1

TABLE OF CONTENTS [FEDERAL INCOME TAX: FALL 2011, PROF. HEEN] I. Compensation for services including fees, commissions, fringe benefits, and similar items; 2 a. Services paid for in property 2 i. 83 Property transferred in Connection with Performance of Services... 1. Election to include in GI in year of transfer 2. Transferability of Property 3. Substantial Risk of Forfeiture 4. Property forfeited while substantially non-vested 5. Property sold/disposed of while substantially non-vested b. Services paid for in exchange for other services 2 c. Certain Fringe Benefits 2 i. Meals/Lodging Furnished for Convenience of the Employer 2 ii. Other Fringe Benefits 2-9 1. No-additional-cost service 2 2. Qualified employee discount 3 i. Property 3 ii. Services 3 iii. Gross profit percentage 4 3. Working condition fringe 4 4. De minimus fringe 4 i. Treatment of Certain Eating Facilities 5 1. NOTE on highly compensated employees. CB p. 126 5. Qualified Transportation Fringe 5-7 i. Transit Pass 6 ii. Commuter Highway Vehicle 6 iii. Qualified Parking 7 iv. Bicycle 7 b. Qualified Moving Expense Reimbursement 7 c. Qualified Retirement Planning Services 8-9 iii. Compensation for Injuries or Sickness 1. AR Workmens compensation 2. AR Damages for Personal injury/physical sickness 3. AR through Accident/Health Insurance 4. AR as pension, annuity or similar allowance for personal injuries or sickness resulting from active military service. 5. AR as disability attributed to terroristic/military activity iv. Amounts Received Under Accident or Health Plans 1. Amounts attributable to employer contributions 2. Amounts expended for medical care 3. Payments unrelated to absence from work v. Rental of Parsonages see rent-V vi. Educational Assistance Programs vii. Dependent Care Assistant Programs Gross income derived from business; Gains derived from dealings in property; Interest;

II. III. IV.

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V. VI. VII. VIII. IX. Rents; Royalties; Dividends; Alimony and separate maintenance payments; Annuities; a. Excluded from GI: i. Amounts received as a pension/annuity for injuries/sickness resulting from military service: 104(a)(4) ii. That part of any amount received as an annuity under an annuity, endowment, or life insurance contract, which bear the same ratio to such amount as the investment in the contract bears to the expected return. 72(b)(1). Amount Received; IiC:ER Income from life insurance and endowment contracts; Pensions; Income from discharge of Indebtedness; Distributive share of partnership gross income; Income in respect of a decedent; AND Income from an interest in an estate or trust.

X. XI. XII. XIII. XIV. XV.

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COMPUTING TAXABLE INCOME: A. Income = Rights Exercised in Consumption +/- Wealth B. TAXES DUE EQUAL TO: a. Gross income minus above the line deductions included in 62(a) equals adjusted gross income. Adjusted gross income minus personal exemptions under 151, minus either the standard deduction or itemized deductions, equals Taxable Income. Taxable Income less any tax credits equals taxes due. b. GROSS INCOME i. Deductions included in 62(a) [above the line deductions] 1. = ADJUSTED GROSS INCOME a. Personal Exemptions 151 b. Standard Deduction OR Itemized Deductions i. = TAXABLE INCOME 1. Tax Credits C. DEFINITIONS: a. ABOVE THE LINE DEDUCTIONS: 62(a) i. Note: Nothing in this section shall permit the same item to be deducted more than once. 62(a). ii. Benefit of Above the Line Deduction: Above the line deductions are favorable to high income tax payers, and therefore not particularly progressive, because they are available to all taxpayers, regardless of the taxpayers tax bracket or choice to itemize or take the standard deduction. If high income taxpayers were required to take these deductions below the line, and they, as many higher income taxpayers do, itemized their deductions, they would be subject to the 7% threshold for itemized deduction under **** iii. (1) Trade and business deductions 1. The deductions allowed by this chapter (other than by part VII of this subchapter [200 series]) which are attributable to a trade or business carried on by the taxpayer, if such trade or business does not consist of the performance of services by the taxpayer as an employee. iv. (2) Certain trade and business deductions of employees 1. (A) Reimbursed expenses of employees a. The deductions allowed by part VI (section 161 and following) which consist of expenses paid or incurred by the taxpayer, in connection with the performance by him of services as an employee, under a reimbursement or other expense allowance arrangement with his employer. The fact that the reimbursement may be provided by a third party shall not be determinative of whether or not the preceding sentence applies. 2. (B) Certain expenses of performing artists a. The deductions allowed by section 162 which consist of expenses paid or incurred by a qualified performing artist in connection with the performances by him of services in the performing arts as an employee. 3. (C) Certain expenses of officials a. The deductions allowed by section 162 which consist of expenses paid or incurred with respect to services

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performed by an official as an employee of a State or a political subdivision thereof in a position compensated in whole or in part on a fee basis. 4. (D) Certain expenses of elementary and secondary school teachers a. In the case of taxable years beginning during 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, or 2011, the deductions allowed by section 162 which consist of expenses, not in excess of $250, paid or incurred by an eligible educator in connection with books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom. 5. (E) Certain expenses of members of reserve components of the Armed Forces of the United States a. The deductions allowed by section 162 which consist of expenses, determined at a rate not in excess of the rates for travel expenses (including per diem in lieu of subsistence) authorized for employees of agencies under subchapter I of chapter 57 of title 5, United States Code, paid or incurred by the taxpayer in connection with the performance of services by such taxpayer as a member of a reserve component of the Armed Forces of the United States for any period during which such individual is more than 100 miles away from home in connection with such services. (3) Losses from sale or exchange of property 1. The deductions allowed by part VI (sec. 161 and following) as losses from the sale or exchange of property. (4) Deductions attributable to rents and royalties 1. The deductions allowed by part VI (sec. 161 and following), by section 212 (relating to expenses for production of income), and by section 611 (relating to depletion) which are attributable to property held for the production of rents or royalties. (5) Certain deductions of life tenants and income beneficiaries of property 1. 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 depreciation allowed by section 167 and the deduction allowed by section 611. (6) Pension, profit-sharing, and annuity plans of self-employed individuals 1. In the case of an individual who is an employee within the meaning of section 401 (c)(1), the deduction allowed by section 404. (7) Retirement savings 1. The deduction allowed by section 219 (relating to deduction of certain retirement savings).

v.

vi.

vii.

viii.

ix.

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x. (9) Penalties forfeited because of premature withdrawal of funds from time savings accounts or deposits 1. The deductions allowed by section 165 for losses incurred in any transaction entered into for profit, though not connected with a trade or business, to the extent that such losses include amounts forfeited to a bank, mutual savings bank, savings and loan association, building and loan association, cooperative bank or homestead association as a penalty for premature withdrawal of funds from a time savings account, certificate of deposit, or similar class of deposit. (10) Alimony 1. The deduction allowed by section 215. (11) Reforestation expenses 1. The deduction allowed by section 194. (12) Certain required repayments of supplemental unemployment compensation benefits 1. The deduction allowed by section 165 for the repayment to a trust described in paragraph (9) or (17) of section 501(c) of supplemental unemployment compensation benefits received from such trust if such repayment is required because of the receipt of trade readjustment allowances under section 231 or 232 of the Trade Act of 1974 (19 U.S.C. 2291 and 2292). (13) Jury duty pay remitted to employer 1. Any deduction allowable under this chapter by reason of an individual remitting any portion of any jury pay to such individuals employer in exchange for payment by the employer of compensation for the period such individual was performing jury duty. For purposes of the preceding sentence, the term jury pay means any payment received by the individual for the discharge of jury duty. (14) Deduction for clean-fuel vehicles and certain refueling property 1. The deduction allowed by section 179A. (15) Moving expenses 1. The deduction allowed by section 217. (17) Interest on education loans 1. The deduction allowed by section 221. (18) Higher education expenses 1. The deduction allowed by section 222. (19) Health savings accounts 1. The deduction allowed by section 223. (20) Costs involving discrimination suits, etc. 1. Any deduction allowable under this chapter for attorney fees and court costs paid by, or on behalf of, the taxpayer in connection with any action involving a claim of unlawful discrimination (as defined in subsection (e)) or a claim of a violation of subchapter III of chapter 37 of title 31, United States Code [1] or a claim made under section 1862(b)(3)(A) of the Social Security Act (42 U.S.C. 1395y (b)(3)(A)). The preceding sentence shall not apply to any deduction in excess of the amount includible in the taxpayers gross income for the taxable year on account of a judgment or settlement (whether by suit or agreement and

xi. xii. xiii.

xiv.

xv. xvi. xvii. xviii. xix. xx.

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whether as lump sum or periodic payments) resulting from such claim. xxi. (21) Attorneys fees relating to awards to whistleblowers 1. Any deduction allowable under this chapter for attorney fees and court costs paid by, or on behalf of, the taxpayer in connection with any award under section 7623 (b) (relating to awards to whistleblowers). The preceding sentence shall not apply to any deduction in excess of the amount includible in the taxpayers gross income for the taxable year on account of such award. b. PERSONAL EXEMPTIONS: 151 i. Exemption Amount: 1. Under 151(d)(1), the exemption amount is $ 2,000, adjusted for inflation under 151(d)(4). 2. Pursuant to Under Rev. Proc. 2011-12, 3.07 (1), for taxable years beginning in 2011, the personal exemption amount under 151(d) is $3,700. ii. Allowed for: 1. Taxpayer: 151(a) 2. Taxpayers Spouse: 151(b) a. Additional exemption of the exemption amount may be taken for taxpayers spouse if: i. no joint return is filed by the taxpayer and his spouse, AND ii. the spouse has no gross income for the calendar year in which the taxable year of the taxpayer begins, AND iii. the spouse is not the dependent of another taxpayer. 3. Taxpayers Dependents: 151(c) a. An exemption of the exemption amount for each individual who is a dependent (as defined in section 152) of the taxpayer for the taxable year. b. Exception: i. Pursuant to 151(d)(2), exemption of the exemption amount is disallowed with respect to dependents with 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. iii. Justification for Personal Exemption: 1. If justification is that personal deductions under 151 are a subsistence allowance, it makes sense to phase out the personal exemption at higher income levels. However, the phase out under 151(d)(4) is not currently in effect, so high income taxpayers like Bill Gates receive the same personal exemption as a person making 20,000/year. c. STANDARD DEDUCTION: 63(c)(2)

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i. Justification: The justification for permitting the standard deduction in lieu of itemizing deductions is to prevent people from itemizing, which is an administratively difficult practice. ii. Marital Status: 1. Marital status is determined at the end of the taxable year. 60(13)(d) & 7703(a)(1). 2. Legally separated spouses may not file as married. 7703(a)(2). a. Exception to the rule under 7703(a)(2) is the case of abandonment: b. 7703(a)(2) does not apply if such taxpayer spouse is a 7703(e) head of household; [abandonment/other spouse absent for 6 months of year/ if taxpayer furnishes over half of support for the year] 3. Reasons not to file jointly. a. In the case where there are trust issues, taxpayers should think carefully before filing jointly because of joint and several liability in filing a joint return; if a spouse is hiding assets or is one who generally files tax return and does so incorrectly, the other spouse is on the hook for the whole of the tax liability] b. Innocent Spouse Rule (relief provision) but it is quite difficult to achieve that kind of relief. i. 6015(b): spouses/former spouses ii. 6015(c): separated/divorced couples iii. Equitable relief 6015(f) iii. 05 (1) In general. Under Rev. Proc. 2011-12, 3.05, for taxable years beginning in 2011, the standard deduction amounts under 63(c)(2) are as follows: Filing Status Standard Deduction Married Individuals Filing Joint Returns and Surviving Spouses ( 1(a)) $11,600 Heads of Households ( 1(b)) $8,500 Unmarried Individuals (other than Surviving Spouses and Heads of Households) ( 1(c)) $5,800 Married Individuals Filing Separate Returns ( 1(d)) $5,800

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iv. d. ITEMIZED DEDUCTIONS: e. TAX CREDITS i. Earned Income Tax Credit 1. Credit is refundable, so it represents a transfer from government to taxpayer; these people would also be subject to payroll taxes, so the EITC serves as a way to offset that amount. 2. Calculation of Earned Income Tax Credit: a. D. RULES FOR DETERMINING PROPER METHOD OF ACCOUNTING: a. E. METHODS OF ACCOUNTING: a. Cash Method of Accounting i. Generally Applicable to: ii. Income: 1. 451(a) 2. Gains, profits and income are to be included in gross income for the taxable year in which they are actually or constructively received by the taxpayer unless includible for a different year in accordance with the taxpayers method of accounting. 1.4511(a). 3. However three rules or doctrines can accelerate income: a. Constructive Receipt: 1.451-2(a) b. Cash Equivalent (checks, money orders): Cowden ccase c. Economic Benefit: Sprouill case iii. Deduction 1. Payment1.461-1(a)(1) 2. But capitalization of expenditure required if it results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year. iv. Deferred Compensation: 1. Under Rev. Rul. 60-31, the Service will not urge application of the cash equivalency doctrine to require immediate inclusion in income of the present value of an unfunded deferred compensation contract even when the employees rights are nonforfeitable and the employer has unquestionable ability to pay. The cash equivalency doctrine might apply if something more than a mere promise guarantees the employees right to receive payment. See also Henritze v. Commissioner.

a.
v. b. Accrual Method of Accounting: i. Generally Applicable to: ii. General Rule GI: Income is includible when: All events Test 1. Under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. 1.451-1(a). 2. All events occur upon the earliest of: a. Performance b. Due date of performance

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c. Payment being made General Rule: Deductions; Deductions deductible when: 1. 461(a) 2. 1.461-1(a)(2): Deduct when all events have occurred that establish the fact of the liability, an the amount can be determined with reasonable accuracy. 3. Capitalization Requirement applies here: 1.461-1(a)(2). iv. Really a hybrid system; where you see disparities is where government is concerned with getting hands its on revenues. v. F. GENERAL RULES: a. Earned income cannot be assigned to another taxpayer for tax purposes: Lucas v. Earl (1930). b. The Marriage Penalty: i. Because of the discrepancy between Community Property States and Common Law States (See Poe v. Seaburn) with regard to income splitting, Congress allows married couples to file jointly (splitting their income 50/50), which creates a singles penalty. To combat this, Congress instituted the Marriage Penalty. ii. The marriage penalty does not offend the equal protection clause and is, therefore, not unconstitutional because it is not an obstacle to the fundamental right of marriage itself. Druker v. Commissioner. 1. Justifications for Marriage Penalty a. Progressivity b. Marriage Neutrality (singles v. married couples) c. Treating married couples with equal earnings equally. i. It is impossible to satisfy all three goals because permitting joint tax returns for married couples, and thereby treating common law and community property states the same, creates a marriage bonus, which in turn causes a singles penalty. The marriage penalty ameliorates the singles penalty, which maintains horizontal equity among taxpayers. iii. Marriage Bonus 1. The current code provides a marriage bonus in favor of singles penalty, which does not affect taxpayers in the 10-15% brackets, to protect lower income taxpayers. 2. Under the Marriage Bonus, taxpayers filing jointly start seeing results at around 100,000 (25% tax rate). 3. Married Couple filing jointly: a. Same results whether 100,000/0 breakdown; 50,000/50,000 breakdown; [horizontal equity among married couples filing jointly, based on joint income] b. Singles penalty ~ 4-5,000 more in tax for 100,000; 4. Singles bonus ~ 50,000/50,000 1,000 less in tax than married couple [this is marriage penalty]. 5. Marriage Penalty fixed at lower income levels. (10-15%) a. Married couple filing jointly (20/20): Tax = 2,300 b. Marriage Couple Filing Jointly (40/0) Tax 2,300 6. Single couple iii.

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a. 20/20: 2,300 b. Single individual or singles as a couple one with no earnings [40,000/0]. 61: GROSS INCOME DEFINED: 1.61-1(a) Gross income means all income from whatever source derived, unless excluded by law.

61(a) GROSS INCOME INCLUDES: A. 61(a)(1) Compensation for services, including fees, commissions, fringe benefits, and similar items; i. 1.61-2(a)(1) Wages, salaries, commissions paid to salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, marriage fees and other contributions received by a clergyman for services, pay of persons in the military or naval services of the United States, retired pay of employees, pensions and retirement allowances are income to the recipients unless excluded by law. PAYMENT OF EMPLOYEES FEDERAL INCOME TAX BY EMPLOYER: included in GI under 61 a. Where employer pays state or federal income taxes on employees salary directly to the government and no income taxes are therefore withheld from such employees salary, such moneys paid by the employer are included in such employees gross income because the duty is on such employee to fulfill that obligation and, therefore, such payment by the employer of that obligation constitutes additional compensation to employee for services rendered under 61. Old Colony Trust v. Commissioner. See also codification of this rule at regulation 1.61(14)(a). See also 102(c) (the discharge by a third person of an obligation of the taxpayer is receipt by the person taxed). i. Absence of an obligation to pay does not render payment of such obligation by unobligated third party a Gift to obligee. Old Colony Trust. See also Commissioner v. Duberstein. ILLEGAL INCOME: included in Gross Income 1. Illegal Gains included in gross income 2. Collins v. Commissioner; 2d Cir. 1993; embezzled money

B.

C.

lost gambling is taxable income.

D. TRASURE TROVE (in USD) included in Gross Income 1. Treasure trove to the extent of its value in United States currency, constitutes Gross income for the taxable year in which it is reduced to undisputed possession. 1.61-14(a). See also Cesarani v. United States (citing Rev.Rul. 61, 1953-1 Cum.Bull. 17) DAMAGES FOR PERONAL INJURY OR SICKNESS: 104 IMPUTED INCOME: Generally not included in GI a. Definition of Imputed Income i. a flow of satisfactions from durable goods owned and used by the

E. F.

taxpayer, OR

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ii. from goods and services arising out of the personal exertions of the

taxpayer on his own behalf. (See coursebook at p. 132).

b. Rule i. Imputed income is generally not included in Gross Income c. Reasoning: i. Self production and consumption eliminates the market transaction. 1. Examples a. Cutting ones own lawn b. One spouse stays home to perform child-care of the couples children. c. Taxpayer grows his own vegetables in his own garden for his own consumption. i. The above are a flow of satisfactions from goods and services arising out of the personal exertions of the taxpayer on his own behalf. ii. Not taxable, mostly because of the administrative and evidentiary difficulties of valuing and including the same in GI. d. Owner-Occupied Dwellings e. Ownership of a Washing Machine i. This is a flow of satisfactions from durable goods owned and used by the taxpayer ii. Not taxable, although, in the absence of ownership of such property, the taxpayer would presumably have to go out on the open market to procure. NON-CASH COMPENSATION: 1.61-2(d)(1) a. Services paid for in Property: i. If services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation. b. 83 PROPERTY TRANSFERRED IN CONNECTION WITH PERFORMANCE OF SERVICES (by employee or independent contractor)- 1.83-1(a)(1): *** i. 83(a) If, in connection with performance of services, property is transferred to any person other than the person for who such services are performed, the excess of 1. (1) the fmv of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable OR are not subject to a substantial risk of forfeiture, whichever occurs earlier, OVER 2. (2) the amount (if any) paid for such property), a. AKA (fmv amount paid) b. Shall be included in the GI of the person who performed such services i. in the first taxable year in which the rights of the person having the beneficial interest in such property are transferrable OR are not subject to a substantial risk of forfeiture, whichever is applicable.

G.

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ii. UNLESS, such person sells or otherwise disposes of such property in an arms length transaction before his rights in such property become transferable or not subject to a substantial risk of forfeiture. c. Subsequent sale, forfeiture or other disposition of non-vested property i. Non-vested property: property is substantially non-vested if it is subject to a substantial risk of forfeiture. 1.83-3(b) ii. Until such property becomes substantially vested, the transferor shall be regarded as the owner of such property, AND iii. any income from such property received by the employee or independent contractor or a beneficiary thereof or the right to the use of such property by the employee or independent contractor constituted additional compensation and shall be included in the gross income of such employee or I.C. for the taxable year in which such income is received or such use is made available. (applies to property transferred in connection with the performance of services, even though the transferor is not the person for whom such services are performed. 1.831(a)(ii). iv. If substantially non-vested property that has been transferred in connection with the performance of services is subsequently sold or otherwise disposed of to a third part in an arms length transaction while substantially non-vested, the person who performed such services shall realize compensation, included in GI, equal to the excess of (i) the amount realized on such sale/disposition, OVER (ii) the amount (if any) paid for such property) 1.83-1(b)(1). a. AKA: AR from disposition (amount received from third party + debt acquired by third party) AP for such property (by TP) = included in GI of TP 2. If substantially non-vested property that has been transferred in connection with the performance of services to the person performing such services is forfeited while still substantially nonvested and held by such person, the difference between the amount paid (if any), and the amount received upon forfeiture (if any) shall be treated as an

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ordinary gain or loss and included in GI of such taxpayer. 1.83-1(b)(2) a. EXCEPTION: unless the property is exchanged for other substantially nonvested property, in which case 83 will apply to such property received (as if it were substituted for the property disposed of). 1.83(b)(3) 3. AKA: AP (if any) for property (by TP) Amount received upon forfeiture = gain/loss Holding Period: 83(f) 1. In determining the period for which the taxpayer has held property which subsection (a) applies, there shall be included only the period beginning at the first time his rights in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier. 83(f) Deduction by Employer (symmetrical): 83(h) 1. In the case of a transfer of property to which 83 applies, there shall be allowed as a deduction under 162, to the person whom were performed the services in connection with which such property was transferred, an amount equal to the amount included under subsection (a) or (b) in the GI of the person who performed such services. a. Such deduction shall be allowed for the taxable year of such person in which or with which ends the taxable year in which such amount is included in the gross income of the person who performed such services. 83(h) Transferability of Property 1. The rights of a person in property are transferable only if the rights in such property of any transferee are not subject to a substantial risk of forfeiture. 83(e)(2) Substantial Risk of Forfeiture 1. The rights of a person are subject to a substantial risk of forfeiture if such persons rights to full enjoyment of such

v.

vi.

vii.

viii.

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property are conditioned upon future performance of substantial services by any individual. 83(e)(1) ix. ELECTION TO INCLUDE IN GI IN YEAR OF TRANSFER: 83(b): 1. Pursuant to 83(b)(1), any person who performs services in connection with which property is transferred to any person may elect to include in his gross income, for the taxable year in which such property is transferred, the excess of a. (A) the fmv of such property at the time of transfer b. (B) the amount paid (if any) for such property. 2. LIMITS ON 83(b) ELECTION a. Election must be made not later than 30 days after the date of transfer. 83(b)(2) b. Such election may not be revoked without consent of the Secretary. 83(b)(2) c. If an election is made, 83(a) shall not apply with respect to the transfer of such property AND i. If such property is subsequently forfeited, no deduction will be allowed with respect of such forfeiture, which means that the elector must be sure he plans to hold on to such property when he makes such election BARTER: Services paid in exchange for other Services: a. Rules: i. The bartering of services is taxable, and the value of such services must be included in Gross Income. Rev. Ruling 79-24. ii. EX: A housepainter and a lawyer exchange painting services for legal services. b. Calculating GI Inclusion: 1.61-2(d)(1) i. Income = value of services received, even if FMV of property or services
traded is the same.

H.

ii. If services are paid for in exchange for other services, the fair market value of such other services taken in payment must be included in income as compensation.

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iii. If the services are rendered at a stipulated price such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary. 1. Exception: Barter exchange does not include the informal exchange of similar services on a non-commercial basis. Reg. 1.6045-1(a)(4). a. Example: Two couples exchange babysitting services. b. Reasoning: Although a bartering of services that generally should be included in GI under Rev. Rul. 7924, this exchange is non-commercial and at such a low level, it is not on the IRSs radar. Furthermore, this policy rewards and encourages neighborly behavior. 1.6045-1(a)(4) i. This would not be imputed income (see page 1); a flow of satisfactions from services arising out of the personal exertions of the taxpayer on his own behalf, because these personal exertions are not only on the taxpayers own behalf. FRINGE BENEFITS a. 119 MEALS OR LODGING FURNISHED FOR THE CONVENIENCE OF THE EMPLOYER i. There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer ONLY IF: 1. In the case of meals, the meals are furnished on the business premises of the employer, OR 2. In the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment. ii. Special Rules For Convenience of Employer 1. Contract/State Statute not determinative: 119(b)(1) In determining whether meals or lodging are furnished for the convenience of the employer, the provisions of an employment contract or of a State statute fixing terms of employment shall not be determinative of whether the meals or lodging are intended as compensation. 2. Certain Factors Not Taken Into Account with Respect to Meals: 119(b)(2) a. Charge is made for such meals b. Fixed Charge: 119(b)(3): excludable from GI: see CB p. 110 c. The fact that the employee may accept or decline such meals 3. Meals furnished to employees on Business premises where meals of most employees are otherwise excludable: 119(b)(4) a. All meals furnished on the business premises of an employer to such employers employees shall be treated as furnished for the convenience of the employer IF, b. Without regard to this paragraph, more than half of the employees whom such meals are furnished on such

I.

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premises are furnished such meals for the convenience of the employer. iii. 132 CERTAIN FRINGE BENEFITS 1. Shall not apply to other fringe benefits expressly provided elsewhere: 132(l) 2. Employee includes spouses and dependent children a. any use by spouse or dependent child of an employee: 132(h)(2) b. dependent child also includes any child both of whose parents who are deceased and who has not attained age 25. c. Employee includes retired and disabled employees: i. employee includes any individual who was formerly employed by such employer in such line of business and who separated from service with such employer in such line of business by reason of retirement or disability: 132(h)(1)(A) b. Employee includes widows/widowers i. Of any individual who died while employed by such employer in such line of business OR while an employee within the meaning of 132(h)(1)(A) [retired/disabled]: 132(h)(1)(B). c. Employee does not include a self-employed individual within the meaning of 401(c)(1), pursuant to 132(f)(5)(E) b. GENERAL RULE: 132(a) Gross income shall not include any fringe benefit which qualifies as a i. (1) no additional cost service 1. 132(b) means any service provided by an employer to an employee for use by such employee if a. (1) such service is offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is providing services, AND b. (2) the employer incurs no substantial additional cost (including forgone revenue) in providing such service to the employee (determined without regard to any amount paid by the employee for such service). ii. (2) qualified employee discount, 1. 132(c)(3)(A)-(B) Employee discount defined: a. The term employee discount means the amount by which the price at which the property or services are provided by the employer to an employee for use by such employee, is less than the price at which such property services are being offered by the employer to customers. b. ED= price to customers - price to employee

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2. 132(c)(1) An excludable qualified employee discount means any employee discount with respect to qualified property or services to the extent such discount does not exceed a. (A) in the case of property, the gross profit percentage of the price at which the property is being offered by the employer to customers, OR b. (B) in the case of services, 20 percent of the price at which the services are being offered by the employer to customers. 3. Qualified Property/Services means any property or services which are offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is providing services, pursuant to 132(c)(4) a. Real property or personal property of a kind held for investment do not count. 4. Gross profit percentage a. 132(c)(2)(A) the percentage of (i) the excess of the aggregate sales price of property sold by the employer to customers over the aggregate cost of such property to the employer IS OF (ii) the aggregate sale price of such property. i. GPP = (aggregate sales price aggregate cost) / aggregate sales price. iii. (3) working condition fringe, 1. 132(d) A working condition fringe means any property or services provided to an employee of the employer to the extent that a. if the employee paid for such property or services, such payment would be allowable as a deduction under 162 or 167. iv. (4) de minimus fringe, 1. 132(e)(1) The term de minimus fringe means any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employers employees) so small as to make accounting for it unreasonable or administratively impracticable. 2. Treatment of Certain Eating Facilities: a. 132(e)(2) The operation of any eating facility for employees shall be treated as a de minimis fringe if i. (A) such facility is ON or NEAR the business premises of the employer, AND ii. (B) revenue derived from such facility normally equals or exceeds the direct operating costs of such facility. iii. AKA [revenue derive > direct operating costs of facility] v. Qualified Transportation Fringe,

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1. 132(f)(3) Qualified transportation fringe includes cash reimbursement, unless, in the case of a transit pass, a voucher or similar or similar item which may be exchanged only for a transit pass is not readily available for direct distribution by the employer to the employee. 2. 132(f)(1) the term qualified transportation fringe means a. (A) Transportation in a commuter highway vehicle if such transportation is in connect with travel between the employees residence and place of employee and is provided in a CHV operated by or for the employer ( 132(f)(5)(D)). i. Limitation on Exclusion from GI: aggregate benefits shall not exceed $100/month, adjusted for inflation pursuant to 132(f)(6). ii. 132(f)(2)(A) b. (B) Any transit pass, i. Mass transit facilities can be publicly or privately owned 132(f)(5)(A)(i) ii. Can provide transit at a discount or zero charge to employee ( 132(f)(5)(A) iii. Limitation on Exclusion from GI: aggregate benefits shall not exceed $100/month, adjusted for inflation pursuant to 132(f)(6). 1. 132(f)(2)(A) vi. Qualified Parking, 1. Limitation on Exclusion from GI: $175/month i. 132(f)(2)(B) vii. Any qualified bicycle commuting reimbursement. 1. Limitation on Exclusion from GI: the applicable annual limitation a. 132(f)(2)(C)Limitation on Exclusion b. (2) the amount which may be excluded from gross income shall not exceed c. See above. d. 132(f)(2) viii. Qualified Moving Expense Reimbursement, 1. Under 132(g) the term qualified moving expense reimbursement means any amount received (directly or indirectly) by an individual from an employer as a payment for (or a reimbursement of) expenses which would be deductible as moving expenses under 217 if directly paid or incurred by the individual. 2. Such term shall not include any payment for (or reimbursement of) an expense actually deducted by the individual in a prior taxable year. ( 132(g)) ix. Qualified Retirement Planning Services.

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1. Under 132(m) qualified retirement planning services means any retirement planning advice or information provided to an employee and his spouse by an employer maintaining a qualified employer plan. a. Qualified Employer Plan: any plan, contract, pension or account described in 219(g)(5) c. COMPENSATION FOR INJURIES OR SICKNESS: 104 i. 104(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 1. (1) amounts received under workmens compensation acts as compensation for personal injuries or sickness; 2. (2) the amount of any personal injury/sickness damages (other than punitive damages) received (whether by suit or agreement and whether as lumps sums or as periodic payments) on account of personal or physical injuries or physical sickness; 3. (3) amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries/sickness (other than amounts received by an employee, to the extent such amounts a. (A) are attributable to contributions by the employer which were not includible in gross income of the employee, OR b. (B) are paid by the employer 4. (4) Amounts received as pension/annuity for military sickness/injury 5. (5) AR as disability income attributable to injuries directly resulting from terroristic or military action d. AMOUNTS RECEIVED UNDER ACCIDENT AND HEALTH PLANS: 105 i. (a) Amounts attributable to Employer Contributionsamounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in GI to the extent such amounts 1. (1) are attributable to contributions by the employer which were not includible in the gross income of the employer, OR 2. (2) are paid by the employer. ii. (b) Amounts expended for medical careExcept in the case of amounts attributable to (and not in excess of) deductions under 213 (relating to medical, etc. expenses) for any prior taxable year, GI does not include amounts referred to in subsection (a) if such amounts are paid directly or indirectly to the taxpayer to reimburse the taxpayer for expenses incurred by him for the medical care (as defined in 213(d)) of i. the taxpayer, his spouse, ii. his dependents 1. (as defined in 152, without regard to (b)(1)-(2) and (d)(1)(B) thereof)

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and any child of the taxpayer who at the end of the taxable year has not attained age 27. = dependent for purposes of this subsection. 1. (as defined in 152(f)(1)) 3. (c) Payments unrelated to Absence from Work a. Gross income does not include amounts referred to in subsection (a) to the extent such amounts i. (1) constitute payment for the permanent loss or loss of use of a member or function of the bdy, or the permanent disfigurement, of the taxpayer, his spouse, or a dependent, AND ii. (2) are computed with reference to the nature of the injury without regard to the period the employee is absent from work. 4. RENTAL VALUE OF PARSONAGES: 107(a) a. See Rent, V 5. EDUCATIONAL ASSISTANCE PROGRAMS: 127 a. Pursuant to 127(a)(1) gross income of an employee does not include amounts paid or expenses incurred by the employer for education assistance to the employee if the assistance is furnished pursuant to a program which is, i. under 127(b)(1), an educational assistance program that is a separate written plan of an employer for the exclusive benefit of his employees to provide such employees with educational assistance, AND ii. under 127(b)(2) is not found by the Secretary to be discriminatory in favor of highly compensated employees, AND iii. under 127(b)(3) not more than 5 percent of amounts paid/incurred by emploer for educational assistance during the yar are provided to shareholders/owners or their spouses/dependents, each of whom own 5 percent of the stock or of the capital or profits interest in the employer, AND iv. under 127(b)(4) the program does not provide eligible employees with a choice between educational assistance and other remuneration includible in gross income, AND v. under 127(b)(6) reasonable notification of the availability and terms of the program are provided to eligible employees. vi. NOTE: 1. under 127(b)(5), a program referred to in 127(b)(1) is not required to be funded. iii.

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2. Under 127(c)(2) employee, includes, self-employed individuals under 401(c)(1) 3. EDUCATIONAL ASSISTANCE defined: a. 127(C)(1)(A)-(B), the payment by an employer, of expenses incurred by or on behalf of an employee for education of the employee, including but not limited to tuition fees, and similar payments, books, supplies, and equipment, AND b. the provision, by an employer, of courses of instruction for such employee, including books, supplies, and equipment. 6. DEPENDENT CARE ASSISTANCE PROGRAMS: 129 a. 129(a) Gross income of an employee does not include amounts paid or incurred by the employer for dependent care assistance provided to such employee, if the assistance is furnished pursuant to a program which is described in paragraph (d). b. 129(d) Definition: i. (1)Dependent Care Assistance Program is a separate written plan of an employer for the exclusive benefit of his employees to provide such employees with dependent care assistance with meets the requirements of paragraphs (2)(8) of this subsection. 1. If any plan would qualifiy as a dependent care assistance program but for a failure to meet the requirements of this subsection, then, notwithstanding such failure, such plan shall be treated as a dependent care assistance program in the case of employees who are no highly compensated employees. ii. Requirements: see CB p. 122 c. Limitation on Dependent Care Assistance Exclusion from GI : 129(2) i. (A) during a taxable year shall not exceed: 1. $5,000 (single person or married person filing joint return) 2. 2,500 (married person filing separate return) ii. (B) the year of inclusion is the year in which services were provided (even if payment occurs in subsequent year)

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iv. SCHOLARSHIPS: Excluded under 117 1. Requirements: a. Must be a degree candidate. 117(a) b. Only excluded if used solely for tuition, fees and books. 117(b)(2). c. Room and board are income. d. Exclusion denied to the extent that services are performed. 117(c). (ex: graduate students who perform teaching services) v. GIFTS AND WINDFALLS 1. Windfalls and Punitive Damages: Included in GI a. Rule: The amount of windfalls and punitive damages are income included in GI under 61. Glenshaw Glass. b. Reasoning: These are undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion. Glenshaw Glass. 2. PUNITIVE DAMAGES: included in GI a. Punitive damages such as treble damages under antitrust laws and exemplary damages for fraud are gross income. 1.61-14(a) 3. PRIZES AND AWARDS: 74 4. GIFTS: Excluded from GI if truly gifts a. Commercial gift of good will: i. Is this in anticipation of the return benefit of good will? 1. If so, not detached and disinterested. Includible in GI under Duberstein. 2. If not, and it is detached and disinterested, 102(a) applies, rendering it excludible from GI. b. Non-Employee Gifts: i. Gifts are excluded from GI under 102(a) if they are true gifts. ii. Gift Test: 1. A gift under 102 requires detached & disinterested generosity. Duberstein 2. If something is given in anticipation of return benefit or for services rendered/to be rendered in the future, this is not a gift because it is not the product of detached and disinterested generosity, but is rather a commercial transaction. Duberstein (Holding: Cadillac for business referrals taxable) 3. Factors: a. Objective intent of donor b. Special relationship c. Inconsistent with payment being a deductible business expense. i. If the exchange is a commercial business

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exchange, this may be considered deductible under 162, but it is not a gift under 102. c. Employer-Employee Gifts: i. Generally included in GI as salary under 102(c). ii. Exceptions: Employer Employee gifts are excludable if: 1. 132(e) de minimis fringes 2. 74(c) Employee Achievement Awards a. Definition: 274(j) i. tangible personal property ii. provided in the context of meaningful presentation iii. Not constituting disguised compensation, iv. With an average cost of which is less than $400. 3. Former employee gift: a. Gift to former Minister was considered a gift in Stanton, and the finding of the first court was not clearly erroneous. iii. Basis of Property Transferred in Gift or Trust: 1015 1. 1015(a) Basis of Property Acquired by Gift 2. If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift 3. EXCEPTION: 1015(a) still: a. basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value. 4. If the facts necessary to determine the basis in the hands of the donor or the last preceding owner are unknown to the donee, the Secretary shall, if possible, obtain such facts from such donor or last preceding owner, or any other person

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cognizant thereof. If the Secretary finds it impossible to obtain such facts, the basis in the hands of such donor or last preceding owner shall be the fair market value of such property as found by the Secretary as of the date or approximate date at which, according to the best information that the Secretary is able to obtain, such property was acquired by such donor or last preceding owner. 61(a)(2) Gross income derived from business; 61(a)(3) Gains derived from dealings in property; a. Gross income includes gains, profits, and income derived from rent, or from any source whatsoever. Hort v. Commisioner i. Petitioner inherited a lot and office building upon his fathers death. The building came encumbered with a lease. The tenant wanted out of the lease and Petitioner negotiated a buyout. Court held that entire amount paid to terminate lease must be included in GI. ii. Held: Cancellation of the lease was a relinquishment of the right to future rental payments. It may have diminished the total amount of income Petitioner would have received, but he is not required to pay income tax on those amounts. b. BASIS OF PROPERTY i. Property Basis (Generally): 1012(a) = cost 1. The basis of property shall be the cost of such property ii. Basis of Property Transferred in Gift or Trust: 1015 1. 1015(a) Basis of Property Acquired by Gift a. If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift 2. EXCEPTION: 1015(a) still: a. If the basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value. 1015(a). i. If AB > FMV, then Basis = FMV ii. If AB < FMV, then Basis = AB b. If the facts necessary to determine the basis in the hands of the donor or the last preceding owner are unknown to the donee, the Secretary shall, if possible, obtain such facts from such donor or last preceding owner, or any other person cognizant thereof. If the Secretary finds it impossible to obtain such facts, the basis in the hands of such donor or last preceding owner shall be the fair market value of such property as found by the Secretary as of the date or approximate date at which, according to the best information that the Secretary is able to obtain, such property was acquired by such donor or last preceding owner.

J. K.

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iii. Basis of Property Acquired from Decedent: 1014 1. 1014 (a) the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedents death by such person, be a. (1) the fair market value of the property at the date of the decedents death 2. 1014(b) For purposes of subsection (a), the following property shall be considered to have been acquired from or to have passed from the decedent: a. (1) Property acquired by bequest, devise, or inheritance, or by the decedents estate from the decedent; b. (2) Property transferred by the decedent during his lifetime in trust to pay the income for life to or on the order or direction of the decedent, with the right reserved to the decedent at all times before his death to revoke the trust. Etc. c. HOLDING PERIOD OF PROPERTY FOR DETERMINING GAIN/LOSS i. Holding Period of Property (Gain/Loss) 1223(2): 1. No matter how acquired, includes the period held by another person when determining gain or loss 2. In determining the period for which the taxpayer has held property however acquired there shall be included the period for which such property was held by any other person, if a. under this chapter such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person. ii. Calculating Holding Period of Property Where Property Acquired from Decedent and Disposed of within 1 Year After Decedents Death: 1223(9) iii. 1229 (9) In the case of a person acquiring property from a decedent or to whom property passed from a decedent (within the meaning of section 1014(b)), if 1. (A) the basis of such property in the hands of such person is determined under section 1014, and 2. (B) such property is sold or otherwise disposed of by such person within 1 year after the decedent's death, then such person shall be considered to have held such property for more than 1 year. d. DETERMINING GAIN/LOSS PROPERTY i. REALIZATION REQUIRMENT: 1. Under 26 U.S.C. 1001(c), a taxpayer cannot claim a loss on property until that loss is realized by "the sale or other disposition of property." a. Exception: a trade between two taxpayers for virtually the same object is not an event of realization. i. Example: if a taxpayer trades a specific issue of a rare comic book to someone for the a different copy of the exact same issue, then that trade

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would be 'virtually identical' and the taxpayer cannot realize any gain/loss on his taxes. b. Distinguished: Where taxpayers trade materially different objects, there is an event of realization. Cottage Savings Assn v. Commissioner: Where S&L traded bad loans with higher adjusted basis for other bad loans with lower fair market value the Court allowed a loss. The Court found that for the IRS's exception to apply, the trade had to be 'virtually identical'. In this case, the bad loans weren't identical enough. The bad loans were made to different people and were for different amounts and had different properties as collateral. Even though they were still all bad loans, they were materially different. ii. (a) Computation of gain or loss: AR AB (gain) ; AB AR (loss) 1. The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized. iii. (b) Amount realized ($ received + mortgage/other) 1. Pursuant to 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. In determining the amount realized a. (1) there shall not be taken into account any amount received as reimbursement for real property taxes which are treated under section 164 (d) as imposed on the purchaser, and b. (2) there shall be taken into account amounts representing real property taxes which are treated under section 164 (d) as imposed on the taxpayer if such taxes are to be paid by the purchaser. 2. Discharge of liabilities is included (mortgage, etc.) a. Pursuant to Reg. 1.1001-2(a) the amount realized from a 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. b. Recourse/Non-Recourse debts are treated the same for the purposes of calculating Adjusted Basis and Amount Realized. Crane. c. Commissioner v. Tufts: where debt > fmv of property when sold, debt is included in AR. i. Under Commissioner v. Tufts, when a taxpayer sells or disposes of property encumbered by a nonrecourse obligation exceeding the fair market value of the property sold, the taxpayer must include in the amount realized the outstanding amount of the obligation; the fair market value of the property is irrelevant to this calculation.

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d. Estate of Franklin v. Commissioner: where debt > fmv of property when debt first incurred to TP = no inclusion in AR. i. Pursuant to Estate of Franklin v. Commissioner, where the amount of the mortgage exceeds the fair market value of the property securing it when the debt was first incurred, the mortgage is not included in the basis and thus will not be included in the amount realized upon disposition, generally foreclosure; No depreciation/no interest payments because no such investment in property and no real debt. ii. In an option situation where the mortgage is inadequately secured, if the amount of mortgage> FMV of Property [at time of Acquisition] loan not included in basis because inadequately secured mortgage. iii. Conversely, where the amount of the mortgage is less than or equal to the fair market value of the property securing it when the debt was first incurred, the mortgage is included in the basis and will also be included in the amount realized upon disposition. iv. iv. (c) Recognition of gain or loss on sale or exchange of property 1. The gain form the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized. 1001(a). a. GAIN = AR AB b. LOSS = AB - AR e. ADJUSTED BASIS OF PROPERTY i. Rule: Adjusted Basis in property is the basis of such property under 1012, 1014, or other applicable section, less any depreciation deductions taken in respect to such property. ii. 1011(a) 1. 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 section 1012 or other applicable sections of this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses)), adjusted as provided in section 1016. iii. 1016: Adjustment to Basis for Capital Property (see Capital Expenditures) 1. (a) General rule: Proper adjustment in respect of the property shall in all cases be made

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a. (1) for expenditures, receipts, losses, or other items, properly chargeable to capital account, but no such adjustment shall be made i. (A) for taxes or other carrying charges described in section 266, or ii. (B) for expenditures described in section 173 (relating to circulation expenditures), b. for which deductions have been taken by the taxpayer in determining taxable income for the taxable year or prior taxable years; 2. (2) in respect of any period since February 28, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent of the amount a. (A) allowed as deductions in computing taxable income under this subtitle or prior income tax laws, and b. (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, warprofits, or excess-profits tax laws, c. but not less than the amount allowable under this subtitle or prior income tax laws. Where no method has been adopted under section 167 (relating to depreciation deduction), the amount allowable shall be determined under the straight line method. f. LOSSES i. 165 permits deductions for certain losses not compensated for by insurance, including: 1. Losses incurred in connection with a trade or business. 165(c)(1). 2. Losses incurred in connection with a transaction entered into for profit, though not in connection with trade or business. 165(c)(2). 3. Losses incurred by reason of casualty or theft. 165(c)(3). ii. See itemized deductions below.

L.

M.

N. O.

61(a)(4) Interest; a. Interest on Indebtedness: 213(a) See Itemized Deductions Below. i. Exception: Personal Interest 213(h)(2) 61(a)(5) Rents; a. Net Income from Rental of Non-Owner Occupied Housing Unit: i. Net Income = Rental Income - Continuing costs (maintenance expenses, depreciation), included in gross income under 61(a)(5). 61(a)(6) Royalties; 61(a)(7) Dividends; a. Dividends paid in Stock, rather than cash: Not included in GI i. Reasoning: Since the shareholder receives no cash, in order to pay any tax on a stock dividend, he might have to convert the stock into cash - he has no wherewithal to pay from the nature of the transaction. "Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that in the nature of

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things it requires conversion of capital in order to pay the tax. Eisner v. Macomber. ii. Holding: a stock dividend is not income. The Revenue Act of 1916 provision subjecting stock dividends to tax was held unconstitutional. Eisner v. Macomber 61(a)(8) Alimony and separate maintenance payments; a. Marital status is determined at the end of the taxable year. 60(13)(d) & 7703(a)(1). b. Legally separated spouses may not file as married. 7703(a)(2). i. Exception to the rule under 7703(a)(2) is the case of abandonment. 7703(e). ii. 7703(a)(2) does not apply if such taxpayer spouse is a 7703(e) head of household; [abandonment/other spouse absent for 6 months of year/ if taxpayer furnishes over half of support for the year] c. Pursuant to 62(a)(1), Alimony is an above the line deduction, which is taken from gross income to calculate adjusted gross income. This deduction may be taken regardless of the choice to take the standard deduction or to itemize, and thus is available to both low and high-income taxpayers, which makes the structure of the deduction less progressive. If high income taxpayers, which generally itemize their deductions, were required to take the alimony deduction below the line, they would be subject to the 7% itemization threshold, and thus the deduction may be considered high-income favorable because it is above the line. d. Pursuant to 215, the payor of alimony or separate maintenance payments, within the meaning of 71(b), may deduct the amount paid during such individuals taxable year from gross income. (ABOVE THE LINE DED.) e. REQUIREMENTS: i. Payment of alimony or separate maintenance is any payment made in cash, which meets the qualifications set forth in 71(b)(1). Under the regulations, of 1.71, checks and money orders qualify, as do direct payments of tuition or mortgage. ii. Must be pursuant to a decree of divorce or separate maintenance or a written instrument incident to such a decree. 71(b)(1)(A). iii. The payment may not be designated in the written instrument/divorce decree that the payment is a payment not includible in gross income under 215. 71(b)(1)(B). iv. In the case of legally separated spouses, such spouses may not be members of the same household at the time payment is made. 71(b)(1)(C). v. Must place no liability on the payor to pay the amounts or cash/property equivalent as a substitute for such payments upon death of the payee spouse. 71(b)(1)(D). f. The recipient of alimony in cash must include it in gross income under 71(a). i. Under 71(c), 71(a), which requires the recipient of separate maintenance/alimony payments to include such payments in gross income, does not apply to payments made to support the payor spouses children. Payors of child support are not permitted a deduction, and

P.

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recipients may not include such amounts received as child support in gross income under 61. ii. 71(f) deters frontloading of alimony payments to prevent deduction and inclusion of child support payments disguised as alimony by requiring inclusion of excess payments under 71(f)(2) in post separation years in payors gross income, and permitting deduction for recipient spouses. 71(f). 1. Exceptions to 71(f)(1) include death, remarriage, pursuant to contingency liability to pay a fixed portion or temporary support order. 71(f)(5). g. Parties can opt for different treatment, for instance, to disallow deduction and GI inclusion. i. EX: 10,000 paid from higher income earner: 10,000 * 30 percent = tax savings; paid to lower income earner: 10,000 * 15% = 1500 add tax to GI. ii. This example would create greater tax savings for the payor, as a result of this negotiation. h. OTHER MARRIAGE SETTLEMENT ISSUES: i. Property Settlement 1. Transfers of property to spouse or former spouse (or in trust for the benefit of such spouse) incident to divorce do not create a realization event (gain or loss) for the payor. 1041(a). a. Exception: Appreciated Property i. Where a taxpayer pays obligation/debt with appreciated property, this is a realization event under Davis. ii. EX: Seller of stock; purchaser of Car: 1. 10,000 fmv 2. 4,000 AB 3. = 6,000 gain iii. Seller of car; purchaser of stock 10,000 fmv ( 1041) 1. 10,000 AB stock 2. = 0 gain iv. 2. The transfer is treated as a gift under 1041(b) to the spouse and, thus, the basis is included as the adjusted basis of the property to the recipient spouse. a. Exception: Anti-nuptual (pre-marriage transfers). Farid. 61(a)(9) Annuities; a. General Rule: Payments from annuities are generally included in gross income. 61(a)(9). i. Pursuant to 72(a)(1) 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. b. Exception: i. 72(b)(1): In general: Gross income does not include that part of any amount received as an annuity under an annuity, endowment, or life

Q.

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insurance contract which bear the same ratio to such amount as the investment in the contract bears to the expected return. [AR * IiC/ER = % of AR not included in GI) ii. 72(b)(2) Exclusion limited to investment 1. However, the portion of any amount received as an annuity which is excluded from gross income under 72(b)(1) shall not exceed the unrecovered investment in the contract immediately before the receipt of such amount. 2. Unrecovered Investment: 72(b)(4) a. GENERAL RULE: the unrecovered investment in a life insurance or annuity contract is the investment in the contract as of the annuity starting date (price), less the aggregate amount received under the contract to date. 72(b)(4). b. For purposes of this subsection, the unrecovered investment in the contract as of any date is i. (A) the investment in the contract (determined without regard to subsection (c)(2)) as of the annuity starting date, reduced by ii. (B) the aggregate amount received under the contract on or after such annuity starting date and before the date as of which the determination is being made, to the extent such amount was excludable from gross income under this subtitle. c. 72(c)(1) Investment in life insurance or annuity contract = i. (a) the aggregate amount of premiums or other consideration paid for the contract, MINUS ii. (b) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income under this subtitle or prior to income tax laws. d. 72(b)(3) Deduction where annuity payments cease before entire investment recovered: Unrecovered amount deducted in annuitants last taxable year i. (A) In general: If 1. (i) after the annuity starting date, payments as an annuity under the contract cease by reason of the death of an annuitant, and 2. (ii) as of the date of such cessation, there is unrecovered investment in the contract, the amount of such unrecovered investment (in excess of any amount specified in subsection (e)(5) which was not included in gross income) shall be allowed as a deduction to the annuitant for his last taxable year. ii. (B) Payments to other persons 1. In the case of any contract which provides for payments meeting the requirements of subparagraphs (B) and (C) of subsection (c)(2), the deduction under subparagraph (A) shall be allowed to the person entitled to such payments for the taxable year in which such payments are received. iii. (C) Net operating loss deductions provided 1. For purposes of section 172, a deduction allowed under this paragraph shall be treated as if it were attributable to a trade or business of the taxpayer.

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R. 61(a)(10) Income from life insurance and endowment contracts; a. NOTE: Where Life insurance/endowment amounts received as annuity, see above with respect to annuities; (what GI shall not include) b. NOT INCLUDED IN GI: i. 101(a) Proceeds of life insurance contracts payable by reason of death: Not included in GI 1. (1) General rule: Except as otherwise provided in paragraph (2), subsection (d), and subsection (f), 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. (2) Transfer for valuable consideration a. In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee. The preceding sentence shall not apply in the case of such a transfer i. (A) if such contract or interest therein has a basis for determining gain or loss in the hands of a transferee determined in whole or in part by reference to such basis of such contract or interest therein in the hands of the transferor, or ii. (B) if such transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer. 1. The term "other amounts" in the first sentence of this paragraph includes interest paid or accrued by the transferee on indebtedness with respect to such contract or any interest therein if such interest paid or accrued is not allowable as a deduction by reason of section 264(a)(4). ii. 101 (c) Interest: included in GI 1. 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. iii. (d) Payment of life insurance proceeds at a date later than death 1. (1) General rule: The amounts held by an insurer with respect to any beneficiary shall be prorated (in accordance with such regulations as may be prescribed by the Secretary) over the period or periods with respect to which such payments are to be made. There shall be excluded from the gross income of such beneficiary in the taxable year received any amount determined by such proration.

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a. Gross income includes, to the extent not excluded by the preceding sentence, amounts received under agreements to which this subsection applies. 2. (2) Amount held by an insurer a. An amount held by an insurer with respect to any beneficiary shall mean an amount to which subsection (a) applies which is i. (A) held by any insurer under an agreement provided for in the life insurance contract, whether as an option or otherwise, to pay such amount on a date or dates later than the death of the insured, and ii. (B) equal to the value of such agreement to such beneficiary 1. (i) as of the date of death of the insured (as if any option exercised under the life insurance contract were exercised at such time), and 2. (ii) as discounted on the basis of the interest rate used by the insurer in calculating payments under the agreement and mortality tables prescribed by the Secretary. iii. (3) Application of subsection 1. This subsection shall not apply to any amount to which subsection (c) is applicable. 61(a)(11) Pensions; 61(a)(12) Income from discharge of Indebtedness; a. Indebtedness of Taxpayer i. Indebtedness of the taxpayer means any indebtedness for which the taxpayer is liable OR subject to which the taxpayer holds property. 108(d) b. General rules for Discharge of Indebtedness not in title 11 cases or insolvency i. Purchase Money Debt Reduction for Solvent Debtor Treated as Price Reduction 1. If the debt of a purchaser of property to the seller of such property which arose out of the purchase of such property is reduced, where a. such reduction does not occur as a result of bankruptsy under Title 11 or insolvency of the purchaser, b. AND but for this paragraph, such reduction would be treated as income to the purchaser from the discharge of indebtedness, c. then such reduction shall be treated as a purchase price adjustment. 108(e)(5) c. Exception: 108 Exclusion from Gross income of discharge of indebtedness if: i. The discharge occurs in a title 11 (bankruptcy) case, 108(a)(1)(A) ii. the discharge occurs when the taxpayer is insolvent. 108(a)(1)(B)

S. T.

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1. Exclusion limited to amount of insolvency. 108(a)(3) 2. Insolvency defined: a. Insolvency means the excess of liabilities over the fair market value of assets as determined immediately before the discharge. b. Liabilities FMV = amount of Indebtedness 108(d)(3) iii. the indebtedness discharged is a qualified farm indebtedness. 108(a)(1)(C) iv. the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013. 108(a)(1)(E) 61(a)(13) Distributive share of partnership gross income; 61(a)(14) Income in respect of a decedent; AND 61(a)(15) Income from an interest in an estate or trust

U. V. W.

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ITEMS DEDUCTIBLE A. General Rule for taxable year of deduction a. The amount of any deduction or credit allowed by this subtitle shall be taken for the taxable year, which is the proper taxable year under the method of accounting used in computing taxable income. 461(a) b. Itemized Deductions: i. Generally subject to 2% floor. Itemized deductions are allowable only to the extent they exceed 2 percent of AGI 67(a). ii. Subject to reduction of itemized deductions under 68. B. Itemized Deductions: a. LOSSES i. BLACK LETTER EXCEPTION FOR PERSONAL LOSSES: 1. Losses that are not connected with trade or business, with transaction entered into for profit, or loss by reason of casualty or theft under 165(c), are personal in nature and generally not deductible. 2. Primary Motive Test: (personal or business (or Profit seeking)) a. Whether the primary motive of acquiring and holding the property was to earn a property? b. Austin v. Commissioner. (2nd Circ.) 3. Mixed Motives: a. 1.165-9(b)(1) permits a deduction if the property has been appropriated to income-producing purposes b. When part of a property is used for one purpose and part for another, or when the same property is used at different times for different purposes, losses from the sale of the property must be allocated between the different uses. Sharp v. U.S. i. Deduction permitted in proportion to business use. ii. 165 permits deductions for certain losses not compensated for by insurance, including: 1. Losses incurred in connection with a trade or business. 165(c)(1). a. MOST FAVORABLE: i. Deductible Above the Line 62(a)(2). (ignore that it is in this part) ii. May be carried forward or back Net operating losses under 172. b. No deduction is permitted for the loss of anticipated income. i. Coursebook pg. 373. c. Employees: Being an employee is treated as being in a trade or business. Yerkie v. Commissioner. 2. Losses incurred in connection with a transaction entered into for profit, though not in connection with trade or business. 165(c)(2). a. LESS FAVORABLE, because must generally be itemized b. Exception:

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i. 165(c)(2) losses can be deducted above the line only if they result from: 1. sale or exchange of property 165(a)(3) OR 2. are attributable to property that produces rent or royalties. 165(a)(4) iii. Example of Fine line between non-business profit seeking losses and trade or business losses: 1. Proper Inquiry: Was the loss related to the trade or business, or a non-related profit-seeking activity? Yerkie v. Commissioner. a. Question of fact i. A taxpayer may be engaged in more than one trade or business, but the activities in which the loss was incurred must be a trade or business to qualify under 165(c)(1). b. Factors: Reese v. Commissioner i. Merely financing of project? Probative of PST ii. History of Engagement in Activity 1. One time deal PST 2. Prior/subsequent projects? ToB iii. Motivation 1. Merely to turn a profit PST or 2. To engage in trade or business of turning a profit? ToB iv. In the business of the activity specifically? 1. Yerkie v. Commissioner. (employee not in trade or business of embezzlement = PST) 2. CASE EX 1: Financing of project as a contractor one time dos not constitute trade or business of being a contractor, although taxpayer in business of being a corporate executive. Reese v. Commissioner. 3. CASE EX 2: Repayment to employer of embezzled funds was not a business loss which could be carried forward and back under 172 because, although the taxpayer was in a trade or business of being a salaried employee, he was not in the business of embezzlement. Therefore, the loss in this case was incurred in an unrelated profit-seeking activity, and allowed deduction for repayment of embezzled funds as an itemized deduction subject to the limitations of 165(c)(2). Yerkie v. Commissioner. 4. Losses incurred by reason of casualty or theft. 165(c)(3). a. See Casualty or Theft below. iv. Timing of Losses: 1. Flexible Practical Approach: Courts look to a definitive or identifiable event or to conduct indicating a closed transaction or no reasonable prospect of recovery, although the taxpayer need not establish that there is absolutely no possibility of eventual recoupment. U.S. v. SS White Dental Manufacturing Co. v. Deduction amount:

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1. Adjusted basis under 1011 for determining loss for sale or disposition of property. 165(a)(2). vi. Special Losses 1. Wagering Losses: 165(d) a. Deduction only permitted to the extent of gains. b. Reasoning: A gambling loss is a loss that is presumed to involve a component of personal consumption. c. Exception: i. Professional Gambling: Commissioner v. Groetinger 1. Selling goods or services is not a necessary element of engaging in a trade or business. 2. Professional gamblers gambling expenses are deductible under 162 and permitted to carryback and carryforward such losses as Net Operating Losses under 172, notwithstanding the limitations of 165(d). ii. Contrary Holding: 1. Even a gambler in a trade or business can only deduct losses up to gains and may not carry them back or forward. Tschetschot v. Commissioner. 2. Capital Losses: 165(f) a. Losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212. b. UNREIMBURSED EMPLOYEE EXPENSES such as ordinary and necessary 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. 1.671(a)(i). i. Depreciation on a computer or cellular telephone required to do your job. ii. Dues to chambers of commerce, professional societies and unions. iii. Education that is employment-related. iv. Home office or part of your home used regularly and exclusively in your work. v. Job-search expenses in your present occupation. vi. Legal fees related to doing or keeping your job. vii. Licenses and regulatory fees as well as occupational taxes. viii. Malpractice insurance premiums. ix. Medical examinations required by an employer. x. Passport for a business trip. xi. Subscriptions to professional journals and trade magazines related to your work. xii. Tools and supplies used in your work. xiii. Travel, transportation, entertainment and gift expenses related to your work.

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xiv. Work clothes and uniforms, and their upkeep costs. c. CHARITABLE CONTRIBUTIONS: 170 i. Charitable Contributions are deductible as itemized deductions only. 170(a). 1. Horizontal Inequity: Taxpayers with same taxable income are treated differently whether they itemize or take the standard deduction. 2. Vertical Inequity: Taxpayers in upper brackets or more likely to itemize, while taxpayers in lower brackets generally take the standard deduction and therefore cannot deduct charitable contributions. 3. Charitable Contributions are not subject to 67 2% floor for itemized deductions, but they are subject to reduction of itemized deductions under 68. ii. Purpose of Permitting Charitable Deduction: 1. Issue: Is giving to charity personal consumption? 2. Arguments: a. Decision to give to charity is a type of personal consumption and therefore deduction is inappropriate. b. Contribution deduction is not actually consumed by the taxpayer because it is not available for personal consumption or for savings, so deduction is appropriate. iii. 170 Requirements for Charitable Deduction Treatment: 1. Deduction must be for a transfer by an individual or a corporation of cash or, in some cases, for the fair market value of property transferred, but NOT for services. 170 i. Exception 1: Unreimbursed, out-of-pocket expenses incurred in connection with donating services to charitable organization. McCullom v. Commissioner. 1. 170(j) permits deduction of travel expenses (including meals and lodging) if there is no significant element of personal pleasure, recreation, or vacation. ii. Exception 2: A taxpayer can claim deduction for paying third parties to assist them in providing charitable services. Rockefeller v. Commissioner. 2. NOT PERMITTED TO INFLUENCE LEGISLATION: 170(f)(6). 3. Contributions are permitted to all churches, by virtue of the establishment clause, including the Church of Scientology. Rev. Rul. 93-73. (Overruling Hernandez) 4. Detached and disinterested generosity is increasingly required, following Duberstein. Babilonia v. Commissioner. 5. Donations to Private Schools: a. Issue: Contributions disguised as non-deductible tuition? b. Factors: Rev. Rul. 83-104

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i. Cost of attending school must be greater than payment. ii. Whether contribution required to attend. iii. Payment not made pursuant to a plan, express or implied, to convert nondeductible tuition into charitable contributions. iv. Receipt of benefit not otherwise contingent on making the payment. a. AKA not getting into school v. No earmarking of contribution for the direct benefit of single individual. vi. No unexplained denial of admission to those who do not contribute. c. Other factors: (in combination) i. Absence of a significant tuition charge ii. Substantial or unusual pressure to contribute iii. Absence of other significant non-contribution potential sources of revenue for operating the school iv. Other factors suggesting that a contribution policy has been created as a means to avoid characterization of payments as tuition. 6. Substantiation Requirement 170(f)(8). a. Deductions of contributions of $250 or more must be substantiated by a contemporaneous written acknowledgment of the contribution by the donee organization that meets the requirements of 170(f)(8)(B). iv. Amount of Charitable Deduction: 1. Individuals: No more than 50 percent of AGI. 170(b)(1)(A) 2. Corporations: No more than 10 percent of taxable income. 170(b)(2)(A). 3. Where contribution makes donor eligible for athletic tickets: a. Deduction is limited to 80% of permitted deduction. 170(l). b. This applies to skyboxes too, despite 274(l). 1999 Tax Notes Today 141-4. d. MEDICAL EXPENSES: 213 e. PERSONAL CASUALTY, THEFT LOSSES: 165(c)(3) i. Deduction is permitted for losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. 165(c)(3). 1. Other Casualty (oftentimes inconsistent treatment) a. EX: b. Factors: i. ii. Limitations: 1. Losses, like gains only produce tax consequences when realized. a. A mere decline in value is insufficient to create a loss under the Code.

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i. However, a casualty is treated as a realization event even if it dos not cause a total loss. Alcoma Association, Inc. v. U.S. (allowing casualty loss deduction for citrus grove partially destroyed by hurricane. b. However, losses are sometimes allowed where property becomes worthless. i. United States v. S.S. White Dental Manufacturing Co. (loss realized when German government sized the taxpayers branch despite the possibility that some sort of claim might subsequently be presented against the German government, thus providing possibility of eventual recoupment) 1. Taxpayer need not establish that there is no possibility of eventual recoupment under this case. ii. Worthless Securities 1. Deductible under 165(g) 2. Sometimes, even realized losses are not deductible under the code. a. Ex: Where no economic loss actually suffered. b. Skully v. United States. (no real economic loss where property sold between two trusts with the same fiduciaries and beneficiaries) f. INTEREST PAID OR ACCRUED ON INDEBTEDNESS: 163 i. Interest on indebtedness is deductible as an itemized deduction pursuant to 163(a); see 67. ii. Applies to non-Corporate taxpayers. 163(b) iii. Includes: 1. 163(h)(2)(A) interest paid or accrued on indebtedness properly allocable to a trade or business (other than the trade or business of performing services as an employee), 2. 163(h)(2)(B) any investment interest (within the meaning of subsection (d)), 3. 163(h)(2)(C) any interest which is taken into account under section 469 in computing income or loss from a passive activity of the taxpayer, 4. 163(h)(2)(D) any qualified residence interest (within the meaning of paragraph (3)), 5. 163(h)(2)(E) any interest payable under section 6601 on any unpaid portion of the tax imposed by section 2001 for the period during which an extension of time for payment of such tax is in effect under section 6163, and 6. 163(h)(2)(F) any interest allowable as a deduction under section 221 (relating to interest on educational loans). iv. Exception: 1. 163(h)(2) Personal interest a. Everything not covered above in 163(h)(2)(A)-(F). g. SUBSTANTIAL AMOUNT HELD UNDER CLAIM OF RIGHT: 213

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h. NON-TRADE OR BUSINESS EXPENSES HELD FOR PRODUCTION OF INCOME: deductible to individuals under 212 i. In the case of an individual, 212(a) allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year: 1. (1) for the production or collection of income; a. investment advisory fees, subscriptions to investment advisory publications, certain attorneys' fees, and the cost of safe deposit boxes, 1.67-1(a)(ii) b. These also apply to part (2) below. 2. (2) for the management, conservation, or maintenance of property held for the production of income; or 3. (3) in connection with the determination, collection, or refund of any tax. a. Expenses for the determination of any tax for which a deduction is otherwise allowable under section 212(3), such as tax counsel fees and appraisal fees. 1.671(a)(iii). ii. Requirements: 1.212-1(a) 1. (1) The expense has been paid or incurred by the taxpayer during the taxable year a. (i) for the production or collection of income which, if and when realized, will be required to be included in income for Federal income tax purposes, or b. (ii) for the management, conservation, or maintenance of property held for the production of such income, or c. (iii) in connection with the determination, collection, or refund of any tax; AND 2. (2) It is an ordinary and necessary expense for any of the purposes stated in subparagraph (1) of this paragraph. iii. Expenditures not allowable as a deduction under 212: 1. 1.212-1(f) Commuter's expenses; expenses of taking special courses or training; expenses for improving personal appearance; the cost of rental of a safe-deposit box for storing jewelry and other personal effects; expenses such as those paid or incurred in seeking employment or in placing oneself in a position to begin rendering personal services for compensation, campaign expenses of a candidate for public office, bar examination fees and other expenses paid or incurred in securing admission to the bar, and corresponding fees and expenses paid or incurred by physicians, dentists, accountants, and other taxpayers for securing the right to practice their respective professions. See, however, section 162 and the regulations there-under. 2. 1.212-1(h) Ordinary and necessary expenses paid or incurred in connection with the management, conservation, or maintenance of property held for use as a residence by the taxpayer. 3. 212-1(k) Expenses paid or incurred in defending or perfecting title to property, in recovering property (other than investment property and amounts of income which, if and when recovered, must be included in gross income), or in developing or improving property, constitute a part of the cost of the property

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and are not deductible expenses. Attorneys' fees paid in a suit to quiet title to lands are not deductible; but if the suit is also to collect accrued rents thereon, that portion of such fees is deductible which is properly allocable to the services rendered in collecting such rents. Expenses paid or incurred in protecting or asserting one's right to property of a decedent as heir or legatee, or as beneficiary under a testamentary trust, are not deductible. iv. Definitions: 1. Expenses: a. 1.212-1(d) Expenses, to be deductible under section 212, must be ordinary and necessary. b. Requirements:, such expenses must be i. reasonable in amount AND ii. bear a reasonable and proximate relation to: 1. the production or collection of taxable income; OR 2. to the management, conservation; OR 3. maintenance of property held for the production of income. 2. Income: a. (b) The term income for the purpose of section 212 includes not merely income of the taxable year but also income which the taxpayer has realized in a prior taxable year or may realize in subsequent taxable years. b. Income is also not confined to recurring income but applies as well to gains from the disposition of property. 1.212-1(b) i. Ex: If defaulted bonds, the interest from which if received would be includible in income, are purchased with the expectation of realizing capital gain on their resale, even though no current yield thereon is anticipated, ordinary and necessary expenses thereafter paid or incurred in connection with such bonds are deductible. ii. Similarly, ordinary and necessary expenses paid or incurred in the management, conservation, or maintenance of a building devoted to rental purposes are deductible notwithstanding that there is actually no income therefrom in the taxable year, and regardless of the manner in which or the purpose for which the property in question was acquired. iii. Expenses paid or incurred in managing, conserving, or maintaining property held for investment may be deductible under section 212 even though the property is not currently productive and there is no likelihood that the property will be sold at a profit or will otherwise be productive of income and even though the

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property is held merely to minimize a loss with respect thereto. C. Above the Line Deductions (deductions not itemized) a. Ordinary and Necessary Business Expenses: Deductible under 162 i. Pursuant to 162(a), ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are deductible. including 1. (1) a reasonable allowance for salaries or other compensation for personal services actually rendered; 2. (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; AND 3. (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. ii. Definitions: 1. Ordinary: a. Ordinary means common or frequent expense in the type of trade or business involved. Gilliam v. Commissioner. 2. Necessary: a. Necessary means appropriate and helpful for the development of the taxpayers business. McCulloch v. Maryland. iii. What is NOT an Ordinary & Necessary Business Expense? 1. Berserk on an Airplane (Air rage is not an ordinary and necessary expense of air travel): Gilliam v. Commissioner a. Where the item is not ordinary and necessary to the conduct of the taxpayers trade or business, it is generally non-deductible, unless so determined under other rules of the subsection. Gilliam v. Commissioner. 2. Amusement Activities or Amusement Activity Facilities a. No deduction is allowed for activities that generally constitute entertainment, amusement, recreation, unless the taxpayer establishes that the item is directly related to, or in the case of an item immediately preceding or following a substantial and bona fide business discussion, associated with, the active conduct of the taxpayers trade or business. 274(a)(1)(A). i. Must show under 274(a)(1)(A): 1. Item is directly related to active conduct of taxpayers trade or business, OR 2. Item immediately preceded or followed a substantial and bona fide business discussion associated with the active conduct of the taxpayers trade or business.

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ii. Where activity passes muster for deductibility under 274(a)(1)(A)-(B), the amount of the deduction is limited to 50% of the expense pursuant to 274(n)(2). iii. The amount must also be substantiated under 274(d)(2). iv. SKYBOXES: 1. Where the activity passes muster under 274(a), deduction is limited for luxury leased skyboxes in sports stadiums rented for more than one event to the sum of the face value of regular box seat tickets for the number of seats in the skybox. 274(l)(2). v. TICKETS 1. Where tickets for entertainment pass muster under 274(a)(1), the deduction allowed for tickets shall not exceed the face value of such ticket. 274(l)(1)(A) 2. Exception: Charity 274(1)(1)(B) a. Event is organized for the primary purpose of benefiting the charitable organization b. All net proceeds go to such charitable organization c. Substantially all work conducted in carrying on the event is performed by volunteers b. Deductions are similarly disallowed for facilities with respect to such amusement activities in 274(a)(1)(A) under 274(a)(1)(B). i. Under 274(a)(1)(B) no deduction may be taken with respect to hunting lodges, yachts, and other entertainment facilities. 3. Business expenses incurred related to drug trafficking are non-deductible under 280E. a. BUT: Legislative history says that you treat the drugs themselves as cost of goods sold, so you can offset gross receipts with cost of goods sold. So, profits from drug trafficking enterprises, like those other illegal enterprises, are included in gross income. 4. Capital Expenditures are NOT Ordinary & Necessary Business Expenditures: 263 a. A capital expenditure is not an ordinary and necessary business expense warranting deduction under 162. 263 explicitly prohibits deduction under 162 for capital expenditures. b. Good Will & Reputation: i. Reputation and learning are akin to capital assets, like the good will of an old partnership.

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The money spent in acquiring them is well and wisely spent. It is not an ordinary expense of the operation of a business. Welch v. Helvering. ii. Payment of anothers obligation: 1. Where a taxpayer pays anothers expenses, and those payments are made to protect the payors own business, they are frequently deductible. Welch v. Helvering. 2. IF, HOWEVER, the payor incurs the expense due to a moral obligation, there is no deduction. Welch v. Helvering. iv. What IS an ordinary and necessary Business Expense under 162? 1. Food & Beverage on Business Premises: a. Expenses for food and beverages (and facilities used in connection therewith) furnished on the business premises of the taxpayer primarily for his employees are deductible. 274(e)(1). 2. Reimbursed Expenses: a. Expenses paid or incurred by the taxpayer, in connection with the performance by him of services for another person (whether or not such other person is his employer), under a reimbursement or other expense allowance arrangement with such other person are deductible pursuant to 274(e)(3), but only if: i. Where services are performed for employer, the employer has not treated such expenses as additional compensation under 274(e)(2); OR ii. Where services are performed for another person not an employer, the taxpayer accounts to such person under 274(d) (relating to substantiation requirements). 3. Pursuant to 162(a)(1), salaries or other compensation for personal services actually rendered deductible, provided they are not unreasonable. a. Requirements: i. Compensation that is the purchase price of services. 1.162-7(b) 1. Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. 1.162-7(b) 2. Look out for dividends disguised as compensationsee below, part (b). ii. Compensation is reasonable 162(a)(1). 1. Reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances. 2. The circumstances to be taken into consideration are those existing at the

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date when the contract for services was made, not those existing at the date when the contract is questioned. 1.162-7(b)(3) 3. Treatment of Excessive Salary a. The income tax liability of the recipient in respect of an amount ostensibly paid to him as compensation, but not allowed to be deducted as such by the payor, will depend upon the circumstances of each case. b. Thus, in the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be a distribution of earnings or profits, the excessive payments will be treated as a dividend. If such payments constitute payment for property, they should be treated by the payor as a capital expenditure and by the recipient as part of the purchase price. In the absence of evidence to justify other treatment, excessive payments for salaries or other compensation for personal services will be included in gross income of the recipient. 1.162-8 b. Look out for! (Dividends Disguised as Compensation)i. REG FACTORS: 1. Closely held corporation having few shareholders, practically all of whom draw salaries. 1.162-7(b) 2. Where salaries are in excess of those ordinarily paid for similar services AND the excessive payments correspond or bear a close relationship to the stockholdings of the officers or employees. 1.162-7(b) ii. INDEPENDENT INVESTOR TEST (2nd & 7th Circuits): 1. independent investors expected return, based on actual profits. Exacto Corp.

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a. If the investors are obtaining a far higher return than they expected, the salary of the individual is presumptively reasonable. 2. Difference in price per share; recent increases proportional to increase in salary a. Could be probative of dividends being disguised as salary b. OR could be evidence of Expected Return on the part of investors 3. Percentage ownership: dividend payments reflect ownership interest under corporate law a. if the taxpayer receives salary proportional to her percent ownership and other shareholders receive salaries proportional to percent ownership, then more likely dividend payment disguised as salary. b. Conversely, if all shareholders received the same salary, regardless of percent ownership, less probative of dividend payments being disguised as salary. c. What if other shareholders do not receive salaries? If the at issue individuals salary still reflects that employees ownership interest, still highly probative of dividends being disguised as salary. d. Her control of the corporation: If the employee controls her own salary, more probative of dividend payment being disguised as salary.

iii. AMORPHOUS TEST (1st, 9th, and 10th circuits) 1. type and extent of services rendered, 2. scarcity of qualified employees, 3. qualifications and prior earning capacity,

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4. contributions of the employee to the venture 5. net earnings of the employer 6. prevailing rates of comparable jobs 7. Peculiar circumstances, such as history of dividend payments McClandess.Tile Service. (not dispositive; sometimes companies want to retain moneys to build business, not pay dividends). a. If dividends generally paid, and now not paid but salaries increased, greater PV 4. Pursuant to 162(a)(2), traveling expenses (including amounts expended for meals and lodging other than amounts that are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business are deductible. a. GENERAL REQUIREMENTS: i. While away from home: 1. 162(a)(2) allows a deduction for travel expenses incurred while away from home in pursuit of a trade or business, including meals. However, the Court concluded in United States v. Correll that away from home does not include any trip not requiring sleep or rest (the overnight rule). Thus, expenses incurred pursuant to a trip that does not require overnight stay are nondeductible under 162(a)(2) because they are not considered incurred away from home. ii. Home Where 2 Residences: 1. Whether it is held in a particular decision that a taxpayers home is his residence or his principal place of business, the ultimate allowance or disallowance of a deduction is a function of the courts assessment of the reason for a taxpayers maintenance of two homes. Hantzis v. Commissioner. 2. If the reason is perceived to be personal, the taxpayers home will generally be held to be his place of employment, rather than his residence and the deduction will be denied. Hantzis v. Commissioner. 3. If the reason is felt to be business exigencies, the persons home will usually be held to be his residence and the deduction will be denied. Hantzis v. Commissioner.

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iii. Settlement must be temporary to be away from home 1. In order for travel expenses away from home to be deductible, settlement must be temporary. 162(a) 2. In order for it to be temporary, she must intend to stay less than a year. See 162(a) flush language: The taxpayer shall not be treated as being temporarily away from home during any period of employment if such period exceeds one year. 3. Thus, the moment the taxpayer knows that she will stay more than a year, no longer deductible expenses. So, when you accept a permanent job, expenses incurred are no longer deductible. a. Intent is the key here. b. Mixing Business & Pleasure i. Under 1.162-2(b)(1) if a taxpayer travels to a destination and while at such destination engages in both business and personal activities, traveling expenses to and from such destination are deductible only if the trip is related primarily to the taxpayers trade or business. If the trip is primarily personal in nature, the traveling expenses to and from the destination are not deductible even though the taxpayer engages in business activities while at such destination. 1. ** However, expenses while at the destination which are properly allocable to the taxpayers trade or business are deductible even though the traveling expenses to and from the destination are not deductible. ii. Pursuant to 1.162(b)(2), whether a trip is related primarily to the taxpayers trade or business or is primarily personal in nature depends on the facts and circumstances in each case. 1. Factors include the amount of time spent during the paper on personal v. business activity c. CONVENTIONS i. The allowance of deductions for expenses incurred at a convention depend upon whether there is a sufficient relationship between the taxpayers trade or business and his attendance at the convention or other meeting so that he is benefiting or advancing the interests of his trade or business by such attendance. 1.162-2(d)

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ii. If the convention is for political, social or other purposes unrelated to the taxpayers trade or business, the expenses are not deductible. 1622(d) d. MEALS i. Under 162, if a personal living expense, such as a meal, is to qualify for deduction, the taxpayer must demonstrate that it was different from or in excess of that which would have been made for the taxpayers personal purposes. Sutter v. Commissioner (1953). ii. Under Rev. Ruling 63-144, judicial decisions under established law hold that a taxpayer cannot obtain a deduction for the portion of his meal cost which does not exceed an amount he would normally spend on himself. iii. Where taxpayer takes clients to lunch: Where a taxpayer takes his clients out to lunch at expensive restaurants that the clients demand, of course he can deduct the expense of their meals, from which he derives no pleasure or sustenance he can (also deduct his own meal) because he cannot eat more cheaply; he cannot munch surreptitiously on a peanut butter and jelly sandwich brought from home The reasoning is that the taxpayer would not pay for it if it were not for the business benefit. He would get more value from using the same money to buy something else; hence the meal confers on him less utility than the cash equivalent would. Posner, 758 F.2d 211 (7th circuit). iv. SUBSTANTIATION REQUIREMENT: 1. Under 274(d) it is advised that the taxpayer should account for business meals by writing on back of receipt and submitting reimbursement request. This substantiates expense in case of audit. v. FACTOR: frequency 1. See Moss v. Commissioner, where court held that daily meals paid for by the firm were nondeductible, even though business was discussed there, given the frequency. vi. Clients Meals 1. The cost of the clients meal would be deductible under 274(a) if it is directly related or associated with the active conduct of a trade or business.

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2. Legislative history indicates that a business meal is directly related to the active conduct of the taxpayers trade or business, if : 3. (1) the taxpayer has more than a general expectation of deriving income or a specific business benefit; 4. (2) the taxpayer engaged in a business discussions during or directly before or after the meal or entertainment, AND 5. (3) the principal reason for the expense was the active conduct of the taxpayers trade or business. vii. Limitations on Deductibility of Business Meals 1. 274(n) limits 162 deductions to 50% for meal expenses. 2. Pursuant to 274(k)(1)(A) lavish or extravagant business meals are not deductible. 5. ADVERTISING a. Efforts to influence the public on particular issues of legislative significance are nondeductible, under 1.162-20. b. Distinguished from deductible institutional or goodwill advertising, which is deductible, provided it is not to influence legislation. 1.162-20. 6. HOME OFFICE EXPENSES a. 280A provides that otherwise allowable deductions under 162, relating to ordinary and necessary business expenses, are prohibited with respect to the use of a dwelling unit which is used by the taxpayer as a residence. The appropriate inquiry is, is the home office her principal place of business within the meaning of 280A. Under the Solomin test, the factors are twofold: (1) relative importance of activities performed in the home office, and (2) the amount of time spent in the home office. i. In Solomin, deduction under 162 was disallowed for a home office where taxpayer anesthesiologist spent 20% of his business time, with 80% spent at the hospital. ii. Exceptions: 1. Under 280A(c)(1), 280A(a) shall not apply to any item to the extent such item is allocable to a portion of the dwelling unit which is exclusively used on a regular basis - (A) as the principal place of business for any trade or business of the taxpayer, (B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the

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taxpayer in the normal course of his trade or business, or (C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business. b. For purposes of subparagraph (A), the term ''principal place of business'' includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business. c. What could be deductible? i. Office furniture? 1. Office furniture is a capital expenditure, which cannot be deducted under 162, pursuant to 263. However, depreciation deductions may be taken under 167(a). ii. Cost of Home? 1. The cost of the home would be a personal capital expenditure. Thus, no deduction may be taken under 162, pursuant to 263. In addition, no depreciation deduction may be taken under 167(a) because this is a personal home. v. Pursuant to 162(a)(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, are deductible. b. Net Operating Loss Deduction i. Defined: 1. The term net operating loss means the excess of the deductions allowed by this chapter over the gross income. 2. Such excess of the deductions shall be computed with the modifications specified in subsection (d) ii. Section 172(a) allows as a deduction in computing taxable income for any taxable year subject to the Code the aggregate of the net operating loss carryovers and net operating loss carrybacks to such taxable year. 1.72-1(a) 1. Pursuant to 172(b)(1)(A)(i)-(ii), except as otherwise provided in 172, a net operating loss for an taxable year a. (i) shall be the net operating loss carryback to each of the 2 taxable years preceding the taxable year of such loss, and b. (ii) shall be a net operating loss carryover to each of the 20 taxable years following the taxable year of the loss.

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2. Section 172 of the Internal Revenue Code now generally allows losses to be carried back 2 years and forward 20 years. a. Contrast with case before 172: Burnet v. Sanford & Brooks Co., which held that an annual accounting system is a practical necessity if the federal income tax is to produce revenue ascertainable and payable at regular intervals. [Disallowance for carryover of net losses from prior years]. i. Receipts from the conduct of a business enterprise are to be included in the taxpayer's return as a part of gross income, regardless of whether the particular transaction results in net profit, ii. Only by including these items of gross income in the 1920 return would it have been possible to ascertain respondent's net income for the period covered by the return, which is what the statute taxes. [ 213]. iii. The excess of gross income over deductions did not any the less constitute net income for the taxable period because respondent, in an earlier period, suffered net losses in the conduct of its business which were in some measure attributable to expenditures made to produce the net income of the later period. iii. The net operating loss is the basis for computation of the net operating loss carryovers and net operating loss carrybacks and ultimately for the net operating loss deduction itself. iv. NOTE: 1. The net operating loss deduction shall not be disallowed for any taxable year merely because the taxpayer has no income from a trade or business for the taxable year. v. Computation of net operating loss deduction: 1.72-2(b)(1)-(3) 1. Compute the net operating loss for any preceding or succeeding taxable year from which a net operating loss ma be carried over or carried back to such taxable year. 2. Compute the net operating loss carryovers to such taxable year from such preceding taxable years and the net operating loss carrybacks to such taxable year from such succeeding years 3. Add such net operating loss carryovers and carrybacks in order to determine the net operating loss deduction for such taxable year. vi. Ascertainment of deduction dependent upon net operating loss carrybacks 1.172(d) 1. If the taxpayer is entitled in computing his net operating loss deduction to a carryback which he is not able to ascertain at the time his return is due, he shall compute the net operating loss deduction on his return without regard to such operating loss carryback

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2. When the taxpayer ascertains the net operating loss carryback, he may within the applicable period of limitations file a claim for credit or refund of the overpayment, if any, resulting from the failure to compute the net operating loss deduction for the taxable year with the inclusion of such carryback. ITEMS NOT DEDUCTIBLE A. CAPITAL EXPENDITURES a. Examples of Capital Expenditures: 1.263(a)-1(a): i. Any amount paid for new buildings or for permanent improvements or betterments made to increase the value of an property or estate, OR ii. Any amount paid in restoring property or in making good the exhaustion thereof for which an allowance is or has been made. iii. Other Examples of Capital expenditures: 1.263(a)-1(c) 1. An amount paid to acquire or produce real or personal tangible property. See 1.263(a)-2 2. An amount paid to improve real or personal tangible property. See 1.263(a)-3 3. An amount paid to acquire or create intangibles. See 1.263(a)-4 4. An amount paid or incurred to facilitate an acquisition of a trade or business, change in capital structure of a business entity, and certain other transactions. See 1.263(a)-5 a. WOODWARD V. COMMR: i. Amounts paid for attorney fees etc. in the course of litigation to appraise minority stock property are not deductible ordinary and necessary business expenses under 162 and must be capitalized. ii. Rules: 1. Ask whether the origin of the claim that is litigated is in the process of the acquisition itself. 2. Costs incurred in the acquisition or disposition of a capital asset are to be treated as capital expenditures. 3. If an expense is capital, it cannot be deducted as ordinary and necessary, either as a business expense under 162 or as an expense of management, conservation or maintenance under 212. b. INDEPCO: expenses incurred in friendly takeover are not deductible business expenses and must be capitalized. i. An amount paid to acquire or create interests in land such as easements, life estates, etc. ii. Amounts paid to sell property: Except in the case of dealers in property, commissions and other transaction costs paid to facilitated the sale

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of property are treated as deductible ordinary and necessary business expenses. b. General Rule for Capital Expenditures: i. Pursuant to 263(a)(1), no deduction is allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of a property or estate where the property is produced by the taxpayer for use by the taxpayer in a trade or business or an activity conducted for profit. See 263A(c)(1). 1. Personal use property Exception: a. Where property is produced by the taxpayer for use by the taxpayer other than in a trade or business or an activity conducted for profit, this subsection does not apply and it need not be capitalized under 263A. 263A(c)(1) 2. Research and Experimental Expenditures Exception: a. Where Amount is allowable as a deduction under 174, relating to research and experimental expenditures, 263A does not apply and such amounts need not be capitalized pursuant to that section. 263A(c)(2). i. Under 174(a), a taxpayer may treat research or experimental expenditures which are paid or incurred by him during the taxable year in connection with his trade or business as expenses which are NOT CHARGEABLE to capital account and may be deducted. b. Research and Experimental Expenditures must be reasonable to be eligible for deduction and non capitalization. 174(e) c. CAPITALIZATION AND INCLUSION IN INVENTORY COSTS OF CERTAIN EXPENSES i. Real or tangible property produced by the taxpayer 1. The term tangible property includes film, sound recording, video tape, book or other such property. 263A(b)(2) 2. Property acquired for resale a. Inventory in hands of TP= not capitalized i. If such real or tangible property is produced by the taxpayer under 263A(b)(1) or acquired for resale under 263A(b)(2)(A), and is Inventory in the hands of the taxpayer, the direct or indirect costs allocable to such property under 263(A)(2)(A)-(B) shall be included in inventory costs and, therefore, not capitalized. 263A(a)(1)(A). b. In any other case= capitalized i. where real or tangible property is produced by the taxpayer or acquired for resale and such property is not inventory in the hands of the taxpayer, the direct costs of such property and such propertys proper share of those indirect costs (including taxes) part or all of which are

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allocable to such property, shall be capitalized. 263A(a)(1)(B); 263A(a)(2)(A)-(B). 1. Exception: a. Where personal property is acquired for resale under 263A(b)(2)(A), and the taxpayer has gross receipts of $ 10,000,000 or less for the 3taxable year period ending with the taxable year preceding such taxable year, 263A(a) shall not apply, and such amounts need not be capitalized, despite not being inventory in the hands of d. ADJUSTMENTS TO BASIS OF CAPITAL PROPERTY i. Expenditures, Receipts Losses, or other items properly chargeable to a capital account: 1. Proper adjustment in respect of the property shall in all cases be made for expenditures, receipts, losses, or other items properly chargeable to capital account. 1016(a)(1); 1016(a). 2. Exception: a. But no such adjustment under 1016(a)(1) shall be made for taxes or other carrying charges described in 266, or for expenditures described in 173, relating to circulation expenditures, for which deductions have been taken by he taxpayer in determining taxable income for the taxable year or prior taxable years. ii. Exhaustion, Wear and tear, obsolescence, amortization, and depletion in respect of any property since February 28, 1913: 1. Proper adjustment in respect of the property shall in all cases be made in respect of any property since February 28, 1913 for wear and tear obsolescence amortization and depletion, to the extent of the amount (A) allowed as deductions in computing taxable income under this subtitle or prior to income tax laws, and (B) resulting (by reason of the deductions so allowed, in a reduction for any taxable year of the taxapayers taxes under this subtitle. 1016(a)(2)(A)-(B). a. Where no method is adopted under 167 (depreciation deduction provision), the amount allowable shall be determined under the straight line method. e. DEPRECIATION DEDUCTIONS FOR CAPITAL PROPERTY USED IN TRADE OR BUSINESS: i. Purpose: 1. Depreciation is a method by which taxpayers can get a tax deduction by spreading the cost of an asset over a period of time. As a result, depreciation reduces the asset's AB. 2. When the asset is subsequently sold, the gain on the sale will be higher since its AB is now lower. 3. How the gain is treated depends on the type of asset. ii. Pursuant to 167(a)(1)-(2), there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear

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(including a reasonable allowance for obsolescence) of property used in a trade or business, or of property held for the production of income. iii. Basis for Depreciation: 1. The basis for which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the allowed in respect of a property shall be the adjusted basis provided in section 1011, for the purpose of determining the gain on the sale or other disposition of such property. 167(c)(1). 2. Special Rule for property subject to lease a. If any property is acquired subject to a lease, no portion of the adjusted basis shall be allocated to the leasehold interest, and the entire adjusted basis will be taken into account in determining the depreciation deduction (if any) with respect to the property subject to the lease. 167(c)(2). 3. No depreciation deduction allowed for certain term property interests a. To taxpayer for any term interest in property for a period during which the remainder interest in such property is held (directly or indirectly) by a related person. 4. Computer Software i. If a depreciation deduction is allowable under 167(a) with respect to any computer software, such deduction shall be computed by using the straight line method and a useful life of 36 months, unless determined to be an amortizable 197 intangible. 167(f)(1). Computing Depreciation Deductions of Capital Property: ACCELERATED COST RECOVERY SYSTEM i. Except as otherwise provided in this section, the depreciation deduction provided by 167(a) for any tangible property shall be determined by using the applicable depreciation method, the applicable recovery period, and the applicable convention. 168(a)(1)-(3). 1. Determine class life 2. Determine classification of property by class life 3. Determine Applicable Depreciation Method 4. Determine Applicable Recovery Period 5. Determine Applicable Convention 6. Do not include salvage value. ii. CLASSIFICATION OF PROPERTY: 168(e) i. See page 175. iii. Applicable Recovery Period i. 168(c), see CB page 174. iv. Applicable Convention 1. In general, pursuant to 168(d), the applicable convention is the half-year convention. a. REAL PROPERTY: MID MONTH CONV. i. In the case of nonresidential real property, residential rental property, or any railroad grading or tunnel bore, the applicable

f.

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convention is the mid-month convention. 168(d)(2)(A)-(C). b. Where substantial property placed in service during last 3 months of the taxable year, the applicable convention is the mid quarter convention. 168(d)(3). v. Applicable Depreciation Method: 1. General Rule: 200% Declining Balance Method a. Under 168(b)(1) the applicable depreciation method is, in general, the 200 percent declining balance method, (B) switching to the straight line method with respect to the adjusted basis as of the beginning of such year will yield a larger allowance. 2. 150% declining balance method in certain cases: a. The declining balance method is 150 percent instead of 200 percent in the case of: i. 15-year or 20-year property to which the straight line method does not apply and no election has been made under 168(b)(5). 168(b)(2) 3. Straight Line Method: a. Where tangible property is used predominately outside of the U.S. or is tax-exempt use property, or tax-exempt bond financed property, or any imported property by an Executive order, the depreciation deduction of such property shall be the alternative depreciation system. 168(g)(1). 4. ALTERNATIVE DEPRECIATION SYSTEM: a. Straight line method (without regard to salvage value) b. Normal applicable convention under 168(d) c. Recovery period under table on page. 179. 168(g)(2). i. Pursuant to 168(b)(3), the applicable depreciation method shall be the straight line method in the case of: 1. Nonresidential real property; 2. Residential rental property a. Where 90 percent or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units under 168(e)(2)(A). 3. Any railroad grading or tunnel bore a. Property with respect to which the taxpayer makes an election under 168(b)(5) to make the provisions of this paragraph ( 168(b)(3)) apply 4. Single purpose agricultural or horticultural structure within the meaning of subjection (i)(13) 5. Qualified leasehold improvement property described in subsection (e)(6)

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where improvement was made by a person who was the lessor of such improvement when such improvement was placed in service only as long as such improvement is held by such person. 168(e)(6) 6. Qualified restaurant property where such property is: a. A building, or an improvement to a building b. And more than 50 percent of the buildings square footage is devoted to the preparation, and seating for on-remises consumption of, prepared meals. 168(e)(7) 7. Qualified retail improvement property under 168(e)(8) a. Property is qualified retail improvement property if nonresidential real property and b. The improvement is to an interior portion of the building which is nonresidential real property c. Such portion is open to the general public and used in the retail trade or business of selling tangible personal property to the general public, and d. Such improvement is placed in service more than 3 years after the date the building was first placed in service. i. Exceptions: the enlargement of the building any elevator or escalator, the structural component benefiting a common area, or the internal structural framework of the building. 168(e)(8)(c)(i)-(iv). g. DEPRECIATION RECAPTURE i. 1245 ii. 1250 VI. TAX PROBLEMS a.

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A. Mis-included Property in GI Under Claim of Right; deduction allowed: a. General Rule: If an item was included in gross income for a prior taxable year or years because it appeared that the Taxpayer had unrestricted right to such item, i. it was established after the close of such prior taxable year or years that the taxpayer did not have an unrestricted right to such item or a to a portion of such item, AND ii. the amount of such deduction exceeds $3,000, then a deduction is allowable for the taxable year under 1341(a)(1)-(2). The tax imposed for the taxable year shall be the lesser of the following: 1. the tax for the taxable year computed with such deduction pursuant to 1341(a)(4); OR a. Amount of Deduction: 2. an amount equal to: a. the tax computed for the taxable year computed with such deduction, minus the decrease in tax for the prior taxable year which would result solely from the the exclusion of such item (or a portion thereof) from such prior taxable year or years. 1341(a)(5)(A)-(B). b. CASE: i. If a taxpayer was not entitled to keep money included in gross income in previous year, he is entitled to a deduction in the year it is refunded. U.S. v. Skelly Oil Co. c. Code: Computation of Tax Where Taxpayer Restores Substantial Amount Under Claim of Right: 1341 i. 1341(b) Special rules 1. (1) If the decrease in tax ascertained under subsection 1341 (a)(5)(B) exceeds the tax imposed by this chapter for the taxable year (computed without the deduction) such excess shall be considered to be a payment of tax on the last day prescribed by law for the payment of tax for the taxable year, and shall be refunded or credited in the same manner as if it were an overpayment for such taxable year. 2. (2) Subsection (a) does not apply to any deduction allowable with respect to an item which was included in gross income by reason of the sale or other disposition of stock in trade of the taxpayer (or other property of a kind which would properly have been included in the inventory of the taxpayer if on hand at the close of the prior taxable year) or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. B. TAX BENEFIT RULE: Where a deduction is taken and events occur that are fundamentally inconsistent with the reason the earlier deduction was taken, it must be returned via inclusion in the taxpayers gross income in the year of recovery. Bliss Diary. a. Defined: The tax benefit rule requires that, where a deduction in a prior year reduced the taxpayer's taxable income, recovery of the deducted item in a subsequent year must be reported as income in the year of recovery. b. Reformulated by Case Law: i. Unless a nonrecognition provision of the Internal Revenue Code prevents it, the tax benefit rule ordinarily applies to require the inclusion of

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income when events occur that are fundamentally inconsistent with an earlier deduction. Hillsboro National Bank; Bliss Dairy. 1. Thus, in Bliss Dairy, where a closely held corporation took a deduction for cattle feed under 162 and later distributed it to shareholders, this was inconsistent event requiring inclusion of the in the taxpayers gross income in the year of recovery. 2. AKA the taxpayer must return the deduction. c. LIMITATION: Where Deduction in Previous Year did not Reduce Tax. i. Pursuant to the Exclusionary Arm of the Rule, 111(a), Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter. IV. TAX EXPENDITURES A. Definition: a. Tax expenditures are provisions that deviate from the normal tax structure, by way of special exemptions, deductions, credits, or exclusions, which result in a federal revenue loss, not de minimus (greater than 50 million over 5 years 20072011), and encourage behavior that would otherwise be subsidized as direct spending outlays by the federal government. b. According to the Joint Committee: i. Provisions that create federal revenue losses, not de minimus, that have a reasonable basis in being classified as tax expenditures (as an alternative of direct spending outlays). 1. Not de mimimus: Result in a total revenue loss of at least $50 million over the preceding five fiscal years: 2007-2011 (current). c. According to Budget Act of 1974: i. Tax expenditures are revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption or deduction from gross income or which provide a special tax credit, a preferential rate of tax, or a deferral of tax liability (the Budget Act 1974). B. Benefits of Tax Expenditures a. Unlimited ability to take advantage of provisions (like an entitlement in that way), as opposed to direct outlays. b. It is easier for Fed to not receive revenue pursuant to a Tax Expenditure program than to spend the revenue they do receive as a direct outlay to accomplish the same result. C. Alternatives to Tax Expenditures to alter taxpayer behavior: a. Regulations b. Direct Grants/Subsidies c. Criminal Laws/Penalties

D. EX: INTEREST ON STATE AND LOCAL BONDS: NOT INCLUDED IN GI 103 a. Pursuant to 103(a), gross income dos not include interest on any State or local bond, unless it is not a qualified bond, such as a bond not in registered form

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under 103(b)(3), an unqualified private activity bond under 103(b)(1), or an arbitrage bond under 103(b)(2). b. This provision encourages the purchase of State and local bonds, which are used to fund community projects and is unlimited in that it is not restricted by caps.

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