Chap 1: Orientation...................................................................................................................................6 I. A Look Forward.......................................................................................

...........................................6 A. Understanding Income Tax...........................................................................................................6 B. Two Types of Tax Practice............................................................................................................6 II. A Glimpse Backwards........................................................................................................................7 A. Law Prior to 1939..........................................................................................................................7 B. Codification...................................................................................................................................7 C. The Income Tax and the Constitution...........................................................................................7 III. The Tax Practitioner's Tools.............................................................................................................8 A. Legislative Materials.....................................................................................................................8 B. Administrative Materials...............................................................................................................8 C. Judicial Materials...........................................................................................................................8 IV. Tax Policy Considerations................................................................................................................8 Identification of Income Subject to Taxation...............................................................................................8 Chap 2: Gross Income § 61.......................................................................................................................8 I. Introduction..........................................................................................................................................8 A. Gross Income defined § 61..........................................................................................................9 B. Equivocal Receipt of Financial Benefit. Regs 1.61-1, -2(a)(1), -2(d)(1), -14(a)..........................9 II. Imputed Income................................................................................................................................10 A. Income without receipt of cash or property Regs 1.61-2(a)(1), -2(d)(1)...................................10 B. Bartering .....................................................................................................................................10 C. From Closely Held Corporations ...............................................................................................10 Chap 3: The Exclusion of Gifts and Inheritances.................................................................................11 I. What to Include, What to Exclude.....................................................................................................11 A. §§ 71 – 90 Items specifically included in gross income..............................................................11 B. §§ 101 – 139 Items specifically excluded from gross income....................................................11 II. Gifts § 102........................................................................................................................................12 A. Income Tax Meaning of Gift § 102(a) Regs 1.102-1(a), (b).....................................................12 B. Gifts to Employees§ 102(c); 274(b) see 74(c); 132(e); 274(j)....................................................12 III. Bequests, Devises, & Inheritances § 102(b) Regs 1.102-1(a), (b).................................................12 A. Definition of inheritance ..........................................................................................................12 Chap 4: Employee Benefits.....................................................................................................................13 I. Exclusions for Fringe Benefits § 132 see 61(a)(1); 79; 83; 112; 120; 125. .....................................13 Regs 1.61-1(a), -21(a)(1) & (2), (b)(1) & (2), 1.132-2(a)(2) & (5)......................................................13 A. No-additional cost service § 132(a)(1) & (b) ...........................................................................14 B. Qualified employee discount § 132(a)(2) & (c) .......................................................................14 C. Working condition fringe § 132(a)(3) & (d).............................................................................15 D. De minimis fringe § 132(a)(4) & (e)........................................................................................15 E. Qualified transportation fringe § 132(a)(5) & (f).......................................................................15 II. Exclusions for Meals & Lodging §§ 107, 119(a) see § 119(d) Reg 1.119-1................................18 Chap 5: Awards.......................................................................................................................................19 I. Prizes § 74 see § 102(c); 132(a)(4), (e); 274(j). Reg 1.74-1..........................................................19 A. Non-taxable prizes ......................................................................................................................19 II. Employee Achievement Awards § 74(c)........................................................................................20 III. Scholarships & Fellowships §§ 117; 127(a), (b)(1), (c)(1) Reg 1.117-6(b), (c)(1)-(4), (d)(1)-(3) ...............................................................................................................................................................20 A. Scholarship..................................................................................................................................20 B. Reduction in Tuition ...................................................................................................................21 Chap 6: Gain from Dealings in Property...............................................................................................22 I. Factors in the Determination of Gain §§ 1001(a), (b) first sentence, (c); 1011(a) Reg 1.1001-1(a) ...............................................................................................................................................................22

II. Determination of Basis §§ 109; 1011(a); 1012; 1016(a)(1); 1019 Reg 1.61-2(d)(2)(i); 1.1012-1(a) ...............................................................................................................................................................23 A. Cost as Basis................................................................................................................................23 B. Property Acquired by Gift § 1015(a) see §§ 1015(d)(1)(A), (4) & (6) Reg 1.1015-1(a) .........24 C. Property Acquired Between Spouses or Incident to Divorce § 1041 Reg 1.1041-1T(a) & (d) ..........................................................................................................................................................25 D. Property Acquired From Decedent § 1014(a), (b)(1) & (6), (e) Reg 1.1014-3(a)....................26 II. Amount Realized § 1001(b) Reg 1.1001-1(a), -2(a), (b), (c) Examples (1) & (2)......................26 Chap 7: Life Insurance Proceeds and Annuities...................................................................................28 I. Life Insurance § 101(a), (c), (d), & (g) Reg 1.101-1(a)(1), (b)(1), -4(a)(1)(i), (b)(1), (c)................28 A. Non-taxable proceeds..................................................................................................................28 B. Interest payments.........................................................................................................................29 C. Payments over time.....................................................................................................................29 II. Annuities (the new rule) § 72(a), (b), (c) Reg 1.72-4(a), -9(table V)............................................30 Chap 8: Discharge of Indebtedness........................................................................................................31 I. Included in income §§ 61(a)(12); 102(a); 108(a), (b)(1)-(3), (d)(1)-(5), (e)(1) & (5); 1017(a), (b) (1), (2), (3)(A) & (B) Reg 1.61-12(a); 1.1001-2(a), 2(c) Ex. 8 ..........................................................31 II. Exceptions to 61(a)(12)...................................................................................................................32 Chap 9: Damages And Related Receipts....................................................................................................36 I. Damages for Business Loss...............................................................................................................36 II. Damages & Recoveries for Personal Injury.....................................................................................37 A. Damages § 104(a) Reg 1.104-1(a), (c), (d).............................................................................37 B. Insurance and Workers' Compensation §§ 105(a)-(c) & (e); 106(a) Reg 1.105-1(a); 1.106-1. .37 Chap 10: Separation And Divorce.........................................................................................................41 I. Alimony and Separate Maintenance Payments.................................................................................41 A. Direct Payments §§ 71; 215(a) & (b); 7701(a)(17) Reg 1.71-1T(a) & (b)...............................41 B. Indirect payments § 71(b)(1(A) Reg 1.71-1T(b)(q 6 & 7).......................................................43 II. Property Settlements § 1041; see 1015(e) Reg 1.1014-1T(b).......................................................44 III. Other Tax Aspects of Divorce........................................................................................................45 A. Child Support § 71(b)(1)(D); (c) Reg 1.71-1T(c)...................................................................45 Chap 11: Other Exclusions From Gross Income..................................................................................46 I. Gains From the Sale of Principle Home § 121 .............................................................................46 Reg 1.121-1(a)-(e), -1(f) ex. 1,6,10 & 11, -2(a), -3(a), (b) ex 1...........................................................46 Identification of the Proper Taxpayer........................................................................................................48 Chap 12: Assignment Of Income............................................................................................................48 I. The Progressive Tax System & Income Splitting §§ 1(a) – (e), (h); 6013(a) see §§ 1(g); 63; 66; 73 ...............................................................................................................................................................48 II. Income From Services......................................................................................................................48 A. Assignment of Income.................................................................................................................48 B. Renunciation of income...............................................................................................................48 C. Waiver of Executor Fee...............................................................................................................48 D. Faculty.........................................................................................................................................48 III. Income From Property....................................................................................................................50 A. General Rule................................................................................................................................50 B. Exceptions...................................................................................................................................50 C. Income Earned But Not Realized................................................................................................50 Deductions in Computing Taxable Income................................................................................................51 Chap 14: Business Deductions................................................................................................................51 I. Introduction §§ 1; 63........................................................................................................................51

A. Deductions...................................................................................................................................51 B. Definition.....................................................................................................................................51 C. Trade or Business Requirement...................................................................................................51 II. The Anatomy of the Business Deduction .......................................................................................51 A. “Ordinary and Necessary” § 162(a) Reg 1.162-1(a)................................................................51 B. “Expenses” §§ 162(a); 263(a) Reg 1.162-4; 1.263(a)-2.........................................................52 C. “Carrying On” Business § 162(a); 195; 262 Reg 1.195-1(a)..................................................53 III. Specific Business Deductions.........................................................................................................54 A. Reasonable Salaries § 162(a)(1) see §§ 162(m); 280G Reg 1.162-7, -8, -9.............................54 B. Travel “Away from Home” §§ 162(a)(2); 274(n)(1) see § 274(c), (h) & (m)(1) & (2) Reg 1.162-2..............................................................................................................................................55 C. Necessary Rental and Similar Payments § 162(a)(3) Reg 1.162-11(a).....................................58 D. Expenses for Education §§162(a); 262; 274(m)(2) Reg 1.162-5(a), (b)(1), (2)(i), 3(i), (c), (d), (e)(i)..................................................................................................................................................58 IV. Miscellaneous Business Deductions...............................................................................................59 A. Introduction §§ 162(a); 274(a), (d), (e), (k), (l), (n) Reg 1.162-20(a)(2); 1.274-2(a)(1), (c), (d) ..........................................................................................................................................................59 B. Business Losses §§ 165(c)(1); 280B..........................................................................................61 V. Depreciation §§ 167; 168................................................................................................................61 A. Introduction.................................................................................................................................61 B. Special Depreciation Rules on Personal Property §§ 168(k); 179; 280F(a) & (b); 197..............62 C. Special Rules on Realty §§ 168; 42; 46; 47................................................................................63 Chap 15: Deductions For Profit-Making, Nonbusiness Activites........................................................64 I. Expenses for production of income §§ 212; 274(h)(7) Reg 1.212-1(g), (k), (l), (m); 1.262-1(b) (7)..........................................................................................................................................................64 A. § 212 or § 162..............................................................................................................................64 B. Limitations & Restrictions...........................................................................................................64 C. Personal expenses are not deductible § 262...............................................................................64 II. Expenses arising out of Transactions entered into for profit §§ 121(a), (d)(6); 165(a), (b), (c)(2); 167(a)(2); 168(a); 212 see §§ 195; 280A Reg 1.165-9(b); 1.167(g)-1; 1.212-1(h)............................65 Chap 16: Deductions Not Limited To Business or Profit-Seeking Activities.....................................68 I. Interest § 163....................................................................................................................................68 A. Personal Interest § 163(h)............................................................................................................69 B. Qualified Educational Loan § 221...............................................................................................69 C. Loans to purchase tax-exempt property § 265(a)(2) .................................................................69 D. Investment interest § 163(d)........................................................................................................69 III. Taxes §§ 164(a), (b), (c), (d)(1); 275; 1001(b)(2) Reg 1.164-3(a)-(d).........................................71 A. Property taxes .............................................................................................................................71 Chap 17: Restrictions on Deductions ....................................................................................................72 I. Introduction........................................................................................................................................72 II. Activities not engaged in for profit § 183(a)-(d).............................................................................72 A. Presumption of profit motive......................................................................................................72 B. Deductions if not for profit (Hobby) § 183(b)............................................................................73 III. Restrictions on Deductions of Homes § 280A(a), (b), (c)(1), (3), & (5), (d)(1), (e), (f), (g).........73 A. Rental of Home...........................................................................................................................73 B. Limits under § 280A....................................................................................................................73 C. Home Office § 280A(c)...............................................................................................................74 IV. Illegality or Impropriety § 162(c), (f), (g)......................................................................................75 A. Criminal Defense.........................................................................................................................75 Chap 18: Deductions For Individuals Only ..........................................................................................75 I. Adjusted gross income ......................................................................................................................75 II. Moving expenses §§ 62(a)(15); 82; 132(a)(6) & (g); 217 Reg 1.217-2(b)(2), (3), (4), & (8).......77 A. Distance & Time.........................................................................................................................77 B. What is included..........................................................................................................................77

....................................78 B.......... Capital Losses § 1211............................................... Definition of Capital Asset § 1221................................................................. Personal exemption § 151..................... Food and lodging..........................................................................................87 B.............................................................78 C............446-1(c)(1)(i).............. Carry forward............................................. -7(a)(1).........................................................................79 E..............87 A.....90 VI.........................................88 V..................89 A........................................................ Dependents §152 Reg 1......86 Chap 21: Capital Gains And Losses § 1(H)..... 68...................................................................... Inclusions................. Introduction........................................90 A.................................................................................................151-1(b) & (c)(2)......................................................................................1...............................................................................................79 A................................................................................ Trade Date............. Calculating Capital Gains § 1222.... Acquisition date................................................. (d)(1)-(4) & (9).... -2........................................................ Addition to home.......................................................... Sale or Exchange Requirement.........................................................................................84 I...........152-1............................................. Exceptions......................................84 Chap 19: Fundamental Timing Principles.............................461-1(a)(1).................................................................165-5(a)-(c)...... (3)......... 1222.....................165-1(e)....79 IV.... Limitation..................... 166(a)-(e) Reg 1.................166-1(c)..........................86 A................................................ Receipts § 446.......................... The Cash Method of Accounting: Cash Receipts and Disbursements.....................67-1T(a).....84 A.......................... Long term care........ Casualty and Theft Loss § 165(a) & (c) Reg 1.... 7703 Reg 1.......................... Bad Debts and Worthless Securities §165(g)(1) & (2).................86 A..............................96 ..................89 B..............................................................90 B........... Net from the inside out............ (b).......... (5).............................................................................................................................. Charitable Donation Deductions § 170(a)(1)............................................................................................................ Exemptions §§ 151..........92 I.................................82 The Year of Inclusion or Deduction...........................78 D.......................... 67.............................. -8(a)(1)..........213-1(a)(1)............................................ (e)(1)-(4)(i)(a)...................................... -5(a)-(b).. Capital Gain............................451-1(a)....................III......................... The Holding Period.87 IV.....................87 A..........................87 B............................... 152.......94 IV.......................................................................................... Standard Deduction § 63.........................................84 B....................90 Chap 23: Deductions Affected by Characterization Principles.................................................................................................. (e)-(g)......86 III.................................................... 1....................... Medical Care §§ 213(a). 1212................................84 The Characterization of Income and Deductions........................................................86 II......................92 II....................................................................................................... Income Property.............................................. Introduction................................................. 451 Reg 1............ -4T..... 263(a)(1) Reg 1............................................................................................................................................................................... 7703 Reg 1...............86 I....................79 B............. Disbursements § 461(a) & (g) Reg 1.......................................78 A............................................... -2(a) & (b)...................... Business expenses................80 C............................................................................... Correlation with prior transactions... (d)....................

edu Individual Tax Formula Gross income . but since they are taxed at different rates the final formula separates them.Value Added Tax – at each stage of production and resale.Introduction to Income Tax Federal Income Tax Individual .Prof Beck. Distinguishing income tax from other taxes: .000 – tax on the wealthy – being phased out by 2010. gross income includes both ordinary income and capital gains for determining adjusted gross income.§ 63 Personal Exemptions & either Standard Deduction or Itemized Deductions = Taxable Income Taxable Income x Tax Rate = Gross Tax Liability Gross Tax Liability .Rbeck@nyls.gift tax: paid on property given before death – similar to estate tax . tax is in the price) – state sales tax is a percentage imposed at the point of sale – paid by vendor on a periodic basis – customer is done with the tax once the purchase is made but does not take account of financial status of customer (poorer pay higher percentage of income in sales tax than the rich) . firearms etc.Tax Credits = Net Tax Liability or Tax Refund From the chart: [(Ordinary income – “above the line” deductions – personal exemptions – the greater of the standard deduction or itemized deductions) x taxpayer’s ordinary rate] + [net capital gain x taxpayer’s capital gains rate] – [credits] = tax liability derivation of the basic formula: the general formula is: tax liability = taxable income x taxpayer’s rate – credits § 63: taxable income = adjusted gross income – personal exemptions – (the greater of the standard deduction or itemized deductions) § 62: adjusted gross income = gross income – above the line deductions § 61: gross income = all includable income So.§ 62 deductions = Adjusted Gross Income .00. a tax is added – but refunds are issued to businesses buying for resale – each person in the chain polices the validity of the taxability of the purchase (self-policing tax) - .inheritance taxes: state level – the heir is taxed on the property received .estate tax: paid on property over $ 1. unless phase out repealed – originally intended to prevent huge wealth from being retained and passed on – raises very little revenue because the wealthy would rather give their money to charities .sales tax: federal sales tax is called excise tax (gasoline. liquor.

same rate within the taxing authority – property taxes tend to be very politicized (especially in their relation to funding of public education) Personal property taxes: avoided by not reporting the property or holding the property out of state Hotel and tourism taxes: federal. More than just a numbers game.65% by employer) – capped at $102.000 @ 0% no tax on first 10.000 for 2008 – for all employees but not independent contractors – easy tax to administer.half of next 10.3% of all pay (7. 3.001 to 30. Scope of Tax Law: has some effect on virtually every substantive area of the law.000 Effective tax rate is 25% Chap 1: Orientation I.- - withholding taxes are a good example of a self policing tax – VAT falls more heavily on the poor.000 pays 0% 10.000 @ 50% . 2. The Code a.000 20. Planning: Tax practice can also involve the structuring of proposed transactions according to tax principles.000 pays 28% each additional dollar pays 28cents Effective rate is the sum of all the tax bracket effecting the tax payer Example: 10. The study of income tax begins with the Internal Revenue Code. clear reasoning and careful attention to policy considerations a. Understanding Income Tax 1. like sales tax o Some items are exempt from sales tax or VAT tax Property tax: every state and local – no federal property tax because clause in Constitution says a direct tax must be apportioned (each states share of the federal tax must be proportional to their population) – this results in a different tax rate from state to state and Constitution requires uniformity across the country – state and local taxes are assessed on value of property. The Code is often cryptic and difficult to understand. B. the study of tax involves both.001 to 20. state and local Social security tax – 15.65% by employee and 7. . no exemptions – and no individual rights to a benefit (the essential aspect of a tax) – this is a flat tax Marginal tax rate: tax on the last dollar of income – brackets of percentage of tax Up to 10.000 total tax is 5. b. A Look Forward A. Why study policy? It fosters an understanding of tax that permits lawyers to predict how unsettled matters will be resolved. 2. no deductions.000 pays 15% 20. Reactive: Tax practice can involve an application of tax principles to completed transactions. Two Types of Tax Practice 1.

fair.. 1975. The Internal Revenue Code of 1986 a. Power to Tax a. c. 1981. and 1984. These taxes were abolished only a decade later – Pollock case 2." 2. Section 2. In an attempt to simplify the tax code. Due to the War of 1812. and it taxed virtually everything. The 1986 Code ended up being more complicated than the 1954 version. Clause 1 requires indirect taxes to be uniform throughout the states. 3. Congress replaced the 1954 Code with what it believed to be broad-based. C. tobacco. clause 3 and Section 9. Save for the years 1994 and 1995. taxes were again imposed in 1813. Section 8. Article 1. Tax laws enacted after 1862 were eventually codified in 1939. Law Prior to 1939 1. The first internal-revenue tax law. (1) An indirect tax is imposed on a person who will shift the burden onto another (e. Constitutional Attack: The taxing power has been interpreted so broadly that most taxing statutes are not subject to constitutional attack. Subsequent. but were abolished five years later. imposed a tax on alcohol.II. enacted in 1791. (2) Only geographic uniformity is required by the Constitution. while subsequent legislation imposed taxes on carriages.g. 1976. B. less drastic revisions occurred in 1969. Two Limits on Congressional Taxing Power a. a. duties. clause 4 require that direct taxes be apportioned among the several states. imposts and excises. Section 8. The Internal Revenue Code of 1954 a. 1977. the monies raised from a direct tax must be divided equally amongst the states in proportion to their populations. 1978. and revenue neutral legislation. The Income Tax and the Constitution 1. 3. The Sixteenth Amendment provides that taxes shall not be subject to the rule of apportionment. b. simple. Codification 1. sugar and other items. in 1986. 2. In 1954. clause 1 of the Constitution vests Congress with the "power to lay and collect taxes. b. (1) In other words. Article 1. Article 1. the first major revision of the Internal Revenue Code was passed by Congress. 4. a sales tax). 1971. 3. 1982. A Glimpse Backwards A. (2) A "direct" tax is one that is imposed on the person who will ultimately pay it. b. the 1986 Code has been amended every year since its enactment. first income tax imposed by Congress was enacted in 1862. .

IRS of the Treasury Dept also issues revenue rulings that answer specific questions posed by a taxpayer. (2) The Court of Appeals for the Federal Circuit reviews decisions from the Court of Federal Claims. c. (but they don’t do many) IV. As usual. The Tax Practitioner's Tools A. (only court if you want to resist) b. Tax Policy Considerations Federal income tax is not neutral. Introduction . Refunds may also be sought in the Court of Federal Claims. Taxpayers may also resort to Federal District Court in order to recover sums they believe were improperly collected. The major source of tax law is the Internal Revenue Code. (can be given force of law by a judge or denied such status by a judge) (1) A ruling may not be relied upon by anyone other than the taxpayer to whom it was issued. (2) Private Letter Rulings are issued to one taxpayer and apply only to that one taxpayer’s specific situation. bills. and committee reports are often used to decipher the meaning of the Code. be it an Article I or Article III court. while any activity that goes untaxed is to some extent encouraged. hearings. As in other areas of the law. a.61) Regulations have force of law as long as they are “a reasonable interpretation of the statute. debates. The Tax Court is a forum provided for taxpayer to challenge those deficiencies determined by the Internal Revenue Commissioner. (3) The Supreme Court reviews cases emanating from any court. Legislative Materials 1. Identification of Income Subject to Taxation Chap 2: Gross Income § 61 I. Taxation is a method used to indirectly "tinker" with the economy.III. Appeals (1) The Federal Circuit Courts of Appeals reviews decision of tax court and district court. 2. 2. the Treasury Department has enacted a series of regulations purporting to interpret the various provisions of the Code. but it does give indication as to how the IRS will treat a specific situation.” b. B. Judicial Materials 1. (Administrative agency) a. d. The Treasury Department is vested with the authority to promulgate regulations for the enforcement of the Code. Both Article I and Article III courts are involved in the interpretive process. for any activity that is taxed is discouraged. (keyed to the code – § 61 interpreted in Regulation § 1. courts serve as the final arbiters of what the Code says. C. Pursuant to this power. Administrative Materials 1.

Charley not cashed in his miles it is most likely that he would not have been taxed on their use. clearly realized. you will be taxed on it 2. b. a. or from both combined) – the treble damages are the investment of the time and labor required for the lawsuit to be pursued. -14(a) 1. James v. Payments for tax purposes are characterized based on the payor’s motive and IRS can re-characterize a payment once it establishes what the payor was trying to do. Gross Income defined § 61 1. Old Colony Trust v. The tax was the personal obligation of the employee and the employer conferred a benefit to the employee by paying his debt to the IRS. 3. (all gains are taxable income unless they are specifically excluded) Commissioner v. So long as there is an economic benefit to the taxpayer. claim of right doctrine: if money or property is apparently yours and yours to dispose of or spend as you will.61-1. -2(a)(1). Commissioner. treasure trove is income b. the fair market value of flyer miles at the time of redemption is the "amount realized. United States. (1) Frequent flier miles will not be taxed by the IRS (recent ruling) There should be little doubt that frequent flyer miles earned on business trips paid for by an employer constitute gross income. even if there is a remote contingency that might negate that. § 61 defines gross income as all income from whatever source derived B. the income need not have come into his possession. (discharge of debt is considered gross income § 61(a)(12)) 3. unless the taxpayer can point to an express exemption. Charley v Commissioner a. b. and over which the taxpayer has complete dominion. Economic benefits are gross income. a. Gross income is an accession to wealth. Technically. gross income includes income from all sources. Glenshaw Glass Co. The IRS therefore refrains from taxing these miles. Beck argues that the old definition from Macomber could apply (the gain derived from capital. Equivocal Receipt of Financial Benefit. -2(d)(1)." whether characterized as a dealing in property or compensation income. from labor. Cesarini v. However. unless they are traded in for cash.A. United States. Had Dr. Illegal activity: Gains from illegal activity are gross income. Regs 1. regardless of their source. but the problem comes with their valuation. 4. Punitive damages awards are taxable as gross income. a. the nature of plane tickets makes it difficult to determine the fair market value because the same ticket can wildly vary in price. . a point at which valuation becomes very easy. Travel credits (for the difference in value between a first class ticket and a coach ticket) converted into cash in a personal travel account established by an employer constitute gross income to the employee.

g. Imputed Income A.Problems pg 65: 1) if Cesarini piano had instead been found to be worth $500.000 – payment to wife does not allow you to evade taxation – IRS looks to employer’s motive to determine the payment’s character. the fair market value of the tomatoes you grew. travel or office Beck test: what would happen if you asked for the cash instead? .000. Revenue Ruling 79-24. then the fair market value of the goods is includable as gross income. he would be taxed on the gain (selling price – original purchase price) 2) free raffle ticket wins watch – any gross income? yes. Hypo: free Ikea bus – is that income? Law student invited for interview – law firm pays for travel – is there income? Employer gives employee an office Probably not income. 5) O rents house to T for summer for $4000 a) what income to O if T pays $1000 and does $3000 in improvements $4000 income (payment in cash or property or services doesn’t matter. Financial benefits received from one's wholly-owned corporation are not imputed income (it can be considered either compensation or dividends). C. not money.000 new car for spouse – income? $35. when he re-sells the piano. what matters is that the payment was intended to be rent) b) what if all labor is done by T at cost to him on only $500 labors are still valued at $3. Double tax on savings: once when earned and again on return (the interest) – consumption is only taxed once. Taxpayer does not have income from the use of his own real property. Imputed income is not "income" under the 16th Amendment. Revenue Ruling 79-24. would the result to the taxpayer be different? no. 2.000 as benefit to O c) what tax to T $2500 income for labor in order to get 2500 worth of summer cottage – it’s a barter of services for services – tax barter situations by converting everything into cash II. 2. nor does a homeowner have income from the use of his own house.000 in company stock and $10..tax cost basis 4) insurance adjuster gets kickback on referrals – income? kickbacks are income. it was intended as payment to employee . and then ate). when earned but not when used B. and thus is generally not taxable. Independent Life Ins. these all benefit the one providing the bus. the fair market value of the property gained 3) employee gets incentives to stay: $20. even if they are illegal – James v U. Helvering v.Simons definition of income: Consumption + savings = income some countries charge a flat tax on consumption – hard to measure consumption – easier to measure it at the source of the income 3. Bartering 1. From Closely Held Corporations 1. 1. the fair market value of the services received is includable as gross income. Haig.61-2(a)(1). -2(d)(1) Imputed income is any product of your own exertions that you yourself consume (e. are exchanged. Co. If a service is exchanged for goods. Exchange of services: In a transaction where services.S. and they must be included as gross income. Income without receipt of cash or property Regs 1. Commissioner. Dean v.

Certain death benefits 102. 117. Amounts received under accident and health plans 106. Transfer of appreciated property to political organization 85. A loan that the person agrees to repay 3. What to Include. Certain fringe benefits 135. Qualified lessee construction allowances for short-term leases 111. Cafeteria plans 126. Excluded from income by a specific statutory provision A. Recovery of tax benefit items 112. Prizes and awards 77. Certain combat zone compensation of members of the Armed Forces 115. Contributions by employer to accident and health plans 107. Income of states. Exclusion of gain from sale of principal residence 123. Unemployment compensation 86. Alimony and separate maintenance payments 72. municipalities etc. What to Exclude Gross income includes any financial benefit unless it is: 1. Dependent care assistance programs 132. Social security and tier 1 railroad retirement benefits B. Amounts received under insurance contracts for certain living expenses 125. §§ 71 – 90 Items specifically included in gross income 71. Income from discharge of indebtedness 109. Property transferred in connection with performance of services 84. Group term life insurance purchased for employees 82. Compensation for injuries or sickness 105. Improvements by lessee on lessor’s property 110. Certain cost-sharing payments 127. Qualified scholarships 118. Interest on state and local bonds 104. certain proceeds of endowment and life insurance contracts 73. Rental value of parsonages 108. Meals or lodging furnished for the convenience of the employer 121. The mere return of capital 2. Educational assistance programs 129.Chap 3: The Exclusion of Gifts and Inheritances I. Commodity credit loans 79. Income from US savings bonds used to pay higher education tuition and fees 137. Gifts and inheritances 103. Contributions to the capital of a corporation 119. Adoption assistance programs . Annuities. Services of child 74. §§ 101 – 139 Items specifically excluded from gross income 101. Reimbursement for expenses of moving 83.

The trier of fact makes this determination on a case by case basis 3. Some employee achievement awards are excluded from gross income under § 74(c) and § 274(j). Income Tax Meaning of Gift § 102(a) Regs 1. respect. (b) Inheritance: non-specific residuary from a will or intestacy Bequest: a gift of personal property Devise: gift of real property A. Section 102(a). Initially § 102 did not address the question of whether transfers from employer to employee that were called gifts were excludable from income under the Section. and even if it is a bequest under state law. Excludes from gross income any property received as a gift. especially where there is a quid pro quo b.-Subsection (a) shall not exclude from gross income any amount transferred by or for an employer to. Commissioner v. § 274 (b)(1) ceiling does not apply III. 3. & Inheritances § 102(b) Regs 1. 4. Bequests. admiration. This was addressed by the addition of § 102(c) prohibits gifts to employees Employee gifts: (1) In general.102-1(a). When an heir receives a payment as the result of settling their contest of a will. 5. Disaster relief payments II. Section 102(b)(1). (b) 1. Stanton portion of the case: The critical consideration in determining whether a transfer is a gift is the intent or motive of the donor. Section 102(b)(2). Does not exclude the gift of an income from a property. or inheritance. bequest. Origin of the claim test: general doctrine in tax law in which you consider the most relevant reason for the transfer – look for the motive for the transfer B. or like impulses. § 132(e). best in context of friends and family .102-1(a). charity. 2. or for the benefit of.139. devise. A. 2. There are exceptions to this for de minimus fringes. Does not exclude from income any income produced by the property that is given. an employee. 274(b) see 74(c). 3. they receive that money because of their status as an heir and thus it is to . Devises.out of place in a commercial setting. Duberstein a. doesn’t mean that it is a bequest under tax law – have to look at the fact and circumstances and discover the true economic substance of the transaction 1. 274(j) 1. may be a gift under property law (intent to make a gift. Gifts to Employees§ 102(c). A gift proceeds from a detached and disinterested generosity out of affection. delivery and acceptance) and not be a gift under tax law. 132(e). Definition of inheritance Just because the taxpayer labels a payment a bequest. Gifts § 102 1. 2. a.

000 in lieu of all compensation as executrix this is a 102 gift 2) if Wolder case arose today. IRS can look through the form of a transaction and re-characterize it according to its true economic substance Problems pg 91 1) Does § 102 apply? a) father leaves daughter $20.000 for services not 102 gift h) father leaves $20.132-2(a) (2) & (5) 1. Lyeth v. he got because he was an heir and so such money should be treated as an inheritance. -21(a)(1) & (2). (b)(1) & (2). State inheritance law governed the payment of state inheritance tax but federal law governs what gets taxed as income. 1. Surrogates court made the lawyer defend the debt to show that it was really owed b. 102 applies – this is an inheritance – excluded from gross income b) father dies intestate and daughter receives $20. 83. § 119 meals and lodging c.000 in his will stating that it is in appreciation for her long & devoted service can be argued either way: Duberstein generosity or payment for services? e) father leaves $20. 112. 125.61-1(a). it can’t be a gift g) daughter is executrix of estate & gets $20. not an employee Chap 4: Employee Benefits I. 2. would 102 apply? No.000 pursuant to written agreement for her services 102 does not apply – this is payment for services – unless she can show that other siblings got the same amount and that she didn’t claim deduction for expenses f) daughter enforces agreement against intestate father’s estate Wolder – if it is supported by a written agreement. Hoey a.000 in his will yes. 102 applies c) will is challenged and case settles – daughter gets $20. 79. § 127 education benefits . What he got. Commissioner a. Congress apparently meant for inheritance to be understood broadly in that although they have tinkered with the language they have not made any move to limit the definition.000 in real estate as his heir yes. Wolder v. Fringe benefits are incidental benefits in an employment context given in kind (a form other than cash) – transfer of non-salary – most have their own sections: a. Exclusions for Fringe Benefits § 132 see 61(a)(1). Regs 1. § 105 health benefits b. Wolder was an independent contractor.be considered an inheritance for purposes of § 102(a). A bequest made in a will for the purpose of satisfying an agreed compensation for services rendered is not excluded from income under § 102(a).000 Lyeth v Hoey – treated as an inheritance d) father leaves daughter $20. 120.

written reciprocal agreements between businesses in the same business allow benefits to be provided to employees from other companies B. Coverage: The no-additional cost service applies to services given to retired and disabled employees. 3. A no-additional cost service can also be offered as a rebate or through reimbursement. tax law on fringe benefits is now completely statutory A. 20% of the price at which the service is offered customers. widows of former employees. or b. A no-additional cost service is a service provided by an employer to an employee: a. a no-additional cost service must be offered to a substantial number of not "highly compensated employees. Congress also realized that fringe benefits are sometimes for the benefit of the employer. (1) However. – catch-all of fringe benefits 3. The gross profit percentage of the price at which the property is being offered by the employer to customers (goods at but not below cost).132-2(a)(3) 5. a." § 132(i). b. and the spouses and dependent children of current employees. he may get the benefit from any of the related businesses b. A qualified employee discount is a discount with respect to qualified property or services that does not exceed: a. a clothing retailer may offer a discount to employees so that they are encouraged to "show off" the newest fashions. (Special Rule for Air Travel: Use of Air transportation by parent of an employee is treated as use by the employee § 132(h)(3) 4. Free hotel rooms for hotel employees and free airline seats for airline employees a. if employee works for more than one business owned by a conglomerate. Reg. § 102(c). No-additional cost service § 132(a)(1) & (b) 1. Gifts from an employer to an employee are includible as gross income. Congress thought it unfair to tax someone who is paid in cash. a. there is no gross income and nothing has to be accounted for. (1) Gross profit percentage is calculated by dividing the dollar difference . To be eligible for the exclusion. 1.d. §§ 4xx retirement plans 2. 2. That is offered in the ordinary course of the line of business of the employer in which the employee works. But if the "gift" falls within § 132. Qualified employee discount § 132(a)(2) & (c) 1. and not intended as additional compensation. Where employer incurs no additional cost in performing the service (and does not lose any income because of it). and b. Policy a. § 132(h). while leaving untaxed the person who is paid in products or services. (2) For example. Non-discriminatory basis.

Employer provided coffee. § 132(c)(4).. 1. Non-discriminatory basis: The qualified employee discount is also subject to the non-discriminatory limitation. etc. qualified parking: maximum allowable exclusion of $175. a. a. § 132(i). Coverage: The discount may be given to retired and disabled employees. and the spouses and dependent children of current employees. no non-discrimination limitations D. Three types of qualified transportation fringe. and can be offered at purchase or through reimbursement. Transportation in a commuter highway vehicle if such transportation is in connection with travel between the employee's residence and work. Qualified parking . pass or transportation in a vehicle: maximum allowable exclusion of $100 per month. § 132(h). Eg. 4. may exclude the reimbursement from gross income because the expenses would be deductible anyway.between the aggregate sales and aggregate cost by dollar amount of aggregate sales (Aggregate sales . water. 5. Qualified transportation fringe § 132(a)(5) & (f) A qualified transportation fringe is excludable from gross income. an employee who gets reimbursed for his business expenses. § 132(f)(2)(B). De minimis fringe § 132(a)(4) & (e) 1. The discount can be offered as a partial rebate. 2. widows of former employees. but not parking that is also used for the employee's residence. 1. § 132(d). . Qualified property or services are those (other than real property or property held for investment) which are offered for sale to customers in the ordinary course of the line of business in which the employee works. 3. Limitation on exclusion a. Working condition fringe § 132(a)(3) & (d) 1. b. For example. Any transit pass c. 2.132-3. § 132(f)(2)(A).Parking provided to an employee on or near the business premises of the employer. E. A de minimis fringe is any property or service that is small enough to make accounting for it impracticable. b. Reg.Aggregate cost) Aggregate sales 2. C. A working condition fringe is any property or service provided to an employee that would otherwise be deductible by the employee if he had to pay for it.

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000 VCR for $1. rent-free is only given to officers.000 = 40% allowable discount $2000 x .§ 132(j)(1) Reg 1.132-1(b)(ii) e) employee stays in rival hotel which has written agreement to give 50% the 50% is excluded § 132(i) f) employee is an officer of the hotel.000.132-2(a)(2) and (5) c) same as a. Employer pays all costs.132-4(a)(1)(iv) i) employee gets 20% discount on his employer’s insurance product excluded §132(c)(1)(b) j) employee is salesman in home electronics store.132-2(a)(3) d) spouse and children use room without employee exclusion applies § 132(h)(2) & Reg 1. $200 is included in income k) employee attends convention in another town.000 400. Non-officer employees pay their own parking fees.000 cost of goods.Problems pg 101 1) excluded from gross income? What statute? a) employee of national hotel chain stays at hotel – there are empty rooms 132a1 exclusion if offered to all employees b) same as above but desk clerk bounces a paying customer to make room for the employee not excluded from income Reg 1.132-8(a)(ii)(2) g) employee works for the shipping line which is owned by the same conglomerate that owns the hotel not excluded §132(b)(1) Reb 1. Exclusions for Meals & Lodging §§ 107. but employee pays for room and later gets rebate exclusion applies Reg 1. Excluded §§ 132(a)(3) & 132(d) l) employer has a bar and provides employees with free drinks at end of week excluded §§ 132(a)(4) & 132(e) m) employer gives employee a case of scotch for Christmas may be excludable if of low fair market value Reg 1.40 = $800 $800 discount is excludable but this employee got $1000 discount. Store has sales of $1. 119(a) see § 119(d) Reg 1.000 = 1. transit voucher benefits was increased from $65 to $100 per month excludable p) Employer puts in a gym for use of employees and their families excludable § 132(j)(4) II.000. employees pay 60% not excluded from income .000.000 $800 is excludable from income §§ 132(a)(2) & 132(c)(1)(a) find gross profit percentage: 1. $175 per month is excludable §§ 132(a)(5) & 132(f)(2)(b) no anti-discrimination rule NB: NY exception Reg 1.000 1.000 and $600.119-1 The value of meals and lodging that are provided to an employee for the employer's convenience is excludable from gross income.132-6(d)(2)(a)(iii) – allows exclusion of the excess of the value of each one-way trip over $1. Employee buys $2.50 in special circumstances. like working late & unsafe to take public transportation o) Employer gives employee $900 in vouchers for mass transit in a year prior to 2002 $120 is included in income §§132(a)(5) & 132(f) in 2002.000.132-6(e)(1) n) employee is an officer of the corporation which pays for his parking in a facility one block away.132-2(a)(1)(i) & -4(a)(1)(iii) h) same as g but employee is comptroller of the conglomerate excluded – he is in all the lines of business Reg 1. To qualify for the exclusion meals must be offered on the business premises.000 – 600. To qualify for the exclusion the lodging must be offered: .

Meals will if she can prove need for emergency calls availability Reg 1. Corporation by contract requires Planner to live in residence and also furnishes her meals. For the convenience of the employer. artistic. literary. 132(a)(4). Herbert G. In Hatt. charitable. As a condition of employment (custom of the industry or necessary for safety) 1. 2) Planner incorporates her hotel and corporation purchases residence adjacent to business premises. four requirements must be met. The residence will probably qualify under § 119(a) (2). 2. The recipient must have been selected without any action on his part to enter the contest or proceeding. Reg 1. Planner worked at hotel and was on call 24-7. 2. educational. or civic achievement. Often. Rental value of $5.the facts and circumstances to support exclusion: 1. (e). State reimburses him. Not excludable because no substantiation supplied by the employee. Hatt. Prizes § 74 see § 102(c). For prizes unrelated to employment to be excludable from gross income. The terms of the employment contract are not determinative of these issues and the IRS may scrutinize the situation to determine whether the lodging is really a condition of employment and for convenience of employer or just a pretext (substance over form). 274(j). § 107 – no limit on parsonage exclusion as long as it is used for housing – current case in S Ct regarding this as violative of First Amendment Problems pg 106 1) Employer provides employee and family with residence on business premises. But an appearance or short speech is thought to be permitted. and c. the phone rang in his apartment d. Chap 5: Awards I. Courts are split as to whether groceries are meals or not. IRS will scrutinize because this is a closely-held corporation. The prize must be made in recognition of religious. 3. Depends on circumstances.119-1(a)(2)(ii)(a) 3) State highway patrolman on duty 8am to 5pm. a. Eats lunch near highway. On the business premises.a. no) b.74-1 A. . the court determined that the petitioner had shown sufficient business reasons for the requirement in his contract .000 per year but employee pays $2000 a) what result if employee’s work does not require employee to live on the premises as condition of employment? Employee has $3000 additional income to report b) what result if employer and employee simple agreed that employee should live on premises? IRS would scrutinize the agreement but the outcome would likely be the same as a c) what result if employee’s work and contract require it and employer provides $3000 of groceries during the year? Value of premises is not included in income but the $3000 for groceries may be. The recipient is not required to render substantial future services. 1. Non-taxable prizes Generally prizes are taxed. (the Beck test: can you ask for the cash? In this case. the IRS will closely scrutinize these contracts in a closely held corporation 3. scientific. it was the practice in the industry to have someone on premises 24 hours a day 2.

The award must be given as part of a meaningful presentation. The award must be given by employer for either length of service or safety achievement. McDonell Problems pg 112 1) national sportswriters give award to most outstanding amateur athlete and give winner $5000. research. (d)(1)-(3) A. (b)(1).600 if part of an established award program. (2) Safety achievement awards cannot have been given to more than 10% of the employees. b. 1. 127(a). employee was required to go on the trip and worked while there Allen J. or civic achievement) II. literary.4. educational. The prize is transferred by the payor to a governmental unit or a recognized charity pursuant to a designation made by the recipient. artistic. (1) Length of service awards cannot be given within the first five years of employment. charitable. a. § 274(j)(4)(B). The award must be an item of tangible property. But Employee Achievement Awards are excludable from income if the cost to the employer of the award does not exceed $400 if not part of an established award program. § 274(j)(4)(C). § 274 sets forth the requirements for an employee achievement award: a. This year’s winner delivers an appropriate rejection “acceptance” speech and donates the money to a charity. Expressly not excluded from gross income are amounts received as payment for teaching.117-6(b). 2. administrators. and the award must be given under conditions that do not create a likelihood that it is disguised compensation. § 117(a). c. or other services required as a condition to the . A qualified scholarship includes any amounts received for: tuition and enrollment fees. 1. Basically. (c) (1)-(4). Employee Achievement Awards § 74(c) Gifts to employees are not allowed under § 102(c). $1. or professionals. Scholarship Amounts received as a "qualified scholarship" by an individual who is a candidate for a degree at an educational institution are excludable from gross income. Scholarships & Fellowships §§ 117. nor given to managers. (c)(1) Reg 1. Includable in income because this is not §74(b) award (in recognition of religious. books. supplies and equipment. the money cannot come under the control or dominion of the recipient. 2. If an award does not meet the requirements of § 74 it may still be excludable from gross income as a de minimis fringe benefit under §132(a)(4). scientific. b. III. 3. and can be given to the same employee only once every five years. § 117(b)(2). clerks. provided the requirements of that section are met. Amounts received for rent (room and board) are not excludable from gross income.

a. b. Reduction in Tuition Any reduction in tuition provided to an employee of an educational organization for education below the graduate level is excluded from gross income. a. § 117(d)(3). (a kind of working condition fringe) § 117(d). 4. 4.scholarship. spouses and dependents of employees. The Award must be from the educational institution itself. Reg 1. a qualified scholarship can be granted by an employer. . The plan cannot be discriminatory in that it is only for highly compensated employees. An exception is allowed for athletic scholarships.117-6(c)(4) defines degree candidate broadly and includes primary and secondary schools. Requirements: 1.250 per year from gross income for amounts paid by the employer for educational assistance (related to work). 5. § 117(d)(2). Thus. but only if there is no requirement that the recipient continue to work for the employer. § 117(c). undergraduate and graduate levels. 3. The term "employee" includes an employee of the institution. § 127 permits an employee to exclude up to $5. 2. Beck queries: do we even need 117a if the scholarship is coming from the school and represents either a gift or a discount to a customer (a non-taxable event)? B. The student must be the employee. Student can be expected to participate but not required to and school cannot take away scholarship if student does not participate. and graduate students who perform services.

(2) Adjustments to the cost basis must be made for various deductions allowed with respect to the property. There is a presumption that all gains realized are recognized. Tuition is $3000 and room and board costs $3000. Other non-scholarship students get paid $10 per hour. Student is required to do 300 hours of research for professor. This could be considered a scholarship and therefore excludable. Gross income includes gains derived from dealings in property. I.1001-1(a) basis = cost amount realized (A/R) – adjusted basis (A/B) = gain (which is taxable) tax cost basis – if you have to take property into income (like the stock example) you get a basis in that property that is equal to the amount that you took into income – so that if you sell it again.M. 1011(a) Reg 1. and the loss is the excess of the adjusted basis over the amount realized. a) what tax? Exempt to $5250 § 127 ($4750 included in income) b) what if she is not required to return to firm? Could be considered compensation for past service Excludable up to $5250 of related costs c) What if she is not an employee but instead receives the stipend as a prize in an essay contest? Taxable under § 74 but § 74(a) excludes scholarships – all scholarships are competitively awarded and could be considered prizes – Beck says find the narrowest category. Stipend is part of firm plan requiring return to firm following their educational leave. b.R.000 toward tuition and room and board.Problems pg 115 1) Student in A. . Factors in the Determination of Gain §§ 1001(a). § 1001(b). degree program gets scholarship of $6. (1) The cost basis is the cost of acquiring the property.B. Chap 6: Gain from Dealings in Property I. § 61(a)(3) 2. The gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis. The adjusted basis for determining a gain or loss is the cost basis adjusted as provided in § 1016. so $4500 is taxable and $1500 is excluded b) What if all students are required to do 300 hours of research for professors? No difference. but losses are not recognized unless there is a specific section so providing.117-4(c)(1) Or argue that $3000 is for room and board so $3000 is excluded Or allocate ½ to each. 3.L. still not excludable c) What if $6000 is athletic scholarship with no work requirement? Excludable § 117(c) d) what if student receives $2500 tuition scholarship. you wind up in the same position as if you had paid cash for it 1.C § 1016. Student’s spouse is employed by neighboring education institution and tuition sholarship is part of a nondiscriminatory plan between the institutions excludable § 117(d)(2)(b) & § 117(d)(3) 2) Lawyer receives $10. a) what tax to student? No exclusion under § 117(c) Reg 1. § 1001 a. The amount realized is the sum of any money plus the fair market value of any other property received.000 stipend to assist her while on leave to obtain her L. (c). § 1011. § 1012. (b) first sentence.

§§ 109 and 1019: value of improvements done by the lessor is not included in lessee’s gross income and does not increase basis .. the acquired property cannot be valued.1012-1(a) A. 1019 Reg 1. Can be recovered when the property is sold (capital gains) 3. b. v. Philadelphia Park Amusement Co.61-2(d) (2)(i).II. cost recovery) Sell it for $100 – gain is $90 (amount realized .substitute for rent that is taken into income goes into basis – this effectively postpones recognition of the gain until the property is sold (not really an exclusion) . its fair market value is assumed to be equal to the fair market value of the property that is given up. 1. the basis in the acquired property is its fair market value at the time of the exchange. In an exchange there are 2 issues: what are the tax consequences of the exchange? And what is the basis of the property received upon subsequent sale (which the judge says in this case is the value of the property received) c. Cost as Basis 1. This is a variation of tax cost basis: whatever was taken into income becomes the basis d. When property is acquired in a barter transaction.taxable) 3 ways to recover cost: 1. Can be recovered in dribbles by depreciating real property (amortizing intangible property) for things having useful life (land and stocks/bonds cannot be depreciated because they last forever) 2. a. Determination of Basis §§ 109. U. If in an arms length transaction. Can be recovered right now by deducting it (reducing income) 2. The basis of property is the cost of such property – whatever you pay for something Stock costs $10 (that is the basis – tax free return of capital. better to deduct than adjust basis because of time value of money (better to have $$ now) and it is better to reduce income than capital gains – faster depreciation is better (faster recovery of cost) 3.S. 1011(a). 1012. 1016(a)(1).

000 (under an employee discount program) and later sells it for $16. $6000 gain e) what if owner rented the land to L for 5 years for $1000 cash per year and L spent $2000 clearing the land.000 $2000 is adjustment to basis (unless it was deducted from income). (1) must have built-in loss (FMV > donor basis) & subsequent sale at a loss (2) if sale is above fair market value and below basis. b. Property Acquired by Gift § 1015(a) see §§ 1015(d)(1)(A). the basis for determining loss to the donee (in the event of a subsequent sale at a loss) is the fair market value of the property at the time of the gift. the donee’s basis is the fair market value of the property at the time acquired by the donor.000.000 basis & $6000 gain. For example. if donor basis < FMV. basis in land is $9000.000 when the gift is made.000.000 basis is $10. then donee basis is donor basis b. there is no gain and no loss c. .Problems pg 121 1) Owner purchases some land for $10. § 1015. (4) & (6) Reg 1.1015-1(a) 1.000 basis in the land g) what if owner works in gallery and buys a $10.000 and later sells it for $16.000 a) what gain? $ 6. $2000 expenditures were properly excluded under § 109. and attributable to the appreciation. If the donor’s basis is not obtainable. Any appreciation in the property that occurred while in the hands of the donor does not affect the donor basis. Substitute for rent goes into basis but this is not rent substitute f) what if land valued at $10. If property is acquired by gift. Taft v.000 is given to employee and his taxes go up $3000 still $10.000. Still $10. Bowers. gain is $6000 c) what if owner sold the option for $1500 instead of buying the land $500 gain d) what if owner purchased the land for $10. the basis is the same as it was in the hands of the donor or last preceding owner by whom it was not acquired by gift. Part sale/part gift: basis is the greater of amount paid by transferee and transferor’s basis (1) donor has a gain if the donee payment is greater than donor basis § 1001 (no loss can be recognized in a part sale/part gift) (2) donee’s basis is the greater of donee cost and donor’s basis (the carryover basis)(or donor basis plus any gain recognized by donor) Reg 1. spent $2000 clearing it prior to sale and then sold it for $18.000 and gain is $7000 – $1000 discount in not excludable under § 132(a)(2) B. Owner reported the cash rental as gross income. the donee takes a basis of only $1. d. and the stock is valued at $2.000 painting for $9. (1) But the donee does get a step up in basis for any taxes paid. a. Appreciation a.1015-4 2.000 b) what if owner paid $1000 for option to purchase land later for $9000 and then later did so basis in option is $1000. if donor basis > FMV of the property at the time the gift is made. if the donor bought stock at a cost to him of $1.

so carry over basis 20.000. not just the label given by the parties.000.000 gift tax – gives to Gainer – Gainer sells to Shelterer – what is Gainer’s basis? 10. A transfer is incident to divorce if it occurs within 1 year after the date on .000 x 6.000 (2) $15. or former spouse if incident to divorce.000. The basis of the transferee is the adjusted basis of the transferor. loss of $5000 (3) $25.000 C. No anti-loss rule – loss can be transferred – absolute carry over basis 2. § 1041. c. then Father has 0 gain.000 plus 2.000.000 = 2. In these types of transfers the property is treated as if it were acquired by gift.3. had FMV of $30.1015-5 4.000 – pays 6. no loss and Daughter has $60. Property Acquired Between Spouses or Incident to Divorce § 1041 Reg 1. Farid-Es-Sultaneh v.000) If Daughter paid $140.000: no gain or loss 2) Father bought land at $120. Definition of Gift a.000 and Daughter has basis of $140.000.000 at time of gift and Donee sold it for: (1) $35. courts and the IRS will focus on the substance of the transaction.000 b) property cost Donor $30. had FMV of $ 20.000 of gain (her basis is the greater of amount paid $100. Relative buys apt for 20. Basis of gift on which gift tax has been paid by donor: § 1015(d)(6): basis in a gift on which gift tax has been paid by donor has its basis increased by an amount in the same ratio of the appreciation in the value of the gift to the amount of the gift o Formula: (appreciation on gift/fair market value) x tax paid = adjustment to basis o The more the gain. Father has gain of $20. In this case. Daughter takes Father’s basis of $120.000 and gain of $40. taxpayer received stock for release of marital rights (contract sale.000 at time of gift and Donee sold it for: (1) $35.000: basis is still 20.1001-1(e) & 1. What gain or loss on subsequent sale? a) property cost Donor $20.000 o See Reg 1. gain of $15.000/30. so use donor basis (2) $15. The general rule is that no gain or loss is recognized on a transfer of property from an individual to a spouse.000. To determine whether a gift has been made.000: basis is again 20.000.000 .000 If Father sold it to Daughter for $100.000 – worth 30. a) What gain to Father and what basis to Daughter under Reg 1.000 and donor basis $120.000 = 22.000. FMV now $180.000: gain of $5000 no loss on the sale. a.1041-1T(a) & (d) 1.000 cash calling the transaction part sale/part gift.000 and has a gain of $60. not a gift). Commissioner. Problems pg 128 1) Donor gave donee property with no gift tax required.000: basis is 20.000: loss of $5000 basis is FMV (3) $24. the more gift tax into basis o Eg. No sale – money is ignored and the property is simply treated as a gift d. b.000. gain of $5.1015-4? Father has gain of 0. Sold to Daughter for $120.

if you have loss property. Policy Underlying § 1041 a. H sells to W for $7000 cash a) what tax? None b) W’s basis? $4000 c) What gain to W if sold? $3000 d) What result if FMV $3000 and H sold to W for $3000? $4000 basis. so § 1041 provides a uniform federal law. Property Acquired From Decedent § 1014(a). or is related to cessation of marriage. But if the decedent received the property within a year of his death. Amount Realized § 1001(b) Reg 1. Spouses file joint returns so they are 1 taxpayer b. § 1014(a) (1). you take the tax liability with you) b. § 1041 is really a deferral because there will be a gain or loss when the transferee spouse sells to a third party. $1000 loss on the sale e) What if W trades property with basis of $5000 and FMV of $7000 instead of cash to H? W takes H’s basis and H takes W’s basis D. (b)(1) & (6). sell it before you die or give it to your spouse c.1001-1(a). 5. (c) Examples (1) & (2) The amount realized from the sale or other disposition of property is the sum of any money received plus the fair market value of any other property received. .1041-1T(b). and the estate transfers it back to the original owner. Reg. A person who acquires property from a decedent has a basis in the property equal to the fair market value of the property at the time of death. which the marriage ceases. c. -2(a). Spouses in different states may be treated differently. § 1001(b). § 1041 does not cover transfers between spouses that are pursuant to a prenuptial agreement. FMV now $7000. thus it makes no sense to tax a "transfer" between the same entity. reverses the Davis case – big improvement because there is no new cash in the transaction (no liquidity to pay the taxes) Problems pg 130 1) Property purchased at $4000. § 1014(a) * If gift tax paid then need to use formula determining portion of gift tax applicable to gain that gets added to basis II.1014-3(a) 1. the original owner keeps the original basis. Treas. It is presumed that transfers are related to the cessation of a marriage if they occur within 6 years and are pursuant to a written decree or agreement. 6. 4. A married couple is one economic entity.3. a. 1. This gives a stepped-up basis to the recipient (with no income tax cost for the appreciation while decedent owned it. estate tax value is used for income tax value of property 2. (b). a. (e) Reg 1.

basis gets apportioned among the lots.000. and a year later you transfer the stock to cancel a debt of $2. Beck stated the rules of Crane this way: 1.000. Crane v. Commissioner v.000 of depreciation. International Freighting Corporation. which you took as a deduction. • Symmetry of the transaction: if you have $1. (1) amount received = amount of debt offloaded + property recd + cash amount recd – adjusted basis = gain.8 of basis and 400. For example. Commissioner. The relief of indebtedness is considered "other property received" § 1001. when you sell for 1. the transferor realizes an amount equal to the unpaid balance on the mortgage. Borrowed money gives you basis in the property as long as it is invested in the property 2. a.000 of gain on the transaction 3. you have 400.1. Inc.000. no matter whether or not the property was worth less than the mortgage. 2. If you transfer appreciated property in satisfaction of a legal obligation there is a taxable gain equal to the difference between the amount of the legal obligation and the adjusted basis in the appreciated property. Offloaded debt is part of the amount realized in the transaction (2) The transfer of a non-recourse mortgage is treated as if the transferor had transferred a loan on which he was personally liable. if you buy stock at a cost of $1. When property encumbered by a non-recourse mortgage is transferred subject to the mortgage. Commissioner. v. you have realized a gain of $1.61-6 . Tufts. If property is sold in portions. b. Reg 1.4.

000 21. § 101(a).000 + 2000 = 22.000 and gives it to G when it is worth $300.000 and pays $20.000 FMV of gift 300.000).000 d) What if Mortgagor uses $100. or for the transfer of the policy or in the case of whole life. land has value of $300.000 b) 2 years later. G sells to S. (b)(1). Non-taxable proceeds • The proceeds of life insurance received by reason of the insured's death are excludable from gross income. Is this income? No c) What is Mortgagor’s basis if $100. . -4(a)(1)(i).101-1(a)(1). a) What gain or loss to G if sale is for $320. as in d. land declines in value to $180. (c). Life Insurance § 101(a).000 180.000.000/18. (d). as in d.000 h) What if.000 32.000 and Mortgagor transfer the land to the bank? $80.000 = 20.000 NB: the more the gain.000 cash subject to the full mortgage. First calculate adjustment to basis for gift tax: (10.000 is used to improve the land? $200. R paid $60.000? Portion of gift tax applicable to gain gets added to basis. What is Purchaser’s cost basis? $120.000 c) What if R paid $8000 cash and $12. (b) (1).000 A/B 100.000 x gift tax paid 60.000 of gain ($180. S took apt for $20. Basis is $100.000 300.000 e) What if. amount discharged is amount received 3) R purchase apt for $200. a) what is Mortgagor’s basis? $100.000 and Mortgagor still owes $80.000 in gift tax.000 f) What if.000) x 3000 = 1667 R G S A/R 12. as in d.000 and value of land $300.000? Same result. Mortgagor sells land for $120.000) 1015(d)(6) – built in gain Chap 7: Life Insurance Proceeds and Annuities I. • Payments can be payment on death.000 to Son.000) i) What if land value declined to $170.000 cash. Gain is $10. the investment gain on the premium. Value of gift 100.000 A/B 20.000 (mortgages of $180. Mortgagor borrows an additional $100.000 G’s basis is 20.Problems pg 153 1) Mortgagor buys land from Seller for $100.000 g) What if Mortgagor gives the land to his spouse? It’s a gift under § 1041.667 32000 (8.000. What is Son’s basis? Part gift/part sale – 2 part analysis under § 1015 Donor Donee A/R 180.000 to buy stock and bonds? $100. Mortgagor borrows $80. the more gift tax into basis b) S’s basis in the apt is $32.000 80.000 mortgage for apt and paid $3000 gift tax? Gave it to G.000.000 amt received by discharge of debt minus basis of $100.000.000 120. Mortgagor gives land subject to mortgages and worth $300.000. & (g) Reg 1. (c) A.

§ 101(g)(2). Interest payments Interest payments made on the amount excludable under § 101 are gross income. all monies received under a life insurance policy are excludable from gross income. § 101(g)(3). If a life insurance policy is sold to a viatical settlement provider (a person who is licensed in the business of trading life insurance contracts) by a terminally or chronically ill person. b. a. (1) For the chronically ill. any payment received above that amount is gross income. C. b. • • . may exclude from gross income an amount that is apportioned equally over the amount of years the payments are to be made. The proceeds are excludable only if the insured dies. not excludable (buyer’s basis is always excludable. Eligible Beneficiaries a. but decides to take an annuity under which the insurance company will pay $5. and relegates himself to receiving only interest payments. partner of insured. § 101(c). Any named beneficiary may take advantage of exclusion. Payments over time A beneficiary who takes life insurance payments over time.101(a) – tax free if in payment for the death of the insured 101(a)(2) – if transferred for valuable consideration after the policy is issued. it may exclude the proceeds received by reason of the employee's death. (1) Note that the viatical settlement provider does not get to take advantage of the § 101 exclusion when the insured dies 2. B. If a corporation takes a life insurance policy out on a key employee. for the terminally ill. 1. the amount realized from the sale is excludable from gross income. or 4k/yr.000 life insurance payment.000/25yr. the amount that the beneficiary may exclude from gross income each year under § 101 is represented by the fraction $100. if a beneficiary is entitled to a $100. Amounts received under a life insurance contract on the life of an insured who is terminally or chronically ill are treated as if received by reason of death. This rule anticipates a situation where the beneficiary leaves the policy amount with the insurance company. but not the gain) o 2 exceptions:  if it was a gift (carry over basis) or transferred to spouse § 101(2)(A)  if it was transferred to the insured. 1. For example. § 101 (g)(1)(A)(B). to partnership in which insured is partner or to a corporation in which insured is a shareholder or officer (key man insurance) § 101(2)(B) (if the transfer is to someone who could have bought the policy in the first place) 1. only life insurance payments sufficient to cover the cost of medical expenses incurred are treated as if received by reason of death.000 for the next 25 years. § 101(d).

a) paid for by corporation: tax free b) bought by employee and then sold to corporation for $20. benefit to corporation. basis is excluded § 101(a)(2)(b) c) if insured is shareholder.000 § 101(a)(2) b) transfer to spouse: no tax § 1041 c) insured sells to viatical settlement because he is terminally ill no tax to insured § 101(g) buyer profit of $20. (2) Beck’s formula: benefit/life expectancy = non-taxable portion (keeps track of basis) b.000. b.000 / 25 = 4. Any portion of the annuity payment attributable to the investment is excluded from gross income. . then all is excludable 3) Insured buys $100. The portion of the annuity payment which is excludable from gross income is determined by the following ratio: Investment Amount/Expected Return. a. But if the beneficiary dies before the end of the expected term.000 is taxable II.000 per year for life expectancy of 25 years divide basis by life expectancy to get non-taxable $100.000 life insurance for $40. What tax under several alternatives? a) $100. Annuities (the new rule) § 72(a). (1) The expected return is the product of each payment amount and the number of payments (Payment amount x No. of payments).000 non-taxable $12. a.2. after which all payments are subject to full taxation.000: $980.000 income § 101(c) c) elects payment of $12. -9(table V) 1. (1) If the annuitant dies prior to the termination of the payments.000 cash: no tax under § 101(a) b) beneficiary leaves $100. the estate does not get to deduct a loss on the un-recovered portion. under new rule which applies if you buy an annuity not related to a death benefit. If the beneficiary receives payments beyond the expected term of the annuity. Employee dies.000 and on death $100. the annuitant's estate is allowed a deduction equal to the un-recovered portion of the investment. the result is the same 2) Corporation buys $1 million life insurance on employee.000 interest this year $10. (c) Reg 1. § 72(b)(3)(A).000 gain child is taxed on $40. you track the basis and payments beyond basis are fully taxable and death before full re-payment of basis is deductible back 2 years (§ 172 look backs on business expenses) Problems pg 158 1) Insured died with policy to pay Beneficiary $100. § 72(b)(2). (b).000 with company and they pay her $10.000 not excludable.72-4(a).000 a) sells policy to child for $60.000 is paid to child insured is taxed on $20. The exclusion is only allowed until the investment is fully recovered. he may still exclude the same fractional amount.000 – 4000 = $8000 taxable d) if she lives beyond her life expectancy. § 72(b).

102(a).000 unrecovered basis. $1000 is taxable b) what is taxable in the 30th year of payments? $3000 taxable. the value of any potential refund (determined by the annuitant's life expectancy) is subtracted from the "investment in the contract.000 policy with $3000 per year benefit over 24 year life expectancy a) what is taxable? 48. basis has been exhausted c) insured dies after 9 years of payments.1001-2(a). The refund itself. What is taxable? 76. (b)(1)-(3). 61(a)(12). however. for it is merely a return of capital. § 72(c).000/year with life expectance of 34 years. Commissioner." decreasing the excludable ratio. (3)(A) & (B) Reg 1. (b)(1). so there is no debt. in the year in which it is forgiven. then you are taxed on the amount you have been forgiven.  If you settle a legal obligation for less than the amount of the obligation. recognizes gross income of $5 per every bond repurchased. but Beck disagrees with this and says there is still debt . 2. 1. Problems pg 163 1) $48. Chap 8: Discharge of Indebtedness I. The settlement for less than face value of an unenforceable obligation is not gross income.  When you borrow money. U. Where the annuity contract calls for a refund of any investment (premiums) not recovered by the annuitant. Zarin v. This case is generally cited as defining discharge of debt as creating income. is not taxed. Included in income §§ 61(a)(12). (2). What tax deduction to estate? 9 x 2000 = 18. 8  Gross income includes income from the discharge of indebtedness. (e)(1) & (5). A company that issues bonds with a face value of $100 and retires those bonds by repurchasing them for $95 each. 1017(a).  result is correct.S.  Not all discharges of debt result in taxable income – look to the economic substance: forgiven loan to employee is compensation (and subject to payroll taxes which discharge of debt would not be) – loan to child forgiven is a gift – loan to shareholder which is forgiven is a dividend – this is called spurious discharge of debt  To be taxable. in lieu of forgiveness.61-12(a).000/24 = 2000 tax free. 108(a). 2(c) Ex. Kirby. a. But if you don’t have to repay it. reasoning is wrong  debt is unenforceable. debt which is discharged must be from a loan of money – not just the avoidance of a loss  Eg: Mom lets Dad out of child support payment (not a loan) so not discharge of indebtedness  No income if taxpayer is insolvent or in chap 11 – but if taxpayer has tax attributes. deductible loss on last return d) 76. v. the difference becomes taxable income.2.500 cost for $3.500/34 = 2250 non taxable $750 is taxable a. you are not taxed on it because you have to repay it. (d)(1)-(5).000 – 18000 = 30.000 48. these will be reduced  For example: 1.

1. C. debtor must also reduce his basis in the property in an amount equal to that of the discharge. 2.  Beck says: avoidance of a loss is not taxable as a gain o Zarin is no better off than before the forgiveness – it is a nullity for tax purposes o this is a return of capital: allowing loser to collect from winner what was formerly his – avoidance of loss is not taxable o there was never any loan of money (casino had never given him anything to spend. Minimum Tax Credit 4. Passive activity loss and credit carryovers. 108(a)(1)(B). The amount of the exclusion is limited to the extent of the taxpayers insolvency. a taxpayer who elects to exclude a discharge under sections 108(a)(1)(A). 108(a)(1)(C). discharge of indebtedness which constitutes a gift or bequest is not treated as . judicially developed insolvency exception: no income arises from discharge of indebtedness if the debtor is insolvent both before and after the transaction. Exceptions to 61(a)(12) A. There is no gross income if the indebtedness discharged was incurred directly with the operation of a farm. Under § 108(b)(2). 3. B. only a free line of credit to gamble with) Don’t cite Zarin for anything – while the result is right. General Business Credit 3. must reduce tax attributes (in lieu of tax) in the following order: 1. The discharge of a debt owed to the seller of property (a purchase-money debt) is treated merely as a retroactive reduction in price by the seller (not as income). 4. There is no gross income if the debt was incurred in connection with real property used in a business or trade. or (C). Peculiar definition of insolvency for this section is that taxpayer’s liabilities exceed assets (usual definition is the inability to meet obligations as they mature) b. 108(a)(1) (A). Basis in the property of the taxpayer 6. D. and if the transaction leaves the debtor with assets whose value exceeds remaining liabilities. § 108(e)(5) 1. There is no gross income if the discharge occurs in bankruptcy. income is realized only to the extent of the excess. the reasoning is wrong II. Net Operating Loss 2. a. There is no gross income if the discharge occurs when the taxpayer is insolvent. Under § 108(a)(1) there are 4 exception to the general rule that discharge of indebtedness is includable in gross income. 108(a)(1)(D). (B). Capital Loss Carryovers 5.

000 of cash and $80.000) taxpayer is taxed on $5000 depreciation recapture income (negative basis is not allowed) . unrealistically.000. Problems pg 180 1) Poor borrowed $10. the adjusted basis of the ambulance is $35.000 (5. in the form of remodeling Rich’s office. it looks like: A/R 170.000 discharge of debt A/B 100.000 debt discharge income b) Same as (a) above. Assume the ambulances are his only depreciable property and.000.000 taxable.income. except that Creditor is also the ambulance dealer who sold the ambulance to the businessman and.000? $2000 taxable as debt discharge c) A painting with a value of $8.000 gain taxable to taxpayer.000.000? $10. Mortgagor uses the $100.000 payment to Rich.000 $40.000 gain 10. renouncing any claim to repayment by poor. Several years later when the principal amount of the mortgages is still $180. Mortgagor transfers the land to the Bank.000? $5000 taxable (3000 capital gain & 2000 debt discharge) d) Services. What consequences under Section 108 and section 1017 in the following circumstances: a) Businessman is solvent but is having financial difficulties and the Creditor compromises the debt for $60.000.000 mortgage. Mortgagor borrows another $100. § 102.1001-2 (a) and 2 (c) Example 8 A/R 180.000. in a non-recourse mortgage but in a recourse mortgage. § 108(e)(5) applies: original purchase now A/B 100. that after some period of time their adjusted basis and value are still $100.000 from Rich several years ago.000 debt discharge income (bank can only collect 3) Businessman borrows $100. which are worth $10. the land declines in value to $170. as a result of depreciation deductions. Land increases in value to $300.000.000 New A/B 35. except that Poor’s Employer makes the $7.000 70.000 A/B 100. a) What are the tax consequences to Mortgagor ? See Reg 1. What tax consequences to Poor if Poor pays off the so far undiminished debt with : a) A settlement of $7. $7000 is payment and $3000 is debt discharge 2) Mortgagor buys land for investment from Seller for $100.000 of cash? $3000 taxable as debt discharge b) A painting with a basis and fair market value of $8. and the Bank discharges all of the Mortgagor’s indebtedness.000 60. these are payment for services rendered (a barter transaction reduced to cash) and is considered spurious forgiveness of debt e) Services that are worth $8000? $8000 is payment and $2000 is debt discharge f) Same as (a) above.000 of loan proceeds to purchase stocks and bond.000 from the Bank.000 65.000 with $20.000 80.000 and a basis of $5. He then purchases ambulances for use in his business at a cost of $100.000 from Creditor to start an ambulance service.000 basis is reduced to reflect debt discharge Deprec 65.

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000) by $125. 1.000) After discharge: 185.000 exceed his assets (the ambulance worth $100. $500 is income and taxable b) What result to Debtor if he instead transferred land worth $8500 with basis of $2000 to satisfy obligation? What basis does Plaintiff take? Debtor has realized gain of $6500 but can deduct $500 as an interest expense Creditor takes a tax cost basis of $8500 and is taxed on $500 of income c) suit was based on breach of contract and Plaintiff recovered $8000 in lost profits and $16. that amount is taxable) Damages are taxable as gross income if they are recovered in lieu of taxable income. the recovery is taxed as if it were profits. Discuss the tax consequences: a) suit was based on a recovery of $8000 loan to Debtor. $8000 for the loan plus $500 interest. Liabilities Assets Insolvency Original situation: 125.000. (1) settled for $10. Taxpayer has $15.A/R $3000 leaves $1000 basis. general business credit carryovers.same facts as in (a) above.000 of loss carry forward. damages are an income substitute and are taxed as ordinary business income • for destruction of property (including goodwill). 4) Decedent owed Friend $5000 and Nephew Owed decedent $10.000 (85. if a plaintiff recovers damages attributable to lost profits. or foreign tax credit carryovers.000 (125. Here he looses the full $30.000 of the $100.000 15. Raytheon Production Corporation v. Plaintiff had $4000 basis for goodwill & valued at $10. e) Same as (c). except that Businessman is insolvent and his liabilities of $225.000 at time of breach.000 of income forgiven but not taxed under § 108(a). the residuary beneficiary of his estate. the damages attributable to the principal are not taxed. Problems pg 182 1) Plaintiff brought suit and unless otherwise indicated successfully recovered. goodwill worth $7000 after breach: Basis $4000 . a) At decedent’s death friend neglected to file a claim against Decedent’s estate in the time allowed by state law and Friend’s claim was barred by the statue of limitations.000 100. but if damages are awarded for a loan default. Plaintiff recovered $8500 cash.000) Taxpayer is protected by §108(a) because he is insolvent before and after the discharge so he has no income d) Same as (c). Further assume Businessman has no net operating losses.000 in punitive damages all of it is taxable as ordinary income (Glenshaw Glass) d) suit was based on claim of injury to goodwill of business arising from breach of contract.000 for goodwill destroyed: $4000 return of capital & not taxable. Inheritance under § 102 and not taxed c) Chap 9: Damages And Related Receipts Damages for physical injury and sickness are accorded express congressional treatment in the Code. capital loss carryovers.000 Insolvent before but solvent afterward. Since there is $40.000. you loose $ for $ tax attributes up to the amount of income that was not taxed. Commissioner. Damages for Business Loss • for lost profits.000 100. $8000 is return of capital. because that is a mere return of capital. What results to Decedents Estate? $5000 income b) What result to the estate in (a) above (with nephew still in cold storage ) if instead Friend simply permitted the statue to run stating that she felt sorry for Decedent’s widow. above except Businessman’s liabilities exceed his assets by $25.000 100. $6000 taxable as gain (2) recovers $4000 for partially destroyed goodwill. what result to Nephew if decedent’s will provided that his estate not collect Nephew’s debt to the estate. no tax leaves $2K deferred gain (3) recovers $3000. passive activity losses or credit carryovers. an award of damages is treated like an amount realized from a forced sale (and the basis is reduced by the amount of the award.000 net operating loss. For instance.000) After discharge: 85. above except that Businessman has a $30. leaves $6000 deferred gain . (Let us defer our concern for nephew).000 (125. now worth $6000: $4000 is return of capital. I.000 100. Liabilities Assets Insolvency Original situation: 225.000 income from debt discharge.000 loan without any payment. Could be called a gift under § 102 and not taxed c) Now. but other types of damages must be dealt with by courts under general tax principles. The Creditor discharges $40. if excess.000. minimum tax credit.

a. interest is also excludable under § 104(a)(2) if settlement does not mention interest. Punitive damages for wrongful death are excluded if they are the only form of wrongful death recovery available. excludes all payments received. and damages are for medical care received attributable to emotional distress.II. Gross income does not include amounts received under accident or health insurance policies for personal injury or sickness paid for by insured without employer contributions. the premiums of one being paid by the individual and the other by the employer and both compensate individual for the same illness then allocation of benefits has to occur. even if the insured recovered under separate policies an amount greater than his medical expenses. 3. (think AFLAC) (1) Interaction of §§ 104(a)(3) & 105(b): If an individual has two accident and health insurance policies. § 104(c). § 106 complements § 105 by excluding from gross income the value of health and accident insurance premiums paid by the employer to cover the employees. received for physical injury or physical sickness are excludable from gross income. all proceeds from the individual’s policy are excludable from income. § 104(a)(1). 3.Return of loss human capital what is lost is not earnings but the ability to earn B. (c). Gross income does not include amounts attributable to work related injuries or sickness that are paid under a workmen's compensation act. the amount excludable under § 105(b) is the proportionate share of benefit received to medical expenses incurred. § 106(a). § 104(a)(3) a. Problem: Offer to settle Personal Injury case:  $1 million cash now would be tax free under 104(a)(2)  $2 million over 20 years is also all tax free Jury Award $1. Recovery for emotional distress is excluded if the emotional distress is incurred on account of physical injury. but § 105(b) limits the exclusion for the employer-provided policy to amounts that reimburse the individual for medical care.104-1(a). Rul. 79-313. Employer's contributions to accident or health plans are not included in gross income. (d) Any damages. 1.00 for lost earnings – Tax-free . The rationale is that the interest is mere compensation for the present value of money. Insurance and Workers' Compensation §§ 105(a)-(c) & (e). 2. 2. Rev. 106(a) Reg 1. § 104(a)(2) 1. If personal injury settlement provides for annual payments that include interest. . In the case of payments received by both policies. except for punitive damages. which would not be taxed if the settlement payment were in one lump sum. Under § 104(a)(3). Damages § 104(a) Reg 1. Damages & Recoveries for Personal Injury A.105-1(a).106-1 1.000.000.

All exclusions under §§ 104 and 105(b) are restricted by including in gross income reimbursements of medical expenses that were deducted in a prior year. which are excludable under § 104(a)(1). Gross income includes amounts received by an employee under insurance for personal injuries or sickness to the extent such amounts are attributable to employer contributions. but § 105(c) excludes from gross income payments for non-work-related disfigurement. a. § 105(a). (1) A worker will often receive payments of this type under workmen's compensation.Amount paid by employer’s policy § 105 Total Paid by insurance §§ 104 & 105 x expenses = excludable under 105 (b) 4. § 105(c). b. 5. § 105(e) gives companies who self-insure same treatment as those buying a plan. or disfigurement are not included in gross income if the payments are computed with regard to only the nature of the injury and not the absence from work. But employer-provided reimbursements for medical expenses are excludable from gross income. Payments received through health or accident insurance provided by an employer for loss of a body member or body function. .

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000 per year of basis from the recovery is tax –free and 50. Spouse’s medical expenses totaled $4.000 $2000 + $3000 x $4. deducted $1. Injured received payments from defendant of $100. it is tax free. This may look like payment for services but it is actually compensation of the loss of ability to earn. above is specifically allocated as compensation for scheduled performances P failed to make as a result of the injured leg. a) P. taxpayer paid $25. they settled their claim for $2. Old Colony Trust does not apply. There are periodic payments Hypo on Damages: Tax Lawyer gives client bad advice to file jointly as opposed to separately. not compensated by insurance or otherwise. The one exception to this rule is that punitive damages received for wrongful death.000 is taxable as profit.000 to compensate for P’s suicidal tendencies resulting from the loss of the use of her leg. lost the use of her leg after a psychotic fan assaulted her with a tire iron. g) P dies as a result of the leg injury and P’s parents recover $1.500 on joint return and filed suit against the wrongdoer. fortunately. c) What are the tax consequences to Injured if the case was settled and in the settlement. Their total medical expenses incurred were $2. If you don’t use word interest and don’t buy annuity.000/20 = 50. In next year.000 and they received $3.000. P was awarded damages of $100. may injured spouse deduct their medical expenses? not deductible.000 of benefits under their policy and $2. tax free and not included in gross income. Wrongful death. There may be touching in this sexual harassment suit but this touching is not central to the injury.000 in punitive damages. taxable because it is an emotional injury and does not stem from a physical injury f) P recovered $200. § 104(c)(1) “the phrase. they carried medical insurance & additionally Spouse had insurance benefits under a policy provided by Employer. $3000 from their policy is not taxed c) Under the facts of (b).000 a year for life? Invested amount/expected return = portion excludable 1. . e) P in a separate suit recovered $100. because here it was a return of capital.000. This is tax free and not includable in gross income because the emotional injury for which P is being compensated is a direct result of a physical injury. § 104(a)(2) b) $50.. under a state statue that does not allow for compensatory damages.500..00 of punitive damages awarded in a wrongful death action under a state statue. § 213(a) states “there shall be allowed as a deduction the expenses paid during the taxable year.000 a year for life? Not taxable. other than punitive damages will not apply to punitive damages awarded in a civil action” 2) Injured and Spouse were injured in an automobile accident.00 of the recovery in (a). taxable. will be excludable. The tax collector calls this income? Result: The court ruled that the lawyer caused the client an injury which caused the client to lose money so therefore it is not taxable and the client is no richer. A taxpayer can exclude a recovery for emotional distress only if the emotional distress is the byproduct of physical injury. Even though economically identical to above. The lawyer offers to pay the client $25. Under § 104(a)(2) and Glenshaw Glass punitive damages are includable in gross income and are therefore taxable d) The jury also awards P damages of $200. above.00 of damages from a fan who mercilessly taunted P about her unnaturally high squeaky voice. What income tax? $1000 excludable & $1500 is income under § 111: Tax Benefit Rule: a recovery from a previously deducted item becomes income and taxable (to avoid a double tax benefit for the same item).Problems pg 190 1) Plaintiff brought suit and successfully recovered in the following situations. b) Spouse was ill but. causing P extreme anxiety and stress. tax free and not included in gross income. This is not a physical injury. for the medical care of the taxpayer…” 3) Injured who has 20 year life expectancy. a) What are the tax consequences to the injured if the $1 million is deposited in a money market account that pays 5% interest? Principal is not taxable but the interest earned is taxable b) What are the tax consequences to injured if the $1 million is used by injured to purchase an annuity to pay injured $100.000 in a suit of sexual harassment against her former boss. Discuss the tax consequences to Plaintiff.000 = $1600 exempt & $400 taxable. a professional gymnast. To what extent are their benefits included in their gross income? $2. c) The jury also awards P $200. the insurance company did.000 of benefits under Employer’s policy. If there was harmful physical touching then it would be excluded. recovers $1 million in a personal injury suit arising out of a boating accident.000 more than if he had filed separately.000.500 a) year of accident. because the couple did not pay their medical expenses. This is not excludable from gross income and is taxable.000.

§ 71(b)(1)(B) (2) payment is not for child support d. 3. ." § 71(f).. (1) Checks and like instruments are considered cash. § 71 is intended to apply only to payments for spousal "support." b. 7701(a)(17) Reg 1. but promissory notes are not. Alimony payments are included in the gross income of the recipient. and there may be no other payment obligation thereafter. The liability for alimony payment must cease upon the death of the recipient. c.Chap 10: Separation And Divorce I. (1) the front loading provisions prevent a party from making enormous "alimony" payments the first two years after the divorce or separation. (3) A decree for support is considered a separation instrument. and deducted from the gross income of the payor.71-1T(a) & (b) 1. Although not expressly mentioned anywhere in the Code. The payment must be in the form of cash. five requirements § 71(b)(1): a. To prevent parties from characterizing property settlements as alimony through the use of large cash payments. (2) But if local law requires that alimony cease upon death of the recipient. payment must be to ex-spouse (or on behalf) pursuant to a divorce/separation instrument. (1) A divorce/separation instrument includes a decree of divorce or separate maintenance or a written instrument incident to such a decree. The divorce/separation instrument cannot designate payment as other than alimony. 215(a) & (b). § 71(b)(2)(A). 2. Alimony and Separate Maintenance Payments A. For a payment to be considered "alimony" for tax purposes. (1) The parties are permitted to characterize "alimony" as something else (non-deductible/ non-includable) in order to forego income splitting. then no provision for cessation is needed in the instrument. § 71(b)(2)(B). "front loading. (2) A written separation agreement also qualifies as a separation instrument. e. b. Property Settlements and Recapture a. §§ 71(a) & 215 (act as an income splitting device). § 71(b)(2) (B). § 71(b) (1)(d) (1) The instrument cannot require alimony for a specific period of time if there is no provision providing for the cessation of alimony upon death of the recipient spouse. the Code provides for the recapture of excess payments made in the first few years following the divorce or separation i. Direct Payments §§ 71.e. The parties may not live in the same household if they are divorced or legally separated under 71(b)(2)(A) a divorce decree or settlement.

(2nd year .(3rd year payment + $15.5 = 62. (1) If the divorce or separation instrument ties payments to some form of variable income. (2nd year payment) . and 3 are within 15K of each other there will be no recapture BUT if there is a steady decline of 15K. there will be recapture of 7.2nd year excess) + 3rd year (1st year) 2 + $15. § 71(f)(3). and deducted by from gross income by recipient § 71(f) Calculation of Recapture Year Amount Step 1 80K 2 80 . (a) included in third year as gross income to payor.000) = Excess payment year 2 (2) Second. alimony payments are allowed to fluctuate beyond the limits permitted by the recapture provisions.[(80 – 35 + 30)/2 +15] = 80 – 52. §71(f)(5) (a) . 15k grace allowed each year c. over which neither party has control. §71(f)(5)(c) (2) Recapture does not apply if the payments cease before the third postseparation year due to the death or remarriage of the parties.with a substantial drop off in the third year. Determining the Amount of Recapture (1) First.5 = 27. calculate the excess payment made in the second post-separation year. There are three exceptions to recapture.[(Average of year 2 adjusted + year 3) + 15]} 3.5 2 80K 1 [80 – (30 +15) = $35 3 30K Steps: 1.500 in year 3 d.0 + 27. § 71(f)(4). add the excess payments for both the first and second postseparation years.000 (3) Finally. Total recapture = Year 1 excess + Year 2 excess 35. Determine Year 2 excess [year 2 – (year 3 + 15)] 2.2. 71(f)(5). calculate the excess payment made in the first post-separation year.5 NB: If the amounts paid in year 1. Determine Year 1 excess {year 1 .

(3) Recapture is also inapplicable if the support payments are made under a decree that is not incident to a divorce or separation. (In other words, payments made pursuant to a decree of separate maintenance)
Problems pgdecree requires Tina to make the following payments (which meet all the requirements of section 71 (b) to Ike: 2) divorce 203 1) Determine whether the following payments are accorded ‘alimony or separate maintenance” status and therefore and Year 1 $80,000 includible2 the$40,000 gross income under § 71(a) and deductible under § 215(a). Unless otherwise states, Andy recipient’s Year in and Fergie are divorced and payments are called for by the Divorce Decree Year 3 $10,000 a) The divorce decree directs Andy to make paymentto Tina and Ike?year to Fergie for her life or until she remarries. a) What are the tax consequences of these payments of $10,000 per Andy makes a1: Year 2 cash payment to Fergie in the current year. Yes, (10 +15) = 15 Step $10,000 - (Year 3 + 15) 40 – this is deductible alimony. b) Same as (a) above, except that Andy transfers his $10,000 promissory note -to (40 - 15) + 10)/2 ] + 15 = 47.5 Step 2: Year 1- [(Year 2 (adjusted) + Year 3)/2] +15 80 [ Fergie. not alimony. 2 excess (fromnote is notYear 1It is a promise step 2) Alimony must be cash . § 71(b)(1) Step 3: Year A promissory step 1) + cash. excess (from to pay. c) Same as (b), above, except that Andy transfers a piece of art work,+having= 62.5 market valueto be recaptured 15 47.5 a fair total excess of $10,000. No this is not alimony. This is notin year 3 and Ike can treated as a deduction from income Tina must declare $62.5k income cash. This would be take it as a gift under § 1041 d) Same results above,payments are addition the decree provides that the payments are nondeductible by Andy and b) What as (a), if the except that in are excludible from Fergie’s Gross income. Year 1 $80,000 Year 2 Yes this is alimony. “Opt-out” of alimony is effective by saying so $70,000 e) Would it make any difference70 – (60 + 15) if you no excess (0 Andy anticipated that he would have little or no Year 3 $60,000 1) in (d), above, = -5 learned that and minus amounts don’t count) taxable income in the immediate – (70 + making § 2150deduction practically worthless to him, and as a 2) 80 future, 60/2) + 15 = no excess No recapture c) consequence if the paymentsto the “non-deductibility” provision in order to enable Fergie to taxes on the What results of this, agreed are payments? No difference 3- $80,000 Payments are Year 1 - $30,000 Year 2 - $40,000 Year here except tax motivationincreasing. § 71(f) does not apply. f) What result in the paymentsdivorce decree directs Andy to pay $10,000 cash each year to Fergie for 10 years? d) results if (a), above if are: Year 1 not alimony because it is requiring Andy to pay Fergie for 10 years w/o including a provision that if $80,000 Year 2 Fergie dies he doesn’t have to pay anymore. Alimony must end at the death of the payee. § 71(b)(1)(D) $50,000 g) Same3 (f), above, except that under local law Andy is - 45 required to make any post-death payments. Year as $80,000 1) 50 – (80 + 15) = not no excess Then it would be alimony 2) 80 – (50 + 80/2) + 15 = 0 No recapture h) Same as (a), above, except the divorce to make payments set forth $10,000 eachthe divorce decree a period of 10 to e) Suppose that instead of requiring Tina decree directs Andy to pay in (a) above, year to Fergie for requires Tina years or50%life,the net income (before taxes) of her oil the decree requiresyears. The payments above each year 50% pay Ike her of whichever ends sooner. Additionally, business for three Andy to pay $15,000 cash represent to Fergienet her estate for a period of 10 years. Andy makes years. What tax payment to Fergie in the year. of the or income from the oil business for the respective a $25,000 cash consequences to Tina and Ike? $10,000 alimony this is OK. There can’t be property settlement if you have fluctuating payments not in First and foremost, $15,000of the payor spouse. § payment continues after death to her estate are not in control of the payor control not alimony because 71(f)(5)(c) says that if fluctuating payments i) Same as ( a), above, deductible as alimony and no recapture isand Fergie are living in the same house. spouse it is except that at the time of payment, Andy taken. f) What areNot alimony. “A payment made at instead provides for the level the payee spouses are per year for three the tax consequences if the decree the time when the payor and payments of $80,000 members of the samedies at the end of year 2 and alimony or separate maintenance if the spouses are legally separated years, but Ike household cannot qualify as the payments terminate at that time according to the express provisions under a decree of divorce or separate rules do not apply because & Regs 1.71-IT (A-9) of the instrument? § 71(f)(5)(a): the recapture maintenance” § 71(b)(1)(C)of death or remarriage of former spouse j) Same result in (a), above, if theAndy and Fergie are pursuant to a § 71(b)(2)(c) decree and support? g) What as (i), above, except that payments are made not divorced or legally separated for the payments are made pursuant § 71(b)(2)(c) describes agreement instead of a maintenance, one of the exceptions to recapture to a written separation an order of temporary divorce. If there is a written separation and the parties are living in the same household this still qualifies as h) Tina and alimony. If there is a non-final order you can live in the sameyear one. Tina the order is final Apartment at Ike are allegedly divorced and live in the same household in household. If moves to a new the parties can’t live in two. Under the divorce decree, Tina makes payments to Ike of the beginning of year the same household Year 1 $120,000 Year 2 $80,000 Year 3 $70,000 Year 4 $60,000 What results to Tina and Ike in each of the years? Year 1 is not treated as alimony because they are living in the same household. §§ 71(f)(6) & 71(b)(1)(c) Years 2 – 4 result in no recapture as in problem 2(b) above

B. Indirect payments § 71(b)(1(A) Reg 1.71-1T(b)(q 6 & 7) 1. Alimony payments made to third parties are anticipated by § 71, for it requires that alimony be "received by (or on behalf of) a spouse."

a. potential for abuse arises when payor controls payment and receives a benefit therefrom. (1) eg, a person making alimony payments can make payments to payee's landlord, but not if the payor is the landlord or owns an interest in the property. Reg. 1.71-1T. b. Payments made on a life insurance policy by the payor spouse will likely be considered alimony if the payee spouse owns the policy and is the irrevocable beneficiary. I.T. 4001.
Problems pg 207 1) Tom and Nicole are divorced. Pursuant to their written separation agreement incorporated into their divorce decree, Tom is required to make the following alternative payments which satisfy the Section 71 (b) requirements. Discuss the tax consequences to both Tom and Nicole. a) Rental payments of $1000 per month to Nicole’s landlord. This is alimony. The H has no interest in the property $1000 income to Nicole and $1000 deduction to Tom § 71(b)(1)(a) b) Mortgage payments of $1000 per month on family home transferred outright to Nicole in the divorce proceedings. This is alimony. The H has no interest in the property. c) Mortgage payments of $1000 per month as well as real estate taxes and upkeep expenses on the house where Nicole is living which is owned by Tom. This is not alimony. The H has an interest in the home. 2) Roseanne agrees to pay Tom $15,000 a year in alimony until the death of either or the marriage of Tom. The alimony satisfies § 71(b) requirements. After 3 years, Tom is concerned about Roseanne’s life expectancy and they agree to reduce the alimony amount to $10,000 a year if Roseanne provides Tom $100,000 of life insurance on her life. a) What are the tax consequences to Tom and Roseanne if Roseanne purchase a single premium $100.000 policy on her life for $60,000 and she transfers it to Tom? she is transferring the policy. Alimony has to be in cash. The policy is property § 1041 and not cash b) What result if Roseanne instead pays Tom $60,000 cash and he purchases the policy for $60,000? Alimony because it is in cash and not subject to recapture because after 3 years c) What result if Roseanne buys an ordinary policy on her life for $5,000, transfers it to Tom, and agrees to transfer $5,000 cash to him each year so he can pay the annual premiums on the policy? The policy is property, not alimony; The payments each year are alimony d) Same as (c), above except that Roseanne pays $5000 annual premiums directly to the insurance Company? This is still alimony. The only difference from c above is that it is made to a 3rd party e) Same as (d) above, except that instead of transferring the policy to Tom, Roseanne retains ownership of the policy but irrevocably names Tom as the beneficiary. not alimony because she retains an interest in the property.

II. Property Settlements § 1041; see 1015(e) Reg 1.1014-1T(b) Property settlements pursuant to a divorce are tax neutral events (gifts). § 1041. 1. A transfer is incident to divorce if it occurs within 1 year after the date on which the marriage ceases, or is related to cessation of marriage. a. presumed that transfers are related to the cessation of a marriage if they occur within 6 yrs and pursuant to written decree or agreement. Reg.1.1041-1T(b) (rebuttable presumption) (1) after 6 yrs presumed to be not incident to the divorce. (also a rebuttable presumption)

(2) Receiving spouse takes carry over basis – no transfer of gain or loss
Problems pg 212 1. Michael and Lisa Marie’s divorce decree becomes final on January 1st, 2000. Discuss the tax consequences of the following transactions to both Michael and Lisa Marie: a) Pursuant to decree, Michael transfers to Lisa Marie in March 2000 a parcel of unimproved land he purchases 10 years ago. The land has a basis of $100,000 and a fair market value of $500,000. Lisa Marie sells in 4/2000 for $600,000. transfer to Lisa Marie is not taxed. Lisa Marie takes $100,000 basis; $500,000 taxable gain when she sells. Will likely be treated as capital gains unless she is a merchant in land. (Holding period is tacked between spouses meaning that it was long tem gain as the property was held by the couple for more than 1 year) b) Same as (a) above, except land is transferred to satisfy a debt that Michael owes Lisa Marie. The land has a basis of $500,000 and a fair market value of $400,000 at time of transfer. Lisa Marie sells the land for $350,000. Anti-loss provision of § 1015(a) does not apply; Lisa Marie takes Michael’s basis and has a loss of $150,000 c) What results if pursuant to the divorce decree, Michael transfers the land in (a) above , to Lisa Marie in March 2005. Considered property settlement pursuant to divorce decree because it was done within 6 years of divorce d) Same as ( c) above, except that the transfer is required by a written instrument incident to a divorce decree. Same e) Same as (c), above except the transfer is made in March,2007. This is over 6 years but it is a rebuttable presumption. In this case, since it is pursuant to a divorce decree it doesn’t matter how long it takes. It is OK.

III. Other Tax Aspects of Divorce A. Child Support § 71(b)(1)(D); (c) Reg 1.71-1T(c) 1. Child support payments are not deductible by the payor. a. The policy rationale is that there is a moral and legal obligation to pay child support, so Congress does not need to encourage it. 2. Types of Child Support Payments a. Payments specifically designated as child support in a written divorce or separation instrument. § 71(c)(1) (1) In the case of these payments it is easy to determine what qualifies for income splitting under § 71(c) & what does not. b. Payments not specifically designated as child support but reduced upon happening of some contingency relating to the child (marriage, reaching majority, et al.) and designated in the written instrument. § 71(c)(2)(A) anti-Lester rule c. Payments not designated as child support but are reduced on the happening of some contingency clearly related to the child, but not designated in the written instrument. § 71(c)(2)(B) also part of anti-Lester rule The bright line test for clearly related to the child: Reg 1.71-1T(b)(q18) gives 2 situatons: (1) where payments are to be reduced within 6 months of the child reaching majority (18 or 21), or (2) (where there are 2 or more children) where payments are to be reduced more than twice, the ages of the children at the time of their reductions must be at least 2 years different when the reductions occur eg: reduction for child 1 is when he is 17yr, 4 mths, 10days; then

1.000 is alimony (Child support payment is counted before alimony is counted) Chap 11: Other Exclusions From Gross Income I. taxpayer must have owned and used property as a principle residence for at least two total years in the five year period preceding the sale.000 taxable income deductible by him and includable by her § 71(b)(1)(a) $4. 11 days (at least 2 years away. -2(a). B. and taxing a sale would create a large increase in tax liability. Problems pg 214 1) Sean and Madonna enter into a written support agreement which is incorporated into their divorce decree at the time of their divorce. § 121(a) (1) Whether a residence is "principle" is determined by the intent of the . but when their child reaches age twenty-one. Sean and Madonna have two children: Daughter (born June 17. Background: There has always been a favorable treatment towards this type of gain for several reasons: 1. and Son (born March 5. 25 days old. a.000 per year on January 1. -1(f) ex. this is easy to beat by adjusting the drop dates so that there is 2 years between the ages of the children on the drop date 3. To be eligible for exclusion. 4 mths. § 121. all circumstances that are often out of the taxpayer's control. either up or down. if Sean pays Madonna only $5.121-1(a)-(e). so $2000 per year per child is considered child support and $6000 is alimony. and to $6.000 of the $10.000 per year on January 1. the amount is to be reduced to $6. Discuss the tax consequences in the following alternative situations: a) The agreement requires Sean to pay Madonna $10.000 is for the support of their child. 2008.000 per year and provides that $4000 of the $10. 6 months & 13 days old.000 per year. $4000 is clearly child support c) The agreement requires Sean to pay Madonna $10. Reduction date is within 6 months of 18th birthday. 2. Daughter will be 17 yrs. On 1/1/12. 8 months. It seems inappropriate to tax people upon the sale of their home because they usually do so to change jobs. so flunk the first test for this reduction.6. The Rule: gross income does not include the gain from the sale or exchange of a principle residence. Gains From the Sale of Principle Home § 121 Reg 1.000 per year but that the payments will be reduced to $8.10 & 11. $6. d) What result in (a) above. 1990). from that age) – so you can Lesterize child support (from the Lester case) but the more children you have the longer you will be paying child support but see pg 214. 1993) On 1/1/08. -3(a). accommodate a growing family or downsize after reaching retirement. Son will be 18 yrs. A home is the largest asset in many taxpayers' estate.000 child support not taxed § 71(c)(1) b) The agreement requires Sean to pay Madonna $10. Same as above. (b) ex 1 A. They have one child who is in Madonna’s custody. There is not more than 2 years between their ages on the drop dates.reduction for child 2 must be 19 yr. it is first considered child support and then alimony. 2012. § 71(c)(3): If payment is less than amount specified.000 obligation in the current year? $4000 child support and $1.000 per year.

Taxpayer deeds one-half of residence to Spouse pursuant to divorce decree.000 several years ago and have lived there for that time $500. after one year of marriage.000 with adjusted basis of $190.000 ($125. get full exclusion (here $400. Taxpayer deeds one-half of residence to Spouse pursuant to divorce decree. Depreciation: § 121(d)(6) – gain is taxed in the amount of depreciation taken Problems pg 226 1) Determine gain that married couple filing jointly must include in income: a) sold principal residence for $600. $125. as well as 2 year limitation do not apply if: (1) The sale or exchange occurred due to a change in place of employment. what income? Only get $250. § 121(b)(1). all $400. Sold house for $400.000 ($500.000 for joint returns) that may be excluded is in the same ratio as the shorter of the actual ownership and use during the prior five years or the time between the prior and current sale to two years.000 is from depreciation so taxable § 121(d)(6). Spouse continued to live in house and one year later.000 and taking depreciation of $10. There is a joint return for the year of the sale.000 for home office use.000? Same as above taxpayer. after one year of marriage. no exclusion f) What if homeowner who met the ownership and use requirement is a single taxpayer. not excludable d) what if homeowners were granted non-recognition under former Roll-over provisions and had basis in second residence of $200. the last year with Spouse.2) Single Taxpayer buys residence for $500. $500.000) but since his gain is only $100. sold the house for $500. b.000 exclusion b) what if they had lived together for 2 years in the house? Then.000 excluded.000 he can exclude all of that b) what if he sold for $700. Either spouse meets ownership requirement iii.000 is excluded from income c) what if second sale occurred 1 ½ years later if the reason for the quick sale is one mentioned in § 121(c)(2)(B).000 gain but $10. then they could exclude 75% otherwise.000 is excluded . and iv.000 of gain is excluded from income b) purchased another principal residence for $600. health.000? Get full exclusion § 121(d)(3)(A)&(B) d) what if. basis $100. sold the house for $500. c.000 gain. ii.000. or unforeseen circumstances.000 due to transfer by employer. Taxpayer continued to live in house and one year later.000? $800. balance of $200.000 and sold it 2 ½ years later for $1 million $400.000.000 exclusion applies.000 gain – no special rule for this.000 a) if file joint return. Neither spouse is ineligible for the benefits because of a previous exclusion within the last two years. The ownership and use requirements. (a) In which case the portion of the $250. (a) In the case of joint returns the exclusion limit is $500k if: i. a) What gain included in income? Gets ½ of $250. $75 included in income 3) Taxpayer has owned and lived in residence for 10 years. Both spouses meet the use requirements.000? $200. $210.000) c) what if. Sell for $500.000 is excludable from income e) what if house was summer residence used for 3 months a year? Doesn’t qualify.000 and one year sold for $600. § 121(c) 2. Purchased for $200. Limitations (1) The amount of gain excluded from gross income on any sale shall not exceed $250k. (2) Exclusions are limited to one every two years.

Rul. 6013(a) see §§ 1(g). Renunciation of income A taxpayer does have the right to make an anticipatory renunciation of income and avoid any tax liability. Assignment of Income The person who earns and has the right to receive income cannot transfer tax consequences by assigning a portion of the income prior to its receipt to another individual by anticipatory assignments or contract. • Who is the taxpayer? Income shifting to someone in a lower tax bracket – 1948 allowed spouse to file jointly and split income • 1986 § 1(g): Kiddie Tax prevents shifting to children under 14. 63. this was not an avoidance of tax strategy by the taxpayer (contract formed in 1901 before income tax) – this partnership for a family is treated differently from a business partnership – Beck thinks this is decided wrongly B. unique factual situations – like doctors in hospital or police officers – don’t have control: the right to receive and enjoy and they were acting as an agent of their organization while earning the money . 1. 66-167. D. 74-581. 56-472. • For this reason individual taxpayers often attempt to transfer some income to another individual in a lower income bracket. 73 The progressive tax system taxes higher income individuals at higher rates. 1. Rev. § 1. Faculty Amounts received for services performed by a faculty member or a student of the university's school of law under the clinical programs and turned over to the university are not includable in the recipient's income. Giannini v. Rev. you are taxed on it 3. Rul. The Progressive Tax System & Income Splitting §§ 1(a) – (e). Rev. If the waiver is not executed prior to the performance of services. Commissioner.Identification of the Proper Taxpayer Chap 12: Assignment Of Income I. he controlled $$ because of his position on the board – Beck thinks this was decided wrongly C. 1. (h). Lucas v. Children under 14 are taxed on all unearned income in excess of $1000 at the tax rate of their highest rate parent (or custodial parent) II. Earl. if he neither receives the income nor directs its disposition. Waiver of Executor Fee The executor of an estate may waive his right to receive statutory commissions without incurring an income tax liability. 1. the fruit has to be taxed to the tree on which it grew 2. 66. there must be some evidence of an intent to render the services gratuitously. Income From Services A. thus lowering the total tax liability. Rul. if you earn it you are taxed on it – if you control it.

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Exceptions 1. he has shifted the tax consequences to the recipient. Income From Property A. but it may be sold in a valid transaction. If the owner of income producing property transfers both the property and the income therefrom. Helvering v. If the Corp. pursuant to her contract with Hi Rolling. Rule 78-581 (she was acting as an agent for the Corp. and that is what he gave away (the income interest was his tree and not the fruit) 2. or if merely income therefrom is being assigned. based on services rendered during the year? Still taxed because she still controls it d) Who is taxed if Executive . The owner of income producing property may also assign income from the property for valid consideration in an arm's length transaction. life estate (taxpayer has no interest in corpus) – income completely assigned to children – he only had the right to receive the income. Susie Salvatore. 1. above. Courts & IRS will look to the substance of a transaction to determine whether property is being transferred. at the beginning of the year. In other words. If income from property has been properly assigned by sale. a. The Executive is showing some control over the income. c) Same as (b). in her corporate role. and income has been earned or matured.000of her salary be paid to any charity the Board of Directors of Hi rolling selects? (Executive is not a member of the board). She can’t shift income even if this is done before the money is earned. b) Who is taxed if Executive at the beginning of the year directs that $20.000 each calendar year.Problems pg 254 1) Executive has a salaried position with Hi Rolling Corporation under which she earns $80.000 year-end bonus which Corporation has announced toward the end of the year.000 of her salary be paid to her aged parents? She is taxed.) III. a. transfer of the underlying property or otherwise. Income Earned But Not Realized 1. 1) Transferring the property after the contract of sale was signed was too late to avoid the tax on the proceeds of the sale. decided not to give the income to charity but keep it the Executive would have some rights against the Corp. Estate of Stranahan v. directs that $20. An assignment is ineffective for tax purposes if only the income from the property is assigned. Commissioner. but . a) Who is taxed if the Exec. income from property may not be assigned gratuitously for tax purposes. She can waive the income but not shift it. turns her $1. Commissioner. Blair v. the right to receive the income creates the tax liability 2. except that Executive makes the same request to a $10. But income can be successfully assigned for tax purposes if the assignor does not own the property which produced the income.? The executive isn’t taxed under Rev. got the enjoyment of the income by giving it to his son 3. while the assignor keeps the property itself. gives a series of lectures on corporate finances at a local business school and. (because son bore the risk that the loan would not be re-paid) a. General Rule The general rule is that the owner of property is taxed on the income from the property. Horst. C. giving away the property would prevent liability for the tax on income B.000 honorarium over to the Corp. 3.

“Ordinary and Necessary” § 162(a) Reg 1. Rev. He is taxed at the time when the donees receive the income and the donees are taxed on the income from the date of the gift. . Introduction §§ 1. meals & entertainment. § 162(a). 2. commuting." § 63. a. The donor is taxed on that portion of income which had accrued up to the date of the gift. The Anatomy of the Business Deduction A. b. like uniforms. C. For example. Deductions Deductions are said to be a matter of "legislative grace. Definition Exclusion is a receipt which is not taxable (like a gift) Deduction is an expense which reduces taxable income The big picture: § 61 gross income § 62 deductions (exclusions which reduce gross income) – most favored deduction adjusted gross income (it is good to get this low) § 63 standard deduction or itemizing deductions – second class deductions taxable income Deductions are amounts subtracted from gross income. it must be capitalized II. the seller of the stock is taxed on the dividend. a taxpayer must find a Code provision that specifically authorizes the deduction sought. 2 main difficulties: a. Rul. Deductions in Computing Taxable Income Chap 14: Business Deductions I.not received or realized on the date of assignment. 1. b. B. While a necessary expense is one that is appropriate and helpful in the business judgment of the taxpayer.162-1(a) 1. Trade or Business Requirement These are aimed only at taxpayers. 63 A. ordinary expenses are those that are common and accepted in the taxpayer's particular trade or business. Welch v. The Code allows deductions for all ordinary and necessary expenses paid or incurred in carrying on a trade or business. child care etc. capital v ordinary – question is one of timing: best is to recover cost immediately by deducting it from gross income and not capitalizing it to be part of basis to be recovered later – rule of thumb: if the item has a useful life longer than a year. 69-102. if the owner of corporate stock sells the shares after a dividend has been announced but not paid." Therefore. individuals or corporations. business v personal – lots of grey area here. engaged in a trade or business. with the difference giving the taxpayer his "taxable income. the income is taxable to the assignor.

Commissioner v Idaho Power Co. it is capitalized . Is Employee entitled to a section 162 deduction? IRS said this was not a necessary expense because she did not have to bear the expense but could have been reimbursed B. v. Norwest Corporation and Subsidiaries v. 2) Employee incurred ordinary and necessary expenses on a business trip for which she was entitled to reimbursement upon a filing a voucher. and pollution clean-up (§ 198) (1) but if an expenditure which is ordinarily deductible is used to create a property with a life longer than 1 year. However. creation or enhancement of an asset is capitalized b. the savings and loan began to go under. Commissioner. he partially donated nearly ½ million dollars to help bail it out. However. INDOPCO. When. expenses for re-structuring the corporation are capitalized because they are for the duration of the corporation’s existence. Is the payment deductible under section 162? This is not deductible. like buying stock. partially due to his mismanagement. even if the expenses were deductible if isolated from the project as a whole. local politician who is also an officer –director of a savings and loan association of which he is the founder. Expenditures that produce benefits lasting beyond the taxable year are generally capital expenses and are non-deductible. “Expenses” §§ 162(a).Helvering. deducted her costs on her income tax return. even if the expense does not create a separate asset. Commissioner. for a time longer than the current tax year c.263(a)-2 1. a. he will recapture his basis (2) land and goodwill cannot be depreciated – but now. “deductions are the exception to the norm of capitalization” – scariest statement in the opinion – resulted in rulings allowing deductions for advertising. 1.162-4. purchased goodwill can be amortized and depreciated Problems pg 319 1) Taxpayer is a businessman. Inc. severance pay. a. He showed the payment was necessary to repair his reputation. Expenses made pursuant to remodeling projects are capital expenses that cannot be deducted. it is deductible as a repair – if an expenditure is intended to make the property better or capable of some additional use. it gets basis. and when he sells the business. This is contribution to capital. Employee did not file a voucher and was not reimbursed but instead. 263(a) Reg 1. this particular taxpayer won and was allowed to deduct. the expenditures must be capitalized . building repairs. training costs. ordinary is defined as anything that is not a capital outlay (therefore currently deductible) (1) if capitalized. improvement is capital – if an expenditure for some property is only to maintain in the same useful condition. the payments were actually re-purchase of goodwill (a capital outlay) b. 2. a. repair is ordinary.

the Treasury will not allow the deductions on the ground that the taxpayer is not "carrying on a trade or business. "ordinary and necessary.) § 195. i. to bring to code is a repair (no change to use or capacity) e) Same as ( d). Morton Frank. The Contaminator wouldn’t put asbestos in knowing that he would later have to take it out. Currently deductible d) Contaminator acquired the building unaware that it contained asbestos. Or a repair to stisfy regulations. Section 162 deductions are not allowed for expenses incurred in looking for a first job. Rul. must be capitalized or treated as a nondeductible expense.b. Contaminator constructed the building containing the asbestos. above except the building is at a Section 198(c) “qualified contaminated site. or entering a new trade or business. 2.” Currently deductible c) Several years ago. Now. (1) exception: Hundley case – payment for employment-seeking services is contingent upon employment and does not become due until . the building is not § 198(c) “qualified contaminated site” a) Contaminator acquired the building aware that it contained asbestos. unless otherwise indicated. 262 Reg 1. Although an individual cannot deduct expenses incurred in entering a trade or business. But if the taxpayer elects. except that the removal occurs in conjunction with a remodeling of the building." Rev. Individuals Engaged in a Trade or Business as Employees a. a. This would be given repair treatment. but not previously deducted. start-up expenditures can be amortized (treated as deferred expenses. asbestos removal as part of a rehabilitation is not deductible Problems pg 331 1) Contaminator incurs asbestos removal costs on a business building.195-1(a) 1. a taxpayer may deduct those start-up expenditures that were amortized. If one obtains the building knowing that it has asbestos but not knowing that it would be a problem. Most likely this would be repair to put back in condition it was before and would be capitalized. above.e. 75-120. Consider the extent to which they are currently deductible in the following alternative situations and assume. he may deduct expenses incurred in searching for a new job within a trade or business that he is engaged in. and the expenses must be of the type allowable under § 162. (3) Upon disposition of the business. b. 195. Then it would be a capital expenditure. Depends on when the building was obtained. when we know about the hazards of asbestos or many years ago.. Section 162 does not allow a deduction for expenses incurred in entering a trade or starting a business. Like Norwest. § 162. § 195(b)(2). “Carrying On” Business § 162(a). not deductible C. deductible over a period of at least five years. the taxpayer must actually have started the business. (1) To be eligible for a § 195 deduction. when such knowledge was lacking? If one knows that they have to get rid of asbestos before they but the building this would be reflected in the purchase price. b) Same as (a)." (2) Start-up expenses not amortized under § 195. then it would be considered repair and would be capitalized. (1) But if a substantial period of time elapses between cessation of the taxpayer's previous employment and his efforts to find new employment.

a. except that Agency’s fee was contingent upon its securing employment from Spouse and the payments will not become due until the Spouse has begun working. except that Spouse previously worked as a secretary in Old Town and seeks employment in New Town where student attends law school.Problems pg 339 1) Determine the deductibility under §§ 162 and 195 of expenses incurred in the following situations a) Tycoon. However. this could be deductible under section 162. This is not deductible under section 162 of the IRC b/c a taxpayer must be “carrying on a business”. Tycoon is then advised by her lawyer that her expenses qualify as section 195 “start up ‘ expenses. above except that Tycoon then begins developing industrial properties. deduction for reasonable salaries and compensation for services rendered. -9 1. The doctor is not “carrying on” a business b/c there is no business to “carry on”. Isn’t deductible. The problem here is with the line of work. -8. a doctor. 1st job isn’t in trade or business. Tycoon decided to invest a part of her fortune in the development of her industrial properties and she incurred expenses in making a preliminary investigation. after two years Tycoon’s fortunes turn sour and she sells the business at a loss. above except that Tycoon. desiring to diversify her investments. Taxpayer has a better argument b/c he is “carrying on ‘ a trade or business c) The facts are the same as in (b). What happens to the deferred investigation expenses? Section 195(b)(2) allows taxpayer to deduct remaining basis immediately 2) Law student’s Spouse completed secretarial school just prior to student entering law school. It is deductible b/c looking for a job in the same profession. Consider whether Spouse’s employment agency fees are deductible in the following circumstances a) Agency is unsuccessful in finding Spouse a job. first job. § 162(a)(1). Yes. b) Agency is successful in finding spouse a job. avoidance of double tax to corporation is accomplished by paying out profits in the form of a deductible expense (like interest on a loan from the shareholder or pay out the profits as salaries) – this only works for closely held corporation (1) Tax Court applies 7 factors to determine reasonableness of the salary paid to CEO Exacto Spring Corporation v Commissioner a) type and extent of services rendered b) scarcity of qualified employees c) qualifications and prior earning capacity of the employee d) contributions of the employee to the business venture . above. b) The facts are the same as in (a) above except that Tycoon. Specific Business Deductions A. Section 195 can be considered “pre-opening expenses”. Could argue that it is still a clerical type of job employment is secured (2) politicians and judges cannot deduct expenses incurred in re-election process III. unexpectedly inherited a sizable amount of money from an eccentric millionaire. This is too different and the taxpayer is stuck with section 195 d) The facts are the same as in (a) . rather than having been a doctor. 280G Reg 1. was a successful developer of residential and shopping center properties. above except that Agency is successful in finding Spouse a job in New Town as a bank teller. incurs expenses in investigating the possibility of purchasing a professional sports team.162-7. Deductible under Hundley decision d) Same as 9(a) and (b). e) Same as (d). § 195 does not apply to job search c) Same as (b) above. Not deductible. cannot “go back” and take § 162 deductions e) The facts are the same as in (d) above. Since Tycoon has commenced developing properties may she forego a section 195 election and deduct her prior expenses under section 162? No option of taking the deduction. The investment is too different than the doctor’s actual practice of medicine. The cost however are deductible under section 195. Reasonable Salaries § 162(a)(1) see §§ 162(m).

and the salary is approved by these independent investors. (a) IRS had considered home to mean tax home (principal place of employment) but this was used to prevent deduction for commuting expenses (b) used the Flowers test to determine if an expense is deductible: 1. Commissioner. (1) percentage agreements are not unreasonable even if excessive. then the salary is an arm’s length deal and not unreasonable (3) Beck feels the 7 factor test is still valid where there is total self-dealing (no independent investors to test) b. Harolds Club v. Commissioner. The Code specifically provides a deduction for travel expenses (50 % of meals & all lodging) incurred while away from home in pursuit of a business or trade. convention or meeting held outside North America is deductible if it is . Travel “Away from Home” §§ 162(a)(2). §162(a)(2). in pursuit of business b. U. and is not dispositive) (1) A itinerant taxpayer with no permanent home may not deduct travel expenses. d. 274(n)(1) see § 274(c). (1) time spent and money earned determine which is the primary home c. Rosenspan v. domestic travel: airfare is fully deductible. An individual can have only one "home" for tax purposes. a.S.e) net earnings of the employer f) prevailing compensation paid to employees with comparable jobs g) peculiar characteristics of the employer’s business (2) opinion by Posner of law & economics: disfavored the 7 factor test and used the independent investor test – if investor was getting a good return (more than 13 percent) as a result of the CEO’s efforts. airfare. § 162(a). Andrews v. (but this is not in the statute. These deductions are allowed in order to offset duplicated living expenses. expense must be reasonable and necessary 2. A taxpayer is not treated as being "away from home" if the period of employment lasts over one year. nature of trip is determined by number of business days e.162-2 1. (h) & (m)(1) & (2) Reg 1. The reasonableness of an employment contract is usually challenged only in the context of closely-held corporations or family owned businesses. incurred while away from home (plain & ordinary meaning) 3. international travel of more than a week and 25% or more is non-business. if they are fair when made (part of a free bargain between parties of equal bargaining power) (2) Beck questions whether this bargain was fair “when paid” B. meals and lodging are prorated a. meals and lodging on business days only are 50% deductible § 274n f.

as reasonable to have it outside NA as it would be to have it in NA .

and returned to New York on the succeeding Friday night? See Reg. May Commuter deduct all or any of his costs of transportation and meals? Can deduct travel but not meals. if you go to convention held outside NA area you get no ded unless it is as reasonable for it to be held outside NA as inside NA. Monday. b) May Traveler deduct any of her spouse’s expenses if he joins her in the trip? § 274 (m)(3) No c) What results in (a). above. then not reasonable. Taxpayer works in Metro. try cases. Are temporary’s expenses in Branch City deductible? This is deductible b/c it is less than 1 year (Remember the one year rule) and duplication of expenses b) What result in (a). Not deductible. 6 bus days out of 9 which means 33% of time is non-business 2/3 of trips is buss therefore 2/3 of transp deductible g) What result in (e). meals. 3 business days and 2 personal days. above. above. and travels to City each weekend to visit her husband and family. a) Employer has trouble in Branch City office in another state. and Tuesday. Transp is deductible. Here. etc. She can deduct the rent for the apartment. above. He eats lunch in other City and returns home in the late afternoon or early evening. Falls within the crack of the rule. b) Same as (a). d) What results in (a) above. NA areas defined in § 274(h)(3)(A) Mexico in NA. a) transportation. because she maintains it solely for business c) Taxpayer and Husband own home in City and Husband works there. What may she deduct? Reason for seeing husband is personal. 4) Temporary works for Employer in City where Temporary and his family live. if Traveler went to Mexico City on Thursday and conducted business on Thursday. so limitation doesn’t apply . Temporary’s family stays in City and he rents an apartment in Branch City. and lodging deductible? Reg 1. may Burly deduct any of his City living expenses which he incurs during the football season? The IRS theory is that City is Burly’s tax home b/c this is where he works. if during the 7-month ‘off season” Burly worked as an insurance salesman in Metro? Andrews case and he should be able to deduct in one of the two places in which he works. what might she deduct? See section 274 (n) (1). if traveler takes a cruise ship leaving Florida on Wednesday night and arriving in New York on Friday? See § 274(m)(1) deduction is limited e) What result in (a). Commuter’s fares are not considered as business expenses and are not deductible b) Same as (a). if Traveler’s trip is to Mexico City rather than Florida? § 274(c) Prorate transp expense f) What result in (e) above. above but Commuter is an attorney and must often travel between office and City Court House to file papers. if the time period is expected to be nine months. if Temporary and his family had lived in a furnished apartment in City and he and his family gave the apartment up and moved to Branch City where they lived in a furnished apartment for nine months? Yes this is deductible b/c it is away from home 5) Traveler flies from her personal and tax home in New York to a business meeting in Florida on Monday . 3) Burly is a professional football player for the City Stompers. a) If Burly’s only source of income is his salary from the Stompers.Problems pg 374 1) Commuter owns a home in Suburb of City and drives to work in City. above. Meals you have to be away overnight and then only deduct 50% c) Commuter resides and works in City. The meeting ends late Wednesday and she flies home on Friday afternoon after two days in the sunshine. a) If her employer send her to Metro on business for two days and one night each week and if Taxpayer is not reimbursed for her expenses. Taxpayer is allowed to deduct all her costs. There is no business reason for seeing him.2( e) No. above. but after eight months it is extended to fifteen months? See Rev Rule 93-86 Should be able to deduct for 1 year but for the remainder he can’t c) What results in (a). May he deduct all or a part of his costs? He can only deduct travel because he didn’t stay overnight.162. a) May Commuter deduct his costs of transportation and/or meals ? Reg 1. but occasionally must fly to Other City on Business for his employer. 50% of meals on MTW and all of MTW lodging. if Traveler’s trip to Mexico City is to attend a business convention? See § 274(h) no deduction. He and his wife own a home in Metro where they reside during the 7-month “off season”. 50% of the cost of meals. except that she works three days and spends two nights each week in Metro and maintains an apartment there. 1. Friday. maintaining an apartment there. As far as his Metro home he can’t deduct either b/c that home is unrelated to work b) Would there be a difference in result in (a).274-4 (d) (2) (v)If trip is > a week and 25% or more of time is personal then prorate transp according to which days are business and personal.162-2(a) and (b) Domestic travel for business purpose. She asks Temporary to supervise the Branch City Office for nine months. primary purpose still business. it is an unreimbursed employee business expense and can only deduct if 2% of AGI § 67 2) Taxpayer lives with her husband and children in City and works there. He eats lunch in various restaurants in City. If he takes deduction. above. if Traveler stays in Florida until Sunday afternoon? Ignore weekends. If you have conference of dentists in Paris and all NY Dentists.

162-11(a) 1.162-5(a)(2). 3(i). Fitzpatrick. 262. a. Treas. Commissioner. Expenses for Education §§162(a). Regs.advantage to the taxpayer was that a lease is deductible. § 162(a) (3). (d). all payments are income. not deductible if education is: (1) intended to qualify you for a new trade or profession (law or medicine) (2) the minimum required for the job you already have (3) travel for education . in a sale. § 1. (c). (b)(1).1625(a). (1) Beck thinks this is best left to Congress to decide – husband was trying to income split but nothing in the transaction was illegal – although the transactions were not valued in an arm’s length manner at fair market value (2) transfers and leasebacks are done by doctors for medical buildings D. A taxpayer may not seek business deductions for necessary rental payments if the rental or lease agreement is. gets depreciation. (1) very unlikely that the lessor will reclaim the property at the end of the lease (2) the total lease payments total the purchase price • buyer/lessee . consider airlines which do not own planes because they don’t need the depreciation – the banks get the depreciation b. in a sale. a sale. (e)(i) 1. in substance. Education expenses incurred to fulfill the requirements of a taxpayer's employment or profession are deductible as necessary and ordinary business expenses. deductible if education is intended to improve or enhance skills in present business or trade (continuing education or further specialization) b.C. Intra-family gift and leaseback arrangements that create the need for a business to make rental payments will be scrutinized to determine whether the transaction has no business purpose or whether the taxpayer retained substantial control over the property. Starr's Estate v. 274(m)(2) Reg 1. Hill v. a. (2)(i). White v. only the depreciation and interest are deductible • sellor/lessor: in a lease. gets basis and interest income – the tax benefits of the depreciation can be substantial. in which case there will be no deduction allowed. Commissioner. Necessary Rental and Similar Payments § 162(a)(3) Reg 1. The Code allows a deduction for rentals or other payments required to be made as a condition to the continued use or possession of business property to which the taxpayer has not taken title or in which he has no equity.

1.162-20(a)(2).M course in taxation. (n) Reg 1. (b) "Associated with" requires the business be conducted immediately preceding or following the entertainment. who travels to Gainesville. (d) 1. is incurring deductible expenses of education? Alice: She is qualifying for a different profession. dentist. Cathy and Denise. who was called upon to give medical testimony in malpractice suits. after some time in practice as an orthopedic surgeon. accountant (CPA) and lawyer. If she was taking a course for doctors in malpractice law which carried no law school credit but involves going as non-matriculated student in a law school. (c). Which. 3) Carl earned a bachelor’s degree in education and he teaches world history in a junior high school. Miscellaneous Business Deductions A. intending to restrict her dental practice to that specialty in the future. What do you advise? see § 274(m)(2): “No deduction shall be allowed under this chapter for travel as a form of education. Denise: This is deductible as specialization in field 2) Assume Denise’s expenses in problem 1. Now travel is not deductible for education. Although business meals and entertainment expenses may be deducted as ordinary and necessary expenses. Cathy enrolled part time in law school (with eventual prospects of attaining a degree) so as to better perform her accounting duties in areas in which law and accounting tend to overlap.162-5(a)(1). what expenses. Barbara: Orthodontics study is specialization within her field and would be deductible Cathy: This isn’t deductible because she already has fulfilled the requirements in her field. § 274(a)(1)(A). § 1. Commissioner. Are Dentists travel. Regs. He wished to know if he may deduct his expenses. (l).2742(a)(1). if any. All of the seminar proceedings are taped and Dentist skies on clear days and watches all of the tapes on snowy days or in another off-the slopes times prior to his return home. (e). the Code imposes some limitations and requires substantiation with respect to such expenses. Washington. Business Meals and Entertainment a. 274(a). (a) "Directly related to" means that business must go on during the entertainment or meal with a client. And Denise took a leave of absence from her firm to enroll in an LL. Florida for a year to participate in their LL. Alice. (k). (1) The expenses must be either "directly related to" or "associated with" the taxpayer's trade or business. Barbara enrolled in a course of post-graduate study in orthodontics. Coughlin v. In the current year he contemplates a summer European tour doing things that will be helpful to his teaching efforts. Barbara. meals and lodging deductible? Very suspicious. it shouldn’t. may she deduct? Does it make a difference that there is program closer to home? No. IV. above are deductible. Problems pg 393 1) Alice. decided to go on to law school so as to better understand this aspect of her medical practice. intending to practice exclusively in the tax area.M program. respectively. . Treas. (2) Only 50% of the meal and entertainment expenses can be deducted. If she is a practitioner is Seattle. this is not deductible. (d). in addition to tuition and books. § 274(n)(1). doctor. Introduction §§ 162(a). 4) Dentist attends a five day dental seminar at a ski resort.2.” Before could write whole thing off as education. In the current year. it would be continuing education so would be deductible. A taxpayer may deduct education expenses incurred in maintaining or improving his professional skills.

6. Lobbying Expenses: As a general matter. § 274(k)(1)(B). § 274(l)(1)(A). advertising expenses are deductible in the year they are incurred or paid.2. 3. b. § 274(k)(1)(A). The cost of entertainment facilities is expressly non-deductible. expenses incurred in petitioning government or any similar activity are nondeductible. 5. § 1. Reg. Political contributions are non-deductible . even though the country club dues are non-deductible. § 1. 4. Advertising: Unless they are used to acquire a capital asset.162-20(c)(3). (3) The taxpayer claiming the deduction must be present.262-1(b)(8). (2) But costs related to the use of such facilities are deductible if they meet the requirements of § 162 and the limitations of § 274. Dues: Dues paid to organizations that directly relate to a business are deductible. (b) The meals cannot be lavish or extravagant. Treas. i. (c) 50% limit applies to face value of any ticket to entertainment event. meals eaten on a business trip are subject to the 50% limitation. § 274(a)(1)(B). and social and athletic clubs among others. (1) Entertainment facilities include sky boxes. Regs. Uniforms: The cost of acquiring and maintaining a uniform required for taxpayer's employment is deductible if the uniform is one that is not suited for general use. (4) Expense must be substantiated by receipt. 50% of the cost of a reasonable business meal eaten at the taxpayer's country club may be deducted. (a) For example. § 162(e)(1). (a) The 50% limitation applies to any deductible meal.

§§ 167. he must report the reimbursement as income. basis of the destroyed building (and the non-deductible demolition costs capitalized) is added to the land V. Deductible subject to § 67 2% floor b) $30 for dry cleaning the uniform. Introduction 1. above. A taxpayer may not deduct losses sustained on account of the demolition of a structure which the taxpayer owns. but Businessperson buys them from hotel concierge fro $100 each? 50% of face value of ticket is deductible 3) Airline pilot incurs the following expenses in the current year. (minus any insurance recovery) a. Treas. and obsolescence of property used in a business or trade.. Employee incurs a $15 cab fare to transport the clients to lunch? The real question is that if this is so close to the lunch that Employee gets 50% of the cab fare. 168. wear and tear. rental property. But could be argued. Depreciation §§ 167.. or be held for the production of income. i. They each have two martinis before lunch. § 280B. The $100 cost includes $5 in tax and $15 for a tip. (2) deduction can be claimed with respect to property that will be . 2) Businessperson who is in New York on business meets with two clients and afterward takes them to the Broadway production of the Producers. deductible c) $100 in newspaper ads to acquire a new job as a property manager in his spare time. b. is limited to the difference between the value before and the value after the accident. To what extent is the $300 cost of their tickets deductible if the marketed price on the tickets is $50 each. § 1. Business Losses §§ 165(c)(1). Regs. up to basis (and basis is reduced by that difference) 2.e.C § 165. i.e. Bar dues are also deductible e) $50 in political contributions to his local legislator who he hopes will push legislation beneficial to airline pilots. a) To what extent are Employee’s expenses deductible? deductible to 50%. employee is deducting this. I.R. 168 A. Loss due to an accident or destruction. Not deductible f) $500 in fees to a local gym to keep in physical shape for flyingNot deductible. e) What results in (a). a) $250 for the cost of a new uniform. To be deductible. Not deductible b/c this is a job search for new line of business d) $200 in union dues This is deductible. Teacher says it is more likely to be 100% deductible. above. A deduction is allowed up to the basis for losses relating to property incurred in a trade or business. a sale. a. a. the loss must be connected with some realizing event.Problems pg 396 1) Employee spends $100 taking 3 business clients to lunch at a local restaurant to discuss a particular business matter.165-1(b). allowing deductions for the exhaustion. that means he is not getting reimbursed by employer b) To what extent are the meals deductible if the lunch is merely to touch base with the clients? Not deductible at all c) What results if Employee merely sends the three clients to lunch w/o going herself but picks up their $75 tab? Not deductible-The employee would have to be there d) What results in (a). if the Employer reimburses Employee for the $100 tab? If employee deducts and gets reimbursed. if in addition. Prerequisites for Deduction (1) The property must be used in a business or trade. The Code treats depreciation as an operating expense. 280B 1. Total § 162 deductions: $480 B.

So the taxpayer is allowed only a half-year deduction in year one. a. § 168(k) Additional Depreciation: extra 30% depreciation on most types of new personal property acquired between 9/10/2001 and 9/11/2004 – basis is . Regs. § 168(b)(4). Special Depreciation Rules on Personal Property §§ 168(k). c. (a) Unimproved real property (land) is non-depreciable.167(a)(2). a taxpayer was required to identify the useful life of depreciable property. 179. 3. A taxpayer's basis in depreciable property is annually reduced in an amount equal to the allowable deduction. The Relationship of Depreciation to Basis a. the taxpayer is allowed an annual deduction of 10% of the basis. (depreciation = basis x amount given in IRS) (c) Half-year convention: built-in deduction for first year no matter when property is purchased. Sharp v. (2) Taxpayers are prevented from taking advantage of the rule by purchasing equipment near the end of the year. then take deductions over the length of that useful life. § 1. Depreciation Methods (1) The "straight-line" method allows equal deductions to be taken over the useful life of the property. Depreciation deductions may be claimed on property that is subject to business and personal use. all other tax attributes must be allocated between personal and business use. 197 1. Planes and heavy equipment is 9 yrs and 27 ½ yrs for residential buildings and 39 yrs for commercial property (buildings). after which the value of the machinery is zero. § 168(d)(3) (A). b. United States. (1) For depreciation purposes. (b) Useful life is generally 5 yrs and recapture is quicker than before. whether the taxpayer chooses to claim the deduction or not.consumed or wear out. Treas. think of home office: if you depreciate the home office and sell your home at a loss you might actually have a gain on the business part (if it has been depreciated to zero) B. (a) The Accelerated Cost Recovery System (ACRS) in place today virtually eliminates this concept and simplifies the process. 280F(a) & (b). if the taxpayer has a basis of $1000 in machinery with a useful life of 10 years. but only to the extent the property is used for business purposes. property is treated as having been placed in service during the midpoint of the year. Useful Life Concept (1) Under the prior depreciation system. (a) For example. (2) Under the "declining balance" method a uniform rate of deduction is applied to the unrecovered basis in the property. 2. § 1016(a)(2).

allocation for depreciation calculation is based on amount of time used for business and amount of time used for personal use .100 year 3 – 2.000 (1) eg: 224. straight line 7.450 year 3 – 1. a.000 and next year 25. leaving 70. and 47. telecommunications equipment.000 subject to 168 additional depreciation.repealed in 1986 – better than depreciation or deduction – they were a dollar for dollar tax reduction for the amount of the credit (reduces tax not the income which is taxed) C. if equipment costs less than 24.000 of property put into service this year = no bonus deduction. 47 1. if amount of business use decreases. 2. a.800.000 remaining – and then take 5-year table depreciation – more than half the cost of the equipment has been deducted in the first year (economic stimulation) d. § 280F(a): Limitations on Luxury Cars (costs more than $12.000 in depreciation and have basis of 46. the entire amount can be deducted as depreciation (and 0 basis remaining) 4. Special Rules on Realty §§ 168. use § 186g b. depreciation for past years in excess of the slower depreciation is re-captured as income 6. § 179 Bonus Depreciation: Taxpayers are allowed an additional deduction on some types of property that qualify for ACRS treatment in the year the property is acquired. applies to leased cars too) a. cannot exceed taxable income from the business during the year c. 46. Real property that is eligible for depreciation deductions is divided into two types: residential rental property and non-residential rental property.000 property put into service – take 30% off.000 bonus deduction b. dollar limits: this year 24.if used for less than 50% business. Under the ACRS both types of properties are subject only to the straight line depreciation method and both have lengthy recovery periods. § 280F(b): Limitations on listed property (property used for entertainment or recreation. boats etc.adjusted down before application of remaining depreciation calculations 2. year 1 – 2. both 168k & 179 can be applied and then the regular depreciation under § 168 eg: $100. 46.000 of property put into service this year = 14.000. . can’t use favorable 5 year accelerated table to depreciate. 42. used for fun and business a. $210. § 168.475 (and for subsequent years until recovery complete) 5. § 197 Amortization of goodwill: depreciable if purchased over 15 years. Congress has provided special incentives for investments in older property and low-income housing. investment tax credits . §§ 42.560 + an additional 4600 under 168k year 2 – 4. to get 54.000 with dollar for dollar reduction for any amount over $200. and computer not used exclusively for business) business airplanes.

Keeping the records of his investments were not sufficient to be a trade or business 2. Lumpkin. however. The requirement is satisfied when the expenses are adequate. Congress passed § 212 due to ruling in Higgins v. like investments. Thus. b. Limitations & Restrictions Deductions under § 212 are subject to same limitations and restrictions as deductions under § 162. The ordinary and necessary requirement is not a strict. may be deducted as non-business expenses. allows deduction for proxy fights expenses. Revenue Ruling 64-236. acquisition costs and costs to perfect title are part of the capital expense 2. (below the line deduction and subject to § 67 2% floor) A. b. (k). applied §162 language of ordinary and necessary (appropriate and helpful) 3. expenses incurred in litigating that claim are personal and not deductible.a. Such a showing is required by the Internal Revenue Service and in other circuits. (compare to Indopco) C. Surasky v. such as alimony. A showing of a proximate relationship between the non-business expense and the income is not necessary in the Fifth Circuit.212-1(g). 1.S. Meyer J. (1) For example. U. his expenses might have been deductible. if the claim would not exist but for the personal relationship. B. a. Expenses for production of income §§ 212. a. (l). (m). 1. legal expenses incurred defending a claim that arises out of one's personal life. 1. are not deductible. Fleischman. Bowers v. are not deductible under § 162's provision for deduction of expenses incurred in carrying on a business. Courts apply a but/for origin of claim test to determine if a claim arises out of one's personal life or out of business or income-producing activities. Legal expenses incurred in collecting income. Litigation expenses incurred in defending or protecting income-producing property are not deductible because they are not ordinary and necessary. however. 274(h)(7) Reg 1. Had he participated in the management of the corporation in which he was invested. because the claim arises out of . however. a. or in managing. technical one. 20% tax credit for rehabilitation of a certified historic structure or 10% on any building built before 1936 Chap 15: Deductions For Profit-Making. even if it may have some effect on income-producing property. helpful and necessary in light of real life circumstances. conserving or maintaining income-producing property are deductible under § 212. § 212 or § 162 § 212 was enacted because expenses incurred in managing personal business. Commissioner. Nonbusiness Activites I. Personal expenses are not deductible § 262 1.262-1(b)(7) Ordinary and necessary non-business expenses incurred in collecting or producing income.

000 deductible? Under Surasky: could be conservation of property – if you have a large investment in stock and use a reasonable amount to determine what is going on with the business. § 212(2): deduction for maintenance and depreciation if converted to investment property – had to be held for production of income – even though never rented. A personal residence may be converted to a transaction entered into for profit by showing more than mere abandonment. are Planner’s legal fees deductible under Section 213 (3)? Under Section 212 (2)? See revenue ruling 72-545. Fourteen months later she sells the shares for $4. like abandonment followed immediately by demolition or renting.collecting income. To what extent if any. They decide to make various inter vivos gifts and draft his will. worth $300. In defending against alimony b) Payee Spouse may deduct attorneys’ fees incurred in getting a divorce. 168(a). paying her broker a commission of $50 on the purchase. above. he had tried to rent it b. 1972-2 To the extent the legal counsel relates to tax advice II. Expenses arising out of Transactions entered into for profit §§ 121(a). consider in what situations : a) Payor Spouse may deduct attorneys’ fees incurred in getting a divorce.timing issue and deducting is worth double what reducing capital gains is worth (different tax rate) but rules require capitalizing it purchase has basis of $3050. unless the property constitutes a transaction entered into for profit and is not a personal residence. 165(a). commissions are capital expense – added to basis and subtracted from amount realized – gain is amount realized minus adjusted basis . A loss resulting from sale of property for less than it was purchased is not deductible. (b). William C. if instead Speculator owned 10% of the total outstanding Sound stock. sale has amount realized of $3940. 212 see §§ 195. Is the $10. Horrmann. a) She would like to treat $100 paid as commissions as § 212 expenses. 167(a)(2). In claiming & collecting alimony c) Payee Spouse’s attorneys’ fees incurred in getting a divorce was deductible by Payor if Payor pays them.167(g)-1.000 paying a commission of $60 on the sale. above. to attend a seminar on investments? § 274(h)(7): no deduction for investment seminars f) Speculator owns 10% of Sound’s stock worth $300. a. As part of alimony agreement 3) Planner consults his attorneys with respect to his estate plane. 1. an eager investor during the time she owned the stock. Beck comment: Husband gets no deduction for resisting alimony but wife can get deduction for claiming and trying to collect alimony.000. 1.212-1(h) Expenses incurred in transactions entered into for profit are also deductible. she incurred $500 of transportation. it may be deductible 2) After reading Fleishman case. Why? Can she? See Reg 1. 1. above if she sells the shares for $2500 paying a $45 commission on the sale? See § 165 (c) (2) 2500 – 45 = 2455 2455 – 3050 = (595) loss on sale c) Speculator owned one-tenth of one percent of the Sound Company Stock but. (c)(2). (d) (6).000 in legal fees and personal costs investigating the operation of the business after the business has some serious setbacks. gain of $895 b) What results in (a). meals and lodging expenses in traveling 1000 miles to new York City to attend Sound’s annual shareholder meeting. 280A Reg 1.000? more reasonable in relation to size of investment e) What result to Speculator is she incurred the expenses in (c). May she deduct her cost under section 212 (2)? might be allowed under § 212 but cost is not reasonable in proportion to the size of her investment d) What result in (c). § 165(c)(2): loss deduction for property used in trade or business or from a transaction entered into for profit – (c)(3) loss on residential property is .263 (a) –2(e). Problems pg 465 1) Speculator buys 100 shares of sound company stock for $3.165-9(b).000 and she incurs $10.

The key question in determining whether a personal residence has been converted into a transaction entered into for profit is to look at whether. the taxpayer had an expectation of profit.S. in light of all the circumstances. Lowry v. a. U. It is not necessary to show the property was offered for rent before being sold in order to show a personal residence was converted into a transaction entered into for profit. (1) didn’t want a tenant spoiling the property and didn’t want the hassle of applying to the tenant’s association for the right to rent – believed the property value would appreciate (2) can hold property for speculative income purposes (not only current income) as stated in the Regs .not deductible unless loss is from a casualty loss – if taxpayer had actually rented or sold. he would have gotten the deduction but merely listing the property for sale or rent is not sufficient (there was no transaction) c. 165-9(b)(2) – basis for a loss on a property converted from personal use is the lesser of the fair market value at the time of conversion or the adjusted basis at the time of conversion – prevents shifting of personal loss to business 2.

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there is no gain and no loss – sold for an amount over the adjusted basis. What result when they subsequently sell the property for: 1) $145. When it was worth $160.165-9(b)(2) there are 2 choices for basis for property converted from personal use: the lesser of fair market value at the time of conversion or the adjusted basis at the time of conversion (similar to loss rules for gifts) . It is also not necessary for the payment to be called interest. for $170. or have no interest at all. above. All loans that have an interest rate that is below market.000? only use 165-9 if there is a loss – using adjusted basis there is a gain of 5 3) $165. no deduction c) What result in (b) (2). To be deductible.00 ($20. 1.problems pg 475 2) Homeowner purchased their vacation residence for $180. Revenue Ruling 69-188. a. it is a nothing and there is no tax. Under the old rule. Thus.000? conundrum – using 165-9 there is a loss using adjusted basis but a gain using fair market value (same as with gifts) – if you sell the property for an amount between the 2 possible bases. Interest § 163 Interest paid or accrued on indebtedness is deductible under § 163. sold for an amount less than fair market value (minus depreciation) there is a loss.000 ($20. . which covers the tax consequences of interest-free and below-market loans.000 which was allocable to the land). This rule was changed when Congress enacted § 7872. c. J. sold for an amount in between. may be deducted as an interest payment. the interest would have been deductible. b.(180 – 10 = 170) or fair market value at conversion (160 – 10 = 150) amount realized is 145 – 150 is basis and loss is 5 2) $175. so long as the payment represents payment of a set amount for the use of borrowed money and not other services.000 of which was allocable to the land). Simpson Dean. they moved out and put it up for sale but not rent. payment made from one's own money to buy down interest rate points. And the deprecation was taken after 1997? 5 of gain which is due to prior depreciation is not protected by § 121 – since 5 of gain is produced due to the 10 of depreciation – they will be taxed on the 5 of gain Chap 16: Deductions Not Limited To Business or Profit-Seeking Activities I. payment of interest must be incidental to an unconditional and legally enforceable obligation. are re-characterized such that the payment of interest is imputed. However. if the property had been Homeowner’s principal residence.000? under Reg 1. even if called a loan-processing fee. there is a gain. Revenue Ruling 69-188.000of depreciation on it. an interest-free loan resulted in no taxable income to the borrower because had the borrower taken out an interest-bearing loan. or the compensation for the use or forbearance of money. 1. you always ask for more than you want) b) Assume instead that they rented the property and properly took $10. a. what types of expenses would qualify? Lowry: holding property for speculative gain and so entitle to deduct the cost of maintaining it – but this seller doesn’t look like he is holding it out for gain but that he is simply selling his house (amount he is asking is so close to market – when you sell your house. Interest is the amount one has contracted to pay for the use of borrowed money.000 a) May they take deprecations for expenses and depreciation on the residence? If so. they had owned it and used it for 4 of the prior 5 years. the obligation need not exist before interest is paid.

Investment interest § 163(d) 1. Taxpayers have paid off $200. Taxpayers take out 2nd mortgage for $100. Residence is worth $500. This includes interest payable on loans used to purchase a qualified residence. D. a.000 in equity in the home after the new debt (c) same as (b) but they use the loan money to buy a Ferrari home equity loan – interest is deductible and can spend it on whatever they want (d) same as in (a).000 secured by residence to add a 4th bedroom and den there is $200.000 of equity in the home as result of increased FMV – 2 nd loan interest is deductible as home equity loan but could be acquisition debt also because it is being used to build a part of their home – they have an additional 100. $50. 1. corporate loans to shareholders.b. Interest payments on loans used to purchase tax-exempt property. However. Personal Interest § 163(h) § 163(h) disallows the interest deduction for personal interest. but Taxpayers by 2000 have reduced balance to $200. In 2000.000. for the deduction to be disallowed.000 on residence.000 used to pay off the 1998 loan and then to pay off personal debts. C. a. more than mere simultaneous purchase of the tax-exempt property and obtaining the loan must be shown. Qualified Educational Loan § 221 1. and giftloans – imputes interest as income to the lender and deductible to the borrower (1) exception: an interest-free gift-loan under $100. Taxpayers get mortgage of $250. . loan can be used for any purpose – Beck doesn’t think this is fair d. old mortgage debts over the limits (pre 1987) are grandfathered in and all the interest is deductible B. but only to the extent the taxpayer has net investment income (more income than expenses related to the Problems pg 505 3) Taxpayers purchase home in 1998 as principal residence. borrowed 200 – 50 is acquisition indebtedness (deductible) – 100 is home equity (deductible) but interest on the remaining 50 is non-deductible investment). They obtain a loan secured by the residence.000 is exempt unless it is invested and earns income (to prevent income shifting) A. What portion of the interest paid is deductible? (a) Purchase price and FMV is $350. home equity – equity in the home (but can be used to buy or build also). § 265(a)(2). such as municipal bonds or certain life insurance policies or annuities. Interest payable on qualified educational loans may also be deductible under § 221.000.000 and FMV of resident has increased to $400.000 of the $250. limits on deductibility – acquisition limit: interest on loan of $1. Interest on qualified residences is usually deductible. employer loans to employees.000 b. refinancing and home equity loans.000 1998 mortgage. Loans to purchase tax-exempt property § 265(a)(2) 1.000 – home equity limit: interest on loan of $100.000.000. Taxpayers borrow $200. may not be deducted. all of the interest is deductible – acquisition indebtedness less than $1 million (b) same as (a).000. Investment interest may also be deducted. acquisition – to buy or to build c.

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Taxpayers have reduced principal to $175.000 is taxable (f) same as (a). plus $100. acquisition cost – borrow 950 – already have 250 outstanding.000 in deductible adviser fees interest is deductible to the extent of gain – net investment income gain can count if the taxpayer elects to treat it as income – 60 dividends – 20 fees – 10 deducted 70 net income so 70 of the interest is deductible against her income and 30 of the interest is not deductible b) the interest is on loans used to purchase tax exempt bonds not deductible –§ 265(a)(2) c) same as above but ½ is used to purchase stocks and bonds and ½ is used to purchase tax exempt bonds only ½ of the income would offset the expense so only 50 of the interest is deductible III.000 to buy a sailboat.000. it is a tax-free return of capital d) federal income tax not deductible e) state gasoline tax not deductible (not a general sales tax because its item-specific)(excise) 2) Which is deductible? a) state tax on cigarettes provided by the taxpayer to customers if an item of tax is both a tax and a business expense. one must look to state statutory law to see who is responsible for the taxes (in this case. 3. Instead. the payment is said to be a gift to the property owner. (d)(1).000 gain.000 in dividends and $10. the property taxes are allocated between the buyer and seller in proportion to the amount of time each owned the property. regardless of who paid the property taxes. A.(e) same as (a). 1.000 toward home purchase and $50.000. so have $1.000 of home equity indebtedness. 1001(b)(2) Reg 1. They use $175.000 in loans and are over the limit – only the interest on $1 million is deductible.000. foreign and real property taxes are deductible. Taxpayers purchase 2 nd home in FL for $1. 2. the character as business expense makes it deductible . Cramer v. 100 is home equity – so interest on 25 is nondeductible 5) Investor incurs investment interest of $100.000 to pay off 1985 loan and remaining $125. Property taxes Property taxes may only be deducted by the person to whom they are assessed. local. borrow 300 – 175 is acquisition (replacing old loan). they may not take the deduction. § 275 Sales taxes are not deductible. Taxes §§ 164(a). interest on $100.000 secured with the home.250. (c).164-3(a)-(d) State. has $20.000. What is deductible? a) sells stock at $60.000) with a loan for $300. If someone other than the person upon whom the taxes were assessed pays them. (b). They finance $950. who was the owner of record or the occupant). use it 45 days a year and elect to treat it as a qualified residence.000 to pay off education loans. By 1998. Taxpayers used $200.200. Commissioner. 275. § 164 (see also § 111) Federal income taxes are not deductible. but in 1998. Per diem as to who Problems pg 509 1) Which of the following taxes would be deductible as such under § 164? a) state sales tax not deductible b) state real property tax of $1000 for which A becomes liable on Jan 1st but sells land on July 1st A can deduct $500 – B can deduct $500 c) state income tax yes – state income tax is deductible – if you overpaid and get a refund. but year of acquisition was 1985. They re-finance the property (now worth $500. it is income § 111 if you got a tax benefit from it – if you take standard deduction and got no tax benefit in the year of payment. To determine whom the property taxes are assessed upon. If the property is sold in the middle of a year.

Activities not engaged in for profit § 183(a)-(d) Whether an activity is engaged in for profit is determined by § 183. those losses attributable to a different activity than the one from which income is derived. under Cramer. A. If activity is engaged in for profit. or use something. if he has sufficient income 4) Employer withholds FICA and pays FICA match. If no presumption arises. restrictions & limitations have been placed on deductions to eliminate tax shelters. Introduction The fact that Congress has provided for a deduction does not necessarily mean the deduction will be allowed. Procedural restrictions are rules that promoters of tax shelters must follow or be penalized for failing to comply. a. The Commissioner may rebut. § 183 creates a rebuttable presumption that an activity that has produced gross income in three of the past five years which exceeds the amount of deductions attributable to that activity is one engaged in for profit (the safe harbor test). II. he doesn’t owe it. it is not a tax – this is not a tax but it may be a business expense – under 162. taxpayer may qualify by using objective standards taking into account all the facts and circumstances. a. tax shelter is a way of hiding income from one source using losses attributable to another. 1. b. Substantive restrictions can be either takeaway provisions or postponing provisions. taxpayer had the objective of making profit b. activity carried on in a businesslike manner or in a manner similar to others of the same nature which are profitable 3. Presumption of profit motive 1. Father pays Son’s intangibles tax.owns the property. b) filing fee required to be paid by candidates entering state primary no – tax is defined as a compulsory contribution (General exaction) to a govt for govt purposes in which the taxpayer has no rights – if you buy the right to go somewhere. §§ 162 & § 212 deductions re allowed . it may be sufficient that there was a small chance of making a large profit c. these require the promoter to register the scheme and keep a list of all participants. candidates filing expenses are not deductible 3) Son in college owns substantial securities. There are two types of restrictions: substantive and procedural. Are payments deductible? not deductible – 164c1 – no deduction for tax assessed against local benefit – he can add them to basis – the property has been improved Chap 17: Restrictions on Deductions I. The goal of both is to disallow deductions for artificial losses. (2 years out of 7 for horse breeders) 2. 2. Generally. a) May Father deduct? Not deductible § 164. a) deductible? she can deduct the withheld tax and the FICA as a business expense but it is not a tax to her and they are not deductible to the employee because it’s a federal tax which cannot be deducted 5) city builds road and assesses adjacent landowners. so it is not deductible to him – 164a2 b) Is it deductible by Son? Yes.

c. B. 1. no deductions are allowed. apply § 183(b). If hobby makes money. (b). 2. deductions are limited to gross income from activity.without limitation. 2. Interest and tax on the garage where you store the antique cars you collect III. (3). deductions are allowed only insofar as the deductions that are attributable to the rental activity exceed the deductions allowable on the residence in general. the restrictions of § 183(b) apply and deductions will only be allowed to the extent that gross income from the rental exceeds the deductions. Deductions if not for profit (Hobby) § 183(b) If the activity is one not engaged in for profit. (quarantine – deductions cannot spread to other income) a. investment or personal deductions. If less than that. allowable interest and taxes must be allocated to the hobby – eg. If the rental is not engaged in for profit. a. but only to the extent the rental income exceeds allocable interest and taxes. B. (g) A. it is a rental unit. (f). This limitation does not apply to business. then § 183(b) allows deductions only to the extent the gross income from the activity exceeds the claimed deductions. If the residence is rented less than fifteen days during the year. a. irrespective or its being rented. A residence is a dwelling unit that the taxpayer uses for personal purposes more than the greater of fourteen days or ten percent of the days for which it is rented. Restrictions on Deductions of Homes § 280A(a). If the residence is rented more than fourteen days. you have income. Rental of Home Generally. (c)(1). § 183 allows expenses attributable to renting a home if the rental is an activity engaged in for profit. (d) (1). Limits under § 280A If the rental is the taxpayer's residence. deductions can only be taken to the extent of net income gross rental income less interest and taxes otherwise deductible on a per diem basis for rental period this gives you the 280A limit on deductible rental income expenses minus out of pocket expenses for the business use allocated to rental period . then § 280A limits the availability of deductions depending on the number of days the residence is rented. A taxpayer's personal use may be disregarded for purposes of determining whether property constitutes a residence if the period of personal use precedes or follows a qualified rental period. income from the property is not required to be included in the taxpayer's gross income. A qualified rental period means rental of the property for twelve consecutive months. However. 3. (Hobby loss) 1. & (5). such as taxes. b. The remaining deductions may be taken. (e). If you have deductions.

60/365 of $3600 600 § 280A(c)(5) limit on deductions 4. Deductions are limited. clients or customers. An employee may also deduct home office expenses if the home office exists solely for the convenience of the employer. to the amount gross income from the home office exceeds deductions allowed for the home in general. however. Home Office § 280A(c) Expenses attributable to a home office are deductible under § 280(a) so long as a portion (based on space) of the home is used exclusively and on a regular basis as the principal place of business. Taxpayer’s deductions are limited by gross rental income as follows: Gross rental 5. and all other expenses attributable to the business but not the home.800 Allocable portion of expenses 60/90 of $1500 1.minus depreciation allocated to rental period eg: Taxpayer owns vacation home. Gross rental is $5400. Real estate taxes and qualified interest are $3600. House was rented for more than 14 days and used by taxpayer for more than the greater of 14 days or 10 percent of actual rental time (Taxpayer does not meet the minimal personal use requirement of § 280A(d)). 1. as a place of business which is used by patients. Rents for 60 days and uses it for 30 days per year. 2.000 Allocable portion of depreciation 60/90 of $6300 4.200 Depreciation deduction gets limited to $3.400 Less allocable portion of taxes and interest. irrespective of the home office. . Other expenses related to the home are $7800 ($1500 for repairs and $6300 for depreciation). or as a separate structure not attached to the dwelling unit.800 because that is the max allowable after deducting other expenses C.

Used exclusively and on a regular basis as principal place of business 2000 gross income -400 I/T 1600 income 1600 expenses for secretary and supplies 0 net income 350 of utilities and depreciation can be carried forward 3) Widow rents rooms to students.280A-1c subsequent years. 2. Is she limited by § 280A? widow is not limited by 280A – boarders are treated as not in your home and are fully deductible as rental income reg § 1. Commissioner v. Public policy exception may be applied to disallow an otherwise valid deduction if allowing the deductions would frustrate a clearly articulated nationwide or statewide policy. Deductions disallowed due to income limitations may be carried over to Problems pg 525 1) Taxpayer owns a vacation home that rents for 90 days and uses for 30 days. Adjusted gross income Adjusted gross income is a means of equalizing taxable income between . IV. (g) A. there is not a denial of deduction due to public policy a. § 162 c & f – no deduction for fine or violation of law and no deduction for illegal kickback – if not one of those. eg: hitman expense for bullets would be deductible Punitive damages deductible unless they are antitrust treble damages Chap 18: Deductions For Individuals Only I. The test for non-deductibility is the severity and immediacy of frustration that would result if the deduction were allowed. Tellier. 1. (f). Illegality or Impropriety § 162(c). a) Limited by § 183 or § 280A? § 280A limitations apply because the house is used personally for more than 10% of the time rented (and more than 14 days) b) what is deductible? gross income from rent 3000 interest & tax deduction – 90/365 x 2000 = 500 (Beck calls this a haircut) so we have net income of 2500 out of pocket 90/120 x 1600 = 1200 deductible so now have 1300 deductible left depreciation 90/120 x 2000 = 1500 depreciation but only 1300 of the depreciation is allowed c) are taxes and mortgage interest deductible? yes fully deductible d) what if T rents the home for 3 weeks and uses it for 1 week rental income only . Criminal Defense Public policy does not bar otherwise valid deductions for ordinary and necessary legal expenses incurred in defending criminal charges arising out of carrying on a business. 3.§ 183 applies – see if it made money in the last 3 years out of 5 similar calculation but all the interest and taxes would reduce the income and no carry forward 2) Taxpayer has home office.a.

principally the following. Certain expenditures are deductible only to the extent that they exceed 2% of the taxpayer’s AGS. Section 62 is considered above the line deduction. the character of which depends on whether the debt is a business or nonbusiness bad debt. Certain retirement savings. i. § 217 iv. – BELOW THE LINE DEDUCTIONS § 63 a.A taxpayer may deduct qualifying moving expenses incurred in moving his or her household to take a new job. Charitable contributions.the itemized deduction is the aggregate of a number of deductions.5% of the AGI. § 219 iii. Miscellaneous expenses. § 63 defines taxable income b. Business expenses & losses. Section 62 gives you a round of deduction which gets you to adjusted gross income..5% of AGI. § 166 vii.A taxpayers capital losses are deductible. Medical expenses.The standard deduction is a statutory fixed amount based on the taxpayers filing status c.A taxpayer may deduct the excess of casualty losses over casualty gains to the extent that they exceed 7.. whether the business . Bad debts. Itemized Deductions. Alimony.ABOVE THE LINE DEDUCTIONS § 62 A. Adjusted Gross Income and Deductions.A taxpayer may deduct contributions to certain qualifying organizations. Computation. § 215 ii. § 213 iv. § 165 ( c) (1) v. Home mortgage interest. or AGI.A taxpayer may deduct certain medical expenses to the extent they exceed 7.individuals based on the source of their respective income. Standardized Deduction. Capital losses. subject to limitations of § 1211 Taxable Income and Deductions. but not sales tax. Casualty loses. allowing the following principal deductions from gross income i. and the rational taxpayer will choose to deduct the larger of the two. – A second group of deductions is subtracted from AGI to produce taxable income. Taxes...A taxpayer may deduct qualified residence income.If a taxpayer’s expenses of doing business exceed the income from that business the net loss will be deductible subject to certain limitations (includes “washes” of reimbursed employee expenses). Section 62 gets you from Gross income to AGI Section 63 is a second class of deductions which gets you from AGI to taxable income . § 163 ii. § 170 vi. subject to certain limitations. v.A taxpayer may deduct certain contributions to an individual retirement account (IRA) and other plans.Debts that become worthless during the taxable year generate a loss. § 164 iii. Computation. § 67 d. Principles Deductions under AGI.A taxpayer may deduct state and local income and property taxes.§ 62 defines adjusted gross income. B.A number of deductions constitute a subtraction from gross income to produce a concept called adjusted gross income. Personal exemption Section 61 tells you what Gross Income is.A taxpayer may deduct the amount of alimony he or she pays. Moving Expenses. The taxpayer may subtract either the standard deduction or the itemized deduction (but not both).

(doubled if self-employed) Eg: old residence: 5 miles to old work – New work must be 50 miles + 6 miles regulations hint that the move must be to the general area of the new work – if no current job.only $250 is above the line § 62(a)(2)(d) II.above the line m) deductible moving expense .above the line – work related n) teacher buys $350 in supplies .below the line subject to § 67 f) payments for the following items: below the line – mortgage interest. 82. you can get the deduction for a move of 50 miles or more B.for employer.below the line – not treated as an expense of the business (it is the personal income) k) tax prep fee. Moving expenses §§ 62(a)(15). charitable contributions and taxes on property g) taxes and interest relating to rental unit . 217 Reg 1. part for business .000 j) state income taxes .* Gives you a choice between standardized deductions and itemized deductions Problems pg 548 1) Which are these? § 62 or § 63 deductions? a) police uniform – an unreimbursed employee expense – below the line and subject to 2% floor (§ 67) b) salesman unreimbursed expense of entertaining client . moving expenses may be deducted provided the distance between the taxpayer's former residence and new workplace is more than fifty miles than the distances between the taxpayer's former residence and old workplace and the taxpayer is employed for at least 39 weeks of the first twelve months at the new location. extra is income (3) underpaid. (3). What is included . & (8) Moving expenses are deductible above the line.above the line – business expenses h) loss on stock held for investment . the remainder is a deduction d) what if employer entertains the client? above the line but 50% haircut e) tuition for business refresher course relating to employment .162-17(b)(1).above the line capital loss – limit $3. 50% haircut on deduction to employer (2) overpaid reimbursement. (3) & (e)(3) (1) if reimbursed. part for personal. (2). medical expenses (subject to 7. it’s a wash .$150 above the line (business expense) & $250 below the line l) alimony payment . See § 62(a)(15).5% floor).217-2(b)(2). Distance & Time Under § 217. A. (4). 132(a)(6) & (g).below the line – misc itemized deduction – only 50% under 274n2 and subject to § 67 c) what if employer reimburses – see Reg 1.

only one of them can take the deduction h) What if employer reimburses him all $850 of expenses? $200 income 2) employee moves and deducts expense but gets disallowance notice from IRS. the taxpayer's spouse or dependents' medical care are deductible under § 213. a) How far away from Sub X must Town Y be for his moving expenses to be deductible? 60 miles from suburb of X b) How far away from Sub X must Town Y be located if L just graduated & this is his first job? 50 miles from old home c) If self employed what time requirement? 78 weeks d) What if L is a partner in law firm? partner is self employed. $150 for transp. ship. cure. insure and store the taxpayer's possessions and the cost of moving. not a cost of moving for Keen – she got her basis. Raymon Gerard a. deduction allowed for amount over which the expenditure increased the value of the home C. They ask her to move again and she cannot sell her house without a loss. Food and lodging expenses incurred en route to a place of medical treatment.000 avoidance of loss could be considered income – employer has a $5. transport. cure. Addition to home 1. deductions must be taken in the year of the move – she can amend her 1998 return within the next 5 days (3 year statute of limitation on amending) 3) Employer moves employee to town and she buys a house. B.Moving expenses include amounts paid to pack. a. excluding meals. Medical Care §§ 213(a). Problems pg 553 1) L works in Town X and lives in Sub X 10 miles away. Reasonable lodging expenses and 50% of food expenses paid while . Commissioner. subject to 7. Montgomery v. (d)(1)-(4) & (9). Expenditures that constitute a permanent addition to a home are deductible as medical expenses only insofar as they do not increase the value of the home over the amount expended. treatment or prevention of disease and for transportation primarily for and essential to the diagnosis.000 business expense (cost of labor) III. Employer buys the house for her cost. mitigation treatment and prevention of disease.213-1(a)(1). (e) (1)-(4)(i)(a) Amounts paid for the taxpayer's. 263(a)(1) Reg 1. Food and lodging 1. but not after arriving. A. (b). but the $5. Decides to work in Town Y and moves family to Town Y.5% of AGI floor for deductibility and only if you itemized your deductions. everything but the meals g) any difference if L’s spouse also takes a job in Town Y? no difference. Inclusions Medical care includes amounts paid for the diagnosis. which the taxpayer's employer did not reimburse. so 78 weeks e) What if only an associate (and so an employee)? only 39 weeks f) What is deductible for moving? $400 for movers. mitigation. are deductible as medical expenses. $100 in lodging & $200 for meals $ 650 above the line.

nature of work clearly requires it b. Personal exemption § 151 1. filing separately: can only claim spouse if spouse has no gross income § 151 (b) 2. Congress cut into the exemptions – unfair. the taxpayer's spouse or dependents is also deductible. 152. $2. then $1020 more – apply 7. other medical expenses of $1020 a) deductible: $2000 for AC. E. 7703 Reg 1.000 per person below the line A. such expenses.000 for this class 3. unless eligible to be claimed on another’s return as a dependent § 151(d) (1) b. Long term care Amounts paid for qualified long-term care of a taxpayer. Exemptions §§ 151. the expense is not paying for something used in personal activities c. Use $2. available to the individual taxpayer and his spouse without restriction a. Business expenses 1. joint return gets 2 exemption c.151-1(b) & (c)(2) In addition to specific deductions available to individual taxpayers. may qualify as business expenses under § 162. increased value of home by $2100. Code and Regs are otherwise silent as to the treatment of the expense Problems pg 565 1) medically necessary addition to home: cost $4100. affects taxpayers unequally – this creates a bubble a. a set deduction that is subtracted from the taxpayer's adjusted gross income to determine the taxable amount. then married all year (2) legally separated is considered not married . D. § 151(d)(3) – phase out: if you make too much money (4 different versions) you lose 2% of your otherwise eligible exemptions for each $2500 AGI exceeds this threshold – instead of increase the tax rate. In some instances where the nature of the taxpayer's work clearly requires a medical expense be incurred to insure sufficient performance or where goods or services purchased are primarily used for work and the IRS Code and Regulations are silent on their deductibility.receiving treatment from a hospital on an in-patient basis are deductible under § 213(d)(2). § 151 provides exemptions for the individual taxpayer. although medical in nature. Three elements must be present: a. § 7703 marital status definition: determined at end of year (1) if married on last day of year.5% to get $900 – first 900 is out so she can deduct 2120 b) deduct $400 per year? deduction has to be taken in the year the expense incurred – depreciation does not apply 2) employee traveling on business gets ill and has to stay in hotel for 2 extra days deductible as a business expense 3) patient pays doctor up front payment to the doctor is a payment against future services IV. his spouse and any dependents.

To claim a dependent exemption. Custody rule: § 152(e) – custodial parent can claim without reference to support test – exemption can be transferred to non-custodial parent if done in writing – see Reg § 1.152 – 4T . support test: that the taxpayer provides over one-half of the support for the person claimed as a dependent (1) if more than ½ support is provided. files separate return b. adopted or foster child.(3) married is considered not married § 7703(b) if taxpayer: a. (1) The gross income requirement is waived if the dependent is the taxpayer's child and is under nineteen or a full-time student under twenty-four. the dependent does not have to be living with the taxpayer c. gross income test: the person claimed does not have gross income over the amount of the exemption allowed. child can earn any amount if parent pays more than ½ their support (2) § 152(d) scholarship does not count as support – see Reg § 1. Dependents §152 Reg 1. or an unrelated individual living as part of the taxpayer's household. the taxpayer must show: a.152-1 (3) Spouse is never a dependent.152-1. maintains household where child/dependent lives for more than ½ the year c. and b. spouse does not live there for last 6 months of the year B. -4T 1. 2. relationship test: that the person claimed as a dependent is a blood relative.

and if the cohabitation does not violate local law . taxpayer pays $2000 in support. so spouse exemption not allowed d) since spouse exemption disallowed. one who paid over 10% of the Problems pg 571 1) married. spouse has no income – how many exemptions? a) spouse earned interest on tax exempt bonds 2 exemptions for himself and spouse – interest is not included in gross income b) received $100 gift from uncle 2 personal exemptions – gifts are excluded from income c) spouse earned $50 gain from sale of the bonds 1 exemption – gain is income.3. separate return. can taxpayer claim as spouse as dependent no. you are allowed the exemption deduction only if the dependent lives with you. separate return. § 152(a) spouse can never be a dependent e) taxpayer and spouse file joint return 2 exemptions 2) married. $3000 from uncle for support father cannot claim son but uncle might be able to (but this is a gift) i) 18 year old son. furnished over ½ support of person earning less than $2000 & not living with taxpayer – Is this a dependent? a) wife’s brother § 152(a)(9) – brother in law is dependent b) 1) wife died year before relationship persists even if link is broken – still a dependent 2) H & W divorced same result c) wife’s sister’s husband relation too far away – double in law d) wife’s sister’s husband lived with taxpayer during year dependent exemption allowed under § 152(a)(9) e) son earned $2000 but is full time student dependent f) daughter earned $500 but married during year and filed joint return not a dependent under § 151(c)(2) g) but daughter’s spouse had little income and filed return only to get a refund can still be claimed as a dependent if there is no tax owed because there is no tax consequence to the joint return h) 18 year old son. taxpayer pays $2000 and son gets $3000 scholarship scholarship doesn’t count so father can claim son as dependent § 152(d) support can claim the exemption For non-related dependents. § 152(c) – multiple support agreements: if qualified related people have provided over ½ the support in aggregate.

The standard deduction is a set amount based upon the taxpayer's status as single. then defacto custody is based on time spent C. $3000 for individual – use this for this class § 63(c)(2) b.000 over threshold in § 68(b)(1) – he looses 3% of excess so he loses $3000 of his itemized deductions 5.000 AGI . blind or elderly. A.$100. head of household. § 67: 2% floor applies to § 212 and unreimbursed business expenses 4. a. and B have contributed 55% in aggregate – either T or A can claim (they are over 10%) could claim the exemption if the other files a declaration that he is not claiming it 4) W & H divorce. B 10% and C 30% . $5000 for joint return c. over 65 and/or blind get $750 for each § 63(f)(3) f. the payment to lawyer would be a wash (above the line deduction) – but this is a personal suit award. you loose 3% of itemized deductions in excess over AGI up to 80% of the deductions eg: $200. get another $600 if 65 or older § 63(f)(1) – considered 65 on the day before your 65th birthday – Reg § 1. so is either under § 212(1) production of income or an unreimbursed employee expense but either way it is a miscellaneous itemized deduction under § 67 and is below the line (and would have to exceed income by more than 2%) a. this is in addition to personal exemptions as above b. W gets custody of son – who gets dependency exemption? a) W supports 40% & H support 60% W has custody and the exemption – no support test b) W waives exemption H can claim it under § 152(e)(2) c) son lives with Grandpa for 9 months nothing changes. 68.67-1T(a) 1. limitation on dependent standard deduction – if eligible to be claimed as a dependent by another taxpayer. 67. T 25%. $2500 for married filing separately d. legal custody is what matters d) not divorced. the problem in this case is that the taxpayer had used Alternative Minimum Tax and so was allowed no deduction at all b. A 20%. § 68 phase out: if you make too much money (over $100.3) father has no gross income – $4000 support provided by X 15%.who gets the dependent exemption? Under § 152(c) T. the standard deduction is the greater of $500 or $250 + earned income (remember someone eligible to be claimed as a dependent by another gets no personal exemption and is limited as to standard deduction as stated here) – Disadvantages Trust Fund Kids 3. or taxpayer can itemize deductions. Sinyard v Commissioner: tort award. married. get another $600 if blind § 63(f)(2) (1) if unmarried. Standard Deduction § 63. what if considered the cost of acquiring property and capitalize it? Beck says this would make the problem go away – no income realized . and in addition to § 62 deductions 2. An individual taxpayer may take the standard deduction provided for in § 63. – choose the higher of the two a.151-1(c)(2) e. 1/3 to lawyer – if this were a business expense under § 162.000). but W moves out – son lives with H – support provided equally H gets exemption if there is no legal custody. 7703 Reg 1.

child of X.1250 standard deduction (earned income plus 250) = 2750 TI c) 4000 earned income personal exemption still 0 and takes standard deduction of $3000 = $1000 TI 3) who should itemize? A pays 4000 state income tax and B pays none A will itemize (state income tax is below the line. then an allocation of legal fees is made Legal fees for civil rights cases are above the line deductions Problems pg 575 1) $20.900 TI 2) single taxpayer. Y pays 2000 for lodging and Z pays 2000 for medical these are valid family members for tax purposes so any of them could claim Dad as dependent important issue is which one of them is in the higher tax bracket and needs the deduction? And medical expenses are deductible for dependents.000 standard deduction and 2 exemptions for $4. both must take standard 5) H & W live apart.900 b) what if taxpayer is 65 reg § 1. 300 bar dues a) what is the taxable income? § 62 deductions = 1500 tax and interest then calculate § 67 subject to 2% floor 1500 unreimbursed employee expense + 200 tax prep + 300 bar dues = 2000 2% x 20. under § 265(a)(1): legal fees to earn a personal injury tax free award (nonincome under § 104a) are non-deductible – if award is part tax-free and part taxable.000 taxable income d) if interest is $4000 then their itemized deductions are greater than the standard deduction 4500 + 1600 = 6100 > 5000 20.X pays 2000 for food. then it is deducted before AGI and she gets the standard deduction also 4) H & W file separately if one itemizes. children live with W $3000 is standard for single .900 tax rate under § 1 of code.000 – 3750 – 2000 = 14.$2500 is for married under § 7703b. both must itemize – if one takes standard. 4000 > 3000) and B will take the standard If 4000 is alimony paid by A.000 AGI.151-1(c)(2) considered 65 on the day before your 65th birthday unmarried and 65 gets an additional $750 – so standard deduction is $3750 and he will take the standard instead of itemizing – 20. he could use the deduction Can’t deduct fees for obtaining tax-free income . she is unmarried and properly takes the $3000 standard deduction H is still considered married can only take the married filing separately deduction of $2500 6) multiple support agreement .000 = 400 – so only 1600 is deductible total deductions are 1500 + 1600 = 3100 taxpayer can take standard deduction of 3000 or itemize 3100 taxpayer can take 1 exemption for $2000 taxable income is 20.c.000 – 6100 – 4000 = $9. unmarried is 15% of 14.000 AGI – exemption of 0 (he is claimed by another taxpayer) – standard deduction of 500 (investment income is not earned income) = $3. 1500 unreimbursed employee expenses.5% of AGI.150 c) married filing joint return $5. student has investment income of $4000 and no deductions – X claims student as dependent a) what is taxable income? 4. single personal exemption with the following itemized deductions: 1000 interest. 200 tax prep.500 b) 1000 earned income and 3000 investment income 4000 AGI . so if Z’s medical deductions exceed 7.0 exemption . 500 taxes.000 = $11.000 – 3100 – 2000 = 14.

a taxpayer cannot turn her back on income to avoid taxes. the value of a check actually received is includable in the year of receipt. In Williams. or property. Promissory notes or other evidence of indebtedness received as payment for services constitute income to the extent of their fair market value. The Cash Method of Accounting: Cash Receipts and Disbursements A. a note received only as an evidence of indebtedness.The Year of Inclusion or Deduction Chap 19: Fundamental Timing Principles I. – Compare in deferred compensation situations – constructive receipt would kick in unless the taxpayer is in a position to assume the risk a an unsecured creditor for their own salary to be paid out in the future B. not subject to set-offs. will not be regarded as income at the time of receipt. and not as payment. it may be that the taxpayer is deemed to have constructively received the income. Williams v. or otherwise made available to a taxpayer unless the taxpayer's control of its receipt is subject to substantial limitations or restrictions. 2. An obligation is a cash equivalent if (1) The obligor is solvent. Paul v. 4. The idea behind the principle of constructive receipt is that if income is made available to a taxpayer. Cowden v. Hornung. However. the receipt of a check is deemed a recognition of income. set apart. Constructive receipt occurs when income is credited. which has no fair market value.451-2(a). Commissioner. Charles F. Income may be in the form of cash. 1. even if the check cannot be converted to cash until the following year. and is therefore liable for the tax due on that income. and (3) The obligation is of a type normally transferable to lenders at a discount not substantially greater than the prevailing premium for money. then the income is received and must be taxed. a. A cash method taxpayer includes income in the year it is received. Commissioner. the court determined that an unsecured promissory note. a. Kahler.446-1(c)(1)(i). is not the equivalent of cash and as such is not includable in a cash method taxpayer's income in the year of receipt. Under the cash method of accounting. As such. and the only thing that keeps her from collecting the income is her own action (or inaction). 5.461-1(a)(1) . Disbursements § 461(a) & (g) Reg 1. Income Tax Reg. could have endorsed the check over to someone else – he had control of the funds 3. b. A readily marketable agreement (obligation/promise) to make future payments that qualifies as the equivalent of cash is taxable upon receipt as cash had it been received by the taxpayer instead of the obligation. § 1. a. a. (2) There is an assignable and unconditional promise to pay. Even when a taxpayer does not have the physical item of income in her hands (actual receipt). -2 1.451-1(a). 451 Reg 1. Receipts § 446. check (treated as the same as cash).

Rul. the funds come from their own pockets). Rul.00 over the three year term of the policy and deduct the corresponding pro rata share each year. There is one exception to this requirement.. c. there is no doctrine of constructive payment. which is codified in § 461(g)(2). exception: A payment made to the issuer of the credit card (e. when expenses relate to the creation of an asset which has a useful life substantially beyond the taxable year (a capital asset).000. but only upon payment of the credit card bill. Cathcart borrowed the points as part of the loan and was not allowed to deduct them in the current year.. Commissioner.g. prorate the value of prepaid interest over the life of the loan). As stated in Cathcart v. No deduction for points on re-financing (not for buying or building). 2. Bolyston Market Ass'n. If a loan is part re-financing and part new loan. a. Vander Poel. taxpayers are required to prorate those expenses and may not take the full deduction for the expense in the year of actual payment. a. however. See also Rev. deductions are only permitted when they are actually paid. Generally speaking. b. § 461(g)(1) requires that taxpayers who employ the cash method of accounting allocate deductions for prepaid interest to the specific periods to which those deductions relate (i. the portion for re-financing is not deductible because it’s not acquisition indebtedness for these purposes. d. a cash method taxpayer can only take a current deduction for expenses actually paid during the taxable year.000..e. 4. the IRC specifically provides for the deductibility of expenses by cash method taxpayers. Though the law recognizes a doctrine of constructive receipt. she must allocate the $1. Francis & Co. Commissioner v. For example. a.1. One such situation is covered by § 461(g). A payment for a deductible expense made to a third-party with a bank-issued credit card is a deduction when the charge is made.e. 87-22.. .00 in the year 2001 for a three year insurance policy on real property (that is a capital asset). Inc. However. Those who qualify for this exception are entitled to deduct the entire amount of prepayment in the year in which it is paid. mail drop counts as payment 5. if a taxpayer pays $1. 87-22. b. that section provides that the general rule contained in subsection (g)(1) does not apply when cash method taxpayers prepay points (a processing fee paid at the time the loan is taken out) on their home mortgages (whether incurred to purchase or improve a home) with funds not obtained from the lender (i. a department store credit card) is not deductible when charged. a. but the party who receives the payment must declare the amount received as income 3. In some situations. Rev.

he can only deduct $3000 and he has $97.000 – $100. sale or exchange of the capital asset c. the following steps must be followed: 1.the other $97. system of capital gains and losses is a quarantine system (like the investment interest income system): deduction against gains can only be deducted against related income 5. Collectibles are taxed at 28%. The applicable rate for net long-term capital gains depends on the type of asset involved. If there is gain on both sides. Introduction To determine how certain gains and losses are taxed. 2. you can only deduct $3000 against other income example of why short term gains are better than ordinary income: lawyer earns fees of $100. holding period of at least 1 yr and a day 2. they must be analyzed quantitatively and qualitatively because certain types of gains and losses are entitled to special treatment. capital asset in hands of taxpayer b. long term capital gain tax rate is 15% 3.000 of loss is carried forward until it is depleted if the income is not legal fees but is short term capital gains. capital losses are deductible infinitely against capital gains .000 in income . 1222 I.What is his taxable income? Because there were no capital gains. Calculating Capital Gains § 1222 A.000 in capital losses .if losses exceed gains. Example: make a column for short term & a column for long term Short Term Long Term 10 50 (20) (10) 30 30 20 net short term gain (ordinary tax rate) 70 net long term gain (taxed at 20%) a. the net short-term gain is taxed as ordinary income and the net long-term gain is taxed under the applicable capital gain rate (usually 20%). he now has $0 taxable income II. Capital Gain 1. Three necessary elements for capital gain: a. Net from the inside out To calculate the tax on a capital gain realized by a noncorporate taxpayer. A. including stocks and .The Characterization of Income and Deductions Chap 21: Capital Gains And Losses § 1(H). the sale of depreciable real estate is taxed at 25%. short term capital gain tax rate is taxpayer’s ordinary income rate (max 35%) but it is not ordinary income – it is much more valuable than long term gains or ordinary income – reason: the loss rules 4. First subtract short-term capital losses from short-term capital gains and longterm capital losses from long-term capital gains. most other capital assets.

15%.000 could be deducted and 7. are taxed at 20%. you are taxed on it at the ordinary rate. they retain their original character as shortterm or long-term and offset the short-term and long-term capital gains in the subsequent year to which they are carried. #24 11/25/02 Chap 21 D – F Capital Gains (skip D3) IV. Capital Losses § 1211. . it is not a capital asset by definition.000 of ordinary income. In certain cases. simply net the two. up to $3. b. in subsequent years. if you have a loss in one column and a gain in the other. capital assets may be taxed at 18%. 10% or 8%. may offset no more than $3. then the $3. the net is 10 of short term loss. to the extent they exceed capital gains. Definition of Capital Asset § 1221 property held by a taxpayer whether or not connected to his trade or business – but not inventory or copyrights – includes personal use assets (loss on home is non-deductible but gain is taxable as capital gain) A. so 3. to the extent they exceed capital gain. § 1212(b) 1. Short Term Long Term 10 50 (20) 10 (30) (30) (40) net short term loss 30 net long term gain Here.000 comes out of short term gains first – why is the $3000 taken from short term first? Because it is better to deduct short term loss – losses keep their character so carrying forward short term losses is better because it reduces ordinary income which is taxed at a higher rate – but the rule requires offsetting the short term – Beck calls this an anti-taxpayer rule because more long term loss B. Carry forward Any capital losses that may not be deducted in a given year may be carried over to offset capital gains. eight classes of property are excepted out of the definition such that if the property falls within one of those eight classes. capital losses may be deducted first against capital gains and then.000 of ordinary income. if losses are experienced in both columns. When carrying over capital losses. if it results in long term gain.000 of short term loss would be carried forward to subsequent years 1. 30 net short term gain is taxed at the ordinary rate III. and again.bonds. then taxed at 20% Short Term Long Term 10 10 (20) (10) 50 (30) 40 net short term gain (30) net long term loss Here. Exceptions 1. Limitation Under § 1211(b). 1212 A. If the net results in a short term gain.

if investor.if that is the dealer’s business. sell at retail (4) can be a dealer in one year and not in the next depending on the circumstances b. ie heir) – if copyright material is bought and re-sold. the stated purpose of the taxpayer is of no importance. copyright material when gain is realized by the one producing the material (or one who takes his basis. improve the property. like bottles of wine or stock (b) § 1236 requires dealer in stock to identify it immediately as either inventory or capital asset b. Income Property Often the trick in applying the rules for capital gains and losses lies in knowing . get ordinary loss – Beck calls this a pro-taxpayer rule c.land can be either capital asset or inventory . accounts or notes receivable – back up to the inventory exception e. primarily means primary and not simply a substantial purpose. as capital gain – but can occur with anything. In determining whether property fits within the statutory definition. gain will be taxed as ordinary income. the gain to the re-seller is taxed as capital gain (1) exception: patents – § 1235 . a. inventory – for a dealer or merchant and sold in the ordinary course of trade (1) same property in the hands of one taxpayer may be capital assets while in the hands of another taxpayer would be inventory (a) this occurs most frequently with land . 2. the property is not a capital asset. To determine whether property is held primarily for sale to customers. Mauldin (1) A number of helpful factors in determining whether property sold by a taxpayer was held primarily for sale to customers in the ordinary course of trade or business: (a) purposes for which the property was acquired.all income forever is treated as capital gain Beck says: Congress loves inventors and hates artists d. commodities derivatives g. whether for sale or investments (b) continuity and frequency of transactions where the sales were in furtherance of the occupation of the taxpayer (5 or more transactions a year) (2) Mauldin was found to be a dealer even though he never replaced his inventory (3) dealer will subdivide. business supplies. government publications received for less than ordinary purchase price f. If it appears from the facts and circumstances that the property was held primarily for sale to customers in a taxpayer's trade or business. depreciating business property – gets better treatment under § 1231 than capital assets.a. hedging transactions are always ordinary gains or losses (not capital) h. losses are not limited by the capital loss $3000 limitation. Malat B.

when a landlord cancels a lease at the request of a tenant and in exchange for a sum certain less than the landlord was entitled to under the full-term of the lease. Metropolitan Building Co. Kenan (1) barter rule: if there is a debt and the taxpayer pays off his debt with appreciated property. Thus. the tenant left and the landlord still had the asset but in Metropolitan. a. Introduction Determining when a sale or exchange of a capital asset has taken place is fairly simple. Selling the rights to money under a lottery win does not result in capital gains and is treated as ordinary income Watkins v. 1. For instance. capital gain or loss. etc. When a lease is canceled or a leasehold interest is sold. requires a sale or exchange of a capital asset. Tenants are treated differently than landlords with regards to cancellation of a lease. A. 1. it is a sale and there is a capital gain (2) in this case. the amount paid to compensate the tenant for giving up his interest in the lease is a capital gain because the transaction is said to be a sale or exchange of a capital asset.what is a capital asset and what is merely ordinary income-producing property. § 22(a) defines gross income as including rent payments. (1) the giving up of a lease by a tenant fits the legal requirements of a sale or exchange and a gain realized by the tenant on such a transaction is capital gain (2) in Hort. however. In certain situations. the payment was a substitute for rent. Moreover. Hort a. the landlord cannot deduct the amount of rental payments that he gave up the right to receive as a loss. Commissioner 4. the payment was to the landlord to leave and Olympic received the leasehold (an asset with a value) 3. rights to earn ordinary income from salary are treated as ordinary income when you sell these rights V. when a trustee uses securities to satisfy a specific bequest of cash. usually bond debt) a. a. not a return of capital 2. This rule overrules Galvin Hudson (since 1997): the payment of money in . Sale or Exchange Requirement Under § 1222. b. Selling tenure. the value would not have mattered and there would have been no tax to the trust 2. a sale or exchange may occur that results in imputed capital gain. whether short-term or long-term. (so you get capital gain or loss. the amount saved by the trustee from not having to disburse cash is imputed as a capital gain to the trust or estate. the amount received by the landlord is ordinary income. there was a pecuniary obligation to pay a specific dollar amount – if the gift had been of x shares of stock. § 1271 Treatment of amounts received on retirement or sale or exchange of debt instruments: amounts received by the holder on retirement of any debt instrument shall be considered as amounts received in exchange thereof.

if a judgment is obtained against a dissolved corporation and paid by former stockholders who became liable solely because of distributions of the corporation's liquidated assets. B. were capital gains. even though no property technically changes hands. Revenue Ruling 66-97 a. Arrowsmith a. when made. Trade Date The calculation of the holding period is no different for debentures (unsecured bonds) sold on the registered market or over the counter. it will not be entitled to longterm capital gain or loss treatment until 7-2-01. The date debentures are sold is the trade date. B. Thus. The holding period begins to run from the date after they are delivered to the date they are sold. the date they are contracted for. known as the trade date.satisfaction of a debt is a sale or exchange as far as the creditor is concerned (even though when the debt is paid. Revenue Ruling 66-97 . Galvin Hudson Skipped a lot – go to the tape----------------------------------------------3. 1. Revenue Ruling 66-7 1. Thus. ----------------------- VI. Acquisition date The holding period for a capital asset begins to run on the day following the date of acquisition of the asset. the payment of that judgment is a capital loss since the distributions. Arrowsmith 2. Skelly Oil Co. 1. a. Looking back at prior tax treatment of transactions also aides in determining whether money that was previously included in a taxpayer's gross income under the claim of right doctrine and refunded in a later year may be deducted in full or only in part. does not start the clock running for purposes of the holding period. Correlation with prior transactions In determining whether a sale or exchange has taken place. Although such debentures are acquired through execution of a contract and delivered at a later date. The Holding Period § 1223 requires that for a capital asset to qualify for long-term treatment. even though no sale or exchange has actually occurred. Looking back at transactions in prior years does not violate the annual accounting method used in computing income tax liability since prior years are not actually reopened. no property is acquired by the creditor). if a capital asset is acquired on 1-1-01. even if for less than full value. it must be held for a year and a day A. reference is often made to tax treatment of transactions in prior tax years. under § 1235 obtaining licenses to use patents or copyrights is treated as a sale or exchange. There are also specific situations that the tax code defines as a sale or exchange. as well as in looking at whether or not an asset is capital or ordinary. For instance.

theft) involuntary conversion 2 Categories of Property: trade or business property – get 1231 treatment in all 3 means of dispostion investment property gets 1231 treatment if the conversion is involuntary (last 2) but sales are not 1231 2 big wrinkles: 1231(a)(4)(c): “Firepot” – All gains and losses from destruction. donee takes the donor holding period – holding periods tack Any property from a decedent which is sold is automatically long term #25 12/2/02 Chap 22 A – B. they are recaptured and recharacterized as ordinary income to the extent of the deducted losses No rule against taking the gain in the earlier year and taking the loss in the next year Case: Wasnok Courts are split as to whether owning and renting one house is a business Williams & McGowan: Sale of all the assets is the sale of each asset – each with its own basis etc. combine it with all the others – but if the net in destruction conversions are losses. flood. Depreciation Recapture – if you have gain from depreciable personal property (1231 property minus land & bldg)(vehicle. storm. computers. office furniture) if you sell it at a gain. and tax treatment § 1245: Mean provision and overrides 1231 453 etc. shipwreck.In a gift. separate from the other 2 types of transactions – very good for taxpayer – preserves the loss and does not reduces the capital gain from the other transactions (if any) 1231(c): Recapture: When you get a 1231 gain. D §§ 1231. 1245 tape middle of A Manner of property – has to be long term (minimum yr and day) 3 Means of Disposition: sale condemnation or requisition by government – involuntary transaction destruction(fire. any gain due to depreciation is ordinary income – does not apply unless you actually took the depreciation . you must look back to the prior 5 years for 1231 losses – If there are losses which were deducted. if there is a gain (insurance). take the loss.

Under § 166(d)(1).1655(a)-(c). Bad Debts and Worthless Securities §165(g)(1) & (2). there is no debt and thus there can be no bad debt deduction. the gain is turned into 50 of ordinary income (called 1245 gain) and 20 of 1231 gain – this is done before the firepot calculation Changes the character of the gain. not to losses Same pattern as in depreciation for real estate § 121 1245 taint sticks to the property – but death wipes out the taint because on death you get stepped up basis and the gain is wiped out anyway #26 12/4/02 Chap 23 A & B Bad Debts. Howard S. . Debts can be either wholly or partially bad. a taxpayer must in turn determine (1) whether there is a debt. not the amount – only applies to gain from depreciation. -5(a)-(b) A. 2." § 166(a)(1). Charity (skip pp812 – end. substantially contemporaneous to the time of such transfer. C. Why Must a Debt be Characterized as Business or Nonbusiness? 1. Bugbee. Business bad debts are not treated the same as nonbusiness bad debts. Whether a transfer of money creates a bona fide debt depends on the existence of an intent by both parties. business bad debt losses are deductible against ordinary income. B. "There shall be allowed as a deduction any debt which becomes worthless within the taxable year. and (3) whether it is a business bad debt. 166(a)-(e) Reg 1. -2(a) & (b). When forgiveness of a loan is construed to be a gift. no probs) Chap 23: Deductions Affected by Characterization Principles I. IRC § 166(b) deals with the amount that can be taken as a bad debt deduction. E. (2) whether it is a bad debt. What Constitutes a Debt? 1. What Constitutes a "Bad" Debt? 1.EX: Truck used in business – cost 100. and sets forth the way each is treated under the code. basis of 50 and gain of 70 – under 1245. (e)-(g). In some cases.166-1(c). A "bad" debt is a debt that is uncollectible.1. a. When determining whether a bad debt deduction under § 166(a)(1) is appropriate. IRC § 166(d) differentiates between business and nonbusiness bad debts. while nonbusiness bad debt losses are deductible only as short-term capital losses. a. 2. Bugbee. D. To qualify for a bad debt deduction under § 166. to establish an enforceable obligation of repayment. the forgiveness of a loan can be construed as a gift (see § 102 and its accompanying cases for the definition of a gift). 1. depreciation of 50 so basis is 50 – sell it at 120. there must exist a bona fide debt which arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed and determinable sum of money.

Partially worthless. you can immediately deduct 90% of the debt – if it is nonbusiness. Bad Debts Business or non-business Business bad debts get favorable treatment: Deduction without limit Non-business bad debt can only be deducted as a short term capital loss Business bad debt: either incurred in the trade or business or become bad and is transferred to trade or business. Nonbusiness and business bad debts are treated differently because of the potential for abuse in nonbusiness settings. the worthless part is deductible Non-business Bad Debt: Treated like all other short term capital losses – must be wholly worthless EX: You loan money to someone who become bankrupt and they can only pay 10 cents on the dollar If business debt. so a classification of a loan as a business loan depends upon the taxpayer's own business. A debt will only qualify as a business bad debt if it bears a direct relationship to the taxpayer's trade or business. Whipple v. you cannot deduct until you know how much you will get and deduct the balance. Haslam. Generes. To screen out gifts What can you deduct? Maximum is your basis (what you have loaned) Landlord/tenant – tenant owes rent – no bad debt – no basis in the debt – hasn’t loaned any money . whatever that is For any kind.e. 2. Charles J. United States v. The character of a bad debt loss is determined by the relationship it bears to the taxpayer's trade or business. c. Beck mentioned the taxpayer’s motive a. b. IRC § 166(d)(2) defines the term nonbusiness bad debt. parties have established a creditor/debtor relationship and there is an expectation of re-payment.b. For the purposes of defining a business bad debt. Commissioner.. the debt must be worthless in whole or in part: this depends on the size of the debt Is it a debt at all? Must be a valid debt. an investment-related debt is a nonbusiness debt). investment activities are not considered the same as a trade or business (i. A corporation's business is not necessarily the same as that of a shareholder.

Alimony: No bad debt, no basis, this is an income item Child support: no loan, no basis; “a bad is a loss; you can’t loose what you never had” all these are are promises that they will pay, these are disappointed promises Year of worthlessness: hard to determine so there is a special statute of limitations of 7 years to allow for amendment of returns if IRS challenges a deduction §111 Recovery of a previously deducted amount – if a bad debt is deducted in one year and then make good in another year, you must report the amount as income (same as you must do for state income tax returns) if there was a tax benefit Worthless securities (Corp bonds and stocks) § 165(g): deemed to have been sold on the last day of the year in which it turned bad; could be long term or short term depending on when bought and then get treated accordingly in capital gains and losses II. Charitable Donation Deductions § 170(a)(1) A. § 170(a)(1) states that, with certain exceptions, a deduction can be claimed for the amount of any charitable contribution (as specified in § 170(c)) made during the taxable year. 1. For the purposes of IRC § 170, a deductible contribution "is a voluntary transfer of money or property that is made with no expectation of procuring a financial benefit commensurate with the amount of the transfer." Rev. Rul. 83-104. a. In ascertaining whether a given payment was made with the expectation of something in return, the IRS focuses its examination on the external features of the transaction in question, thus obviating the need for imprecise inquiries into the motivations of individual taxpayers. 2. When money is donated to a charity, the amount of the deduction is the amount donated. When property is donated, the fair market value of the property generally serves as the amount which can be deducted (though in the case of appreciated property the amount deductible may be reduced by some or all of the value of the built-in gain). a. A gift of services or time is not deductible under § 170. Nor is a gift to an individual (as opposed to an organization). b. If a taxpayer donates less than a full interest in a piece of property to charity, a series of special rules applies. 3. Congress allows the § 170 deduction because it relieves the federal government of the obligation to provide the public with the services that the charities provide. 4. IRC § 170(c) divides the qualified charitable organizations into two groups: public charities (which are substantially funded by members of the general public) and private foundations (which are substantially funded by private persons or small groups).

5.

B.

C.

D.

Congress has imposed various ceilings on the total amount of charitable deductions that a single taxpayer may deduct in one year. a. IRC § 170(b) imposes a 50% ceiling on individual gifts to public charities, meaning no individual may claim charitable deductions to public charities in excess of 50% of his or her adjusted gross income. b. There is a 30% ceiling on gifts from individuals made for the use of public charities and on gifts to private charities. c. The IRC allows a carry-over of up to five years of charitable donation deductions. 6. Charitable contribution deductions will only be permitted if they can be properly verified by means of a receipt, cancelled check, etc. Rev. Rul. 83-104 provides an example of the workings of IRC § 170 in a religious school-contribution context. 1. In Rev. Rul. 83-104 the Treasury Department concluded that "Tuition expenditures by a taxpayer to an educational institution are . . . not deductible as charitable contributions . . . because they are required payments for which the taxpayer receives benefits presumably equal in value to the amount paid." 2. The Department also stated: "Similarly, payments made . . . on behalf of children attending . . . church-sponsored schools are not allowable deductions as contributions either to the school or to the religious organization . . . if the payments are earmarked for such children." 3. Finally, the Department further decided that "the fact that the payments are not earmarked does not necessarily mean that the payments are deductible," and that conversely, "a charitable deduction for a payment to an organization that operates a school will not be denied solely because the payment was, to any substantial extent, offset by the fair market value of the services rendered to the taxpayer in the nature of tuition" (i.e., if the amount of a contribution exceeds the fair market value of the education (as measured by tuition), the difference is deductible). With respect to payments to organizations operated exclusively for religious purposes, a contribution is deductible only if such payment is a "contribution or gift" made with no expectation of gaining religious benefits or access to a religious service. Hernandez v. Commissioner. Rev. Rul. 67-246 addresses the application of IRC § 170 in the context of payments "in connection with admission to . . . fund-raising activities for charity." 1. In this ruling, the Treasury Department stated: "As a general rule, where a transaction involving a payment is in the form of a purchase of an item of value, the presumption arises that no gift has been made for charitable contribution purposes, the presumption being that the payment in such case is the purchase price." a. In the case of the purchase of tickets to a fund-raising activity, this principle dictates that if the cost of the tickets to a charity banquet is equal to the admission price of a similar banquet for which tickets are normally purchased, no charitable deduction is

2.

3.

available. For example, if the cost of a charitable dinner is $150, and the value of the dinner is $50, the taxpayer can take only a $100 deduction. The Department further stated that "if a charitable contribution deduction is claimed with respect to [such a] payment, the burden is on the taxpayer to establish that the amount paid is not the purchase price of the privileges or benefits [i.e., the total payment exceeded the value of the item purchased] and that part of the payment, in fact, does not qualify as a gift." In the normal case, an organization conducting a charitable event should specify what percentage of the ticket price represents the fair market value of the good received, and what percent can be deducted as a charitable contribution. Deductible if: 1) to a qualified institution – charitable status determined by IRS 2) no quid pro quo – cannot receive anything of market value 3) gift can be property or cash (cannot deduct value of time) but can deduct out of pocket expenses incident to volunteering your time – property at full fair market value (great if you have appreciated property because you don’t pay the capital gains)

§170(e): If you donate property which would otherwise have produced income, you can only deduct your basis can’t donate more than 50% of income IV. Casualty and Theft Loss § 165(a) & (c) Reg 1.165-1(e), -7(a)(1), (3), (5), -8(a)(1), (d) A. The Nature of Casualty and Theft Losses Allowed 1. IRC § 165(c)(3) provides that in the case of an individual, a deduction may be taken for "losses of property not connected with a trade or business or a transaction entered into for profit [i.e., personal items], if such losses arise from fire, storm, shipwreck, or other casualty or theft." a. IRC § 165(c)(3) is an exception to the general rule that personal losses (i.e., those unconnected with a trade or business) are nondeductible. 2. In order for a "casualty" loss to occur, there must be "an identifiable event of a sudden, unusual or unexpected nature" which causes the loss of property to occur. a. For instance, in Rev. Rul. 63-232, the Treasury Department determined that a loss resulting from damage caused by termites does not qualify as a casualty loss because "termite infestation and the resulting damage cannot be inflicted with the suddenness comparable to that caused by fire, storm or shipwreck."

4.3. but gains are taxable Exception is casualty losses Losses due to fire. the proper course of action is to file an amended return for the year in which the losses are first deducted. the deduction may be permitted for a year prior to the loss. yet recovery is unexpectedly received. flood. 4. no deduction will be permitted until it becomes clear there will be no recovery. the amount of deductible loss is the same regardless of whether the loss is business or personal). Other Facets of the Casualty and Theft Loss Provisions 1. business and personal casualty losses are measured in the same way (i. Reg. Pulvers v. shipwreck and theft Firepot losses of § 1231 Losses from involuntary conversion or destruction are deductible but with huge limits $100 per occurrence haircut 10% of AGI floor . B. Commissioner. 2. Mary Frances Allen. a. a. return of stolen items.. then a taxpayer is justified in taking a § 165 theft deduction. Casualty losses are generally deductible for the year in which they are sustained. which are set forth in Treas. Generally.e. however. 3. The term "other casualty loss" in IRC 165(c)(3) refers to casualty losses involving physical damage or loss of physical property. and not just a decrease in value. Personal Use Property: Loss is not deductible.165-7(b). If a deduction is taken because there is no such reasonable prospect of recovery. The burden of proof is on the taxpayer to show that a § 165(c)(3) loss has occurred and that a deduction is appropriate. If additional losses stemming from the same theft are discovered in later years. the amount recovered is deemed to be taxable income in the year in which it is received. There are some differences. If there is a reasonable prospect of recovery of the loss (such as insurance payments. One limited exception to the general rule provides that if a casualty loss occurs as a result of a disaster which subsequently leads to the area being declared a disaster area by the President. 1. but in other cases it may be the year in which the amount of loss is actually ascertained (which may not be the year in which the loss occurs). In many cases this is the year of the casualty. etc. Theft losses are generally deductible in the year in which the theft is discovered. If the reasonable inferences from evidence presented regarding the disappearance of a valuable item point to theft.).

make sure to subtract $100 for each occurrence if there is a net gain. there is a liquidity problem because you will owe taxes on the total gain § 453 matches the tax on the gain with the payments due in the current year FMV 1000 AB 100 Sell it with down payment 200 and 8 future payments of 100 This is taxed by calculating profit if all the payments are made – in eg profit would be 900 Profit ratio is 900/1000or 90% Multiple each installment by the profit ratio so each payment would be taxable 90% and 10% return of basis Down payment is subject to same rule – 90% x 200 = 180 of gain and 20 return of capital Total exempts = basis Total taxable = gain Purchaser gets full basis in year one – he is borrowing money from the seller Wrinkles: . no deduction amount of the loss? Measure of loss is the difference between value before loss and after loss. it is capital gain if there is a net loss. limited by basis fmv before is 100 fmv after is 10 then loss is 90 but if your basis is only 50. then apply the 10% floor and deduct the rest below the line case law: loss must be sudden – house collapse due to termites is not casualty but flood would be there must be actual damage – Pulver case: burden of proof is on taxpayer – Mary allen case: missing brooch. Chap 24 A Installment Sales. then that is your loss #27 Chap 23 C Casualty Losses. Chap 25 Losses (skim only) § 453 Installment Sale if you sell property with payments due in future years.What if you casualty gains and losses from insurance? Net them. claimed to be stolen but she couldn’t prove it.

you have to get rid of the property Wash sales rule § 1091: if you have a stock loss and want to get the loss. not in year in which payment is received Interest: Separately dealt with If you have 10% interest on an installment sale. you will not be taxed on the gain (to the extent of the disallowed loss) Consistent with the carry over basis in the case of gifts and the case of no man’s land of non recognition of transaction for tax purposes where the sale is above FMV but below basis This applies to direct sales and indirect sales Moral: to get a loss deduction. Buyer would like the entire purchase price to go into basis.Cannot defer § 1245 gain – overrides 453 and will not let you defer the gain It gets taxed immediately and you must reduce the expected profit and adjust the profit ratio Can’t defer gain for publicly listed securities – taxed on gain on year in which you make sale. but want to rebuy the stock. you lose the loss §267(d): but if the property goes back up in value. Losses If you have property you are holding at a loss Fmv 10 Basis 100 If you sell it you will have a loss (not a personal use asset) §267: if you sell to a related party. you must wait 31 days in order to maintain the loss . If interest is not provided for. So they both want to hide interest. interest will be imputed. the interest is income to the seller Seller would prefer to be taxed at the capital rate. an exception to step-up basis rule. Pg 876 § 691 & 1014 what happens to income items which are owed to decedents? They are ordinary income to whoever collects them.

but allow it to go unrecognized for tax purposes. 6. Some Code provisions are merely timing devices to determine when to recognize gain or loss. at least for the time being. If gain or loss is not subject to immediate consideration. b. 1223(1) Reg 1. 4. 2. Exchanges must be of like kind property as defined in the statute. 5. but others are outright disallowances of recognition. Gain or loss has no economic or tax significance unless it is both realized (obtained or incurred) and recognized. Like kind exchanges are exchanges of property held for productive use in a trade or business or for investment.1031(d)-1 1. Provisions that allow for nonrecognition or deferred reporting usually recognize the existence of a gain or loss. along with other nonrecognition provisions carries with it an adjusted basis concept. . encountered in an earlier chapter. it is not generally subject to tax. a.1031(a)-1. 1. Introduction to Non-recognition principles A. The transaction must be an exchange rather than a sale for Section 1031 to apply. B. Nonrecognition provisions are predicated on the notion that gain or loss is sensibly deferred when the taxpayer has essentially retained an investment that is similar to the original investment. a. An exchange of property that does not fit within these categories does not qualify for like kind exchange treatment. provides for the nonrecognition of gain or loss on transfers between spouses or incident to a divorce. 3. Not all realized gains are subject to immediate consideration under the IRC. Most nonrecognition provisions basically provide only a postponement of tax on gain or deduction of loss that initially goes unrecognized by utilizing adjusted basis concepts. 1031. a. A threshold question in tax liability is always whether a realized gain or loss is recognized under the Code.12/4/02 #28 Chap 26 A – D Non-recognition I. Non-Recognition in like kind exchanges §§ 1001(c). § 1041.1031(b)-1(b) ex 1. c. 1. 1. b. -2(a). § 1041.

b. Century Electric Co. personal property that is exchanged with property in the same class is like kind property. The Second and Third Circuits have interpreted sale-leaseback arrangements with lease terms of 30+ years as constituting sales. 3. Like kind is given a more narrow interpretation when personal property is exchanged. b. a. For example. v.2. 4. c. v.e. The IRS has taken the position that a sale and leaseback in which the fee title is exchanged for a long-term leasehold interest (30 or more years) is a like kind exchange and any gain or loss on the transaction is not recognized. (1) 5. (2) Section 1031 and the regulations promulgated thereunder classify personal property into "General Asset Classes" or "Product Classes. (1) An exchange is a reciprocal transfer of properties while a sale is the transfer of property for money consideration only. Commissioner. v. an exchange is property for property. An exchange of real property for real property is a like kind exchange. The Eight Circuit and the IRS take the position that a saleleaseback arrangement providing for a lease term of 30 + years is a like kind exchange and subject to nonrecognition. c. (a) In general. but the presence of a small amount of cash in an exchange of property will not automatically disqualify the transfer for like kind treatment. Commissioner. Commissioner. a. (3) To determine whether money was the sole consideration for a transfer of property. real or personal. and not to its grade or quality. Commissioner. Leslie Co. Like kind is interpreted broadly when applied to real estate transactions. Bloomington Coca-Cola Bottling Co. v. The rule is that like kind property refers to the nature or character of the property. Leslie Co. i. v. (2) The initial issue to be resolved is the character of the transaction. the IRS has held that an exchange of gold bullion for silver bullion is not an exchange of like kind property because the metals are primarily used in different ways. Leslie Co. v. A sale is a transfer of property for money or its equivalent Generally. Leslie Co. Commissioner. The IRS and Courts have interpreted sale-leaseback transactions differently. . Commissioner. regardless of the dissimilarities in grade or nature between the properties. it is necessary to value the properties involved in the transaction." among others.

See Revenue Ruling 77-297.d. 3. The exchange period is generally 180 days after the transfer is made. Section 1031(a) applies only to exchanges for like kind property. 2. Non-simultaneous exchanges have been scrutinized by Congress and provisions have been made to narrow the availability of 1031 treatment in cases of non-simultaneous exchanges. 1. Section 1031 applies to both losses and gains and is non-elective. D. 5. the amount of the liability is treated as cash boot received by the transferor in the transaction. the IRS uses the familiar substance over form argument in attempts to invoke the non-recognition of losses in transactions involving the exchange of property C. Section 1031(a)(3) allows an outright transfer but limits the taxpayer to relatively short periods of time within which to identify and receive like kind property. If the requirements of 1031 are met the Section applies automatically. a. 1. a. Section 1031 does not apply if property is sold for money and the proceeds are invested in property of a like kind. a. The IRS recognizes the use of three-cornered exchanges. The identification period is generally 45 days after the taxpayer transfers the property that is relinquished. which use a combination of Section 1031 and other tax neutralizing factors to effectuate a transaction. Section 1031 (b) or (c) may apply to exchanges for like kind property involving cash or non like kind property in the form of boot. 4. b. If the property exchanged is subject to a liability. 2. Three-cornered exchanges are sometimes used by taxpayers to avoid adverse tax consequences. . Occasionally. Section 1031 is accompanied by an exchanged basis provision and a tacked holding period. Issues arising under Section 1031 1. E. the amount of liabilities on both are offset against one another and any excess relief is treated as boot to the receiver. If both properties in the exchange are encumbered.

and one piece is involuntarily converted. The test for whether property is similar or related in use to the converted property centers on an inquiry as to the relationship of the taxpayer to the properties involved. The IRS will examine the physical properties and the end uses to which the properties are put. When two pieces of property are used together and constitute one economic unit. v. . Masser. The courts and the IRS have disagreed as to the degree of consideration that should be given to the investment character of the properties involved. Clifton Investment Co. to decide if the properties are similar or related in use. Co. in addition to other factors. Harry G. seizure. If there is a material alteration in the relationship of the taxpayer to the replacement property versus the original property. 1. Section 1033 provides for the nonrecognition of gain in certain circumstances where property has been involuntarily converted. C. Involuntary Conversions A. 2. The taxpayer must purchase replacement property that is "similar or related in use" to the converted property and must do so within the time period mandated by the section in order to qualify for nonrecognition of gain. Commissioner. theft. Section 1033 is an elective provision that allows the taxpayer to recognize gain on an involuntary conversion of property only to the extent that the amount realized exceeds the cost of replacement property. or by the sale of the property as a result of the threat or imminence of requisition or condemnation. they will ordinarily be considered properties similar or related in use for purposes of Section 1031. a. Revenue Ruling 76319. b. An involuntary conversion may occur as a result of total destruction. If the properties require the same sorts of management and services to be rendered by the owner and have similar business risks associated with them. the properties will not generally be considered similar or related in use. v. 4.II. 1. 3. the IRS has considered the other piece to have been involuntarily converted also. B. The taxpayer is only taxed on a gain if the cost of the replacement property is lower than the amount received for the involuntary conversion. D. Clifton Inv. reclamation. The section allows the taxpayer to take the monetary proceeds of the involuntary conversion and buy replacement property with those proceeds. Commissioner. and replacement property bought with the proceeds of the involuntary conversion plus the sale of the other property have qualified for nonrecognition under Section 1033. requisition or condemnation.

Exchanges of some United States obligations for other such obligations can be accorded nonrecognition in the proper circumstances. A transfer of property to a new corporation in exchange for its shares. the character is not controlling. Non-Recognition: § 1031 & 1033 Like Kind Exchanges: Permits exchange of appreciated property for other property with deferment of tax AB 10 FMV 100 Exchanged for like property with same FMV – carry forward old basis of 10 – gain lurks until you sell the second property . 2. A. There are several other nonrecognition provisions in the Code. The IRS also considers the investment character of the properties involved to be pertinent to the determination of whether the properties are similar or related in use. III. Certain investments in specialized small business investment companies qualify for nonrecognition under Section 1044 of the IRC. Revenue Ruling 71-41. 3. B. 2. Non-corporate and non-business nonrecognition provisions: 1. 4. 3. Corporate and business nonrecognition examples: 1. Some exchanges of life insurance or annuity contracts qualify for non-recognition. There are several different types of corporate reorganizations involving transfers of stock that result in nonrecognition for both the corporation and the shareholders involved. however. there is and a tacked holding period usually applies.5. With respect to most of these nonrecognition provisions. or a transfer of property to a partnership in exchange for a partnership interest is generally subject to nonrecognition. Some partnership distributions and some liquidation distributions are subject to nonrecognition.

narrower – o Gold ingots and silver ingots are not like kind o Livestock of different sexes are not like kind o Computer is not like kind to a desk (but may be for a printer) o Car exchanged for a truck does not qualify ..Heavy construction equipment exchanges likely will qualify Intangibles: Securities can never be like kind exchanges (Stock for Stock) Mechanics of like kind exchange: Property A ab 10 fmv 100 Property B ab 10 fmv 125 Exchange thru C Cash is called boot – if you receive cash. like kind is stricter. because B is only worth 80: New Basis = carry over + gain recognized – boot rec’d 10 = 10 + 20 – 20 . you are taxed on the gain A has 25 more of basis on property B after the exchange – 35 of basis If A gets cash.Requires an actual barter/ exchange – can’t just sell property A for cash and then buy property B What is like kind? Property has to be held for business or investment (both properties) AND Like kind is broad when considering land – hotel in NY is like kind to mineral rights in CO if mineral rights in CO are considered an interest in real property (Lease of 30 years or longer is also an interest in land which would qualify for a like-kind exchange) For other tangible property.

One more problem: Delayed transfer A wants to exchange to defer gain. his promise/contract to buy B once A finds it and exchanging with A There are time limits: A has to identify property B within 90 days and the exchange must occur within 180 days of the first transfer Property Which is condemned or destroyed: § 1033: If tax gain is due to condemnation or destruction. it will be allowed because the owner’s relationship to the property is the same (passive lessor) - question 5 on exam question 1 on exam: 2million grandfathered debt + another 100. no good – Other Rulings: Looks not at end use to see if it is similar or related in service or use but to the relationship of the owner to the property – owner was not owner of the property but leased out the property to tenant/mgr who really runs the business – owner just collects lease check – if pool parlor burns down and owner rebuilds and leases to another type of business.000 of home equity indebtedness . tax can be delayed provided you replace the property within 2 years (even if you get cash) – must be similar or related in service or use (construed extremely narrowly) rulings in book: pool parlor replaced by bowling alley. so looks for buyer C who wants to buy immediately but A hasn’t found B property yet A transfers to C and receives only from C. no good – office building replaced by hotel.

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