation. Thi allocation %ro!le$ can alo arie 0hen a ta4%a#er %urchae
land 0ith a !uildin(. The ta4%a#er +au$in( it i /or !uine. can ta6e a deduction /or de%reciation o/ the !uildin(
!ut cannot ta6e de%reciation /or the land. 3o0 $uch hould !e allocated to the !uildin( and landI
Trea. Re(. B 1.6156+a. tate that the !ai ha to !e e9uita!l# a%%ortioned a$on( the everal %art. @ne 0a# i to
ue a%%raier to a%%raie the value o/ the everal %art.
I>. ,ersonal 5eductions
Jeronal deduction uuall# re/er to thoe deduction that are availa!le onl# to individual ta4%a#er. There are
a!ove the line deduction 0hich are u!tracted /ro$ inco$e to reach ad"uted (ro inco$e +,A>I-.. Then there are
ite$iDed deduction. Ite$iDed deduction can onl# !e ta6en i/ the ta4%a#er doe not ta6e the tandard deduction.
A. Charitable Contributions -. &D004 C" )51E F" 5&2
&. The *ationale
@ne reaon /or the charita!le contri!ution deduction i to encoura(e ta4%a#er to u%%ort charita!le or(aniDation.
Thi can !e "uti/ied !ecaue the (overn$ent i relieved o/ an o!li(ation it 0ould other0ie have had to $eet* or on
(round that the charita!le or(aniDation %rovide a (eneral %u!lic !ene/it. 3o0ever* the charita!le ector include
or(aniDation 0hich Con(re could not !e %eruaded to u%%ort or 0hich Con(re 0ould not !e %er$itted to
u%%ort under the Contitution. 'econd* ta4%a#er in the hi(her !rac6et have a (reater incentive !ecaue the ta4
avin( %er dollar donated de%end on the ta4%a#er2 $ar(inal ta4 rate. 8inall#* it i not clear that allo0in(
deduction /or contri!ution actuall# reult in (reater charita!le (ivin(.
Another "uti/ication i that a charita!le deduction i an accurate re/lection o/ inco$e !ecaue the ta4%a#er doe not
have the conu$%tion o/ the charita!le (i/t.
Trea. Re(. B 1.170A51+(. tate that ,KnMo deduction i allo0ed under KBM 170 /or a contri!ution o/ ervice.- 8or
e4a$%le* i/ S i a $a(ician and donate a ho0 to a children2 ho%ital* S doe not (et a charita!le deduction* !ut
alo conider that the ho0 i not included in S2 inco$e !ecaue thi i i$%uted inco$e.
2. The Amount of the 5eduction
The ta4%a#er (et a deduction o/ 8;N re(ardle o/ the ta4%a#er2 !ai. 8or e4a$%le* i/ S (ive charit# toc6 0ith
a !ai o/ H10*000 and a value o/ H100*000* !# lo(ic* the deduction hould !e H10*000 +!ecaue thi i 0hat 0a
%revioul# ta4ed. !ut S can ta6e a deduction on H100*000 +even thou(h S never %aid ta4 on H90*000.. 'ee Trea.
Re(. B 1.170A51+c.+1..
In $ot cae* the unrealiDed (ain in donated %ro%ert# i deducti!le onl# i/A
19
+1. The (ain 0ould have !een lon(5ter$ ca%ital (ain had the ta4%a#er old the %ro%ert#E
+2. In the cae o/ a contri!ution o/ tan(i!le %eronal %ro%ert#* the ue o/ the %ro%ert# !# the charit# i related to the
charit#2 ta45e4e$%t %ur%oeE and
+3. The %ro%ert# i not (iven to a ,%rivate /oundation-
@ther0ie* the charita!le deduction i li$ited to the ta4%a#er2 !ai in the %ro%ert#.
I/ the %ro%ert# ha a clai$ed value o/ $ore than H5*000* the ta4%a#er ha to o!tain an a%%raial.
). %li#ible *eci$ients
'ection 170+c. de/ine the eli(i!le or(aniDation to 0hich deducti!le contri!ution can !e $ade. It u!tantiall#
trac6 B 501+c.+3. 0hich i the e4e$%tion /ro$ /ederal ta4 /or charita!le or(aniDation.
/. !imitations on 5eductions and Carrovers
19
'ee B 170+e.
23
There are li$it to the a$ount a ta4%a#er can deduct de%endin( on the t#%e o/ charit#* the t#%e o/ %ro%ert#
contri!uted* and the t#%e o/ tran/er. The li$it are a %ercenta(e o/ the ta4%a#er contri!ution !ae 0hich i the
ta4%a#er2 A>I co$%uted 0ithout re(ard to an# 1@7 carr#!ac6.
There are t0o t#%e o/ charitieA +1. charitie to 0ho$ the ta4%a#er $a# contri!ute u% to 50F o/ hi contri!ution
!aeE and +2. charitie to 0ho$ the ta4%a#er $a# contri!ute u% to 30F o/ hi contri!ution !ae.
50F charitie includeA churche or aociation o/ churche* chool and colle(e* ho%ital* $edical chool or
$edical reearch or(aniDation* or(aniDation receivin( a u!tantial %art o/ their u%%ort /ro$ the tate or /ederal
(overn$ent or the (eneral %u!lic* the tate or /ederal (overn$ent* and certain %rivate /oundation. 'ee B 170+!.+1.
+A. and Trea. Re(. B 1.170A59. 30F charitie are thoe or(aniDation 9uali/ied to receive deducti!le charita!le
contri!ution !ut do not 9uali/# a 50F charitie. 'ee B 170+!.+1.+<..
I/ a ta4%a#er $a6e contri!ution to !oth 50F and 30F charitie* the a$ount o/ the contri!ution to the 50F
charitie are ta6en /irt. I/ thoe contri!ution have not e4hauted the li$it* the contri!ution to the 30F charitie*
u% to 30F o/ the contri!ution !ae* or the re$ainin( a$ount on the 50F li$it 0hichever i le* are allo0ed.
Contri!ution to 50F charitie 0hich e4ceed 50F o/ the contri!ution !ae $a# !e carried /or0ard /or 5 #ear.
Contri!ution to 30F charitie 0hich e4ceed 30F o/ the contri!ution !ae cannot !e carried /or0ard.
I/ the ta4%a#er contri!ute ca%ital (ain %ro%ert#* it $a# !e deducted onl# to the e4tent it doe not e4ceed 30F o/ the
ta4%a#er2 charita!le contri!ution !ae. 'ee B 170+!.+1.+C.+i..
Charita!le contri!ution have to !e u!tantiated accordin( to the re(ulation. In addition* the ta4%a#er ha the
!urden o/ eta!lihin( that a charit# 9uali/ie /or the recei%t o/ deducti!le contri!ution.
Cor%orate ta4%a#er can deduct u% to 10F o/ their ta4a!le inco$e* co$%uted 0ithout re(ard to their charita!le (i/t*
their dividend5received deduction* and an# carr#!ac6 /or ca%ital or o%eratin( loe. 'ee B 170+!.+2..
5. >ehicle 5onations
To to% a!ue o/ donation o/ ued auto$o!ile* Con(re enacted B 170+/.+12.. 8irt* ta4%a#er are onl# allo0ed to
deduct contri!ution i/ the charit# %rovide a conte$%oraneou 0ritten ac6no0led(e$ent o/ the donation. The
ac6no0led($ent ha to (ive the (ro %roceed o/ the ale o/ the vehicle and a tate$ent that the deducti!le a$ount
$a# not e4ceed the (ro %roceed. Thi %roviion doe not a%%l# i/ the charit# i (oin( to ue the vehicle a %art o/
it charita!le $iion +e.(. to deliver $eal* ervice* etc...
1. Guid ,ro Guo
The 9uid %ro 9uo %rinci%le i that a deduction i not allo0ed /or a contri!ution to charit# 0here a %eron receive
o$e !ene/it /ro$ the contri!ution.
a. The Colle#e Football Sa#a
In Rev. Rul. 845132 C< 406* the IR' declared that a ta4%a#er 0ho %aid $one# to an athletic cholarhi% %ro(ra$
and 0a* !ecaue o/ the donation* entitled to !u# /oot!all tic6et /or %re/erred eatin(* 0a not a charita!le
deduction. A a (eneral rule* %a#$ent to a charita!le or(aniDation 0hich reult in the recei%t o/ a u!tantial
!ene/it create the %reu$%tion that no charita!le contri!ution ha !een $ade.
In 1986* Con(re created a ri/le hot %roviion /or 7'& and Te4a* allo0in( deduction /or their /oot!all %ro(ra$.
In 1988* Con(re leveled the /ield !# enactin( B 170+l. 0hich allo0 80F o/ a (i/t to !e deducted i/ the (i/t entitle
the ta4%a#er to %urchae eatin( at athletic event.
b. Intan#ible *eli#ious "enefits
Rev. Rul. 70547 allo0ed the charita!le deduction o/ %e0 rent. Rev. Rul. 785189 denied charita!le contri!ution !#
ta4%a#er to the Church o/ 'cientolo(# /or a ,/i4ed donation- $ade to the church /or %a#$ent o/ auditin( coure
unle the ta4%a#er can %rove that the donation e4ceeded the 8;N o/ the !ene/it received. In that cae* the
ta4%a#er could deduct the e4ce o/ 8;N donated.
24
3ernandeD v. Co$$iioner C< 413
The ta4%a#er ar(ued that the /i4ed donation to the Church o/ 'cientolo(# 0a not 9uid %ro 9uo !ecaue the !ene/it
received /ro$ the donation 0a %urel# reli(iou and %a#$ent $ade to %artici%ate in reli(iou ervice hould !e
auto$aticall# deducti!le under B 170. The Court dia(ree holdin( that there i no e4ce%tion to the 9uid %ro 9uo
doctrine /or reli(iou !ene/it. 'econd* the ta4%a#er ar(ue that den#in( the deduction violate the ?ta!lih$ent
Claue and the 8ree ?4ercie Claue o/ the 8irt A$end$ent* 0hich the Court denie. 8inall#* the ta4%a#er ar(ue
that the IR' treat the Church o/ 'cientolo(# di//erent /ro$ other reli(iou %ractice. The Court hold the ta4%a#er
ha not eta!lihed a co$%lete /actual record u%on 0hich the Court can $a6e a deter$ination. The dient clai$ed
that it i hard to %ut a value on thee intan(i!le reli(iou !ene/it.
In Rev. Rul. 93573* the IR' revered it %oition* e//ectivel# re%udiatin( 3ernandeD. The rulin( 0a %art o/ a
ettle$ent !et0een the IR' and the Church o/ 'cientolo(#. The IR' doe not have the %o0er to overrule the
'u%re$e CourtE ho0ever* the ta4%a#er certainl# in2t (oin( to challen(e the IR'2 6indne and it i unli6el# that
an#one ele ha tandin( to challen(e the IR'.
'6lar v. Co$$iioner C< 421
The ta4%a#er ar(ued that 55F o/ their %rivate chool tuition 0a /or reli(iou intruction 0hich 0a an intan(i!le
reli(iou !ene/it li6e the auditin( in the Church o/ 'cientolo(#. The court held that the IR' %olic# to0ard the
Church o/ 'cientolo(# /aciall# dicri$inated a$on( reli(ion 0hich i uncontitutional* !ut the ta4%a#er lot
!ecaue the# did not %rove that the %rivate chool cot $ore than the %u!lic chool or that an# %art o/ their %a#$ent
0a /or intan(i!le reli(iou !ene/it. The ta4%a#er lot thi cae !ut could re/ile the cae /or another ta4 #ear and
%rove the %a#$ent.
". Interest %x$ense4 C" )1)E F" /20
'ection 163+a. tate that there i a deduction o/ all interet %aid. 3o0ever* B 163+h. li$it thi deduction in the
cae o/ %eronal interet.
20
&nder B 163+h.* all interet i %eronal unle the ta4%a#er i a cor%oration or in the cae
o/ a non5cor%oration* the interet /all under one o/ the e4ce%tion* 0hich includeA !uine interet* certain a$ount
o/ ho$e $ort(a(e interet* invet$ent interet* %aive activit# interet* and education loan interet. Interet i
ai(ned !aed on the ta4%a#er2 ue o/ the !orro0ed /und on 0hich the interet i %aid.
&. Gualified *esidence Interest
A ta4%a#er can deduct the interet on $ort(a(e ecured !# a %eronal reidence. The nu$!er o/ %eronal
reidence 0hoe $ort(a(e can (enerate deducti!le interet i li$ited to t0o* 0ith $arried cou%le 0ho /ile
e%aratel# !ein( allo0ed onl# one reidence each. 'ee B 163+h.+4.+A.+ii.. 'econd* the %eronal reidence $ut
ecure the $ort(a(e loan 0hoe interet o!li(ation the ta4%a#er ee6 to deduct. Third* the $ort(a(e loan $ut !e
either ,ac9uiition inde!tedne- or ,ho$e e9uit# inde!tedne.- Ac9uiition inde!tedne i a $ort(a(e ued to
!u#* !uild* or u!tantiall# i$%rove the reidence or re/inance e4itin( ac9uiition inde!tedne. IRC B 163+h.+3.
+<.. 3o$e e9uit# inde!tedne i an# de!t ecured !# a reidence that i not ac9uiition inde!tedne and i li$ited
to the 8;N +even i/ the !an6 0ould lend $ore than the ta4%a#er2 e9uit# in the ho$e.. IRC B 163+h.+3.+C..
8inall#* the loan a$ount (eneratin( the deducti!le interet are li$ited. Ac9uiition inde!tedne interet i
deducti!le /or loan a$ount u% to H1 $illion +it i li$ited to the ta4%a#er2 !ai.* and ho$e e9uit# de!t interet i
deducti!le u% to H100*000.
Jau v. Co$$iioner C< 367
The ta4%a#er %urchaed a ho$e /or H1.7 $illion. The# /inanced the %urchae 0ith a $ort(a(e o/ H1.3 $illion. The#
deducted interet /ro$ H1.1 $illion o/ the $ort(a(e clai$in( that the a((re(ate o/ the ac9uiition inde!tedne and
ho$e e9uit# inde!tedne reulted in H1.1 $illion. The court held that all H1.1 $illion 0a ac9uiition inde!tedne
and ac9uiition de!t 0a li$ited to H1 $illion. 3o$e e9uit# de!t could not !e ued /or ho$e ac9uiition de!t.
There/ore* the ta4%a#er 0ere li$ited to a deduction o/ interet on H1 $illion.
2. "usiness 5ebt
20
8or !uinee* BB 264 and 265 diallo0 deduction /or interet %aid on loan ued to %roduce ta4 e4e$%t inco$e
and B 163+d. diallo0 a deduction /or interet on de!t incurred to /inance invet$ent.
25
Interet i an a!ove the line deduction i/ it i attri!uta!le to the inde!tedne incurred in connection 0ith a !uine
+unle it i incurred not !# the !uine !ut !# an e$%lo#ee in 0hich cae it i an ite$iDed deduction.. B 62+a.+1.
and +4..
In Redlar6 v. Co$$iioner* the iue 0a ho0 %ro4i$atel# related a de!t $ut !e to the trade or !uine to "uti/#
deducti!ilit#. The ta4%a#er o%erated an unincor%orated !uine. The !uine (enerated inco$e ta4 lia!ilit# and
interet on the ta4 lia!ilit#. The ta4%a#er deducted the interet ar(uin( that it 0a ,%ro%erl# alloca!le- to the
!uine. The IR' ar(ued that the 0ord ,%ro%erl# alloca!le- are deli!eratel# a$!i(uou and the Co$$iioner can
deter$ine 0hat i ,%ro%erl# allocated.- The %eronal inco$e ta4 i a %eronal o!li(ation and de/iciencie are never
%ro%erl# alloca!le to a !uine. The court de/er to the IR'2 inter%retation and held the interet 0a not %ro%erl#
alloca!le.
:hat i interetin( i that the interet 0a !ecaue the !uine $ade $one# and (enerated inco$e ta4 lia!ilit#. I/
the !uine had !een incor%orated !e/ore (eneratin( inco$e* the interet 0ould have !een deducti!le.
). Investment and ,assive Activit Interest
Invet$ent interet i onl# deducti!le a(aint invet$ent (ain. 1o net lo deduction +a in a cae 0here interet
e4%ene e4ceed inco$e. are allo0ed.
/. %ducational !oan Interest
'ection 221 allo0 interet deduction o/ u% to H2*500 on educational loan +at an interet rate o/ 5F* thi 0ould
allo0 interet %aid on u% to H50*000..
21
The loan $ut !e a 9uali/ied education loan incurred to %a# /or 9uali/ied
education e4%ene. 'ee B 221+d.. 8or inco$e a!ove H50*000 +H100*000 /or ta4%a#er /ilin( "ointl#.* deducti!ilit#
!e(in to !e %haed out. <# the ti$e $odi/ied A>I reache H65*000 +H130*000 /or ta4%a#er /ilin( "ointl#.* all
deduction on education interet are denied. 'ee B 221+!.+2.+<..
C. State and !ocal Taxes4 C" )D5E F" /2'
A deduction i allo0ed /or tate and local ta4e. Thi i "uti/ied a a conceion to /ederali$. An ar(u$ent a(aint
thi i that citiDen o/ hi(her ta4ed tate 0ill en"o# (reater tate and local (overn$ent ervice and at the a$e ti$e
lo0er /ederal ta4 lia!ilitie +due to the deduction o/ tate and local ta4e.. There i an ar(u$ent that %art o/ tate
ta4e i actuall# %eronal conu$%tion !ecaue the tate %rovide ervice to the ta4%a#er.
>enerall#* B 164 %rovide that tate and local inco$e ta4e* real %ro%ert# ta4e* and %eronal %ro%ert# ta4e are
deducti!le. 'ection 164 alo allo0 deduction o/ /orei(n inco$e and real %ro%ert# ta4e. 'ection 164+!.+5. allo0 a
ta4%a#er to $a6e an election to deduct tate ale ta4 intead o/ tate and local inco$e ta4.
@ne interetin( a%ect o/ thi i i/ certain ervice* uch a trah collection* are included in ta4e* it i deducti!le.
3o0ever* a ta4%a#er %a# /or thi ervice e%arate /ro$ ta4e* it i not deducti!le. The reaon citie don2t include it
in ta4e i %oliticall# to $a6e the ta4e lo0er.
An iue i deter$inin( 0ho i entitled to the deduction. The deduction de%end on the le(al incidence o/ the ta4*
the %eron 0ho 0a o!li(ated to %a# the ta4. Trea. Re(. B 1.16451+a. %rovide that ta4e are (enerall# deducti!le
onl# !# the %eron on 0ho$ the# are i$%oed. 'ee 7oria v. Co$$iioner C< 379 +Jetitioner2 !rother
%urchaed %ro%ert# !ecaue %etitioner did not have ade9uate credit. Jetitioner %aid ta4e on the %ro%ert# !ut the
court diallo0ed the deduction !ecaue %etitioner 0a not the le(al o0ner o/ the %ro%ert# and 0a not o!li(ated to
%a# the ta4e..
5. Casualt !osses4 C" )'28 /D0(/D'E F" 500
7oe +caualt#. are allo0ed to individual ta4%a#er i/ the# are incurred in a trade or !uine or incurred in a
tranaction entered into /or %ro/it* to the e4tent not co$%enated /or !# inurance. 7oe 0ith re%ect to %eronal5
ue %ro%ert# are allo0ed* u!"ect to certain li$itation. 'ee B 165+c.+3.. 8irt* the a$ount o/ an individual lo to
%eronal5ue %ro%ert# i deducti!le onl# to the e4tent that it e4ceed a H100 /loor a$ount. The econd li$it i that
the a((re(ate o/ all thee %eronal5ue caualtie* a/ter u!traction o/ the H100 /loor* i onl# deducti!le to the e4tent
21
1ote thi i H2*500 o/ interet and i not a li$it on the %rinci%al li6e the ho$e $ort(a(e ection.
26
it e4ceed 10F o/ the ta4%a#er A>I. The 10F /loor %ut %reure on ta4%a#er to tr# to ho0 that a caualt# lo
0a !uine or invet$ent %ro%ert# +0hich i deducti!le 0ithout re(ard to the 10F /loor..
'te% a Ta4%a#er $ut (o throu(h to deter$ine the allo0a!le deductionA
1. 8or each %iece o/ %ro%ert# that 0a da$a(ed* lot* or detro#ed* !e(in 0ith the 8;N o/ the %ro%ert# !e/ore the
caualt#.
2. 'u!tract the value o/ the %ro%ert# a/ter the caualt# +0hich 0ill !e Dero i/ the %ro%ert# i totall# lot or detro#ed..
3. Co$%are the reult 0ith the ad"uted !ai o/ the %ro%ert#* ta6in( the leer o/ the t0o nu$!er a the tentative
caualt# lo +or caualt# (ain..
4. 'u!tract the a$ount o/ an# recoverie /ro$ tort5/eaor or inurance covera(e.
5. @nce that %roce i co$%lete /or each %iece o/ %ro%ert# lot or da$a(ed in the caualt#* the tentative caualt#
loe are added.
6. Caualt# (ain* i/ an#* and the tatutor# H100 deducti!le are u!tracted.
7. I/ the ta4%a#er u//ered $ore than one caualt#* the te% a!ove $ut !e re%eated /or each %iece o/ %ro%ert# in
each additional caualt# u//ered.
8. @nce the (ain and loe /ro$ each caualt# are co$%uted* the ta4%a#er add the$ to(ether* then u!tract 10F
o/ A>I. Thi i the a$ount o/ the allo0a!le deduction.
22
The reaon /or the !uine deduction i clear* allo0in( a deduction i conitent 0ith the (eneral theor# o/ allo0in(
deduction /or loe. The reaon /or a deduction /or %eronal %ro%ert# i $ot li6el# !ecaue 0e don2t 0ant to 6ic6
a %eron 0hen the# are do0n. In addition* allo0in( the deduction allo0 /or a !etter re%reentation o/ a %eron2
true inco$e. An ar(u$ent a(aint it i that caualt# loe are %art o/ the ri6 o/ livin(.
Caualt# loe included loe /ro$ /ire* tor$* hi%0rec6* or other caualt#* or /ro$ the/t. 'ee B 165+c.+3.. The
IR' ha ruled that ,other caualt#- $ut !e analo(ou to /ire* tor$ or hi%0rec6. In %articular* an ,other
caualt#- $ut !e ,udden- +a o%%oed to (radual or %ro(reive.E une4%ected +a o%%oed to antici%ated* and
unuual +a o%%oed to co$$onl# occurrin(.. Rev. Rul. 725592.
In Cha$ale v. Co$$iioner C< 470E 3< 503* the ta4%a#er lived near @.=. 'i$%on2 houe. The# clai$ed
their %ro%ert# 0a devalued due to the cro0d that (athered outide hi ho$e. The ta4 court deter$ined thi 0a not
a caualt# lo* holdin( that the 1inth Circuit ha deter$ined that there i not a caualt# lo unle there i actual
%h#ical da$a(e or a!andon$ent !# %h#ical neceit#. The ta4%a#er here had no uch %h#ical da$a(e.
The ?leventh circuit doe not re9uire %h#ical da$a(e !ut intead loo6 to ee i/ there i a %er$anent devaluation
due to the caualt#. It i unli6el# that even thi tandard 0ould have hel%ed the ta4%a#er.
Rev. Rul. 635232 C< 474* held that da$a(e !# ter$ite 0a not a deducti!le caualt# lo under B 165+c.+3.
!ecaue it occur lo0l# over ti$e and not uddenl# li6e /ire* tor$* or hi%0rec6.
%. 6edical %x$enses4 C" )''E F" 5&/
The $edical e4%ene deduction* B 213* allo0 a deduction /or $edical e4%ene on the ta4%a#er2 !ehal/ or on the
hal/ o/ the ta4%a#er2 de%endent* !ut onl# to the e4tent the $edical e4%ene e4ceed 7.5F o/ the ta4%a#er2
ad"uted (ro inco$e. 'ection 213+d.+1.+A. de/ine $edical care a ,a$ount %aid /or the dia(noi* cure*
$iti(ation* or %revention o/ dieae* or /or the %ur%oe o/ a//ectin( an# tructure or /unction o/ the !od#.-
In Co$$iioner v. <ilder C< 389* the ta4%a#er* a 1e0 =ere# reident* too6 a deduction /or rent %aid in 8lorida*
!ecaue the ta4%a#er clai$ed he 0a advied !# hi heart %ecialit to %end the 0inter in a 0ar$ client. The court
held the rent 0a not deducti!le !ain( it o%inion on a co$$ittee re%ort 0hich aid that $edical e4%ene doe not
include an# /ood or lod(in( 0hile a0a# /ro$ ho$e receivin( $edical treat$ent. Thi i ar(ua!l# a %eronal
conu$%tion. 3o0ever* the ta4%a#er could deduct the travel e4%ene to 8lorida.
22
I/ the reult i a caualt# (ain* it i ta4a!le a lon(5ter$ ca%ital (ain i/ the a((re(ate o/ uch (ain e4ceed the
a((re(ate o/ caualt# loe /or the ta4 #ear. 'ee C< 384* B 165+h.+2.+<..
27
The court have alo denied deduction /or %rivate choolin( /or a ta4%a#er2 children. 'ee @ch v. Co$$iioner
C< 391 n.2E 3< 516. The court held that even thou(h !oardin( chool a%%eared necear# to alleviate de$and on
the $other u//erin( /ro$ throat cancer* the e4%ene 0ere not deducti!le.
Ju!lication 17 contain a lit o/ ite$ 0hich can !e included and 0hich cannot !e included. 'ee J 154.
The deduction i allo0ed /or e4%ene ,%aid- durin( a ta4a!le #ear re(ardle o/ 0hen the $edical ervice 0ere
%er/or$ed* and re(ardle o/ the ta4%a#er2 uual $ethod o/ accountin(. Thu* it $a6e ene /or ta4%a#er to
!unch their $edical e4%ene i/ the# can. In addition* thi $a# !e a ituation 0here $arried ta4%a#er $a# 0ant to
/ile a e%arate return.
F. 6iscellaneous Itemi?ed 5eductions4 C" )2/E F" 52D
'ection 67+a. tate that $icellaneou ite$iDed deduction are onl# allo0ed to the e4tent that the a((re(ate o/ the
deduction e4ceed 2F o/ the ta4%a#er A>I. ;icellaneou ite$iDed deduction are de/ined ne(ativel# a ite$iDed
deduction other than the ite$iDed deduction lited in B 67+!. and the a!ove the line deduction in B 62.
3. *eduction of Itemi?ed 5eductions for Fi#h Income Tax$aers4 C"
)25
'ection 68* %rovide that ite$iDed deduction $ut !e reduced /or ta4%a#er 0hoe ad"uted (ro inco$e e4ceed
H100*000 +H50*000 in the cae o/ $arried ta4%a#er 0ho /ile e%aratel#.. Thi ha !een inde4ed /or in/lation +a o/
2003* it 0a at H139*500.. I/ the ta4%a#er e4ceed that threhold* the total ite$iDed deduction clai$ed are reduced
!# the leer o/ the t0o /ollo0in( a$ountA
1. 3F o/ A>I $inu the threhold
2. 80F o/ the ite$iDed deduction other0ie allo0a!le /or the ta4 #ear
>. "usiness %x$ense 5eductions
In !uine* inco$e i nor$all# undertood to !e the net reult o/ a !uine over a #ear. Inco$e i calculated !#
/irt calculatin( (ro inco$e and then u!tractin( le(iti$ate e4%ene o/ conductin( the !uine. 'ection 162
allo0 deduction /or ,all ordinar# and necear# e4%ene %aid or incurred durin( the ta4a!le #ear in carr#in( on
an# trade or !uine.- 'ection 212 allo0 a deduction /or ,all the ordinar# and necear# e4%ene- /or %ro/it5
ee6in( or invet$ent activit#.
A. Hhat is an AOrdinar and 9ecessarB ex$ense7 + C" /25
&. 9ecessar
The 'u%re$e Court decri!ed the 0ord ,necear#- a re9uirin( onl# that e4%ene !e ,a%%ro%riate and hel%/ul- in
,the develo%$ent o/ the Kta4%a#er2M !uine.- :elch v. 3elverin(. I/ deduction 0ere allo0ed onl# /or necear#
e4%ene* the IR' 0ould !e revie0in( ever# !uine e4%ene to $a6e ure the !uine e4%ene 0a necear# +do
the 0or6er2 reall# need %enI.. The ta4 "uri%rudence rarel# denie an e4%ene !ecaue it 0an2t ,necear#.- 'ee
Jalo Alto To0n Q Countr# Nilla(e* Inc. v. Co$$iioner C< 495 +ta4%a#er2 %aid a /ee to an air%lane ervice to
6ee% a %lane availa!le /or ta4%a#er2 on tand!# !aiE the court held it 0a a%%ro%riate and hel%/ul to the !uine...
2. Ordinar
:hether an e4%ene i ,ordinar#- ha !een $ore controverial. There are t0o $eanin( o/ ordinar#. @ne $eanin(
i that it i an e4%ene o/ a nor$al t#%e. The econd $eanin(* cloer to actual ua(e in $ot cae* i that ,ordinar#-
$ean o$ethin( that i ued u% in the %roduction o/ inco$e in the current ta4 #ear +a o%%oed to a ca%ital e4%ene
0hich !ene/it $ore than one ta4 #ear.. In Co$$iioner v. 3einin(er C< 497* the court held that le(al e4%ene
0ere ordinar# and necear#* $eanin( o/ a t#%e 0hich 0a e4%ected !# a !uine* !ecaue the ta4%a#er 0a
de/endin( hi !uine and i/ he lot* he 0ould loe hi !uine.
". Hhat is a ATrade or "usinessB7
There i no ditinction in ta4 "uri%rudence !et0een a trade and a !uineE the# are one and the a$e. )eter$inin(
0hat /all in thi cate(or# i $ore di//icult. In 3i((in v. Co$$iioner* the 'u%re$e Court held that $erel#
$ana(in( a %ort/olio* no $atter ho0 lar(e the %ort/olio or ho0 e4%enive the $ana(e$ent* 0a not a trade or
28
!uine. Con(re added B 212 0hich allo0 deduction o/ certain %ro/it5ee6in( e4%ene that 0ere not %art o/ a
trade or !uine. 3o0ever* there continue to !e i$%ortant di//erence !et0een B 162 and B 212. >enerall# B 162
e4%ene are treated $ore /avora!l# than B 212 +$ot B 212 e4%ene are $icellaneou ite$iDed deduction*
$icellaneou ite$iDed deduction cannot !e deducted /ro$ the alternative $ini$u$ ta4* other deduction de%end
on 0hether or not the ta4%a#er i en(a(ed in a trade or !uine.. 3o0ever* there are !ene/it to !ein( under B 212.
Inco$e /ro$ el/5e$%lo#$ent 0hich 9uali/ie a a trade or !uine i u!"ect to el/5e$%lo#$ent ta4e* 0herea
i$%l# $ana(in( an invet$ent doe not (enerate el/5inco$e ta4 lia!ilitie.
In Co$$iioner v. >roetDin(er* the 'u%re$e Court held that the ta4%a#er 0a in the trade or !uine o/ a (a$!ler.
The# held that ,to !e en(a(ed in a trade or !uine* the ta4%a#er $ut !e involved in the activit# 0ith continuit#
and re(ularit# and that the ta4%a#er2 %ri$ar# %ur%oe /or en(a(in( in the activit# $ut !e /or inco$e or %ro/it. A
%oradic activit#* a ho!!#* or an a$ue$ent diverion doe not 9uali/#.- The ta4%a#er2 (a$!lin( 0a %urued /ull
ti$e* in (ood /aith* and 0ith re(ularit#* /or the %roduction o/ a livelihood. It 0a not a ho!!#.
C. ,ublic ,olic !imitations
'hould deduction !e allo0ed /or e4%ene 0hich violate %u!lic %olic#* /or e4a$%leA %a#$ent !# a !an6 ro!!er to a
(eta0a# driver or !ri!e and 6ic6!ac6 to o!tain valua!le contractI
Tan6 Truc6 Rental* Inc. v. Co$$iioner C< 509
Tan6 Truc6 Rental +,Tan6-. %aid everal hundred /ine i$%oed on it /or violation o/ tate $a4i$u$ 0ei(ht la0.
Tan6 deducted thoe e4%ene a ordinar# and necear# !uine e4%ene. The co$$iioner denied the
deduction. The 'u%re$e Court held that Con(re intended to ta4 net inco$e and not (ro inco$e. 3o0ever*
allo0in( a deduction uch a thi 0ould encoura(e violation o/ tate la0 !#* in e//ect* u!idiDin( the /ine. Tan6
ar(ued that the /ine 0ere not %enaltie !ut rather a revenue toll. The Court dia(ree holdin( that the /ine 0ere a
%enal $eaure.
In 1969* Con(re enacted B 162+/. 0hich denie a deduction /or an# /ine or i$ilar %enalt# %aid to a (overn$ent
/or the violation o/ a la0. @ne %ro!le$ 0ith thi recentl#* a %eron co$$it inider tradin(* the %eron ettle !#
donatin( H200 $illion to charit#. )oe the %eron (et a deductionI Ar(ua!l#* it 0an2t a /ine and it 0an2t %aid to a
(overn$ent. @n the other hand* #ou could ar(ue thi 0ould /rutrate %u!lic %olic#.
5. !obbin# %x$enses
'ection 162+e. %rohi!it a !uine e4%ene deduction /or lo!!#in( e4%ene in virtuall# all cae. In >ear# v.
Co$$iioner C< 516* the ta4%a#er 0ith ventrilo9uit du$$# atte$%ted to deduct e4%ene /or %uttin( an iue
on the !allot to ave hi %u%%et. The ta4%a#er ar(ued it 0an2t atte$%tin( to in/luence the %u!lic !ut rather i$%l#
%uttin( the iue !e/ore the %u!lic. The Court denied the deduction holdin( that it 0a a lo!!#in( e4%ene !ecaue
the !road lan(ua(e o/ B 162+e.+2.+<. $a6e non5deducti!le an# a$ount incurred ,in connection 0ith an# atte$%t to
in/luence the (eneral %u!lic.-
In e//ect* Con(re i a#in( lo!!#in( houldn2t !e u!idiDed !# the 8ederal (overn$ent.
%. *easonable Com$ensation
'ection 162+a.+1. allo0 ,a reaona!le allo0ance /or alarie or other co$%enation /or %eronal ervice actuall#
rendered.- I/ the o//icer and e4ecutive o/ a cor%oration are u!tantiall# identical 0ith it $a"or hareholder* a
te$%tation $a# arie to ditri!ute o$e o/ the earnin( o/ the cor%oration a co$%enation /or ervice rather than
throu(h dividend to avoid dou!le ta4ation.
In ?4acto '%rin( Cor%. v. Co$$iioner C< 521E 3< 367* the ta4 court a%%lied a even /actor tet to deter$ine
reaona!le co$%enationA +1. the t#%e and e4tent o/ the ervice renderedE +2. the carcit# o/ 9uali/ied e$%lo#eeE
+3. the 9uali/ication and earnin( ca%acit# o/ the e$%lo#eeE +4. the contri!ution o/ the e$%lo#ee to the !uine
ventureE +5. the net earnin( o/ the e$%lo#erE +6. the %revailin( co$%enation %aid to e$%lo#ee 0ith co$%ara!le
"o!E and +7. the %eculiar characteritic o/ the e$%lo#er2 !uine. In a%%l#in( the /actor* the ta4 court held the
%reident o/ ?4acto '%rin( 0a over5co$%enated. The Court o/ A%%eal revered re"ectin( the tet ued !# the ta4
court and intead a%%lied the inde%endent invetor tet. &nder thi tet* the court loo6 to ee 0hether the invetor
29
are receivin( an acce%ta!le level o/ return on their invet$ent. I/ the# are* the court !elieve that the co$%enation
i %reu$%tivel# valid.
@ther court a%%l#in( the inde%endent invetor tet re/er to the tet a a ,len- throu(h 0hich one a%%lie the even
/actor tet.
F. Travel and %ntertainment
&. Travel
'ection 162+a.+2. allo0 a deduction /or travelin( e4%ene* includin( $eal and lod(in(* 0hile a0a# /ro$ ho$e in
%uruit o/ a trade or !uine. The IR' ha added t0o other re9uire$entA the ta4%a#er $ut !e a0a# /ro$ hi ,ta4
ho$e- in order to 9uali/# /or thee deduction and the ta4%a#er $ut ati/# the ,overni(ht rule*- $eanin( that an#
tri% that doen2t involve a u!tantial ret %eriod* a%%ro4i$atin( ei(ht hour in !ed* doen2t %ut the ta4%a#er in travel
tatu /or the %ur%oe o/ thi %roviion. Co$$utin( and $eal cot are ordinaril# %eronal conu$%tion
e4%enditure* not !uine e4%ene.
Oee% in $ind that althou(h a deduction* uch a a $eal* $a# not deducted under B 162+a.+2.* it $a# till !e
deducted under B 162+a..
3antDi v. Co$$iioner C< 530E 3< 372
The ta4%a#er 0a a econd5#ear la0 tudent at 3arvard. 'he 0a una!le to /ind u$$er 0or6 in <oton and intead
too6 a "o! in 1e0 Cor6. Ta4%a#er2 hu!and re$ained in <oton durin( the u$$er. The ta4%a#er deducted H3*204
/ro$ her ta4 return* re%reentin( the cot o/ $eal* lod(in( in 1e0 Cor6* and the tran%ortation /ro$ <oton to 1e0
Cor6. The court held no deduction !ecaue althou(h the ta4%a#er did incur the e4%ene in the %uruit o/ a trade or
!uine* the ta4%a#er 0a not a0a# /ro$ her ta4 ho$e* 0hich 0a 1e0 Cor6. The ta4%a#er had no !uine reaon
to $aintain a ho$e in <oton.
Accordin( to Rev. Rul. 9957A C< 537* i/ a %eron doe not have a %lace o/ !uine* /or e4a$%le a travelin( ale
%eron* the %eron cannot deduct an# o/ their travelin( e4%ene.
2. %ntertainment
Ar(ua!l#* !uine i a ocial activit# and ee6in( client or cuto$er o/ten involve /ood* !evera(e* or
entertain$ent. 3o0ever* in addition to a !uine %ur%oe* there i alo o$e ele$ent o/ %eronal conu$%tion.
Cohan v. Co$$iioner % 539
>eor(e Cohan o/ten entertained actor* e$%lo#ee* and critic. 3e alo traveled o/ten. 3i e4%ene 0ere
u!tantial and at leat o$e o/ the$ 0ere deducti!le. 3o0ever* he did not 6ee% record. The ta4 court held that
!ecaue he did not have an# record* he could not ta6e an# deduction. The court o/ a%%eal revered holdin( that
,a!olute certaint#- i o/ten not %oi!le and a reaona!le a%%ro4i$ation hould !e $ade. I/ the eti$ate i
conervative that i o6a# !ecaue it i the ta4%a#er2 /ault.
A a reult o/ cae li6e thi*
23
Con(re enacted B 274. 'ection 274 act a a li$itation on B 162+a.. 'ection 274
li$it* condition* or %rohi!it certain deduction that B 162 or B 212 0ould other0ie %er$it. 'ection 274+d.
re9uire ta4%a#er to docu$ent their travel and entertain$ent e4%ene* overrulin( Cohan.
@vervie0 o/ B 274A
24
1. An activit# 0hich i (enerall# conidered to !e entertain$ent* a$ue$ent or recreation* it e4%ene $a# !e
deducted onl# i/ +a. the activit# i directl# related to the ta4%a#er2 !uine* or +!. the activit# i aociated 0ith the
conduct o/ the ta4%a#er2 !uine and it i$$ediatel# %recede or /ollo0 a u!tantial !uine dicuion. 8or an
ela!oration on the ter$ ,directl# related- or ,aociated 0ith- ee Trea. Re(. B 1.27452+c. and +d.. >enerall#* the
entertain$ent $ut !e o/ a ort conducive to a !uine dicuion.
23
8or an outra(eou cae ee 'anitar# 8ar$ )air#* Inc. v. Co$$iioner in 0hich the court held that an A/rican
a/ari 0a a deducti!le !uine e4%ene o/ the dair#* 3< 399.
24
8or a nice chart* ee 3< 401.
30
2. )eduction /or /acilitie ued in connection 0ith entertain$ent +uch a #acht* clu!* and the li6e. are denied*
unle the /acilit# i ued %ri$aril# /or the /urtherance o/ the ta4%a#er2 !uine* and 0a ,directl# related to the
active conduct o/ uch trade or !uine. B 274+a.+1.+<. and 274+a.+2..
3. 'ection 274+!. li$it the deduction /or ,!uine (i/t- to H25 %er reci%ient %er #ear.
4. 'ection 274+c. cover allocation !et0een !uine and non5!uine e4%ene /or /orei(n travel.
5. UU N?RC I;J@RTA1T UU 'ection 274+n. li$it deduction /or !oth t#%e o/ deducti!le !uine $eal e4%ene
travel and non5travel to 50F o/ the a$ount actuall# %ent. 'ection 274+n. alo a%%lie to entertain$ent e4%ene.
6. 'ection 274+e. (ive everal e4ce%tion to B 274
7. 'ection 274+d. i the u!tantiation re9uire$ent. I/ the e$%lo#ee i rei$!ured /or !uine $eal* then he i not
u!"ect to thee rule +rather the e$%lo#er 0ould !e..
3. ,atrollin# the "usiness(,ersonal "orders
'ection 162 allo0 a deduction /or !uine e4%ene. 'ection 262 diallo0 deduction o/ ,%eronal* livin(* or
/a$il# e4%ene.- )ecidin( 0hat i !uine and 0hat i %eronal i co$%licated and i $ani/eted in the /ollo0in(
area.
&. Fobb !osses
'ection 183+a. diallo0 deduction /or activitie not en(a(ed in /or %ro/it.
Oeanini v. Co$$iioner C< 546
The ta4%a#er ran a do( !reedin( and (roo$in( !uine. The ta4%a#er too6 deduction in connection 0ith their
,o%eration.- The IR' ar(ued that the# 0ere not en(a(ed in a do( o%eration /or %ro/it 0ithin the $eanin( o/ B
183+a.. &nder B 183+a.* individual are not allo0ed to deduct loe attri!uta!le to an activit# not en(a(ed in /or a
%ro/it. The IR' ar(ued that the do( !reedin( and (roo$in( 0ere e%arate activitie and the !reedin( o%eration 0a
not an activit# en(a(ed in /or %ro/it. The court held that the t0o activitie 0ere a in(le activit# /or the %ur%oe o/
B 183 under Trea. Re(. B 1.18351+d.+1.* !ecaue there 0a a cloe or(aniDational and econo$ic relationhi%
!et0een the !reedin( o%eration and the (roo$in( ho%. The court ne4t hold that the ta4%a#er 0ere en(a(ed in the
do( o%eration 0ith the o!"ective o/ $a6in( %ro/it. To !e en(a(ed in an activit# /or a %ro/it* the individual ha to
/irt have an actual and honet o!"ective o/ $a6in( a %ro/it +it doen2t $atter i/ thi e4%ectation i reaona!le.. The
court conidered the nine /actor lited !elo0.
Trea. Re(. B 1.18352+!. (ive nine /actor to conider in deter$inin( 0hether an activit# i en(a(ed in /or %ro/itA
1. The $anner in 0hich the ta4%a#er carried on the activit#
2. The e4%ertie o/ the ta4%a#er or hi advior
3. The ti$e and e//ort e4%ended !# the ta4%a#er in carr#in( on the activit#
4. The e4%ectation that aet ued in the activit# $a# a%%reciate in value
5. The ucce o/ the ta4%a#er in carr#in( on other i$ilar or dii$ilar activitie
6. The ta4%a#er2 hitor# o/ inco$e or lo 0ith re%ect to the activit#
7. The a$ount o/ occaional %ro/it* i/ an#* 0hich i earned
8. The /inancial tatu o/ the ta4%a#er
9. :hether ele$ent o/ %eronal %leaure or recreation are involved
'ection 183+!. retore deducti!ilit# /or t0o cate(orie o/ deduction. 'ection 183+!.+1. allo0 deduction that do
not de%end on an# !uine or %ro/it5ee6in( %ur%oe* e.(. tate and local %ro%ert# ta4e a(aint %ro%ert# not held
/or !uine or invet$ent %ur%oe. 'ection 183+!.+2. allo0 a deduction that do de%end on %ro/it5ee6in(
%ur%oe to the e4tent that the# do not e4ceed the inco$e /ro$ the activit# +0hich i reduced !# thoe deduction
ta6en under B 183+!.+1...
2. >acation Fomes
Ta4%a#er 0ho rent vacation or other ho$e 0hich the# alo ue /or %eronal %ur%oe are li$ited in the deduction
the# $a# ta6e. Rental ho$e can !e divided into /our cate(orieA
1. Rental ho$e that are not ued !# the ta4%a#er /or %eronal %ur%oe at an# ti$e durin( the ta4a!le #ear. The
ta4%a#er $a6e ta6e deduction 0ith re%ect to thee %ro%ertie under the uual rule under BB 162* 212* 167* and
31
168.
25
&nder B 280A+d.+3.* a ta4%a#er can rent a d0ellin( to an# %eron +includin( relative. /or ue a the tenant2
%rinci%al reidence at /air rental and it 0ill not !e treated a uin( the d0ellin( /or %eronal %ur%oe.
2. Rental ho$e ued /or %eronal %ur%oe /or a %eriod 0hich doe not e4ceed the (reater o/ /ourteen da#* or 10
%ercent o/ the nu$!er o/ da# durin( uch #ear /or 0hich the unit i rented at a /air rental. Ta4%a#er can ta6e
deduction 0hich are allo0a!le 0ithout re(ard to the !uine ue o/ the %ro%ert# +e.(. $ort(a(e interet* %ro%ert#
ta4e* and caualt# loe.. )eduction 0hich $a# !e ta6en i/ the# are attri!uta!le to %ro%ert# ue in !uine +uch
a $aintenance* utilitie* de%reciation* and caualt# loe. $a# onl# !e ta6en to a li$ited e4tent !aed on ua(e.
The ua(e li$it a to thee deduction i that the# $a# !e ta6en onl# in %ro%ortion to the nu$!er o/ da# the
%ro%ert# i rented out* divided !# the total nu$!er o/ da# the %ro%ert# i ued /or rental and %eronal %ur%oe.
3. Rental ho$e ued /or %eronal %ur%oe /or a nu$!er o/ da# 0hich e4ceed the (reater o/ /ourteen da# or 10F
o/ the nu$!er o/ da# durin( the #ear /or 0hich the unit i rented at a /air rental. Thee are u!"ect to the a$e
ua(e retriction on deduction a unit in cate(or# +2.. In addition to the ua(e li$it* unit in thi cate(or# are
u!"ect to an inco$e li$it. <uine5t#%e deduction* uch a $aintenance* utilitie* and de%reciation 0hich $eet
the ua(e li$it are till u!"ect to the /urther inco$e li$it that the# cannot !e deducted to the e4tent that the# e4ceed
the (ro rental inco$e derived /ro$ rentin( the %ro%ert# le the deduction that 0ould !e allo0ed re(ardle o/
!uine ue. In <olton v. Co$$iioner* the court held that the ratio ued /or deduction that 0ould !e allo0ed
re(ardle o/ !uine ue i the nu$!er o/ da# rented divided !# the nu$!er o/ da# in the #ear. Thi create a
$aller a$ount 0hich i u!tracted /irt /ro$ the inco$e /ro$ the unit. Thi allo0 /or $ore !uine e4%ene.
The deduction allo0ed re(ardle o/ !uine ue are not li$ited to the inco$e* the# can !e ta6en no $atter ho0
$uch inco$e the rental ho$e (enerate.
4. Rental ho$e rented /or le than /i/teen da#. I/ a ta4%a#er $a6e %eronal ue o/ hi vacation or other rental
ho$e and doe rent it* !ut /or le than /i/teen da# cannot ta6e an# deduction attri!uta!le to the rental ue.
3o0ever* the rental inco$e o (enerated i e4cluded /ro$ (ro inco$e.
). Fome Office
'ection 280A %rovide rule /or deducti!ilit# o/ e4%ene o/ a ta4%a#er uin( a %ortion o/ hi ho$e a an ,o//ice.-
8irt* deduction that are (enerall# allo0ed 0ithout re(ard to 0hether the ta4%a#er ha an o//ice in hi ho$e 0ill
continue to !e allo0ed +e.(. $ort(a(e interet* %ro%ert# ta4e* and caualt# loe.. :ith re%ect to !uine
deduction +uch a $aintenance e4%ene* utilit# e4%ene* rent* and de%reciation. the# are onl# allo0ed to the
e4tent the# are alloca!le to a %ortion o/ the ta4%a#er2 reidence 0hich i e4cluivel# ued on a re(ular !ai +a. a
the %rinci%al %lace o/ !uine /or an# trade or !uine o/ the ta4%a#erE +!. a a %lace o/ !uine 0hich i ued !#
%atient* client* or cuto$er in $eetin( or dealin( 0ith the ta4%a#er in the nor$al coure o/ hi trade or !uineE
or +c. in the cae o/ a e%arate tructure 0hich i not attached to the ta4%a#er2 reidence* in connection 0ith the
ta4%a#er2 trade or !uine. I/ the ta4%a#er2 !uine involve hi$ !ein( an e$%lo#ee* he $a# onl# ta6e !uine
deduction attri!uta!le to hi ho$e o//ice i/ the ue o/ the ho$e o//ice i /or the convenience o/ the ta4%a#er2
e$%lo#er.

/. %ducation %x$enses
?ducation e4%ene are deducti!le i/ the# +1. $aintain or i$%rove 6ill re9uired !# the individual in hi
e$%lo#$ent or other trade or !uine or +2. $eet the e4%re re9uire$ent o/ the ta4%a#er2 e$%lo#er* or the
re9uire$ent o/ a%%lica!le la0 a a condition to the retention !# the ta4%a#er o/ hi e$%lo#$ent or rate o/
co$%enation. Trea. Re(. B 1.16255. 8urther$ore* a/ter the# $eet either +1. or +2.* the e4%ene 0ill onl# !e
deducti!le i/ the# +a. are not e4%enditure $ade !# an individual /or education to $eet the $ini$u$ educational
re9uire$ent /or 9uali/ication in hi e$%lo#$ent or other trade or !uineE and +!. do not lead to 9uali/#in( the
ta4%a#er /or a ne0 trade or !uine.
In 1a$ro0 v. Co$$iioner C< 554* the court denied the deduction !# the ta4%a#er o/ e4%ene /or trainin( in
%#choanal#i. The ta4%a#er* a %#chiatrit* ar(ued that the trainin( 0a $erel# i$%rovin( a 6ill. The court held
that it 9uali/ied the ta4%a#er /or a ne0 career.
25
BB 167 and 168 relate to de%reciation.
32
5. Hor=(*elated Clothin#
The court in Jevner v. Co$$iioner C< 560* et out a three %ron( tet /or the deducti!ilit# o/ 0or65related
clothin(A +1. the clothin( in 9uetion $ut !e re9uired a a condition o/ e$%lo#$entE +2. it $ut not !e uita!le /or
(eneral 0earE and +3. it $ut not !e o 0orn. In Jevner the court held that +2. i an o!"ective tet and the Cve 't.
7aurent a%%arel the ta4%a#er had to !u# /or 0or6 0a uita!le /or (eneral 0ear.
>I. Ca$itali?ation and Cost *ecover
A. Ca$itali?ation and 5e$reciation4 The "asics
&nder the ,accelerated cot recover# #te$- +,ACR'. o/ B 168* the cot recover# chedule /or a %articular aet
de%end on three thin(A the total a$ount o/ cot to !e recovered* the nu$!er o/ #ear over 0hich the cot i to !e
recovered* and the rate at 0hich the cot i to !e recovered. 'ection 168+!.+4. %rovide that the alva(e value i
al0a# treated a Dero. Althou(h B 168 re9uire trai(ht line de%reciation /or !uildin( and a /e0 other t#%e o/
aet +ee B 168+!.+3.. $ot aet are eli(i!le /or an accelerated chedule* under 0hich lar(er deduction are
allo0ed in the earlier #ear.
&nder the 200 %ercent +or ,dou!le-. declinin( !alance $ethod* the /irt te% i to calculate the %ercenta(e o/ cot the
ta4%a#er could recover each #ear under the trai(ht line $ethod. The ne4t te% i to deter$ine the rate 0hich i
dou!le the trai(ht line rate. That %ercenta(e i then a%%lied each #ear to the unrecovered !ai o/ the aet. The
$ethod i 0itched to trai(ht line 0hen trai(ht line recover# o/ the re$ainin( !ai %roduce a lar(er deduction
than continued ue o/ 200 %ercent declinin( !alance.
I/ an aet i not %lace in ervice at the !e(innin( o/ #ear 1* B 168+d.+1. treat $ot aet a !ein( %laced in ervice
in the $iddle o/ the #ear* 0ith the reult that onl# a hal/5#ear2 0orth o/ de%reciation i allo0ed /or the /irt #ear.
Thi i 6no0n a the hal/5#ear convention.
&nder B 1016* the ta4%a#er2 ad"uted !ai i reduced !# the a$ount o/ the deduction allo0ed under B 168.
'ection 1245 deal 0ith (ain /ro$ de%recia!le %ro%ert#. 'ection 1245 tate that an# (ain that re%reent the
reca%ture o/ overl# (enerou ACR' deduction on tan(i!le %eronal %ro%ert# 0ill !e treated a ordinar# inco$e.
'ection 1245 doe not a%%l# to real %ro%ert#.
3#%oA Ta4%a#er !ou(ht a car /or H10*000. )e%reciation o/ H6*160 0a ta6en. The car ha an ad"uted !ai o/
H3*840 0hen the car i old /or H12*000. H6*160 +the reca%ture o/ de%reciation. i ta4ed at ordinar# inco$e and the
other H2*000 could 9uali/# a ca%ital (ain under B 1231.
'ection 1250 a%%lie to real %ro%ert#* !ut onl# i/ accelerated de%reciation 0a ta6en* 0hich ha not !een allo0ed
ince 1986. &nder B 1+h.+1.+).* reca%tured de%reciation i u!"ect to 25F ta4. >ain a!ove the reca%tured
de%reciation i ta4ed at the ca%ital (ain rate +15F..
'ection 1231 deal 0ith the ta4ation o/ the ale o/ de%recia!le %lant and e9ui%$ent. &nder B 1221+a.+2.*
de%recia!le %ro%ert# ued in a trade or !uine i not treated a a ca%ital aet +not eli(i!le /or ca%ital (ain treat$ent
under B 1222.. &nder B 1231+a.+1.* (ain are treated a lon(5ter$ ca%ital (ain. 7oe are treated a ordinar#. IRC
B 1231+a.+2..
26
". Hhat is 5e$reciable7
1ot ever# lon(5lived !uine aet i de%recia!le. 7and i one aet 0hich i nonde%recia!le. I/ a ta4%a#er
ac9uire land and a !uildin( /or ue in hi !uine* he $ut allocate hi cot !et0een the de%recia!le !uildin( and
the nonde%recia!le land. The IR' ha the %oition that art or anti9ue ued in a !uine +uch a %aintin(
di%la#ed in a lo!!#. are not allo0ed de%reciation deduction. An intan(i!le !uine aet i alo eli(i!le /or
de%reciation +uuall# called a$ortiDation. i/ it 0ill !e ued in the !uine /or onl# a li$ited %eriod* the len(th o/
0hich can !e eti$ated 0ith reaona!le accurac#. 'ee Trea. Re(. B 1.167+a.53 +de%reciated under trai(ht line
$ethod over 15 #ear..
26
8or a $ore in5de%th decri%tion o/ B 1231* ee 3< 294.
33
&nder B 197* ta4%a#er are allo0ed to recover the cot o/ a 0ide ran(e o/ %urchaed intan(i!le* includin( (ood0ill
and other ,cuto$er5!aed intan(i!le*- on a trai(ht line !ai over 15 #ear* 0ithout re(ard to the actual ue li/e o/
the aet. :ith a /e0 e4ce%tion* B 197 doe not a%%l# to intan(i!le created !# the ta4%a#er itel/* uch a el/5
created (ood0ill.
The IRC alo %er$it the (radual cot recover# o/ e4hauti!le natural reource. Ta4%a#er can chooe !et0een t0o
di//erent cot recover# $ethodA cot de%letion under B 612 and %ercenta(e de%letion under B 613.
27
C. Hhat Costs 6ust "e Ca$itali?ed7
&. Self(,roduced ,ro$ert
Co$$iioner v. Idaho Jo0er Co. C< 586
The ta4%a#er ued it o0n e9ui%$ent and e$%lo#ee to contruct i$%rove$ent and addition to it ca%ital /acilitie.
The ta4%a#er on it !oo6 /or the 8ederal Jo0er Co$$iion ca%italiDed the contruction5related e4%ene !ut /or
ta4 %ur%oe clai$ed a deduction /or de%reciation under the de%reciation chedule o/ B 167. The iue 0a 0hether
the ta4%a#er could ta6e a deduction /or de%reciation over the horter li/e o/ the e9ui%$ent or i/ intead the e4%ene
had to !e ca%italiDed and de%reciated over the lon(er li/e o/ the ca%ital /acilitie contructed. The court held the
e4%ene had to !e ca%italiDed. ,Contruction5related de%reciation on the e9ui%$ent i not an e4%ene to the
ta4%a#er o/ it da#5to5da# !uine. It i KLM a%%ro%riatel# reco(niDed a %art o/ the ta4%a#er2 cot KLM in the
ca%ital invet$ent.-
2. I95O,CO
I1)@JC@* Inc. v. Co$$iioner C< 592E 3< 465
&nilever 0a intereted in !u#in( I1)@JC@. The lar(et hareholder o/ I1)@JC@ a(reed i/ the# could tran/er
their hare to &nilever ta4 /ree. 7a0#er develo%ed a %lan. I1)@JC@ incurred /ee /ro$ ;or(an 'tanle# o/ H2.2
$illion in creatin( the $er(er. I1)@JC@ clai$ed a deduction /or thoe e4%ene. I1)@JC@ ar(ued that the tet
/or ca%ital e4%enditure i 0hether an aet 0a created or enhanced. 1o aet 0a created or enhanced here. The
court held that thoe e4%ene hould !e ca%italiDed. :hile an e4%enditure that create or enhance a e%arate and
ditinct aet hould !e ca%italiDed* it doe not /ollo0 that onl# e4%enditure that create or enhance e%arate and
ditinct aet are to !e ca%italiDed. :hile the %reence o/ a /uture !ene/it i not controllin(* it i undenia!l#
i$%ortant in decidin( i/ an e4%enditure i ca%ital. The e4%ene o/ %lannin( thi $er(er created u!tantial /uture
!ene/it.
In Rev. Rul. 92580 C< 596* the IR' ruled that advertiin( cot could !e deducted a ordinar# !uine e4%ene
under B 162 and did not have to !e ca%italiDed.
). *e$airs
Rev. Rul. 200154 C< 600
Trea. Re(. B 1.16254 allo0 a deduction /or the cot o/ incidental re%air that neither $ateriall# add to the value o/
the %ro%ert# nor a%%recia!l# %rolon( it ue/ul li/e. ?ven a routine re%air could !e conidered to %rolon( the ue/ul
li/e and increae the value o/ the %ro%ert#. The IR' hold that characteriDin( a cot a a deducti!le re%air or ca%ital
i$%rove$ent de%end on the conte4t in 0hich the cot i incurred. :here an e4%enditure i $ade a %art o/ a
(eneral %lan o/ reha!ilitation* $oderniDation* and i$%rove$ent o/ the %ro%ert#* the e4%enditure $ut !e ca%italiDed*
even thou(h tandin( alone* the ite$ $a# !e clai/ied a one o/ re%air or $aintenance. In the rulin(* the IR' held
that re%air o/ the air%lane* althou(h it cot H2 $illion* did not e4tend the li/e o/ the air%lane nor $a6e it 0orth $ore.
There/ore* the re%air could !e currentl# deducted.
/. %x$enses to Create or 6aintain a "usiness *e$utation
:elch v. 3elverin( C< 606E 3< 459
Ta4%a#er 0a the ecretar# o/ a co$%an# en(a(ed in the (rain !uine. The co$%an# 0ent !an6ru%t and 0a
releaed /ro$ it de!t. The ta4%a#er (ot a "o! to %urchae (rain on co$$iion /or another co$%an#. In order to
re5eta!lih relation 0ith cuto$er that he had 0or6ed 0ith %revioul#* he decided to tr# to %a# o// a $an# o/ the
de!t o/ the !an6ru%t co$%an# a he 0a a!le. The IR' ar(ued that the %a#$ent 0ere not deducti!le a ordinar#
and necear# !uine e4%ene under B 162 !ecaue the# 0ere ca%ital e4%enditure /or the develo%$ent o/
27
'ee C< 585
34
re%utation and (ood0ill. The court held the %a#$ent 0ere not deducti!le !ecaue +1. the %a#$ent 0ere necear#
!ut not ordinar#E and +2. the %a#$ent 0ere ca%ital e4%enditure.
3o0ever* the court in =en6in v. Co$$iioner C< 609* allo0ed a necear# and ordinar# !uine deduction /or
%a#$ent to invetor o/ a /ailed retaurant venture. Thi can !e ditin(uihed /ro$ :elch in that :elch2 !uine
0a %revioul# co$%letel# detro#ed and he %aid the $one# to co$%letel# re!uild (ood0ill 0hile T0itt#2 +the
ta4%a#er in =en6in. 0a onl# li(htl# da$a(ed and he 0a %a#in( to re%air.
5. Iob Funtin# %x$enses
The IR'2 %oition i that "o! huntin( e4%ene are currentl# deducti!le i/ the ta4%a#er i ee6in( ne0 e$%lo#$ent in
the a$e trade or !uine in 0hich he i currentl# e$%lo#ed. 3o0ever* 0here the ta4%a#er i ee6in( hi /irt "o!*
or e$%lo#$ent in a ne0 trade or !uine* no current deduction i allo0ed. 'ee Rev. Rul. 78593 C< 614.
>II. Tax Accountin#
A. 3enerall
There are t0o t#%e o/ ta4 accountin(A cah and accrual. Individual are al$ot e4cluivel# cah $ethod ta4%a#er.
The cah $ethod include o$ethin( in inco$e 0hen the ta4%a#er receive it. The accrual $ethod %ut it into
inco$e 0hen all event necear# to earn have occurred and there i reaona!le certaint# a to the a$ount.
Ta4%a#er %re/er the cah $ethod !ecaue it i eaier and inco$e i de/erred until it i received. 3o0ever* accrual i
thou(ht to (enerall# $atch inco$e and e4%ene.
>ro Inco$e T Total 'ale Cot o/ >ood 'old
Calculatin( Cot o/ >ood 'old i di//icult.
Cot o/ >ood 'old T @%enin( Inventor# V Jurchae Cloin( Inventor#.
There are t0o $ethod o/ calculatin( Cloin( Inventor#A 8I8@ and 7I8@. Au$in( that cot are riin(* 7I8@ i
!etter. Cot o/ >ood 'old i hi(her and #ou are ho0in( le %ro/it. There/ore* #ou are ta4ed le. 3o0ever* 7I8@
caue #our /inancial tate$ent to ho0 le %ro/it. The Code $andate that #ou ue the a$e inventor# $ethod
/or !oth ta4 and accountin(.
". Cash 6ethod4 Constructive *ecei$t
&nder the cah $ethod* a ta4%a#er $ut include an ite$ in inco$e 0hen it i actuall# or contructivel# received.
&nder the doctrine o/ contructive recei%t* a ta4%a#er $a# not deli!eratel# turn hi !ac6 u%on inco$e and thu elect
the #ear /or 0hich he 0ill re%ort it. &nder B 451* i/ a ta4%a#er ha an unretricted ri(ht to de$and the %a#$ent o/ an
a$ount* the ta4%a#er i in contructive recei%t o/ that a$ount* 0hether or not the ta4%a#er $a6e the de$and and
actuall# receive %a#$ent. 'ee the co$$ittee re%ort /or B 451 C< 641.
C. Accrual 6ethod
&. All %vents Test8 Clear *eflection of Income8 and %conomic ,erformance
8ord ;otor Co. v. Co$$iioner C< 642
In 1980* the ta4%a#er et u% tructured ettle$ent in everal ettle$ent o/ %eronal in"ur# or accidental death
clai$. 8ord eti$ated their total %a#$ent 0ould !e H24*477*699. To cover the %eriodic %a#$ent* 8ord %urchaed
annuit# contract /or H4*424*587. 8ord clai$ed deduction in 1980 /or H10*636*994* clai$in( that thi 0ould !e
8ord2 lia!ilit# /or the ettle$ent. 8ord included in inco$e the a$ount received /ro$ the annuit# contract. The
IR' clai$ed 8ord2 $ethod o/ accountin( /or the tructured ettle$ent did not clearl# re/lect inco$e under B
446+!.. The court held that the co$$iioner ha !road dicretion under B 446+!.. The tet /or deter$inin( 0hen
an e4%ene i ,incurred- i the all event tet. Thi tet %rovide that an accrual $ethod ta4%a#er $ut deduct an
e4%ene in the ta4a!le #ear 0hen all the event have occurred that eta!lih the /act o/ lia!ilit# (ivin( rie to the
deduction and the a$ount o/ the lia!ilit# can !e deter$ined 0ith reaona!le accurac#. The court held that even i/
the ,all event tet- i $et* the Co$$iioner till ha the authorit# under B 446+!. to deter$ine that a ta4%a#er2
$ethod o/ accountin( doe not clearl# re/lect inco$e. The court li$ited 8ord2 deduction to H4.5 0hich 0a the
cot o/ the annuit# contract. Thi i intuitivel# the correct reult !ecaue H4.5 $illion i the %reent value o/ 8ord2
lia!ilit#. I/ 8ord had !een allo0ed to deduct H10.5 $illion* 8ord could have !ene/ited. 'ee C< 649 n.1.
35
Con(re enacted B 461+h. 0hich are ,econo$ic %er/or$ance- rule. &nder B 461+h.* an accrual $ethod ta4%a#er
$a# not deduct an e4%ene* even thou(h the all event tet ha !een ati/ied* until econo$ic %er/or$ance 0ith
re%ect to uch ite$ occur.
2. %arl Cash *ecei$ts of Accrual 6ethod Tax$aers
'chlude v. Co$$iioner C< 650E 3< 630
The ta4%a#er o%erated an Arthur ;urra# dance tudio. The cuto$er i(ned contract /or dance leon that 0ere
noncancella!le. The contract %eci/ied a nu$!er o/ leon hour ran(in( /ro$ /ive to 1*200 +0ith o$e contract
%rovidin( li/eti$e coure.. The ta4%a#er conidered the %a#$ent on the contract de/erred inco$e until the
cuto$er actuall# too6 a cla or /ailed to ta6e a leon /or one #ear. The IR'* uin( B 446+!.* clai$ed the #te$
0a not clearl# re/lectin( inco$e and the# had to include all at once. The court rel#in( on A$erican Auto$o!ile
Aociation 3< 629* a(reed 0ith the IR'.
>III. Tax ,references
A. Tax Shelters
&. ,assive !oss *ules of . /12
The %aive lo rule (enerall# %rohi!it ta4%a#er /ro$ deductin( loe /ro$ ,%aive activitie- a(aint either
alar# inco$e or %ort/olio inco$e +uch a interet and dividend.. A ,%aive activit#- i de/ined a an# activit#
0hich involve the conduct o/ an# trade or !uine or B 2125t#%e activit#* in 0hich the ta4%a#er doe not $ateriall#
%artici%ate. Jaive activitie al0a# include rental activit#* re(ardle o/ 0hether the ta4%a#er $ateriall#
%artici%ate in the rental activit#.
28
The loe and credit (enerated /ro$ all uch %aive activitie ta6en to(ether can onl# !e ta6en a(aint the inco$e
and ta4 lia!ilit# (enerated /ro$ uch %aive activitie ta6en to(ether. An# unued %aive activit# loe and
credit are carried /or0ard to the ne4t #ear 0here the# $a# !e a%%lied a(aint %aive activit# inco$e and ta4
lia!ilit# /or that #ear. Thi carr#/or0ard continue inde/initel#.
Jort/olio or invet$ent inco$e i not conidered to !e inco$e /ro$ a %aive activit# /or thee %ur%oe. I/ an
activit# chan(e /ro$ !ein( %aive to !ein( active* an# unued deduction alloca!le to uch activit# i o//et a(aint
the inco$e /ro$ the activit# /or the ta4a!le #ear. I/ durin( a ta4 #ear* a ta4%a#er di%oe o/ hi entire interet in a
%aive activit# or /or$er %aive activit#* then the /ollo0in( rule a%%l#A I/ all realiDed (ain or lo i reco(niDed*
an# lo /ro$ uch activit# 0hich ha not %revioul# !een allo0ed a a deduction i not treated a a %aive activit#
lo.
In addition to the %aive lo rule are the at5ri6 rule o/ B 465. 'ection 465 li$it deduction /ro$ an activit# to
the a$ount the ta4%a#er ha ,at ri6- in the activit#. The# ta6e ai$ at non5recoure /inancin(* an i$%ortant %art o/
ta4 helter. Cou can2t ta6e a deduction /or $ore than #ou have at5ri6.
2. Iudicial Anti(Abuse 5octrines
?ven in the a!ence o/ %eci/ic anti5helter le(ilation* court have ued a nu$!er o/ co$$on la0 doctrine to
retrain the ue o/ ta4 helter trate(ie.
Onetch v. &nited 'tate C< 686
The ta4%a#er !ou(ht an annuit# /or H4 $illion. 3e %aid H4*000 cah and i(ned a note /or H4 $illion o/ nonrecoure
loan /or the !alance. 3e !orro0ed at 3.5F interet to invet in an annuit# 0ith 2.5F interet. ?ach #ear* he had a
return o/ 51F. At that ti$e* interet 0a deducti!le. The real cot 0a H38*000 +a/ter ta4 deduction.* then he
receive the 100*000 ta4 /ree. 3e $ade $one# on the tranaction. The court held Con(re didn2t intend the tatute
to !e ued thi 0a#. It 0a a ha$ !ecaue a!ent the ta4 deduction* there 0a no 0a# he could $a6e $one# on the
tranaction. A tranaction ha to have u!tance and utilit# !e#ond the deduction 0hich i (enerated.
There are t0o ha$e tranaction doctrineA
1. Tranaction lac6in( econo$ic u!tance the tranaction /ollo0 the letter o/ the la0 !ut no u!tance and utilit#
28
A li$ited e4ce%tion allo0 a ta4%a#er activel# %artici%ated in rental real etate activitie durin( the #ear to ta6e u%
to H25*000 o/ net loe ariin( /ro$ that activit# a a deduction a(aint non5%aive inco$e.
36
2. 'ha$ tranaction it reall# didn2t ha%%en. There are no econo$ic realitie* "ut %a%er hu//lin(.
Rice2 To#ota :orld* Inc. v. Co$$iioner C< 691
To treat a tranaction a a ha$* /or ta4 %ur%oe* the court $ut /ind that the ta4%a#er 0a $otivated !# no !uine
%ur%oe other than o!tainin( ta4 !ene/it in enterin( the tranaction* and that the tranaction ha no econo$ic
u!tance !ecaue no reaona!le %oi!ilit# o/ a %ro/it e4it. The court held that the !uine %ur%oe %ron( i a
u!"ective tet and the econo$ic !ene/it %ron( i an o!"ective tet. In thi cae* the court held that the ta4%a#er did
not have a !uine %ur%oe and there 0a no econo$ic !ene/it.
'o$e court re9uire !oth %ron( and other 0ill /ind a ha$ tranaction i/ either %ron( i $et.
". Alternative 6inimum Tax
Thin6 o/ thi a runnin( %arallel to the other ta4 #te$. Thi i a $ini$u$ a$ount o/ ta4 ever#one %a#. The ta4
!ae i !road +not $an# deduction. and the rate are lo0. It a//ectA +1. %eo%le 0ho are doin( ta4 henani(anE
%eo%le 0ith a lot o/ children +!ecaue it %rovide no e4e$%tion /or children.E and %eo%le in tate 0ith hi(h tate and
local ta4e.
Olaaen v. Co$$iioner C< 699
The ta4%a#er had ten children. &nder the re(ular ta4 #te$* he (ot an e4e$%tion. &nder A;T* there 0a no
e4e$%tion. 3e ar(ued that Con(re didn2t intend A;T to a%%l#. The court hold that the tatute i una$!i(uou
and con(reional intent i clear.
:e don2t have to calculate A;T.
IJ. Taxation and the Famil
A. Tax Allowances for Famil *es$onsibilities
There are t0o t#%e o/ !ene/it /or %arent 0ith de%endent children. @ne t#%e i !aed on the actual dollar %aid /or
child care 0hile %arent are at 0or6. The econd t#%e i !aed i$%l# on the /act that the ta4%a#er i a %arent o/
de%endent children.
&. Allowances for Child Care %x$enses
a. Child Care as a "usiness %x$ense
It ha lon( !een ettled that child care i not deducti!le a a !uine e4%ene. It can !e co$%ared to the
diallo0ance o/ co$$utin( e4%ene.
b. The . 2& Child Care Credit
'ection 21 %rovide a credit e9ual to a %ercenta(e o/ a ta4%a#er2 child care e4%ene* i/ the e4%ene are ,incurred
to ena!le the ta4%a#er to !e (ain/ull# e$%lo#ed.- ?4%ene eli(i!le /or the credit are ca%%ed at H3*000 /or a
ta4%a#er 0ith one ,9uali/#in( individual- +(enerall# a child under the a(e o/ 13 or another individual una!le to care
/or hi$el/. and at H6*000 /or a ta4%a#er 0ith t0o or $ore 9uali/#in( individual. 8or a ta4%a#er 0ith A>I o/
H15*000 or le* the credit i 35F o/ the credit5eli(i!le e4%ene. The rate o/ credit i reduced !# one %ercenta(e
%oint /or each H2*000 +or /raction thereo/. !# 0hich A>I e4ceed H15*000* !ut the credit i never reduced !elo0
20F.
It ee$ to !e the intent o/ Con(re to ue the ta4 #te$ to u!idiDe the cot o/ child care /or 0or6in( %arent.
<# onl# u!idiDin( a %ercenta(e* the ta4%a#er ha o$e incentive to (et child care the# can a//ord. I/ it 0a a
dollar /or dollar credit* ever#one 0ould (et the Jorhe o/ child care.
c. The . &22 5e$endent Care Assistance %xclusion
'ection 129 %rovide an e4cluion /or ,de%endent care aitance- received !# an e$%lo#ee /ro$ hi e$%lo#er* i/
the e$%lo#er ha a 9uali/#in( ,de%endent care aitance %ro(ra$-. The e4cluion i u!"ect to a ceilin( o/ H5*000
re(ardle o/ ho0 $an# children the ta4%a#er ha. Thi not onl# cover an e$%lo#er5o%erated on5ite child care
/acilit#* !ut it alo cover cah rei$!ure$ent o/ e$%lo#ee2 child care e4%ene. A ta4%a#er cannot ue the a$e
dollar o/ child care e4%ene to (enerate !oth an e4cluion under B 129 and a credit under B 21.
37
2. Child Tax "enefits 9ot "ased on %x$enditures
a. %xem$tions
'ection 151 allo0 a ta4%a#er to clai$ one %eronal e4e$%tion /or hi$el/ +t0o e4e$%tion /or a $arried cou%le
/ilin( a "oint return. and an additional e4e$%tion /or each de%endent. The %eronal and de%endenc# e4e$%tion
erve t0o /unction. 8irt* the# 0or6 to(ether 0ith the tandard deduction to %revent the i$%oition o/ inco$e ta4
lia!ilit# on %eron livin( at or !elo0 the %overt# level. The econd %ur%oe i to ad"ut ta4 lia!ilitie /or
di//erence in /a$il# iDe acro a 0ide ran(e o/ inco$e level. 'ection 151+d.+3. %hae out e4e$%tion /or u%%er
inco$e ta4%a#er. In the cae o/ a child o/ divorced %arent* B 152+e. (enerall# allocate the de%endenc# e4e$%tion
to the %arent 0ho ha cutod# o/ the child /or $ot o/ the #ear* !ut the cutodial %arent can 0aive the ri(ht to the
e4e$%tion in /avor o/ the non5cutodial %arent. The B 24 child credit /ollo0 the allocation o/ the e4e$%tion.
b. The Child Credit
The B 24 child credit i in addition to B 151 rather than a re%lace$ent. The credit i inde%endent o/ the ta4%a#er2
$ar(inal rate. To calculateA $ulti%l# H1*000 !# the nu$!er o/ the ta4%a#er2 ,9uali/#in( children.- The credit i
%haed out /or hi(her inco$e ta4%a#er* !e(innin( at H110*000 /or $arried cou%le /ilin( "oint return. The ta4
credit i non5re/unda!le $eanin( i/ the credit i /or $ore than the ta4 lia!ilit#* the re$ainder i i$%l# lot.
c. Fead(of(Fousehold Status
A in(le %arent 0ho live 0ith one or $ore de%endent children 0ill uuall# 9uali/# a a head o/ houehold /or
%ur%oe o/ the inco$e ta4. 3ead5o/5houehold i entitled to a u!tantiall# lar(er tandard deduction than that
availa!le to other un$arried ta4%a#er. In addition* a head o/ houehold %a# ta4 under a B 1 rate chedule 0ith
0ider !rac6et than the B 1 rate chedule /or other un$arried ta4%a#er.
". Income Tax Treatment of 6arria#e
7uca v. ?arl C< 733
The ta4%a#er and hi 0i/e $ade a contract to divide all inco$e e9uall#. The# then /iled e%arate return +there!#
reducin( their inco$e ta4 lia!ilitie..
29
The court held that inco$e i ta4ed to the earner.
Joe v. 'ea!orn C< 734
Thi 0a in a co$$unit# %ro%ert# tate. The hu!and and 0i/e each re%orted hal/ the inco$e and hal/ the
deduction on their return. The court held thi 0a o6a# !ecaue unli6e ?arl thi 0a a co$$unit# %ro%ert# tate.
A uch* hal/ the inco$e !eco$e i$$ediatel# veted in the other %oue.
The o%%oite reult o/ thee cae !aed on 0hether a tate 0a co$$on la0 %ro%ert# or co$$unit# %ro%ert#
caued tur$oil. 'tate !e(an to chan(e to co$$unit# %ro%ert# tate /or the !ene/it o/ their citiDen. In 1948*
Con(re allo0ed a "oint return.
C. Income Tax Conse<uences of 5ivorce
Ja#$ent $eetin( the de/inition o/ ali$on# are ta4a!le to the %a#ee under B 71+a. and are deducti!le !# the %a#or* B
215+a.. &nder B 62+a.+10.* the deduction i allo0ed in arrivin( at the A>I* o it i availa!le even to a %a#or
clai$in( the tandard deduction.
Another divorce ta4 %lannin( 9uetion i 0hich e45%oue hould clai$ the de%endenc# e4e$%tion /or a child o/ the
$arria(e. &nder B 152+e.+1.* the de/ault rule i that the cutodial %arent i entitled to the e4e$%tionE ho0ever* the
cutodial %arent can 0aive the e4e$%tion in /avor o/ the noncutodial %arent. 'ection 24+c.+1. %rovide that the
child ta4 credit (oe to the %arent 0ho i entitled to the de%endenc# e4e$%tion.
There are three reaon 0h# one e45%oue $i(ht $a6e tran/er to the otherA +1. to ati/# a continuin( o!li(ation
o/ %oual u%%ortE +2. to u%%ort children o/ the $arria(e livin( 0ith the other %arentE and +3. to ettle clai$
relatin( to $arital %ro%ert# ri(ht. The inco$e hi/tin( rule o/ BB 71 and 215 onl# a%%l# to %oual u%%ort.
29
1ote that thi 0a !e/ore there 0a a "oint return.
38
T0o a%ect o/ the B 71+!. de/inition o/ ali$on# are dei(ned to 0eed out %ro%ert# ettle$ent /ro$ ali$on#. 8irt*
B 71+!.+1. %rovide that onl# %a#$ent ,in cah- can 9uali/# a ali$on#. 'econd* B 71+!.+1.+). %rovide that
%a#$ent cannot 9uali/# a ali$on# i/ the %a#or %oue 0ould !e re9uired to continue to $a6e %a#$ent even a/ter
the death o/ the %a#ee %oue.
30
I/ annual ali$on# %a#$ent decreae har%l# durin( the /irt three %ot5e%aration #ear* then the ta4 !ene/it rule
%rinci%le 0ill a%%l# in the third #ear. 'ee C< 748 and B 71+/..
&nder B 1041+a.* no (ain or lo i reco(niDed on an# tran/er o/ %ro%ert# to one2 %oue* or to one2 /or$er %oue
i/ the tran/er i ,incident to the divorce.- The unreco(niDed (ain or lo doe not dia%%ear. Intead* B 1041+!.+2.
(ive the tran/eree %oue a !ai in the %ro%ert# e9ual to the tran/eror2 ad"uted !ai.
5. %arned Income Tax Credit
The earned inco$e ta4 credit +,?ITC-. i et /orth in B 32 o/ the Code and can !e undertood a ervin( the (oal o/
increain( the a/ter5ta4 inco$e o/ lo050a(e 0or6er 0ith /a$il# re%oni!ilitie. The ?ITC i re/unda!le. The
a$ount o/ the credit de%end in %art on the nu$!er o/ the ta4%a#er2 9uali/#in( children. The $a4i$u$ credit i
H4*140.
31
J. Identifin# the ,ro$er Tax$aer -Attribution0
A. %arned Income
In 7uca v. ?arl C< 733* the 'u%re$e Court held that earned inco$e $ut !e ta4ed to the earner even i/ the earner
i not the conu$erA The ,/ruit- $a# not !e attri!uted to a di//erent tree /ro$ that on 0hich the# (re0.- 8or
e4a$%le* a ta4a!le /rin(e !ene/it i included in the inco$e o/ the %eron %er/or$in( the ervice in connection 0ith
0hich the /rin(e !ene/it i /urnihed.
". Income from ,ro$ert
Ta/t v. <o0er C< 815
A %urchaed 100 hare o/ toc6 /or H1*000. The toc6 a%%reciated to H2*000. A (ave the$ to < 0ho old the toc6
/or H5*000. The IR' ar(ued that < o0ed inco$e ta4 on H4*000 +H5*000 5 H1*000 !ai.. < ar(ued that he o0ed
inco$e ta4 on H3*000 +the a%%reciation durin( <2 o0nerhi%.. < ar(ued that Con(re didn2t have the %o0er to ta4
the a%%reciation !e/ore < received the toc6. The court held that i/ A had old the toc6 intead o/ (ivin( it a0a#* A
0ould have !een ta4ed on the (ain. A couldn2t 6ee% /ro$ !ein( ta4ed !# (ivin( the toc6 a0a#. Con(re ha the
%o0er to re9uire the donee to acce%t the %oition o/ the donor +in thi cae* the !ai o/ H1*000..
'ection 1+(. %rovide that the invet$ent inco$e o/ a child under the a(e o/ 14 i ta4ed to the child* !ut that it i
ta4ed at the $ar(inal ta4 rate o/ the child2 %arent. Ta4in( the inco$e at the %arent2 $ar(inal rate ta6e the ta4 /un
out o/ $a6in( (i/t o/ invet$ent %ro%ert# to #oun( children.
&nder B 7872* in the cae o/ a ,(i/t loan- +de/ined a a loan !earin( a !elo05$ar6et rate o/ interet 0hen the
/or(oin( o/ interet i in the nature o/ a (i/t. the tatute create a dee$ed interet %a#$ent /ro$ the !orro0er to the
lender. The a$ount o/ the dee$ed interet %a#$ent i the di//erence !et0een interet at the a%%lica!le /ederal rate
and the actual interet char(ed. The dee$ed interet i ta4a!le to the %arent. The dee$ed interet $a# !e
deducti!le !# the !orro0er.
32
JI. Ca$ital 3ains and !osses
=uti/ication /or ca%ital (ain and loe areA
33
30
The !oo6 $ention a %oi!le %otential /or $al%ractice lia!ilit# here* i/ the divorce intru$ent /ail to a#
an#thin( a!out 0hether %a#$ent 0ould continue a/ter death and a court inter%ret the intru$ent to re9uire
continued %a#$ent in the cae o/ the %a#ee2 death.
31
'ee C< 756 and 3< 639.
32
'ee 3< 345
33
'ee C< 850
39
1. Ca%ital (ain are ca%ital* not inco$e +,1o re%oni!le co$$entator de/end /avora!le ca%ital (ain rate a a
conceion- that ca%ital (ain hould not !e ta4ed at all..
2. In/lation +thi i an e4tre$el# crude $ethod o/ in/lation ad"ut$ent.
3. <unchin(
4. Incentive
5. 7oc65in and 7a//er curve
A. 6echanics of 9et Ca$ital 3ain Com$utation
&. !on# and Short Term Ca$ital 3ains and !osses
@nl# ca%ital aet held /or $ore than one #ear can 9uali/# /or /avora!le treat$ent.
34
>enerall#* a ta4%a#er2
holdin( %eriod include the holdin( %eriod o/ %rior o0ner+. o/ the ca%ital aet i/ the aet 0a ac9uired in a
tranaction in 0hich reco(nition o/ the %rior o0ner2 (ain or lo 0a de/erred !# o%eration o/ la0. 'ee B 1223.
&nder a %ecial holdin(5%eriod rule a%%l#in( to tran/er at death* even %ro%ert# that receive a ne0 !ai in the
hand o/ an heir under B 1014 i treated a thou(h the heir had held the %ro%ert# /or $ore than one #ear /ro$ the
$o$ent he receive it. IRC B 1223+11.. Jro%ert# held /or one #ear or le (enerate ,hort5ter$- ca%ital (ain or
loe.
2. 9ettin# of !on# and Short 3ains and !osses
C< 855
1. 7on(5ter$ (ain are netted a(aint lon(5ter$ loe.
2. 'hort5ter$ (ain are netted a(aint hort5ter$ loe.
3. I/ the reult o/ the /irt t0o nettin( %rocedure have the a$e i(n* then the ta4%a#er ha that a$ount o/ each
t#%e o/ net (ain or lo* and each i treated accordin(l#. <ut i/ the reult o/ the /irt t0o nettin( %rocedure have
o%%oite i(n* thoe t0o outco$e are netted a(aint each other. Thi /inal reult ha the character o/ 0hatever t#%e
o/ (ain or lo ,tic6 out- a/ter the nettin( %rocedure.
Thi %roce i decri!ed in B 1222.
<aicall#* hort ter$ loe can !e ued to o//et lon(5ter$ (ain +that i !ad. and hort ter$ (ain can o//et lon(5
ter$ loe +that i (ood..
). The Several Ca$ital 3ains *ates
I/ #our net ca%ital (ain i /ro$ L Then #our $a4i$u$ ca%ital (ain rate i . . .
Collecti!le >ain 28F
&nreca%tured B 1250 (ain 25F
@ther (ain and the re(ular ta4 rate that 0ould a%%l# i
25F or hi(her
15F
@ther (ain and the re(ular ta4 rate that 0ould a%%l# i
lo0er than 25F
5F
Collecti!le ta4ed under the 28F rate include 0or6 o/ art* ru( and anti9ue* ta$% and coin* $etal and "e0el*
alcoholic !evera(e* and an#thin( ele that the 'ecretar# o/ the Treaur# decide to include in thi cate(or#.
'ection 1202 (ain +28F.
Thi i a %ecial cate(or# o/ $all !uine cor%orate toc6. The !aic rule o/ B 1202 allo0 e4cluion o/ hal/ o/ the
(ain /ro$ ale or e4chan(e o/ thi toc6 +thi $ean that the e//ective rate i 14F o/ the entire (ain..
&nreca%tured B 1250 >ain +ta4ed at 25F.
'ection 1250* 0hich a%%lie to di%oition o/ de%recia!le real %ro%ert#* reca%ure onl# the e4ce o/ de%reciation
clai$ed over the allo0a!le trai(ht5line de%reciation.
/. 9ettin# the S$ecial *ate Cate#ories
34
8or the de/inition o/ a ca%ital aet* ee B 1221.
40
I/ the ta4%a#er ha a net hort5ter$ ca%ital lo and net lon(5ter$ ca%ital (ain* the tatute +0hich i %ro5ta4%a#er.
$andate nettin( the lo /irt a(aint the cate(or# o/ (ain that 0ould !e $ore hi(hl# ta4ed.
". !imitations on 5eductions of Ca$ital !osses
&. *ationale
Ta4%a#er have a (ood deal o/ control over the ti$in( o/ their ca%ital aet tranaction. I/ there 0ere no li$itation
on lo deduction a(aint ordinar# inco$e* $an# %eo%le 0ould !e a!le to ue their control o/ their realiDation
event to o//et inco$e 0ith realiDed loe* and thu to %a# little or no ta4.
2. The Ca$ital !oss !imitation *ule
'ection 1211* /or noncor%orate ta4%a#er* onl# allo0 ca%ital loe u% to the a$ount o/ ca%ital (ain in the a$e
#ear* %lu H3*000 a(aint ordinar# inco$e. Cor%orate ta4%a#er can deduct loe onl# to the e4tent o/ (ain in the
a$e #ear.
). A "i# %xce$tion for Small "usiness Stoc=
'ection 1244 allo0 an e4ce%tion to the lo li$itation rule 0ith re%ect to invet$ent in $all !uinee.
Puali/#in( loe are allo0ed u% to H50*000 %er #ear +or H100*000 /or a cou%le /ilin( "oint return. on the ale o/
toc6 o/ a cor%oration that 0a ca%italiDed 0ith le than H1 $illion o/ ca%ital contri!ution. 'ee B 1244.
/. Ca$ital !oss Carrbac= and Carrover
&nder B 1212* cor%orate ta4%a#er $a# carr# !ac6 thoe ca%ital loe /or u% to the three %recedin( ta4a!le #ear* to
o//et an# net ca%ital (ain the cor%oration $i(ht have en"o#ed in thoe %rior #ear. I/ the loe cannot !e a!or!ed
!# %rior (ain* then thoe loe $a# !e carried over to an# o/ the /ive ta4a!le #ear /ollo0in( the #ear the lo 0a
utained.
8or noncor%orate ta4%a#er* there i no carr#!ac6 %roviion. 3o0ever* loe that are nondeducti!le !ecaue o/ the
B 1211 li$itation $a# !e carried over to /uture #ear inde/initel#.
C. 5efinition of a Ca$ital Asset
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Ca%ital aet are de/ined in B 1221+a. !# e4cluion.
&. ,ro$ert Feld for Sale to Customers
&nited 'tate v. :inthro% C< 861
The ta4%a#er inherited %ro%ert#. 3e u!divided the %ro%ert#* (raded and %aved the treet* and intalled electricit#
and 0ater /acilitie* all at the ta4%a#er2 e4%ene. 3e old the %ro%ertie 0ithout an# advertiin(. The ale o/ the
%ro%ertie 0a hi $ain 0or6 durin( the ti$e. The ta4%a#er re%orted the %ro/it a ca%ital (ain. The IR' ar(ued
the land 0a held /or ale in the ordinar# coure o/ !uineE there/ore* the (ain 0a not a ca%ital (ain under B 1221.
The trial court loo6ed at even /actorA +1. the nature and %ur%oe o/ the ac9uiition o/ the %ro%ert# and the duration
o/ the o0nerhi%E +2. the e4tent and nature o/ the ta4%a#er2 e//ort to ell the %ro%ert#E +3. the nu$!er* e4tent*
continuit# and u!tantialit# o/ the aleE +4. the e4tent o/ u!dividin(* develo%in(* and advertiin( to increae aleE
+5. the ue o/ a !uine o//ice /or the ale o/ the %ro%ert#E +6. the character and de(ree o/ u%erviion or control
e4ercied !# the ta4%a#er over an# re%reentative ellin( the %ro%ert#E and +7. the ti$e and e//ort the ta4%a#er
ha!ituall# devoted to the ale. The court hold that the ulti$ate deter$ination o/ 0hether the %ro%ert# 0a held /or
ale to cuto$er i a deter$ination o/ la0 and there/ore* the deciion o/ the court !elo0 i not u!"ect to the clearl#
erroneou tandard. The court overturn the court !elo0* holdin( that the %ro%ert# 0a held /or ale to cuto$er
and there/ore not a ca%ital aet.
2. ,ro$ert @sed in a Trade or "usiness
Corn Jroduct Re/inin( Co. v. Co$$iioner C< 869
The ta4%a#er 0a a $anu/acturer o/ tarch* u(ar and their !#5%roduct 0hich 0ere $ade /ro$ corn. In 1937*
ta4%a#er !e(an !u#in( corn /uture.
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The ta4%a#er2 /uture tranaction 0ere in the nature o/ hed(in(. The
ta4%a#er 0a not loo6in( to $a6e a 6illin( in the co$$oditie $ar6et !ut rather ou(ht to %rotect it !uine
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The /i(ht reall# center around B 1221+a.+1..
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o%eration. Corn /uture 0ere not trictl# %ea6in(* inventor# or toc6 in trade held !# the ta4%a#er %ri$aril# /or
ale to cuto$er in the ordinar# coure o/ it trade or !uine. Ta4%a#er 0a not in the !uine o/ ellin( corn
/uture. Ta4%a#er ar(ued that the corn /uture 0ere a ca%ital aet. The 'u%re$e Court /elt the %ur%oe o/ Con(re
0a to den# ca%ital (ain or lo treat$ent to the %ro/it and loe ariin( /ro$ the ever#da# o%eration o/ a !uine.
The Court held the ta4%a#er had ordinar# (ain and lo on it corn /uture tranaction.
In Corn Jroduct* the Court a# ,the de/inition o/ a ca%ital aet $ut !e narro0l# a%%lied and it e4cluion $ut
!e inter%reted !roadl#.- The 9uetion a/ter the o%inion 0a 0hich one the court !aed it o%inion on.
The 'u%re$e Court an0ered thi 9uetion in Ar6ana <et Cor%. v. Co$$iioner C< 873. The Court dealt
0ith a cae in 0hich toc6 0a received !# the ta4%a#er /ro$ a trou!led !an6 in e4chan(e /or the ta4%a#er $a6in(
invet$ent in the !an6. The invet$ent 0ere dei(ned to %reerve the ta4%a#er2 re%utation !# 6ee%in( the !an6
/ro$ /ailin(. The Court held the lo on the ale o/ the toc6 0a ca%ital. The Court aid Corn Jroduct did not
create a co$$on la0 e4ce%tion to ca%ital lo treat$ent* !ut intead inter%reted the inventor# e4ce%tion !roadl#.
5. Sale or %xchan#e *e<uirement
'ection 1001 re9uire co$%utation o/ (ain or lo on an# ,ale or other di%oition.- 3o0ever* the de/inition o/
ca%ital (ain and loe %ea6 o/ a ,ale or e4chan(e.- IRC B 1222+1.5+4.. In 3elverin( v. :illia$ 8laccu @a6
7eather C< 878* the ta4%a#er2 %ro%ert# 0a detro#ed !# /ire. The ta4%a#er received co$%enation /ro$ an
inurance co$%an#. The ta4%a#er treated the inurance %roceed a ca%ital (ain. The co$$iioner aid the# 0ere
ordinar# inco$e. The 'u%re$e Court held the# 0ere ordinar# inco$e !ecaue the tatute a# ,ale or e4chan(e.-
Thi 0a not either.
@n thee a$e /act toda#* B 1231 0ould chan(e the reult. 'ee C< 880 n.2.
%. Substitutes for Future Ordinar Income
3ort v. Co$$iioner C< 882
Ta4%a#er leae a %ro%ert# to an inurance co$%an# /or H25*000 %er #ear /or 15 #ear. The de%reion hit and the
$ar6et /or leae dro%. The inurance co$%an# %a# H140*000 to cancel the leae. The ta4%a#er clai$ the %reent
value o/ the leae 0a H161*000 and there/ore* he had a lo o/ H21*000. The %ro!le$ i he never %aid ta4 on the
H161*000E there/ore* he had no !ai. The court hold that it i a u!titute /or ordinar# inco$e +u!titute /or rental
%a#$ent..
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A co$$odit# /uture i a contract to !u# a /i4ed a$ount o/ the co$$odit# at a /i4ed %rice at a /uture date. The
%urchaer o/ uch a contract i aid to !e ,lon(- and !ene/it /ro$ a rie in the %rice o/ the co$$odit#. The eller o/
uch a contract 0ho ha thu a(reed to ell the co$$odit# at a /i4ed %rice on a /uture date i aid to !e hrot and
!ene/it /or$ a dro% in the %rice o/ the co$$odit#.
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