Circle all of the dates & yrs on the exam. Also, take note of the TPs profession.

Tax
I. Background Info a. Administrative feasibility is the goal and purpose behind all tax laws. b. 16th Amend gives Congress the authority to tax individuals. i. Congress shall have the power to lay and collect taxes on

c.

d.

e.

incomes, from whatever source derived, w/o apportionment among the several States, and w/o regard to any census or enumeration The US uses a Global Approach to taxation i. Global approach income from all sources is combined and taxed under a rate schedule that applies to the TPs entire income, minus any allowable losses or deductions. Tax Incidence the ultimate economic burden of a tax i. Ex. Refrigerator manufacturer is obligated to pay a tax to the govt. The manufacturer raises the prices for the fridges to the consumer then the tax incidence has been shifted to the consumers. Compliance and Administration i. Audits you know what this is SoL = 3yrs ii. Relief avail to TPs aft audits 1. Tax Court a. TP declines to pay the tax and then file a petition for review. b. Only avail if the TP has not paid the tax at the time of the petition. c. Theres no jury trial and the decision is reviewable by the Circuit Ct in that jurisdiction and SC upon writ of certoria d. If the TP loses than he must pay the tax w/interest eff the date the payment wouldve been due. e. TP should weigh the current interest rate charged by the govt against what he must pay or can earn on the $$ elsewhere bef resorting to this option.

f.

Reviewable by the fed circuit cts of appeal where the TP resides 2. Federal Tax Court a. The TP pays the tax and then sues for a refund from the fed govt. b. Jury trial is avail c. Reviewable by the Cir ct of appeals & SC d. TP must file in his jurisdiction 3. US of Fed Claims a. TP must pay the tax and then sue for a refund in the US of fed claims ct. b. Reviewable by the US ct of appeals for fed circuit c. If the TP obtains a favorable rulin in this ct & the ruling is held up on appeal; all other TPs may take their case reg the same issue/facts to that ct to foreclose the possibility of conflict among circuits 4. Revenue Ruling a. Ct doesnt have to go along w/this; its just the IRSs interpretation of the law. Penalties for Noncompliance i. 20% penalty imposed for underpayment due to Negligence ii. 10% or $5k whichever is greater for substantially understating income 1. $10k for corporations iii. These penalties can be waived if the TP demonstrates reasonable cause and good faith iv. No double penalties if the TP violates both he only has to pay the 20% v. Failure to file a tax return 1. 5% p/m not to exceed 25% vi. Failure to pay a tax shown on a return when due or w/in 10days when assessed and demanded by the IRS 1. .5% p/m not to exceed 25% vii. Fraud 1. 75% of the fraudulent underpayment 2. Highly flagrant behavior viii. Criminal fraud

f.

g.

h.

Any willful attempt to vade or defeat any tax imposed by this title or the payment thereof 2. Felony 3. No more than $100k / $500k for corporations or 5 yrs in prison 4. Civil v. crim fraud penalties a. Crim SoL = 6yrs b. Civil SoL = none What TPs should do if they discover a mistake aft they file i. If the mistake is only discovered aft the tax return was filed, the TP should make an adj on their tax return in the year they discover the mistake ii. If the mistake was plainly an error at the time the return was filed, then the TP should file an amendment to their tax return. iii. There is no penalty for innocent error; however, the TP will be responsible for interest on the underpayment if they are audited. Tax Practice i. The TP must be able to provide a reasonable basis for his or her decision for exclusions on his tax return ii. Atty cannot promote or assist in lying or concealment to the IRS on the basis that there is a slim probability of the TP being caught; however, the atty can inform the TP of the possibility for making claims based on weak but reasonable grounds.

1.

II. Tax Terms a. Tax accounting

i. 2 methods of accounting for tax purposes 1. cash method TP reports as income the CASH or CASH equivalent he recs or pay out in that tax year 2. accrual method TP reports as income items earned by him regardless if he has been paid or not. & for deductible purposes items owed by him are counted regardless of whether he paid or not. a. Corps usually uses this method. b/c it accurately reflects economic realities. b. Types of Tax Rate Structures i. Regressive tax rates go down as the TPs income rises ii. Progressive income tax the avg. tax rates increase as the TPs income rises. 1. This is the one we use & it is accomplished by use of the MTR. iii. Proportional rate everyone is taxed the same specific tax rate c. Taxable Income i. AGI minus the following: 1. (a) The amt of the personal exemptions of the TPS & their dependents; 2. (b) Either one of the following: a. (i) The standard deduction or i. standard amt of $$ that all TPs are allowed to take based on the TPs filing status b. (ii) itemized deductions i. interest paid on mortgage; ii. state income & property taxes iii. casualty losses above 10% of AGI; iv. med expenses that exceed 2% of the AGI

d. Realization i. A gain or loss is said to be realized when there has been some change in circumstances such that the gain or loss might be taken into acct for tax purposes e. Recognized i. A gain or loss is said to be recognized when the change in circumstances is such that the gain or loss is taken into account f. Difference between the 2 Recognized the gain or loss will def be taken into acct for tax purposes. Realization it may be. g. Marginal Tax Rates this is important for determining how much the TP will be taxed. h. Gross Income i. 61 all income i. Adjusted Gross Income (AGI) i. Gross income items listed in 62 = AGI j. tax credits i. are not deductions but instead things that may be used to offset the TPs tax liability 1. 21-41 2. 62 k. Alternative Minimum Tax i. 55 1. imposed at the rate of 26% on the first $175k 2. 28% on amts above $175k l. Capital Gains & Dividend Income i. Capital gain or loss is the loss or gain from the sale or exchange of a capital assets, i.e. property or inventory ii. Capital Gains are taxable at the rate of 15% iii. Capital losses can be used to offset capital gains. iv. TP can use capital losses to offset ordinary income up to $3k v. Dividend income is taxed at the same rate of capital gains m. Cost / Basis i. The amt the TP spent to acquire the investment n. Deferral & its value i. Deferral TP is allowed to stash away $$ and not pay taxes on the $$ or the interest earned from the $$ 1. Ex. IRA. ii. Discounting to present value the process of calculating the present value of a future amt iii. ** you always want to find ways to allow your clt , the TP to hold on to his $$ longer***

INCOME
1. Clearly realized income over which the TP has complete dominion a. Clearly realized - there has been a change in circumstances which could affect it 2. Gross Income accession to wealth a. Glenshaw Glass b. Reg. Sec. 1.61-1 Gross Income -(a) GI = all income from whatever source derived unless excluded by law. Includes income realized in any form c. Reg. Sec. 1.61-2 Compensation paid other than in cash - If svcs are paid for in property other than cash then they are taxable at the fair market value (FMV) 3. Haig Simons Income a. TPs personal expenditures for the year (+) or (-) TPs increase or decrease in wealth for the year i. Ex. If TPs house went up in value, that would be income.

4. Non Cash Benefits a. Meals & Lodging Provided to Employers i. Sec. 119 is the benefit to the TP incidental to the benefit to

employer 1. Convenience to Employer R: (a)meals & lodging supplied to the employee, his spouse or dependents shall be excluded from his gross income if provided for the convenience of his employer &: a. (1)the meals are provided on the premises of the employer b. (2)the lodging are on the employer's premises & are a condition of his employment i. Benaglia v. commissioner -F: TPs lived at the Hawaiian resort where they worked and rec'd all of their meals from the hotel. They lived at the resort purely for the convenience of the TP's employer. The IRS computed the value of the rooms they rec'd and the food and added it to their GI. R: Convenience to the Employer H: the ct held that since the TP lived at the hotel for the convenience of the employer the value of the rooms and food were not taxable. Bd's Reasoning: the benefit to the TP was purely incidentally to the performance of his duty; the dominant benefit of the TPs lodging was the convenience of the employer. Dissent: The dissenter believed that the TP should 6

2. (b) special rules

have been taxed on the value of the rooms and meals. The dissenter reasoned that the TP's presence was not req on the premises at all time. He based this on the fact that the TP was the manager of 3 resorts from his employer but only lived on one of the resorts. Additionally, the inclusion of the rooms and food was req by the TP in his lttr of intent to accept employment. Also, the TP spent mths at a time off of the resort. The dissenter concludes that at most the room and bd was a mutual benefit to both the employer and the TP as opposed to only the employer.

a. (1)Provisions of an employment K or State statute fixing terms of employment are not determinative of whether the meals & lodging are provided for the convenience of the employer b. (2) that fact that "a charge is made for such meals" or that the employee may accept or decline the meals are not determinative either c. (3)Certain fixed charges for meals Emp collects $$ to provide meals for the employees TPs i. TP m/b required to contribute to the meal fund even if he doesnt take the meals for it to be NT. 1. Sibla v. Commissioner the ct held that the $3 a day the TP was obligated to contribute to for the organized mess at the station house. Cts Reasoning: The ct reasoned that this was distinguishable from Kowalski in that the TP in this case had to turn over the $$ to his employer and the $$ was used for meals; however, in Kowalski, the

TP was given the $$ and technically free to use it wherever and on whatever he chose. d. (4) Meals furnished to employees on business premises where meals of most employees are otherwise excludable i. If more than the employees receive meals at the employers convenience than it will be assumed that all meals furnished on the job are furnished for the convenience of the employer. 3. Some courts will allow groceries under this R. 4. Furnished a. The employer must provide the food as opposed to just providing the employee w/the money for such. i. Commissioner v. Kowalski the ct held the meal allowance given to highway troopers was not excludable under 119. 5. Employee a. This rule can be extended to sole shareholders of a corporation.

Other Fringe Benefits

****Partners are not employees!!******* 5. 79 - $50k worth of group term life insurance a. anything above $50k, the TP must rpt/include as income i. ex. TPs emp provides a life insurance policy for $70k at a rate of $20 per $10k of coverage. TP must include $40 in her gross income for the xtra coverage 6. 105(b) & 106 med ins and pymts a. deductible for the employer and NT to the TP employee 7. 129 dependent care assistance - ck child care for more info

8. Sec. 132
a. Whos covered under 132 i. 132(h)(1) retired and disabled employees & widows & widowers ii. 132(h)(2)- spouse and dependent children( under the age of 25) b. (a) Exclusion from gross income. -- Gross income shall not include any fringe benefit which qualifies as a-i. (1) no-additional-cost service, - NON DISCRIMInation 1. 132(b) No-additional-cost service defined. services performed by the employer, i.e. hair salon provided hair styling for its employees. 2. Discount is limited to 20% 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 performing 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, (cannot discriminate) 1. the discount cannot be below cost. 2. For services the discount cannot be more than 20% below cost 3. 132(b)(1) applies the service or product for which the discount is provided m/b one offered by the employer for sale to customers in the ordinary course of the line of business of the employer for which the employee is employed. 1. Ex. If the emps profit is

iii.

iv.

v.

28% & the emp offers the TP a 30% discount. The difference 2% m/b rptd by the TP employee. (3) working condition fringe (Employer can Discriminate) 1. such as the business use of a company car, or a free subscription to a magazine that relates to the employees job (4) de minimis fringe- (NON_DISCRIMINATION) 1. Does not include cash, unless its provided for occasional meal $$ or local transportation. {Reg. 1.132-6} 2. (1) In general. -- The term "de minimis 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 employer's employees) so small as to make accounting for it unreasonable or administratively impracticable. 3. (2) Treatment of certain eating facilities. -The operation by an employer of any eating facility for employees shall be treated as a de minimis fringe if-a. (A) such facility is located on or near the business premises of the employer, and b. (B) revenue derived from such facility normally equals or exceeds the direct operating costs of such facility. (5) qualified transportation fringe, (Discrimination Allowed) 1. Can be in the form of cash reimbursement or just upfront pymt by the employer 2. Does not cover airplanes; theres a separate rule. 3. (4) No constructive receipt the fact that the employee may choose to opt out of the benefit does not f w/its excludability 4. (7) Coordination with other provisions. -- For purposes of this section, the terms "working condition fringe" and "de minimis fringe" shall not include any qualified transportation fringe (determined without regard to paragraph (2)). 5. (A) reg vehicle used for transportation between the employees home and place of employment $230 limit p/m a. (i) the seating capacity of which is at 10

least 6 adults (not including the driver), and 6. (B) Any transit pass. - $230 limit p/m 7. (C) Qualified parking. - $230 limit p/m 8. (D) Any qualified bicycle commuting reimbursement. - $20 p/m limit vi. (6) qualified moving expense reimbursement, (D allowed) 1. moving expenses that would be deductible under 217 vii. (7) qualified retirement planning services, or (D allowed) viii. (8) qualified military base realignment and closure fringe. (Discrimination allowed) c. (j) Special rules. -i. (4) On-premises gyms and other athletic facilities. -1. (A) In general. -- Gross income shall not include the value of any on-premises athletic facility provided by an employer to his employees. 2. (B) On-premises athletic facility. -- For purposes of this paragraph, the term "onpremises athletic facility" means any gym or other athletic facility-a. (i) which is located on the premises of the employer, b. (ii) which is operated by the employer, and c. (iii) substantially all the use of which is by employees of the employer, their spouses, and their dependent children (within
the meaning of subsection (h)).

9. Cafeteria Plans 125 NoN -Discrimination

Allows the employee to choose among a variety of noncash nontaxable benefits or may choose to take cash (thats taxable). b. 125(f) limits the benefits that can be included in cafeteria plans to: i. dependent care ii. group-term life insurance iii. adoption assistance iv. excludable accident and health benefits v. deferred comp plans. c. Non decimation rule applicable
a.

10.

Frequent flyer miles

11

R: the use of frequent flyer miles earned from business travel, for personal use does not have to be rptd. 11. Benefits from someone other than the employer a. Unsolicited items recd from someone other than the employer is not taxable. 12. Valuation i. The value of the exclusion is the amt of the exclusion multiplied by your Marginal Tax Rate (MTR) 1. Ex. Seton Hall allows the costs of parking to be deducted from the profs income. Prof income $82k parking costs $2k 2. the value of the exclusion would be $600 if her MTR is 30%. a. $2k x 30% = $600 3. the employer also doesnt have to pay the payroll tax on the $2k allowed for the parking ii. Turner v. Commissioner - TP won 2 1st tickets to Rio de Jeneiro. He traded the tickets in for 4 coach tickets which he paid an addtl $12.50. He rptd income of $520 on his taxes for the price of the tickets. The commissioner valued them out at $2220 the retail price of the tickets. D: The ct just basically took the avg of the two amts, the one rptd by the TP and the one the commissioner valued the tickets at. iii. Revenue Ruling i. The ct doesnt have to go along w/it. Its the IRS interpretation of the law. ii. Bartering services are taxable at the fair market value
a.

12

Windfalls & Gifts

13. Punitive Damages are taxable as income a. Commissioner v. Glenshaw Glass Co. the ct held that the $$ the TPs recd in punitive damages from a civil suit was taxable. The ct reasoned that the punitive damages were accessions to wealth, clearly realized and over which the TP had complete dominion. The ct concluded that the fact that the $$ was paid as punishment from the other party for unlawful conduct does not change the fact that its taxable. D: Commissioner award taxable 14. Found property is taxable to TP@ the FMV 15. Gifts. a. 102 - General Rule Gifts are not taxable. Even money gifts i. ex. If D earns $100k and gives E $30k out of love. b/c E doesnt have any income. E would not be taxed on the $30k. D will not rec a deduction and she would be taxed on her $100k income. b. Exceptions: i. if the property is converted to cash then it is taxable -T ii. cash over $10k (gift tax is the applicable law) - T iii. employee gifts - T 1. Exception 132(e)- de minis gifts & certain limited safety and length of service awards(5yr watch or name plate like Pompey has) - NT c. A gift is something given in detached and disinterested generosity. i. The intention of the donor is necessary for the analysis of whether the property/cash given was in fact a gift 1. In conducting this analysis the ct should consider if the gift was given in return for services rendered or proceeds from the constraining force of any moral or legal duty or anticipates a benefit to the payor. a. Commissioner v. Duberstein F: the TP recd a caddy for giving someone business leads. TPs argument: it was a gift and gifts are NT. I: What is the criteria for something to be considered a gift. R: (see above) H: the ct held that the caddy was not a gift b/c it was given as repayment for the business leads TP gave. D: Commissioner caddy taxed. b. Stanton ct found $20k gift given to the investment president of a church when he retired was NT. Cts Reasoning: The members testified that they gave him the gift b/c he had a pleasing personality, did a splendid piece of work and was well liked by the members of the church personally. 13

ii.

(gift tax would apply) 2. (e) Income taxed to grantor or assignor. Section 102 is not intended to tax a donee upon the same income, which is taxed to the grantor of a trust or assignor of income under section 61 or sections 671 through 677, inclusive. Scholarships, fellowships, gifts given for marriage are not covered under this section 1. (2) Cross references. -2. For provisions excluding certain employee achievement awards from gross income, see section 74(c). 3. For provisions excluding certain de minimis fringes from gross income, see section 132(e).

14

Gifts between family members 1. If the gift is based on the familial relationship or circumstances of their employment - T d. Limitations i. General Rule TP gift giver cannot take a deduction for gifts over $25 ii. 274(b)- exception for business gifts 1. the gift giver can only deduct $25 per ind per year and the receiver does not have to include it in his income a. {dont get trapped up by this! This is not determinative of whether the gift is taxable or not. Remember the ques will more than likely ask whether the gift is taxable to the TP.} b. surrogate taxation i. Congress is satisfied as long as someone pays taxes on it 1. One person can exclude it or the other person through disallowance. c. This causes problems when the other side of the transaction doesnt care about deductions, e.g. nonprofits and other tax exempts organizations iii. Exceptions: 1. (A) an item having a cost to the taxpayer not in excess of $4.00 on which the name of the taxpayer is clearly and permanently imprinted and which is one of a number of identical items distributed generally by the taxpayer, or 2. (B) a sign, display rack, or other promotional material to be used on the business premises of the recipient. 3. (2) Special rules. -a. (A) In the case of a gift by a partnership, the limitation contained in paragraph (1) shall apply to the partnership as well as to each member thereof. b. (B) For purposes of paragraph (1), a husband and wife shall be treated as one taxpayer.

iii.

15

Transfer of unrealized gain by gift

****Determine whether the transfer is a gift 1st****** 16. Analysis: a. (1) Is it a gift? i. Emotional tie to the gift ii. Non-gifts get FMV @ date of transfer b. (2) whether the gift is depreciated or appreciated property i. depreciated the basis is FMV the day the gift was given or the donors basis whichever is lower 1. You should advise the clt to never make a gift of depreciated value; they should sell it and then gift it ii. appreciated the basis is the donors basis - TP steps in the donors shoes for tax purposes c. No Mans Land i. if the thing is sold for anything between the donors orig basis and the FMV at the time of gift, there is no gain or loss ii. 1014 -Basis R for transfers at death 1. The basis for gifts transferred at death is the FMV of the gift @ the date of death a. The heir receives a step up in basis to FMV at the date of death i. A buys Property for $1000 ii. 2011 A dies. FMV $1500 iii. Heirs Basis $1500 iv. the $500 in appreciation escapes taxation

16

Recovery of Capital - 72
d. If the TP owns several investments that he purchased over a period of time, the default rule is first in, first out {Fifo} i. Ex. 50 shares purchased 2006 - $300 50 Shares purchased 2007 - $700 Fifo method A/R: $700 Basis: $300 Gain: $400

1. Basis First (Inja Land) TP allowed to recover her basis bef she has

to include the $$ recd as income a. Inja Land Co. v. Commissioner the TP argued that he could not seriously allocate a basis to the easement he gave the govt for which he recd $$. The Commissioner argued that the TP should have to pay taxes on the full amt that he recd. The ct held that if no reasonable allocation of basis can be made to the piece that they sold then no gain can be recognized 2. Annuities a. Retirement K where the TP pays the co then at retirement the co pays the TP based on the amt they made off of the $$ b. calls for equal periodic cash pymts commencing at a certain date c. in order to analyze annuity cases you need to know the TPs life expectancy or term of pymts d. exclusion ratio the amt invested divided by the expected rtn i. exclusion ratio x the amt recd in that year = the amt of income TP is NT on a. ex. Investment in K - $100k (divided by) $180k = 55.55%. Therefore, for every $9k pymt TP recd from the annuity, 55.55% ($5k) would be treated as NT recovery of investment & the other $4k would be income e. Deferred Annuities i. 72(e) 1. if the TP takes out a loan against an annuity, he must recognize the amt of the loan or the increase in the value of the policy whichever is less. 2. If the TP takes his $$ out bef the age of 59 he must recognize the gain and pay a penalty of 10% of the income.

17

e.

(3) Deduction where annuity payments cease before entire investment recovered. i. (A) In general. -- If

ii.

iii.

1. (i) after the annuity starting date, if the pymts stop b/c of the death of the annuitant; and 2. (ii) there is $$ to recover for the initial investment, 3. the amount of such unrecovered investment)shall be allowed as a deduction to the annuitant for his last taxable year. (B) Payments to other persons. if someone else other than the annuitant is entitled to rec pymts under the annuity K then that person is allowed to take the deduction. (4) Unrecovered investment. -- For purposes of this subsection, the unrecovered investment in the contract as of any date is 1. (A) the investment in the contract (determined without regard to subsection (c)(2)) as of the annuity starting date, reduced by 2. (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.

Pensions f. The $$ contributed by the TP is tax free if its taxed bef the TP pays it into the pension@ retirement but the $$ contributed by the employer is taxable to the TP g. the employer's contribution is deductible as compensation h. the $$ contributed by the TP is taxable at retirement if the $$ paid into the pension is pre-tax dollars Gains and Losses from Gambling i. Gain from gambling are taxable j. Losses are only deductible up to the amt of the gains i. Ex. TP wins $700 but then loses $800 later. He can only rec a deduction for $700, the amt of his gains from gambling. k. Enforcement i. Any gambling win over $600 m/b rptd by the place paying the win.

18

Annual accounting Principle l. Claim of Right - 1341 i. de minis anything less than $3k no need to report ii. R: if a TP receives earnings under a claim of rt and w/o restriction as to its disposition, he has recd income which he is req to rpt on his tax rtn, even though it may still be claimed that he is not entitled to retain the $$, & even though he may still be adjudged liable to restore its equivalent. 1. North American Oil Consolidated v. Burnet the issue here was whether the TP corp responsible to report the money it recd from a receiver during ongoing litigation on a case. The TP argued that it should not have had to rpt the $$ as income b/c if it lost its case against the govt it would have had to pay the $$ back. The ct held that the $$ was taxable in the year the TP recd it from the receiver under a claim of right. iii. If the TP recs income erroneously and later rtns it, he is entitled to a deduction for that amt in the year he returns it. 1. US v. Lewis -F: TP recd a bonus in the amt of $22k. Later he was court ordered to rtn $11k of the bonus back to his employer b/c the amt was incorrectly calculated. TP argued that he s/b refunded the taxes he paid on the $11k b/c he had to give it back. The govt argued that the TP was only entitled to a deduction in the amount of $11k representing the loss in income. The ct sided w/the govt and held that the TP was entitled to a deduction in the current tax yr for the amt he rtnd. iv. Doesnt allow for interest whereas an amendment would. 1. *** Amendments for tax returns are only allowed if there was an error made at the time the tax return was completed; not if one was later found.

19

2. Is not allowed for embezzlers b/c they never had a claim of rt to the $$

m. The Tax Benefit Rule i. (1) TP takes a deduction for something he gives away or loses ii. (2) then the TP gets the $$ or property back, iii. (3) he must report it as income 1. Alice Phelan Sullivan Corp v. US (1939/1940 -AP TP gave some property to a church. The value of the property was $8700 the value of the deduction was $1900 (tax benefit). 1957 the church returned the property b/c it could not use it in accordance w/the stipulation TP put on it. The property was now worth $12k. IRSs argument: Inclusion - $8700 TP would owe $4500 in tax. TPs argument: we should only have to pay the $1900 back for the deduction we recd D: the property s/b included in the TPs income, the year of recovery at a value equal to the amts deducted as charitable contributions in the earlier years. iv. Exclusionary 1. 111 Sec. 111. Recovery of tax benefit items a. (a) Deductions. -- 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.(if the tax consequence would have been the same then TP doesnt need to include it) i. Bliss Diary-The co. took a deduction for cattle feed. Then they liquidated the corp. The lft over cattle feed was distributed to the investors. the fact that the co took a deduction for the cattle feed that was used for a business 20

v.

the value for the cattle feed had to be included in the cos tax rtn The Tax Benefit Rule will cancel out earlier deductions only when a careful examination shows that the later event is indeed fundamentally inconsistent w/the premise on which the deduction was initially based. 1. ex. If a TP made a rental pymt for 1mth at the end of the yr and the leased premises are destroyed by fire on Jan 10th then the inability of the TP to use the property is not a fundamentally inconsistent event a. if the TP converts if from business to personal use this would be a fundamentally inconsistent event. 2. if you have a subsequent event that changes the bottom line for the deduction, then its fundamentally inconsistent.

Dividend a. The same rate as capital gains apply. b. 0 and 15% are the taxable rates depending on the MTR c. 1(h) d. Dividends do not get offset by capital loses

21

Recoveries and Structured settlements n. Recoveries for personal and business injuries i. Compensatory Damages NT 1. Except for Emotional Distress - T ii. Punitive Damages - T iii. It does not matter from whom the TP recovers from. iv. The purpose of excluding recovery from gross income is that the $$ the TP recd only made him whole as opposed to a windfall. v. Sec. 104. Compensation for injuries or sickness 1. (a) In general. -- Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, the following are NT-a. (1) amounts received under workmen's compensation acts as compensation for personal injuries or sickness; b. (2) the amount of any damages received whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness; i. exceptions: 1. Punitive damages 2. Awards for emotional distress ii. The interest earned on periodic (structed) pymts are NT iii. Deferred pymts are more favorable to the TP c. (3) amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries or sickness i. Exception: other than amounts received by an employee, to the extent such amounts (A) are attributable to contributions by the employer which were not includible in the gross income of

22

o. Hypo i.

the employee, or (B) are paid by the employer); 1. These pymts also include $$ set aside by self-employed people for this purpose which were not taxed when set aside. d. (4) amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the armed forces of any country or in the Coast and Geodetic Survey or the Public Health Service, or as a disability annuity payable under the provisions of section 808 of the Foreign Service Act of 1980; and e. (5) amounts received by an individual as disability income attributable to injuries incurred as a direct result of a terroristic or military action (as defined in section 692(c)(2)). Tom is standing on the corner and sees a car driven by a dd. The car strikes his wife, C. C sues and recovers $100k for physical injury. She gets $50k for med expenses and $1m for punitive damages. Tom sues and recovers $100k for loss of consortium & Emotional Trauma & $10k for psychiatrist bills. 1. Whats excludable and whats not a. C - $100k for PI excludable b. C- $50k for med expenses excludable i. R- as long as she hasnt taken any deductions for the med expenses then they are excludable. c. C - $1m includable d. T - $10k excludable e. T - $100k excludable 2. (b) Termination of application of subsection (a)(4) in certain cases. (Military Cases) a. (1) In general. -- Subsection (a)(4) shall not apply in the case of any individual who is not described in paragraph (2). 23

b. (2) Individuals to whom subsection (a)(4) continues to apply. -- An individual is described in this paragraph if-i. (A) on or before September 24, 1975, he was entitled to receive any amount described in subsection (a)(4), ii. (B) on September 24, 1975, he was a member of any organization (or reserve component thereof) referred to in subsection (a)(4) or under a binding written commitment to become such a member, iii. (C) he receives an amount described in subsection (a)(4) by reason of a combat-related injury, or iv. (D) on application therefor, he would be entitled to receive disability compensation from the Veterans' Administration. c. (3) Special rules for combat-related injuries. -- For purposes of this subsection, the term "combat-related injury" means personal injury or sickness-i. (A) which is incurred-1. (i) as a direct result of armed conflict, 2. (ii) while engaged in extra hazardous service, or 3. (iii) under conditions simulating war; or ii. (B) which is caused by an instrumentality of war. iii. In the case of an individual who is not described in subparagraph (A) or (B) of paragraph (2), except as provided in paragraph (4), the only amounts taken into account under subsection (a)(4) shall be the amounts which he receives by reason of a combat-related injury. d. (4) Amount excluded to be not less than veterans' disability compensation. -- In the case of any individual described in

24

paragraph (2), the amounts excludable under subsection (a)(4) for any period with respect to any individual shall not be less than the maximum amount which such individual, on application therefor, would be entitled to receive as disability compensation from the Veterans' Administration. e. Doesnt apply to awards bef 1995 3. (d) Cross references. -a. (1) For exclusion from employee's gross income of employer contributions to accident and health plans, see section 106. b. (2) For exclusion of part of disability retirement pay from the application of subsection (a)(4) of this section, see section 1403 of title 10, United States Code (relating to career compensation laws). p. Business injuries i. General Rule the recovery is taxable in the year recd to the extent it exceeds the basis of the property. ii. Exception: if the TP reinvests the $$ in a similar or related use then he is allowed to defer taxation. 1. Ex. The TP corp has a bldg. w/a basis of $600k and FMV of $700k and the bldg. is destroyed in a fire. The TP recs $700k from the insurance co. If the TP buys another bldg. similar to the one destroyed, then only $100k is taxable. q. Medical Expenses & other Recoveries & Benefits i. Med expenses are only deductible if they are above 7.5% of the TPs income. 1. 7.5% is the standardized deduction everyone gets. 2. An employee cannot deduct the amt she pays for health insurance from her gross income.

25

Transactions involving loans & Income for Discharge of Indebtedness

r. General Rule: Loan proceeds are not gross income s. General Rule: Loan repayments are not deductible i. Exception: Discharged of Indebtedness 61(a)(12) 1. A TP must report the difference between what he recd from a loan and what he paid back NO MATTER WHAT. a. US v. Kirby Lumber F: Kirby sold bonds $12m worth of bonds and then purchased $1m of the bonds back in the same year for $862k. D Liable for tax on the difference

26

ii.

iii.

iv.

v.

vi.

b. Vukosovich, Inc. v. Commissioner The TP unsuccessfully argued that it should not be made to recognize income from discharge of indebtedness for $$ it borrowed b/c it lost $$ on the transaction in which it invested the $$. The ct held that this was irrelevant. The IRS doesnt care what the TP does w/the $$ aft they rec it. Exception: Insolvent Debtors 108(a)(1)(B) 1. If the TP is broke or has filed a BK, then the income from discharge of indebtedness is excluded. Exception: Solvent Farmers 1. The exception provided for insolvent debtors is avail for not so broke farmers for qualified farm indebtness. a. QFI- debt incurred in the operation of a farm by someone who during the 3 preceding taxable years derived more than 50% of his annual gross receipts from farming 108(g) Exception: Adj of purchase money debt 108(e)(5) 1. Reduction of debt incurred to purchase property and owed to the seller is treated as a reduction in sale price, rather than income to the purchaser Exception: Student loan forgiveness 108(f)(2) 1. Discharge of student loans are excluded from income if the discharge is contingent upon work for a charitable or educational institution. Exception: Mortgage forgiveness 108(h) 1. TP can exclude up to $2m of forgiven qualified principal residence indebtedness. a. Usually arises when the home is foreclosed or the mortgage co. renogiates the terms of the mortgage b. The TP must reduce her basis in the principal residence (but not below zero) by the amt excluded. 2. Ex. Home costs - $250k. The basis of the home is $250k. If the homeowner gets the bank to forgive $50k under prev would be income. Under the current provision the basis is reduce 27

3. by the amt forgiven; the basis would then be $200k so the gain realized by the TP when the home is sold would be based on that amt. t. Be careful w/the following examples: i. If the loan is forgiven in the spirit of love, affection, etc. ITS A GIFT & NT 1. Ex. TPs parents forgive a loan she used for school in the spirit of pride and admiration. This is not income for tax purposes b/c it was recd as a gift (the discharge/forgiveness of the loan was done b/c the parents were proud). 2. Ex. TPs parents pay the bank she borrowed the money from directly. This is still not a discharge of indebtness b/c the bank was pd. 3. Ex. TPs emp pays the student loan off as a X-mas bonus for TPs hard work. This is not a discharge b/c the debt was paid in full.

17.Transfer of Property Subject to Debt

a. Gain or loss shall be the difference between the amt realized from a sale or other disposition of property and the TPs adj basis for the property sold. 1001(b) i. Amt realized includes any cash recd and the FMV of property recd ii. Adj basis cost 1. 1016(a)(2) the basis of depreciable property (such as bldgs. And machines) shall be reduced from year to year by the amt allowable as a deduction for exhaustion, wear and tear, obsolescence, amortization, and depletion. b. NON Recourse Mortgage - If the value of the property is less than the amt of the mortgage, a mortgagor who is not personally liable cannot realize a benefit equal to the mortgage. c. Crane Rule (only used for Business property and depreciation) i. The amt realized by a seller of mortgaged property included both the cash recd from the buyer and face amt of the mortgage to which the property was subject. 1. Ex. If TP sells property w/a FMV of $2k and encumbered by a mortgage of $1k for $1k in cash and transfer of the mortgage to the buyer, the seller must recognize the full $2k ii. If mortgage indebtedness is included in amt realized when the property is sold, then it m/b reflected in the sellers adj basis when acquired. 1. Parker v. Delaney: a. TP acquired a bldg. for 0 cash down and a

28

$273k mortgage. The TP took depreciation deductions for 10yrs using the amt of the mortgage as his cost and paid $14k towards the mortgage. In year 11, TP abandoned the property and the bank assumed the property w/the outstanding balance of $259k (orig amt of mortgage $273k $14k pymts made by the TP towards the mortgage). The TPs adj basis was $228k ($273k (orig mortgage/cost) - $45k in depreciation he took during the 10yrs of ownership. The ct held that the mortgage balance was A/R by the TP in accordance w/the Crane rule and held that he had a taxable gain of $31k( $259k ( the amt remaining on the mortgage) $228k (his adj basis). d. The tax consequences must match the economic consequences regardless if the mortgage exceeds the FMV of the property sold. i. Commissioner v. Tufts F: the partnership formed to purchase an apt complex for $1.85m. all of the partners total contribution was $40k.. the basis was 1.84m, $1.85 - $40k partners contribution. $1.84m (basis) - $440k depreciation = $1.45m (1016). Default FMV 1.4m. IRS argument: the TPs tax liability s/b based on $1.85m. TPs argument the tax liability s/b based on $1.4m b/c thats all the property is worth. I: Whether the same rule applies when the unpaid amt of the mortgage exceeds the FMV of the property sold. H: YES. Cts Reasoning: The TPS took a tax loss of $440k but they only invested $40k so the amt realized is $440k based on the fact that they recd a deduction in excess of their investment based on the amt of the property.

29

Sale of Principle Residence - 121

e. General Rule: Gain from the sale of a TPs primary residence is excluded from income if the TP owned the property and used it for his primary residence for at least 2yrs during the 5yr period bef sell. i. Primary Residence s/b determined by the place the TP spends the majority of his time. If this is not easily determinable, then you should look to the other norm factors, reg to vote, address on license, etc. ii. Vacant Land is only included if its used as part of the TPs primary residence and is adjacent to the property iii. Limits 1. $250k Single 2. Married Exclusion - $500k a. Only One of the married TPS must have owned the property for at least 2yrs during the 5yr period bef the sell b. Both Spouses must have used the residence as his/her primary residence for at least 2yrs during the 5yr period bef sell c. Neither spouse could not have used the exclusion w/in the last 2yrs. 3. Exception: Widowed TPS are allowed to take the $500k exclusion for married couples if the sale of the property takes place 2yrs after the death of the deceased spouse and the ownership and holding periods were satisfied. iv. General Rule: TP can only take the exclusion every 2yrs. 1. Exception: if the sale or transfer of the property is by reason of a change in place of employment, health, or to the extent provided in regs, unforeseen circumstances. 121(2)(B) a. if the TP qualifies for this exception the amt of the exclusion will be pro-rated by the amt of time she actually owned and used the property. i. Ex. Unmarried TP lived in the PR house for 1yr then gets transfer to NY from CA the amt of exclusion she can take for the gain of the sale of the house is $125k. f. Losses and Gains above the limits i. Losses on primary residences are not deductible b/c they are considered personal losses ii. Gains above the $250k and $500k limits are taxable at the TPs MTR.

30

Problems of Timing

1. Statutory Nonrecognition Provisions

Timing is important for 2rsns: (1) a TPs MTR may go down from one year to the next (2) the time value of $$ and the ability to earn interest a. the function of the rule is to allow TPs to defer recognition of a gain or loss to a later time i. Administrative feasibility ii. Problems w/valuation of items. iii. Horizontal equity argument 1. Horizontal equity all like TPs s/b treated the same iv. the nature of the investment hasnt changed so the TP s/b treated as someone who held on to their property b. (2) Exception. -- This subsection shall not apply to any exchange of-i. (A) stock in trade or other property held primarily for sale, ii. (B) stocks, bonds, or notes, iii. (C) other securities or evidences of indebtedness or interest, iv. (D) interests in a partnership, v. (E) certificates of trust or beneficial interests, or vi. (F) choses in action. c. Like Kind Rule Sec. 1031. i. If there is a property transfer of like kind property & no boot then the TP doesnt recognize anything and the basis gets transferred ii. If there is a boot involved in the transaction then the TP will recognize the amt of gain up to the amt of the boot iii. If the TP pays a boot then it becomes part of her basis iv. A+B=C 1. A = Orig. Basis 2. B = G/Recognized 3. C = total basis to be allocated between the like-kind property recd & the boot v. The Like-Kind Requirement 1. Reg. 1.1031(a)-1(b)

31

vi.

a. Like-kind refers to the nature or character of the property not its grade or quality i. Private Letter Ruling 1. The TP wanted to know whether the exchange of an easement for a fee interest in another property that was also burdened w/the same easement was a like-kind event. 2. The IRS said yes. & they listed ex in the Regs of other exchanges that are considered like-kind. (a) Nonrecognition of gain or loss from exchanges solely in kind. -1. (1) In general. -- No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. a. It m/b the same thing exchanged, e.g. baseball memorabilia for baseball memorabilia, not baseball memorabilia for a house. b. The property cannot have been held as inventory; it must have been for investment or trade or business. i. Regs. 1.1031(a)(2)(c) Examples of exchanges of property of a ``like kind.'' No gain or loss is recognized if (1) a taxpayer exchanges property held for productive use in his trade or business, together with cash, for other property of like kind for the same use, such as a truck for a new truck or a passenger automobile for a new passenger automobile to be used for a like purpose; or (2) a taxpayer who is 32

not a dealer in real estate exchanges city real estate for a ranch or farm, or exchanges a leasehold of a fee with 30 years or more to run for real estate, or exchanges improved real estate for unimproved real estate; or (3) a taxpayer exchanges investment property and cash for investment property of a like kind. vii. 1033- Hardship situations, (fire, theft, destruction, or condemnation) 1. Nonrecognititon applies to property that is compulsorily or involuntarily converted & replaces w/property that is similar or related in service or use 2. Cash received for involuntary conversion of property a. TP must replace the prop w/in 2yrs b. Anything lft over aft the TP replaces the prop m/b included in income or realized viii. (3) Requirement that property be identified and that exchange be completed not more than 180 days after transfer of exchanged property. d. Like-Kind Exchange w/Boot i. If the TP recs a boot the gain is only recognized up to the amt of the boot recd or FMV of property given as Boot 1. Ex. [Gain]A has $50 basis in his bldg.. A exchanges his bldg. worth $100 for a new apt bldg. worth $90 & recs $10 in cash. His basis remains the same ($50) and he must recognizes the $10 in gain. ii. Ex. [Loss] As Basis - $120. FMV of the bldg $100. He exchanges it for new property worth $90 & $10 in cash. As new basis - $110 ($120 OB $10 BB) iii. Ex. [mortgaged property] A purchased a bldg. for $40 cash and $20 mortgage. As Basis under the Crane Rule is $60. FMV at the time of the exchange $100. If A then exchanges the bldg. for a new unmortgaged property worth $80 plus the

33

$20 mortgage assumed by the transferee. A would recognize a gain of $20 1. OB + G/R = TB a. OB orig Basis b. G/R gain recognized c. TB Total Basis 2. TB BB = NB a. TB Total Basis b. BB boot basis (FMV) c. NB New basis i. Use this formula when the ques asks what is the new basis of .. g. (f) exchanges between related persons.

34

2. Installment Sales 453

a. Formula G/R Sales Price(A/R) = % of each installment pymt that s/b treated as gain. The remaining portion is treated as recovery of basis i. Ex. TPs Basis -$100k. She sells the property for $300k. $300k(A/R) - $100k(Basis) = $200k G/R. $200k $300k = 2/3 (% of each inst. pymt that s/b as G/R). 1st pymt -$30k x 2/3=$20k(G/R) The other $10k is recovery of basis and NT. Adj/Basis(A/B) $90k = OB($100k) R/B($10k) b. Applies to sales of property where at least 1 pymt is to be recd aft the close of the tax year in which it was sold. c. Permits nonrecognition of gain in transactions involving the sale of property. d. TP is permitted to not elect not to use this method. e. Only avail where the consideration recd for the loan is not considered readily convertible into cash. i. Demand notes and publicly tradable debt obligations are equal to their FMV. ii. Promises to pay are not treated the same f. (2) Exceptions. -- The term "installment sale" does not

include i. (A) Dealer dispositions. -- Any dealer disposition (as defined in subsection (l)). 1. Real estate developer is a dealer of property 2. Ask yourself is the TP getting rid of inventory
ii.

iii. iv.

v. vi. g. If the TP uses the obl under a inst. Sale to secure a loan the loan is treated as pymt of the installment obl h. Installment sales between related ppl - 453(e) i. If a person sells property to a family member subj to installment pymts and then the family member

(B) Inventories of personal property. -- A disposition of personal property of a kind which is required to be included in the inventory of the taxpayer if on hand at the close of the taxable year. does not apply to sales of personal property under a revolving credit plan, publicly traded property time share units and residential lost can use the inst. Method but then must pay the govt interest on the amt of tax deferred. Does not apply to recapture gain (453(i) Does not apply for the purpose of computing the AMT

35

resells the property that TP must realize the gain from the sell. 1. This closed the loophole, which allowed ppl to sell property to their family and defer pymt of taxes on the gain. 2. Family doesnt include same sex partners or other type of non-legal relationships i. Sales w/Contingent pymts i. These will usually appear in quests such as TP sells his interest in a corp for Lump sum pymt + 10% of the corp. earnings for the next 5yrs. ii. 3 different ways to deal w/these 1. if its possible to determine a max amt that may be paid, use the max amt to be paid as the selling price in the inst. Formula 2. if its not possible to determine a max amt but you can determine a max time period, i.e. pymts will be made for 10yrs in the amt equal to the CPI, then use the time period as the selling price in the inst. Formula, thus resulting in basis being allocated in equal annual amts over that time period 3. if its not possible to determine either one, max amt or max time, then basis is recovered in equal amts over 15 yrs a. ex. Regs 15a.453-1 Example (2). C owns
Blackacre, which is encumbered by a long-standing mortgage of $100,000. On January 15, 1981, C sells Blackacre to D under the following payment arrangement: $100,000 in cash on closing; nine equal annual installment payments of $100,000 commencing January 15, 1982; and nine annual payments (the first to be made on March 30, 1982) equal to 5% of the gross annual rental receipts from Blackacre generated during the preceding calendar year. The agreement provides that each deferred payment shall be accompanied by a payment of interest calculated at the rate of 12% per annum and that the maximum amount payable to C under the agreement (exclusive of interest) shall be $2,100,000. The agreement also specifies that D will assume the long-standing mortgage. C's basis (inclusive of selling expenses) in Blackacre is $300,000. Accordingly, selling price is $2,100,000 and contract price is $2,000,000 (selling price of $2,100,000 less the $100,000 mortgage). The gross profit ratio is 9/10 (gross profit of $1,800,000 divided by $2,000,000 contract price). Of the $100,000 cash payment received by C in 1981, $90,000 is gain attributable to the sale of Blackacre and $10,000 is recovery of basis.

36

3. Constructive Receipt Doctrine a. If the ck is already made out for the TP then its constructive Receipt and Economic Benefit. b. If the payor says he will pay but no ck has been cut then its just Constructive Receipt. c. If the $$ is put somewhere (bank acct) for the TP then its just Economic Benefit
d. A TP may not postpone income that is avail to her just by not collecting it for tax purposes i. No Rule/ Case Law & reg e. Income is recd or realized under this doctrine when it is made subj to the will and control of the TP and can be, except for his own action or inaction, reduced to actual possession ~Amend(case law) i. It is irrelevant why the TP has failed to take control of the $$. The only determining factor is whether he could have. 1. Ask yourself Is the $$ fully avail to the TP??? f. Reg. 1.451-2 Constructive receipt of income. i. (a) General rule. Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. Thus, if a corporation credits its employees with bonus stock, but the stock is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute receipt. In the case of interest, dividends, or other earnings (whether or not credited) payable in respect of any deposit or account in a bank, building and loan association, savings and loan association, or similar institution, the following are not substantial limitations or restrictions on the taxpayer's control over the receipt of such earnings:

37

g. R: A promise to pay in the future does not fall under the doctrine of constructive receipt. i. Amend v. Commissioner TP entered into a K w/someone over wheat where the guy was to rec the wheat this and year & pay in the beginning of the next year h. Economic Benefit Doctrine i. TPs are taxed on $$ in funds which have been irrevocably set aside for them in trust and is beyond the reach of the payors creditors 1. Pulsifer v. Commissioner - F: The TPs were minors when they won an Irish sweepstakes. As a result the $$ was deposited in an interest bearing acct w/the Irish ct (the acct was in the childrens names) until they reached the age of majority. The TPs parents were informed that they could rec the winnings for the minor TPs if they filed a motion w/the ct for release of such; however, they did not do so. TPs argument: the should not be made to pay taxes on the in 1969 b/c they did not rec the $$ until later Economic-benefit theory That the TP has an absolute right to Cts Analysis: here the TPs had an absolute, non forfeitable rt to the winnings on deposit w/the Irish ct. the $$ was set aside for their sole benefit & all that was needed to rec the $$ was for their parents to apply for such ii. If the TP is required to perform substantial services or substantial conditions are posed upon him bef he can actually get the $$ then EB is not applicable. iii. The difference between constructive receipt and economic-benefit doctrine 1. Under CR, the TP m/b able to get at the $$ 2. However, under the EB doctrine, whether or not the TP will be taxed on the $$ is based on whether the $$ has been set aside for the TP it is irrelevant whether or not they can get to it a. The $$ m/b irrevocably set aside for the TP, nonforfeitable and beyond the reach of the payors creditors. iv. Claim of Right 1. Who does the $$ belong to

38

4. Deferred Compensation & Qualified Employee Plans

a. Under a nonqualified plan, there is no limit to the amt of current compensation the TP can defer. b. These types of questions are analyzed under the CR & EB doctrines. c. Usually once a is involved in the DC, then it will be taxable i. i.e. TPs employer offers a DC plan in which it will take the $$ its employees contribute and turn them over to a financial co. who will invested & hold the $$ then it will more than likely be taxable. d. Mere promises to pay in the future, unsecured or represented by notes will not be taxable. i. Ex. A football player enters into a K w/a team. If the team offers to sign an unconditional agreement to pay $1m to the player at the end of 5yrs & the owner of the team personally agrees to sign a guarantee of the teams obligation, the player will not be taxed on the $$ until recd. All the football player has is a promise to pay; NO CR or EB. e. 83(a) - A TP must report any property (cash) given to him for performance of services unless the TPs rights in such property are subj to a substantial risk of forfeiture i. Minor v. US the ct agreed w/TP that he did not have to report the $$ he placed in his employers DC plan. F: The TP, a doctor entered into a Supplemental Agreement w/his employer. The SA allowed an employee to defer any % ranging from 10-90% of his income. The TPs agreement was for 50% of the current scheduled fees & 10% thereafter; therefore 50% of his current compensation for the 1st year would go into a trust and then 90% thereafter. The employer est a trust to hold the $$. The trust purchased annuities. The DC was to be paid when the employee retired, died, became disabled or lft to practice somewhere else. The employee had to promise to limit his practice, cont to provide emergency & consulting services for the employers request & refrain from practicing w/other competing groups. The TP only claimed the 10% of income he actually recd on his taxes. R: Economic Benefit Doctrine is applicable only if the employers promise is capable 39

ii.

of valuation; that is, the employer makes a contribution to the employees DC plan that is: (1) nonforfeitable, (2) fully vested in the employee, (3) out of the reach of the employers creditor (in a trust). The ct found this inapplicable to the case at bar b/c the plan was not out of the reach of TPs employers creditors. H: the ct held that while the SA DC plan stretched the limits of a non-qualified DC plan, the ct found the plan to be unfunded, unsecured & subj to a risk of forfeiture. D: TP Rabbi Trust 1. Rev Proc 92-64 1992-2CB44 2. The trust is still avail to the general creditors

f. 409A i. provides that amts payable in the future are taxable when bargained for if the plan allows employees to accelerate benefits or provides that upon a deterioration of the employers financial health, the assets are shielded from outside of its creditors reach. ii. Does not apply to Qualified DC plans. g. Qualified Plans Pensions, 401ks, IRAs, etc. (ck sheets from prof for further details) i. Employer cannot discriminate when offering these plans. ii. Pensions employer invest the $$ recd from its employees bef tax earnings. The employer agrees to pay its employees a set amt of $$ every year upon retirement. The employer bears the risk of the market. iii. 401k Employee invests his own $$ bef taxes in the market for retirement. The employee bears all the risk. The employer will usually offer some sort of match. Employee doesnt pay taxes on the $$ until he withdraws it. iv. IRA same as 401k but the employer

v.

usually doesnt match the contributions. Employee does it on her own Roth IRA - $$ is invested aft taxes. Therefore the $$ is tax free when withdrawn.
1. Income limit - $150k 2. Qualified deductions allowed aft 5yrs. a. Buying a home, education, hardship, etc.

40

vi.

3. Subjected to early withdrawal penalty (10%) if taken for any other rsn 530 plans 1. TP can set aside $$ for education 2. Limited to $500 p/yr. 3. Income limit - $190k jnt / $95 ind 4. The contributions m/b made bef the beneficiary turns 18.

vii.

ERISA after a certain amt of time the employee must become vested and his $$ invested in one of the above plans are nonforfeitureable.

41

Marriage & Divorce

h. Sec. 1041. Transfers of property between spouses or incident to divorce i. (a) General rule. -- No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)-1. (1) a spouse, or 2. (2) a former spouse, but only if the transfer is incident to the divorce. ii. (b) Transfer treated as gift; transferee has transferor's basis. -- In the case of any transfer of property between husband & wife or exes (only if done incident to divorce) 1. (1) for purposes of this subtitle, the property shall be treated as acquired by the transferee by gift, and 2. (2) the basis of the transferee in the property shall be the adjusted basis of the transferor. iii. (c) Incident to divorce. -- a transfer of property is incident to the divorce if such transfer-1. (1) occurs within 1 year after the date on which the marriage ceases, or 2. (2) is related to the cessation of the marriage 3. Person lft w/the house keeps the orig basis!! i. 1041 overrides Davis holding!!! (Davis was an old case, if you need it ck the other outline). j. Examples i. Example 1: 1. H and W, when they were married, jointly owned a house with a Basis of $100,000 and a FMV of $400,000. After divorce, H took title and executed a promissory note for $200,000 payable to W and secured by the house. 2. What amount of gain, if any, is recognized by W? a. $0 gain recognized 3. What is Ws basis for the note? a. $200,000 4. What is Hs basis for the house a. $100,000 (when H sells house he will have to recognize gain, but allowed exclusion under 121 up to $250k) 5. What if 1041 was non-existent? 42

ii.

iii.

a. Ws gain will be $150,000 i. $200,000 (her original cost basis) $50,000 (half basis in the house) b. Hs gain will be $250,000 i. $200,000 (his original cost basis) $50,000 (half basis in the house) Example 2: 1. H and W were divorced 6 years ago. H sells the house for $400,000. Its Basis was $100,000. Can W, who lives in an apt, exclude the $150,000 from income under 121? a. individual shall be treated as using property as such individuals principal residence during any period of ownership while such individuals spouse or former spouse is granted use of the property under a divorce or separation instrument i. Even though she never lived there during the 5-year period. Example 3: 1. H & W divorce. Decree said to H to remain in home until child reached 18. At that point sold and divided between H&W. House was sold for $300K gain. Can W exclude $150K gain from income under 121? a. YES 12(d)(3)(b): Property used by former spouse pursuant to divorce decree b. Solely for purposes of this section, an individual shall be treated as using property as such individual's principal residence during any period of ownership while such individual's spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in section 71(b)(2)).

43

Alimony, Child Support & Property Settlements

1. Child Support ND or Taxable 2. Property Settlements ND or Taxable 3. Alimony

a. 71(b)(1)(B) the parties are permitted to k around the tax consequences of the alimony pymts. i. Ex. If A & B divorce and A agrees to pay B $1k p/m in alimony (all the other req are met). A&B can agree in written that for fed income tax purposes, pymts made under this agreemen are not to be treated as gross income for B and are not deductible by A. b. Taxable to the payee c. Deductible to the payor d. Requirements 71 i. (1) m/b cash ii. (2) m/b pursuant to a written instrument (divorce decree or separation agreement). 1. Oral Agreements wont cut it! iii. (3) the parties must not have agreed that the pymts will be nontaxable to payee and nondeductible to the payor iv. (4) parties cannot be members of the same household 1. this only applies to parties separated under some legal instrument, i.e., divorce decree or separation agreement. 71(b)(1)(C) v. (5) pymts cannot cont aft the death of the payee. vi. (6) cannot be for child support 71 vii. (7) only pymts that are substantially equal for the first 3yrs will be treated as alimony 71(f) 1. Purpose to prevent TPs from disguising property settlements as alimony. 2. Front Loading a. Purpose to prevent ppl from converting property settlements into alimony b. If the pymts in the 1st yr exceed the avg pymts in the 2nd & 3rd yrs by more than $15k, the pymts are initially treated as alimony but the excess amts are recaptured in the 3rd yr. i. Recaptured payor must report the excess. 1. Does not apply if: 44

c. Hypos: i. After divorce, W orally agrees to pay H $2K per month 1. NOT alimonymust be written K ii. W dies. M continues making payments to father and M paying insurance policy w/father as beneficiary 1. NOT alimony. Does not terminate upon death. Not in cash iii. H pays wife $40K for 10 years unless child dies sooner 1. NOT alimony. This is child support

a. (1) either party dies b. (2) the payee remarries by the end of the calendar yr that is 2yrs aft the pymts begun; a. (3) pymts end b/c of remarriage. b. (4) temp support pymts c. (5) pymts based on an obl to pay a set portion of the payors income for at least 3yrs. d. x = 60,000 - ((60,000 40,000) + $5,000) + 15,000 e. 2 f. x = 60,000 -27,500 g. x = 32,500 recapture ($27,500 allowed as alimony) h. TOTAL RECAPTURE: X (yr 1 excess) + Y (yr 2 excess) i. 32,500 + 40,000 ($72,500)

45

iv. H pays $10K per year in stock that has basis of $1K. 1. Stock is not alimony Must be paid for in cash 2. In first year, no gain or loss recognized by W on stock though. W gets Hs basis. 3. In subsequent years, 1041 does not apply. Treats it as if H sold stock and transferred cash. a. Thus, H is taxed and W gets $10K basis in stock. 4. If $10K is paid, but upon child turning 18 payment decreases to $7K, then a. Only $7K throughout entire period should be included in income of payee as alimony b. Remaining $3K was child support and not taxable, nor deductible k. 682 allows one spouse to set up an alimony trust for the other. i. The income from the trust is taxable to the payor ii. Ex. A has to pay B $25k p/yr for 2yrs. A has bonds that pay interest of $25k p/yr. A can create a trust w/a duration of 2yrs w/ B as the income beneficiary and w/the reversion to A. The amts recd will be taxed to B each yr for 2yrs and then rtnd to A.

46

Marriage Penalty a. A marriage penalty exists when both spouses work. iii. Exception: married ppl in the 10 & 15% tax bracket b. A marriage bonus occurs when only one spouse works. c. Example TPs TI Combo Tax Effect A, B Single $200k, 0 $51,143 Bonus $6879 A+B Married $200k, 0 $44,264 Bonus filing Joint/MFJ C, D single $100k, $43,440 Penalty $100k 5. Most other countries avoid the marriage penalty by requiring everyone file a single tax return

47

Deductions For Cost of Earning Income

I. Current Deduction v. Capitalization a. 262 Personal Living Expenses - no deduction allowed for personal expenses except as otherwise noted b. R: 162(a) allows the deduct of all the ordinary and necessary expenses paid or incurred during the taxable yr in carrying on any trade or business. (a) Exception: Capital Expenditures 1. ND even if they are ordinary & necessary business expenses. c. Ordinary & Necessary Business Expenses (a) Sec. 162. Trade or business expenses 1. In general. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-a. (1) a reasonable allowance for salaries or other compensation for personal services actually rendered; b. (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 c. (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. i. For purposes of the preceding sentence, the place of residence of a Member of Congress (including any Delegate and Resident Commissioner) within the State, congressional district, or possession which he represents in Congress shall be considered his home, but amounts expended by such Members within each taxable year for living expenses shall not 48

be deductible for income tax purposes in excess of $3,000. For purposes of paragraph (2), the taxpayer shall not be treated as being temporarily away from home during any period of employment if such period exceeds 1 year. The preceding sentence shall not apply to any Federal employee during any period for which such employee is certified by the Attorney General (or the designee thereof) as traveling on behalf of the United States in temporary duty status to investigate or prosecute, or provide support services for the investigation or prosecution of, a Federal crime. *** d. Sec. 263. Capital expenditures (a) What is a capital expenditure 1. Something that will produce income over a period of time; its useful life m/b more than a year. 2. Cars are wasting assets 3. Property is a wasting asset (b) (a) General rule. -- No deduction shall be allowed for-1. (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. This paragraph shall not apply to-a. (B) research and experimental expenditures deductible under section 174, b. (C) soil and water conservation expenditures deductible under section 175, c. (D) expenditures by farmers for fertilizer, etc., deductible under section 180, d. (G) expenditures for which a deduction is allowed under section 179,

49

e. (J) expenditures for which a deduction is allowed under section 179C, Refinery f. (K) expenditures for which a deduction is allowed under section 179D Farms or fertilizer g. (2) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made. e. Encyclopedia Britannica V. Commissioner TP corp took a deduction for an advance it paid to a publisher for its encyclopedias as a business expense. The ct held that the pymt was a capital expenditure and thus ND as a business expense. The ct reasoned that the work the TP corp paid for was intended to generate income over a period of years. The ct stated the purpose of 162 and 263 is to match up expenditures w/the income they generate. However, when the income is generated over a period of years the expenditures s/b classified as capital. (a) If Encyclopedia decided to scrap part of the work from the publisher, it still would not be allowed a loss deduction. The amt paid for the orig manuscript would be treated as the cost of what was ultimately used. f. Authors, Writers, photographers and Artists do not have to follow 263 rules - 263A(h) g. Repairs & Alterations (a) Incidental Repairs are not capitalized 1. Repair is something w/a limited purpose to cont the propertys operation for the duration of its expected life or to maintain its norm outlay & existing capacity. (b) Unless, it extends the life of the asset then it m/b capitalized 1. Mt. Morris Drive IN the TP bought a tract of farm land w/the intentions of making a drive-in movie theater. The construction on the farm caused flooding of the neighbors property. The neighbors threatened to sue so the TP added a drainage system. The ct held that the costs for the drainage system was a capital expenditure and thus ND. 2. Expenses acquired by un planned events will more than likely not req capitalization / D 50

a. TPs property was 25yrs old. Stuff from the refinery next to TPs property started to seep into the basement where she kept animal hides. The authorities told her she had to fix it or shut down. The ct held the expense was deductible even though it was essentially a repair. i. One reason m/b b/c the property was soo old the property had been fully depreciated so there was no basis in the property. Any repairs done to the property aft full depreciation are life-prolonging and thus deductible (c) Hypos 1. Small repairs no capitalization 2. Raising the floor to protect from flood damage - Capitalized 3. Cement flood wall - Capitalized 4. Steel beams to fix a sagging floor Deductible a. Year 1, 2, 3, . 40 b. TP Pos $100, 100, 100.. 0 c. IRS Pos 0, $100, $100. $100 d. Tax Benefit e. TP 35, 35, 35. 0 i. The TP is just deferring the deduction until year 40 (d) Even if the TP is req to make the repair by the govt, it will not automatically be deducible 1. Hotel Sulgrave v. Commissioner the TP was req by the city to install a sprinkler system in a hotel in order to comply w/the city fire code. The ct held the system had to be capitalized. h. Business intangibles & advertising (a) Marketing, advertising and things that relate to sales do not have to be capitalized. (b) INDOPCO Regs 1. Cover expenses for acquiring intangibles related to business even though they may provide future benefits a. E.g. Goodwill, customer lists, covenants not to compete, an assembled workforce,

51

license to practice law, training materials, etc. (c) REGS 1.263(a)-4(b)(3) 1. If the expense creates or facilitates the creation of a separate & distinct intangible then it m/b capitalized a. Separate & distinct an intangible assets that has a i. (1)measureable value in moneys worth ii. (2)legally protected; and iii. (3)capable of being sold, transferred or pledged iv. separate & apart from a trade or business (d) De minimis rule excludes expenses under $5k 1. Cell phone exception cell phone companies can deduct the cost of the free cell phone it gives its cust to induce them to sign multi-year K i. Lease of purchase (a) If the property is something so unique & specific to the TP that the orig owner could have no significant interest in the property then it m/b capitalized. 1. Starrs Estate the TP leased a weird sprinkler system for 5yrs. The ct held that the system had to be capitalized b/c of the individualized nature of the equipment, the fact that the lease for the thing was renewable at no cost, that the owner of the thing really did not want it back or had no interest in claiming it back. j. Prepaid Expenses (a) Commissioner v. Boylston Market Assoc. a cash basis TP was req to capitalize prepaid insurance premiums covering a 3yr period. (b) 461(g) a TP must capitalize most forms of prepaid interest. k. Uniform Capitalization Rules of 263(A) (a) UNICAP the costs of producing inventory & other self-created assets m/b capitalized.

52

II.

1. Not only includes the salaries of ppl writing the manuscript but such indirect expenses as the allocable share of the salaries of supervisory & admin ppl. 2. Extends to all manufacturers. Depreciation & expensing a. Depreciation (a) Allowed for assets which by nature are subj to being exhausted, worn out or becoming obsolete. (b) Allows for the offset of wasting assets used for the production revenue against the revenues it generates (c) Depreciation starts when the item is placed in service (d) Allowed for items that have a life expectancy over 1yr. (e) ONLY ALLOWED FOR BUSINESS EXPENSES (f) Land does not depreciate. (g) Inventory N/A b. Intangible Assets do not depreciate- they amortize (a) IP Assets that amortize 1. Goodwill, 2. Going concern value, 3. The value of work force in place, & 4. The value of current relationships w/cust or suppliers (b) These assets amortize over 15yrs c. Limited Expensing (a) 179 allows for an immediate deduction of the full amt of personal property, e.g. widget maker, furniture can be immed expensed to the extent the item exceeds $2m. (b) up to $500k is avail for immed expensing. (c) Anything below $2m m/b capitalized 1. ques may appear on the exam as whether the TP can expense.. a. ex. $2300000- the TP can only expense $300k d. See Power Point pgs in binder

53

Gains & Losses From Capital Assets

I. 1221 a. A capital asset is something that the TP is holding for appreciation or income. b. In contrast property held for sale to a cust is not included as a capital asset i. Inventory ii. Copyrights & similar items not purchased iii. Publications of the US govt 1202 small business stock a. TP must have held the qualified stock for more than 5yrs. Holding Period - 1223 a. A capital Asset m/b held for @ least 1yr in order to receive the prefential tax rate for capital gains. i. The orig owners holding period is transferred w/the CA when he gifts it to someone else. ii. If the CA is recd from a dead person or recd by a person who recd it from a dead person, the 1yr holding period will be satisfied if the TP sells/disposes of the CA w/in a year aft receipt. b. CAs held for less then a year (Short Term ST) rec ordinary tax treatment Tax Rates a. LT prefential Tax 15% max b. ST Ordinary Tax Capital Losses a. R: Capital Losses are only deductible up to the amt of Capital Gain- $3k p/yr. i. The TP cont to take the $3k deduction until the loss is depleted (up to the amt of the Capital Gain) 1. Problems a. #1. T has taxable income of $3m. b. T has LTCL of $100k c. T has no other Capital Losses during that year d. T can only deduct $3k. Then he carries over the rest until its depleted. b. Realty Co -TP corp purchased a plantation and the city cont to encroach on it until it became more valuable to sell it off as separate lots I: Whether the sale of the lots are capital gains or ordinary income. Cts Reasoning: Frequency, expenditures he made on the sales and the amt. The TP turned into a dealer D: Ordinary income IRS 54

II. III.

IV. I.

II.

III.

IV.

c. There is a first in first out rule. i. This prevents TPs from cherry picking which assets to get rid of for the prefentrial treatment Netting Capital Gains & Losses a. (1) determine the long term capital gain and loss b. (2) determine the short term capital gain & loss i. (3)(a)if step 1 & 2 equal negative losses then you get $3k a yr for losses 1. it comes first from short term and then long term ii. (3)(b)if step 1 &2 equal positive numbers then they are taxed at the respective CG Tax Rate c. (3) if theres a positive and a negative then we combine them & the larger # determines the tax treatment. i. LTCG-$5k ii. STCG-$1k iii. STCL(-$2k) 1. Net the ST-negative $1k iv. Then combine the two -$5k LTCG 1231 Quasi Assets a. Inventory b. Depreciable Property used in a trade or business or real property used in a trade or business c. any recognized gain on the sale or property used in a trade or business. d. When you sell at a gain you get capital gain treatment and when you sell at a loss you get ordinary loss treatment i. Depreciation Recapture 1. T purchases a machine for $50k for business use a. $50k is the basis 1012 b. $20k of depreciation c. $30k adj basis 1016 d. Amt recd for machine when sold - $40k e. $30k adj basis f. $10k ordinary income g. to the extent of depreciation taken you must recapture. 1245 trumps 1231 a. 1245 Gain from dispositions of certain depreciable property i. this is used for personal property used in business or trade, i.e. machines, cpu, etc.

55

deductions iii. TP only realizes gain from amt of property used in trade or business that exceeds her adjusted basis. 1. Ex. TP sells depreciable property used in trade or business. 2. TPs OB $80k 3. Depreciable Deductions $70k 4. Adj Basis $10k 5. NO Gain unless the sale price is above $10k b. Regs 1. 1245-1(b)(2) i. Example 1. On January 1, 1964, Brown purchases section 1245 property for use in his manufacturing business. The property has a basis for depreciation of $3,300. After taking depreciation deductions of $1,300 (the amount allowable), Brown realizes after selling expenses the amount of $2,900 upon sale of the property on January 1, 1969. Brown's gain is $900 ($2,900 amount realized minus $2,000 adjusted basis). Since the amount realized upon disposition of the property ($2,900) is lower than its recomputed basis ($3,300, i.e., $2,000 adjusted basis plus $1,300 in depreciation deductions), the entire gain is treated as ordinary income under section 1245(a)(1) and not as gain from the sale or exchange of property described in section 1231. ii. Example 2. Assume the same facts as in example (1) except that Brown exchanges the section 1245 property for land, which has a fair market value of $3,700, thereby realizing a gain of $1,700 ($3,700 amount realized minus $2,000 adjusted basis). Since the recomputed basis of the property ($3,300) is lower than the amount realized upon its disposition ($3,700), the excess of recomputed basis over adjusted basis, or $1,300, is treated as ordinary income under section 1245(a)(1). The remaining $400 of the gain may be treated as gain from the sale or exchange of property described in section 1231. 1. A/R$60k 2. Adj Basis $30k 3. Gain $30k 56

ii. use this when the TP has taken deprectioan

4. The first $20k will be treated as ordinary income. 5. The other $10k will be treated as 1231 gain

V.

1250 a. this is not for LAND only real property

b. when real property is transferred the portion of the gain reflecting prev taken depreciation deductions m/b recaputured c. Hypo i. Apt bldg. -$500k ii. - Depreciation - $45k iii. = Adj basis - $455k iv. A/R-$520 v. -$455k vi. =Gain-$65k vii. Capital Gain -$45k (the amt of the deduction) 25% viii. $20k capital gain 15% d. Lock-in effect i. This is the one the prof says persuades her the most ii. It may force ppl to hold on to stuff that is not the most proficient use of the capital .

57

Personal Deductions Below Line Deductions

I. Charitable Contributions
i. Charitable donations 1. 170 the amt of charitable donations are limited to 50% of the TPs AGI when made to churches, educational orgs, med insts & certain publicly supported orgs & 30% for Priv. a. the total amt allowed is 50% of the TPs AGI. {if the TP donates to both a priv & public charity, he cannot go over 50% of his AGI for both} b. any thing above these limits are carried over to they next tax year i. ex. TP donates 50% of his income to a public charity & 30% to a private. The TP is only allowed to deduct 50% of his AGI in total. So if it was $1000k, TP would get a deduction in the amt of $500 this year and a $500 deduction next year (if his income stayed the same or greater). ii. TP cannot take a deduction for volunteer work; however, the unreimbursed expenses incurred when providing/volunteering services for charity are deductible {117(d) iii. Gifts of appreciated property 1. TP donors of appreciated property get the FMV of the property @ the date of gift a. Exception: Dealers 2. The TP does not have to pay tax on the donation and still gets the benefit of the deduction for the FMV of the property a. TPs basis: $5k b. FMV at time of donation: $25k c. TP sells the stock and realizes: $20k d. TP is subj to 15% LTCG tax e. Final value of the stock: $22k f. If the TP just transfers the stock the Charity gets the full $25k g. If the stock is depreciated, then TP should be advised to sell it first iv. Quid Pro Quo Contributions

58

1. TPs charitable contribution is only deductible for the amt above the FMV of the benefit he recd when making the donation. a. Ex. Charity Dinner- Cost of attendance is $500 per plate. The FMV of the dinner is $200. The TP is only allowed to deduct the remaining $300 as a charitable deduction. b. Raffle tickets 0 deduction b/c you got the benefit of a chance to win 2. 6115 Charities are required to provide donors w/a written statement of a good faith estimate of the value of the benefit it provided the donor for goods or services over the amt of $75. a. This does not change the rule for donations under $75. 3. Psychic benefits (intangible benefits) the rule doesnt apply to psychic benefits, i.e. naming something after the donor. 4. Cash is not deductible unless you get a substation. v. Policy Justifications 1. The charitable deduction is allowed b/c it encourages TPs to make charitable contributions a. When the tax rate is higher charitable donations are higher b. When the tax rate is lower so are charitable donations vi. Overvaluation of Contributed Property 1. These are the rules Congress came up w/to deal w/the problem of ppl beefing up the amt of their deductions a. Substantiation i. Req for cash donations over $5k or $10k for nonpublicly held traded stock. ii. Not req for publicly traded stock iii. R: the donor must obtain a qualified appraisal from an independent appraiser (cannot be the person or anyone working for the person who sold the property 59

to the donor) and attach to his tax rtn. iv. R: if the charity sells the property w/in 2yrs aft it receives it, it must report the selling price and ID the donor. b. Donations over $250 - 170(f)(8) . i. TP must have a written acknowledgement of the donation which states the FMV of the goods/services from the charity (cancelled check wont work) ii. Exception: the charity can just send the information directly to the IRS 170(f)(8)(D) c. 170(f)(11) donations of property not readily valued i. >$500 - if the TP can not readily determine the value of the property, he must include a description of the property & anything the Treasury requires for property over $500 ii. >$5k TP must include a qualified appraisal. d. Cars, boats, & airplanes 170(f)(12) i. TP must include (1) acknowledgment of the donation; and (2)where the vehicle was sold [if the donation/deduction is the proceeds from the sell] ii. Contemperous statement stating how much the vehicle was sold. vii. Donations to College Sports teams - 170(l) 1. If the donation to a college sports program is req in order for the TP to get good seats for the games, the deduction is limited to 80% of the donation. viii. Religious Benefits & Services 1. If the donation is to a church it will more than likely qualify.

60

2. 170(f)(8)(B) the cost of attending Jewish High Holy Days deductible subj to the substantiation rule. 3. Costs of attending catholic schools are not deductible, even if the school teaches religion. ix. Court Ordered Pymts 1. If TP is court ordered to make pymts to a charity those pymts are not deductible. a. Lombardo v. Commissioner the TP was ordered to make a pymt of $145k to the county school fund. He claimed charitable deductions for the pymts. The ct held that the TP was not entitled to a deduction b/c the pymts were made w/o any charitable impulse. The ct reasoned the TP only made the pymts so he could stay out of prison.

61

Casualty Losses - 165 b. The amt of TPs Loss 10% of his AGI - $100(floor) - $$
recd from insurance co for reimbursement = Casualty Loss deduction. 1. Basis = FMV or TPs orig basis whichever is lower 2. what is a casualty a. losses of property not connected to a trade or business b. losses from fire, storm, shipwreck or from other casualty or theft i. Dyer v. Commissioner the ct held that a vase damaged by their sick cat was not a casualty and therefore, ND. The TP tried to argue that the loss was sudden and unexpected towards the line of the other casualties and s/b allowed b/c it was the cats first fit. c. Suddenness Requirement i. The damages has to have occurred w/the same suddenness comparable to that caused by fire, storm or shipwreck. 1. Termite damage- ND; Dry Rot- ND (ct rule that these did not occur w/the req suddenness) 2. Diamond rings a. It seems like theres no real logic to what type of event triggers a ND d. Depreciation in value of propertyChamales v. Commissioner - F: TPs lived near OJ Simpson during the whole murder fiasco. The TPs took a casualty loss deduction based on the decrease in value of their property. I: Whether the TPs were entitled to a casualty loss deduction based upon a postulated decline in value of their residential propertyTPs argument: the murders were sudden, unexpected, and unusual events and b/c the hoopla surrounding 62

3.

4.

5.

6.

the murders have caused them to suffer a casualty loss. Also, the value of the property will perm decline b/c of the stigma surrounding living next to OJ. TP were not allowed a deduction b/c it wasnt the type of casualty contemplated by 165. However, the TPs ere not penalized b/c they relied on advice from an accountant & Real Estate agent. Negligence a. Negligence by the TP per se is not a bar to a casualty loss deduction; however, gross negligence by the TP is. i. Gross Negligence willfully and knowingly damaging or allowing to be damaged TPs own property 1. Blackman v. Commissioner F: TP burned down his own house where his estranged wife was living b/c the wife was cheating on him. I: whether TP is allowed a deduction for damaging his own property. H: NO. {Negligence Rule}. Cts Reasoning: The ct finds the TPs burning of his house to be gross negligence b/c he didnt put out the fire he started. 165(h)(1)- de minimis rule a. theres a $100 floor for casualty losses i. anything $100 or less are not deductible. ii. Every casualty you must deduct $100 165(h)(2) a. the net casualty loss is limited to the extent it exceeds 10% of your income. i. Anything below 10% of your gross income is ND Limited to The drop in FMV or the adj basis in the property 63

7. Hypo a. Uninsured car basis: $20k b. FMV: $20k c. Hurricane destroys car dropping the FMV to: $8k d. The casualty loss: $12k e. - the $100 floor: f. =$11,900 deduction for hurricane casualty 8. the $100 floor is per casualty a. tornado hits the car dropping the FMV to: $5k b. -$100 floor: $4900k c. total casualty loss: $16,800 i. this is limited to 10% of the TPs AGI c. if the quest states that TPs insurance co. would have pd . The difference between that amt and the FMV is the actual casualty loss. So if its not above 10% of the TPs AGI no deduction

64

Medical Expenses

d. 213(a) med expenses above 7.5% of the TPs AGI are deductible i. the % increases to 10% for AMT e. HSA Health Savings Acct i. Thing I have ii. TP can take this deduction even if they do not itemize. iii. Not subj to AMT & no phase out amt f. most questions involve what is medical care i. Taylor v. Commissioner F: TP tried to deduct his law mowing costs as a med expense b/c he was allergic to grass. The ct held that the deduction was not allowed b/c the TP did not show why other family members could not undertake the activity of mowing the lawn or whether the TP would have paid for the lawn mowing absent his allergy. D: ND ii. OCHS v. Commissioner F: TP sent his kids to boarding school while his wife recovered from cancer; he then deducted this from his taxes as a med expense. The ct held this was not a deductible med expense b/c it was for the benefit of his kids, thus a nondeductible family expense. D: IRS. iii. Rev. Rul. 75-318 the difference between the amt for Braile reading material and regular printed reading material is deductible. iv. Rev. Rul. 64-173 the cost for hiring an escort for a blind person is deductible g. Depreciation is not an expense paid or amt paid; therefore not a med expense i. Henderson v. Commissioner F: TPs son was in a wheelchair. The TPs bought a van & modified it to make it wheelchair accessible. On the TPs taxes, they took a depreciation deduction for 5yrs for the cost of the van and the modifications made to it. I: Whether depreciation is deductible as a med expense under 213. TPs argument : the total cost of the van is deductible & is depreciable over 5yrs as a med expense. IRSs argument: depreciation is not a med expense. But the cost of the modifications to the van is deductible med expense. D: IRS h. 213(B)(9)Cosmetic Surgery

65

i. 1991 cosmetic surgery is not deductible unless its medically necessary i. Gender Changes i. ODonnabhain v. Commissioner the ct held that expenses incurred for gender reassignment surgery & related hormone therapy are deductible. However the boob job was not. j. Alterations to Primary residence i. An alteration made to a TPs primary residence for the primary purpose of accommodating a disabled person, that does not add to the value of the home is deductible. 1. IRS lists the following as such a. Constructing an entrance or exit ramp b. Widening doorways at entrances or exits to the residence c. Widening or otherwise modifying the hallways & interior doorways d. Installing railing, support bars, or other mods to bathroom e. Lowering or making other mods to kitchen cabinets & equipment f. Altering the location of or otherwise modifying electrical outlets & fixtures g. Installing porch lifts & other forms of lifts i. But not elevators h. Modifying fire alarms, smoke detectors, &other warning systems i. Modifying stairs j. Adding handrails or grab bars whether or not in the bathroom k. Modifying hardware on doors l. Modifying areas in front of entrance & exit doorways m. Grading of ground to provide access to residence. k. Policy i. $$ spent on extraordinary med expenses do not provide consumption in the ordinary sense & therefore are not part of income ii. ind who pay their own med expenses relieve the govt of the obl to do so iii. provides encouragement to ppl to take care of themselves 66

iv. in many cases, the illness or injury stems from wok or interferes w/the ability to work so the cost of med care s/b reg as a cost of producing income.

67

Interest
l. Analysis: i. What was the loan for? 1. Business a. The proceeds m/b used for the production of income in order to get the deduction 2. Personal a. Acquisition m/b used to buy, improve or build a home b. Limited to $1m 3. Home equity can be used for anything. a. If it looks like a home equity loan treat it as such b. Limited to whichever is less: i. $100k or the Fmv of the property m. Business or Investment Interest i. Int incurred in a trade or business or for the production of income 1. Limitations 163(d) a. Investment Int i. The amt of int deducted for an investment cannot exceed the net amt of the investment income in a tax year 1. The amt of int remaining can be carried over to the next year for the deduction ii. (B) Exceptions. -- The term "investment interest" shall not include-a. (i) any qualified residence interest (as defined in subsection (h)(3)), or b. (ii) any interest, which is taken into account under section 469 in computing income or loss from a passive activity of the taxpayer. n. Tracing

68

i. If a TP takes a loan secured by his business and uses the $$ for personal use, the interest is not deductible. 1. Its the use of the loan proceeds that determine whether its personal or business interest. a. Interest is allocated based on the use o. Personal Interest i. Only Interest accrued for qualified residences is deductible as personal interest. 163(h)(3) ii. Allowable for one other home such as a vacation home but it is limited to $1m for both 1. This includes interest on home equity loans a. It doesnt matter what the TP uses the $$ from the home equity loan for. b. FMV Limit - This is limited to the lesser of $100k or the FMV of the property (-) any acquisition indebtness on the property i. Ex. The FMV of the home is $975k and the Acquisition Indebtness is $900k. Only the interest on the $75k is deducted. {its the lesser of the FMV of $975} $975k $900k = $75k < $100k so you get $75k ii. Problem: B buys a home for $300k w/ a loan of $115k and $185k from her savings. A mth later she takes out another $125k loan. 1. The acquisition indebtness is $115k. The other loan is only deductible for $100k {home equity debt} c. This is not allowable for 2nd mortgages when the TP takes the mortgage aft he has paid off the orig principal of the residence. p. Whether the property is a qualified residence is determined at the time the interest is accrued. q. Acquisition indebtedness 163(h)(3)(B) i. Interest paid on debt used to buy, build or improve the qualified residence that is secured by the property is deductible. ii. Limit - $1m 69

r. Policy Justifications for denying a deduction for interest paid on consumer debt i. Congress stated that allowing TPs a deduction for consumer debt gave TPs an incentive to consume rather than invest. ii. Also, the TPs have avoided paying tax on the $$ it could have earned if TP invested the $$ instead of wasting it. iii. To encourage home ownership s. Problems i. TP has $50k in savings. She uses the $50k to buy a Benz & the next day borrows $50k to buy a fast-food place that she intends to operate. Will the interest on the loan be deductible? 1. Yes. The loan was used for a business expense. 2. if she would have bought a benz then it wouldnt be deductible b/c the loan was use for personal use ii. TP owns her house outright. The FMV on the house is $100k. She takes out a $50k home equity loan. Is the interest deductible if: 1. (a) She uses the $$ to buy a Benz a. Yes. 163(h)(3)(ii). It doesnt matter what the TP does w/the $$. 2. (b) She uses the $$ to buy taxable bonds a. NO. 265(a)(2) No deduction for interest accrued on debt used to buy nontaxable items. 3. She uses the $$ from the loan to buy taxable bonds, but at the time she holds $50k of tax-exempt bonds a. NO. b/c the loan allowed her to cont to hold tax- exempt bonds. But for the law she would have had to sell the bonds. iii. TP has a portfolio of stocks and bonds worth $200k. The annual income from the portfolio is $12k. Joe borrows $50k on a margin loan & uses the proceeds to buy a Benz. Since the proceeds are used to buy the benz, the interest on the loan is personal interest. 1. Sell $50k worth of stock. Use the proceeds to buy the car and then borrow on the margin later and then buy the stocks back 70

II.

t. Student Loans Interest i. 221 TP is allowed to deduct up to $2500 for interest paid on student loans for himself, spouse, & dependents. ii. The deduction is subj to certain income limitations. iii. Ck the education sheet the prof handed out. SALT State And Local Taxes - 164 a. An Itemize deducting TP is allowed to deduct the $$ it pays in state & local taxes. b. Deduction appears on Schedule A c. Rationale d. Alternatives to current method of State & Local taxation i. Allow ppl who pay more in taxes than the benefits they rec a deduction for the excess ii. & ppl who rec more benefits than what they pay in taxes would be taxed on the excess iii. Not give the deduction at all. treat the pymt as a gift e. User fees are deductible f. Foreign taxes i. Foreign tax credit

71

Miscellanous Itemized Deductions

1. 67 TP is allowed a below-line deduction for non-reimbursed employment expenses. Only to the extent that the exceed 2% of your AGI 2. the purpose is to disallow expenses that have a general personal purpose 3. not allowed under the AMT 4. Employee Business Expenses a. reimbursed employee business expenses are treated as above-line expenses, therefore, they are deducted from the TPs gross income. i. The employer takes the deduction as a business expense. b. Unreimbursed employee business expenses are treated as below-line expenses/ deductible only to the extent that they exceed 2%of the AGI 5. Miscellaneous deductions are added back to the taxable income for purposes of AMT. 6. 62(a)(19) a. TP is allowed an above the line deduction for attys fees & ct costs for claims of unlawful discrimination under civil rights law. i. Commissioner v. Banks employee was fired and recd $1m in recovery. $400k went to the atty. He was made to rpt the full amt. Congress enacted the above rule to handle issue like this one. 7. TP does not have to itemize in order to get the deduction a. (20) Costs involving discrimination suits, etc. -- 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 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 taxpayer's gross income for the taxable year on account of a judgment or settlement (whether by suit or agreement and whether as lump sum or periodic payments) resulting from such claim.

72

Personal & Dependency Exemptions a. 151 every TP is allowed a deduction for a personal exemption. i. $3650 per exemption, i.e., you, child, spouse, qualifying relative b. no Phase outs!!! c. 151 Dependents i. Each TP gets an exemption for each qualifying dependent child . 1. m/b younger than 19 or 24 if the dependent goes to school 2. has not provided more than of his own support; and 3. lives w/the TP for more than a year ii. & qualifying relative 1. a family member other than the child or someone who lives w/the TP 2. recs more than of his support from the TP 3. has gross income less than the exemption amt iii. Baby Mama Drama 1. The TP the child lived w/the longest period of time (in that tax year) gets the exemption a. If its equal than the TP w/the highest AGI gets it iv. John Szilagyi 1. Guy who came up w/the idea of having TPs provide the SS# for their dependents in the mid 80s d. ** Personal & dependency exemptions are avail in addition to the standard deduction amt. ***** e. Support Test in Case of Child of unmarried parents152(e) i. Who gets the exemption for the kid? The person who: 1. (A) a child receives over one-half of the child's support during the calendar year from the child's parents-a. (i) who are divorced or legally separated under a decree of divorce or separate maintenance, b. (ii) who are separated under a written separation agreement, or

73

c. (iii) who live apart at all times during the last 6 months of the calendar year, and-2. (B) such child is in the custody of 1 or both of the child's parents for more than one-half of the calendar year, such child shall be treated as being the qualifying child or qualifying relative of the noncustodial parent for a calendar year if the requirements described in paragraph (2) or (3) are met. ii. (2) Exception where custodial parent releases claim exemption for the year, if the CP signs away the rt to the deduction for that year 1. King v. Commissioner the TPS seeking to take the dependent exemption for the kid were the parents of the kid; the parents were never married. When the TPS were together, the mother (CP) signed a 8332 form releasing her claim to exemption for future years w/reg to claiming the kid on her taxes. Then in 1993, the CP remarried. At that time her & her husband started claiming the kid. The CP never told the NCP that she wanted to revoke her consent for him to claim the kid. They both claimed the kid on their taxes in 1999. CPs Argument: the special support test doesnt apply to parents who never married; therefore, the CP could not waive her rt to the exemption. I: Who is entitled to the exemption for the kid? H: the NCP. The ct reasoned that the NCP was entitled to the exemption b/c the parents lived apart @ all times during the last 6mths of 98 & 99 & that the CP released her rt to claim the kid when she was w/the NCP. The ct also found that it was clear by the use of parents who lived apart for the last 6mths of the tax year in the statute that Congress intended it to apply to unmarried TPs. CP also tried to argue that she signed the form under duress. The ct rejected this b/c the CP testified that the NCP didnt threaten her the day she signed.

74

Credits Based on Personal Circumstances

f. *** refundable even if you have no tax liability the govt will still give u a ck***** g. Earned income Tax Credit i. 32 1. qualifying child m/b <19yrs old 2. is refundable, thus the TP recs a pymt from the govt for the excess above his tax liability 3. is like a wage subsidy or supplement 4. 34% of the EI = the max credit allowed for TP a. ex. TPs EI - $8970 x 34% = $3000. The tP has no tax liability and will rec $$$ from the govt 5. 3 or more children a. 45% 6. TP ind could get it w/o any children but she must have very very low income ii. Marriage Penalty??? 1. If the TPs would qualify for the EITC then they shouldnt get married. This would reduce the amt of the EITC b/c their income would increase iii. However, if the TPs wouldnt qualify separately (one has kids but no income and the other has qualifying income but no kids) then they would get a benefit from marriage b/c they would then qualify for the EITC h. UK Working Tax Credit i. They req the TPs work a certain amt of hrs bef they would qualify. i. Credit for the Elderly & the Permanently & Totally Disabled i. 22 provides a credit for senior citizens who pay for the own retirement, either from investments or working. 1. The credit is reduced for single TPs w/income of $7,500 or above, married $10k or higher and married but filling separately to $5k j. Child Tax Credit i. 24 provides a $1k credit for each dependent child under the age of 17. 1. This is reduced by $50 for every $1k of AGI above the threshold amt a. Threshold amts : 75

i. Married: $110k ii. Single: $75k b. Phase out amts (once the TPs income hit these levels , they would no longer be entitled to the CT credit): i. Married: $150k ii. Single: $115k 2. Middle Income ppl benefit from this credit ii. 24(d) the CT credit is refundable (the govt gives back $$ ) to the extent that 15% of the amt by which the TPs earned income exceeds $8500. 1. Ex. TP w/earned income of $20k. The TP would be entitled to $1725 (15% x $20k $8500). a. 15% x Earned Income - $8500 = CT credit k. Child Care Expenses - 21 i. 21 provides a credit for household services 1. <$3k for 1 kid 2. <$6k for 2 or more kids 3. the percentage used to the determine the amt of the credit declines as the income rises. a. 20% High Income b. 35% Low Income c. These limitations were done to address the arguments on p. 479 ii. Qualifying Dependent m/b: 1. Younger than 13yrs old for healthy children 2. Any age if the dependent is disabled iii. Qualified Child Care Provider 1. Relatives Cool but not: a. One of the TPs dependents b. TPs child under 19yrs even if TP cant claim the child c. Spouse d. Parent of the qualifying child iv. When the MTR is lower than the CC credit the TP should use the 21 credit v. Employment Related Expenses 1. The CC credit is not allowed for the cost of overnight camps 2. Zoltan v. Commissioner-TP recd a credit for sending her kid to an eight wk overnight camp while she worked. Alternative means of child 76

care would have cost about the same amt. the TP also recd a credit for sending her kid on a field trip to D.C.. the ct reduced her credit for the trip b/c of the educational value of the trip. vi. Problems 1. TPs EI - $10k 2. - $3k (new amt for 2010) 3. $7k x 15% = $1050 is the amt refundable to the TP. a. The family has to make $11, 400 (standardized deduction) bef it pays any taxes that plus the $14,600 for the 4 exemptions (3650x4) = $26k ( the TP has to make this bef they will have any tax liability. i. ck the handouts for the info vii. Hypo: under which would the TP get the better benefit 1. 21 if the TP is low income & has 2 children a. 35% x $6k = $2100 2. 21 if the TP is high income the rate is increased to 20% x $6k (for 2 children) = $1200 3. 129 {plan where the employer provides the daycare svcs or reimburses for such} - $5k x 15% (MTR) = $750 {low income} 4. 129 - $5k x 35% (MTR) = $1750 {high income} a. The low income TP would be better off w/the 21 5. The high income TP would be better of w/the 129 viii. Unemployed Full-Time Student 1. if the TP is a full-time student, his yearly income will be imputed as $3k if he has one child, $6k if he has 2 children. 21 i. 129 allows the TP to exclude the value for child care provided by the employer, both on-site & off-site. l. 129 Employer provided or pd Child Care i. limit $5k ii. Formula: 1. Amt pd x MTR = value to the TP/Tax savings m. Making Work Pay Tax Credit 77

i. TP is allowed a refundable credit equal to the lesser of 6.2% or $400. $800 for joint rtns. ii. This is done through the TPs income withholdings on their paycheck 1. Limited to ppl who make $75k or less and$150 for married ppl 2. Tax cut under Obamas plan. He doesnt rec much credit for b/c its done bef taxes are filed.

78

Education ***See Sheet in Binder**** n. Expenses of Education i. Reg. 1.162-5(a)(1) 1. TP is allowed to deduct the costs of education expenses he takes to maintain or improve his skills required by his emp. However, TP is not allowed a deduction for the costs of education expenses incurred to satisfy the min qualification for the trade or business.; or 2. Education expenses TP incurs to get a qualify for a new job or trade. a. Carroll v. Commissioner F: TP was a police officer who was attending college. The TP took psychology classes. TP deducted the costs he incurred for college. TP argued that the classes were necessary b/c he wanted to go to law school so he needed a BA first. The ct said no. b. Example (3). E, who has completed 2 years of a normal 3-year law school course leading to a bachelor of laws degree (LL.B.)(JD), is hired by a law firm to do legal research and perform other functions on a full-time basis. As a condition to continued employment, E is required to obtain an LL.B. and pass the State bar examination. E completes his law school education by attending night law school, and he takes a bar review course in order to prepare for the State bar examination. The law courses and bar review course constitute education required to meet the minimum educational requirements for qualification in E's trade or business and, thus, the expenditures for such courses are not deductible. ii. MBA & LLM may be deductible 1. The decisive factor will be whether the TP has started in his trade or business a. If the TP is already working then its deductible 79

II.

iii. LLM is deductible 1. Even if the TP is a general atty the TP can deduct it Even if the TP lves practice for a yr and comes back.

80

AMT
1. Has its own tax rate structure a. 26% on the first $175k b. 28% on amts over $175K 2. Formula a. AMTI AMT Exemption = AMT Taxable Excess b. AMT Taxable Excess x AMT rate = TMT c. TMT Reg Tax = AMT i. TP has to pay the larger of the TMT or the reg tax 3. Long-term capital gain a. Still get the same preferential tax rate ; however, it may cause you to be subj to the AMT 4. Exemption Preference a. $45k for married couples b. $33,750 for single TP c. 50% of AMT for married filing separetly i. (3) Phase-out of exemption amount. Exemption amt x 25% = phase out exemption amt (but not below 0) The exemption amount of any taxpayer shall be reduced (but not below zero) by an amount equal to 25 percent of the amount by which the alternative minimum taxable income of the taxpayer exceeds-1. (A) $150,000 - Married or 2. (B) $112,500 Single 3. (C) $75,000 - married filing separately or estate or trust filing 5. personal exemptions & certain itemized expenses are not allowed for AMT purposes. a. Misc expenses & SALT.

6. Problems w/AMT a. It hasnt been adj for inflation while everything has b. Doesnt provide a dependent deductions i. So large families get caught in the AMT net when
based on the amt of $$ & the amt of ppl who rely on it they are really not rich.

Tax Shelters

81

Role of the Tax Atty Preparing opinion letter Evaluate tax shelters Tax Shelter An investment that is unrelated to the TPs trade or business certain to prove a tax loss but not an economic loss Elements o Tax deferral o Conversion Convert ordinary income into capital gain income o Tax arbitrage You get a big deduction for expenses that generate tax favored income Real Estate o TP will end up breaking even but he will have the much sought aft loss o Congress lengthed the lives of real estate & straight line depreciation Overvaluation Nonrecourse Debt 2004 Act they tightened up the rules expanded the category of transactions Transparency is the key A petitioner cannot sign his tax rtns unless its more likely than not that his position would be upheld Need to know the tax shelter elements

82