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Federal Taxation

Judith Wiseman
Fall 2010
Fundamentals of Federal Income Taxation, Fifteenth Edition, Freeland,
Lathrope, Lind, and Stephens
Text, pp. 2-44
Orientation
Key is learning to decipher the messages of the Internal Revenue Code
Two main types of tax practice
o (1) Application of tax principles to past events or transactions
o (2) Advice as to how tax principles will apply to proposed events or transactions
History of Federal Income Tax
First tax enacted in 1791 on distilled spirits and stills
Income taxes ebbed and flowed on similar items for several years
Several different attempts were made to organize tax laws
Act of July 1, 1862 largely the basis of our present system of taxations
Internal Revenue Code of 1939 largely a matter or sorting and putting together
currently operative internal revenue statutes (codification)
Later codes in 1954 and 1986 would replace, revise and update the 1939 Code
Goal of 1986 legislation = broad-based, simple, fair and revenue neutral
o Actually, became much more complex than predecessor
Income Tax and the United States Constitution
The Power to Tax
Power to tax is derived from Article 1, 8, cl. 1
o Confers on Congress the power to lay and collect taxes, duties, imposts and
excises
o 2, cl. 3 and 9, cl. 4 further provide that direct taxes be apportioned among
the several states according to their respective populations
o 8, cl. 1 further provides that all duties, imposts, and excises shall be uniform
throughout the US
Still applies Constitution requires geographic uniformity
Direct Tax = tax demanded from the very person who is intended to pay it (flat tax)
Indirect Tax = tax paid primarily by a person who can shift the burden of the tax to
someone else or who at least is under no legal compulsion to pay the tax (sales tax)
The 16th Amendment
Provides that income taxes shall not be subject to the rule of apportionment regardless of
the sources from which the tax income is derived
Supreme Court stresses that the amendment applies to gains derived from capital or labor
and includes profit gained through a sale or conversion of ppy
The Tax Practitioners Tools
For all Fed Tax questions two steps:
o (1) Statutory law that bears on the problem must be found
o (2) Determine proper meaning of such law

Primary materials of Fed Tax Legislative, Administrative and Judicial


Procedures
Legislative Materials the power to tax is vested in Congress, so it is statutory
1. Internal Revenue Code of 1986 the code is the law
2. Bills formal beginning of the tax legislative process is the introduction of a bill in the
House
a. Most actually originate in Treasury Department, but enter legislative branch
when introduced by a member of the House
3. Hearings upon submission, tax bills are usually referred to committees, who may then
hold extensive hearings on the proposed legislation (Ways and Means Committee)
4. Committee Reports when the committee brings the bill back to the floor, a report
accompanies the bill (*crucially important for legislative history)
5. Debates Congressional Record publishes parliamentary debates of proposed legislation
6. Prior Law
7. Treaties accorded same weight as statutory law
Administrative Materials
The administrative branch of tax governance, the Treasury (of which the IRS is a part),
issues a wide range of documents providing its interpretation of the IRC
1. Regulations (Treasury Regulations)
a. Must be given great weight because when you fight the IRS, you are fighting the
Treasury, and therefore Treasury Regs should be given great weight
b. Sec. of Treasury is given authority to prescribe all needful rules and regulations
for the enforcement of the IRC
c. Congress sometimes carves out areas where the Treasury can actually make, not
interpret, the Rules the IRS interprets the regulations
d. In final analysis, judiciary has the right to say whether the regulations
promulgated by the executive conform to the statute enacted by the legislature
e. Keep is mind that while regulations may be illustrative, still generally
subordinate statute
2. Rulings (Revenue Rulings)
a. Generally, the Treasurys answer to specific questions raised by a taxpayer
concerning the taxpayers tax liability published to provide precedents for use
in the disposition of like cases
b. The IRS will also issue Letter Rulings directly to the taxpayer
i. Private Letter Ruling (PLR) or Technical Advice Memorandums (TAMs)
only binding on the IRS towards the taxpayer who asked the question
or solicited advice
ii. Revenue Ruling binding on all taxpayers who have identical facts
iii. General Council Memorandum (GCM) opinions/legal analysis
provided by IRS agents on IRS issues
c. Rulings dont have the force and effect of regulations, but they do at least reflect
the current policies of the IRS and may be cited and relied upon
d. Revenue Procedures IRS issues opinions telling the taxpayer how and in what
form to do something
3. Action on Decisions (AOD)
a. IRS states its position when it has lost an issue in a Tax Court case
b. Voices whether or not the IRS is going to continue litigation on an issue

c. Provides guidance to taxpayers as to whether the Service agrees or disagrees in


the courts determination of issues adverse to the government

d. Either acquiesce or nonacquiesce


i. If non-acquiesce plan to keep litigating the issue

Judicial Materials
When a tax controversy gets into court, the courts function at trial level is to identify the
problem, determine the relevant facts and interpret the law/code provisions
You may choose to bring case to Tax court or federal court
o Tax Court
No jury, one of 19 judges hears case
Sometimes, entire court reviews individual judges decision
After tax court, appeals are fed back into a federal court of appeals
o District Court Decisions forum for a tax refund (can have a jury trial)
o Court of federal claims decisions resembles the tax court in organization and
procedure and resembles district court in that it is a forum for refund claims
o Court of Appeals Decisions
o Supreme Court Decisions
Tax Policy Considerations
- Every tax has an inescapable regulatory effect
- Imposing a tax discourages something; Removing a tax encourages something
- Federal income tax is far from a neutral, revenue raising device; it has a profound
impact on what people do.
Types of Tax Reform
1. Improving an Existing Tax Base
a. Goal: Gains or increases in wealth, from whatever source, constitute the ideal
personal income tax base, whether those gains are saved or spent on the current
consumption
b. Eliminate certain tax shelters
2. Introducing a New Tax
a. Deals with scrapping the income tax and creating a consumption tax
b. Advantages: fairness, economic efficiency, and administrative simplicity
c. Flat Tax
i. Business part makes the aggregate base for the Flat Tax = Retail Sales
ii. All business would include all sales in the tax base and deduct all
purchases from other businesses
iii. Business can also deduct wages
d. USA Tax (Unlimited Savings Allowance)
i. Business tax is same as flat tax, without the deduction for wages
ii. Individual level allow unlimited deduction for all savings

Gross Income
Text, pp. 46-66
Code: 61; Regs: 1.61-1, 1.61-14
Gross Income: The Scope of Section 61
Code/Regulations
IRC 61 -- All income from whatever source derived, except as otherwise provided in this
subtitle.
Reg. 1.61-1 (Gross Income) all income from whatever source derived, unless
excluded by law. Includes income realized in any form, whether in money, property, or services.
Income may be realized, therefore in the form of services, meals, accommodations, stock, or
other property, as well as in cash
Reg. 1.61-2 (Compensation for services, including fees, commissions, and
similar items)
(a) Many examples of things, paid in cash, that should be included as gross income
(d) Compensation paid other than cash that should be included in gross income
If property or services are taken as compensation, the fair market value of
such property or services should be included as gross income
Reg. 1.61-14 (Miscellaneous Items of Gross Income) other items of gross
income, including: punitive damages, another persons payment of a taxpayers income tax is
gross income to the taxpayer, illegal gains, and treasure trove. These things are gross income for
the taxable year in which it is reduced to undisputed possession.
Intro:
What is income?
- Taxable income is gross income less certain authorized deductions
- Gross income is all income from whatever source derived
- Accession to wealth (are you better off after the transaction than before?)
- When do you have an increase in wealth? When you have dominion over the
possession
- To be income, it must be realized
- To be realized, there must be an event triggering an increase in value, unless there is
already a substantial value associated with the income item
- Summary: To have income, it must be:
o An increase in wealth
o Dominion/Control over the possession
o Realized

Equivocal Receipt of Financial Benefit


Cesarini v. United States Question of treasure trove (yes = income)
Facts:
- A couple bought an old piano in 1957, and in 1964 found $4,467 in the piano.
- Initially they filed a tax return and claimed that money in income, they paid $836 in
taxes for that money
- Later they filed a filed a second return eliminating the piano money and requested a
refund for the $836 they allegedly overpaid
- They claimed:
o 1. The $4,467 is not includable in gross income under 61 of the IRC
o 2. Even if the money was includable under 61, it was due in the year the
piano was bought (1957), not the year the money was found, and if thats the
case the Statute of Limitations has passed
o 3. If the treasure trove money is gross income for 1964, it was entitled to
capital gains treatment.
- The IRS rejected their refund claim.
Hold:

This court also concluded the tax payers are not entitled to a refund, nor was the gain
to have been reported in the year of the piano purchase (must be realized) nor is the
gain entitled to capital gains treatment.

Reasoning

61 says gross income shall include all income from whatever source
derived, unless excluded in another statute
Reg. 1.61-1 Gross income includes income realized in any form
Part III of Subchapter B ( 101) specifically lists things not included as gross income,
and found money is not listed.
Rev. Rul. 61, 1953-1 says the finder of treasure trove is in receipt of taxable income
for Federal income tax purposes in the year in which it was reduced to
undisputed possession.
Essentially Ps argument that it is not taxable overlooks the statutory scheme
whereby income from all sources is taxed unless the taxpayer can point to an express
exemption
Reg. 1.61-14 Miscellaneous items of gross income actually lists treasure trove as
an item of gross income (this was never mentioned by either party)
The couples argument that the SOL has run is not appropriate b/c the treasure trove is
gross income when the found money was reduced to undisputed possession

Old Colony Trust Co. v. Commissioner Question of indirect income/tax payment (yes,
income for taxpayer)
Facts:
- Mr. Wood engaged in an agreement with his employer, where the employer would
pay his taxes.
- His employer did pay his taxes for 1918 and 1919, in the amounts of $681K and
$351K, but did not include such tax payments as part of gross income
Question:
- Did the payment by the employer of the income taxes assessable against the
employee constitute additional taxable income?
Hold:

Income Without Receipt of Cash or Property


Helvering v. Independent Life Ins. Co. Question of owner reporting rental value of ppy
he occupies as income (No)
- Owner lived in a building he also rented out, but he doesnt have to report the rental
value as income for renting it to himself
- The rental value of the building used by the owner does not constitute income within
the 16th Amendment
Revenue Ruling 79-24
- If property or services are rendered in exchange for something, the
fair market value of that property or service must be recorded
under gross income
- Not pursuant to Revenue Ruling 79-24, but a reasonable valuation of what the
property or services may cost is also sufficient in valuing the amount to record as
gross income.
Dean v. Commissioner Question of company-owned home being lived in by employee at
no rent (unpaid rent is income)
- Occupancy in a home owned by a corporation, but in which the taxpayer resides, is
gross income
- Because the taxpayer lives in a home owned by a corporation he must treat the fair
market value of living there as gross income
- It was the taxpayers legal obligation to provide a family home and if he did it by the
occupancy of a property which was held in the name of a corporation of which he
was president, we think the fair value of that occupancy was income to him
- This is different from Helvering b/c the Corporation here is a separate entity, in
essence the couple here is receiving services from someone else
PROBLEMS
P. 66, Q2
(a) Regardless of the equality of the swap, both dr and lawyer would have to report the fair
market value of the service received ($200) as part of eachs gross income (Rev. Ruling 79-24)
because you are better off because of receiving the services
(b) No. Similar to the owner in Helvering who did not have to report the rental value of the
property he owned and occupied, here, the lawyer does not have to declare as his gross income,
his own services rendered imputed income
Imputed Income
- Examples include: preparing your own tax return, or owning your home, or cleaning
your own house instead of renting or having other do those things for you.
- You are not taxed on imputed income

Gains from Dealings in Property


Text, pp. 114-115, 115-118, 119-121, 126-128, 128-130
Code: 1001(a), (b), (c); 1011(a); Regs: 1.1001-1(a)
Cost Basis - 1012; 1016(a)(1)
Gift Basis - 1015(a), (e)
Interspousal Transfer - 1041(a), (b)
Acquisition from Decedent - 1014(a)(1), (e), (f)
Gain From Dealings in Property
Its important to know what the gain is because 61(3) says gains are considered as gross
income

Factors in the Determination of Gain


Code 1001(a) Computation of Gain The gain from the sale or other
disposition of property is the excess of amount realized (FMV + $ received) over the
adjusted basis (how much have you got in something COST) provided in section
1011
Gain is the amount over and above what youve put into the property
To have a gain, there must be a sale or other disposition of the
property (like trading it
Code 1001(a) Computation of Loss Loss shall be the excess of the
adjusted basis provided in 1011 for determining loss over the amount realized
Computation of Gain or Loss Reg. 1.1001-1(a)
Gives the general rules as determined in the statutes for computing a gain or loss
The amount realized from a sale or other disposition of property shall be the sum of any
money received plus the fair market value of the property (other than money) received
The amount which remains after the adjusted basis has been restored to the taxpayer
constitutes the realized gain
If the amount realized upon the sale or exchange is insufficient to restore the taxpayer the
adjusted basis (cost) of the property, a loss is sustained to the extent of the difference
between such adjusted basis and amount realized
Amount Realized
Code 1001(b)
The amount realized from the sale or other disposition of property shall be the sum of any
money received plus the fair market value of the property (other than money) received
Whatever cash you get plus the fair market value of any other property
you may receive
Recognition of Gain or Loss
Code 1001(c)
Except as otherwise provided in this subtitle (Subtitle A Income Tax) the entire amount
of the gain or loss, determined under this section, on the sale or exchange or exchange of
property shall be recognized.
Adjusted Basis for Determining Gain or Loss
Code 1011(a)
The adjusted basis for determining the gain or loss from the sale or other disposition of
property, whenever acquired, shall be the basis determined under 1012
Basis of Property Cost Basis
Code 1012
The basis shall be the cost of such property, except as otherwise provided
The cost of real property shall not include any amount in respect of real property taxes
Puts a monetary value on the taxpayers investment in property
To have lower taxes, you want a higher basis, because it makes your
gain lower
Adjustment to Basis General Rule
Code 1016(a)(1)
Proper adjustment in respect of the property shall in all cases be made for which
deductions have been taken by the taxpayer in determining taxable income for the taxable
year or prior taxable years
Adjustment shall be made to expenditures, receipts, losses, or other items, properly
chargeable to capital account
No such adjustment shall be made for taxes or other charges described in 266, or for

Determination of Basis Cost Basis


See Code 1012
Basis is how much you have in something basis and value must be carefully differentiated
(ex: you could pay $10 for a stock and if it goes up to $15, the basis would be $10 and the value
would be $15)
Philadelphia Park Amusement Co. v. United States
- In 1889 a taxpayer was granted a 50 year lease to operate a railway.
- At the cost of $381K he built a bridge over the river for the railway.
- In 1934 he deeded the bridge to the city in exchange for a 10 yr. extension on the
lease
Question
- For the purposes of calculating gains and losses, what is the cost basis of the 10 yr.
extension of the taxpayers franchise.
Hold:
- The ct. holds the cost basis of the property received in a taxable
exchange is the fair market value of the property received in the
exchange, not the property given.
- When property is exchanged for property in an exchange the taxpayer is taxed
on the difference b/t the adjusted basis of the property given in
exchange and the FMV of the property received in exchange
- Therefore the cost basis of the 10-year extension of the franchise was its fair market
value on the date of the exchange (Aug. 3, 1934).
- In an arms-length transaction two properties exchanged are presumed to be equal in
value so look at value of bridge to determine value of 10-yr franchise
PROBLEMS
P. 118, Q1(a), (b), (d), (f)
(a) Gain = amount realized cost basis = $16k-$10k = $6k gain
Gain is the amount over and above what you put into the property
(b) Gain = amount realized cost basis = $16k-$10k (9k and 1k for option) = $6k gain
Your basis would be the total cost to you
(d) Gain = amount realized cost basis = $16k-$10k (2k in cash and 8k in mortgage) = $6k gain
This would apply regardless of whether it was a recourse or nonrecourse mortgage
The focus on basis is what does it take to acquire that property
Debt used to acquire property is considered basis thus, you include debt in basis
(f) Gain = amount realized cost basis = $18k-$10k = $8k
Dont include lease payments
Expenditures are excluded

Property Acquired by Gift Gift Basis


See Code 1015(a), (e)
- Applies to Gifts After December 31, 1920
- If the property was acquired by gift the basis shall be the same as it would be in the
hands of the donor (or the last preceding person who did not acquire it by gift)
- Unless the basis is greater than the fair market value of the property at the time of the
gift, in such case for the purpose of determining loss the basis shall be such fair
market value.
o If the basis is less than the FMV at the time of the gift then
the FMV shall be used as the basis in determining loss.
- If the donee cannot determine the basis the Secretary should attempt to find the facts
necessary to determine the donor.
o If the Secretary finds it impossible to find the basis the basis shall be the fair
market value at the time the property was acquired by the last preceding
owner.
- The donee gets the benefit of the donors basis (Transferred basis)
- General Rule
o General rule donor to donee = transferred basis
o If selling price (of donee) is more than the donors basis you
still use the transferred basis
o If the selling price is less than the FMV you use the FMV basis
when calculating a loss.(the FMV is used b/c of the exception
used when calculating a loss)
o If the selling price is in between the donors basis and the
FMV you dont recognize a gain or a loss. Its no mans land.
Put another way if the selling price is above the
highest number (donors basis) you use the normal
rule (transferred basis). If the selling price is below the
lowest number, you use the exception (FMV b/c your
calculating a loss). If its in b/t the two numbers (basis
and FMV) your and no mans land and you dont have
a gain or a loss.
Code 1015(e) gifts between spouses use 1041
Taft v. Bowers (U.S. Supreme Ct. 1929)
- Petitioners, who are donees of stocks, seek to recover income taxes exacted b/c of
advancement in the market value of those stocks while owned by the donors.
- Heres what happened:
o A purchased 100 shares of stock for 1K, which he held until 1923 when the
shares were worth 2K
o A then gave the stock to B, who sold them later in 1923 for 5K
o The Government says B must pay taxes on 4K of realized profits, but
o B argues that only 3K of appreciation during her ownership can be taxable
income per the 16th Amendment
- The Supreme Court ruled she had to pay taxes on a gain of 4K because when she sold
the stock she actually got the original sum invested, plus the entire appreciation.
- Per Code 1001(a) she had a gain of $4K b/c the realized value was $5K and
per Code 1015(a) she had a basis of $1K
- This case is basically what 1015 codified.

Property Acquired Between Spouses or Incident to Divorce


Code 1041(a)
- No gain or loss shall be recognized on a transfer of property from an individual to:
- 1. a spouse; or
- 2. a former spouse, but only if the transfer is incident to the divorce
- Gains can still be realized, just not recognized in these situations
- Policy reason: the code in many places recognizes husband and
wife as a single entity
Code 1041(b)
- In any transfer of property described in section (a), for the purposes of this subtitle
should be treated as a gift, and
- The basis of the transferee in the property shall be the adjusted basis of the transferor.
PROBLEMS
P. 128, Q1
(a) No tax consequences - 1041(a) No gain or loss shall be recognized on a transfer or
property from an individual to a spouse (Andre still realizes a $3k gain, but the gain is not
recognized for income tax purposes)
(b) Based on 1041(b) The property shall be treated as acquired by the transferee by gift
basis of the transferee so what Andres basis is = $4k
(c) If Steffi sells for FMV, Gain = amount realized ($7k) Adjusted Basis ($4k) = $3k gain
(d) Still no tax consequences for Andre and pursuant to the statute, Steffis adjusted basis is still
Andres basis which is $4k, so if Steffi sold it for 3k, her loss would be 1k
(e) No recognized tax gains or losses for the exchange. The basis of the property Andre received
is $5k and the basis of the property Steffi received is still $4k.

Property Acquired from a Decedent


Code 1014(a)(1)
- The basis of the property in the hands of a person acquiring the property from a
decedent shall be the FMV of the property at the date of the decedents death, but
only
- if not sold, exchanged, or otherwise disposed of before the decedents death by such
person. (this could occur if you know youre getting property from a
relative and you enter into a K to sell it before the decedent dies,
then you will not get the step-up basis
o The policy is that then it would be like an inter-vivos gift,
governed by 1015.
- This increased basis (FMV at time of decedents death, versus the
initial basis of the decedent) is called a step-up basis
Code 1014(e)
- Applies when a decedent dies after December 31, 1981
- When appreciated property was acquired by the decedent by gift during the 1 year
period ending on the date of the decedents death, and
- Such property is acquired from decedent by the donor of such property
- The basis of such property in the hands of such donor shall be the adjusted basis of
such property in the hands of the decedent immediately b/f the death of the decedent.
- Prevents people from taking advantage of the rule in 1014(a)
Code 1014(f)
- Section shall not apply to decedents dying after 12/31/2009
Notes from textbook on these sections:
- Under 1014 property acquired from a decedent generally receives a basis equal to
its FMV on the date on which it was valued for federal estate tax purposes (the date
of the decedents death)
- 1014(e) prevents people from taking advantage of the rule in 1014(a)
o For instance, if someone transfers property to an elderly person with the idea
that if they die w/in a year, the decedent will transfer it back to the donor in
hopes that the donors basis will be higher since 1014(a) says its equal the
FMV at time of decedents death.
o However (e) prevents that from happening (see p. 129 and top of 130 for an
example).
o This was covered in class, but probably wont be tested upon.
o The transfer from the decedent to the donee must occur w/ in
one year of the transfer from the donee to the decedent.
However after a year the donee would be able to get the
item back w/ a stepped up basis.
PROBLEMS
P. 130, Q1
Block 1 purchased for $50k years ago (Current value = $1 million)
Block 2 purchased for $950k (Current value = $1 million)
Giver should retain block 1 until his death because the basis for the block will be the fair market
value ($1,000,000) instead of a $50k basis if he were to give it as a gift before he dies, which
would result in the donee having a huge taxable gain whenever such person decides to sell. Thus,
giver should give Block 2 inter vivos.
If giving an inter vivos gift, see 1015(a) the donees basis will be the donors basis

Gains from Dealings in Property


Text, pp. 131-150
Code: 1001(a), (b), (c); 1011(a); Regs: 1.1001-1(a)
Cost Basis - 1012; 1016(a)(1)
Gift Basis - 1015(a), (e)
Interspousal Transfer - 1041(a), (b)
Acquisition from Decedent - 1014(a)(1), (e), (f)
AMOUNT REALIZED

Amount Realized
Code 1001(b)
The amount realized from the sale or other disposition of property shall be the sum of any
money received plus the fair market value of the property (other than money) received
Whatever cash you get plus the fair market value of any other property
you may receive
Computation of Gain or Loss Reg. 1.1001-1(a)
Gives the general rules as determined in the statutes for computing a gain or loss
The amount realized from a sale or other disposition of property shall be the sum of any
money received plus the fair market value of the property (other than money) received
The amount which remains after the adjusted basis has been restored to the taxpayer
constitutes the realized gain
If the amount realized upon the sale or exchange is insufficient to restore the taxpayer the
adjusted basis (cost) of the property, a loss is sustained to the extent of the difference
between such adjusted basis and amount realized
Discharge of Liabilities Inclusion in Amount Realized Reg. 1.1001-2(a)
In general, the amount realized from sale or other disposition of property includes the
amount of liabilities from which the transferor is discharged as a result of the sale or
disposition
Effect of Fair Market Value of Security Reg. 1.1001-2(b)
The FMV of the security at the time of the sale or disposition isnt relevant for purposes
of determining under paragraph (a) of this section, the amount of liabilities from which
the taxpayer is discharged or treated as discharged
Thus, the fact that the FMV of the property is less than the amount of liabilities it secures
does not prevent the full amount of these liabilities from being treated as money received
from the sale or other disposition of property
Factors in the Determination of Gain
Code 1001(a) Computation of Gain The gain from the sale or other
disposition of property is the excess of amount realized (FMV + $ received) over the
adjusted basis (how much have you got in something COST) provided in section
1011
Gain is the amount over and above what youve put into the property
To have a gain, there must be a sale or other disposition of the
property (like trading it
Code 1001(a) Computation of Loss Loss shall be the excess of the
adjusted basis provided in 1011 for determining loss over the amount realized
Recognition of Gain or Loss
Code 1001(c)
Except as otherwise provided in this subtitle (Subtitle A Income Tax) the entire amount
of the gain or loss, determined under this section, on the sale or exchange or exchange of
property shall be recognized.
Adjustment to Basis General Rule
Code 1016(a)(1)
Proper adjustment in respect of the property shall in all cases be made for which
deductions have been taken by the taxpayer in determining taxable income for the taxable
year or prior taxable years
Adjustment shall be made to expenditures, receipts, losses, or other items, properly
chargeable to capital account
No such adjustment shall be made for taxes or other charges described in 266, or for

AMOUNT REALIZED
International Freighting Corp, Inc. v. Commissioner (2nd Cir. Ct. of Appeals 1943)
- The taxpayer (the Corp. listed above) gave some of its outstanding employees a
bonus in stock (DuPont), w/ a FMV of $24K (at the time it gave the stock out) but
with a cost to the Corp. of $16K when it purchased
- The taxpayer reported a deduction of $24K since it discharged the stock
- The tax commissioner reduced the deduction to 16K reasoning that b/c the bonus was
paid in property its basis should be the cost, not the FMV
- This left a deficiency of 8,7k resulting in 2k short in taxes.
Prior History:
- Tax Court held that the taxpayer was entitled to a deduction of 24K, but in doing so
they realized a gain of an additional 8.7k and were still deficient in the amount of
2.156k
This Cts Decision
- First the ct. established that the stock given to the employees was not a gift
o It was not a gift b/c it was compensation for services actually rendered
(outstanding services)
- The ct. finds that there was a taxable gain equal to the difference b/t the cost of the
shares and the FMV
- To determine the gain here the ct. applies 1001(a): the excess of the amount
realized over the adjusted basis.
o The adjusted basis is the cost of the stock (16K)
- Per 1001(b) the moneys worth is deemed the amount realized (24K) when there
is no property or money received.
- This means the gain was 8K and the Tax Court is affirmed
Rationale:
- IFC gave the EE some stock ($25K) in return for some services
o B/c this is compensation its income
- The stock had an Adjusted Basis to IFC of $16K and a $25K FMV
- Here the taxpayer is saying that the AR is $16K (the basis), but the Ct. says
otherwise.
o You gave stock to the employees for $25K worth of services.
o Therefore there is a gain to the co. of $8.7K (AR = 25k, AB = 16.3k)
- Hold:
o This case shows that in addition to what 1001(b) defines as
Amount Realized, the value of services may also be used to
determine amount realized.
o Even broader this case says that 1001(b) goes beyond
money received or FMV of property in determining the
amount realized.
Main Ideas in the Crane and Tufts Cases
- 1. If you use debt to acquire property you get to include the debt in
your basis
- 2. When you are relieved of liabilities (in a sale, exchange, or other
disposition of property) the amount of liabilities is included in the
amount realized.
- These two principals are expanding on the theory in the

Exclusions from Income: Gifts and Inheritances


Text, pp. 67-80, 85-88
Code: 102; Regs: 1.102-1
Gross Income: Inclusions and Exclusions
Certain items are specifically includable in gross income or partially includable - 71-90
Other items are specifically excludable from gross income or partially excludable -
101-139A
Differentiate exclusions from deductions
Gross Income Includes the Receipt of Any Financial Benefit Which Is:
Not a mere return on capital, and
Not accompanied by a contemporaneously acknowledged obligation to repay, and
Not excluded by a specific statutory provisions (EXCLUSIONS)

Code 102 Gifts and Inheritances


Code 102(a) General Rule
- Gross income does not include the value of property acquired by gift, bequest,
devise, or inheritance.
Code 102(b) Income
- Subsection (a) shall not exclude from gross income
o 1 the income from any property referred to in subsection (a), or
o 2. where the gift, bequest, devise, or inheritance is of income from property,
the amount of such income
Ex. When a donor gives a donee stock w/ future
dividends, all future income is not excludable.
Code 102(c) Employee Gifts
- Subsection (a) shall not exclude from gross income any amount transferred by or for
an employer to, or for the benefit of, an employee.
o This sets a presumption that everything given from an
employer to an employee is not a gift, but is instead
includable as gross income.
Reg. 1.102-(a) Gifts and Inheritances General Rule
- Property received as a gift or received under a will or under statutes of descent and
distribution, is not includible in gross income, although the income from such
property is includible in gross income.
- An amount of principal paid under a marriage settlement is a gift ( 71 governs even
further)
- Section 102 does not apply to prizes and awards nor to scholarships and fellowship
grants
Reg. 1.102-(b) Income from Gifts and Inheritances
- The income from any property received as a gift, or under a will or statute of descent
and distribution shall not be excluded from gross income under paragraph (a) of this
section.
Reg. 1.102-1(f) Proposed Amendment to Regulation
- (1) Section 102 does not apply to
o Prizes and awards (including employee achievement awards) (see 74)
o Certain de minimis Fringe benefits (when an employee dies) (see 132)
o Any amount transferred by or for an employer to, or for the benefit of, an
employee, or
o To qualified scholarships
- (2) For purposes of 102(c) if an EE can show the transfer was not made in
recognition of the EEs employment, then it can still be considered a gift and 102(c)
wont effect its gift status. Exception to the rule
- Furthermore 102(c) wont apply to related parties if the circumstances of the
transfer can be attributed to the family relationship, not the circumstances of their
employment.

GIFTS
Commissioner v. Duberstein
Facts:
- Duberstein was the president of a metal co.
- Berman was the president of another metal co. and they often did business together
- Duberstein supplied Berman w/ some names of potential clients
- As a gift for the info Berman gave Duberstein a Cadillac
- Berman later deducted the value of the Cadillac as a business expense on his
companys tax return
- Duberstein failed to report the value of the car as income and the Commissioner cited
a deficiency
Prior History:
- The Tax Ct. held that the item was not a gift and Duberstein should have reported it
as gross income.
- The Ct. for the 6th Circuit Reversed.
Facts:
- Stanton v. US - There are similar facts where a comptroller for a company was
given a cash sum of $20K (payable in $2000 installments) and did not report it as
income
Prior History
- The Tax Ct. determined the sum was a gift
- The Ct. of Appeals for the 2nd Circuit Reversed
Hold:
- As to the first case the court reverses the Appellate Cts decision and upholds the trial
cts decision
- As to the second case the Appellate Cts decision is vacated and the case is remanded
for further fact finding in the District Ct.
Ultimate Question:
- What is a gift question is whether a specific transfer to a taxpayer amounted to a
gift to him within the meaning of the statute such that it can be EXCLUDED from
income under 61 because of 102
Rule:
- What is a gift is dependent upon the facts of each case.
- It will be decided on a case by case basis by the fact finder No absolute test
- The intent of the donor of the alleged gift will ultimately help decide if it is a gift.
Reasoning/Rationale
- Mere absence of a legal or moral obligation to make such a payment does not
establish that it is a gift
- If the payment proceeds primarily from the constraining force of any moral or legal
duty, or from the incentive of anticipated benefit of an economic nature, it is not a
gift.
- A gift in the statutory sense proceeds from a detached and disinterested generosity,
out of affection, respect, admiration, charity, or like impulses
Class Notes:
- Duberstein defines what a gift is
- Duberstein shows that when a taxpayer receives something you must look at the facts
to determine whether its a gift.
- It says you must look at the INTENT OF THE DONOR

Employee Gifts
General Contexts:
(1) Employer to an employee during an ongoing employment relationship
(2) Employer to an employee upon or after retirement
(3) Employer to an employees survivors upon the death of an employee
Code Treatment
- Traditional 102(c) considers all transfers by or for an employer to, or for the benefit
of, an employee as gross income (So, you do not exclude these from gross income
like other gifts under 102(a))
- Reg. 1.102-1(f) lays out some exceptions to this rule extraordinary transfers to the
natural objects of an employers bounty (if the employee can show that the transfer
was not made in recognition of the employees employment)
Class Notes:
- When someone gives you $100 is it income?
- Not always, it could be a Loan, return of capital, testamentary gift, inter vivos gift,
etc.
PROBLEMS
P. 80, Q1 & Q3
Q1
Under 61, gross income is all income from whatever source derived, except as otherwise
provided
102(a) provides general rule that gifts are excluded from income
102(c) however, provides exception to gift exclusion in that gifts from employer to
employee are generally treated as income
Reg. 1.102-1(f)(2) provides, however, that the 102(c) exception to the gift exclusion does not
apply to amounts transferred between related parties if the purpose of the transfer was
substantially related to the familial relationship and not to the circumstances of the employment
(so if employer/employee are family and substantial relation of gift is to family tie it is a gift,
not employer-employee exception to gift exclusion)
Here, normal gift to employee was $120 and this was $700 so substantially related to
mother/son relation
If the son was higher-ranked than other employees, it would look more like an employeremployee compensation, not a gift, and thus the son would have to include it as income
Q3
Under 61, gross income is all income from whatever source derived, except as otherwise
provided
102(a) provides general rule that gifts are excluded from income
102(c) however, provides exception to gift exclusion in that gifts from employer to
employee are generally treated as income
The contribution ($2000) from the employer directly would seem to be like compensation for
past serviced rendered; whereas the contribution ($3000) from his co-workers seems to be more
like a an act of detached and disinterested generosity on their part
Thus, the $2k would be included as income under 61 and not privy to the 102(a) gift
exclusion because of 102(c)
102(c) trumps the normal gift exclusion, unless there is a family relation, then see regulation
The $3k would be excludable from gross income under 102(a)

BEQUESTS, DEVISES, AND INHERITANCES


Wolder v. Commissioner
- Mr Wolder an attorney did legal work for Mrs. Boyce over the course of her life
- The two had a contract agreement that Mr. Wolder would not charge Mrs. Boyce for
any of his services and in return she promised to leave him a healthy sum in her will
o She left him 15,845 and 750 shares of stock
Question:
- Is the money in her will considered income?
- Whether an attorney contracting to and performing lifetime legal services for a client
receives income when the client, pursuant to the contract, bequeaths a substantial
sum to the attorney in lieu of the payment of fees during the clients lifetime
- Tax Court held that the FMV of the stock and cash received under the clients will
constituted taxable income under 61
Arguments:
- Mr. Wolder argues that the money left to him via the will is a gift an per 102(a)
- He shouldnt have to include it as income rather, it should be EXCLUDABLE
Hold:
- The court holds that it is income and says Mr. Wolder must pay taxes on it
- The reason is b/c it was compensation for services and 61(1) holds that all
Compensation for services, including fees, commissions and similar items shall be
considered income
Class Notes:
- Compensation for services disguised in a will is still considered income
PROBLEMS
P. 88, Q1(a)-(e)
(a) Father leaves D $20k in will
General rule applies not income from property and not for past services rendered
Donative intent of father
(b) D receives $20k worth of real estate as heir
General rule applies not income from property and not for past services rendered
(inheritance)
(c) D receives $20k in settlement of will/estate
102(a) likely applies because the $ D receives is still inheritance from fathers estate/will
(d) D receives $20k for long and devoted service to him
102(a) likely still applies, but want to know more facts about the type of service, but this still
seems like detached and disinterested act of generosity is this a payment for past services?
(e) D receives $20k pursuant to agreement for care in declining years
102(a) exclusion likely does not apply, and instead treated as 61 gross income because the
father bequeathed the $ in compensation for the services the daughter rendered which would have
a fee associated (Wolder)

Exclusions from Income: Employee Benefits


Text, pp. 89-98
Code: 132(a), (b); Regs: 1.61-21(a), (b)(1)-(2); 1.132-1(b), -2
Introduction:
61(a)(1) specifically includes in gross income compensation for services
61(a)(1) is broad enough to include in taxable income any economic or financial
benefits conferred on the employee as compensation, whatever the form or mode by
which it is effected
If an employee benefits is not specifically excluded from gross income, its value must be
included within gross income under 61
132 excludes from gross income an ever expanding list of categories
of fringes

Code 132(a) Certain Fringe Benefits Exclusions from Gross Income


- Gross income shall not include any fringe benefit which qualifies as a:
o 1. no additional-cost service, 2. qualified EE discount; 3. working
condition fringe; 4. de minimis fringe; 5. qualified transportation
fringe; 6. qualified moving expense reimbursement; 7. qualified
retirement planning services; or 8. qualified military base realignment
and closure fringe
o Typically under 61(1)(a) fringe benefits are considered
gross income, this is an exception.
o Because there is a statute on this, what is considered a
fringe benefit is pretty narrowly construed.
Code 132(b) No Additional-Cost Service Defined
- For purposes of this section, the term no-additional-cost service means any
service provided by an ER to an EE for use by such EE if
o 1. such service is offered for sale to customer in the ordinary course of
the line of business of the ER in which the EE is performing services
o 2. the ER incurs no substantial additional cost (including forgone
revenue) in providing such service to the EE (determined w/out regard
to any amount paid by the EE for such services)
Code 132(c) Qualified Employee Discount
- (1) the term qualified EE discount means any EE discount w/ respect to
qualified property or services to the extent such discount does not exceed
o (a) In the case of property, the gross profit percentage of the price at
which the property is being offered by the ER to customers, or
o (b) in the case of services, 20% of the price at which the services are
being offered by the ER to customers.
Reg. 1.61-1 Gross Income
- (a) all income from whatever source derived, unless excluded by law. It
includes income realized in any form, whether in money, property, or services.
Income may be realized, therefore in the form of services, meals,
accommodations, stock, or other property, as well as in cash.
Reg. 1.61-21 (a)(1) Taxation of Fringe Benefits
- (1) 61(a)(1) provides that, except as otherwise provided in subtitle A of the
IRC of 1986, Gross Income includes compensation for services, including
fees, commissions, fringe benefits, and similar items.
- (1) Examples of fringe benefits include: an employer-provided automobile, a
flight on an employer-provided aircraft, an employer-provided free or
discounted commercial airline flight, an employer-provided vacation, an
employer-provided membership in a country club or other social club, and an
employer-provided ticket to an entertainment or sporting event
Reg. 1.61-21(a)(2) Fringe Benefits Excluded From Income
1

Exclusions For Fringe Benefits


- If an employee benefit is not specifically excluded from gross income, its
value must be included w/in gross income under 61
- Most of the exclusionary rules apply in 132
- The exclusionary rules must not discriminate
o The nondiscrimination requirement denies highly compensated
Employees an exclusion for those fringes unless the fringes are
provided on substantially the same terms to a broad group of
Employees.
o If youre going to exclude it from income it needs to be
available to all people.
- No-Additional-Cost Services -- 132(a)(1)
o Services provided to an Employee by an Employer
o Definition of an employee is expanded to include not only persons
currently employed but also retired and disabled ex-employees and the
surviving spouses of employees or retired or disabled ex-employees as
well as spouses as dependent children of employees Reg. 1.1321(b)
o Such services are only excludable from Gross Income if
the services are offered for sale to customers in the same line of
business as that in which the employee is performing is
performing services,
the Employer incurs no substantial additional cost in providing
the service to the Employee, and
in the case of highly compensated Employees, the services are
provide on a nondiscriminatory basis.
o The services must be provided in the same line of business as that in
which the employee is employed.
Ex. An airline employee taking an open airline seat that would
not be used, but the flight would occur anyway.
It does not apply to all the employees of big conglomerates.
o It is allowable for two companies to form an agreement where the
respective employees of one co. can take advantage of the services of
another co. and vice versa
Ex. If one airline co. has an open seat an employee of another
airline co. may use it if the two cos. have an agreement.
- Qualified Employee Discounts -- 132(a)(2)
o An Employee may exclude from Gross Income the value of courtesy
discounts on items purchased from his Employer for use by the
Employee.
o Definition of an employee is expanded to include not only persons
currently employed but also retired and disabled ex-employees and the
surviving spouses of employees or retired or disabled ex-employees as

well as spouses as dependent children of employees Reg. 1.1321(b)


o Must be nondiscriminatory
o In terms of services the discount must not be greater than 20%
o In terms of property the discount must not be more than the
Employers gross profit percentage on the goods in the Employees
line of business
aggregate sales price reduced by cost
aggregate sales price
Working Condition Fringe -- 132(a)(3)
o An exclusion for any property or services provided to an Employee the
cost of which, if the Employee had paid for the property or services,
would have been deductible by the Employee as a business expense or
by way of depreciation deductions.
o Definition of employee includes (i) any individual who is currently
employed by the employer, (ii) any partner who performs services for
the partnership, (iii) any director of the employer, and (iv) any
independent contractor who performs services for the employer
Reg. 1.132-1(2)
o There is no discrimination limitation on this exclusion and probably
none needed
Ex. A company car for business purposes.
De Minimis Fringes
o Any property or service whose value is so small as to make required
accounting for it unreasonable or administratively impracticable is
excluded as a fringe benefit.
Ex. Occasional personal use of the company copying machine,
coffee and doughnuts
o Must be both small and infrequent.
Qualified Transportation Fringe
o Includes a toll pass or qualified parking
o If a cash equivalent is taken, that must be reported as gross income.
Qualified Moving Expense Reimbursement

PROBLEMS
P. 98, Q1
(a)
This is excludable under no additional cost services under 132(a)(1)
Same line of business
No additional cost to employer no foregone revenue
Under facts, seems non-discriminatory
(b)
This would not be excludable under no additional cost services under 132(a)(1) because
the employer is foregoing income it would otherwise be receiving
(g)
Not excludable under any of the exclusions from income because it does not fit in 132(a)(1)
exclusion
This is not in the same line of business
This would not be allowed because under 132(b)(1), it is not in the ordinary course of the
line of business of the employer in which the employee is performing services
(l)
This would probably classify as de minimis fringe which is excludable per 132(a)(4) or
132(e)
De minimis is defined as unreasonable or administratively impracticable it also must be
occasional
(m)
It would depend you would have to argue based on the facts of the situation
This does not seem de minimis also sounds similar to a gift
How much is the scotch valued at?
(o)
Under section 132(a)(5) $100 would be excluded and the other $10 would be included into
gross income because it exceeds the statutory limit for mass transportation fringe payments

Exclusions from Income: Life Insurance Proceeds


Text, pp. 152-155
Code: 101(a)(1), (2) (flush language), (c), (d), (g)(1), (2), (3)(A), (4); Regs: 1.101-4(a), (b)
Introduction
101(a) provides general rule however, it lays out some exceptions
o 101(a)(2) Transfer for Value Rules
o 101(d) Prorated amount is excluded (beyond that its not excluded)
o 101(c) Interest payments on a policy are not excluded

Code 101(a) Proceeds of Life Insurance Contracts Payable by Reason


of Death
- (1) Except as otherwise provided in 101(a)(2), 101 (d), 101 (f), and 101
(j), gross income does not include amounts received (whether in a single sum
or otherwise) under a life insurance contract, if such amounts are paid by
reason of the death of the insured.
- (2) Transfer for Valuable Consideration In the case of a transfer for a
valuable consideration, by assignment or otherwise, of a life insurance K or
any interest therein, the amount excluded from gross income by paragraph (1)
shall not exceed an amount equal to the sum of the actual value of such
consideration and the premiums and other amounts subsequently paid by the
transferee.
o The amount excluded cannot exceed
The amount of consideration paid; and
The premiums and other amounts subsequently
paid by the transferee
o The transferee can only exclude his or her investment in
the life insurance policy.
Code 101(c) Interest from Certain Death Benefits
- If any amount excluded from Gross Income by subsection (a) is held under an
agreement to pay interest thereon, the interest payments shall be included in
gross income
Code 101(d) Payment of Life Insurance Proceeds at a Date Later Than
Death
- (1) If life insurance payments are prorated (spread out over several years) the
beneficiary shall exclude the prorated payments from Gross Income in the
year theyre received
o If the insurer is paying the beneficiary b/c of an
insurance contract, the beneficiary has to include in
income the amount above paragraph (1) the amount
above the policy value
o See Question 1, part c
- (3) this subsection shall not apply to any amount to which subsection (c) is
applicable (Interest is still included in gross income)
Code 101(g) Treatment of Certain Accelerated Death Benefits
- (1) For purposes of this section, the following shall be treated as an amount
paid by reason of the death of an insured:
o any amount received under a life insurance contract on the life of an
insured who is a (a) terminally or (b) chronically ill individual
- (2) Treatment of Viatical Settlements
o (A) If any portion of the death benefit under a life insurance K is sold
or assigned to a viatical settlement provider, the amount paid for the
sale or assignment of such portion shall be treated as an amount paid
under the life insurance K by reason of the death of such insured.
1

Notes:
Life Insurance
- Insurer = Insurance Company
- Insured = Person who the policy is on
- Owner = The owner takes out the life insurance policy on the insured
- Beneficiary = Receives the face value of the policy when the insured dies.
o The owner determines who is the beneficiary.
- The exclusion in 101(a) only applies to death benefits
o For example, after a policy has been in effect for some time, the cash
surrender value of the policy (the amount the insurer will pay the
policy owner during the insureds life in discharge of all rights under
the policy) will exceed the net premiums paid.
o If the insured takes the cash surrender value, the insured will realize an
amount in excess of basis, which is a taxable gain unprotected by the
exclusionary rules of 101(a)(1), b/c it is an amount not paid by
reason of the insureds death.
- There is an exception:
o In 101(g) benefits paid out to a terminally ill or
chronically ill patient are treated as paid by reason of
death of the insured and are therefore excluded from
gross income.
o There is no ceiling on benefits excluded by terminally ill patients,
but chronically ill patients may only exclude $175 a day ($63,875
per year).

PROBLEMS
P. 155, Q1
(a)
61 all income from whatever source derived unless otherwise provided
101(a)(1) - gross income does not include amounts received (whether in a single sum or
otherwise) under a life insurance contract, if such amounts are paid by reason of the
death of the insured
(b)
61 - all income from whatever source derived unless otherwise provided
Under 101(a)(1), the $100k proceeds are excludable, but 101(c) provides that interest paid
on the proceeds is not excludable as income
(c)
61 - all income from whatever source derived unless otherwise provided
Under 101(d), the beneficiary must include as income, any amount greater than the predefined proceeds amounts ($100k) each year. If she is to receive 25 years of payments, this would
equate with a $4k a year payment to her, which would be excludable under 101(d). Anything
above $4k a year, would be gross income that is not excludable.
Q3
(a)
Insured Gain = AR-AB = $60k-$40k = $20k
Purchaser (Child) Under 101(a)(2), the purchaser of a life insurance policy can only exclude
the amount he/she purchased the policy for (including any premiums paid on the policy), so here,
purchaser who received $100k on the insureds death would be able to exclude $60k under
101(a)(2), but would still have $40k gross income on the insureds death.
(b)
Insured Gain = AR-AB = $60k-$40k = $20k realized gain, but under 1041(a), this amount is
not recognized
Purchaser (Spouse) - Under 101(a)(2), the purchaser of a life insurance policy can only exclude
the amount he/she purchased the policy for (including any premiums paid on the policy), so here,
purchaser who received $100k on the insureds death would be able to exclude $60k under
101(a)(2), but would still have $40k gross income on the insureds death.
(c)
Insured Under 101(g)(2)(A), a terminally ill individual may exclude from gross income any
amount received from a Viatical Settlerment Provider because this is still considered a payment
by reason of death of the insured
Purchaser - Under 101(a)(2), the purchaser of a life insurance policy can only exclude the
amount he/she purchased the policy for (including any premiums paid on the policy), so here,
purchaser who received $100k on the insureds death would be able to exclude $80k under
101(a)(2), but would still have $20k gross income on the insureds death.

Exclusions from Income: Annuity Payments


Text, pp. 156-160
Code: 72(a), (b)(1) & (2), (c)(1)
Introduction
Annuity arrangement under which one buys a right to future money payments
Endowment purchaser may buy right to receive certain $ per month for some specified
period of time
Both annuities and endowments receive the same treatment under 72
Key Concepts
Income connotes Gain
A mere return of capital is not income

Code 72(a) General Rule for Annuities


- Except as otherwise provided in this chapter, Gross Income includes any
amount received as an annuity (whether for a period certain or during one or
more lives) under an annuity, endowment, or life insurance contract.
Code 72(b) Exclusion Ratio
- (1) Gross Income does not include that part of any amount received as an
annuity under an annuity, endowment, or life insurance K which bears the
same ratio to such amount as the investment in the K (as of the annuity
starting date) bears to the expected return under the K (as of such date)
- (2) Exclusion Limited to Investment The portion of any amount received as
an annuity which is excluded from gross income under paragraph (1) shall not
exceed the unrecovered investment in the contract immediately before the
receipt of such amount.
- Exclusion Ratio = Cost of K/Expected Return
o The taxable portion is the amount above the cost of the
K per payment. You can get this by taking the (Payment
x Exclusion Ratio)
o This is really all we need to know about annuity
payments
Code 72(c) Definitions
- (1) Investment in the K For purposes of subsection (b), the investment in the
K as of the annuity starting date is
o (A) the aggregate amount of premiums or other consideration paid for
the K, minus
o (B) the aggregate amount received under the K before such date, to the
extent that such amount was excludable from gross income under this
subtitle or prior income tax laws.
- (3) Expected Return For purposes of subsection (b), the expected return
under the contract shall be determined as follows:
o (A) Life Expectancy - If the expected return under the K, for the
period on and after the annuity starting date, depends in whole or in
part on the life expectancy of one or more individuals the expected
return shall be computed w/ reference to actuarial tables prescribed by
the Secretary
o (B) Installment Payments If subparagraph (A) does not apply, the
expected return is the aggregate of the amounts received under the K
as an annuity.

Notes:

An annuity is an arrangement under which one buys a right for future money
payments
- Example:
o Typically an insurance co. sells annuities. A person may pay $20K for
a $2K payment a year for the rest of their life once they reach the age
of X.
- The annuities are sort of a bet w/ the insurance co.
o If someone outlives their life expectancy the insurance
co. loses, but if they live shorter than their life
expectancy the insurance co. wins
- An endowment contract would exist if the purchaser bought the right to
receive X amount of money a month for 20 years and the payments would
continue to the designee in the event of the purchasers death.
- Types of Annuities:
o Single Life Annuity calls for fixed money payments to the
annuitant for her life after which all rights under the K cease
o Self and Survivor Annuity fixed payments are made to an
annuitant during her life and are then continued to another after her
death.
o Joint-and-Survivor Annuity Pays amounts jointly to two
annuitants while both are living, and then payments are continued to
the survivor
- Key concepts in understanding the taxing of annuities
o Income connotes gain, and
o A mere return of capital is not income.
- W/ annuities in each payment the only part taxed is the
excess of the expected return under the K over the
investment in the K
PROBLEMS
P. 160, Q1
(a)
Per 72(b) the only part of an annuity which may be taxed is the expected return in excess of the
investment in the K.
o Return on capital is not taxed (so $48k of the $72k will not be taxed)
o Here the expected return is $72K (24 years times $3K per year)
o The investment in the K is $48K
o $48/$72K = 2/3
Therefore only 1/3 of each years payment is taxable.
So only $1K of the $3K each year is included in Gross Income
(b)
Under 72(b)(2), if an annuitant lives beyond her life expectancy and fully recovers her
investment in the contract, the full amount of any subsequent annuity payment is included in her
gross income

Exclusions from Income: Discharge from Indebtedness


Text, pp. 162-173
Code: 61(a)(12); 108(a), (d)(1)-(3), (f)(1); Regs: 1.1001-2(a)(1) & (2)

Code 61 Gross Income Defined


(a) Except as otherwise provided in this subtitle, gross income means all income from
whatever source derived, including:
a. (12) Income from discharge of indebtedness
- Discharge of Indebtedness (DOI) or Cancellation of Debt (COD) is
considered Gross income
- US v. Kirby expresses this if a corporation purchases and retires any of such
bonds at a price less than the issuing price or face value, the excess of the issuing
price or face value over the purchase price is gain or income for the taxable year
- If a Taxpayer pays off a debt for less than the amount owing, the
difference constitutes income to him, because he realizes an
economic benefit by way of an increase in his net worth much as if
he had sold property at a profit
Code 108(a) Exclusions Where theres Cancellation Of Debt or Discharge Of
Indebtedness income
- (1) Exclusion from Gross Income Gross income does not include any amount
which would be includible in gross income by reason of the discharge (in whole or in
part) of indebtedness of the taxpayer if
o (A) the discharge occurs in a title 11 case, or
o (B) the discharge occurs when the taxpayer is insolvent,
o (C) the indebtedness discharged is qualified farm indebtedness, or
o (D) in the case of a taxpayer other than a C corporation, the indebtedness
discharged is qualified real property business indebtedness
- (2) Coordination of Exclusions
o (A) Title 11 Exclusion Takes Precedence Subparagraphs (B), (C), and (D)
of paragraph (1) shall not apply to a discharge that occurs in a title 11 case.
o (B) Insolvency Exclusion Takes Precedence Over Qualified Farm Exclusion
and Qualified Real Property Business Exclusion. Subparagraphs (C) and
(D) of paragraph (1) shall not apply to a discharge to the extent the taxpayer
is insolvent.
- (3) Insolvency Exclusion Limited to Amount of Insolvency In the case of a
discharge to which paragraph (1)(B) applies, the amount excluded under paragraph
(1)(B) shall not exceed the amount by which the taxpayer is insolvent.
Reg. 1.61-12 Income from Discharge of Indebtedness
- The discharge of indebtedness, in whole or in part, may result in the realization of
income.
- For example if an individual performs services for a creditor, who in consideration
thereof cancels the debt, the debtor realizes income in the amount of the debt as a
compensation for his services.
Reg. 1.1001-2 Discharge of Liabilities (a) Inclusion in Amount Realized
Reg. 1.1001-2 Discharge of Liabilities (C) Examples
- If X transfers $6K to a creditor and the creditor releases X from a $7.5K debt which
X was personally liable, then the Amount Realized on the disposition of the asset is it
FMV ($6K).
- X still has an income from the discharge of indebtedness for $1.5K.
- X has tax liability for the discharge of indebtedness AND for the gain on the sale of

CASES
U.S. v. Kirby Lumber Co. (U.S. Supreme Ct. 1931)
- If a taxpayer pays off a debt for less than the amount owing, the difference constitutes
income to him, b/c he realizes an economic benefit by way of an increase in his net worth
much as if he had sold property at a profit.
Zarin v. Commissioner (US Ct. of Appeals 3rd Circuit)
- Zarin appeals the tax court.s decision where they determined his discharge of $2.9
million in gambling debt was considered income and should be taxed.
- Zarin eventually racked up a $3.4 million dollar gambling debt
o Zarin claimed the casino was partially responsible b/c he was a compulsive
gambler.
- Eventually the casino settled their case w/ him for $500K.
- The Tax Court then ruled that he had received income of $2.9 million for the release
of his indebtedness (equal to the amount he owed minus the amount he settled the
claim for).
Hold:
- The general rule is that income from the discharge of indebtedness is considered
gross income. 61(a)(12)
- However, the court here determines Zarin did not actually have debt.
o They believe that gambling chips are merely an accounting mechanism to
evidence debt.
- They also believe that the contested liability doctrine applies
o Under this doctrine, if a taxpayer, in good faith, disputed the amount of a
debt, a subsequent settlement of the dispute would be treated as the amount
of debt cognizable for tax purposes.
o For this to occur there must be a disputed amount and there must be a
settlement
- Therefore all that was cognizable for tax purposes in Zarins case was the $500K and
paying this amount to the casino equaled the amount he had borrowed from them
so no taxable event
Class Notes:
- 108(d) was used to define indebtedness
- Taxpayer is saying this isnt a debt otherwise he would have
Cancellation Of Debt or Discharge Of Indebtedness income.
- The commissioner is saying this is a debt and he owed on a
deficiency
- The Taxpayer says this is unenforceable b/c NJ had law designed to
prevent compulsive gamblers for losing lots of money.
- Therefore because they settled for $500K the $500K was his debt,
which he repaid in full
- Where there is a disputed liability there is not a debt until you have
a determination of what the liability is.
o You cant have Cancellation Of Debt or Discharge Of
Indebtedness until you have an undisputed liability or the
debt is certain.
o These situations usually arise when services or billing rates
are involved.

Summary:
- Kirby = you owe money for COD or DOI
- Zerin must be undisputed debt to have COD or DOI
o A settlement is an agreement on the debt.
- 108(a) provides exclusions in having to include COD and DOI as GI

Exclusions from Income: Damages


Text, pp. 179-190
Code: 104(a); Regs: 1.104-1(c)

Code 104(a) Compensation for Injuries or Sickness


- (a) Except in the case of amounts attributable to (and not in excess of) deductions
allowed under 213 (relating to medical, etc. expenses) for any prior taxable year,
gross income does not include
o (1) amounts received under workmens compensation acts as compensation
for personal injuries or sickness;
Must be job-related not merely under a statute
entitled workers compensation
o (2) the amount of any damages (other than punitive damages) received
(whether by suit or agreement and whether as lump sums or as periodic
payments) on account of personal physical injuries or physical sickness
Emotional distress shall not be treated as a physical injury or
physical sickness unless they are a result of the personal
physical injuries in which case any damages resulting
from a personal physical injury (except punitive) are
excludable from gross income.
If the cause of action is emotional distress it is
excludable from gross income to the extent to
compensate for medical expenses
For example: if a P has to see a psychiatrist to
help cure the emotional distress, the bills for the
psychologist are excludable from gross income
o (3) amounts received through accident or health insurance for personal
injuries or sickness (other than amounts received by an employee, to the
extent such amounts: (A) are attributable to contributions by the employer
which are not includible in the GI of the EE, or (B) are paid by the ER).
o (4) amounts received as a pension, annuity, or similar allowance for personal
injuries or sickness resulting from active service in the armed forces of any
country or in the Coast Geodetic Survey or the Public Health Service, or as a
disability annuity payable under the provisions of ..
o (5) amounts received by an individual as disability income attributable to
injuries incurred as a direct result of a terroristic or military action
Regs. 1.104-1(a), (c), (d) Compensation for Injuries or Sickness
- (c) the term damages received (whether by suit or agreement) means an amount
received (other than workmens compensation) through prosecution of a legal suit or
action based upon tort or tort type rights, or through a settlement agreement entered
into in lieu of such prosecution.
Revenue Ruling 79-313
Facts
Taxpayer sustained severe and permanent personal injuries as the result of being struck
by a car driven by X
M, Xs insurer, proposed a settlement of taxpayers suit against X, which the taxpayer
accepted
M agreed to make 50 consecutive annual payments to the taxpayer for personal injury,
pain and suffering, disability, and loss of bodily function.
Holding
104(a)(2) gross income does not include the amount of any damages received on
account of personal injuries or sickness

DAMAGES IN GENERAL
Notes:

In determining income the real question is was there any element of a gain in a
receipt
Regarding Damages taxability of a recovery of damages can be
determined, in part, by identifying the nature of the injury (So, ask
the question In lieu of what were the damages awarded?)
If for lost profits = income
If punitive damages = income, even is punitive damages for personal injury
104(a)(2) -- To be excluded Must be tort-like personal injury and damages
incurred must be on account of personal injuries or sickness

Raytheon Production Corp. v. Commissioner


- Taxpayer settled a lawsuit under fed. Anti-trust laws against R.C.A. The issue was
whether the settlement was required to be included in the taxpayers gross income
- Damages for violations where the damages represent compensation for lost
profits/wages are considered gross income.
- Conversely damages for a return of capital (such as tortuous personal injury claims,
or the payments to restore a damaged car) are considered non-taxable
o Class example of X having to pay Y for damages to his car:
this would not be income b/c its a return on capital
Lost wages on the other hand are considered income
o Injury to goodwill is non-taxable. (Raytheon)
- The suit here was to recover damages for the destruction of the business and good
will, the recovery represents a return of capital
o The fact that the suit ended in a compromise settlement does not change the
nature of the recovery.
- Even though this is a suit to recover capital part of the damages can still be taxable.
- The damages awarded in excess of the basis/cost is taxable as gross income.
- Essentially, any gain received from the damages in this situation is considered gross
income
o Damages awarded that reflect a gain are considered taxable
income
o Class Example: Joe had a car for 1k and it rose in value to
20k. The car is then damaged and he is awarded 20k in
damages. The gain of 19k is realized when he gets the
settlement/damages and it is taxable income.
Damages and Other Recoveries for Personal Injuries
- 104 106 take the stance that the taxpayer has suffered enough
- They basically say that one who has incurred personal injury should not additionally
suffer injury to ones purse in the form of tax liability on the receipt of a damage
award
- 104(a)(2) exclusion only applies if the action is based on tort or tort-type rights and
the damages are on account of physical injuries or physical sickness
o Nonphysical injuries such as defamation, First Amendment rights, and
sex and age discrimination are no longer excludable.
o Emotional distress damages depend on the situation as to whether they are

Exclusions from Income: Sale of Residence (Income Earned)


Text, pp. 218-223
Code: 121(a), (b), (c)(2), (d)(1)-(3); Regs: 1.121-1(b), 1.121-2(a)(3)

Code 121 Exclusion of Gain from Sale of Principal Residence


Code 121(a) Exclusion of Gain from Sale of Principal Residence
- (a) Exclusion: Gross Income shall not include gain from the sale or exchange of
property if, during the 5 year period ending on the date of the sale or exchange,
such property has been owned & used by the taxpayer as the taxpayers principal
residence for periods aggregating 2 years or more
- Key characteristics for this section to apply:
o Principal Residence
o Own 2 of last 5 years
o Lived 2 of last 5 years
o Married (gives extra money to exclude; see 121(b)
- Congress enacted this statute in part
o To benefit the people who need to downsize
The elderly, people w/ a down turn in their finances
o To reduce the burden for taxpayers having to keep track of
the proper basis
o Congressmen saying Its just not right to have to pay taxes
on your house
This is an example of something in the code where
Congress feels its just not right to make taxpayers pay
a certain tax
Code 121(b) Limitations of the Exclusion of Gain from Sale of Principal
Residence
- 1. The amount of gain excluded from Gross Income under subsection (a) w/ respect
to any sale or exchange shall not exceed $250,000
- 2. Special Rules for Joint Returns husband & wife make joint return
o A. When a joint return is filed $500K shall be substituted for $250K if
(i) either spouse meets the ownership requirements of subsection (a)
w/ respect to such property;
(ii) both spouses meet the use requirements of subsection (a) w/
respect to such property; and
(iii) neither spouse is ineligible for the benefits of subsection (a) w/
respect to such property by reason of paragraph 3.
o This means that both spouses must meet all requirements of
subsection A for the $500K exclusion on a joint return to
apply.
Ex. If A lived in a place for 10 years as a principle
residence for the last ten years and then gets married
a year ago will the $500K exception apply
If they lived together for at least 2 of the last 5
years prior to this year then they qualify for the
$500K exclusion
If not then they can only use a $250k exception
Furthermore if the new spouse had recently sold
her house, then she would not qualify and they
could not get the $500k exclusion
What if they cant file for the $500K exclusion? Do they

Exclusions from Income: Income Earned Abroad


Text, pp. 224-225
Code: 911
Income Earned Abroad
- 911: Income Earned Abroad may be excluded from Gross Income, but an American
must:
o Be a bona fide resident of a foreign country or countries for an uninterrupted
period that includes an entire taxable year or
o An American citizen or resident must be present in a foreign country or countries
for at least 330 days during any period of twelve consecutive months
- 911(b)(1)(A): exclusion applies only to income from a foreign source which is
attributable to the taxpayers performance of services.
o Maximum exclusion is 80,000 (indexed for inflation 2006)

Exclusions from Income: Federal Taxes/State Activities


Text, pp. 233-237
Code: 103
Code 103 Interest on State and Local Bonds
- (a) Exclusion Except as provided in subsection (b), Gross Income does not include
interest on any State or local bond
o This exclusion applies for FEDERAL income tax purposes
- (b) Exceptions Subsection (a) shall not apply to (meaning that interest income
received on these bonds is Gross Income)
o (1) Private Activity Bond Which is Not a Qualified Bond Any
private bond which is not a qualified bond (w/ in the meaning of 141)
A private activity bond is any bond that is part of a
bond issue where, in general, more than 10% of the
proceeds are to be used for private use.
Ex. A bond to build a building for a private co. to use
tax-free, to encourage it to locate w/in a state or
community.
o (2) Arbitrage Bond Any arbitrage bond (w/ in meaning of 148)
o (3) Bond Not in Registered Form, Etc. Any bond unless such bond meets
the applicable requirements of 149
- (c) Definitions For purposes of this section and part IVo (1) State or Local Bond The term State or local Bond means an
obligation of a state or political subdivision thereof.
o (2) State The term State includes the District of Columbia and any
possession of the United States
Class Example:
- You invest $10K in IBM and get 5% interest, after taxes (assuming they are 25%)
you only get $375 in the bank b/c $125 of the $500 in interest is paid in tax
- Comparatively if you can purchase a state bond it would only need to give you an
interest rate of 3.75% b/c its not taxable. You would still have $375 in the bank
- Essentially the Federal Government is subsidizing such bonds b/c they are not taxing
them.

Income Tax Treatment: Separation and Divorce Alimony Direct Payments


and Indirect Payments
Text, pp. 192-197, 202-204
Code: 71(a)-(e), 215(a)-(c); Regs. 1.71.1T(b) Q5-7

Code 71 Alimony and Separate Maintenance Payments


Code 71(a) Alimony and Separate Maintenance Payments General Rule
- Gross income includes amounts received as alimony or separate maintenance
payments
Code 71(b) Alimony and Separate Maintenance Payments Defined
- For the purposes of this section
- (1) The term alimony or separate maintenance payment means any payment in
cash if
o (A) Such payment is received by (or on behalf of) a spouse under a divorce
or separation instrument
The or on behalf of indicates payments may be made
indirectly (See spouse Reg 1.71-1T(b)(A-6))
o (B) The divorce or separation instrument does not designate such payment as
a payment which is not includable in Gross Income under this section and not
allowable as a deduction under section 215
o (C) In the case of an individual legally separated from his spouse under
decree of divorce or of separate maintenance, the payee spouse and the payor
spouse are not members of the same household at the time payment is made
You could have married individuals who are married
and forced to make support agreements while still
married. This section does not apply to them, they
may still live in the same house.
o (D) There is no liability to make any such payment for any period after the
death of the payee spouse or no liability to make substitute payments after
death of payee spouse.
If there is any possibility to make a payment after the
former spouses death, then it is not considered
alimony
Alimony is determined by meeting the above listed requirements (including
71(c) and cash) not by what the agreement says it is (for instance it may not
meet the definition of alimony but the agreement may call it alimony in
such a case it wouldnt be alimony)
- (2) The term divorce or separation instrument means
o (A) a decree of divorce or separate maintenance or a written instrument to
such a decree,
o (B) a written separation agreement, or
o (C) a decree (not described in paragraph A) requiring spouse to make
payments for the support or maintenance of the other spouse
Code 71(c) Payments to Support the Children
- (1) Subsection (a) shall not include payments or portions of any payment which the
terms of the divorce or separation instrument fix as a sum which is payable for the
support of children of the payors spouse.
o Child support payments are neither considered gross income
by the payee, nor are they deductible by the payors spouse
Reg 1.7101T(b)(A-15)
o Ex. If payor is required to pay $35K to divorced payee
spouse, and after payees death continue to pay $15K to

Income Tax Treatment: Separation and Divorce Property Settlements


Text, pp. 205-208
Code: 1041(a)-(c); Regs. 1.1041-1T, Q6-9

Code 1041(a) Transfers of Property b/t Spouses or Incident to Divorce


- No gain or loss shall be recognized on a transfer of property from an individual to:
- 1. a spouse; or
- 2. a former spouse, but only if the transfer is incident to the divorce
- Gains can still be realized, just not recognized in these situations
- Policy reason: the code in many places recognizes husband and
wife as a single entity
Code 1041(b) Transfer Treated as a Gift, Transferee Has Transferors Basis
- In any transfer of property described in section (a), for the purposes of this subtitle
should be treated as a gift, and
- The basis of the transferee in the property shall be the adjusted basis of the transferor.
Code 1041(c) Incident to Divorce
- (c) for purposes of subsection (a)(2), a transfer of property is incident to the divorce
if such transfer o (1) occurs w/in 1 year after the date on which the marriage ceases, or
If its w/in 1 year it does NOT have to be pursuant to
the divorce decree
o (2) is related to the cessation of the marriage
Cessation of the marriage defined in Regs: 1.10411T(b) A-7
To be related to the Cessation of marriag it must
be:
o Inside a 6 year period; and
o Pursuant to the divorce decree.
o If its not w/in the divorce decree or inside
the 6 years it is a rebuttable presumption
that it is not related to the cessation of
marriage.
Regs: 1.1041-1T(b) Treatment of transfer of property b/t spouses or incident
to divorce
- What is property related to the cessation of the marriage?
- A-7 To be related to the cessation of marriage the transfer must
o 1. be pursuant to a divorce or separation instrument as defined by 71(b)(2),
AND
o 2. the transfer must occur not more than 6 years after the date on which the
marriage ceases.
If its unrelated to the divorce decree or outside of the 6 year period there
is a rebuttable presumption that it is not related to the cessation of marriage.
PROBLEMS
P. 209, Q1
(a)
Pursuant to 1041(a), the transfer from Michael to Lisa Marie is considered incident to
divorce pursuant to 1041(c) because it occurred within 1 year of the date of the marriage
ceasing
Michael = no tax consequences
1041(a) pursuant to the divorce decree, Lisa Marie would not have any recognized gain on

Income Tax Treatment: Separation and Divorce Child Support


Text, pp. 209-210
Code: 71(c)
Code 71(c) Payments to Support the Children
- (1) Subsection (a) shall not include payments or portions of any payment which the
terms of the divorce or separation instrument fix as a sum which is payable for the
support of children of the payors spouse.
o Child support payments are neither considered gross income
by the payee, nor are they deductible by the payors spouse
Reg 1.7101T(b)(A-15)
o Ex. If payor is required to pay $35K to divorced payee
spouse, and after payees death continue to pay $15K to
payees children, then only $20k of the initial $35K may be
counted as alimony.
Child Support
- Child support is not deductible by the parent paying the child support nor is it
considered gross income by the spouse receiving it.
- Congress later stated that any amount specified in an instrument will be reduced on a
child attaining a specified age, marrying, dying, leaving school, or upon a similar
contingency, or at a time which can clearly be associated w/ such contingency, such
amount will be treated as child support.
PROBLEMS
P. 211, Q1
(a)
Under 71(c), child support payments are not considered alimony and therefore are not
includible as GI under 71(a), nor deductible under 215(a)
Therefore, the $4k expressly supporting the child is not alimony
As to the other $6k, likely alimony, but need more facts
(b)
Under 71(c), child support payments are not considered alimony and therefore are not
includible as GI under 71(a), nor deductible under 215(a)
Further, 71(c)(2) provides that contingency payments based on the child attaining a certain
age are considered fixed payments for child support
Here, $4k which ends on child turning 21, will be considered child support
Need more facts about the other $6k

Assignment of Income
Text, pp. 240-272
Code:

Code 1 Tax Imposed


Code 1(a) Married Individuals Filing Joint Returns and Surviving Spouses
- There is hereby imposed on the taxable income of
o (1) every married individual (as defined in section 7703) who makes a single
return jointly w/ his spouse under 6013, and
o (2) every surviving spouse (as defined in 2(a)),
- A tax determined in accordance w/ the following table:
- See p. 1 in Code book for Table
Code 1(b) Head of Households
- There is hereby imposed on the taxable income of every head of a household (as
defined in 2(b)) a tax determined in accordance w/ the following table:
- See p. 1 in Code book for Table
Code 1(c) Unmarried Individuals (other than surviving spouses and head of
households).
- There is hereby imposed on the taxable income of every individual (other than a
surviving spouse as defined in section 2(a) or the head of a household as defined in
2(b) who is not a married individual (as defined in 7703) a tax determined in
accordance w/ the following table:
Code 1(d) Married Individuals Filing Separate Returns
- There is hereby imposed on the taxable income of every married individual (as
defined in 7703) who does not make a single return jointly w/ his spouse under
6013, a tax determined in accordance w/ the following table:
Code 1(e) Estates and Trusts
- There is hereby imposed on the taxable income of
o (1) every estate, and
o (2) every trust,
- Taxable under this subsection a tax determined in accordance w/ the following table.
Code 6013(a) Joint Returns of Income by Husband and Wife
- (a) a husband and wife may make a single return jointly of income taxes under
subtitle A, even though one of the spouses has neither gross income nor deductions,
except as provided below:
o (1) no joint return shall be made if either the husband or wife at any time
during the taxable year is a nonresident alien;
o (2) No joint return shall be made if the husband and wife have different
taxable years;
Except that if such taxable years begins on the same day and end on
different days b/c of the death of either or both, then the joint return
may be made w/ respect to the taxable year of each
The above exception shall not apply if the surviving spouse
remarries b/f the close of his taxable year, nor if the taxable year of
either spouse is a fractional part of a year under 443(a)(1)
o (3) in the case of death of one spouse or both spouses the joint return w/
respect to the decedent may be made only by his executor or administrator
Except that in the case of the death of one spouse the joint return
may be made by the surviving spouse w/ respect to both himself and
the decedent if no return for the taxable year had been made by the
decedent, no executor or decedent has been appointed, and no
executor or administrator is appointed b/f the last day prescribed by
law for filing the return of the surviving spouse.

Assignment of Income:
- Everything is a judgment by the court, there is no statute
- We have a tax system that has a graduated rate scale:
o The higher the income the higher the tax rate
- Assignment of income comes into play when people in higher tax
brackets attempt to assign their income to people at lower tax.
o It would be beneficial for a parent to transfer to their children
money b/c the child would likely have a lower tax rate.
o This doesnt always work.
Example: Kiddie tax
Kiddie Tax if a kid is under 18 they are taxed at their
parents rate.
Fruit and Tree Doctrine
- Mom owns a tree and the apples are the income
- You can transfer the apples to the kid, but you cant transfer the
apple income unless you transfer the whole tree.
- The income is associated w/ the tree and the only way to transfer
the income to the kid is to transfer the source of the income
- You could transfer half the tree and then half the income would go
to the kid.
- Income in this sense is Gross Income that is taxable.
Reading Notes on Assignment of Income:
- Tax is imposed on taxable income at progressive rates under which increasing
rates are applicable to additional increments of taxable income
- Progressive rates provide incentive to fragment income
o Taxpayer in a high bracket can transfer some income to another individual in
a lower bracket
- Congress has attempted to limit the fragmenting of income to some degree
o For instance theyve enacted a kiddie tax which states a child 18 years and
under is generally taxed on almost all of her unearned income at her parents
rate, nullifying the tax advantage by assignment of income to such minors.
- 73 provides that amounts received in respect of the services of a child shall be
included in his (the childs) gross income.
o This is also favorable to taxpayers b/c it doesnt say who gets to keep the
money only who is taxed upon the money.
o This would trump any state law that says a minor child could be taxed to the
parents as the parents, for federal income tax purposes.

Lucas v. Earl
- A man only paid taxes on half of the money he earned as an attorney
- His reasoning was that he and his wife entered a contract whereby everything they
possessed, earned, owned, etc. was to be held in joint tenancy and this meant they
shared everything equally
- The mans argument was that half of the money he earned was his and half was his
wifes, therefore he felt he should only have to pay half the taxes.
- The ct. disagreed and ruled that the tax statute allowed for the taxing of statutes to
those who earned them and provided that the tax could not be escaped by anticipatory
arrangement and Ks however skillfully devised to prevent the salary when paid from
vesting even for a second in the man who earned it.
Class Notes:
- There was no problem w/ the K here, it was valid.
- However he still gets taxed on the income b/c he cant give away
the fruit of his labor.
o He can assign the right for her to receive the money, but he cant transfer the
income to her in the sense that it is her income and that he can avoid taxes on
it (he will still be taxed on it)
****
Commissioner v. Giannini
- The taxpayer was the president and director of Bancitaly Corp. in CA
- In 1925 he accepted his salary (which was 5% of the net profits) from January to July
and it equaled $445K.
- He then however refused to accept his profits for the remainder of the year which
totaled $1.5 million
- Instead he suggested that something worthwhile be done with the money.
- The company made a $1.5 million dollar donation to University of CA Regents in the
taxpayers name (the profits from the year didnt quite add up to $1.5 million so the
taxpayer contributed the remaining $142K on his own).
- The commissioner argues that one half of the $1.357 million should have been
reported by the taxpayer and the other half reported by his wife since they filed
separately
- Commissioners argument:
o The actual receipt of money or property is not always necessary to constitute
taxable income; that it is the realization of taxable income rather than
actual receipt which gives rise to the tax
o A taxpayer realizes income when he directs the disposition thereof in a
manner so that it reaches the object of his bounty
- Question:
o Does the taxpayers unqualified refusal not to take income remove the
burden of the taxpayer to pay taxes?
- The taxpayer argues that his refusal to take the property is a renunciation of the
proffered property w/out a transfer of such right to another.
- The Ct. sided w/ the taxpayer:
- They say the facts show that b/c the taxpayer never received the
money, and that he did not direct is disposition it could not be
considered compensation.
o He did not direct where the compensation go, he simply refused to accept it.
Hold:

Individuals Deduction
Adjusted Gross Income (AGI)
Moving Expenses Above-the-line ( 62) Deduction
Standard Deduction
Text, pp. 471-473, 540-542, 543-547, 566-569
Code: 262(a); 62, 1.62-2(c)(4); 217(a)-(c), 132(g); 63

GI - 62 Deductions = AGI
AGI Personal Exemptions ( 151, 152) (Either Standard
Deductions or Itemized Deductions) = 63(e)) = Taxable Income
Taxable Income x Rate = Tax Liabilities
Tax Liabilities Credits = Tax Due (Refund)
Standard Deduction ( 63)
o Fixed Amount
Fixed amount depends on Filing Status (c)(2) 2
Head of Household term of art defined under
2
Surviving Spouse not every surviving spouse is
a surviving spouse for tax purposes
Aged or Blind or both will add to the standard
deduction 63(c)(3)
Dependent (defined in 152) There is also an
exception to the amount of the standard deduction if
taxpayer is dependent of another taxpayer. 63(c)(5)
Exceptions wont get into for this class
Itemized Deductions 63(d)
o Cannot be:
Deductions under 62 (above the line)
Interest 163
Taxes 164
Casualty and Loss 165
Charitable 170
Medical 213
Only amount over 7.5% over AGI may be
deductible thats why its called Extraordinary
Medical Expenses
Misc. ____
The total of misc. itemized deductions must
exceed 2% of AGI per 67(a)
o You can only deduct the amount over 2%
of the AGI
If AGI is 100k and you have 2.5k
you can only deduct $500.

Sections 62 or 63 dont tell you whether or not or why something is deducted,


it tells you where something is deducted.
- Is it deducted above the line (62) or below the line (63)
Start w/ the authority for deduction (for example if it were moving expenses it
would be 217).
- Then you go to 62
- If its not 62 you go to 63
- Then you see if its miscellaneous or not
o 67(b) is a list of itemized deductions

Adjusted Gross Income


Code 62(a) Adjusted Gross Income
- (a) For purposes of this subtitle, the term adjusted gross income means, in the case
of an individual, gross income minus the following deductions:
o The below list is not why you get to deduct things, it where
you get to deduct these things.
o (1) Trade and Business Deductions the deductions allowed by this chapter
which are attributable to a trade or business carried on by the taxpayer, if
such trade or business does not consist of the performance of services by the
taxpayer as employee.
Deductions will be below the line for an employee who
incurs expenses related to his employment
If the employer would have reimbursed those
expenses they would have been deducted above the
line per 62(a)(2)
As below the line they will be Misc. Itemized
deductions.
Only if you are your own employer does this section
allow you to make business expenses above the line
o (2) Certain Trade and Business Deductions of employees
(A) Reimbursed Expenses of employees The deductions allowed
by part VI ( 161) which consist of expenses paid or incurred by the
taxpayer, in connection w/ the performance by him of services as an
employee, under a reimbursement agreement w/ his employer.
If its a reimbursement from your employer it
would be above the line. However if your
employer paid you the reimbursement must be
tabulated under Gross Income, therefore its a
wash.
(B) Certain Expenses of Performing Artists The deductions
allowed by 162 which consist of expenses paid or incurred by a
qualified performing artist in connection w/ the performances by him
of services in the performing arts as an EE.
(C) Certain Expenses of Officials The deductions allowed by 162
which consist of expenses paid or incurred w/ respect to services
performed by an official as an EE of a State or a political subdivision
or a political subdivision thereof in a position compensated in whole
or in part on a fee basis
(D) Certain Expenses of Elementary and Secondary School Teachers
The deductions of 162 which may not exceed 250 paid
for school supplies (see statute for list)
(E) Certain Expenses of Members of Reserve Components of the
Armed Forces of the U.S.
o (3) Losses from Sale or Exchange of Property The deductions allowed by
VI ( 161 and following) as losses from the sale or exchange of property.
o (4) Deductions Attributable to Rents and Royalties
o (5) Certain Deductions of Life Tenants and Income Beneficiaries of Property
In the case of a life tenant of property, or an income beneficiary of property
held in trust, or an heir, legatee, or devisee of an estate, the deduction for

MOVING EXPENSES

Code 82 Reimbursement of Moving Expenses


- Except as provided in 132(a)(6), there shall be included in Gross Income (as
compensation for services) any amount received or accrued, directly or indirectly, by
an individual as a payment for or reimbursement of expenses of moving from one
residence to another residence which is attributable to employment of self
employment
o Reimbursements Since the moving expense deduction is an
above the line deduction, any reimbursement of deductible
moving expenses would result in both an inclusion in and a
deduction from gross income when calculating AGI, thus
resulting in a wash for tax calculating reporting purposes.
Code 132(a)(6) Moving Expense as a Fringe Benefit
- Gross Income shall NOT include any fringe benefit which qualifies as a qualified
moving expense reimbursement
Code 132(g) Qualified Moving Expense Reimbursement
- For purposes of this section, the term qualified moving expense reimbursement
means any amount received (directly or indirectly) by an individual from an
Employer as a payment for (or reimbursement of) expenses which would be
deductible as moving expenses under 217 if directly paid or incurred by the
individual.
Code 217(a) Moving Expenses (Above the line 62(a)(15))
- (a) There shall be allowed as a deduction moving expenses paid or incurred during
the taxable year in connection w/ the commencement of work by the taxpayer as an
employee or as a self employed individual at a new principal place of work.
Code 217(b) Defining Moving Expenses
- (1) For the purposes of this section the term moving expenses means only the
reasonable expenses
o (A) of moving household goods and personal effects from the former
residence to the new residence, and
o (B) of traveling (including lodging) from the former residence to the new
place of residence (Such term shall not include any expenses for meals)
- (2) In the case of any individual other than the taxpayer, expenses referred to in
paragraph (1) shall be taken into account only if such individual has both the former
residence and the new residence as his principal place of abode and is a member of
the taxpayers family and the new residence as his principal place of abode and is a
member of the taxpayers household
o In own words the deduction for moving expenses will apply to
any other individual if such individual has both the former
residence and new residence as his principal place of abode
AND is a member of the taxpayers household.
Code 217(c) Conditions for Allowance
- (c) No deduction shall be allowed under this section unless
o (1) The taxpayers new principal place of work
(A) Is 50 miles farther from his former residence than was his former
principal place of work, or (Read Carefully)

STANDARD DEDUCTION VS. ITEMIZED DEDUCTIONS

Code 63(a) Taxable Income Defined


- (a) Except as provided in subsection (b), for purposes of this subtitle, the term
taxable income means gross income minus the deductions allowed by this chapter
(other than the standard deduction)
Code 63(b) Individuals who do NOT Itemize their Deductions
- In the case of a person that does not elect to itemize his deductions for the taxable
year, for purposes of this subtitle, the term taxable income means adjusted gross
income, minus
o (1) the standard deduction, and
o (2) the deduction for personal exemptions provided in 151.
Code 63(c) Standard Deduction
- (1) Except as provided in this subsection, the term standard deduction means the sum
of
o (A) the basic standard deduction, and
o (B) the additional standard deduction
- (2) The basic standard deduction is
- (3) Additional Standard Deduction for Aged and Blind
- (4) Adjustments for Inflation
- (5) Limitation on Basic Standard Deduction in the case of Certain Dependents
o If a taxpayer is listed as a dependent for another taxpayer, the basic standard
deduction applicable to such individual for such individuals taxable year
shall not exceed the greater of
(A) $850, or
(B) the sum of $300 and such individuals earned income
Earned income is money you actually earned,
its distinguished from passive income such as
interest.
o For exact values see CPI index on p. xi
o This section sets a limit on what a dependent can deduct as a
standard deduction
However this section 63(c) is still subject to the limits
imposed in 63(c)
(6) Certain Individuals, not Eligible for Standard Deduction
Code 63(d) Itemized Deductions
- For purposes of this subtitle, the term itemized deductions means the deduction
allowable under this chapter other than
o (1) the deductions allowable in arriving at adjusted gross income
o (2) the deduction for personal exemptions provided by 151
Code 63(e) Election to Itemize
- (1) In General unless an individual makes an election under this subsection for the
taxable year, no itemized deduction shall be allowed for the taxable year.
- (2) Any election under this subsection shall be made on the taxpayers return.
- (3) Change Election
- This means the standard deduction automatically applies to a
taxpayer unless the taxpayer elects on her tax return to itemize her

STANDARD DEDUCTION
Problem Sheet
1. Standard Deduction = $10,900 (greater than itemized)
2. Itemized deductions = $15,000 (greater than standard)
3. Itemized, unless head of household
4. Standard deduction = $5450
5. Standard deduction ($5450) + additional for aged and unmarried ($1350) = $6800 (greater
than itemized)
6. Itemized deduction ($15,000) is greater than standard ($10,900) + additional ($3150) =
$14050
7. $900 standard deduction
8. $300 + EI ($1000) = $1300
9. $300 + EI ($7000) = $7300

Extraordinary Medical Expenses


Text, pp. 548-558
Code: 213(a)-(c)(1), (d)(1), (9); Reg. 1.213-1(e)

Code 213(a) Medical, Dental, Etc. Expenses (Below the Line Deductions)
- (a) There shall be allowed as a deduction the expenses paid during the taxable year,
not compensated for by insurance or otherwise, for medical care of the taxpayer,
his spouse, or a dependent, to the extent that such expenses exceed 7.5%
- Requirements:
o 1. Must be paid,
o 2. Insurance cant pay for it
o 3. For taxpayer, spouse, or a dependent
o 4. Only the dollar amount over 7.5% of AGI can be deducted
- Things this includes for deductions
o Glasses, braces, enzyme solutions for soaking contacts,
seeing eye dog, chiropractor, modifications to your home
medical reasons (person in a wheel chair), mental health
disease (213(d)), acupuncture, artificial teeth, motorized
wheel chair, changes to automobiles, guide dogs, long term
care, smoking cessation programs, rehab centers, nursing
homes (the nursing home will give you a statement showing
what portion is for the medical bills), fertility treatments, self
employed individuals paying own health insurance
NOTE: all deductions must be reasonable.
Code 213(b) Limitation w/ Respect to Medicine and Drugs
- An amount paid during the taxable year for medicine or a drug shall be taken into
account under subsection (a) only if such medicine or drug is prescribed or is
insulin
Code 213(d) Definitions (See Text)
- (1) The term medical care means amounts paid
o (A) For the diagnosis, cure, mitigation, treatment, or prevention of disease, or
for the purpose of affecting any structure or function of the body
Interpreted very broadly, see p. 553
o (B) For transportation primarily for and essential to medical care referred to
in subparagraph (A)
o (C) For qualified long-term services
o (D) For insurance covering medical care referred to in subparagraphs (A) and
(B) or for any qualified long term care insurance K
- (2) Amounts paid for lodging (not lavish or extravagant under the circumstances)
while away from home primarily for and essential to medical care referred to in
paragraph (1)(A) shall be treated as amounts paid for medical care if:
o (A) The medical care referred to in paragraph (1)(A) is provided by a
physician in a licensed hospital (or in a medical care facility which is related
to, or the equivalent of, a licensed hospital), and
o (B) There is no significant element of personal pleasure, recreation, or
vacation in the travel away from home.
- The amount taken into account under the preceding sentence shall not exceed $50 for
each night for each individual.
- (3) Prescription Drug The term prescribed drug means a drug or biological which
requires a prescription of physician for its use by an individual.
o Must be w/ in the US

Charitable Contributions
Text, pp. 790-801; 786-789
Code: 170(a)(1), (c), (e)(1), (5)

Code 170(a) Charitable Contributions and Gifts Allowance of Deduction


- (1) There shall be allowed as a deduction any charitable contribution (as defined in
subsection c) payment of which is made w/in the taxable year. A charitable
contribution shall be allowable as a deduction only if verified under regulations
prescribed by the Secretary
Class Notes:
- Charitable contributions are not miscellaneous and are not subject
to the 2% floor
- Requirements
o 1. Must be the proper type of organization under the statute
o 2. It must be a gift; no quid pro quo
The charitable deduction is only the part that is a true
gift that you are not getting something back in return
Ex. If you pay $100 to a charity and get to run in a
race; the only part that is a charitable donation is the
amount above the value of the race (what you got in
return).
Any org. that takes contributions must give a receipt
that says what you got in return
o 3. Amount of Gift
Generally get FMV deduction of a charitable gift
Ex. If you give $100 and get nothing in return the
value of your gift is $100
Ex. You buy a share of stock for $10 and you sell it for
$100 you have a $90 gain (Generally get FMV
deduction of a charitable gift)
If you gave that stock directly to a charity before
selling it then your deduction is the FMV of the
property
Essentially if you give property you avoid all
taxation on the gain.
o There are a lot of exceptions to this but
we wont get into all this ( 170(e))
Exceptions 1
o It depends on whether it is ordinary
income or a capital gain
o The statute says you dont get to take
FMV (you take basis) if the income you
recognize if you would have sold it would
have been ordinary
Exception 2
o If you give tangible personal property (not
realty)
Tangible property is you can feel it
or touch it
Intangible property is like a bank
account, stock, or patent
o If you give tangible personal property to a

Interest
Text, pp. 474-476, 491-498
Code: 163(a), (h), (d)(1)-(3)

Code 163(a) Interest General Rule


- There shall be allowed as a deduction all interest paid or accrued w/in the taxable
year on indebtedness.
o 163(h) limits the deduction under 163(a)
Code 163(h) Disallowance of Deduction for Personal Interest
- (1) In the case of a taxpayer other than a corporation, no deduction shall be allowed
under this chapter for personal interest paid or accrued during the taxable year.
- (2) Personal Interest means any interest allowable as a deduction under this chapter
other than (This section shows whats actually deductible)
o (A) Interest paid or accrued on indebtedness properly allocable to a trade or
business (self business)
Ex. Mom or Pops Grocery Store (their interest paid on
debt will be deductible)
o (B) Any investment interest (w/in the meaning of subsection (d))
Interest incurred on debt used for investment.
Ex. You want to invest in some stocks, you want
to invest in stocks and you take out a loan to do
so. The interest on that debt is deductible.
Investment interest is only deductible to extent that
there is investment income
Ex. You take out a 100k to buy land (as an
investment) the interest on debt is not
deductible b/c it does not earn you income
If you had a 100k loan to buy stock and the
stock produced a 50k dividend, you could
deduct up to $50K b/c that is the extent that
there is investment income
o C. Any interest which is taken into account under 469 in computing income
or loss from a passive activity of the taxpayer
Will not talk about this, for the purposes of this class.
o D. Any qualified residence interest (w/in meaning of paragraph 3)
See the problems below for this section.
o E. Any interest payable under section 6601 on any unpaid portion of the tax
imposed by 2001 for the period during which an extenstion of time for
payment of such tax is in eefect under section 6163
o F. Any interest allowable as a deduction under 221 (relating to interest on
educational loans)
We will talk about this when we talk about deductions
for higher education
- (3) Qualified Residence Interest
o (A) The term qualified resident interest means any interest which is paid or
accrued during the taxable year on
(i) Acquisition indebtedness w/ respect to any qualified residence of
the taxpayer, or
(ii) Home equity indebtedness w/ respect to any qualified residence
of the taxpayer
o (B) Acquisition of Indebtedness
(i) Acquisition indebtedness means any indebtedness which

Taxes
Text, pp.
Code: 164(a), (b), (d)(1)

Code 164(a) Taxes (Below the Line Itemized Deduction)


- (a) Except as otherwise provided in this section, the following taxes shall be allowed
as a deduction for the taxable year w/in which paid or accrued:
o (1) State and local, and foreign, real property taxes
o (2) State and local personal property taxes
o (3) State and local, and foreign, income, war profits, and excess profits taxes
o (4) The GST tax imposed on income distributions
o (5) The environment tax imposed by section 59A
Code 164(b) Definitions and Special Rules
- (1) Personal Property Taxes The term personal property tax means an ad valorem
tax which is imposed on an annual basis in respect of personal property
- (2) State or Local Taxes A State or local tax includes on a tax imposed by a State, a
possession of the U.S., or a political subdivision of any of the foregoing, or by the
District of Columbia
- (3) Foreign Taxes A foreign tax includes only a tax imposed by the authority of a
foreign country
- (4) Special Rules for GST Tax-
- This section contains much more, see IRC text as necessary
Code 164(d) Apportionment of Taxes on Real Property B/t Seller and
Purchaser
- For purposes of subsection (a), if real property is sold during any real property tax
year, then
o (A) so much of the real property tax as is properly allocable to that part of
such year which ends on the day b/f the date of the sale shall be treated as a
tax imposed on the seller, and
o (B) so much of such tax as is property allocable to that part of such year
which begins on the date of the sale shall be treated as a tax imposed on the
purchaser.
The only taxes that are deductble are:
- Real property taxes 164(a)(1)
- State or local income tax 164(a)(3)
- Sales Tax 164(b)(5)
o Here the taxpayer must choose b/t state income tax and sales taxes to be
deductible, but not both
o This was brought about by people in states that dont have state income
taxes.
PROBLEMS
P. 503, Q1
(a)
To be deductible, the taxpayer must choose between deducting such a sales tax or deducting
state or local income tax - 164(b)(5)
(b)
164(a)(1) allows deduction for state and local real property taxes
164(d) apportions property tax deductions between seller and buyer
Seller may deduct for part of year when he owned ppy, Buyer may deduct for part of year
when he owned ppy
Even if you are not paying the taxes, you get a deduction for the proportion of time you owned
(c)
164(a)(3) allows this deduction

Floor on Miscellaneous Itemized Deductions


Text, pp.
Code: 67(a) & (b); Reg. 1.67-1T(a)

67. 2-percent floor on miscellaneous itemized deductions.


(a) General rule. In the case of an individual, the miscellaneous itemized deductions for any
taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2
percent of adjusted gross income.
(b) Miscellaneous itemized deductions. For purposes of this section, the term "miscellaneous
itemized deductions" means the itemized deductions other than-(1) the deduction under section 163 [IRC Sec. 163] (relating to interest),
(2) the deduction under section 164 [IRC Sec. 164] (relating to taxes),
(3) the deduction under section 165(a) [IRC Sec. 165(a)] for casualty or theft losses described
in paragraph (2) or (3) of section 165(c) [IRC Sec. 165(c)] or for losses described in section
165(d) [IRC Sec. 165(d)],
(4) the deductions under section 170 [IRC Sec. 170] (relating to charitable, etc., contributions
and gifts) and section 642(c) [IRC Sec. 642(c)] (relating to deduction for amounts paid or
permanently set aside for a charitable purpose),
(5) the deduction under section 213 [IRC Sec. 213] (relating to medical, dental, etc., expenses),
(6) any deduction allowable for impairment-related work expenses,
(7) the deduction under section 691(c) [IRC Sec. 691(c)] (relating to deduction for estate tax in
case of income in respect of the decedent),
(8) any deduction allowable in connection with personal property used in a short sale,
(9) the deduction under section 1341 [IRC Sec. 1341] (relating to computation of tax where
taxpayer restores substantial amount held under claim of right),
(10) the deduction under section 72(b)(3) [IRC Sec. 72(b)(3)] (relating to deduction where
annuity payments cease before investment recovered),
(11) the deduction under section 171 [IRC Sec. 171] (relating to deduction for amortizable bond
premium), and
(12) the deduction under section 216 [IRC Sec. 216] (relating to deductions in connection with
cooperative housing corporations).
1.67-1T 2-percent floor on miscellaneous itemized deductions (temporary).
(a) Type of expenses subject to the floor--(1) In general. With respect to individuals, section 67
[26 USCS 67] disallows deductions for miscellaneous itemized deductions (as defined in
paragraph (b) of this section) in computing taxable income (i.e., so-called "below-the-line"
deductions) to the extent that such otherwise allowable deductions do not exceed 2 percent of the
individual's adjusted gross income (as defined in section 62 [26 USCS 62] and the regulations
thereunder). Examples of expenses that, if otherwise deductible, are subject to the 2-percent floor
include but are not limited to-(i) Unreimbursed employee expenses, such as expenses for transportation, travel fares and
lodging while away from home, business meals and entertainment, continuing education courses,
subscriptions to professional journals, union or professional dues, professional uniforms, job
hunting, and the business use of the employee's home.
(ii) Expenses for the production or collection of income for which a deduction is otherwise
allowable under section 212 (1) and (2) [26 USCS 212 (1) and (2)], such as investment advisory
fees, subscriptions to investment advisory publications, certain attorneys' fees, and the cost of
safe deposit boxes,
(iii) Expenses for the determination of any tax for which a deduction is otherwise allowable under
section 212(3) [26 USCS 212(3)], such as tax counsel fees and appraisal fees, and

Retirement
Text, pp.
Code: 219(a), (e)
219. Retirement savings [Caution: See prospective amendment note below.].
(a) Allowance of deduction. In the case of an individual, there shall be allowed as a deduction an
amount equal to the qualified retirement contributions of the individual for the taxable year.
(e) Qualified retirement contribution. For purposes of this section, the term "qualified retirement
contribution" means-(1) any amount paid in cash for the taxable year by or on behalf of an individual to an
individual retirement plan for such individual's benefit, and
(2) any amount contributed on behalf of any individual to a plan described in section 501(c)(18)
[IRC Sec. 501(c)(18)].

Personal/Dependency Exemptions
Text, pp. 561-565
Code: 151(a)-(d)(1), (4)(A), 152; Reg. 1.151-1(b)
Personal Exemption Overview:
- Every person as a resident of the U.S. has a personal exemption.
o This doesnt mean you only get one exemption
o You also get them for dependents
- If an individual files a joint return they get 2 personal exemptions
for everyone on the list.

Personal and Dependency Exemptions


Code 151(a) Allowance of Deductions for Personal Exemptions
- In the case of an individual, the exemption provided by this section shall be as
deductions in computing taxable income.
Code 151(b) Taxpayer and Spouse
- An exemption of the exemption amount for the taxpayer; and an additional
exemption of the exemption amount for the spouse of the taxpayer if a joint return is
not made by the taxpayer and his spouse, and if the spouse, for the calendar year in
which the taxable year of the taxpayer begins, has no gross income and is not the
dependent of another taxpayer
- If there is no joint return and the spouse has no GI then you get 2
PEs
- If there is no joint return and the spouse has GI, then each will take
their PE on their separate returns
- If they file a joint return b/c there are two taxpayers filing that
return, they get 2 PEs b/c they are filing together.
Code 151(c) Additional Exemption for Dependents
- An exemption of the exemption amount for each individual who is a dependent (as
defined in 152) of the taxpayer for the taxable year.
- Defined in 152(d)
Code 151(d) Exemption Amount
- (d) for purposes of this section negotiations
o (1) In General Except as otherwise provided in this subsection, the term
exemption amount means $3,400 (INFLATION ADJUSTED).
o (2) Exemption Amount Disallowed in Case of Certain Dependents - In the
case of an individual w/ respect to whom a deduction under this section is
allowable to another taxpayer for a taxable year beginning in the calendar
year in which the individuals taxable year begins, the exemption amount
applicable to such individual for such individuals taxable year shall be zero
o (3) Phaseout OMITTED
o (4) Inflation Adjustment
(A) Adjustment to Basic Amount of Exemption
(B) Adjustment to Threshold Amounts for years After 1991
Code 152(a) Dependent Defined
- For purposes of this subtitle, the term dependent means
o (1) a qualifying child, or
o (2) qualifying relative.
Code 152(b) Exceptions
- (b) for purposes of this section o (1) If you are the dependent of a taxpayer, you may not claim any dependents
(does this include receiving a Personal Exemption for
themselves - no)
o (2) An individual shall not be treated as a dependent if they are married file
jointly w/ their spouse in the same taxable year.
o (3) Citizens or Nationals of Other Countries

Higher Education
Text, pp. 225-232
Code: 25A, 127(a), (b)(1)-(2), (c)(1)
Notes:

Understand distinction b/t deduction and credit


A deduction will reduce you GI, its reducing your tax base.
A tax credit is a dollar for dollar reduction of tax.
After youve computed the amount of tax due, the credit reduces
that amount dollar for dollar
o Ex. If we have $100K of tax income and a 25% tax rate then
we would owe $25K in taxes. Therefore if we had a $20K tax
credit we would only pay $5K in taxes
If they are the same amount you should want a credit over the
deduction
You can calculate your tax savings by taking the deduction times
the tax rate
To compare your deduction or a credit, compare the tax savings
versus the credit
If you have a 20K deduction and a 25% tax rate or the possibility of
receiving a $7K tax credit then it would be better to take the 7K
credit

Exclusions for Higher Education Costs


- Which would you rather have a 222 deduction or 25A tax credit
- Make sure youre asking yourself this.
Code 25A(a) Hope and Lifetime Learning Credits
- (a) In the case of an individual, there shall be allowed as a credit against the tax
imposed by this chapter for the taxable year the amount equal to the sum of
o (1) the Hope Scholarship Credit, plus
o (2) the Lifetime Learning Credit
This was enacted under President Clintons administration that everyone
should be able to go to college.
- If an individual is eligible for the Hope Credit the Gov. is giving them
$1500 to go to school ($2000 for the Lifetime learning Credit)
Code 25A(b) Hope Scholarship Credit
- (1) the Hope Scholarship Credit is an amount equal to the sum of
o (A) 100% of so much of the qualified tuition and related expenses paid by
the taxpayer during the taxable year (for education furnished to the eligible
student during any academic period beginning in such taxable year) as does
not exceed $1100 (inflation adjusted), plus
o (B) 50% of such expenses so paid as exceeds $1,000 but does not exceed the
applicable limit
Applicable limit is 2 times the dollar amount under
paragraph 1A.
You get 150% of $1,100
- (2) Limitations Applicable to the Hope Scholarship Credit
o (A) Credit Allowed Only For 2 Taxable Years You can only apply the Hope
Scholarship Credit if you have not made an election for any 2 prior years
o (B) Credit Allowed For Year Only if Individual is at Least Time Student
For Portion of Year Hope Scholarship credit does not apply unless an
individual is an eligible student for at least one academic period which
begins during such year.
o (C) Credit allowed only for First 2 Years of Post Secondary Education
o (D) Denial of Credit if Student Convicted of a Felony Drug Offense
- (3) Eligible Student means any student who
o (A) meets the requirements of 484(a)(1)
o (B) is carrying at least the normal full time work load for the course of
study the student is pursuing.
Code 25A(c) Lifetime Learning Credit
- (1) The Lifetime Learning Credit for any taxpayer for any taxable year is an amount
equal to 20% of so much of the qualified tuition and related expenses paid by the
taxpayer during the taxable year (for education furnished during any academic period
beginning in such taxable year) as does not exceed $10,000 ($5,000 in the case of
taxable years beginning before January 1, 2003).
- (2) Special Rules For Determining Expenses
o (A) Coordination with the Hope Scholarship The qualified tuition and
related expenses w/ respect to an individual who is an eligible student for
whom a Hope Scholarship Credit under subsection (a)(1) is allowed for the

Code 221 Interest on Educational Loans


- (a) Allowance of Deduction In the case of an individual, there shall be allowed as a
deduction for the taxable year an amount equal to the interest paid by the taxpayer
during the taxable year on any qualified educational loan
- (b) The deductions shall not exceed $2,500 after the year 2001
- (b)(2) The amount of the deduction shall be reduced (but not below zero) by the
amount which bears the same ratio to the amount which would be so taken into
account as-:
o (B)(i) the excess of
(I ) the taxpayers modified AGI for such taxable year ove
(II) $50K ($100K in the case of a joint return), bears to
o (B)(ii) $15,000 ($30,000 in the case of a joint return
- (c) No deduction shall be allowed by this section to an individual for the taxable year
if a deduction under section 151 w/ respect to such individual is allowed to another
taxpayer for the taxable year beginning in the calendar year in which such
individuals taxable year begins

Qualified Tuition/529 Plans


Text, pp. 559-560
Code: 529(a), (b)(1)-(5), (c)(3)(b)(ii)&(v); 530(a), (b)(1); 222

Exclusions for Higher Education Costs


- Which would you rather have a 222 deduction or 25A tax credit
- Make sure youre asking yourself this

Brief Summary on Taxes w/ Education


- Tuition reduction under 222
- Hope and lifetime learning credit under 25A
Must choose b/t those three
- Exclusion in student loan interest 221
o Low ceiling
- Qualified Scholarships are excluded 117
o Cant be athletic or work related
Code 529(a) Qualified Tuition Programs
- (a) A qualified tuition program shall be exempt from taxation under this subtitle.
Notwithstanding the preceding sentence, such program shall be subject to the taxes
imposed by 511 (relating to imposition of tax on unrelated business income of
charitable orgs.)
- (b)(1) Qualified tuition program means a program established & maintained by a
State or agency or instrumentality there of
o (A) under which a person
(i) may purchase tuition credits or certificates on behalf of a
designated beneficiary which entitle the beneficiary to the waiver or
payment of qualified higher education expenses of the beneficiary, or
(ii) may make contributions to an account which is established for
the purpose of meeting the qualified education expenses of the
designated beneficiary of the account, and
o (B) which meets the other requirements of this subsection
Code 529(c) Tax Treatment of Designated Beneficiaries and Contributions
- (1) no amount shall be includible in GI of
o A. a designated beneficiary under a qualified tuition program, or
o B. a contributor to such program on behalf of a designated beneficiary
with respect to any distribution or earnings under such program.
Education Savings Account
Per 529 and 530 one may set money aside for a childs college tuition and
you will not have to pay taxes on the interest or earnings on that money, so
long as that money is used for the beneficiaries education
Code 222(a) Qualified Tuition and Related Expenses
- (a) Allowance of Deduction In the case of an individual, there shall be allowed as a
deduction an amount equal to the qualified tuition and related expenses paid by the
taxpayer during the taxable year.
Code 222(b) Dollar Limitations
- (1) The amount allowed as a deduction under subsection (a) w/ respect to the
taxpayer for any taxable year shall not exceed the applicable dollar limit
- (2) Applicable Dollar Limit

Scholarships
Text, pp. 110-112
Code: 117(a)-(c)

Any thing under 117 is an EXCLUSION


Code 117(a) Qualified Scholarships
- GI does not include any amount received as a qualified scholarship by an individual
who is a candidate for a degree at an education organization described in 170(b(1)
(A)(ii)
o See 170(b)(1)(A)(ii)
Code 117(b) Qualified Scholarships
- (b)(1) qualified scholarship means any amount received by an individual as a
scholarship or fellowship grant to the extent the individual establishes that, in
accordance w/ the conditions of the grant, such amount was used for qualified tuition
and related expenses
- (2) qualified tuition and related expenses means
o (A) tuition and fees required for the enrollment or attendance of a student at
an education org. described in 170(b(1)(A)(ii), and
o (B) fees, books, supplies, and equipment required for courses of instruction
at such and educational org.
In order to be treated as related expenses under this
section, the fees, books, supplies, and equipment must
be required of all students in the particular course of
instruction - 1.117(c)(2)(ii)
Code 117(c) Limitation
- (c)(1) Except as provide in paragraph 2, subsections (a) and (d) shall not apply to that
portion of any amount received which represents payment for teaching research, or
other services by the student required as a condition for receiving the qualified
scholarship or qualified tuition reduction
- If youre required to do research as part of your scholarship youre
not allowed to deduct that portion from any amount received
PROBLEMS
P. 112, Q1
(a)
Per 117(b)(2)(B), scholarship funds may be excluded from GI if they are used for tuition and
fees, books, supplies, and equipment required for courses thus, any scholarship funds received
allocable to room and board is not excludable
Reduces excludable amount from $15k to $10k
117(c)(1) further provides that any scholarship funds allocable to work/research done as a
condition to receiving the scholarship, must be included in Gross Income which would make
you think that an additional $3000 would be included as GI but this might have been a $3k
award allocable to room and board, not tuition
(b)
117(c) does not mention anything about other people having to work as well thus, even if
everyone has to work, any amounts you receive from that work/research must still be included as
Gross Income
(c)
The treatment of this scholarship would depend on whether or not student is required to
participate in the sport. If she is required, the scholarship would be more like compensation for
services and would be includible as Gross Income. If not required to participate, then she may be
able to exclude the full amount of the scholarship.
Q2

Computation of Tax
Text, pp. 912-923
Code: 1(a)-(e), (g)(1)-(4); 2; 63

Different Filing Statuses


o Head of Households (HH)
o Unmarried
o Married Filing Separately
This is the worst table but it keeps the taxpayer
from having to file joint and several liability.
o Married Filing Jointly
o Surviving Spouse
Know what a Marginal Tax Rate is
- Its the rate accessed to each additional dollar over a certain
amount.
Code 2(a) Definition of Surviving Spouse
- (1) For purposes of section 1, the term surviving spouse means a taxpayer
o (A) whose spouse died during either of his two taxable years immediately
preceding the taxable year, and
o (B) who maintains as his home a household which constitutes for the taxable
year the principal place of abode of a dependent (i) who is a son, stepson,
daughter, or stepdaughter of the taxpayer, and (ii) w/ respect to whom the
taxpayer is entitled to a deduction for the taxable year under 151
- An individual shall be considered as maintaining a household only if over half of the
cost of maintaining the household during the taxable year is furnished by such
individual
- (2) Limitations a taxpayer shall not be considered to be a surviving spouse
o (A) if the taxpayer has remarried at any time before the taxable year, or
o (B) unless, for the taxpayers taxable year during which his spouse died, a
joint return could have been made under the provisions of section 6013
(w/out regard to subsection (a)(3) thereof)
Surviving Spouse
(1) Spouse died in either of two preceding taxable years
(2) Principal place of abode of dependent
(3) Relationship: child or stepchild
(4) Entitled to personal exemption for the dependent
(5) Provides > support for household
Code 2(b) Definition of Head of Household
- (1) an individual shall be considered a head of household if, and only if, such
individual is not married at the close of his taxable year, is not a surviving spouse,
and either
o (A) maintains as his home a household which constitutes for more than onehalf of such taxable year the principal place of abode, as a member of such
household, of
(i) a qualifying child of the individual (per 152), but not if such
child
(I) is married at the close of the taxpayers taxable year, and
(II) is not a dependent of such individual by reason of
152(b)(2) or 152(b)(3), or both, or
(ii) any other person who is a dependent of the taxpayer, if the

Credits Against Tax


Text, pp. 923-932
Code: 21(a), (b)(1); 22(a), (b); 24(a), (b)(1), (c)(1); 26(a)(1); 31(a); 32(a), (b), (c)(1)

Credits Against Tax (For exam know basics: ex. Difference b/t refundable and nonrefundable
credit)
- The final step in computing a TPs regular tax liability is to reduce the TPs tax
liability as determined above by the amount of any tax credits allowed to the taxpayer
- A credit of a certain dollar amount is more advantageous to the taxpayer than a
deduction of the same dollar amount
o Deductions effect greater tax savings as the Tps tax rate increases
- Even if credits exceed amount of tax computed, they do not generate a refund to the
TPer
- Generally there is a ceiling on the combined credits of $25,K of the tax liability plus
75% of such liability in excess of $25K.
Personal Credits
- 21 Credit for Dependent Care Services (Non-Refundable)
o Credit is allowed for employment related expenses, that are incurred for
household services or day care of a qualifying individual if incurred to
enable the taxpayer to be gainfully employed.
o Limits amount of expense to $3K w/ a maximum of $6K
You still only get a percentage of those expenses as a credit
That percentage depends on the earned income of the taxpayer (the
max is 35% for low income people)
o Ex. You pay $3K x 20% = $600 credit
In other words the government subsidizes child care by $600 in this
case.
o Must be gainfully employed
o If youre a married couple and one is not working the credit is limited to the
lower income of the two.
So if someone isnt working they cant get this credit
There is an exception if one of the spouses is going to school, its
assumed they earn $250 a month.
- 22 Credit for the Elderly and the Permanently and Totally Disabled
o Looks like a nice credit,
o But if the individual is getting any retirement benefit or any other income
they will get over the $7,500 threshold real quick.
o Rare that this applies.
- 23 Credit for Qualified Adoption Expenses
o A maximum of $11K per eligible child credit is allowed for qualified
adoption expenses on the adoption of a child w/ special needs, a child w/
special needs
o This is a dollar for dollar credit for the adoption expenses
If its a special needs child its assumed you paid $11K whether you
did or not.
- 24 Child Tax Credit
o A credit is allowed for each qualifying child of the taxpayer
Qualifying child is a qualifying child as defined in 152(c) who is
under age 17.
o Credit of $1000 per child under the age of 17; this is in addition to the $3400
credit you get as a dependent.
o There is a phaseout, Upper middle taxpayers will not get a credit for this tax
credit

Alternative Minimum Tax


Text, pp. 932-944; Internet-reading
Code: 55(a), (b)(1)(A), (2)(d)(1)

A tax created to prevent people from avoiding tax, even though the avoidance
was proper and legal
This started b/c people began receiving all kinds of deduction
and this allowed Congress to mandate that everyone pay just
a normal tax.
The AMT is a tax at a rate of 26% or 28%, but above this a flat
rate will be applied to all your income
W/ the AMT you have to start adding back things
o You start w/ personal exemptions, deductions, and other
things as if you didnt get a deduction in those things.
o This is done to calculate your AMTI
This could cause your AMTI to go way up and your
regular income to be lots less
If you AMTI is more than your regular tax you will
have to pay taxes on it as well.
B/c people are caught in the AMT trap b/c people are having
to pay it who were never intended to do so
o Its more people today b/c today many more people
have deductions of all kinds of things that didnt used to
be a deduction.
Congress is trying to figure out a way to eliminate it, but if
they did they will be forgoing billions of dollars in revenue.
Taxes were initially thought to have people act in a certain way, the AMT
completely gets in the way of this.
How do you realize when AMT applies?
o You have to fill out another form.
For exam simply have a feel for what AMT is about
o Its a tax above what the regular tax would be
o Its computed by adding back certain deductions and
applying a tax rate to that.

Klaassen v. Commissioner
- The Klaassens claimed 12 exemptions on their tax return (10 kids plus 2 PEs)
- They did not report any liability for the AMT
- The respondent issued a notice of deficiency, but did not disallow any of the
deductions or exemptions claimed by petitioners on their Form 1040
- Rather the commissioner determined that petitioners are liable for the AMT
prescribed by 55
- 55 imposes the AMT in addition to the regular tax
o 55a the AMT is the difference b/t the tentative minimum tax and
the regular tax
The tentative minimum tax here is 26% over the taxpayers
AMTI over $45K
- The AMT serves to impose a tax whenever the sum of specified percentages
of the excess of AMTI over the applicable exemption amount exceeds the
regular tax for the taxable year.
- In view of the foregoing, we hold that petitioners are liable for the alternative
1

Business Deductions:
Generally, Ordinary and Necessary, Expense vs. Capitalize, Carrying On
Text, pp. 312-314, 314-316, 317-326, 335-342
Code: 162(a), (c), (e)(1)&(2), (f), (l)(1); 195.
Regulation: 1.162-1

Business Deductions
Code 62 Helps answer the question of whether Trade or Business Expenses
are Above or Below the Line.
- (a)(1) If its an Employee business expense its below the line, if its
a non-employee business expense its above the line.
o Self Employed or your own trade or business Expenses are
above the line
o If youre an employee and you have expenses they are below
the line (Miscellaneous Itemized Deduction)
- Section 162 gives us authority for the business expense deduction.
Code 162(a) Trade or Business Expenses
- (a) There shall be allowed as a deduction all the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on any trade or business
(theres no definition for trade or business), including
o (1) a reasonable allowance for salaries or other compensation for personal
services actually rendered;
o (2) traveling expenses (including amounts expended for meals and lodging
other than amounts which are lavish or extravagant under the circumstances)
while away from home in the pursuit of a trade or business
May not be considered temporarily away from home if
time exceeds one year.
o (3) rentals or other payments required to be made as a condition to the
continued use or possession, for purposes of the trade or business, of
property to which the taxpayer has not taken or is not taking title or in which
he has no equity
Pre-employment expenses may be deductible under 162, so long as that
person later becomes an employee in that field or trade.
AN Employees expenses in seeking employment elsewhere but in the
same trade are deductible
Reg. 1.162-1(a) Business Expenses
- Items included in business expenses: mgmt. expenses, commissions, labor, supplies,
incidental repairs, operating expenses of automobiles used in the trade or business,
traveling expenses while away from home solely in the pursuit of a trade or business,
advertising, insurance premiums,
- It will not be considered a business expense if its used by the taxpayer in computing
the cost of property included in its inventory or used in determining the gain or loss
basis of its plant equipment or other property.
Code 263(a) Capital Expenditures
- (a) No deduction shall be allowed for
o (1) Any amount paid out for new buildings or for permanent improvements
or betterments made to increase the value of any property or estate. This
paragraph shall not apply to
(A) expenditures for the development of mines or deposits deductible
under 616
(B) research and experimental expenditures deductible under 174
(C) soil and water conservation expenditures deductible under 175

TAX POLICIES OF PRESIDENTIAL CANDIDATES

OBAMA
Obamas Comprehensive Tax Policy Plan for America will:
Cut taxes for 95 percent of workers and their families with a tax cut of $500 for workers or $1,000
for working couples
Provide generous tax cuts for low- and middle-income seniors, homeowners, the uninsured, and
families sending a child to college or looking to save and accumulate wealth
Eliminate capital gains taxes for small businesses, cut corporate taxes for firms that invest and
create jobs in the United States, and provide tax credits to reduce the cost of healthcare and to
reward investments in innovation
Dramatically simplify taxes by consolidating existing tax credits, eliminating the need for millions
of senior citizens to file tax forms, and enabling as many as 40 million middle-class Americans to
do their own taxes in less than five minutes without an accountant
Under the Obama Plan:
Middle class families will see their taxes cut and no family making less than $250,000 will see
their taxes increase. The typical middle class family will receive well over $1,000 in tax relief
under the Obama plan, and will pay tax rates that are 20% lower than they faced under President
Reagan. According to the Tax Policy Center, the Obama plan provides three times as much tax
relief for middle class families as the McCain plan
Families making more than $250,000 will pay either the same or lower tax rates than they paid in
the 1990s. Obama will ask the wealthiest 2% of families to give back a portion of the tax cuts they
have received over the past eight years to ensure we are restoring fairness and returning to fiscal
responsibility. But no family will pay higher tax rates than they would have paid in the 1990s. In
fact, dividend rates would be 39 percent lower than what President Bush proposed in his 2001 tax
cut
Obamas plan will cut taxes overall, reducing revenues to below the levels that prevailed under
Ronald Reagan (less than 18.2 percent of GDP). The Obama tax plan is a net tax cut his tax
relief for middle class families is larger than the revenue raised by his tax changes for families
over $250,000. Coupled with his commitment to cut unnecessary spending, Obama will pay for
this tax relief while bringing down the budget deficit.
MCCAIN

Keep Tax Rates Low: Entrepreneurs are at the heart of American innovation, growth and
prosperity. Entrepreneurs create the ultimate job security - a new, better opportunity if your current
job goes away. Entrepreneurs should not be taxed into submission. John McCain will keep the top
tax rate at 35 percent, maintain the 15 percent rates on dividends and capital gains, and phase-out
the Alternative Minimum Tax. Small businesses are the heart of job growth; raising taxes on them
hurts every worker.
Cut The Corporate Tax Rate From 35 To 25 Percent: A lower corporate tax rate is essential to
keeping good jobs in the United States. America was once a low-tax business environment, but as
our trade partners lowered their rates, America failed to keep pace. We now have the second
highest corporate tax rate in the world, making America a less attractive place for companies to do
business. American workers deserve the chance to make fine products here and sell them around
the globe.
Allow First-Year Deduction, Or "Expensing", Of Equipment And Technology Investments:
American workers need the finest technologies to compete. Expensing of equipment and
technology will provide an immediate boost to capital expenditures and reward investments in
cutting-edge technologies.
Establish Permanent Tax Credit Equal To 10 Percent Of Wages Spent On R&D: This reform will
simplify the tax code, reward activity in the United States, and make us more competitive with
other countries. A permanent credit will provide an incentive to innovate and remove uncertainty.
At a time when our companies need to be more competitive, we need to provide a permanent

Business Deductions:
Travel, Educations, Disallowance, Miscellaneous
Text, pp. 365-374, 381-389, 389-396
Code: 274(a), (b), (d), (e)(3) & (4), (h)(7), (k), (n)(1).
Regulations: 1.162-2; 1.162-5; 1.274-1; 1.274-2(b)(1), (c), (d).

Travel
Code 162(a) Travel Expenses
- (a) There shall be allowed as a deduction all the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on any trade or business,
including
o (2) traveling expenses (including amounts expended for meals and lodging
other than amounts which are lavish or extravagant under the circumstances)
while away from home in the pursuit of a trade or business
o What does Away From Home?
Home is your primary business is conducted
Its where your primary place of business is
Andrews v. Commissioner defines home as the place
where your primary place of duty is.
o Temporary Absences away from Home
As long as the absence is less than a year and theres
no anticipation that the absence will be more than a
year, and it is not more than a year, then the travel
expenses related to a trade or business will be
deductible.
o You must allocate expenses between business and non
business
If you travel to NY for a week and only one day is for
business then only 1/7 is deductible
o What if your spouse goes?
Depends if her duty is
Code 274(n) Disallowance of Certain Entertainment Etc. Expenses
- Only 50% of Meal and Entertainment Expenses Allowed as Deduction
o (1) The amount allowable as a deduction under this chapter for
(A) any expense for food or beverages, and
(B) any item w/ respect to an activity which is of a type generally
considered to constitute entertainment, amusement, or recreation, or
w/ respect to a facility used in connection w/ such activity
- Shall not exceed 50% of the amount of such expense or item which would (but for
this paragraph) be allowable as a deduction under this chapter.
Reg 1.162-2 Traveling Expenses
- (a) Only such traveling expenses as are reasonable and necessary in the conduct of
the taxpayers business and directly attributable to it may be deducted
o Examples: travel fares, meals and lodging, expenses incident to travel such as
expenses for sample rooms, telephone and telegraph
- (b) (1) If the trip is both personal and business related, travel expenses are only
deductible only if the trip is related primarily to the taxpayers trade or business
o So if the trip is predominately for personal reasons the travel expenses to and
from the destination are not deductible even if related to business, but
expenses while at the destination related to the TPs trade or business are
deductible.
Andrews v. Commissioner

Education Business Expenses


Read these Regulations very carefully. Reg. 1.162-5(a) is dealing w/ education in regards to a
trade or a business;
- If its a business deduction you may get to deduct the full tuition amount
- You look at this section if theres something you cant deduct under 222 or to see if
you can get more of a deduction that 222 will allow.
Education
In this case the education expenses are deductible for carrying on a trade or
business
Code 262 Personal, Living, and Family Expenses
- (a) Except as otherwise expressly provided in this chapter, no deduction shall be
allowed for personal, living, or family expenses
- (b) Treatment of Certain Phone Expenses For purposes of subsection (a), in the
case of an individual, any charge (including taxes thereon) for basic local telephone
service w/ respect to the 1st telephone line provided to any residence of the taxpayer
shall be treated as a personal expense.
Code 274(m) Additional Limitations on Travel Expenses
- (2) No Deduction shall be allowed under this chapter for expenses for travel as a
form of education
Regs: 1.162-5 Expenses for Education
- (a) Expenditures made by an individual for education (including research undertaken
as part of his educational program) are deductible as ordinary and necessary business
expenses if the education
o (1) Maintains or improves skills required by the individual in his
employment or other trade or business, or
o (2) Meets the express requirements of the individuals Employer, or the
requirements of applicable law or regulations, imposed as a condition to the
retention by the individual of an established employment relationship, status,
or rate of compensation
- (b) Nondeductible Educational Expenditures
o (2)(i) If an educational expense is incurred in order for someone to meet the
minimum education requirements to qualify for his employment or other
trade or business then the expense is not deductible.
o (3)(i) Educational expenses are not deductible if done to qualify someone for
a new trade or business
Ex. If an engineer attended law school, those expenses
would not be deductible b/c they involve the lawyer
pursuing a new trade or business.
- (c) An Employee may deduct educational expenses incurred to maintain or
improve skills required by their employment
- (e) Travel away from home. If an individual travels away from home
primarily to obtain education the expenses of which are deductible under this section,
his expenditures for travel, meals, and lodging while away from home are deductible.
Class Notes on Reg: 1.162-5 Expenses for Education

Miscellaneous
Section 274 narrows the scope of 162 w/ respect to expenses for business
meals, entertainment, gifts, Employee awards, and travel by (1) imposing
some limitations and (2) requiring substantiation.
Code 274(a) Disallowance of Certain Entertainment Etc. Expenses
- (1) In general no deduction under this chapter shall be allowed for any item
o (A) With respect to an activity which is of a type generally considered to
constitute entertainment, amusement, or recreation, unless the taxpayer
establishes that the item was directly related to, or, in the case of an item
directly preceding or following a substantial and bona fide
business discussion, that such item was associated w/ the active conduct
of the taxpayers trade or business
What does directly related to mean?
If a business conversation takes place during a
ball game its directly related to
What does associated w/ mean?
If you go on a golf outing and discuss business
immediately afterwards its associated w/ the
trade or business
o (B) W/ respect to a facility used in connection w/ any activity referred to in
subparagraph (A) the deduction shall in no event exceed the portion of such
item which meets the requirements of (A)
- (2) Special Rules
o (A) Dues or fees to any social, athletic, or sporting club or org. shall be
treated as items w/ respect to facilities
o (B) An activity described in 212 shall be treated as a trade or business
o (C) In the case of a club, paragraph (1)(B) shall apply unless the taxpayer
establishes that the facility was used primarily for the furtherance of the
taxpayers trade or business and that the item was directly related to the
active conduct of such trade or business
- (3) Denial of Deduction for Club Dues Notwithstanding the preceding provisions of
this subsection, no deduction shall be allowed under this chapter for amounts paid or
incurred for membership in any club organized for business, pleasure, recreation, or
other social purpose.
Code 274(d) Substantiation Required
- No deduction or credit shall be allowed
o (1) under 162 or 212 for any traveling expense (including meals and lodging
while away from home)
o (2) for any item w/ respect to an activity which is of a type generally
considered to constitute entertainment, etc. or w/ respect to a facility used in
connection w/ such an activity
o (3) for any expense for gifts, or
o (4) w/ respect to any listed property
- UNLESS the taxpayer substantiates by adequate records or by sufficient evidence
corroborating the taxpayers statement.
Code 274(e) Exceptions to Application of Subsection (a)

Business Deductions:
Depreciation
Text, pp. 400-417, 425-434, 436-438
Code: 167(a), (c)(1); 168(a)-(f)(4), (i)(1) & (2); 179(a), (b)(1)-(3), (c), (d)(1)
Regulations: 1.167(a)-1, -2
Business Deductions DEPRECIATION

Occurs when you Capitalize something


o You can recover this cost in one of two ways
1. When you sell it
2. Depreciate it
Basic authority on depreciation is 167
o A deduction shall be allowed for the ordinary wear and tear
depreciation
o Depreciation is allowable for property used in a trade or
business or in an activity used for the production of income
For Example, You dont get a deduction for your
personal automobile
168 tells you how you can depreciate something
o Tells you how to take a deduction
o You must Determine the following
Recovery Period, Method, and Convention
Statute spells these things out depending upon
what type of property it is.
Table on p. XV
Tells you what your Depreciation Rate is for the Cost of
your property
If its Real Property see charts on XVI and XVII
Rate of Depreciation
o Straight line:
Same rate of depreciation for the useful life of property
o Accelerated Depreciation:
Depreciate more in the early years of the useful life
than in the later years of the useful life.
In the end both methods equal the same amount of
depreciation (your tax savings will be the same for
each)
It may be better though to use the accelerated method
b/c you save more initially and a dollar today is worth
more than a dollar in the future.
Accelerated Depreciation was initially created to
stimulate the economy.
The idea is that you save more money early and
you will then use that money to buy things in
the economy.
o ACRS (Accelerated Cost Recovery System)
Under 168(a)(b)(c)(d) (the other stuff is alternative)

Describes a specific method of computing depreciation


To use this method you must know: 168(a)
Recovery Period ( 168(c))
o The amount of time you will dedicate to
recover the cost you have paid

o The time limits given under 168(c)

refers to the propertys classification in


168(e)
Method 168(b)
o (1) General Rule is 200% declining
balance switching to straight line method
for the 1st taxable year for which using
straight line will yield a larger allowance.
The table on p. xv builds in the
calculation for when you are
supposed to switch to straight line
Table ex: For 5 yr property in the
first year you take 20% of your
basis (not adjusted basis) in the
second year you take 32% of the
basis (not your adjusted basis)
o (2) 150% declining balance
(A) used for any 15 or 20 yr.
property (table takes this into
consideration)
However if you make an election
outside the normal rules and use
150% or SL when not required then
you cannot use the table.
o You cant use 200% or 150% if its
(A) Nonresidential real Property
(B) Residential rental property
(C) (H)
Straight line is used for all these
Convention
o Half Year
In year you place property into
service and the year you get rid of
it, instead of getting a full year of
depreciation you only get a half.
First year no matter when it
goes into service you only
get a half year of
depreciation.
o The table builds in the
half year calculation
for the year you buy
the property

The table does not build in

the calculation for the year


you sell it
o Therefore you must
take only half of that
percentage in the year
you sell it; unless your
property has been
fully depreciated in
which case you may
use the entire
percentage in the final
year on the chart.

o Mid Quarter
If you back load your acquisitions

(buying them towards the end of


the year) then you dont get to use
half year convention you only get
to use mid quarter convention
which gives you less depreciation
in that first year.
o Mid Month
Used for real property
Ex: If you buy property on February
1st, you get 10.5/12 months of
depreciation for that year.
How to use the table if bought in
Feb.
Take basis in property times
the depreciate rate under
column 2 b/c you bought it in
Feb. (3.182)
All the depreciation rates
here are the same b/c you
are using SL depreciation
The table does not build in
the calculation for the year
you sell it
o Therefore you must
take only half of that
percentage in the year
you sell it; unless your
property has been
fully depreciated in
which case you may
use the entire
percentage in the final
year on the chart.

You can only depreciate the portion of your

property that is used for business


o 280(f) if you use your property for less
than 50% business the amount you can
depreciate is severely limited.
179 offers an immediate deduction for up to a certain amount of
property placed into service each year
o The limit is inflation adjusted to $125K each year
o Allows you to depreciate up to $125K of capitalized property
additions in the first year
o To qualify for 179
Property must be acquired by purchase
Its for the small business owners
If business acquires more than $400K of
property in a year, the $125K is reduced.
It must be personal property it cant be real property
Random Note
o If you buy and sell something in the same year
You double the rate listed on the first line of the chart.

Code 167(a) Depreciation


- (a) There shall be allowed as a depreciation deduction a reasonable allowance for the
exhaustion, wear and tear (including a reasonable allowance for obsolescence)
o (1) of property used in the trade or business, or
o (2) of property held for the production of income
Code 167(c) Basis for Depreciation
- (c) (1) The basis on which exhaustion, wear and tear, and obsolescence are to be
allowed in respect of any property shall be the adjusted basis provided in 1011, for
the purpose of determining the gain on the sale or other disposition of such property.
Code 168(a) (e) Accelerated Cost Recovery System
- (a) Except as otherwise provided in this section, the depreciation deduction provided
by 167(a) for any tangible property shall be determined by using
o (1) the applicable depreciation method
o (2) the applicable recovery period, and
o (3) the applicable convention
Code 179(a) Election to Expense Certain Depreciable Business Assets
- (a) A taxpayer may elect to treat the cost of any 179 property as an expense which is
not chargeable to capital account. Any cost so treated shall be allowed as a deduction
for the taxable year in which the 179 property is placed in service.
- (b) Limitations .
- (c) Election .
- (d) Definitions and Special Rules
Code 280(F) Limitation on Depreciation for Luxury Automobiles; Limitation
where certain property used for personal purposes.
Code 1016(a) Adjustments to Basis
- (a)(2) Proper adjustment in respect of the property shall in all cases be made iin
respect for exhaustion, wear and tear, obsolescence, amortization, and depletion, to
the extent of the amount
o (A) allowed as deduction in computing taxable income under this subtitle or
prior income tax laws
o (B) resulting (by reason of the deductions so allowed) in a reduction for any
taxable year of the taxpayers taxes under this subtitle (other than chapter 2,
relating to tax on self employment income), or prior income, war profits, or
excess profits tax laws
- But not less than the amount allowable under this subtitle or prior income tax laws.
Where not method has been adopted under 167, the amount allowable shall be
determined under the straight line method.
Reg. 1.167(a)-1(a) Depreciation in General
- (1)(a) 167(a) provides that a reasonable allowance for the exhaustion, wear and
tear, and obsolescence of property used in the trade or business or of property held by
the taxpayer for the production of income shall be allowed as a depreciation
deduction
Reg. 1.167(a)-10) When Depreciation Deduction is Allowable
- (a) A taxpayer should deduct the proper depreciation allowance each year and may

PROBLEMS
P. 435, Q1
(b) ACRS Method
o Purchase price = $300k (Adjusted Basis = $300k)
o 5-year property due to 168(e)(1) (class life of 6 years)
o Recovery period = 5 years per 168(c)
o Half-year convention applies, per 168(d)(1)
o Sells after the recovery period runs, so no convention to apply to
disposition
o Under the ACRS, salvage value is irrelevant because the code mandates
our recovery period, 168(b)(4)
o You multiply the BASIS (NOT the adjusted basis) times the depreciation
rate
o You repeat this for each year and each year you still use your original basis
($300,000), not the adjusted basis
o After year 5 (the recovery period) the adjusted basis will be the original
basis minus the depreciation deductions
(c) Dispose of the property in Year 5
o You will have half year depreciation in the year you buy the property
(which the chart accounts for)
o You will have half year depreciation in the year you sell it because you are
selling before the recovery period runs
o Chart does not take half year into account on disposition so have to recalculate depreciation amount
(d) Uses 179
o I believe that a 179 deduction changes the basis to which depreciation
then applies
P. 435, Q2
(a) Luxury car for personal and business use
o First must determine personal/business allocation
o Per Sharp, depreciation only applies to business portion
o Also, see page 430 for discussion on Luxury Car limitations
P. 439, Q1
(a) The building is an apartment building (residential rental
property)
o Land is not depreciable per 167
o Because it is real property, you use straight line depreciation method,
168(b)(3)(B)
o Residential rental property has a recovery period of 27.5 years ( 168(c))
(b) The building is an office building
o Now, this is nonresidential real property
o The recovery period is now 39 years

Business Deductions:
Deductions for Transactions entered into for profit; Home deduction
Text, pp. 440-444, 452-460, 464-470, 514-519
Code: 212; 165(c); 280A(a), (c)(1) & (3), (d)(1) & (2), (f)(1), (g)
Regulations: 1.165-1(b)-(c); 1.212-1(f)
Deductions for Transactions entered into for Profit
Code 212 Expenses For Production of Income
- In the case of an individual, there shall be allowed as a deduction all the ordinary
and necessary expenses paid or incurred during the taxable year
o (1) for the production or collection of income;
o (2) for the management, conservation, or maintenance of property held for
the production of income; or
o (3) in connection w/ the determination, collection, or refund of any tax.
Code 165(c) Losses Limitation on Losses of Individuals
- (c) In the case of an individual, the deduction under subsection (a) shall be limited to

o (1) losses incurred in trade or business


o (2) losses incurred in any transaction entered into for profit, though not
connected w/ a trade or business; and
o (3) except as provided in subsection (h), losses of property not connected w/
a trade or business transaction entered into for profit, if such losses arise
from fire, storm, shipwreck, or other casualty, or from theft.
Class Notes: (Good Clarification of the Oct. 30 Material)
- 162 Deductions for ordinary and necessary expenses related to a trade and a business
- How is 212 different from 162?.
o If an activity doesnt rise to the level of a trade or business
under 162, then you may be able to deduct it under 212.
- Ex. A person rents out 40 different properties
o Is that a trade or business
o Probably
o What if that person is now a law professor who rents out property?
In this case its probably not a trade or business, but it would still be
for the production of income
Thus under 212 you may deduct expenses associated with
this so long as its for the production of income
- 167 Depreciation allows as a deduction wear and tear of
o Property used in a trade or business ( 167)
o Property held in the production of income ( 212)
- 262(a) except as otherwise provided in this chapter, no deduction shall be allowed
for personal, living, or family expenses.
- 280A Came about b/c there was a lot of controversy about homes that you rent out
as a vacation home but also live in (should it be a deduction under 212 or not
deductible as 262 there is a clash of authorities)
o Under 280A Residence is defined as:

Residence is defined as a dwelling unit that the taxpayer uses for

personal purposes for more than 14 days or 10% of rental period


whichever is greater ( 280A(d))
o If its a residence you cant deduct expenses under 280A(a)
o However under 280A(c) you can deduct things up to the income you have in
the property.
Therefore if you get up to $5000 income in the property you can
deduct up to that amount.
Therefore if you have 20K in expenses but only get $5K in
income from the property then you can deduct up to $5K.
o Under 162 or 212 you would be able to deduct all
$20K but b/c this is a residence 280A governs and
you can only deduct up to your income if its
considered a residence
183 if its not engaged in for profit there shall be no deductions, but there are
exceptions
o Ex. You have a Dr. who has a business as both being a Dr. and a Rancher
o As a Dr. he has $5K worth of income, as a rancher he has 10 K of income
and 200K of expenses
He has a loss of $190K as a rancher
If Dr. has a trade or business as being a rancher or his ranching is for
the production of income he can deduct all $200K of the expenses
(162 or 212)
However if its neither (and assuming 280A doesnt apply)
then 183 says he cant deduct anything.
o However 183 does have an exception that will allow
the rancher to deduct an amount up to the amount of
income earned from the property.
In this case under 183 the rancher/Dr. would
be able to deduct 10K
What determines whether something is for the production of income, is a trade or
business, or is for personal use?
o IT ALL DEPENDS UPON THE FACTS
Consult Regs. 183.
Whats the difference between the deductions under 162 and deductions under
212..
o Ex. Taxpayer has a 15K of income and 50K of expenses giving you a 35K
loss.
o 165(c) says we can use that loss to offset other forms of income the
taxpayer may have.
o Then if the Taxpayer has an additional salary then their Total Income is a loss
of $15K (this would be the approach used under 162 and 212)
o If 183 is used the Taxpayer can only deduct 15K of expenses b/c that is all
the income they received), therefore if like the above example is still true the
Taxpayer will recognize taxable income of $20000
Net Operating Loss
o NOL -
In the above example the $15K is NOL

o 172 says if its a trade or business and you have negative taxable income,
you can use these deductions in a different year.
Under 172 you can carry back those deduction meaning you can use
them in previous years for 2 years and can use them in future years
for 20 years.
This is only true if its a trade or business.
It does not apply to 212, you will never get to use the extra
deductions under 212, this only applies when they are
expenses under a trade or business under 162.
o The only time you will see a difference b/t 162 and 212 is when there is a
loss.
Text Notes:
Higgins v. Commissioner
- The Petitioner didnt technically participate directly or indirectly in the corporations
he held stock and bonds
- However he claimed the expenses incurred in looking after his investments were
deductible as a business expense.
- The tax ct. held that those activities did not constitute carrying on a business and that
the expenses were capable of apportionment b/t the real estate and the investment.
- Petitioner argues his actions are not like a small investor and b/c they are so large in
scale it should be considered constant and repetitious and he should be able to deduct
them.
Issue:
- what is the definition of carrying on a business
Hold:
- The ct. says his actions in managing his investments are not Carrying on a business
and therefore not deductible.
After this case Congress enacted 212 where the phrase carrying on of business was replaced
by 3 more specific yet broad criterion
Meyer J. Fleischman v. Commissioner
- May the petitioner deduct legal expenses incurred in defending his wifes lawsuit to
set aside their antenuptial K
- The Tax ct. disallowed such a deduction and the petitioner appealed.
- This Ct. holds that he is barred from deduction the legal expenses by 262 of the
code.
- Petitioner argues that the expense here should be deductible under 212 b/c it was
for the preservation and protection of taxpayers real property inherited from his
mother.
- The court enters a decision for the respondent saying the expenses were personal
instead of business related therefore the legal expenses were not deductible.
Class Notes:
Are Attorneys Fees Deductible under 212:
- For instance is it deductible in estate planning.
o Probably not: Conservation of property doesnt mean preserving it for your
estate.

o Any expense (legal, CPA, tax advisement, franchise tax) if it relates to tax
-

may be deductible, therefore if its just a portion of the estate planning then
the portion related to tax advice is deductible.
Trial Lawyer Charges a Contingent Fee.
o The Individual is essentially paying the lawyer a 40% contingent fee
o Is that contingent fee for the production of income deductible under 212
YES, you hire the attorney to get you income
o Dont get too excited though b/c its a below the line deductions and its a
misc. deduction at that.
Therefore its only deductible to the extent it exceeds 2% of our AGI
The Alternative Minimum Tax really hurts you here as well.
o Ex. If the taxpayer won $1million bucks after taxes (35%) and paying lawyer
(40%) they only have $250K left in their pocket.
o A year and a half ago 62(a)(20) allows attorneys fees to now be deductible
above the line which takes away the AMT problems
Therefore the taxpayer is really only taxed on the $600K not the
$400K given to the lawyer as a contingent fee.

Whats the difference b/t a deduction under 162 and 212?


- If its in trade or business (162) and you dont have enough income
to use all your deductions you can use them in subsequent years.
You cant do this for deductions for the production of income
Lowry v. U.S
Issue:
- Whether the Ps, who ceased to use their summer house as residential property in
1967 and immediately offered it for sale w/out attempting to rent the property,
converted it into income producing property thereby entitling them to deduct the
maintenance expenses incurred after it was put on the market and prior to its sale in
1973.
- Petitioner rationalized the deductions by saying the home was for the production of
income.
- When and how does residential property get converted to income producing
property?
o The Ct. said that usually the taxpayer has to put the house up for rent for it to
be considered income producing
This ct. rejects the inflexibility of the rental standard
o However if the taxpayer believes that the value of the property may
appreciate and decides to hold it for some period in order to realize upon
such anticipated appreciation, as well as excess over his investment, it can be
said that the property is being held for the production of income
B/c the plaintiff knew the real estate game and depended upon his
house appreciating in value the ct. determined his actions were in
expectation of profit
- Therefore his expenses were deducted.
- Hold: If a taxpayer has the INTENT to use the property as an
investment then he may take deductions under 212
PROBLEMS

P. 460, Q. 1
(c) Under 212(2), you may deduct ordinary and necessary expenses incurred for the
management, conservation, or maintenance of property held for the production of
income.
o One of the big questions is are these expenses ordinary and necessary in the
production of income
o It all depends on the facts
o Necessary if defined as helpful, may be sufficient
o Ordinary an argument can be made that this isnt ordinary because she only
owns such a small percentage
It may be ordinary if she was the largest shareholder in the company
(d) Under 212(2), you may deduct ordinary and necessary expenses incurred for the
management, conservation, or maintenance of property held for the production of
income.
o This appears to be more ordinary and necessary
o Example Say she only spent one day at the meeting and toured NYC for the
rest of the week. Is it still deductible?
Per 262 personal expenses arent deductible, therefore only the
portion used in relation to the production of income or the trade or
business expenses
(e) Under 212(2), you may deduct ordinary and necessary expenses incurred for the
management, conservation, or maintenance of property held for the production of
income.
o This seems more like an instructional seminar Not deductible
o 274(h)(7) specifically says that seminars for 212 are not deductible
(f) Under 212(2), you may deduct ordinary and necessary expenses incurred for the
management, conservation, or maintenance of property held for the production of
income.
o It all depends on the facts, here are some things you should ask in analyzing:
Would other investors do this, whats necessary to maintain her investment, these
are expenses that are necessary to protect the investment (BUT consider the
amount of her investment, etc.)
P. 461, Q. 3

Are Attorneys Fees Deductible under 212:


- For instance is it deductible in estate planning.
o Probably not: Conservation of property doesnt mean
preserving it for your estate.
o Any expense (legal, CPA, tax advisement, franchise tax)
if it relates to tax may be deductible, there fore if its just
a portion of the estate planning then the portion related
to tax advice is deductible.
P. 470, Q.2
(a) You may deduct
o Under 262 no deductions for personal expenses
o However, you can try and treat it as an investment under 212
o Under Lowry, you may treat a home as an investment without even renting so
long as you expected the house to go up in value and you were going to make a
profit

In Lowry, its obvious he knew the real estate market and that it was

currently not doing well and that it would soon turn around, thus he listed
the house at a high price
It was important here that he was an expert in this field and that
there were particular facts that would lead one to indicate the
housing market would go up
o What makes it look like you will sell it for a profit?
In Lowry, its his expertise
o The Lowry case looks at the intent of the taxpayer, in that case his intent was to
hold out until the market went up.
o Most taxpayers who simply try to sell w/out renting have a hard time saying that
their old residence is investment property.
Therefore they cant deduct the expenses necessary to upkeep the
property
The actual answer here is that if facts show they were using the property as investment
property then they could deduct, we arent aware of those facts in this case.
(b)
o When we depreciate property the AB goes down.
o You can only adjust the basis of the part associated w/ the
building, not the land.
o (1) $160 - $10K = 150K + 20K in land = AB = 170K
AR = 145K
It would initially appear that he can record a loss of 25K,
but he lost the first 20K while it was still a residence.
You cannot deduct a portion of the loss while it was
still a residence.
Therefore instead of a 25K loss he will only get a 5K loss
o (2) AR = $175; AB = 170K making him realize a gain of $5K
You recognize a gain above what was initially paid for the
property (minus depreciation) and you recognize a loss
only if its below the conversion price (minus
depreciation).
121 allows exclusion of gain from GI of principal
residence up to $250K
But this isnt the case in our scenario b/c the only
reason he has a gain is b/c he was able to factor in
depreciation deductions.

Restrictions on Deductions on Home (Text Notes on 280A)


- 280A provides specific rules limiting deduction on a tps residence
o Residence is defined as a dwelling unit that the tper uses for personal
purposes for more than 14 days or 10% of rental period whichever is greater
( 280A(d))
- 280A(a) generally denies a tper deductions for expenses attributable to the use of
ones home for business purposes, but makes exception for the extent such
deductions are attributable to a portion of the home used exclusively and on a
regular basis:
o (1) as the principal place of business for any trade or business of the
taxpayer;
o (2) as a place of business which is used by patients, clients, or customers in
meeting or dealing w/ the tper in the normal course of business, or
o (3) as a separate structure not attached to the dwelling unit used in
connection w/ the tper or business.
Class Notes on 280A
- Generally 280A limits expenses in regards to residences
- What if one of the rooms in a residence was a home office?
o Say the home office was 30% of the taxpayers home.
o What expenses would be deductible:
The question is asked b/c if it were an out of home
office of course those expenses would be deductible
under 162.
280A(c) if its a trade or business office you may
deduct the percentage that the office occupies from
total expenses
Conditions for this to apply:
o 1. Must be used Regularly (there
everyday)
o 2. Must be used Exclusively (if you can do
other things in that room its not
exclusive)(Exclusively means Exclusively)
o 3. Must be the principal place of business
Exclusive use must be for the
convenience of the ER. (i.e. ER
doesnt have enough office space
for you)
The above sentence applies
if you spend part of your
time in an office and part of
your time at home.
If theres no other place for
administrative duties then you may
deduct the expenses.
If all these conditions are met the percentage
the office occupies may be deductible
Prop. Reg. 1.280A-1 (c) Defines Dwelling Unit

(C) includes a house, apartment, condominium, mobile home, boat, or similar


property, which provides basic living accommodations such as a sleeping space, toilet
and other facitilities.
o If its a dwelling place the owner is limited by 280A in the deductions they
can take
(2) Exception
o Hotels and motels are not dwelling units
o Neither is long term boarding to tourists or students
o Therefore the limits of 280A do not apply.

PROBLEMS
P. 519, Q3
- If these were deductible the widow would take a proportion of all the expenses for
the home and figure out which portion of those expenses applied to those rooms
- Is this a residence:
o Yes she lives there for more than 14 days
o Can she deduct those portions of the homes expenses attributed to the space
occupied by the three rooms
o Under $280A b/c its a residence you can only deduct up to the amount she
receives in income from renting the rooms.
- The exception in Prop. Reg. 1.280A-1(c) says that youre not limited to just to the
extent of the income when it comes to deductions.
o This Reg. is still being looked at.

Losses b/t Related Taxpayers


Code 267(a) Losses Expenses and Interest w/ Respect to Transactions B/t
Related Taxpayers
- (a) No deduction shall be allowed in respect of any loss from the sale or exchange or
property, directly or indirectly, b/t persons specified in (b). The
- (b) The persons referred to in subsection (a) are:
o (1) Members of a family, as defined in subsection (c)(4)
- (c)(4) The family of an individual shall include only his brothers and sisters (whether
by the whole or half blood), spouse, ancestors, and lineal descendants
McWilliams v. Commissioner
- Husband managed both his and his wife estate and attempted to deduct the losses.
- However the Commissioner said the authority was not deductible b/c the code
prohibits sales or exchanges of property, directly or indirectly b/t members of a
family and b/t certain other closely related individuals and corps
- The ct. affirmed the Commissioners decision
Problems 1 p. 870
- Part A
o Dad has a 1012 basis of 50K sells to daughter for $40K
Daughter sells to 3rd party for 3rd $45K
o When Dad sells to daughter he has a loss of $10K
o Daughter has a realized gain under 267(b) ($5K) but she
doesnt have to recognize it under 267(e or d) b/c there was
an overall economic loss of $5K
o A sale to a related party at a loss, the loss is disallowed
permanenty unless the transferee then sells it at a gain then
the transferee can not recognize the gain to the extentto
the extent of the loss that was disallowed? (See 267(d)or (e)
- Part B
o Now instead of a $5K gain she has $15K gain, she still
doesnt have to recognize it to the extent that it was
disallowed, so she must recognize a $5 K gain (55-50)
- Part C
o No the daughter has a $5K loss, she can only deduct her own
loss of $5K, she doesnt get to include her fathers 10K loss.
- Part D
o When daughter gives the stock to son he takes a 1015
transferred basis of $40K, when he sells it for $48 he has an
$ 8K gain and he must recognize it b/c under 267(b) he is
not the related party transferee.
267 was enacted to curb abuses
- Its pretty harsh b/c the loss deduction goes away forever

Methods of Accounting
(These statutes only govern WHEN tax is due)
Code 446 General Rule For Methods of Accounting
- (a) Taxable Income shall be computed under the method of accounting on the basis of
which the taxpayer regularly computes his income in keeping his books
Code 446(b) Exceptions
- (b) If no method of accounting has been regularly used by the taxpayer, or if the
method used does not clearly reflect income, the computation of taxable income shall
be made under such method as, in the opinion of the Secretary, does clearly reflect
Code 446(c) Permissible Methods
- (c) subject to (a) and (b) the taxpayer may comute taxable income in any of the
following methods:
o (1) The cash receipts and disbursements method;
o (2) an accrual method;
o (3) any other method permitted by this chapter; or
o (4) any combination of the foregoing methods permitted under regulations
prescribed by the Secretary
Code 446(d) Engaged in more than one business
- (d) taxpayer may use a different method of accounting if engaged in more than one
business for each trade or business
Code 446(e) Requirement Respecting change of Accounting Method
- (e) a tper who changes the method of accounting on the basis of which he regularly
computes his income in keeping his books shall, b/f computing his taxable income
under the new method, secure the consent of the Secretary
Code 446(f) Failure to Request Change of Method of Accounting
- (f) IF the tper does not file w/ the Secretary a request to change the method of
accountin the absence of the consent of the Secretary to a change in the method of
accounting shall not be taken into account
o (1) to prevent the imposition of any penalty, or the addition of any amount to
tax, under this title, or
o (2) to diminish the amount of such penalty or addition to tax
Code 446 General Rule for Taxable Year of Inclusion
- (a) The amount of any item of GI shall be included in the GI for the taxable year in
which received by the tper, unless, under the method of accounting used in
computing taxable income, such amount is to be properly accounted for as a different
period
- (b) SPECIAL RULE IN CASE OF DEATH; In the case of death the tper whose
taxable income is computed under an accrual method of accounting, any amount
accrued only by reason of the death of the tper shall not be included in computing
taxable income for the period in which falls the date of the tpers death.
- (c) Special Rule for EE Tips For purposes of subsection (a), tips included in a
written statement furnished an ER by an EE pursuant to 6053(a) shall be deemed to
be received at the time the written statement including tips is furnished to the ER.

The Cash Receipts and Disbursements Method


Cash basis measures tax liability by including an item in income or allowing a
deduction at the time that cash or its equivalent is received or paid.
Class Notes
- Most sole prioprietorships use the cash method
- It allows your income statement to mirror the cash you have in the
bank.
- Its much less complicated
- Corporations cannot use the cash method
o Unless their gross receipts are less than $5million; or
o The corp. is an S Corp.
- If a business has inventory one cannot use the cash method must
use accrual method
Charles F. Kahler v. commissioner
Issue:
- When did the petitioner realize the income represented by the commission check?
o Petitioner claims it should be realized in 1947 b/c the check was not received
in enough time in 1946 to convert it into cash before 1947.
Hold:
- Even thought the petitioner received the check late it should be taxable in 1946 when
the check was delivered to him.
Williams v. Commissioner
- The receipt by the petitioner of the promissory note in 1951 does not constitute
taxable income realized during that year.
Hornung v. Commissioner
Issue:
- Should the value of a 1962 Corvette automobile which was won by petitioner for his
performance in a professional football game be included in his Gross Income for the
taxable year of 1962
Facts:
- At 4:30 pm on Dec. 31, 1961 the editor in chief of Sport magazine named Hornung
the MVP of the championship game which by agreement entitled Hornung to a new
car
- The editor did not have the key or the title to the Corvette with him in Green By and
petitioner did no request or demand immediate possession fo the car at that time but
he accepted the car
- In fact the car was w/ a dealer in NY, nowhere near Green Bay
Is this Constructive Receipt?
- Income not actually reduced to a taxpayers possession is constructively received
by him in the taxable year during which it is credited to his account, set apart for him,
or otherwise made available so that he may draw upon it at any time, or so he could
have drawn upon it during the taxable year

However income is not constructively received if the taxpayers control is subject to


substantial limitations

Here the Ct. said there were too many limitations in the way so it was not considered
constructive receipt
It should be reported on Hornungs 1962 income.

Hold:

Class Notes on Hornung:


- Constructive Receipt Unfettered control
o In this case he didnt have control over the corvette in year 1
therefore it wasnt income to him in that year
o He wanted to it to be income in year 1 b/c the SOL was
approaching.
Commissioner v. Boylston Market Assn
- Taxpayer shall deduct the pro rata portion of insurance applicable to that year and not
just the specific insurance that is paid that year.
- Most insurance Ks last longer than a year but its okay to allow the pro rata portion
of the insurance K to count in that specific year.
Text Notes:

Obviously cash and checks spent on things may be deducted in the year payment is
made under the cash basis accounting system
The same is also true for a credit card, CC payments may be deducted in years in
which the payment is made (Rev. Rule 78-38)
What is a cash method for tax purposes?
o You record income in a cash basis when:
1. you receive it
2. when you constructively receive it
o You record an expense under a cash basis:
When you pay it.

PROBLEMS
P. 610, Q2
(a) Under a cash method, lawyer would not have income from the clients bill until he
receives the payment in year 2. Similarly, client, would not have a deduction for the
business expense until he pays it in year 2.
o If the lawyer were operating on the accrual basis, the lawyer would record
income when the services were rendered (year 1)
Under Accrual basis income is recorded when the
services are rendered, not when they are billed.
After the client then pays the lawyer in year two
(lawyer under accrual system has already recorded the
income) do you have more income
NO. Its the repayment of a debt
(b) Under a cash system, lawyer would receive and report income for year 1 because he
received payment in that year. Client, similarly, because credit cards are treated like

cash/check, incurs a deductible expense in year 1 because the expense is paid when the
bill is paid.
(c) Under the cash method, it hinges on when you receive the income and/or when you
make the payment. Thus, lawyer has income in year 1 and year 2. Client, similarly, has
deductible expense in year 1 and year 2.
(d) This is a prime example of constructive receipt,
o Even though the lawyer has not actually received it, it has
been:
o set aside so it can be drawn upon any time
o It was available and it could have been picked up at any
time.
o See Hornung Case:
Football player was arguing it should be income in year
1, when normally you defer to later years, but if he got
it so it was income in year 1 the SOL would have run
out.

Accrual Method
- Normally used by businesses versus individuals
- Measures tax liability by including an item in income at the time the taxpayer
becomes entitled to it (Time the services were rendered) and allowing a
deduction at the time a deductible obligation becomes fixed and certain
Class Notes:
- Focus is on when services were rendered or received
New Capital Hotel, Inc. v. Commissioner
Issue:
- Is a $30K advance payment received in 1949 by the petitioner lessor, an accrual basis
taxpayer, includable in GI in 1949, as determined by the Commissioner, or in 1959
the year in which the advance payment is to be applied to rent.
- The Ct. affirms the commissioners ruling and says the $30K must be reported as GI
in the year it was received (1949)
Artell Co. v. Commissioner
Issue:
- If someone receives prepayments for tickets to sporting events, under the accrual
system, do they have to report the income when its received or can they wait until
the games are played and other services rendered.
- Do the White Sox have to report all advanced ticket sales, television rights fees, or
season parking passes when they get them or can they wait until the games are
played.
- If the payments received can be specifically related to services w/
fixed dates in the future, the payments received will be more likely
to be deferred.
o Certainty is a big thing. The services are Fixed.
You know the baseball games will take place
- Ct. will allow the deferral of revenue when you know for certain the
services will take place.
- Up until this point the IRS said income was income in the year your
received it, no deferral (they used their discretion to say this)
- The ct. ends up ruling saying it does not have to be considered income in the time
period its received, and the case is remanded to specifically see if the facts of this
case will allow for deferral.
Revenue Ruling 57-463
- Interest accruing on the deferred payments may be allowed as a deduction ratably as
the tpers liability for such interest accrues.
Schuessler v. Commissioner
- A taxpayer sells furnaces and is able to charge b/t $20 and $25 more per furnace b/c
he guarantees to turn them off and on each year.
- The Taxpayer then sets aside $13,300 in the current year and chooses to defer this
income over the course of the next five years where he will actually earn that income
in performing his guarantee to turn the furnaces off and on.
Class Notes

What do you need to look to in an accrual system to see if there is


an expense
You cant deduct it under the accrual method unless you meet the
below requirements
o 1. The All Events Test ( 461(h))
You can take a deduction for that expense if indeed
you establish there is a liability for the taxpayer to pay
that amount
Here Client would have to establish lawyer
rendered service and client owes them
You have to be able to ascertain w/in a reasonable
certainty the amount of the liability
o 2. Economic Performance
The taxpayers have done what theyve contracted to
do
Youre paying for the services that the lawyer has
actually done
The lawyer must have actually rendered the
services (ex. A retainer fee wouldnt be a
deductible expense.)

PROBLEMS
P. 637, Q1
- What do you need to look to in an accrual system to see if there is
an expense
- You cant deduct it under the accrual method unless you meet the
below requirments
o 1. The All Events Test ( 461(h))
You can take a deduction for that expense if indeed
you establish there is a liability for the taxpayer to pay
that amount
Here Client would have to establish lawyer
rendered service and client owes them
You have to be able to ascertain w/in a reasonable
certainty the amount of the liability
o 2. Economic Performance
The taxpayers have done what theyve contracted to
do
Youre paying for the services that the lawyer has
actually done
The lawyer must have actually rendered the
services (ex. A retainer fee wouldnt be a
deductible expense.
P. 638, Q3
When can the INCOME be recorded by the Studio
- This case is like the Artnell Case.

The income should be matched to the year you have the expense
We have the certainty that Artnell requires here.
Rev. Proc. 2004-34 allows you to defer for only 1 year.
o Under this Rev. Proc. You could record some income in yr. 1
and the rest would have to be recorded in year 2.
o This was an indication that the IRS backed off its stance that
income must be recorded in yr. 1
- The big question here is do you have power to defer your income
more than 1 year. (Arnell doesnt address this but the Rev. Proc.
Only allows you to defer for 1 year)
- The taxpayer would make the argument that I did above but the IRS
sticks to their guns w/ the Rev. Proc. Only allows deferment for 1
year.
o The IRS also bases their argument that income is an
accession to wealth and that when the taxpayer becomes
better off (yr. 1) thats when the TPer should have to report
the income.
- At most as this problem demonstrates probably the most you will
ever be able to defer is 2 yrs.
When can the dance studio record the EXPENSEs that they paid up front:
- To record or deduct an expense she must meet the:
o 1. All Events Test and
Was there an obligation b/t the dance studio and the
utility companies or cost to perform dance lessons
Is the amount reasonably certain
o 2. Economic Performance Test.
This test is met when the dance lessons were given
the students
- Ex. If the rent was paid on Dec. 31 the dance studio couldnt record
an expense in year 1 b.c even though it meets the All Events Test, it
does not meet the Economic Performance Test until the lessons are
given.

Characterization of Income
- Is something taxed as ordinary or capital gain income
- The prize: If you have a net capital gain, most of these will be
taxed at 15%
o Therefore if you can classify your income as a net capital
gain you can save (usually 10%) from the other ordinary
rates.
o You only get the prize if you have a net capital gain
- When do you have a net capital gain?
o IF there is a sale or exchange on a net capital asset you will
have a capital gain or capital loss.
- What happens if you have a capital loss? (See 1211)
o Under 1211 if you have a capital loss you can only deduct
capital losses against the extent you have capital gains that
you may have
Its not deductible against ordinary income; EXCEPT to
the lesser of
$3000K, or
The excess over CG
o However 1212 says to the extent you cannot use CL in one
year you can carry it over to the next year
In year 2 you can deduct up to another $3K, in year 3
she can deduct up to another $3K, and in 50 years
shell be able to deduct the whole thing.
- Therefore if you are arguing about whether something is a capital
asset you need to know if you have a gain or loss
o If you have a gain you want it to be a capital asset
o If you have a loss you dont want to be a capital asset
B/c if its not a capital asset and you have a loss you
can deduct the entire amount, whereas if it would have
been a capital asset you wouldnt be able to deduct it
beyond the extent that you have capital gains or $3K.
- If you have 30K of regular income and 150K of CG, you are taxed on
your ordinary income at 180K at a higher tax rate, and then the
150K is taxed at the CG rate.
- Per 1222(11) you can only get the prize by having a Net Capital
Gain by having long term capital gains being in excess of short term
capital losses
Netting:
- Net the Shorts
o STCG STCL
- Net the Longs
o LTCG LTCL
If you have a net LTCL you cannot get the prize per the
definition in 1222(11)
- Net Capital Gain = NLTCG NSTCL
o If you have a NLTCG and a NSTCG

Your Net Capital Gain is just your NLTCG; your NSTCG is


still taxed at the ordinary rate b/c its not included in
the definition of net capital gain in 1222(11)

Capital Gains and Capital Losses


Capital Gains
Code 1222 Terms Relating to Capital Gains and Losses
- (1) Short Term Capital Gain
o Gain from the sale or exchange of a capital asset held for not more than 1
year, to the extent the gain is taken into account for computing GI
- (2) Short-Term Capital Loss
o Loss from the sale or exchange of a capital asset held for not more than 1
year, if and to the extent the loss is used in computing taxable income
- (3) Long-Term Capital Gain
o Gain from the sale or exchange of a capital asset held for more than 1 year, to
the extent the gain is taken into account for computing GI
- (4) Long-Term Capital Loss
o Loss from the sale or exchange of a capital asset held for more than 1 year, if
and to the extent the loss is used in computing taxable income
- (5) Net Short Term Capital Gain
o The excess of short term capital gain over short term capital losses for such
year
- (6) Net Short Term Capital Loss
o The excess of short term capital losses for the taxable year over the short
term capital gains for such year
- (7) Net Long-Term Capital Gain
o Long term capital gains in excess of long term capital losses
- (8) Net Long-Term Capital Loss
o Long term capital losses in excess of long term capital gains
- (9) Capital Gain Net Income
o The Excess of the gains from sales or exchanges of capital assets over the
losses from such sales or exchanges
- (10) Net Capital Loss
o Excess of the losses from sales or exchanges of capital assets over the sum
allowed under 1211.
o In case of a corp., for the purpose of determining losses under this paragraph,
amounts which are short-term capital losses under 1212 shall be excluded
- (11) Net Capital Gain
o Excess of the net long term capital gain for the taxable year over the net
short-term capital loss for such year
This means that in order to get the prize you must
have net long-term capital gains.
o If you have a NLTCG and a NSTCG
Your Net Capital Gain is just your NLTCG; your NSTCG is
still taxed at the ordinary rate b/c its not included in
the definition of net capital gain in 1222(11)
Code 1(h) Maximum Capital Gains Rate

(1) Only applies if a taxpayer has a net capital gain then the tax on
that net capital gain shall not exceed what 1(h) is talking about.
o (C) 15% is the tax rate for most net capital gains
This will be the focus of our class
If you have a net capital gain, most of these will be taxed at 15%
o Therefore if you can classify your income as a net capital
gain you can save (usually 10%) from the other ordinary
rates.
o Not all your income is taxed at 15%, just your capital gains.

Capital Losses
Code 1211 Limitation on Capital Losses
- (a) Corporations In the case of corporation, losses from sales or exchanges of
capital assets shall be allowed only to the extent of gains from such sales or
exchanges
- (b) Other Taxpayers In the case of a taxpayer other than a corp., losses from sales
or exchanges of capital assets shall be allowed only to the extent of gains from such
sales or exchanges, plus (if such losses exceed such gains) the lower of
o (1) $3,000 ($1,500 in the case of a married individual filing a separate
return), or
o (2) the excess of such losses over such gains
Code 1212 Capital Loss Carrybacks and Carryovers
- (a) Corporations
o (1) if a corp. has a net capital loss for any taxable year the amount thereof
shall be
(A) a capital loss carryback to each of the 3 taxable years
preceding the loss year, UNLESS
(i) the loss is related to foreign expropriation
(ii) the carryback of such loss does not increase or produce a
net operating loss (defined in 172(c)) for a year in which its
being carried back
(B) (except as provided for in (C)), a capital loss carryover to each
of the 5 taxable years succeeding the loss year, and
(C) A capital loss carryover
(i) in case of an regulated investment co. to each of the 8
taxable years succeeding the loss
(ii) in case of a loss attributable to foreign expropriation
capital loss, to each of the 10 taxable years succeeding loss
year.
o (3) Special Rules on Carrybacks a net capital loss of a corporation shall not
be carried back under paragraph (1)(A) to a taxable year if its a
(A) regulated investment co., or
(B) for which it is a real estate investment trus
- (b) Other Taxpayers
o (1) If a tper other than a corp has a net capital loss for any taxable year

(A) the excess of the net short-term capital loss over the net longterm capital gain for such year shall be a short-term capital loss in
the succeeding taxable year, and
(B) the excess of the net long-term capital loss over the net short
term capital gain for such year shall be a long-term capital loss in the
succeeding taxable year.
o (2) Treatment of Amounts Allowed Under 1211(b)(1) or (2)
(A) For purposes of determining the excess referred to in
subparagraph (A) or (B) of paragraph (1), there shall be treated as a
short term capital gain in the taxable year an amount lesser of
(i) the amount allowed for the taxable year under paragraph
(1) or (2) of 1211(b), or
(ii) the adjusted taxable income for such taxable year
(B) Adjusted Taxable Income For purposes of subparagraph (A),
the term adjusted taxable income means taxable income increased
by the sum of
(i) the amount allowed for the taxable year under paragraph
(1) or (2) of 1211(b), and
(ii) the deduction allowed for such year under 151 or any
deduction in lieu thereof
For purposes of the preceding sentence, any excess of the deduction
allowed for the taxable year over the GI for such year shall be taken
into account as negative taxable income.
Text Notes:
- Capital gains are given preferential tax treatment and there are limitations placed on
the deductibility of capital losses.
- Whether a gain or loss is subject to special treatment as capital as opposed to
ordinary usually is dependent upon
o 1. whether it arises in a transaction involving a capital asset
o 2. whether the capital the capital asset has been the subject of a sale or
exchange, and
o 3. How long the taxpayer has held the asset
- In Merchants Loan the court ended much debate on whether capital gains could
be taxed, saying that Capital Gains could indeed be taxed.
- Today Capital gains still receive preferential tax treatment, w/ a 28% ceiling versus a
35% ceiling on regular income.
- Limitations are also placed on the amount people can deduct w/ a capital loss.
Mechanics of Capital Gains
Is there a Net Capital Gain?
- First figure out if you have an Net Short-Term Capital Gain or Loss
o Take the Short term Capital Gains (1222(1) Short Term Capital Losses
(1222(2) = Net Short Term Capital Gain or Loss (1222(5) & (6))
- Next determine if you have a Net Long-Term Capital Gain or Loss:
o Take Long Term Capital Gain (1222(3)) Long Term Capital Loss (1222(4))
= Net Long Term Capital Gain or Loss (1222(7) and (8))

Next you must Net the Net Short Term Capital Gain or Loss (1222(5) & (6))
against the Net Long Term Capital Gain or Loss (1222(7) and (8))
If Net Gains Exceed Net Losses you have a Net Capital Gain
If Net Losses Exceed Net Gains you have a Net Capital Loss
If it is a Net Gain, Only the amount of the net amount of the gain is included
Good Example of this whole Process in the Middle of p. 681
The line for what is a long term v. short term classification is marked by the holding
period (1 year in this case)

Section 1(h) (Noncorporate Taxpayers)


- If there is a Net Capital Gain Section 1(h) comes into play
- When section 1(h) applies, net capital gains are treated as though they were the last
taxable income received
- First 1(h) begins by extracting a portion of noncorporate taxpayers taxable income
and taxing it at ordinary income tax rates under 1(a)-(e)
- Usually capital gains are taxed under 1(h) at 15% (25% is also regularly used)
28 Percent Rate
- Imposed on capital assets that are collectibles:
o Art work, antiques, gems, coins stamps and alcoholic beverages
o 1202 gains, but only to the extent those gains are included in GI
25 Percent Rate
- imposed on unrecaptured 1250 gain to the extent such gain makes up net capital
gain
o This rate applies to gains on the sale of depreciable real property
15 Percent Rate
- pretty much all other types of capital gains other than those mentioned above
- Includes gain on stocks, bonds, investment land, and other types of capital assets
which is statutorily labeled adjusted net capital gain
The Regular Sections 1(a)-(e) 10 and 15 percent rates
- Get from class
The 5 percent Rate
- Get from class
Netting w/in Section 1(h)
- Netting first occurs w/in each rate classification.
- IF there are net losses w/in any classification, they then wipe out net gains that would
otherwise be taxed at the highest rate or combination of rates under the 1(h)(1) rate
schedule\
- Example: If a person has net losses from capital assets whose gains would be taxed at
a 15% rate, those net losses would first wipe out net 28 percent gains and then net
25% gains
Section 1202
- This section was added to the code to allow a noncorporate taxpayer an exclusion of
generally 50% of the gain on qualified small business stock held for more than 5
years
- The tax rate for this stock is 14% a one percent savings from 15%
Mechanics of Capital Losses

Section

Section

1222(2) and (4) defines short and long term capital loss and includes only losses as
are taken into account in computing taxable income
taken into account in computing taxable income is essentially asking if something
is deductible under 165(c)
Capital losses can be deductible to a limited extent
Capital losses in excess of capital gains can be deducted from
ordinary income
Any capital loss balance is carried over into succeeding taxable
years.
However the carryover loss is only applied against capital gains
(and to a limited extent against ordinary income)
1211(b) Limitation
A taxpayer can only can only deduct capital losses to the extent you have a capital
gain
The capital losses may be deducted against ordinary income to the lesser of
o $3K ($1.5K in case of MFsep) or
o The extent they exceed capital gains
1212(b) Carryover
This statute provides that capital losses not utilized in the year incurred are carried
over into subsequent taxable years and treated as long-term or short-term losses
depending on their original character
1212(b) only applies if capital losses exceed capital gains by more than $3K
In working w/ this statute one should make computations under 1212(b)(2) b/f
working w/ 1212(b)(1)
This section helps one determine the character of the capital loss:
o If its LTCL that exceeds the $3K then it will be treated as LTCL here,
o If its STCL that exceeds the $3K then it will be treated as STCL here.
o If its both net LTCL and STCL the STCL is used first
For best understanding see example in the book.

Problem p. 691 #1
Year 1
- LTCG = $2,000
- LTCL = $6,000
- Net long term capital loss = $4000
- STCG = $2,600
- STCL = $1000
- Net Short Term Gain = $1,600
- Net Capital Loss = $2,400
- B/c $2,400 is less than $3,000 (per 1211(b)(1)) we can deduct all $2,400 of the
capital loss against the taxpayers ordinary income
Year 2
- LTCG = $2,000
- LTCL = $10,000
- Net long term loss = $8000
- STCG = $2,000
- STCL = $4000
- Net Short Term Loss = $2000
- Net Capital Loss = $10,000
- Now b/c $10K exceeds $3K we must use 1212, and I believe first you recognize a
short term gain of $3,000 (1212(b)(2)(A))
o This changes our Net STCL to a STCG of $1K which changes our Net
Capital Loss from $10K to $7K ($8 -$1K)
o Per 1212(b)(1)(B) this $7K is then treated as a LTCL in the succeeding
taxable years
o Im not sure what happens after this, Get from Class
Class Notes:
- First Identify that there is NO way you are analyzing a capital gain
o Step back and see if you have more losses than gains or
more gains than losses.
- Could you ever have a Net Capital Gain if you didnt have any longterm capital gains.
o N0, b/c under 1222(11), its the excess of net long-term
capital gain over the net of short term capital loss
- Next analyze under 1211
o YEAR 1
o We have $7K of losses and $4,600 in gains
o 1211 says we can deduct losses to the extent we have gains
Therefore we can deduct $4,600 (this leaves us w/
$2,400)
o Then per 1211(b) we can deduct up to $3K in excess of the
gains and because we only have $2,400 we can deduct it all
- Year 2:
o We have 14,000 in losses and $4K in gains
o We must first net the losses against our gains which is 14K
versus $4K leaving us w/ $10K
o Next in 1211(b) we can deduct the lesser of $10K (the
remaining) or $3), so we can deduct $3K leaving us w/ $7K

o This means when all is said and done, we will have $4K in

gains and $7K losses, leaving:


$7K is our NCL
The only reason we want to know our NCL is to see
what can be carried over to next year.
o We can then deduct the losses to the extent we have gains.
This means of the $7K we can deduct $4K (what we have in
gains). This means we will have $3K left that cannot be
deducted.
o However per _____ we can deduct the $3K carryover in
subsequent years.
If we have a NCL defined by 1222, we can deduct those losses as a
carryover loss under 1212(b)
For the purposes of this class we dont need to know whether a
carryover is considered long term or short term loss

The Meaning of Capital Asset


Code 1221 Capital Asset Defined
- (a) Capital asset means property held by the taxpayer (whether or not connected w/
his trade or business), but does not include
o (1) Stock in the trade of the taxpayer, or property included in the inventory of
the taxpayer if on hand at the end of the year, or property held by the
taxpayer primarily for sale to customers in the ordinary course of his trade
or business
Was this for investment or business income: If
investment its more likely to be a capital asset on this
problem.
Most of the litigation in this part
If its a gain taxpayers will say it was just an
investment and it is a capital asset
If its a loss the taxpayer will say it was part of
their business and its not a capital asset
o (2) Property, used in his trade or business, of a character which is subject to
the allowance for depreciation provided in section 167, or real property used
in his trade or business
o (3) A copyright, a literary, musical, or artistic composition, a letter or
memorandum, or similar property, held by
(A) a taxpayer whose personal efforts created such property,
(B) in the case of letter, memo, or similar property, a tper for whom
such property was prepared or produced, or
(C) ..
o (4) Accounts or notes receivable acquired in the ordinary course or trade or
business for services rendered or from the sale of property described in
paragraph (1)
o (5) A publication of the U.S. Government (including the Congressional
Record) which is received from the U.S. Government or any agency thereof,
other than by purchase at the price at which it is offered for sale to the
public
(A)
(B)
o (6) Any commondoties derivative financial instrument held by a
commodoties derivative dealer, unless
(A)
(B)
o (7) Any hedging transaction which is clearly identified as such b/f the close
of the day on which it was acquired, originated, or entered into
o (8) Supplies of a type regularly used or consumed by the taxpayer in the
ordinary course of a trade or business of the taxpayer.
- (b) Definitions of
o (1) Commodities Derivative Financial Instruments
o (2) Hedging Transaction
Class Notes:
- Section (3)-(8) are easily defined
- (1)

o If its inventory its not a capital asset


o Property held by the taxpayer primarily for sale to customers
in the ordinary course of trade or business
What does this mean?
See Reg: 1221-1
o However gain or loss upon the sale or
exchange of land held by a taxpayer
primarily for sale to customers in the
ordinary course of his business, as in the
case of a dealer in real estate, Is not
subject to the provision of subchapter
1201, chapter of the Code

(2)

o Depreciable property used in a trade or business is not a


capital asset (but consider it again under 1231)

o Real property used in a trade our business is not a capital


asset

Mauldin v. Commissioner
- Petitioner (Mauldin) owned several lots of property for a long time.
- He claims it was a capital asset in order to receive the favorable tax treatment as a
capital gain
o Mauldin was aggressively engaged in selling the tracts of land during 1939
and 1940 but contends that after 1940 he had stopped
o This is important b/c if the property was held primarily for sale to customers
in the ordinary course of his trade or business it would not be a capital asset
( 1221(a)(1))
- However the Commissioner determined Mauldins profits were ordinary income
- The purpose for which the property was acquired is of some weight, but the ultimate
question is the purpose for which it was held.
- Here even though Mauldin didnt originally purchase the property w/ selling tracts in
mind, the record shows that he continually sold tracts of land as the economic market
allowed.
- Therefore b/c he held property primarily for sale to customers in the ordinary course
of his trade or business (1221(a)(1)) he cannot count the property as a capital asset
and thus cannot recognize the sales as a capital gain, and thus cannot get preferential
tax treatement.
- This Ct. Defines Primarily as of First Importance or principally
o Primarily is interpreted in its ordinary usage.
o This ct. says the Dist. ct. misapplied the correct legal standard so it remands
the case.
Malat v. Riddell
- Joint venturers purchase 40 acres of property and were going to rent it or sell it
whichever was most profitable
- Petitioner contends he is entitled to treat the profits from this last sale as capital
gains; the respondent takes the position that this was property held by the taxpayer
primarily for sale to customers in the ordinary course of business and thus subject to
taxation as ordinary income.

District ct. said petitioner failed to establish property was not held primarily for
sale to customers in the ordinary course of business and thus rejected petitioners
claim that it was a capital asset giving him capital gain treatment

The Sale or Exchange Requirement


Kenan v. Commissioner
- There is a will that mandates at the age of 40 a beneficiary receive $5 million and it
can be in cash or marketable securities
- The trustees give half in cash and half in marketable securities
- B/c the securities appreciated in value during the period for which they were held by
the trustees and the Commissioner said that transfer to the niece resulted in capital
gains which were taxed to the trustees under the rates specified.
- I dont understand why the Commissioner wants it to be a capital
gain
Hudson v. Commissioner
- Is the gain realized from the settlement of a judgment ordinary income or capital gain
when the settlement was made b/t the judgment debtor (Hudson and Taylor), the
transferee from a prior judgment creditor (Cole).
- Petitioners claims it is capital gain, but the Respondent has determined it is ordinary
income.
- Question was there a sale or exchange of the capital asset
- The ct. says that when the judgment debtor settled the judgment, the claim arising
from the judgment was extinguished w/out the transfer of any property or property
right to the judgment debtor.
Text Notes:

What is a sale or transaction?


o Its not determined by what the parties call the exchange

Holding Period
- To get long term treatment it must be greater than 1 year.
- If you get something by gift the donors holding period tacks on to
the donees time period
- If you receive property by bequest its automatically long term
capital gain treatment for beneficiary even if decedent didnt hold it
for 1 year.

Section 1231 Recharacterization


Class Notes on 1231
- If you have 1231 property, it gets a second chance to be treated as
a capital asset
o You can get 1231 gains if they are greater than 1231 losses
- 1231(a)(3) Gains
o This takes what was exempted (couldnt be a capital asset)
out of 1221(2) and this section gives it a second chance
- 1231(a)(1)
o If 1231 gains exceed 1231 losses for any taxable year they
are treated as LTCG and LTCL
o You put all gains and losses together (hotchpot) and if theres
more gains than losses all the gains then are capital gains
and all the losses are capital losses this is a good thing
- 1231(a)(2)
o If losses exceed gains everything is treated as a ordinary
instead of capital gains.
Code 1231 Property Used in the Trade or Business and Involuntary
Conversions
- (a)(1) If 1231 gains exceed 1231 losses for any taxable year they are treated as
LTCG and LTCL
- (a)(2) If 1231 gains do not exceed 1231 losses for any taxable year such gains
and losses shall not be treated as gains and losses from sales or exchanges of capital
assets.
- No Netting is Required
- (a)(3)(A) 1231 Gain means
o (i) Any recognized gain on the sale or exchange of property used in the trade
or business, and
o (ii) any recognized gain from the compulsory or involuntary conversion (as a
result of destruction in whole or in part, theft or seizure, or an exercise of the
power of requisition or condemnation or threat of imminence thereof) into
property or money of
(I) property use in the trade or business,
(II) any capital asset which is held for more than 1 year and is held in
connection w/ a trade or business or a transaction entered into for
profit.
- (a)(3)(B) 1231 Loss means any recognized loss form a sale or exchange or
conversion described in subparagraph (A)
Code 1231(b) Definition of Property Used in the Trade or Business For the
purposes of this subsection
- (1) The term property used in the trade or business means property used in the
trade or business, of character which is subject to the:
o The allowance for depreciation provided in 167, held for more than 1 year,
and
o Real property used in the trade or business held for more than 1 year, both of
which are not
- (A) Property which would be inventory to the taxpayer at the end of the year

(B) Property held primarily for the sale to customer in the ordinary course of business
(C) a copyright, a literary, musical, or artistic composition, a letter or memo, or
similar property, held by a tper
- (D) a publication of the US Government
- (2) Timber, Coal, or Domestic Iron Ore
- (3) Livestock
o See code for more details
- (4) Unharvested Crop
Code 1231(c) Recapture of Net Ordinary Losses
- (1) The net 1231 gain for any taxable year shall be treated as ordinary income to the
extent such gain does not exceed the non recaptured net section 1231 losses
- (2) Non recaptured net section 1231 losses
o Non Recaptured net 1231 losses means the excess of
o (A) the aggregate amount of the net section 1231 losses for the 5 most recent
preceding taxable years beginning after Dec. 31, 1981, over
o (B) the portion of such losses taken into account under paragraph (1) for such
preceding taxable years
Text Notes on 1231
- B/c of 1231 sometimes a capital asset is created where one doesnt exist
o Its all about recharacterization
- Under 1231(a) no netting is required
- Overview:
o 1231(a) allows taxpayer to treat things (property used in the trade or
business) that would normally not be capital gains to be treated that way.
It allows us to treat those things as capital gains and still deduct
losses as ordinary income, not capital losses
o 1231(c) places a limitation on what 1231 transactions may be treated as
gains.
For instance the gains from 1231 transactions must be offset against
losses from the preceding 5 years.
Ex. If you had $10K of gains in year 3 but in year 1 lost $5K
and year 2 lost $3K then you would be able to treat $2K as
capital gains and $8K as ordinary income
PROBLEM
P. 749, Q3
(a) Sells business for $100,000k
Full (ordinary tax) on Inventory sold (AR-AB) = $8k tax gain
Full (ordinary tax) on Goodwill sold = $20k tax gain
Full (ordinary tax) on noncompete = $10k tax gain
Land (used in business), Building (used in business) and Machinery &
Equipment (used in business) are all non- 1221 capital assets, but are given
a second chance under the 1231 hotchpot. In this scenario, the losses
($10k) exceed the gains ($7k), so the gains and losses are treated as
ordinary.
(b) Sells stock (basis of $70k) for $90k
Selling stock is eligible for net capital gain treatment

Class Notes on 1245


- If you buy property for $100K and you capitalize it taking
depreciation on it as you go
o You own it for 7 years and its 5 year property, meaning youve
depreciated the entire $100K
o Your basis is $100K (1012), but your AB is $0 (1016)
o What happens now if you go to sell the property for $30K, do
you have a gain.
From a tax pt. of view you would have a gain $30 - $0 =
$30,
You have the gain b/c youve taken depreciation
deductions all along, this is true even though you
dont have a financial gain (you bought it for $100K
and sold it for $30)
o You took a depreciation deduction of $100K and a taxable gain
of $30K, which gives you a $70K loss (excess of deductions over
gains)
Why do we have 1245 or 1250
o Its about character.
o But for 1245 wed be taxing the gain at 15% but only getting tax
savings on the $100K loss of 35%
o 1245 to the extent that any gain was generated from
depreciation deductions its recharacterized as ordinary income
If you sell something below what you paid for it and you
have a gain b/c you took depreciation then all that gain
should be recaptured and recharacterized as ordinary
income.
- What if in the example above you would have sold the land for $120
(after you have an AB of $0 due to depreciation)
o $100 would be taxed as ordinary income (per 1045), but the $20
in excess of what you paid for the property should be a capital
gain and taxed accordingly (15%)
o If you sell property for more than what you pay for it that
amount over what you paid is capital gain (the real economic
gain can be taxed as a capital gain), but the rest is ordinary
income
- 1245 Statutory Language
o Says you take Recomputed basis (AB + Depreciation deductions
you took) and you compare this to the AR.
You then take the lesser of those two and the excess of
this amount over the AB should be ordinary income.
The remaining that is not ordinary income may be taxed
as a capital gain.
- What is 1245 property?
o See 1245(a)(3)
Its depreciable property

Its personal property tangible property (NOT real


property)

Dont focus on the 1245(a)(3)(B)

Code 1245(a) Gain From Dispositions of Certain Depreciable Property


(a) General Rule
o (1) If 1245 property is disposed of the amount by which the lower of
(A) the recomputed basis of property, or
(B) (i) in the case of a sale, exchange, or involuntary conversion, the
amount realized, or
(ii) in the case of any other disposition, the FMV of such
property,
o Exceeds the adjusted basis of such property be treated as ordinary income. Such
gain shall be recognized notwithstanding any other provision of this subtitle.
o (2)(A) Recomputed Basis means w/ respect to any property, its adjusted basis
recomputed by adding thereto all adjustments reflected in such adjusted basis on
account of deductions (whether in respect of the same or other property) allowed
or allowable to the taxpayer or to any other person for depreciation or
amortization
(B) Dont need to Know!
(C) Dont need to Know!
o (3) Section 1245 Property For purposes of this section, the term section 1245
property means any property which is or has been property of a character
subject to the allowance for depreciation provided in 167 (while in the
tpers hands or the hands of others) and is either
(A) personal property,
(B) other property (not including a building or a structural component)
but only if such other property is tangible and has an adjusted basis in
which there are reflected adjustments described in paragraph (2) for a
period in which such property (or other property)
(i)
(ii)
(iii)
(C) so much of any real property (other than any property described in
(B)) which has an adjusted basis in which there are reflected adjustments
for amortization under ..
(D)
(E)
(F)
Code 1245(b) Exceptions and Limitations
- (1) Gifts Subsection (a) shall not apply to a disposition by gift
- (2) Transfers at Death Except as provided in 691 subsection (a) shall not apply to
a transfer at death
- (3) Certain Tax-Free Transactions
- (4) Like Kind Exchanges; Involuntary Conversions
- (5) Property Distributed by a Partnership to a Partner
- (6) Transfers to Tax Exempt Organizations Where Property will be used in Unrelated
Business

(7) Timber Property


(8) Disposition of Amortizable 197 Intangibles.

Recapture Under 1245 Text Notes:


- Predominately a characterization provision converting what is possibly capital
gain to ordinary income, but here we recognize that they are significant
recognition sections as well (requiring a recognition of a gain)
- 1245 provides for the inclusion in GI (as ordinary income) of the gain from the
disposition of certain depreciable property, to the extent of depreciation deductions
taken in periods after Dec. 31, 1961, which are reflected in the adjusted basis of such
property
- Treats gains of 1245 property shall be treated as ordinary income
- Recapture is best understood if you consider it to be the lower of:
o In case of a sale or exchange or involuntary conversion:
Recomputed basis Adjusted basis or Amount realized Adjusted Basis;
OR
o In the case of other disposition of property:
Recomputed basis Adjusted Basis or FMV Adjusted Basis
- Ex of Recomputed basis, if someone had property they purchased for $10K and then
over time depreciated it for $2K, then when they give it to you even though
their/your adjusted basis is $8K, the recomputed basis is $10K.
Revenue Rule 69-487
- A car is held only for business purposes.
- Conversion to personal use is not a disposition of the automobile
- Accordingly there is no gain to be recognized by the tper upon the conversion of
personal use.
- However the provisions of 1245 of the Code would apply to any disposition of the
automobile by the taxpayer at a later date.

PROBLEM
P. 763, Q1
(a) Recap sells the equipment to Buyer in Y7 for $30,000
Because it is 5-year property, the property has depreciated to 0 and the
TPs adjusted basis is therefore 0
AR-AB = $30k gain eligible to be treated as second chance capital gain
Under 1245, the amount will be recaptured and treated as ordinary
gain
(b) What difference if Recap had elected to use 179?
1245 says we will treat 179 deductions just like ordinary deductions
(c) What if didnt take depreciation deduction?
1245(a)(2)(A) says this applies to deductions you actually took (allowed)
or deductions (you could have taken)
Therefore youd have $100K added back whether you take the
depreciation or not.
What happens if you dont actually take the deduction
1016(a)(2) you reduce the amount of AB by the
depreciation allowed, but not less than the amount
allowable.
Even if you never take depreciation on a tax return you
still have to reduce your basis by what you could have
taken
(d) If Recap sells to spouse?
There is a gain realized but per 1041 there is no gain recognized and you
cant have recapture if there is no gain recognized
1245 does not effect the amount of a gain it only effects the character of
such gain.
When the spouse then sells the property is it all capital gain to the spouse,
No the character of ordinary income carries forward to the
spouse.
When transferee spouse resells the property any gain
must be recharacterized as ordinary income (last part of
1245(a)(2)(A))
(e) Sells to Desperate for $110k
That 10K of real gain still has the ability to be capital gain, but the other
$100K will be recharacterized as ordinary of gain
Class Notes on 1250
- This is the section on Real Property
- However land is not depreciable so this isnt what we are talking
about
- So if were talking about 1250 and recapture were referring to the
building itself b/c it must be depreciable realty.
1250 Statutory Language
- What is 1250 property
o Any real property, thats depreciable (cant be land)
- Whats Additional Depreciation (1250(b))

o Additional depreciation is what you took on your tax return less

what you would have taken had you used the straight line
deprecation (any real property can only use straight line)
This will always = zero b/c both elements are the same
thing.
- Providing you have property placed into service after 1986 you
have no recapture
- This means that you will always take ordinary deductions on real
property
There is only one catch ( 1(h)(6))
- Instead of getting the 15% prize this type of property is taxed at
25%
Summation:
- No recapture on real property but the gain thats generated b/c of
depreciation deduction is taxed at 25%

Code 1250 Gain From Disposition of Certain Depreciable Realty


- (a) General Rule Except as otherwise provided in this section
o (1) Additional Depreciation after December 31, 1975
(A) If 1250 property is disposed of after December 31, 1975, the the
applicable percentage of the lower of
(i) that portion of the additional deprectiation (defined in (b)(1)
or (4)) attributable to periods after Dec. 31, 1975, in respect of
the property, or
o Always zero, so it will always apply b/c it
says take the lower
(ii) the excess of the amount realized (in the case of sale,
exchange, or involuntary conversion), or the FMV of such
property (in the case other disposition), over the adjusted basis of
the property,
Shall be treated as gain whichi s ordinary income. Such gain shall be
recognized notwithstanding any other provision of this subtitle.
Text notes on 1250
- 1250 treats as ordinary income a certain percentage (generally 100%) of what is
called additional depreciation or the amount of gain realized on the sale of the
property, whichever is smaller.
Problem p. 766 # 1
- If such real property is held for a period of one year or less, all depreciation allowed
is treated as additional depreciation, other wise the 1986 act made 1250 property a
dead letter b/c the amount of additional depreciation will generally be zero.

Deductions Affected By Characterization Principles


Bad Debts and Worthless Securities
Code 166 Bad Debts
- (a)(1) Wholly Worthless Debts There shall be allowed as a deduction any debt
which becomes worthless w/in the taxable year
- (a)(2) Partially Worthless Debts When satisfied that a debt is recoverable only in
part, the Secretary may allow such debt, in an amount not in excess of the part
charged off w/in the taxable year as a deduction
- (b) Amount of Deduction for purposes of subsection (a), the basis for determining
the amount of the deduction for any bad debt shall be the AB provided in 1011 for
determining the loss from the sale or other disposition of property.
- (d) Non Business Debts
o (1) General Rule In the case of a taxpayer other than a corp.
(A) subsection (a) shall not apply to any nonbusiness debt; and
(B) where any nonbusiness debt becomes worthless w/in the taxable
year, of a capital asset held for not more than 1 year
o (2) Nonbusiness Debt Defined means a debt other than
(A) a debt created or acquired (as the case may be) in connection w/ a
trade or business of the taxpayer; or
(B) a debt the loss from the worthlessness of which is incurred in the
tpers trade or business
If its a nonbusiness debt it may be a capital loss
- (e) Worthless Securities This section shall not apply to a debt which is evidenced by
a security as defined in 165(g)(2)(C).
Howard S. Bugbee v. Commissioner
- Commissioner alleged a deficiency of $7K
- Issue: has petitioner established the existence of a debtor-creditor relationship w/
respect to funds advanced by petitioner to one Paul Billings and thereby validated his
claim to a short term capital loss under 166(a), (d).
- Bugbee owned a bar and Billings was a patron
- Bugbee ended up advancing $19,750 to Billings
- Bilings was actually unemployed during this time and while he used some of the
money to investigate business possibilities the majority of it was used to live off of.
- Petitioner claimed the loans as Bad Debts on his 1966 tax return, but the IRS
wouldnt allow it b/c he hadnt established the debtor-creditor relationship when he
made the loans.
Opinion:
- to qualify under 166 there must first be a bona fide debt which arises from a debtor
creditor relationship
o This means you must examine the parties intent
- The ct. decides that b/c the petitioners financial state showed he expected to be
repaid, its an indication that a debtor creditor relationship existed.
Text Notes:
Ask three questions:
- 1. Is there a debt? (to be bad debt it must be a debt)

o There is a presumption that transfers b/t relatives and close friends dont
-

constitute loans (debt).


To be bad debt it must be a loan and not a gift
2. Is it a bad debt?
3. Is it a business bad debt?

Problems p. 780 #1
(a) The relation of the parties, and the intention when the services and the bill was sent
o IF they are not related and the services were not a gift the bad debt may be
deductible
o Assume here there is a debt.
o Here you need to know if they are using cash or accrual method.
Under cash method income is recorded when you get the
cash
If youre accrual basis youre recording income when the
services are performed
They would have reported income in year 1 but
wrote it off in year 6 as worthless
o What factors will you look at to see if its worthless?
Length of time debt is outstanding
(b) Yes the SOL does effect the lawyer b/c under 166(a)(1) the deduction is only allowed in the
year in which the debt became worthless
- Normally SOL is 3 years unless its fraud in which its open forever
- The service is saying were disallowing the deduction in year 6 b/c it
should have been deducted in year 2.
- This means you reported income, never collected, and dont get to
take a deduction
- 6511 allows for times when the SOL may be extended beyond 3
years, in this case it extends to 7 years.
(c) Great question
o He might have to report a gain of $1000 to offset the loss in addition to his
reporting of $1000 of GI. (I doubt this is right)
o Facts:
Assume in year 1, you report income in year 1 b/c you use
the accrual system, in year 6 you write it off as bad debt,
if you are then paid the money in year 7 you must report
that money as GI, b/c you are better off.
What type of expense is the debt?
- Capital or Ordinary
o Ordinary (166)

Casualty and Theft Losses


Code 165(c) Losses Limitation on Losses of Individuals
- (a) there shall be a deduction any loss sustained during the taxable year and not
compensated for insurance or otherwise
- (c) In the case of an individual, the deduction under subsection (a) shall be limited to
o (1) losses incurred in trade or business
o (2) losses incurred in any transaction entered into for profit, though not
connected w/ a trade or business; and
o (3) except as provided in subsection (h), losses of property not connected w/
a trade or business transaction entered into for profit, if such losses arise
from fire, storm, shipwreck, or other casualty, or from theft.
You need actual loss, something must be rendered
unusable.
Ex. If a drought kills your trees and theyre
gone, thats a casualty loss, if they just lose
some limbs, thats not a loss
You can have more than one casualty in one year
Define a Other Casualty:
Must be Sudden or Unexpected (Rev. Ruling 63232)
o Ex a person who lost a diamond after it
was loosened a day earlier would not
have a deduction for loss b/c its b/c it
wasnt expected
o Unexpected means that it couldnt be
predictable (ex. Mudslide, earthquake)
Code 165(h) Treatment of Casualty Gains and Losses
- (h)(1) $100 limitation per casualty any loss of an individual described in subsection
(c)(3) shall be allowed only to the extent that the amount of the loss to such
individual arisiong from each casualty,. Or from each theft exceeds $100
o Essentially you must subtract $100 from each loss
- (h)(2)Net Casualty Loss Allowed only to the extent it Exceeds 10% of AGI
o (A) If the personal casualty losses for any taxable yr. exceed the personal
casualty gains for such taxable year, such losses shall be allowed for the
taxable year only to the extent of the sum of
(i) the amount of the personal casualty gains for the taxable year,
plus
(ii) so much of such excess as exceeds 10% of the AGI of the
individual
Text Notes
- Losses incurred in the taxpayers trade or business are deductible under 165(a) and
(c)(1) w/out regard to how
- Generally a loss outside Ts business and in a transaction not entered into for profit
generally are not deductible in keeping w/ the philosophy of 262.
- Casualty and theft losses are permitted under 165(c)(3)
Rev. Ruling 63-232

Termite damage does not constitute casualty or loss provided for in 165(c)(3)

Pulvers v. Commissioner
- Issue: can a taxpayer claim as other casualty loss damage that occurred via a
mudslide to 3 surrounding properties but did not harm their property in anyway,
except that it negatively effected the property values.
- The ct. here says NO it does not qualify. They seem to fell there needs to be some
form of physical damage
Marry Frances Allen v. Commissioner
- Petitioner lost a brooch while visiting the MET of modern art. She cannot prove it
was stolen
- ITs the petitioners burden to prove it was stolen and she cannot do that.
- The dissent feels the brooch was stolen.
Other Aspects of Casualty
- You do not only have losses when you suffer a casualty or theft, you could also have
a gain.
- Ex. You have a ring you purchased a long time ago w/ a basis of 1k which is worth
10K today. This would be a gain
Timing:
- Casualty losses are deductible for the year in which the loss is sustained (Reg.
1.165-7(a)(1)
o This could be subsequent years if it took that long for the full amount of the
loss to be accertained
- Theft losses are generally a deduction for the year in which the theft is discovered
o If you deduct theft losses in year one and in subsequent years realize other
items that were stolen you must amend the return for year 1 instead of filing
a loss deduction in a subsequent year.
- Neither theft nor casualty losses are deductible if there is a chance of recovery unless
you are sure there will be no recovery. Reg. 1.165-1(d)(2)
Measuring Losses (See Reg. 1.165-7(b)
- 165(h)(1) puts a $100 minimum on personal losses not related to a trade or business
- On personal property the value of the loss is the value immediately preceding the
casualty and the value after the casualty (this value may be zero) - Helvering v.
Owens
- 1231 hotchpot rules apply to characterize only business and proft-making property
losses
o Do we need to know 162(h)(2)
Problem p. 814 #1(a) and #2
- (1)(a) Her personal casualty loss on the car is $7K, the difference b/t the value
immediately b/f the accident ($8K) and the value after the acciedent ($1K)
Helvering v. Owens
- Immediately you know that 165(c)(1) (2) dont apply b/c its a
personal loss
- Basis = 10K
- FMV before wreck = 8K
- After wreck FMV = 1K

Amount of loss = FMV before FMV afterwards which = $7K


This should further be reduced by the $1K she received from
insurance so w/ the car she has a $6K loss
o This is a capital loss
o It must also be reduced by $100 (165(h))
What about the Vase
o 10K basis
o 20K FMV
o 20K insurance
This means she has a 10K casualty gain
It would be a capital gain
This must also be reduced by $100 (165(h)
Most casualtys are losses not gains
You have a casualty loss of $5,900 loss
o B/c this is not listed in 62 we know that casualty losses are
below the line
o Then check 67 to see if this is miscellaneous losses
Its listed in 67 so a casualty loss is a nonmiscellaneous loss
o However b/c a casualty loss it is subject to a 10% floor
(165(h)(2)(A))
You would then take $5,900 - $3K (10% of AGI) which
will give us a deductions of $2,900.