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Leff – Federal Income Tax – Spring_2016

Tax Computation
1. Step One: Determine Gross Income S. 61
a. Note items specifically included in gross income S. 71 – 90
b. Determine excluded income S. 101 – 140
c. Determine Capital Gains (income)
2. Step Two: Gross – [Above the Line Deductions] = Adjusted Gross Income S. 62
a. TP’s trade or business expenses
i. Reimbursed employee business expenses  TP had income and deduction above the line
resulting in a wash; are permitted to ignore for tax purposes.
b. Alimony
3. Step Three: Adjusted Gross Income – [Below the Line Deductions] = Taxable Income. S. 63
a. Personal Exemption § 151 AND
b. Standard Deduction; OR
c. Itemized Deductions
i. Misc. itemized deductions subject to 2% AGI floor: Unreimbursed employee business expenses
1. Unreimbursed meals are also subject to 50% limitation under s. 274(n)(1)
ii. Charitable contribution deduction
iii. Medical expenses deduction
iv. Home Mortgage deduction
v. State and local taxes deduction
4. Step Four: Taxable Income * [Tax Rates schedules] = Income Tax Owed
5. Step Five: Income Tax Owed – Tax Credits = Amount Due under Ordinary Tax Scheme
a. §§ 21 – 54. Note that some credits are refundable and others are not
6. The Alternative Minimum Tax (AMT)
a. The AMT is imposed whenever it is greater than the regular tax for which the taxpayer would
otherwise be liable.
b. See S. 51 – 59.

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I. INTRO & POLICY CONSIDERATIONS

1. Considerations for a Well-Designed Tax System
a. Equity: Fairness
i. Horizontal Equity: People who are similarly situated (same income) should pay the same taxes 
people more kids, served in military, has health problem (benefit theory) should pay less/more.
ii. Vertical Equity: People should pay same % proportional to their incomes people w/more
income should pay more taxes.
1. Flat tax, progressive, radically progressive
b. Efficiency:
i. Should not distort the choices of economic actors would have made if there was no taxes
ii. Ensure a productive economy (incentivize savings or spending)
iii. Should be the least costly to administer (min costs of people lying, avoiding taxes, avoiding
earning come)
c. Simplicity:
i. TP should be able to understanding the rules, compute and pay; gov’t needs to ne able to police it

II. GROSS INCOME

 Haig-Simons: Income = Consumption + Savings during a certain time period
 S. 61: Income includes all income from whatever source derived (see list). Broadly construed

1. Included in Gross Income/Taxable: Income if economic benefit/compensation (amount that enriches you
in an employment relationship)
a. Compensation for services (present or past): Payment by an employer of an employee’s income
taxes constitutes income to the employee. Old Colony Trust
b. Barter Income = FMV of services received
c. Prizes/Awards S. 74(a): for recognition
i. S. 1.74-1 Prizes/Awards includes amounts from radio & television give-away shows, door
prizes, and awards in contests of all types, and any prizes/awards from an employers to an
employee in recognition of some achievement in connection w/his employment
ii. In-kind prize is income on the date you received it. Value = FMV on that day; this also
becomes the basis for that prize.
2. Excluded from Gross Income/Not Taxable
a. Imputed Income
i. In-Kind benefits derived from labor on one’s own behalf (i.e., combining your hair) or from
outside ordinary market process (i.e., living in a house you own instead of renting)
b. Gifts & Inheritances
i. S. 102(a): Income excludes value of property acquired by gift, bequest, devise or
inheritance.
ii. A transfer is a gift only if it from a detached and disinterested generosity; out of affection,
respect, admiration, charity, or like impulses. Must examine transferor’s dominant intentions
– fact intensive. Duberstein
iii. S. 102(c): [added after Duberstein] Transfers from employer to employee is income, NOT
gifts – includes past employer/employees. (But still can be excluded as a fringe benefit)

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iv. When the recipient of the transfer is the natural bounty of their employer, s. 102(c) is
overridden. Use Duberstein to determine whether the transfer is a gift or not.
c. Qualified Scholarships & Fellowships s. 117(a)-(c)(1)
i. (a) Student must be a candidate for a degree at an qualified educational organization
ii. (b): “Qualified” tuition/related expenses = tuition and fees for enrollment; fees, books,
supplies, and equipment r/q for courses
iii. (c): [Limitation] amount is income to the extent it is received as payment for teaching,
research or other services by student r/q as a condition for receiving the scholarship/tuition
reduction. Eg: housing stipend is income.
d. Fringe Benefits: In-kind transfers from employer to employee predominately for the employer’s
benefit. The transfer is a Fringe Benefit and excluded from recipient’s income IF the benefit is a
i. Work Related Fringe s. 132(a) OR
1. (1) No additional cost service [worker getting stuff his company is selling]
a. Must be a service (not tangible good);
b. Provided from employer to employee – employee includes former workers
who left due to retirement/disability, worker’s widower, spouse, dependent
children, and parents
c. Service is one that is offered for sale to customers in the ordinary course of
the line of your employer’s business; AND
d. Employer incurs no substantial additional costs in providing such services
(i.e., foregone revenue – flight attendants can only fly on standby, not in
first-class)
2. (2) Qualified employee discount
a. Discount must be for qualified services/property = offered for sale to
customers in the ordinary course of the line of business of the employer in
which the employee is performing services
b. Property  Tax free to the extent discount does not exceed the gross profit
% (if gross profit is 25%, and discount is 30%, the 5% is taxable)
c. Services  Tax free to the extent discount does not exceed 20% of the price
of the service
3. (3) Working condition fringe
a. Property or Services from employer to employee is tax free to the extent
that, if the employee paid for such property/services, such payment would
allowed as a deduction under s.162/s.163 (an ordinary & necessary business
expense)
4. (4) De Minimis fringe
a. Benefit is tax-free if it is so small that accounting for it is administratively
impractical [can even be compensatory]
b. S. 1.132-6(e) Examples
i. Occasional types of personal letters by secretary
ii. Occasional person use of employers copying machines as long as
company has a system to ensure that at least 85% of the use is for
business purposes
iii. Occasional group meals, cocktail parties, or picnics for employees &
their guests
iv. Traditional birthday or holiday gifts of property (not cash) w/low FMV

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v.Occasional theater or sporting event tickets

vi.Coffee, doughnuts, soft drinks
vii.Local telephone calls
viii.Flowers, fruits, books, or similar property provided to employee
under special circumstances (illness, outstanding performance, family
crisis)
ii. S. 119 Food and Lodging for Convenience of Employer
1. Meals/Lodge given to employee, his spouse, and dependents are not income if
a. Meals are provided on the business premises
b. Lodging: Employee is r/q to accept lodging on the business premises as a
condition of his employment
2. Benaglia: Lodging and Meals taken for free by manager and wife of deluxe resort
was not income b/c his job required him to life at the hotel. Meals/Lodging were not
given to him for his personal pleasure (not compensation for his services).

Return on Principle & Basis

1. S. 1001(a) Gain/Loss = Amount Realized – Basis.
a. Basis is how much you spent on the property/ the cost of capital, regardless of its value.
i. Garber: Cost of your blood = zero.
b. Tax system only taxes gain, not return on capital.
2. S. 1012: If you buy the property, Basis = Cost of property
a. If you buy property w/other property/services, Basis = FMV of the property received
3. S. 1015: If you receive the property as a gift, Basis = Basis of the Donor (or the last proceeding owner by
whom the property was not a gift) Carryover basis.
4. S. 1014: If you receive if from someone who died [inheritance], Basis = FMV at the decedent’s death.
Stepped-up/down Basis: the built in gain is not subject to tax.
5. Allocation of Basis:
a. When property is not uniform and you want to sell a part of it, you must use a reasonable
allocation method on the original basis in order to determine the basis for the piece you are selling.
The method can assign more basis for parts w/more favorable characteristic (more farmable). TP
wants to allocate larger basis to the part sold to min gain (time-value of money).
b. If the part of property has a house on it, then you must add the basis/cost you spent building the
house to the cost of that piece of land.
c. Ex: You bought 10 acres for 100K. Allocation could be: 100/10=$10K as basis for each acre. If you
sell 5 acres for $60K. Then 60K – 50K = $10K gain.

Realization
1. Only realized income is taxed. Appreciation of property is not taxed until it is realized through
disposition.
a. If you buy sth, and then finding out that is more valuable (discovery is part of the thing you bought)
 no tax
b. If you buy sth, then get sth new  that windfall is taxable/income

2. Realization occurs on sale OR exchanges/trades of property (UNLESS the two properties are exactly the
same Cottage Savings)

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3. Treasure trove and found money is income when it is realized. Realization occurs when you have
undisputed possession/complete dominion over the thing + knowledge of your possession
4. Income amount of found treasure = FMV on the day it was found. When you sell your found treasure, its
basis = FMV on the day it was found (what you had paid taxes on)
5. Cesarini realization = exercised dominion and control over cash in piano
a. Found trove/money is income if it is distinct/separate from the thing you have purchased. Ex: if
cash was part of the piano, then it constitutes as increase in the piano’s value, not realized income.
6. Haverly Receiving unsolicited textbooks = not realization (special case); realization occurred when when
professor took a deduction for them as a chartable donation).
7. Interest: realization/income to you when it accrues (when you have legal rt to it, even if you do not have
access to it).
8. Dividends:
a. Cash dividends: whole amount is realized/income on receipt (though taxed at the preferential long-
term capital gains rate, even though the income is not capital gain); the distribution of the
dividend has no effect on the stock’s basis
b. Stock dividends/Stock split: not realized/income b/c after the spilt, you have the same
proportionate interest in the company – did not draw away anything different from what you
original had before Eisner
c. Other types of dividends – in-kind (rings), new non-pro-rata shares of stock – are income.
9. Annuities:
a. S. 72 An annuity payment is partially taxable income and partially a tax-free return of capital. The
non-taxable amount is represented by the exclusion ratio.
i. Exclusion ratio: = investment in the K (what you paid)/Expected return (total return)
1. Exclusion ratio = $267.30/$300
2. Exclusion ratio = 89.10%
3. 100*89.1=$89.10 excluded from each payment  the tax-free return of capital
4. $100-$89.10=$10.90 is taxable amount (at the ordinary rate)
b. Annuities, you pay less tax in early yrs, and more in later yrs. This is better than a loan where you as
loaner pay more tax in early years.
10. Borrowed Funds or Illegal Funds:
a. Generally: Loans is excluded from income b/c no realized gain; any increase in net worth from
proceeds of a loan is offset by a corresponding obligation to repay it
i. Loan is not income to borrower on receipt and it is not deductible for lender when making
the loan and not realized income on repayment
b. Stolen money is taxable when he receives it (benefits from his illegal action) and deductible when
he repays it. Theft’s unilateral promise to repay stolen money does not turn it into a loan
i. Embezzler can claim a tax deduction for repayments in the year the repayment is made
ii. Collins Stole money to buy $80K worth of betting tickets, returned $42K (winnings). $34K
stolen money = taxable income
c. Forgiven Debt: Forgiveness of indebtedness/obligation to repay, the relieved amount is income in
the year it was forgiven. Zarin

III. DEDUCTIONS
Profiting seeking expenditures are deductible

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1. S. 62(a)(1): “adjusted gross income” means, in the case of an individual, gross income minus the
following deductions: (1) The deductions allowed by this chapter which are attributable to a trade or
business carried on by the taxpayer, if such trade or business does not consist of the performance of
services by the taxpayer as an employee
2. S. 162(a): Deduction allowed for all ordinary and necessary expenses paid … In carrying on any trade or
business – including
a. (1) reasonable allowance for salaries or compensation
b. (2) traveling expenses (including amounts for meals and lodging if they are not extravagant
under the circumstances)
c. (3) rentals payments
3. An Ordinary and Necessary expense:
a. Necessary: Must have a business nexus – “appropriate or helpful” for the business
b. Ordinary: common/not weird, recurring periodic expense, an expense can be ordinary even if it
happens only once in the taxpayer’s life. It only has to be common or a frequent occurrence in
the type of business involved.
i. Capital expenditure is not an ordinary business expense.
ii. Preparatory expenses to enter into a business in not ordinary. Welch: repaying of a
loan that TP did not have an obligation to pay in order to build his reputation in the
business world is not deductible  H: necessary but not ordinary. This is more like
capital expenditure, which is not deductible.
iii. Legal fees incurred from no-business nexus incident not ordinary. Gilliam (TP went
crazy on the plane during his business trip)
1. But if the incident giving rise to the expense occurred on business trip and is
common in that business, then deductible.
4. Exception under S. 162(a):
a. Expenses Contrary to Public Policy are Not Deductible
i. Fines, penalties paid to the government in violation of the law are not deductible s.
162(f)
1. Treas Reg 1.162-1: Deduction not allowed under s. 162(a) if allowance would
frustrate a sharply defined public policy.
2. Treas Reg 1.162-21: Fine/Penalty includes
a. $ paid for a crime in a criminal proceeding
b. $ paid as a civil penalty imposed by federal, state, or local law
c. $ paid in settlement of TP’s actual or potential liable for civil or criminal
fine/penalty
ii. Legal fees incurred in the defense of an action is deductible if the action/lobbying was
related to the business (must be O&N, even if the expense is not deductible)
1. Tellier: TP can deduct his legal fees spent in defending fraud/conspiracy changes
relation to his securities business b/c it was O&N.
b. Lobbying and political expenditures are not deductible
i. S. 162(e)(1): No deduction allowed for any amount paid in connection to
1. Influence legislation = through communication w/any member or employee of a
legislative body or with any official or employee who participates in the
formulation of legislation
2. Participate or influencing political campaign

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3. Attempt to influence the general public or segment wrt to elections, legislative

matters or referendums or
4. Any direct communication w/an executive branch official in attempt to influence
the official actions/position of that official
ii. Exception: S. 162(e)(5): Lobbying/political expenses may be deductible
1. Paid lobbyists (lobbying businesses) can deduct their business expenses to
determine their own income. BUT businesses who paid them are not allowed to
deduct their cost of hiring them
2. De minimis: permits businesses to deduct a de minimis amount of lobbying
expenses. They can deduct in house expenses of up to $2,000 (costs associated
w/doing your own lobbying can be deducted as long as they don’t exceed
$2,000). Cliff: Once they exceed $2,000, the entire amount is not deductible.
a. When calculating whether you exceed $2,000, you don’t have to allocate
overhead costs (like the salary or portion of the office used by an
employee). But, once you exceed it, you have to include those allocated
costs as part of what is not deductible.
3. Costs related to lobbying local govt is deductible

Business/Personal Borderline
a. Personal Expenses Are Not Deductible S. 262(a) No deductions for personal, living, or family
expenses.
i. Hamper v. Comm’r: female TV reporter not allowed to deduct clothes, makeup, gym
membership as business expenses b/c most of these things did not have a connection to her
professional life
b. Employees Business Expenses
ii. S. 62(a)(2)(A): If expense is reimbursed, employee can take a deduction if the expense is an
ordinary and necessary business expense
c. Work Clothes are deductible as an ordinary and necessary business expense IF it
 1) Is the type specifically required as a condition of employment;
 2) Is not adaptable to general use as ordinary clothing (objective standard); AND
 3) Was not worn by the TP outside of work.
 Pevsner: YSL clothing by YSL manager is not deductible b/c failed #2: they were not
adaptable to general usage
 Difficult test b/c #2 is strict; pretty much only uniforms are deductible
d. Travel S. 162(a)(2) traveling expenses (including amounts for meals and lodging if they are not
extravagant under the circumstances) incurred while away from home in pursuit of a trade or
business is deductible.
i. Business trips other than Commuting travel (home to work) is deductible Treas Reg s.
1.162-2(e).
ii. Commuting expenses can be deductible if you are carrying work tools, only applicable for
additional costs of using the same mode of transportation.
4. if you drive to work, with tools you have to attach a trailer. Trailer is deductible
5. If you walk to work, with tools you have to cab. Taxi fare not deductible.
iii. Home  Office  Client 1  Client 2  Office  Home. Underlined trips deductible
iv. Meals and lodging during business trips are deductible as long as they are not
extravagant/lavish. (But IRS don’t really enforce)

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v. Away from home = must be overnight.

vi. “Home” for the purpose of s. 162(a)(2) means you business home, not personal home
6. Hantiz: student not permitted to deduct travel btw Boston (personal home) to NY
(internship place) b/c her “home” was her NY apt so her costs were not incurred
“away from home”. Student did not fall w/in temp employment doctrine b/c she had
no business nexus to Boston.
7. Temporary employment doctrine: if you work in Boston and got a temporary job in
NY who term is less than 1 yr, then travelling to temp job can be business deduction
e. Business Meals & Entertainment:
i. S. 274(n)(1) Self-employed TP/employer can deduct 50% of costs of business
meals/entertainment (employees can deduct 100%) if there is a business purpose for the
meal/entertainment, which cannot be everyday
1. Moss Daily meals are inherently personal. (Noon hours was the most
convenient time to meet was not suff business purpose).
2. Ex: during overnight business trip, meeting w/client to build rapport, meeting
with your colleagues.
ii. Food (any food or beverage) and entertainment (any activity that is generally considered
entertainment)
f. Home Offices
i. S. 280A General rule: no deductions are permitted for a “home office”. EXCEPT
ii. S. 280A(c)(1): Can deduct for home offices – only applies to “a use of a dwelling unit which
is used by the TP during the taxable yr as a residence”. A place is a home office IF allocable +
Exclusively used on a Regular basis + falls under A/B/C
1. (A) As TP’s principle place of business. PPB depends on OR
i. Relative importance of the location (location where goods and services
are delivered is more imp); AND
ii. The amount of time spend there
b. Popov: Living room was violinist PPB and she could deduct 40% of rent and
utilities b/c
i. Exclusive? Yes. Living room was exclusively used for violin practice: TP
had no other place to practice; 4-5 hrs used as practice space; NEVER use
it for personal activities; daughter was never allowed to enter.
ii. Studio or Home imp? Both, practicing is just as important as recording
iii. Relative Time? TP spent 4-5 hrs; spent more time her than any other
place
c. PPB includes places a TP does administrative or management tasks only if he
has no other place location to do those activities Soliman
d. If home is your office, for your convenience, then not deductible
2. (B): used as a place of business which is used by patients, clients or customers in
meeting or dealing w/TP in the normal course of his trade or business OR
3. (C): use a separate structure not attached to the dwelling unit in connection w/TP’s
trade or business
g. Hobbies:
i. S. 183(a): No deduction allowed for expenses from activities not carried out for profit
EXCEPT

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ii. S. 183(b) If your activity (hobby) generated profits, you can deduct expenses from that
hobby activity to wipe out the income generated by that activity, but not income outside of
the basket.
iii. S. 183(d) presumption that an activity is engaged for profit if it has produced a profit in 3
of the past 5 years. If activity involves horses, then 2/7 yrs.
iv. If fail presumption, activity can still be engaged for profit if it meets the multi-factor Storey
test
1. How professionally the TP carried on the activity (advertisements, marketing, getting
investors)
2. What expertise TP has in the activity (TP had experience and took filing class in NY)
3. How much time and effort the TP expends in carrying on the activity
4. The expectation that the assets used in the activity may appreciate in value
5. The success of the TP in carrying on other similar or dissimilar activities
6. The financial status of the TP
7. Whether elements of personal pleasure or recreations are involved
v. *No factor is controlling; existence of maj of fact not control. Certain factors can have more
weight if they are more meaningfully applied. Greater weight given to objective facts than
to the TP’s statement of intent
vi. Storey (TP filming making activities was engaged for profits – went about it in a professional
way even though she had not made any profits by then. Held as a “start-up” phase
business)

Personal Deductions
1. Below the line deductions. Deductible w/o a business hook.
2. Itemized Deduction or Standardize Deduction = TP pick the one w/greater amount

Itemized Deductions:
1. Miscellaneous itemized deductions  s. 67 subject to 2% AGI floor (if aggregate of misc itemized
deductions exceed 2% AGI, then can only deduct the portion in excess. If under 2% AGI, cannot deduct
anything)
a. S. 62(a)(2)(A): business expenses unreimbursed by TP’s employer
2. Interest S. 163(a) personal interests are not deductible
a. Exception: Qualified Residence Interest (QRI) is deductible -- QRI is any interest which is paid or
accrued during the taxable year with respect to
i. Acquisition indebtedness (AI) S. 163(h)(3)(B)
1. Debt is for buying, constructing or substantially improving TP’s residence AND is
secured by such residence.
2. Only interest on $1M of such debt is deductible ($500K in case of married filing
separately)
3. *If you use up all $1M, you can also use the $100k in home equity*
ii. Home equity indebtedness (HEI) S. 163(h)(3)(C)
1. Any other indebtedness that is secured by a qualified residence (QR). The HEI
must be below the difference btw [FMV of home – AI] to qualify.
2. Only interest on $100,000 of home equity debt is deductible ($50k in the case of
married filing separately)
3. QR= primary residence + one other (vacation home, can be a boat)

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3. State and Local Taxes S. 164(1)-(3) deductible if taxes falls under

i. state and local, and foreign, real property taxes
ii. state and local personal property taxes
iii. state and local, and foreign, income taxes
4. Medical expenses S. 213 Amount spent out of pocket and not compensated by insurance for medical
care for TP, his spouse, or dependent  subject to 10% AGI floor.
a. Medical care expenses: IRS does not allow doctors to define it
i. Diagnosis, cure, mitigation, treatment, or prevention of disease or for purpose of
affecting any structure of function of body  Broad
ii. For transportation primarily for and essential to medical care
iii. For qualified long-term service – swimming pool if directly related, expenses for
removing structural barriers in home to accommodate handicapped TP or TP’s spouse
iv. For insurance including amounts paid as premiums
v. Cosmetic surgery is not “medical care” UNLESS it is necessary to ameliorate a deformity
related to congenital abnormality, a personal injury resulting from accident or trauma
OR a disfiguring disease
vi. Expenditure that is beneficial for general well-being is not deductible.
vii. Food is never deductible.
viii. Deductible: Weight loss if related to a disease like Obesity, Medical smoking cession,
prescription drug
ix. Non-prescription drug is not deductible UNLESS it’s insulin
b. Medical expenses that are capital expenditures are deductible (Revenue Ruling)
i. BUT if capital expenditure increases property value, then can only deduct: [medical
capex expenditure] – [increase in property value}
1. Ex: spent $200K on an elevator in home. Increased home value by $100K
2. Can only deduct 100K
ii. Medical additions that do not increase property value: see pp 441
5. Charitable Donations: subject to 50% AGI ceiling; 30% if give to personal foundations
a. S. 170(c): You can deduct your donations if the organization (i.e., 501(c)(3) org)
i. Operate exclusively for a charitable purpose;
ii. Does not distribute profits; AND
iii. Do not influences legislation or intervene in any political campaign
b. Donate cash=deduct whole amount
c. Donate Property= deduct full FMV of prop with specific limitations
d. Donate services (volunteer your time)= no deduction
i. Blood donation = services, no deduction
e. Something for something (quid quo pro): If you get sth in return
i. Donation – the thing you got = X amount that is deductible
1. Benefit includes intangible spiritual advancement Wollershein

IV. CAPITAL EXPENDITURE/RECOVERY

1. CapEx is a 1) a business expenditure on a property that has a useful life beyond the current tax yr
(machinery, buildings, contracts/patents); OR 2) a business expenditure on an intangible investment
assets (stock, bonds)
2. S. 263: CapEx cannot be deducted/immediately expensed; it must be capitalized into the cost of the
property (and potentially recovered over time through depreciation).
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a. Woodward Costs incurred in acquisition of capital asset (appraisal litigation fees of) must be
capitalized w/the cost of property/investment (added to the basis of the property/invest)
b. Idaho Power: Costs of construction, production, or substantially improving a capital asset
(costs related to machinery, materials, and salaries) must be capitalized into the cost of
property/investment (added to the basis of the property/invest)
c. If expense is an ordinary & necessary business expense, not a CapEx, then cost can be
expensed.
3. Capital Recovery: Depreciation
a. S. 167(a) Depreciable if property is used to generate profits (in your trade or business or as an
investment) AND is a wasting Asset
i. Wasting Asset: objects that is subject to “wear and tear”, exhaustion, and obsolescence
1. i.e. Buildings (fall apart); Technology (becomes obsolete)
2. Land is NOT a wasting asset  theoretically it does NOT get used
4. Methods of Depreciation
a. Depreciation can ONLY start when the capital asset is placed into service.
b. Straight Line Depreciation
i. Basis/Recovery Period (yrs). $5000 prop over 5 years  depreciate $1,000/year (&
subtract from basis as above the line deduction EXCEPT if the TP is an employee and it
was an unreimbursed expense; then the depreciation amount is misc itemized deduction
subject to 2% AGI floor)
c. Double Declining Balance Depreciation
i. In the first year, you double what would be depreciated under the Straight Line
method, then take that percentage and apply it to the remaining basis in each
subsequent year
ii. Continue this method until the year that Straight Line deduction would deduct MORE,
then switch to Straight Line
(1) You calculate the Straight Line deduction amount for the remaining years
ii. Comparison Chart
a. HYPO: Depreciation of a 5 year useful life of a property worth $1,000
Year Straight-Line Double Declining Balance
20% each year Deduction Remaining Basis
1 $1,000 $2,000 (40%) $3,000
2 $1,000 $1,200 (40%) $1,800
3 $1,000 $720 (40%) $1,080
4 $1,000 $540 (50%) Switch to Straight
Line*
5 $1,000 $540 (50%)
* Remaining Basis: $1,080 over 2 years = $540/year (DDB would only be $432)
V. CAPITAL GAIN/LOSS
1. Capital Gains:
a. Short Term – taxed at ordinary income rate
b. Long Term – taxed at preferential rate, which is ALWAYS less than ordinary rate. CAN be 0%...it
corresponds with your bracket!
2. Capital Loss (Short and Long)
a. Can ONLY deduct Capital Losses against Capital Gains and $3,000 of ORDINARY INCOME

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3. S. 1221(a): Capital Asset is property held by TP (whether or not connected w/his trade or business) but
does NOT include
a. (1) Inventory held for the TP’s trade OR
b. (2) Property held by the taxpayer primarily for sale to customers in the ordinary course of his
trade of business
4. Bramblett: In determining whether land was a capital asset (and thus, gets capital gain treatment) OR
Business inventory, the court looked at seven factors:
a. The nature and purposes of the acquisition of the property, and the duration of ownership
b. The extent and nature of the taxpayer’s efforts to sell the property
i. Investor = holding it longer; Trade/Business = the more you do, the more likely
c. The number, extent, continuity, and substantiality of the sales
i. More sales = Trade or Business
ii. Here, 5 sales over 3 years  not enough to find trade/business
d. The extent of subdividing, developing, and advertising to increase sales
i. If they broke it up, made roads, made infrastructure, it’s a Trade/Business
e. The use of a business office for the sale of the property
i. Office = trade/business
f. The character and degree of supervision or control exercised by the taxpayer over anything
representing the sale of the property
g. The time and effort the taxpayer habitually devoted to the sales
h. ** The frequency and substantiality of the sales is MOST important
iii. Held: it is clearly erroneous to hold that the partnership, without any of the corporation’s
activities, is engaged in the trade or business of selling property, thus the partnership GETS
capital gains treatment
2. Sales of Securities
i. If you are in the trade or business of selling securities to customers, you get ORDINARY
gain/loss treatment (dealers)
a. Note: you CAN opt in to capital treatment for specific long term transactions ahead of time
ii. Day Traders generally get capital gain/loss treatment (even though they are doing it every day!)
a. The IRS takes the “to customers” requirement VERY seriously
b. Investors ONLY get capital gains treatment

VI. Non-Recognition of Capital Gains

1. S. 121: Exclusion: Allows an unmarried TP to exclude $250,000 of gain from sale of principal
residence if TP owned AND lived in it for 2 of the previous 5 yrs
a. Limitations
(1) If married filling jointly, then TPs can exclude up to $500,000 if
(i) either spouse owns it (at least 1 owned the house for 2 of the last 5 years)
(ii) both spouses meet the use reqs (both lived in the house for 2 of the last 5 years)
(iii) neither spouse is ineligible under limitation (3)
(2) Can only claim 1 sale every 2 years
2. S. 1031: LIKE-KIND Exchanges: G/L from exchanges of property held for productive use in a trade
or business or for investment (not personal property) is not recognized for tax purposes.
a. Exceptions – This does NOT apply to an exchange of:
i. Stock in trade or other property held primarily for sale
ii. Stocks, bonds or notes
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iii. Other securities or evidence of indebtedness or interest

iv. Interest in a partnership
v. Certificates of trust or beneficial interests, OR
vi. Choses in action (essentially a right to sue)
b. Gain from Exchange NOT OF LIKE-KIND (I get the in-kind property PLUS more, the more =
boot). Gain from the exchange must be recognized up to the boot amount.
i. “Boot”  Cash value or FMV of the “other property” received in the exchange is
taxed
c. Like-Kind Definition: ” Treas. Reg. 1.1031(a): Like kind refers to the nature, character of
property and not to its grade or quality. In real estate, fact that one piece of land is
improved or unimproved is not material, b/c fact of improvement relates only to the grade
or quality.
i. Exchanges of Livestock of DIFFERENT SEXES are NOT property of like kind!
ii. California Fed. Life Insurance: held that exchange of Swiss Franc and US $20 gold
coins were not of like kind even though they are both money; one is actual currency
and the other is an antique.
d. If exchange does not qualify a LIKE-KIND Exchange,
i. Gains are capital gains, losses are capital losses

VII. POTENTIAL ABUSES

1. S. 1091(a): losses from sale/disposition of stocks cannot be deducted if TP acquired the substantially
identical stocks 30 days before or after the sale UNLESS the TP is a deal in stock and the loss is
sustained in a transaction made in the ordinary course of business
a. Cottage Savings: realization: any exchange of property for materially different property is a
realization and materially different is a very easy standard to meet. Any property with legally
distinct rights and obligations is materially different from each other.
i. loss was allowed b/c realization occurs when assets are materially different (does not
need to be substantially different). The mortgages were materially different b/c the
second bundle of mortgages were secured by different homes and have different
obligors (though swap was done for tax saving reason only)
b. Fender: No deduction allowed even though TP waited more than 30 days b/c there was not a
bona fide loss (no economic substance): D was an owner and had sufficient control over the
bank/buyer so that there was no real risk that he could not repurchase the bonds. In reality, he
did not really sell the bonds.
2. S. 7701(o): Transaction shall have Economic Substance only if
a. The transaction changes in a meaningful way (apart from tax benefits) the TP’s economic
position (objective strand) OR
b. The TP has a substantial purpose (apart from tax benefits) for entering into such transaction
(subjective strand)
3. AMC: failed s. 7701(o) – sham deal; losses not allowed
a. Transaction did not change AMC’s economic position in a meaningful way: the transactions
with respect to the Citicorp notes had only nominal, incidental effects on ACM’s net economic
position, leaving ACM in the same position it had occupied before engaging in the offsetting
acquisition and disposition of the notes

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b. No substantial purpose: Although there was a legitimate sale in a non-tax sense (they actually
bought and sold these notes & it was a legally binding transaction), there was no reason to do it
except for tax purposes. The transaction was pointless except for tax benefits.
4. There is nothing wrong with a taxpayer entering into a legitimate transaction to avoid tax. But if the
transaction has no economic substance (sham), then TP cannot take advantage of the tax benefits
allowed to him by the Code.

VIII. FAMILIES AND THE TAX CODE

Low Income Families
1. S. 151 Personal Exemption: each person in family gets $4K deduction
2. Standard Deduction: $6300 single. See chart
3. S. 32 Earned Income Tax Credit (EITC): refundable
a. The “max earned income amount” represents the point at which a TP stops earning additional
EITC as he earns additional income. It is the end of the “phase in” range.
b. When earned income is below the “max earned income amount”, the gov’t provides a
refundable credit for every dollar earned up the max amount. Once income exceeds the
“phaseout start amount”, the government takes away some of his EITC for every dollar he
earns.
c. Calculation:
i. [Earned income] – [phaseout start amount] * phaseout % = [total phaseout amount]
ii. [Maximum EITC credit amount] – [total phaseout amount] = # of credit TP is entitled to
(if negative # (not eligible for ETIC))
4. S. 24: Child Tax Credit: $1K credit for each qualifying child who is under 17 AND who is the TP’s
dependent. Non-refundable: can only reduce tax liability to zero.
a. Phased out at $50/$1000 over the threshold
b. Additional Child Tax Credit: refundable limitation;
i. TP must have earned income above $3K; and
ii. Addition child tax credit < (Earned income – 3K)*0.15
c. *Ceiling is 1K btw CTC and ACTC
5. Effective/Marginal tax rates

Marriage
1. S. 1: filing status
a) married filing jointly
b) head of household
c) unmarried
d) married filling separately
2. Martial status is determined on the last day of the year.
a. Federal govt must respect state def’n of marriage
3. Drunker: marriage penalty is constitutional.
a. Lower brackets: marriage bonus (married joint bracket is double that of singles)
b. Higher brackets: married brackets are only 1.5 that of singles:
i. Bonus = unequal incomes
ii. Penalty = equal incomes

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Separation and Divorce

1. IRS defers to state law about marriage and the dissolution of marriage, but can ignore a divorce if it seems
to be a sham divorce
a. Annulment Couple filed jointly but state ct annulled their marriage  annulment means couple was
never married; TP is treated as single retroactively (TP must file amendments to reflect their non-
married status
b. Divorce: couple divorced just to get tax advantages  H: shame divorce will not be recognized (deem
couple as still married; must file as married jointly or separately).
2. S. 71/S. 215: Alimony – above the line deduction like business expenses
a. Income to recipient, deductible to payor
b. If payment is child support or sth that does not qualify as alimony, then NOT income to recipient, NOT
deductible to payor.
c. S. 71(b)(1) To qualify as alimony, the transfer must be (5 factor test)
i. In cash payments (not property or services)
ii. Received under divorce or separation instrument (legal writing that says you must pay)
iii. With no designation in the divorce instrument to treat the the payments as nontaxable to the
receiver
iv. The payor and receiver must live in separate households (can’t pay alimony to people in same
house); AND
v. No liability to make payments after death of spouse
d. Banach: If the divorce instrument/agt is silent as to whether payments will be made after spouse’s
death, then defer to state law. H: lump-sum payments survive the spouse, thus, not Alimony under fed
tax law.
3. S. 71(c): Child Support
a. NOT income to the recipient, NOT deductible to the payor
4. S. 1041: Property Settlements
a. (a) NOT income to the recipient, NOT deductible to the payor
b. (b): Not a realization event (no gain/loss shall be recognized). Recipient’s basis is the same as the giver
(carryover basis like gift)

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c. (c): Transfer is incident to divorce if it 1) occurs w/in 1 yr after the date marriage ceases; or 2) related
to the cessation of the marriage
5. S. 6015: Innocent Spouse
a. Joint filing – both members are jointly and severally liable for the debt. So after divorce, one of them
could be held liable for the whole debt.
b. S. 6015(b): An individual who has made a joint filing is not liable for the tax deficiency if he/she singed
the return without knowing or having reason to know about the erroneous position.
c. S. 6015(f): An individual who has made a joint filing may seek equitable relief to not be liable for the
tax deficiency. Factors (TOC balance): Porter
i. Martial Status of couple
1. Divorce  favors relief
ii. Petitioner would Suffer Economic Hardship if no relief present if payment of tax would
prevent the TP from affording her reasonable basic living expenses.
1. Due to debts from divorce, TP had filed for bankruptcy  favors relief
iii. Petitioner Had Reason To Know of the Item Giving Rise to the Deficiency: TP who signed has
constructive knowledge of the law
1. TP failed here  she should have known about the deficiency from IRS distribution b/c
it was right on the form and she knew her husband’s age
iv. Petitioner Did Not Receive a Significant Benefit Beyond Normal Support From the Item Giving
Rise to the Deficiency (who used saved tax dollars?)
v. Petitioner Complied w/All Income Tax Laws in Subsequent Tax Years
d. Porter: 1) Wife was entitled 6015(b) relief for the "nonemployee income" that her husband failed to
report b/c evidence suggested that she did not know and did not have reason to know about it. 2)
Since she had reason to know about the penalty for early withdrawal from a retirement account (the
withdrawal was reported on the return & she knew her husband's age)  No 6015(b) relief, but ct
granted her relief under 6015(f).

VIIII. ASSIGNMENT OF INCOME/ALTERNATIVE MINIMUM TAX

1. Income is taxed to the person who earns it, regardless of who gets beneficial use of it after. Income
shifting to family members not allowed. Lucas v Earle: couple made K to replicate common property
state so husband’s income was shared w/wife  Ct ignored K
2. Exceptions: can shift income if amount qualifies as a business expense to the recipient Hundley: TP
paid his dad for coaching services; so TP is deductible to TP and income for dad.
3. S. 55: AMT:
a. The rates are flatter  |-----------------0-------------------|------26-------|---28----|
b. The base is broader  many ordinary deductions are not allowed under AMT
c. Must pay the higher tax amount btw ordinary and AMT system
d. Calculation:
i. Take the ordinary taxable income
ii. Add back AMT preferences: (those deductions that is not allowed under AMT)
1. Personal Exemptions and Standard Deductions
2. Itemized Deductions
a. Miscellaneous Itemized Deductions
b. Home Mortgage Interest: Interest on Home Equity Indebtedness ONLY
c. State, local, foreign taxes on income, real or personal property
iii. = [Alternative Minimum Taxable Amount] – [AMT Exemption Amount]
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1. AMT exemption amount Is $53,600 and subject to phase-out

2. If you AGI is lower than $53,600, no AMT taxes owed
iv. = Taxable Excess * [%]
1. Excess taxed at 26% up to $175k, 28% over $175K
v. = [Tentative Minimum Tax] – [Regular Tax]
vi. = AMT Tax Owed
vii. Federal Income Taxes Owed is the bigger number

X. CONSTITUTIONAL TAX
1. Art I, s. 2, Cl. 3 All direct taxes must be apportioned
a. Art 1, s. 9, cl. 4: Apportionment means the basis for tax is # of people. Two states with the same
# of people must collect the same total $ amount of taxes.
2. 16th Amendment: Although Income tax is a direct tax, it does not need to be apportioned

Is the Tax Constitutional? [See Flowchart]

Step 2: Tax vs Penalty
- Sebelius: Functional Approach; do not rely on the statutory language
- It is a Tax if it looks like a tax:
o it’s paid to the Treasury when TP file their returns
o it does not apply to individuals whose income is too low;
o its amount is determined based on income, # of dependents, filings status;
o requirements to pay is found in Code and enforced by IRS; and
o it produces “at least some” revenue
- It is a Penalty if (1921 Drexel Furniture a child labor penalty)
o 1) imposed an exceedingly heavy burden (i.e., 10% of revenue);
o 2) only applied to violators who knowingly engaged in the activity; and
o 3) was enforced by the Dept of Labor.
- Held: Individual Mandate is a Tax

Step 3. Direct vs Indirect Tax?

- Head tax, property tax, income tax = direct tax
- Anything other than these 3 items = indirect tax
- H: Individual Mandate is a Indirect Tax, do not need to be apportioned, and thus, is Constitutional

XI. ETHICS
1. Legal standard: There must be some realistic possibility of success for the opinion/advice you provided
a. Can be below 51%; sth like 33%

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