Income

A. Gross Income

1. Economists’ concept – Haig-Simons

a. Imputed income

b. Accretion in value (Glenshaw Glass)

2. Tax Law concept

GROSS INCOME

- § 62 decductions

= adjusted gross income

- personal exemptions $ deduction (standard or itemized)

= taxable income

x tax rate

= gross tax liability

- credits

= net tax liability or refund

a. Realization requirement – 1001(a) (see timing)

Policy justifications:

1) hard to measure

2) may not have cash on hand

3) still faces risk of loss if subseq decline in value – nature of investment has not changed

4) mobility of capital

Eisner v Macomber - while not constl req as in this case, embedded in tax code that we do not tax unrealized gainst in prop values – tax “transactions” or “taxable events” – realization

Helvering v Bruun - realization of gain need not be in cash derived from the sale of an asset. Gain may occur as a result of exchange of property, payment of the taxpayer's indebtedness, relief from a liability, or other profit realized from the completion of a transaction. Therefore, improvements to a leased property are recognized income (though this specifically later superceded by § 109).

Hort v Com’r – amt received for cancellation of the lease must be included in gross income – substitute for rental payments specifically identified by 61(a)(5) as income 0 no “carved-out interest”

Woodsam Associates (2nd Cir) – pet argued that her debt refinancing, going from recourse to nonrecourse, shd have been taxable event and so no later basis readjustment – augmenting existing mort indebtedness not “disposed” in 1001(a), so gain postponed until later sale

Cottage Savings – taxpayer swapped interests w/o another financial portfolio to realize loss – SC said “material difference” is test of realization but fact that they were econ subs or equivalents does not mean it fails – different homes, borrowers, legally distinct entitlements

Short Sales - § 1259 – “constructive sale of an appreciated financial position” – even if borrowing/shifting accomplished – regs allowed to police

Specific listed 1259(c)(1)(A – D)

Of if he has taken part in 1 or more transactions with “substantially the same effect as” those listed 1259(c)(1)(E)

b. Receipt of economic benefit Old Colony

1) not borrowing – 61(a)(12)

2) illegal gains included

James v US – embezzled funds inc to embezzler

Gilbert v Com’r – but embezzler, who intends to repay, believes will be approved, makes assignment, does not constitute income – acknowledged req to repay

3) rebate of puchase price not, just reducition on price

4) damages – not if just to make plaintiff whole Glensahaw Glass

B. Examples of gross income

1. Compensation for services 61(a)(1) – gross income

a. payments in kind Smith

b. Bargain-purchase Regs 1.61-2(d)(2)(i)

c. Compensation w/o receipt of cash or property – Old Colony Trust – even if paid to

d. Excessive compensation

e. Fringe Benefits

1) In general

2) no additional cost services 132(a)(1)()

Income

General

61(a) – “all income from whatever source derived” – wages, interest but “not limited to” these

Eisner v. Macomber (1920) – “gain derived from capital, from labor, or both combined” SINCE CLARIFIED that this is not limited

Commissioner v. Glenshaw Glass (1955) – “Congress applied no limitations as to the source of taxable receipts, nor restrictive labels as to their nature” ... “accession to wealth”, “realized”

Haig-Simons: (1) mkt value of rights exercised in consumption + (2) change in value of the store of property rights

Specifically included in Gross Income by statute

§61(a)(1): Compensation for Services

§61(a)(2): Income derived from business

Dealing in Property 61(a)(3) – “gains from dealing in property” – amt realized over adjusted basis in prop 1001(a)

Basis

Usually Cost Basis – 1012 – cash paid and other costs of acquiring (broker, etc) - e

Deferred payment – amt party pays at time or agrees to pay in the future, not incluing interest

Exchanges of property

Amt realized for prop given up is FMV of prop received 1001(b)

“Tax cost” basis – FMV of property received (even if no payment made in exchange)

Acquired from a decendent –

FMV of property at decedent’s death 1014 – “stepped-up basis”- appreciation of value during decedent’s life evades tax

Effect is to encourage people to hold on to appreciate prop until gift

Test of estate inclusion – if includible in decedent’s gross estate for purposes of estate tax 1014(b)

Exceptions from estate tax apply 1014(a)(2), (3)

Community Property – only 1/2 included in deceased spouse’s gross estate, but 1014(b)(6) treats remaining share as though it is acquired from decedent – giving spouse stepped-up basis

Death’s door – FIND THIS

1014(e) – to stop abuse – if acquired by gift w/in year of death and passes back to initial donor, no stepped-up basis, instead transferred basis equal to donor’s basis

Acquired via gift – “transferred basis” – adjusted basis is the same as in the hands of the donee 1015(1)

Taft v Bowers (1929) – yes gift of stock’s value counts

Exception for losses – 1015(a) - to avoid transferring loss to someone else, do not apply transferred basis, instead consider FMV at time of gift if:

Donor’s adjusted basis is greater than FMV as of date of gift AND

Donee disposes of prop at a loss

SPLIT BASIS:

for gains, used transferred basis

for losses, FMV at time of the gift

(could be bracket in between – no consequences of sale)

Effect of gift tax – gift tax and income tax only overlap to the “net appreciation in the value of the gift” – 1015(d)(6) – increase to basis = tax paid x (FMV of gift – donor’s basis / FMV gift)

Part gift/part sale

Bargain sale to charity 1011(b)

So 1011(b) – transferor in bargain sale to charity must apportion basis between “sale” and “gift” portions: “gain” basis = adj basis x (amt realized / prop’s FMV)

Generally, no gain/loss if prop transferred for consideration = adj basis, and if prop is transferred to charity, transfeor enitle to ded = FMV – consideration received §170 - So without 1011(b), this would ordinarily permit prop to be transferred to charit in return for consideration up to amt of adj basis w/o transferor realizing any gain but recieiving benefit of ded, and unrealized appreciation never taxable

Acquired from spouse – treated as gift – value excluded from income – basis is as in hands of transferor – gift basis rules tdo not apply

Adjustments to basis/depreciation – 1016

** CHECK THIS - ONLY for things subject to wear/tear, utilized in trade/bus or held in investment

Increases – 1016(a)(1) – by cost of cap improvements

Generally

Benefit to count these

Reductions – greater of amt taken or allowable 1016(a)(2)

ACRS (accelerated cost recvery system) – depreciation - §168

Take a deduction each year in the amt ACRS, and adjust basis accordingly

168 (c), (e), (f), (g) explain how quickly different types of assets depreciate

Apportionment of basis – normally basis applied to all prop, but later trans make make it necy to apportion – normal rule is to apportion

Inaja Land Co – if impossible to determine, taxpayer permitted to treat entire amt received for easement as recovery of capital (perhaps influenced by involuntariness and valuation difficulty)

Uniform Basis Rule 1.1014-4, 1.1015-1(b) – covered?

Personal Use Property converted to business – lower of its cost basis or date-of-conversion FMV 1.165-9(b)(2) – H#6

Amount Realized – amt realized over adjusted basis – 1001(a)

FMV of consideration received – included in amt realized

Crane v Com’r - Includes receipt of services and other liabilities including being relieved of a liability – nonrecourse or recourse

Selling expenses – reduce amt realized

Apportionment – if several items sold for liump sum

Mixed motive transactions – discepency between sale price and FMV disregarded unless made for other reason

Role of liabilities – if prop encumbered by liability disposed of, amt of liability is included in amt realized – value or property

Crane v. Comm’r – if transferring prop & seller assumes liability – buyer realizes price + liability – same result if byer merely takes property subject to mortgage rather than assuming it

Comm’r v Tufts – prop w/ FMV of 9k but encumbered by nonrecourse mortgage of 10k – transferred subject to the mortgage – seller’s amt realized is still 10k – onligation to pay relieved – recourse and nonrecourse the same

Depreciation of (ACRS) –

Realized gain vs recognized gain – 1001(c) – entire amt is to be recognized

Not recovery of capital

Allocation of cost sometime

Prizes and Awards 74(a) – unless

117 Qualified scholarship – (SEE EDUCATiONAL BELOW)

to extent it was used for tuition/books/fees

but NOT if payment for services (teaching etc)

threshold inquiry: compensation for employment, or paid to enable studies or research that benefits grantor 1.117-4(c)

tuition and fees, books supplies and equipment, not meals, lodging, laundry, travel 117(b)

Rev. Reg 77-264 – IRS has never tried to treat athletic scholarships as income

74(b) “Achievement” award and:

(1) didn’t enter contest

(2) not required to render services

(3) transferred to charity

74(c), 274(j) Employee achievement awards to the extent the cost of providing does not exceed amt deductible by employer

tangible pers property transferred as part of a meaningful presentation in recognition of length of service or safety achievement, but not disguised compensation 274(j)(3)

Alimony and Separate Maintenance Payments - §§ 61(a)(8), 71(a), 215(a) (w/ deduction available to paying spouse)

Annuities – §61(a)(9), 72(a)

Exception that permits recip to exclude from inc the portion of annity payments rec’d which is attributable to his cost of purchasing the annuity – exclusion ratio under term - 72(b)

Dividends – 61(a)(7)

Discharge of Indebtedness 61(a)(12), unless insolvent/bankrupt

§85: unemployment

Regs §1.61-14 Punitive Damages (even if based in physical injury)

Not Included in Gross Income

Family

Child Support – not treated as alimony to extent it’s fixed as amt payable for child support - § 71(c) – no ded, no inc

“fixed” if it would be reduced on contingency (child’s age, marrying, dying) “clearly associated” § 71(c)(2)

Diez-Argulles – can’t deduct value of child support payments owed but not paid

Gifts and Inheritances

102(a) – excludes value of property acquired by gift

Duberstein - retiree – trier of fact determines dominant reason was out of affection, respect, admiration, charity or like umplueses, or from detached and disinterested gneresity

BAD LAW NOW – at least wrt to because employer/employee now limited by 102(c)??

US v Harris – widower’s companions – entitled to treat cash from lover as gift as long as something more than payments for specific sessions of sex – donor’s intent critical consideration (wha117 tever donee thought)

Between spouses, assumed gift 1041(b)(1)

Tips aren’t gifts (1.51-2(a)(1)), nor craps dealer payments (Olk)

$10,000 limit to same person in year (estate tax)

102(c) – employer-employee gifts not excludible

274(b) - can deduct only the first $25 of any business gift – once per year, per relationship - so that payments treated by payees as exempt cannot be deducted as business expenses by payors

Does not apply to prizes, awards or scholarships

Turner v Commissioner - cruise to South America – “the court under such circumstances must arrive at some figure and has done so”

Barry Bonds ball – won’t be taxed, as when immediately decline a prize

102(a) – bequest, devise or inheritance

Transfer between spouses or incident to divorce - § 1051(a) – no gain or loss recognized

Future Savings

Int on State and Local Bonds – does not include int received wrt onligs issued by or on behalf of state and local govts 103(a)

“Political subdivisions”

Not fed bonds

EXCEPTIONS – these two included in income:

Pvt Activity Bond which is not a qualified bond (used by pvt nongovt agents) 103(b)(1) - unless in one of 7 specific categories (141(e))

Arbitrage bond 103(b)(2) – proceeds reasonably expected to be used by st or local govts to acquire higher yielding investments

Registration requirement – bonds w/ maturity of 1 yr or more must be in registered form for exclusion to apply 103(b)(3)

§ 402 – qualified deferred compensation plan –

employees not req’d to include until receive payments (401(k))

employers enitled to deduction for amts paid

earnings on funds paid into it and invested not taxed

Roth 401(k) – employee taxed on amts paid into, but distribs tax-free

BUT may not discriminate – comp benefits to all employees

BUT § 83(a) - Special rules for prop (such as corp stock), subject to restriction or risk of forfeiture – inc = excess of FMV at time of transferrable over amt paid

CASE – Minor?

§ 83(b) – employee may elect to include FMV – amt paid at the time of transfer, rather than waiting until prop becomes transferrable

IRAs - § 408 –

5k year may be set aside, and claimed as a deduction

includible when paid out

Roth IRA - § 408A –

Non deduction when paid in

But no income when paid out

Gross inc must be below 150k

Portion of annuities – 72(a)

Exception that permits recip to exclude from inc the portion of annity payments rec’d which is attributable to his cost of purchasing the annuity – exclusion ratio under term - 72(b)

Unpleasant

Life Insurance Payouts – 101(1)(a)

Including “savings element” – incentivizing it as savings vehicle – with certain limits:

BUT 264(a)(2) – int paid on indebtedness incurred or continued to purchase or carry a single premium life ins, endowment or annuity K

254(a)(1) – deny deduction for corp buying 1-year term ins for employee with itself as beneficiary

Only benefits paid “by reason of the death of the insured”, not other (cash-in)

Good deal if you die, lose the money if you

Terminally and chronically ill count 101(g)(1)

Installment payments

Lump sum or payments both excludible 101(a)(1)

But only date-of-death PV of later payments excludible – 101(d)(1) – exclude principal, but later earnings taxable

But if ins co retains principal, and benefic received primarily interest, then int 101(d) doesn’t apply and full amt excluduble – 101()c)

Transfer of Policy for Valuable consideration

Generally no exclusion 101(a)(2)

Two exceptions 101(a)(2)(A), (B):

1) transferee has transferred basis in the policy

2) if transferee is the insured, partner, in partnership with, or corp in which ins is shareholder/officer

Ins provided by employer – see sec 79 (up to 50k)

Annuities

Multiply each payment is exclusion ratio = investment in the K / expected return under K 72(b)(1)

Investment in K generally amt of premiums paid 72(c)(1)

72(c)(3) expectued return – multiply amt of payments by:

number of payments called for under K or

if it’s indefinite, acturarial value Regs §1.72, Table V

If tpayer Outlives vs. underlive:

Total amt limited by investment in annuity K 72(B)(2) and (4)

If death before payments received equaling investment, then deduction allowed for unrecovered amt 72(B)(3), (4)

Compensation for Injuries or Sickness or Damages

Generally:

Damage for lost business profits, liquidated damages for breach of K, punitive damages taxable (all would have been taxed anyway)

“making the plaintiff whole” for loss not income if does not exceed adjusted basis in damaged property

damage to good will? Might be basis in that? §197

no basis in things you created (like personal good will) §197(c)(2)(B)

104 - Compensation for injuries or sickness excluded unless recipient has taken deduction on acct of same medical expenses (viA §213, BELOW), from:

Workmen’s Comp – 104(a)(1)

Also certain govt employees and retired armed forces personnel 104(a)(4), (5)

Personal physical injuries

Includes emotional distress if it had its origin on physical injury/sickness 104(a)

Emotional distress alone not enough, but it is to extent of the amt paid for med care attributable 104(a)

But not punitive damages Glenshaw Glass, 104(a)(2)

Recoveries made under accident or health insurance excludable 104(a)(3), unlimited, unless made to an employee either:

By the employer OR

Under a plan to which the employer made contributions excluded from income under 106

But then they may qualify for exclusion under 105

“whether as a lump sum or periodic payments” 104(a)(2) – nontaxation of interest component creates incentive for tort victims to structure settlements

106 – payments for and recoveries under employer-provided accident/health plans excludible by employee to the extent that tey exceed 7.5% of adjusted gross income (213)

self-employed inds generally not considered employees 105(g)

Amounts spent for medical care – amts required to be included by 105(a) excluded under 105(b) to the extent thay are paid to reimburse employee for med exepenses incurrent for self, spouse & dependents

Does not apply if employee has taken deduction in any prior year or if am recived is in excess of med expenses

If emp receives a recovery which qualifies for exclusion under 105(b), and receives a recovery qualifying for exclusion uner 104(a)(3), allocation of expenses incurred must be made to determine amt excludible

Payments unrelated to absence from work – amts included by 105(a) may be excluded 105(c) to extent payment for perm loss of limb/disfigurement of emp/sp/dep

Discharge of Indebtedness 61(a)(12) – loan proceeds are not included, but discharge of indebtedness is:

US v Kirby Lumber Co – KL borrowed $12m, wasn’t inc bec had obligation to repay, but when they later were able to buy up outstanding bonds for $10m , had to pay tax on $2m in income

Gilbert v Com’r – but embezzler, who intends to repay, believes will be approved, makes assignment, does not constitute income – acknowledged req to repay

Nonrecourse loan to acquire/improve prop - not inc, added to basis

Crane v. Comm’r – if transferring prop & seller assumes liability – buyer realizes price + liability – same result if byer merely takes property subject to mortgage rather than assuming it

Comm’r v Tufts – prop w/ FMV of 9k but encumbered by nonrecourse mortgage of 10k – transferred subject to the mortgage – seller’s amt realized is still 10k

Regs §1.0001-2(a), (c): Nonrecourse loan to acquire/improve prop: “bifurcated approach”

1) Debt discharge is incuded in amt realized on proper up to FMV of prop

2) any additional discharge recognized inc

EXCEPTION – NOT INCOME IF:

Bankruptcy and Insolvency – not income if discharge if occurs in bankruptcy or to extent taxpayer is insolvent – 108(a)(1)(A), (B) – applies to extent that liabilities exceed FMV of assets immediately prior to discharge

Reduction of Tax Attributes – if all goes well and taxpayer has profits - 108(B)(1) if income excluded under bankruptcy/insolvency, various tax attributes must be reduced by amt so excluded 106(B)(2):

1) NOL

2) certain tax credit carryovers

3) capital loss carryovers

4) adj basis if property

5) passive activity loss & credit carryovers

6) foreign tax credit carryovers

OR as alt, may elect to first reduce basis of depreciable prop and real prop inventory 108(b)(5)

Reduction of Basis – if basis required to be reduced under 108, special rules of 1017 must be applied to effect the reduction in the basis of prop which the taxpayer holds at the beginning of the taxable yr following yr in which discharge occurs

Solvency or Partial Solvency – income included except to extent taxpayer is insolvent, but some other exceptions:

1) Purchase Price Agreement – if indebtedness arising out of purchase of property is reduced/discharged by seller, reduction is treated as reduction in purchase price of property rather than income 108(3)(5) (cost basis also reduced)

2) Gratuitious Debt Forgiveness – cancellation that constitutes gift/bequest not included

3) Equity for Debt 108(e)(8)

4) Student Loans discharge not included if bec of work fo period of time in certain professions 108(f)

But does not apply to loans made by certain insts if on acct of services performed by such services 108(f)(3)

5) Qualified Farm Indebtedness – though subject to reduction of tax attributes rules above 108(a)(1)(C)

6) Qualified Real Property Business Indebtedness – cancellation of debt incurred in acquisition or improvement of real prop used in trade/bus – discharge may be excluded

7) mortgage forgiveness – 108(h) – up to 2m of qualified principal residence indebtedness when lender foreclose on taxpayer’s principal residence

Welfare not included

“workfare” also if:

received directly from welfare agency

need-based, funded entirely by TANF

size of payment determined by welfare law, and hours worked limited

§86: social sec excludible depending upon income

§123: ins receipts for “extraordinary costs” excludible insofar its used to cover living expenses that she wdn’t have incurred if not for calamity

Pleasant

Achievement Awards 74(b) – WHEN

74(b) “Achievement” award and:

(1) didn’t enter contest

(2) not required to render services

(3) transferred to charity

74(c), 274(j) Employee achievement awards to the extent the cost of providing does not exceed amt deductible by employer

tangible pers property transferred as part of a meaningful presentation in recognition of length of service or safety achievement, but not disguised compensation 274(j)(3)

117 Qualified scholarship – (SEE EDUCATiONAL BELOW)

to extent it was used for tuition/books/fees

but NOT if payment for services (teaching etc)

threshold inquiry: compensation for employment, or paid to enable studies or research that benefits grantor 1.117-4(c)

tuition and fees, books supplies and equipment, not meals, lodging, laundry, travel 117(b)

Rev. Reg 77-264 – IRS has never tried to treat athletic scholarships as income

Educational

117(a) qualified scholarships

threshold inquiry: not compensation for employment, or paid to enable studies or research that benefits grantor 1.117-4(c)

tuition and fees, books supplies and equipment, not meals, lodging, laundry, travel 117(b)

Rev. Reg 77-264 – IRS has never tried to treat athletic scholarships as income

117(d) qualified tuition reduction – provided to employee of an education inst (below grad level)

117(d)(5) – special rule for grad students teaching or researching

117(d)(2)(B) – also to spouse, dependent and in some cases surviving spouse

117(d)(3) – may not discrim in favor of highly compensated employee

§111: recovery of tax loss

Clark v Commissioner – tax counsel cost customer money and then repaid it – not obligated to report as income

§121: Sale of Principal Residence

Gain excluded if owned by taxpayer and used as principal res for periods totaling 2 yrs during 5 yrs before disposition 121(a)

But if acquired in a like-kind exchange, must be held at least a full 5 yrs 121(d)(10)

Principal residence - if more than one, only principal applies – depends on all facts & circums – gf

Two limitations:

Max excludible is 250k, or 500k for spouses filing jt return if either spouse meets ownership test and both spouses meet use test

Can only use once every 2 years – 121(b)(3)

Limited exclusion for those who do not satisfy 2-yr ownership and use tests – if bec of change in place of employment, health or other unfioreseen circums 121(c)(1)

Multiply 121(a) exclusion amt (250 or 500)

By fraction – denominator is 2 years, numerator is shorter of:

Time period since 121(a) was applied to a previous sale

Time period house was owned and used as a principal residence

Recognition of gain attributable to depreciation – if used for inc-producing purposes, must include gain from sale of property to the extent of the depreciation deductions taken after 5/6/97 121(d)(6)

If acquired in a like-kind exchange (per 1031), exclusion will not apply unless prp is helf for a full yrs 121(d)(10)

Loss on sale correspondingly can’t be deducted bec it’s personal expense – some specific rules if it were used as inc-producing property ...

§1202: sale of qualified stock

Work

106(a) – health insurance paid for by employer excluded

Meals and Lodging Furnished to Employees 119(a) – “for the convenience of the employer” “his spouse or any of his dependents”

Meals

On the business premises

For the convenience of the employer

Substantial noncompensatory business purpose – 1.119-1

Not reimbursements (probably not groceries) Kowalski

If lodging provided, meals excluded

119(b)(2) – fact that charge is made, and employee may accept or decline, not taken into account

BUT reg 1,11801(a)(3)(i)?

119(b)(3) – excludible in the amount of fixed charge?

Lodging

On the business premises

“as a condition of his employment” 119(a)(2) – surplusage?

Benaglia – hotel manager (over dissent which noted that he had called it part of his compensation)

Certain Fringe Benefits - 132

132(a)(1), (b) – no additional cost services

132(b)(1) offered in the ordinary course of the line of business AND

132(b)(2) no substantial additional cost

132(a)(2), (c) – qualified employee discount

Property – limited to “gross profit percentage” – avg markup – 132(c)(1)(A), (2), (4)

Services – may not exceed 20% of price at which services offered in ordinary course of business 132(C)(1)(B)

132(a)(3), 132(d) – working condition fringes (company car) – to extent would be entitled to deduction if employee purchased

132(a)(4), 132(e)(1) – de minimis fringes - impracticable

132(e)(2) – extends to certain eating facilities even if otherwise exempt if located on or near bus prem & price charge is > or = costs of operating

Reg 1.132-6(d) – special rules – but must be OCCASIONAL, not if it’s routine

132(a)(5) qualified transportation fringe

between residence and place of employment 132(f)(2)(A)

up to $100/month – aggregate of:

commuter highway vehicle OR

seats at least six adults

used 80% of mileage to transport res -> work or transport at least 3 on bus-related trips

transit pass

qualified parking 132(f)(1)(C)

$175/month, inflation adjusted

on or near bus prem, or place where commute via transit pass, commveh or carpool

limitations

132(f)(4) – if choice between fringe or cash, income only if chooses cash

132(f)(3) – reimbursements qualify, but

132(a)(6) – qualified moving expense reimbursement - to the extent would have been deductible

132(a)(7) – qualified retirement planning services – advice, but not related services

132(j)(4) – on-premises athletic facilities – operated by emp, substantially all use by employees

Additional Considerations:

Nondiscrimination rules - 132(e)(2), (j)(1), can’t discriminate towards highly compensated employees with:

No-additional cost fringes

Employee discounts

Employer provided eating facilities

Expanded definition of employee for:

No-additional cost fringes

Employee discounts

Athletic facilities

For those, employee includes:

Spouse

Dependent children

Parents (in limited sits)

Former emps separated by retirement or disability

Widows and widowers of inds who died while employed, retired or disabled

Corp jet flights – if 50% or more employees, other family member hangers-on free - Regs

Valuation – Regs 1.161-21, 1.132-1 to -8, “fair market value,” – “safe harbor” values (1.61-21).

125 – cafeteria plans – choose whether to take noncash benefits or cash – authorized but

limited to:

group-term life insurance (up to 25k)

§129: DCAP (dep care assistance program) - permits emp to make up to 5k available for child-care expense through DCAP – as part of 125 cafeteria plan – but have to choose between this and §21 credit - tax-planning choice

adoption assistance

excludable accident and health benefits

elective contributions to 401k

use-it-or lose-it 125(d)(2)(A) – if you take the benefit and don’t use all of it, it’s lost – cant be paid out or carried forward

2002-10 IRB 621 – frequent flyer miles – just gave in

§129: DCAP (dep care assistance program) –

permits emp to make up to 5k available for child-care expense through DCAP – as part of 125 cafeteria plan – but have to choose between this and §21 credit - tax-planning choice

BUT LIKE §21, must be necy for gainful employment

§21(d)(2): Spouse students count for period full-time

Group-Term Life Ins Purchased for Employees – employee may exclude up to 50k- 79a

Personal Deductions, Exemptions, Credits

Profit-Related Deductions and Allowances

Trade and Business Expenses §162?!?(a), (b) §162:

1!) “ordinary and necessary” – usually means good bus purpose

Welch v Helvering (US, 1933) – atty’s fees to defend lawsuit is common and accepted in bus cmty, even though had never happened to this particular def – BUT paying off the debts of company taking over found not ord/necy – not clear why, it was pretty ordinary, and

Moss v. Com’r (Posner) – regular coordination meeting at Café Angelo – every right to insist it be a real bus necessity – meal itself was not an organic part of the meeting

Danville (8th Cir) – super bowl trip doesn’t count – common & accepted –

Gilliam v. Com’r – denied ded for civil settlement from flipping out on an airplane while traveling for work

2)! Current “expenses,” not cap expenditures – no ded for cap expenditure at time (though may give rise to deds for depreciation or amoritization at a later time)

capital expenditures vs. repairs

Regs. § 1.263(a)-2: CEs include costs of acquiring or constructing bldgs, machinery, equipment and other tangible or intangible prop which has a useful life substantially beyond the taxable year

Encyclopedia Brittannica (7th Cir 1982) – where inc is generated over a period of years, shd be capital – out of normal method of doing bus –

Rev. Ruling 94-38 – groundwater treatment facilities useful life beyond construction – must be capitizalied -

Reg. §1.162-6: BUT some items which have short life or small cost may be ded’le

§1016(a)(1): Amt added to the basis of prop

Regs. §1.263(a)-1(b): CE also include amts which add to the value of property, substantially prolong useful life, or adapt property to different use

Mt. Morris Drive-In (TC 1955) – drainage system necy for operation of drive-in – at time theater constructed, obvious drainage system would be required, so cap investment incomplete until added – did not merely restore, created a new cap asset

ER: don’t know from these opinions how much he foreseeability might factor in – my sense is that it doesn’t – “thing that is distinct from other thing” is capitalization

Rev. Rul. 94-38 – soil remeditation and ongoing groundwater treatment did not produce perm improvements -

ER: “thing that is distinct from the other thing”

Regs § 1.162-4: repair merely keeps prop in ordinarily efficient operating condition – take ded and do not change basis

Midland Empire Packing Co. (TC 1950) – expenditure to oilproof basement does not add to value or prolong life, merely keeps in ord working order

Intangible property must also be capitalized if provide significant benefits which extend beyond year

INDOPCO, Inc. v. Com’r (1992) – exps incurred engaging investment banking firm acquiring another corp – cap expends, because benefits of acquiring corp extend beyond tax year

BUT IRS prefers to use instead Regs § 1.263(a)-4, capitalization required of:

1) amt paid to acquire, create or enhance an intangible asset

2) amt paid to create or facilitate a sep and distinct intangible asset

3) amt paid to create or enhance a future benefit indentified in the Fed Register or Internal Revenue Bulletin

4) amt paid to facilitate acquisition or creation of an intangible asset

Advertising

Reg. § 1.162-1(a): for products and services ded’le

Reg. §1.162-20(a)(2): also, for instl or goodwill – such as ads for Red Cross, etc

Despite the fact that benefits of ads may extend beyond taxable year

However, if medium of the ad material is such that it will have useful life significantly more than one yr – amt may be cap expend

§195: start-up expenditures ded’le:

amts paid investigating creation or acquisition of an existing active trade/bus, which are not ded’le because they violate “carrying on” requirement of §162

limited to amt = lesser of expends, or 5 reduced by amt of expends that exceed 50k for taxable yr

§263A: Uniform Capitalization (UNICAP) rules

ER: what I want you to know is that for large bus (over $10m) – cap’n of salaries and overhead is serious – have to allocate to all of your products – recover costs not immediately but only as you sell

§263A(b): costs of producting inventory and other self-created assets must be capitalizaed

Rev. Rul 94-38 – constructing groundwater treatment facilities = production, so required to cap direct costs and allocable share of indirect

Regs. §1.263A-1(e): costs of producing goods must be added to cost of ivnenvory and deducted when sold

Environmental remeditation costs subjetc to capitalization ... costs incurred to clean up plan must be included in inventory costs

Regs. §1.263A-1(e)(4): marketing, ad costs, costs of exps not related to sale/prpdocution – not required to be capitalized

§263A(b)(2)(B): excluding retailers and wholesalers w/ annual gross receipts less than $10m – also freelancers

“carrying on”

Henderson v. Com’r (TCM 1983) – “sufficient nexus” exps and “carrying on” trade/bus – decorating ofc with plants and print only tangentially, if at all, aided in performance working as Asst AG for St of SC – no evidence either necy or helpful in performing her required svcs

ER: bad decision because ordinarily the courts don’t look all that closely at “ord & necy”

3!) “trade or business” (not personal)

Moller v. U.S. (US, 1983) – investment activity of couple is not a trade/bus (and therefore may not deduct home office via §280A) – relevant considerations are investment intent, nature of inc and frequency of transactions –return on investment was mostly dividends and int, long-term holding of secs, not short-term profits

U.S. v. Gilmore – legal fees expended in divorce proceedings not ded’le, even though necy to protect trade/bus stockholding, because arose from personal (marriage) not from trade/bus

Accardo v. Com’r (7th Cir) – convicted mobsters can deduct costs of defending racketeering lawsuit because part of trade/bus of being criminals, but acquitted ind can’t

though §212 makes available anything incurred in production or collection of inc, or dealing w/ prop held for prod of inc, even if not “trade or bus”

But still relevant to:

§62(a)(1): determining gross inc (before itemizing)

§280A(c)(1)(A): deds to bus use of portions of persona residence

§469: limits on passive inc

§67 – 23% rule

salaries

§162(a)(1): “reasonable” salaries and compensation

Regs §1.162-7(b)(2): reasonable in light of nature/extent of circums, arms’-length

Regs §1.162-7(b)(2): only for “personal sevices actually rendered” (not payment for property, distribution of dividend”

§162(m): limits on deductibility of executive salaries:

if company registered via Sec Exchan Act

only compensation in excess of $1m and to five “covered emps” (CEO & next 4 highest paid)

does not apply to ind commissions, or contingent on pre-existing perf goals

does not apply to contrubs to tax-free retirement plans and excludable things like fronge benefits

§280G: golden parachute restrictions

traveling expenses ded §162(a)(2) – 3 reqs from Flowers, must be:

1) reasonable and necy

§162(a)(2): not if “lavish or extravagant” (rarely enforced)

Regs §1.162: cost of travel itself (tickets, taxis), as well as meals, lodgings, expenses incident to travel (phone calls, sample roms, tips, baggage charges, launry, helpers for handicapped)

Com’r v Flowers – traveling fom Mobile to Jackson – exps are only bec of tp’s desire to live in Jackson, not ded’le

2) incurred while away from home

Hantzis v Com’r – law student traveling NY/Bos – expense shd be the result of bus exigencies

Temp. employment doctrine – allows ded for second home if “temp” – less than yr – if bus connections to both

Hantzis – but this has no application where she has no bus connection to first home!

§162(a): If period away from home exceeds one year, no longer “temp’ly away from home”

(weird case ER told us about from 1st Cir in which he split 6 mos each place – allowed to ded entire 6 mos expenses bec you can only have one tax home)

background principle: duplicating expenses? IRS usually argues that that’s the underlying principle but they haven’t always won on that point

3) incurred in the pursuit of trade/bus –

Regs §1.162-2(b): only if primary reason for trip relates to trade/bus

Rudolph v. U.S. – (though before the statute, and only concurrence discusses it)

overnight rule

Rev. Rul. 75-170, 1975-1 C.B. 60: lodging and meals (50%) only ded’le if tp away long enough to require stop for substantial sleep or rest

US v Correll – traveling salesperson – breakfasts and lunches not allowed

Foreign travel:

§274(c): if travel outside US lasts more than 1 week, or if nobus acts constitute 25% or more of time traveling outside US, only portion of exps ded’le even if primary purpose is trade/bus

Reg. 1.274-4(g)

§274(h): add’l restrictions for conventions in certain foreign locations

Water transportation

§274(m)(1): restirctions for transpo by water/convention, seminar, cruise ship – limited to 2x highes per diem allowance for fed emps travel

§274(h)(2) & (5): does not apply to convention/mtg ON ship, but specific limits

Other persons traveling

§274(m)(3): no ded for spouse, dep or person accompanying

UNLESS also an emp traveling on bona fide bus reasns and expends otherwise deductible

Legislators

§162(a), first sente following subpara 3

§162(h)

National Guard/Reserve

§62(a)(2)(E)

162(p)

Meals

§ 274(k): not if lavish/extravagant or tp not present (rare)

§274(n)(1): limited to 50% of cost (ER: wholly arbitrary figure)

“bona fide bus conversation”

§274(a): unless traveling, treated as ent exp and only ded’le if directly related to or associated with trade/bus

Moss v. Com’r (Posner) – regular coordination meeting at Café Angelo – every right to insist it be a real bus necessity – meal itself was not an organic part of the meeting

Food/bev incurred by traveler also treated as ent exp unless eats alone or with persons who are not bus-connected (and then, only 50% qualifies)

education – ded’le if one of two tests of deductability are satisfied and neither of two tests of nondeductability are violated

tests of deductability (Reg. §1.162-5(a)), EITHER

maintaining or improving skills required by him as an employee (Reg. §1.162-5(c)(1)) OR

Carroll v. Com’r (7th Cir 1969) – police officer can’t deduct costs of courses generally and basically unrelated to duties as a policeman

Krist v. Com’r (2nd Cir 1973) – before additon of §274(m)(2) schoolteacher had tried arguing her six-month travel was education before this section was added – did not bear a direct relationship to improvement of traveler’s particular skills

Ruehmann (TC 1921) – had already passed GA bar in his 2L year – so tried to ded for cost of 3L year and a LLM Year – sharpening his skills as a lawyer – TC ruled he can’t ded 3L bec while he was a bar member, getting a JD was a de facto requirement of working at his firm – but LLM year costs can be deducted

Wassenaar (TC 1979) – couldn’t ded LLM year because, while he had done some legal work, and had passed bar, the kind of work (summer) he did was not substantially the same as t/b of being a lawyer, and he had yet to accept membership in the bar despite passing

meeting requirements of employer or law (Reg. §1.162-5(c)(2))

tests of nondeductibility – must be incurred in trade/bus, so nondeductibilite if either:

minimum educational requirements – if laws, regs, or prof standards require to meet min ed reqs of trade/bus (Reg. §1.162-5(B)(2)(i))

1.212-1(f): bar fees not deductible

OR

qualification for new trade/bus – but rule does not apply if for new duties if w/in same general type of work (Reg. § 1.162-5(b)(3))

Sharon (TC 1976) – no ded for lawyer taking bar prep course in different state

§274(m)(2): travel as education not deductible

Krist v. Com’r (2nd Cir 1973) – schoolteacher had tried arguing her six-month travel was education before this section was added – did not bear a direct relationship to improvement of traveler’s particular skills

§222: qualified tuition and related expenses –

incurred by tp, spouse or deps

above the line

tuition and fees required for enrollment or attendance at eligible inst for instruction

max amt ded’le:

4k if inc < 65k alone/130k jt

2k for AGI > 65/130 but < 80/160

none If higher

§222(c)(1) & (2): no ded for exps ded’le under some other provision, for amts allowed as ed credits, and amts excluded under AGI

§222(c)(3), (d)(4) & (d)(5): no ded for ind who may be claimed as dep, to married filing sep returns, or certain nonres aliens

§221: can ded interest on ed loans up to $2500

§529, 530: education IRAs (function like Roth IRAs)

exception to cancellation of debt income for forgiven sch loans in exchange for pub int service

taxes – §164: ded for payment of specifically enumerated st, local and foreign taxes

but NOT for tax paid in connection w/ acquiring and disposing of prop – instead, added to cost basis (if paid by buyer) or subtracted from amt realized (if paid by seller)

`Reg. 1.164-1(a): if not listed in 164, but not disallowed in 275, may be ded if incurred as ord and necy bus expenses

clothing

1) type specifically required as condition of employment

2) not adaptable to general usage

Pevsner v. Com’r (5th Cir) – bec of admin necessity, objective test w/o reference to ind taxpayer’s style – clothes could have been worn, so not ded’le

Practicallspeaking, means it has to be uniform - logo

Nelson v. Com’r (1964 TCM) Ozzie and Harriet can ded – too heavey for use in Southern Cal, wear/tear in poduction, no time to wear clothes off set

3) is not so worn

substantiation requirements

§274(d): specifically disallows deds w/o substantion of amt, time/place, date & description, bus purpose, bus relationship to donee, for

traveling exps

bus gifts

ent exps

bus meals

“listed prop”

autos

cell phones

pers computers

Reg. §1.274-5: specified acceptable substantion

§280F(d)(4): adequate record or evidence

“public policy” exceptions –

Tank Truck Rentals – cant deduct fines

Nonbusiness expenses – “mostly investment related” §212: all ord and necy expenses (w/ similar principles as §163 – 2?!?):

§212(1) for production or collection of inc

Reg §1.183-2(b): primary purpose – tp bears burden of proving bona fie expectation of realizing profit, even regardless of reasonableeness of expectation – factors:

Nickerson v Com’r (7th Cir) – need only prove operated farm w/ epectation would later reap profit, not just from current level of act but eventually

U.S. v. Gilmore (US, Harlan) – legal fees – turns on nature of the claims, not the consequences of a failure to litigate – must arise in connection w/ profit-seeking activities – marriage isn’t, so legal fees defending, not deductible

1) businesslike manner

2) expertise of tp or advisers

3) time and effort

4) expecation that assets uses may appreciate

5) success in similar/dissimilar acts

6) history of inc/losses wrt act

7) amt of occasional profits

8) financial status of tp

9) elements of pers pleasure/rec (not necyly exclusive)

Nickerson – absence of alt explanation for to’s actions in renovating farms

Regs 1.212-1(b): may be dedle even though inc not realized in same yr as expense paid

Regs 1.212-1(k):

inc = rents, divs, int, alimony and other current recepits, and inc from disp of prop –

expenses protecting one’s rights to prop or inc, as heir or beneficiary = cap expend, not dedle

§212(3): atty’s fees incident to cdiveroce generally nonded’le, may be to extent attributable to obtaining alimony or are related to tax advice

§1.212-1(f): job-seeking expenses not allowed

EXCEPT WHEN REIMBURSED by potential employer – due to obscure Rev. Rul. – which seems to be based in the fact there is less of a concern about abuse, as with someone gallivanting off the Hawaii and claiming it’s to find a job

Whitten v Com’r (TC Memo, 1995) – losses incurred wrt appearance on Wheel of Fortune at best misc itemized deds

§212(2) for management of property held for production of inc

Regs § 1.212-1(b): even if prop not currently producing inc or unlikely disposed of at a gain

Not for prop held for personal purposes – though can change relationship

§212(3) for dealing w/ tax matters

incurred or paid in connection with “determination, collection or refund” of ANY tax

misc. itemized deds,- only for itemizers

subject to§67 2%/AGI limit

added back for AMT purposes

Losses

Generally, deduction allowed for any loss sustained during a taxable yr not compensated for by insurance of otherwise 165(a)

§ 165(c) - Inds may take deds only for losses:

incurred in a trade or bus

incurred in trans enter into for profit

generates receipts that iares included in income

Gervitz – intitially planned to rent it, then decided to live in it – claime had always been motivated by profit but denied – treated as personal

Weir – owne shares in apt bldg, but was himself a tenant – ded’le bec his capital was being used to generate inc

certain casualty losses

Regs §1.165-9(a) – loss on sale of principal residence not deductible -

Amount of Loss – excess of adjusted basis of prop over amt realized 1001(a)

If there is no realization event (ie damages by fire), amt is lesser of difference in FMV or adj basis – 165(b)

Reg. §1.165-1(c): Loss deduction capped at adjusted basis – it’s the decline in value or the adjusted basis, whichever is lower

Reg. §1.165-7(b): however, if prop is totally destroyed in casualty loss, can deduct full amt of adj basis even if it’s greater than

If converted from pers to bus use , and if FMV is less than adj basis on date of conversion, loss is limited to FMV of prop Reg. § 1.165-7(a)(5))

Classification of Losses

Trade/Bus (using concepts in §162) – ded’le

Demolition Losses

Gambling Losses – limited to extent of gains from gambling during taxable year 165(d)

SUBSTANTIATION REQUIREMENTS

ATL IF PROF GAMBLER

BTL OTHERWISE, BUT NOT LIMITED BY §67

§165(c)(2): Trans entered into for profit – ded’le

§165(g): special rules for worthless securities

§165(j): registration requirement

§165(c)(3) - Personal casualty losses have special rules (see personal losses below)

Bad Debts - §166(a): allowed for any debt which becomes worthless during year

Bona fide debt

Tp burden of demonstrating worthlessless

§166(b): amt of ded limited to adj basis of debt

Special Rules for Business Bad Debts

§165: ded allowed is an ordinary loss

debt which is neiher nonbusiness debt nor a security

§166(a): for ind, allowedf for debt which becomes wholly worthless during yr, or to extent it becomes partially worthless during yr

Special Rules for Nonbusiness debts

§166(d)(2): debt which is debt other than created in connection

§166(d): For inds, must become wholly worthless, and amt is short-term cap loss, ded’le as such

Special Rules for Worthnless Securities (§165(g)

Property

§167(a): Depreciation Deds for prop which by its nature is subject to being exhausted worn out or being obselete (NOT inventory, prop held rforo sale, or used for personal purposes)

§167(c): reference to Cost or other basis

§280F limitations if not used exclusively for bus purposes

over salvage value

Useful life

Amoritization for intangibles

Methods:

Straight-line:

basis – salvage value = depreciable base

1 / useful life = depreciation rae

declining balance (reg. §1.167(b)-2)

sum of the years-digitis

dep allowance limited in total to cost-basis

§168: ACRS

§168(e): recovery period (useful life irrelevant) – use one of 10 classes

3 yr (tools, racehorses)

5 y (computers, trucks, etc)

7r

10 yr

15 yr

207r

Simon – violinist can deduct a collectible bow, which is the sort of thing that degrades even though this one didn’t

salvage value irrelevant – assume zero

“any tangible property”

anti-churning rules between related persons (§168(f)(5))

Special Rules for Personal Property, if used in t/b or held for prod/inc, may qualify for bonus dep in addition to ACRS

§179 Depreciation: may elect to expense cost of any “section 179 prop” in the yr placed in service

tangible personal prop §1245

limitations:

dollar limits §179(b)

income §176(b)(2)

recapture §§179(c)(1) & (d)(10)

§168 ACRS

§167 Depreciation

§260F Limitations:

Luxury Autos

§280F(a)(1)(A) & (B): deds may not exceed:

$2560 for first yr in service

$4100 second yr

$2450 third yr

$1475 succeeding yrs until basis zero

§280F(d)(7): adjusted annually

§ 280F(d)(1): amts deducted under 179 treated as depreciation deds for these purposes

“Listed Property”

§280F(d)(4): includes:

1) any passenger auto

2) any other prop used as transpo

3) any prop generally used for enertainment, rec or amusement

4) any computer or peripheral equipment

5) any cellular phone

6) any other prop in regs

§280F(b)(1): if less than 50% of use is for qual bus use, dep deds must be determined by alt dep system of §168(g) in current and subseq yrs

§280F(b)(2): if exceeds 50% in previous yrs, but falls below in this yr, amts of deds that would have been allowed must be “recaptured” – included in gross inc in current year

Also, §274 substantion reqs

Net Operating Loss Deduction

Normally, annual accounting system, no “negative taxes” in one year to be offset

Burnet v Sanford&Brooks – harsh result

But Deduction in taxable year for NOL carryovers and carrybacks for the year 172(a)

NOL = excess of allowable business deductions over gross income over taxable year 172(c)

Carryback to each of the preceding 2 years (sometimes 3) 172(b)(1)

Carryover to each of the 20 taxable years following 172(b)(1)

§172(d) - For inds, primarily business losses, NOT

investment losses

personal exemptions authorized by § 151

unused non-§62 deductions

personal dependency exemptions

other nonbusiness deductions

Personal Deductions and Allowances

Family

Personal Exemptions §151: $3,650 in 09, adjusted by COL (§151(d)(4))

Taxpayer and spouse – §151(b): for each of couple if filing together, or if filing separately taxpaying spouse can claim 2x if spouse has no inc and is not anyone’s dep

§151(d)(2): may not claim if claimed as dep

§151(d)(3): phased out for AGIs above threshold amts

Dependents - §151(c): additional ded for exemption amt for each dep, either:

Qualifying child - §152(c)(1):

Related - §152(c)(2):

Child or descendent of child

§152(f)(1): child = step, eligibl foster, adopted children

Brother, sister, stepbro, stepsister or descendant of any such

Lives in same hh for more than half year

Is under 19, student under 24, or perm’ly disabled

Has not provided more than half of her own supp

If claimed by 2+ tpayers – tiebreaker - §152(c)(4)(A):

Parent

If none parent, highest gross inc

If parents do not file jt return, §152(c)(4)(B): child will be treated as of parent with whom child resided for longest time

If tied, highest gross inc

Qualifying relative - §151(d)(1):

Related - §152(d)(2):

Child or desc of child

Bro, sis, stepbro, stepsis

Father or mother or ancestor of either

Stepfather, stepmom

Nephew/niece

Unclue/aunt

Son-, daugher-, father-, mother-, brother-, sister-in-law

Has same principal place of abode as tpayer and is member of hh (but not spouse)

Gross inc less than exemption amt

Provids more than half of support

§152(d)(3): OR multiple support agreement

no one may contrib. over onehalf of ind’s suppt

but over half must be provided by qualified rels

tpayer must contrubute oer 10% of support

each person related to ind who furnished over 10% of dep’s syppt must file written dec that they will not claim exemption for that ind

Not qualifying child of any tpayer

Children of divorced /sep parents - §152(e)(1): if:

Child receives more than ½ of her suppt from parents, but

parents divorced, separated or living apart during last 6 mos, and

King v Com’r (2003, TC) – applies to any parents wort marital status as long as they lived apart all of last 6 mos – not just those married but living apart (causing revision in 2004)

in custody of one or both prents for more than ½ of the yr

then treated as aulifying child of custodial parent

§152(e)(2): but if cus parent signs written dec stating will not claim child and noncustodial attaches to return, may claim

King v. Com’r (2003, TC) – parties stiupulated that she released claim

§152(e)(5): does not apply if multiple suppt arrangement

Also:

§152(b)(2): Cannot be dep if filed jt return

§152(b)(3): dep must be citizen, resident, or res of country contiguous (other than certain adoptees)

Alimony - § 215 – allowed for amts paid during taxable yr for alimony or separate maintenance payments

Planning for the future

§219 IRA contributions

§162 health ins for self-employed

§220, 223 med savings acct contribs

§221 student loan int

Interest – generally personal int not deducible - §163(h)(2) but §163(a): ded allowed for int paid or accrued – for one of six situations:

1) trade or business int - §163(h)(2)(A): other than services as employee

2) investment int - §163(h)(2)(B): paid or accrued incurred to purchase or carry prop held for investment

§163(d)(1-2): limited to amt of net investment inc for that yr – any in excess may be carried over

§163(d)(4): net investment inc = excess of gross inc and gains foom investments over deductible expsnes directly connected with prod if investment inc

3) int in connection w/ passive activity - §163(h)(2)(C): to extent allowed under “passive activity” rules, deductible

4) qualified residence int - §163(h)(2)(D), if secured by qualified res – 2 types:

“acquisition indebtedness” - §163(h)(3)(B): incurred acquiring, constructing or substantially improving qual resx

limited to $1m

if refinanced, that debt qualifies up to amt of refinanced in

“home equity indebtedness” - §163(h)(3)(C): other than AI (for other things)

cannot exceed lesser of:

excess of FMV of res over amt of AI

100k

unlike AI, no restriction on use of funds borrowed

§163(h)(4)(A): res need not be primary residence, but limited to 2, and if 2, one must be principal

including your yacht!

net effect is that int on the first $1.1m of principal is deductible

5) int payable on estate tax deficincies - §163(h)(2)(E): in certain situations, time for payment of est tax may be deferred, but int must be paid – those payments ded’le

6) int on education loans - §163(h)(2)(F), §221(a):

max is $2500

phased out ratably for inc 50-65k, 100-130 for jt filers

to pay expenses of tp, spouse or any dep

not allowable for any payment otherwise allowable under other section, such as HI indebteness

not dedle if from related person

allowed in calcultating AGI – need not itemize to make use

Tracing – determine int by use of loan proceeds (not source, securitzation). Reg § 1.163-8T

Unstated interest – deds may be allowed tofr int not actually paid but imputed and deemed to be paid under:

“installment purchases” rules of § 163(b)

“interest on deferred payments” rules of § 1274 or 483

“original issue discount” rules of §§ 1272, 1273

“loans w/ below-mkt rates” rules of § 7872

Year of Deduction

If accrual method – in year in which int arises

If cash method - yr in which tp pays the int

However, §461(g) – int paid on a laon which extends beyond taxable yr in which the int is paid, is protated over period of loan and deductible in the yrs to which it is apportioned

This rule does not apply to int in the form of “points” paid on a loan made to purchase or improve principal residence

§408, 408A – Retirement savings

Health Savings Accounts (HSAs) - §223

Must have - §223(c)(2):

Ded of at least 1k and not more than 5k for self-only

Twice that for family coverage

Annual adj for inflation

Ded for lesser of - §223(b):

Amt of deductible

$2,250 (self-only) or $4,500 (family coverage)

Treated as adj to gross inc and therefore may be claimed by nonitemizers

Not phased out under §62, not subject to AMT

Unpleasant Events

Taxes –

§164(a), (b)(5): ded for:

St, local and foreign real prop taxes

§ 164(c): imposed on ints in real prop, levied for gen pub welfare

§164(c): charges imposed for local benefits of a ind tending to inc value of prop (special assessments) are not dedle

§164(d): if real prop sold mid-year, may only ded amy of taxes attributable to portion of year owned

St and local personal prop taxes

§164(b)(1): “ad voleremx tax” (proportional to value) imposed on an annual basis in respect of personal prop

St local and foreign taxes on inc, war profits, and excess profits

Sales tax – tp may elect to ded in lieu of ded’ing st or local inc taxes (primarily for benefit of people in sts with no inc tax):

Imposed on retail sale of a broad range of items (exceptions for food, clothing, med supplies and motor vehicles)

IRS table used to approximate amts

Future of this ded rmains uncertain

§164(b)(2): st or local = imposed by st, possession of US, pol subdivision (muni, county, sch dis), or DC

also taxes incurred in carrying on a trade/bus or producing inc

but tax paid in acquiring or dosposing prop may not be ded – added to basis or reduces amt realized

Extraordinary Medical Expenses - §213

Expenses actually paid during taxable year

Henderson v Com’r (2000 TC Memo) – modified van for treatment of spina bifida – modifications allowed but not depreciation – not “expense paid”

Not compd by ins or otherwise

For medical care - § 213(b) & (d)

(d)(1)(A): “diagnosis, cure, mitigation treatment or prevention of disease” or “for the purpose of affecting any structure or function of the body”

§213(d)(9): not cosmetic surgery

Taylor v. Com’r (TCM, 1987) – severe allergy – not allowed ded for amts paid to have someone mow his lawn – seemed to care that there was no showing citing:

Altman v Com’r (TCM 1987) – playing golf not ded despite being recommended for treatment of emphysema

Ochs v Com’r (2nd Cir, 1952) – children being around caused “nervousness and irritation” – cost of sending them to boarding sch not ded – difficult to draw line but expenditures for one family member benefit others as well - unlikely Congress intended to transform family expenses into med expenses

(d)(1)(B)transpo primarily and essential for such med care

(b): prescribed drugs and insulin

(d)(1)(C): qualified long-term care svcs

MORE HERE – RE C

(d)(1)(D): ins covering such med care

(d)(2): lodging up to $50/night per ind, while away for rom home primarily for med are – if care itsl is provided in hosp and no significant element of pleasure or vacation

Available for care of:

Tpayer

§213(c) – if dies, med expenses paid by estate for care w/in 1 yr deemed paid and deductible when incurred (rather than paid)

Spouse

Deps (defined in §152)

Child or

§213(d)(5): Child of divorcees dep of both

“qualifying relative” 152(d)

provides one-half of ind’s support for yr

direct relative (child, sibling, ancestor, step, uncle/aunt, dir in-law, and cohabitant)

§213(d): To extent that expenses exceed 7.5% of adj gross inc

10% for purposes of AMT

Alternatively, might be better off

Personal Casualty and Theft Losses – fire, storm, shipwreck or other casualty, theft 165(d)(3)(B) – or similarly sudden event

Permitted only to extent not compensated by ins or otherwise, like all losses 165(a)

165(b) - As w/ profit-seeks deds, limited to lesser of:

change in FMV or

adj basis

§165(h) – no loss to extent reimbursed by ins

Amount - §165(h)(1) – allowed only ro extent that amt of loss arising from each casualty exceeds $100

“personal casualty gain” = recognized gain from invol conversion (§165(h)(3)(A)) – amts paid by an insurer

“personal casualty loss” = theft or casualty loss reduced by $100 floor (§165(h)(1) & (3)(B))

If PCL for yr exceeds PCGs, losses only allowed to extent:

Amt of PCG +

Amt by which excess of PCLs over PCGs exceeds 10% of adj gross inc

PCL up to amt of PCGs treated as ded allowable in computing adj gross inc – excess is treated as itemized ded

Reg. §1.165-7(b): if prop is totally destroyed in casualty loss, can deduct full amt of adj basis even if it’s greater than

FORMULA:

(VALUE BEFORE – VALUE AFTER) – any compensation for ins - $100 – 10% of AGI

But if this exceeds basis, can only deduct amt of basis

Regs 1.165-7(a)(3) – automobile – not if willful act or willful negligence

Basis reduced by ded amt

“suddenness comparable to that caused by fire, storm or shipwreck” Rev Rul 63-232, 1963-2 C.B. 97

termites and dry rot don’t count

Dyer – neurotic cat, even though having its first fit, isn’t enough

Ring cases - disposal is sudden, flushing is too gradual

Chamales – OJ’s neighbor, not sudden

Physical damage required by tax court -

Chamales – force was not exerted upon the property itself

*SPLIT - 11th Cir rule, Finkbohner v US – need not be physical, but still must be permanent –

Not if gross negligence – white v. Comm’r TC

Blackman – set his wife’s clothes on paper -

Not where frustrate articulate public policy Com’r v. Heininger, and Comm’r Heininger

Blackman – burned wife’s clothes – MD policy vs arson and burning

Sustained in yr where

Admirable Events

Charitable Contributions §170(a): ded authorized for any “charitable contribution” made w/in taxable yr

TAKE DED IF IT’S QUALIFIED

CHECK TO SEE IF 30% LIMITS REACHED

BUT IF BARGAIN SALE, GOING TO ADD SOME TO AGI – apportion some of basis to sale and some to gift and take gain over basis

Qualified Donee - §170(c), (g): “charitable contribution” = contrib. or gift to or for the use of:

fed, st or local gov

only if for exclusively pub purposes

Ottawa Silica Co – not if donor receives, or anticipates reciving a substantial benefit in return

religious, charitable, scientifie, literary or education organizations

certain war vets orgs

domestic fraternal lodge-system societies or orderies

cemetery companies

ALSO amts paid to maintain foreign exchange student

BUT NOT if clearly contrary to public policy (mainly discrim)

Bob Jones University -

“Contributions”

With donative intent and w/o consideration Rev. Rul. 71-112, 1971-21 CB 93 (and Ottawa Silica )

Ottawa Silica Co v US (1983 Fed Cir) – mining co donates land for sch but benefitted thereby by having roads provided – argued they were substantially

Case

If partial consideration received, ded allowable to extent amt exceeds partial consideration – net contribution

§170(l): special rule for higher ed where entitled to purchase athletic tix – 80% of amt transferred treated as charitable contrib.

Bargain sale – if for amt less than FMV - §1011(b) – adj basis must be apportioned between sale and gift: sale portion = adj basis X (amt realized / FMV)

Amount of Contribution

If Cash: amt – consideration received

§170(f)(17): cash/check contrib. must be verified by bank records or documentation from recipient

If property, = FMV at time contrib. – value of consideration, subj to further reduction via §170(e) (?)

Vehicles §170(f)(12): if claimed value exceeds $500, must receive contemp written acknowledgment from donee, including VIN and cert by donee how it intends to use veh, or whether it intends to sell it, and donor must attach acknolwedgement to tax return – if donee sells shortly after, ded limited to gross proceeds

Clothing and household goods - §170(f)(16): no ded if minimal monetary value, and even if greater value, must be in good condition

Includes furnioture, furnishings, electonic apps, linens, and similar

But not food or art, jewelery and similar

If value excess of $500, must accompany qualified appraisal

Ord inc & short-term cap gain prop = §170(e)(1)(A): amt reduced by amt of gain which would have been ord incor short-term cap gain if onor had sole prop at date-of-contribution FMV

long-term cap gain prop

§170(e)(1)(B): amt reduced by all of amt of gain which would have been long-term cap gain if donor had sold prop at its date-of –contrib FMV, AND if contrib. is:

1) of tangible personal prop the use of which is unrelated to exempt purpose of donee, OR

2) to or for the use of a nonoperating pvt foundation

§170(e)(5): reduction does not apply to contribs of “qualified appreciated stock” to nonoperating pvt foundations

“QAS” = stock for which mkt quotations are available. §170(e)(5)

may not exceed 10% of value of all outstanding stock of corp. §170(e)(5)(C)

prop disposed of by donee

§170(e)(1)(B)(i)(II), (7)(C) & (D): if tangible pers prop w/ claimed value of more than $5k, and donee sells before end of yr,

ded limited to taxpayers basis in prop

unless donee certifies that prop is intended to be used for purpose related to exempt purpose

§170(e)(7): if disposes of prop after yr, but w/in 3 yrs of contrib., donor must include in gross inc for that yr the amt by which ded exceeds donor’s basis

If services – no ded

Reg. 1.170A-1(g) -unreimbursed expenditures incurred may be

§170(i): if car used, may ded either amt of actual expenses or 14 cents per mile

170(j): no ded for traveling expenses unless no significant element of pleasure, recreation or vacation

If partial int in prop, ded only in limited circums (§170(f)), but these limits do not apply if donor makes charitable contribs of all of tpayer’s ints in prop (§170(f)(2)(D))

Transfers in trust –

§170(f)(2)(A) – transfer of remainder int only ded if trust is charitable remainder annuity trust, charitable remainder unitrust or pooled inc fund (general thrust = adequately preserved for charitable org)

§170(f)(2)(B) – transfer other than remainder int ded only if int is in the form of guaranteed annuity, or if specified fixed percentage of FM must be distributed annually to charitable org (same general thrust)

transfers not in trust: §170(f)(3) & (h): ded only if:

partial int in prop which would be ded if transferred in trust (above)

remainder int in pers res

remainder int in farm

undivided portion of donor’s entire int

qualified conservation contribution

Limitations

contribution base - §170(b)(1)(G): amt of adj gross inc w/o net operating loss carryback

public charities – 50% limitation – §170(b)(1)(A): ded contributions to (but for the use of) “public charities” ot extent total does not exceed 50% of contribution base

Reg. § 1.170A-8(a)(2): contrib. of inc int in prop, or contrib. of prop to be held in trust is considered “for the use of” rather than to – subject to 30% limit -

Private foundations - 30% limitation – §170(b)(1)(B): may ded contribs made, other than contribs TO pub charities, only to exten total does not exceed lesser of:

1) 30% of contribution base

2) excess of 50% of contrib. base over amt of charitable contribs allowable under 50% limitation rules

(so max ded to pvt foundations is 30%)

§170(b): amts that exceed contrib. limits may be carried over and treated as a contrib. of same character/classification of donee in the 5 suceedig taxable years (15 for qualifified conservation)

more generous than casualty losses or med expenses

Further limits on cap gain prop –

§170(b)(1)(C): may be deducted only to extent doesn’t exceed 30% of contrib. base if:

Sale of prop would produce long-term cap gain or gain whose character is determined under §1231 (“cap gain prop”) AND

Reduction rules of 170(e)(1)(B) do not apply

Alternatively, may elect to have amt of charitable contrib. reduced under tules of 170(e(1)(B), thereby subjecting to 50% limit rather than 30%

§170(b)(1)(D): contibs of cap gain prop other than contribs to 50% orgs, may be deducted only to extent the total am does not exceed lesser of:

1) 20% of contrib. base

2) excess of 30% of contrib. base over the amt of contribs of cap gain prop to pub charities

“cap gain prop” = prop which if sold would produce long-term cap gain or gain whose character is determined under 1231 – in additon, the amt of contrib. opf cap gain other than to 50% orgs may be required to be reduced under rules of 170(e)

carryovers - §170(d): if total amt of contribs exceed s lmits, may be carried over and treated as charitable contrib. of same type of prop to the same class of charity made in each of 5 succeeding years – amt carried over is excess of amt initially carried over less any amt treated as contrib. during intervening succeeding yr

Year of Deduction- generally, ded only in yr paid or carryover yr (not pledge)– even if using accrual

Verification - §170(a)(1): ded allowed only if verified

§170(f)(11): Prop for more than $500 ded – must attach descro[ption, and if claimed value in exceess of $5k, appraisal

§170(f)(17): cash/check/monetary gify – bank record or written communication from donee that shows name of donee org, date, and amt of contrib.

§170(f)(8): contrib. $250 or more – by time of return, acknowledgement from donee – amt of cash given, description of any noncash prop given, statement as to whether donee provided goods/services in consideration for gift value therof

but not required in case of an “intangible religious

§6115(a): charitable orgs which receive payment of more than $75 which is partly a contrib. and partly a payment for goods/services msut provide written statement to donor which:

1) informs donor that only excess amt of payment over value is deductible, AND

2_ provides good faith est of value of goods/services provided

Donation of prizes awards §74

Work

Moving Expenses - §217(a): generally may ded qual moving expenses incurred in connection w/ beginning work at new principal place of work (§82: and reimbursements not included as inc provided not fring)

§217(c): Conditions for allowance - BOTH

Distance – § 217(c)(1): new work at least 50 miles father (measured by shortest of more commonly traveled routes) than

Old work

Or res (if doesn’t have old worl)

Employment-Duration, §217(c)(2), either:

Employee test

During 12-mo period following arrival in general loc

Full-time emp in gen area for at least 39 weeks

Self-employed test

During 24 mo period immediately following arrival in gen loc, either

Full-time emp, OR

Performs svcs as self-emp ind on a fulltime bus

In that gen area for a period of 78 weeks which at leas 39 weeks must be suring furst 12 mos of 24-mo period

Self-emp ind = performs pers svcs as sole properietor, or partner in partnership performing trade/bus

§217(d)(1): waived if death/disability, or would have satified but emp involuntarily seps him from employment

Qual Moving Expenses

217(b)(1): rle amys spent for moving hh gooda dn pers effects, and traveling there (incl lodging but not meals)

217(b)(2)(C): including exps incurred for members of hh

Time for Ded

Taxable yr in which exps incurred, according to acting method

§217(d)(2): if haven’t satisfied emp-duration during yr:

may claim ded if still possible to satisfy, OR

Reg. §1.217-2(d)(3): but if she later doesn’t satisy, must include in gross inc amt = amt of earlier ded

may file w/o claiming and then file amended return if qualifies later

§217(g)-(i): Special Rules for armed forces, foreign countries

Jury Duty Pay - §62(a)(13): if receive payment and remit to emp in exchange for compensation, as required by emp

Certain educator expenses - §62(a)

§212: unreimbursed emp bus expenses

Restrictions on Deductions

§262: Personal living and family expenses generally not allowed unless specific provision

Smith v. Com’r – cost of having kids not ded’le despite being but-for cause of employment (tax credit available though)

Illegal Activities

§162(c): no ded for kickbacks, etc.

§162(f): no ded for fines for violation of laws paid to the government

Tank Trucking - ER thinks PA was just using this to raise revenue

Stephens v. Com’r – restitution paid pursuant to fraud conviction is ded’le – primarily remedial measure, not fine, and made to Raytheon, not govt

§162(e): nothing for political contributions, initiatives

§183(a): “hobby losses” - no ded for expenses attributable to an activity not engaged in for profit

§183(c): = other than one allowable under §§ 162 or 212(1) or (2)

§183(d): Activity presumed to be for profit if Gross inc exceeds ded attributable during at least 3 out of the 5 consecutive years ending with the current yr

5 of 7 yrs for horseracing

§183(e)(1): tp may elect to defer this determination until close of 4th yr following yr in which first engages in activity

Reg §1.183-2(b): primary purpose – tp bears burden of proving bona fie expectation of realizing profit, even regardless of reasonableeness of expectation – factors:

Nickerson v Com’r (7th Cir) – need only prove operated farm w/ epectation would later reap profit, not just from current level of act but eventually

1) businesslike manner

2) expertise of tp or advisers

3) time and effort

4) expecation that assets uses may appreciate

5) success in similar/dissimilar acts

6) history of inc/losses wrt act

7) amt of occasional profits

8) financial status of tp

9) elements of pers pleasure/rec (not necyly exclusive)

Nickerson – absence of alt explanation for to’s actions in renovating farms

§183(b): even if not engaged in for profit, deds still allowed:

1) to the extent ded would be allowed under authority of some provision other than §§ 162 or 212

2) to extent expenditure would be allowed under §§ 162 or 212 if activity was engaged in for profit – but only to extent act produces gross inc in excess of deds allowed under 1)

§274: T&E expenses generally not allowed unless meet criteria

§274(n): Limited to 50% of cost

§274(a)(1)(A): Activity

directly related to active conduct of t/b or

Reg. §1.274-2(c): trade/bus acts go on, during ent, or

“associated with” t/b AND directly precede or follow “substantial and bona fie bus discussion”

Reg. §1.274-2(d): clear bus purpose in making expenditure

Danville (8th Cir) – super bowl trip doesn’t count – building goodwill alone insufficient

Moss v. Com’r – not allowed to ded lunch w/o clients, coordinating, etc

Churchill Downs – purely social event – event ws not attended by tp’s primary customers, just to generate goodwill

Limits

§274(a)(1)(B): nothing for facility used

§274(a)(3): nothing for dues paid for club org’d for bus, pleasure, rec, or other soc purpose

Ent Tickets

§274(l)(1): no ded for ticket unless to qualifying charitable sports event

Danville (8th Cir) – super bowl trip doesn’t count -

§274(l)(2): Skyboxes limited to sum of face alue of same number of nonluxury tix available to gen pub

§274(d) Exceptions for emps to emps on bus premi, copensation, reimbursed exps, bus mtgs for emps, sholder s or dirs

§274(d): Substantiation

§274(e): exceptions

§465: Deds limited to amt at risk

§465(a), (d): ded only to extent tp is “at risk” from act at close of yr -

§465(b)(6): “at risk” = wrt act:

amt of money and

adjusted bases of prop contributed and

amts borrowed

if personally liable

or net value of prop pledged as security (assuming not prop used in act)

§465(b)(5): any loss disallowed by this rule treated as ded in next yr – may be allowable depending on risk in that yr

§465(d): “loss” = excess ded allocable to the act over the inc derived

§465(c): generally applies to trade/bus or inc production

§465(e): recapture – if amt at risk less than zero , must include negative as gross inc, an = amt is ded in succeeding yr

§469: Passive Activity Limits

§469(c): “passive activity” = involves conduct of trade/bus (per §212) in which the tp does not materially participate

§469(h): involved in th ops on a regular, continuous and substantial basis

Temp. Reg. §1.469-5T(a): objective tests/factors

§469(h)(2): limitied partner generally not materially participat

§469(c)(2) & (4): rental activities generally not even if materially participate

§469(c)(7): but not treated as rental at if involves rendition of significant personal services

§469(c)(3) & (4): working ints in oil and gas prop generally not

Passive Act Loss or Credit

§469(d)(1): “PA Loss” = excess deds from passive acts over total inc from passive acts

§469(d)92): “PA Credit” = excess of sum of tax creidts attributable to passive acts over liability allocable to passive acts

§469(e)(1): “portfolio inc” (int, divs, annuyities, royalties) not taken into acct

Treatment: §469(a)-(d): PALs/PAC only allowed to extent it exceeds PA inc from yr – remainder is carried over to subseq yrs

§469(c)(7): special rules fo real estate rental – more than ½ of all person sevs perfmroed (and more than 750 hrs) performed in real prop trades/bus in which mat participates

§469(i):*PROB NOT ASSIGNED special rule for not actively but not materially participate in rental real estate

§469(f):*PROB NOT ASSIGNED former passive acts

**§469(g): taxable dospo of passive act

**469(j): nontaable dispo of passive act

Interrelationship with other code provisions

Generally, apply other limits on losses (§267, §465 at-risk) before passive activirt

Deds for int paid wrt passive act not subject to §163, so must first run §469 gauntlet

PACs on ther other thand limited first under §469 before applying limits on max amts of bus creidts (§38(c))

But limits on increasing research acts (§41) applied first

§163(d)(1-2): limited to amt of net investment inc for that yr – any in excess may be carried over

§163(d)(4): net investment inc = excess of gross inc and gains foom investments over deductible expsnes directly connected with prod if investment inc

§280A: Business Use of Home and Rental of Vacation Homes

Definition of “used as a residence” = used for personal purposes for more than the greater of:

14 DAYS OR

10% of days rented at FMR

used for “personal purposes”

1) tp or any member or family uses

2) someone uses it and tp thereby becs entitled to use some other dwelling unit

3) any ind (other than emp entitled to exlude rental value from inc under §119) uses it and pays less than fair rental

First two apply w/o regard to whether fair rental charged unless rented at fair rental to someone for use as that person’s personal res

IF NOT USED AS A RES, expenses dedble as ord/necy or production of inc. LIMITS:

§280A(e): if used for some pers purposes, may deduct only fraction of the expenses that are dedble only if dwelling is rented

fraction = days rented at mkt rate / days used (rented + personal)

Separate the deds available for all purposes, and those only allowed because it’s rented

Multiply the renting deds by the fraction

§183: hobby losses if under this section, tp rental bus not engaged in for profit, then deds limited to inc from activity

§469: Passive Activity Loss rules generally limit inc from passive activities to gain

§469(i): inds may still recognize 25k of losses annually – phased out for high-incs

§469(c)(7): rules exempt inds who perform more than 50% of svcs in real prop trade/bus in which they “materially participate”

IF USED AS RES, RENTED FOR 14 DAYS OR LESS, no ded for any exps and rent excluded from gross inc (§280A(g)) (too trivial)

IF USED AS RES, RENTED FOR 15 DAYS OR MORE, rent is inc via §61(a)(5), §280A(b) allows certain exps routinely ded’le by homeowners to be deducted (mort int, prop taxes)

Take any deds available in any case (taxes, mort int, brokers’ fees)

Additional exps ded’le only for period of ratio

Circuit split

“Basketing” – but deds limited to the amt of rental

LIMITS:

§280A(c)(5): limits deds to gross inc from rental (other than those routinely ded’le)

§280A(e):

§280A(f)(3): hobby loss rules do not apply

§280A(a): no ded allowed wrt use of dwelling unit used as res by tp (**REBREAK THIS DOWN BY ER’S HANDOUT)

§260A(f)(1): “dwelling unit” = house, apt, condo, mobile home, boat or similar, ut not any portion of unit ised exlusively as hotel, motel, or inn

§280A(d): “use as a residence”

FOR greater of:

15 days OR

**DOUBLECHECK THIS: DOESN’T COUNT TIMES

excess of 10% of number of days rented during yr for fair rental

§260A(b): does not apply to expenditure which are dedble w/o regard to whether they are connected to tp’s trade/bus or inc-producing act, such as qual res int or st/local taxes

§280A(c): does not apply to extend dedble item allocable to portion of the unit devoted to

“certain bus uses”

1) principal place of bus for any trade/bus

§280A(c)(1): “principal place of bus” = includes portion of dwelling used for admin or mgmt acts of tp’s trade/bus provided there is no other fixed location where such acts conducted

Soliman – anestheologist not allowed to ded home ofc despite exclusive use for bus and no other location - made bad law by this stat

Popov (9th Cir) – violinist practicing – consider two factors: 1) “relative importance of acts performed in each location” & 2) time spent in each case – relative impt doesn’t help but significantly more time sent practicing at home – ded’le

Moller v. U.S. (US, 1983) – investment activity of couple is not a trade/bus – relvant considerations are investment intent, nature of inc and frequency of transactions –return on investment was mostly dividends and int, long-term holding of secs, not short-term profits

Henderson v. Com’r (TCM 1983) – “sufficient nexus” exps and “carrying on” trade/bus – decorating ofc with plants and print only tangentially, if at all, aided in performance working as Asst AG for St of SC – no evidence either necy or helpful in performing her required svcs

ER: bad decision because ordinarily the courts don’t look all that closely at “ord & necy”

2) place of bys used by pats, clients or customers in normal course of trade/bus

3) in connection w/ tp’s trade/bus, if prop is sep structure

artist studo

§280A(c)(1): if emp, exclusive use of unit must be “for the conveninence of his employer”

§280A(c)(6): no circumventing by renting prop for use by emp in performing services

“certain storage use” - §280A(c)(2):

if unit is the sole fixed loc of trade/bus, involves selling prods wholesale or retail

deds to extent allocable to space used on reg basis to store inventory or prod samples

use in providing day care - §280A(c)(4):

to extent allocable to portions used on reg basis

in trade/bus providing day care for:

children

inds 65

physiacally or mantally incapable of caring for themselves

280A(c)(5): limited to excess of:

gross in derive from the bus uses over

sum of

deds (such as mort nt and taxes) allocable to that portion of the unit plus

bus deds other than those attributable to the use of the dwelling

amt in excess be carried over to next yr, subject to same limits

Rental of Dwelling Unit

§280A(g): “de minimus rule ” – rental inc excluded if less than 15 days/yr (and no other ded allowed, such as for dep or repairs)

Rented for more than 14 days, not “res”

If not used for pers purposes on any day, ded limits of 280A don’t apply, but 183 might if activity not “engaged in for profit”

If used for person purposes on one or more days, ded limits of §280A(c)(5) do not apply,but limit of §280A(e) does apply

Rented for more than 14 days and used as res

Rent is income

Deds wrt dwelling unit subject to restrictions of both §280A(c)(5) & (e)

§280A(e): reqs allocation of those exps not generally allowable twixt rental & pers use days

Provisions of §183 not applicable for such year

Rental of Principal Residence

§280A(d)(4): ded limits of §280A(c)(5) do not apply to principal res if only use occurs before or after “qual rental period”

“qual rental period” = consecutive period of 12 months or more, or shorteter period ending w/ sale or exchanged, during which unit is rented or held for fair rental

§67(a): MISC Itemized Deds - §67(a): only to extent total amt exceeds 2% of AGI – notably:

deds claimed under §212

ded claimed by employees under §162

The Timing of Income

Methods of Accounting – type regularly used in keeping books (§446(a)) – but IRS can require change to different method if it does not “clearly reflect income” (§ 446(b))

Cash Receipts and Disbursements Method – §451(a) – generally include inc in yr actually or constructively received, takes into account deductions in year paid

Constructive receipt – Reg § 1.451-2(a) – must include when constructively received (may not postpone inc by merely failing to collect it)

Credited to his account

Set apart for him

Or otherwerwise available to draw on at any time

Arend v. Com’r – wheat sale delivered – but did not have right to money until following Januaru – bona fied arms-length transaction – failure to receive money not of his own volition

Or could ave drawn upon if notice of intention to withdraw had been given

Pulsifer v Com’r – Irish minor prizewinners – all that was needd to receive was for legal rep to apply for funds – so econ-benefit thyu -

NOT if risk of nonpayment

NOT if receipt subject to substantial limits or restrictions

Minor v US – doctor and deferred comp plan – but merely credits fund, mere promise to pay funds – not income at that time

As long

Concern for matching income & deductions if possible

Also remember imputed interest rules (§7872, OED) which may require recognition of income not yet received – see above

Disbursements – gemerally, take allowable deds in yr of payment (§461(a), BUT

Prepaid expenses

If expediture creates asset w/ useful life extending substantially beuond end of taxable yr, ded must be spread out over taxable yrs used. Regs § 1.461-1(a)(1)

§461(g)(1) – must capitalize all prepaid int and deduct ratably over period of loan - Ded for payment of int only in yr in which into s properly allocable – prepayment in one year will be spread out over taxable years loan is expanding.

Exception for “points” paid in respect of indebtedness incurred to purchase or make improvements to principal residence § 461(g)(2)

Farmers get to treat as current expenses a wide variety of costs other tps would have to capitalize

§§ 263A & 464: attempt to distinguish between active farmers and passive investors in syndicates as tax shelters – ded feed, fertilizer, etc, only when actually consumed

Accrual Method – include iterms which fix right to receive and fix amount Regs, 1.451-1(a) Spring City Foundry Co v Com’r,

Lucas v North Texas Lumber Co (US, 1930) – accrual not permitted or required until goods or sves treansferred or performed, even where booked and binding sale K entered into at fixed price – seems inconsistent w/ Anderson

Uncertainty – “reasonable expectancy”

Economic contingencies – § 448(d)(5) sufficient if legal right has been established and amt reasonably determined

“Georgia School-Book Depository – per K, publisher’s right to payment had arisen – need not pay if had no “reasonable expectancy” but this is an exception and must not swallow up the rule – despite econ situation and nonpayment for 2 years, no reasonable expectancy they wouldn’t be paid – St of GA is good for it, plus they kept supplying books which indicates they expected to be paid

Legal contingencies –

Of inc/inclusion:

Continental Tie – implied distinction between basic liability (delay inclusion) as opposed to amt (do not delay if reasonable estimate available)

NOT REALLY, CALLED INTO QUESTION

Of ded/liability

if subject of litigation, right not fixed until lit and appeals concluded, unless cash flows §461(f) and (h)

overruling US v Consolidated -

Advance Payments generally income when received EXCEPT

Occasionally, prepayment relates to an obligation to perform services that is not definite, not at discretion/demand of customers – may defer payment until services performed, so as to match – if sufficiently specific

Artnell Co (7th Cir) – inc rec deferred for prepaid admission to baseball games played in following yr – time and extent of future services sufficiently specific – unlike AAA and Schlude

Westpac – advance trade discounts, volume discount for purchasing – as it made purchases in satisfaction of required volume, subtracted pro rata the earned pirtion – had to pay money back if it did not meet commitment, so properly considered a liability at that time, not an accession to wealth

IPL – advance payments required of credit-suspicious customers analogous to loans rather than advance payments

§455 – prepaid income from sibscriptions to periodicial – may be included in inc in which liability to deliver exists

§456 – membership organizations – prepaid dues inc, entitling member to services or privieleges over a period time beyond end of yr (but w/in 36 months) may be included in inc in the taxable yrs in which liability to priovde services exist

BAD LAW? – AAA v US – clear mandate from Congress in allowing section to explire – not allowing AAA’s practice of reporting only portion of dues, ratably corresponding to membership months covered by those dues

Schlude (after 456) – dancing sch taxable in yr of receipt on amts paid by students for lessons to be provided in the future

Security Deposits not taxable, unlike Payments

Westpac – advance trade discounts, volume discount for purchasing – as it made purchases in satisfaction of required volume, subtracted pro rata the earned portion – had to pay money back if it did not meet commitment, so properly considered a liability at that time, not an accession to wealth

IPL – advance payments required of credit-suspicious customers analogous to loans rather than advance payments

Current Deductions for Future Expenses – §461(h) can take if “all events” test is satisfied, but not any earlier than taxable yr in which econ performance occurs

§ 461(h)(4), US v Anderson, and old common law, “all events test” =

all events have occurred which can determine fact of liability, and

amt can be determined with reasonable accuracy.

US v General Dynamics Corp (US, 1987) – emp provided med benefits – claimed ded for services rendered but empl had not considered claims – all-events test not satisfied until claims submitted – some might fail to submit claims to which they are entitled – refuse to sanction expense accruals on the basis of estimates

§ 461(h)(2) & (3) “economic performance” =

if for services, services performed

if for property, property provided

if for use of property, property used

if to satisfy obligation, person paid

IRS has authority to provide in other cases

§461(g) – prepaid interest

Inventory method (per §471, used whenerver necy to clearly determine inc):

FIFO method:

1) Cost – value determined by actual cost – fairly wide fluctuations in inc

2) Cost or Market (whichever is lower) – may be desirable where mkt price fluctuate

LIFO method

Installment Method – § 453 - while normally inc recognized in year (§ 1001(c), installment method allows spreading the recognition of gain.

First apply §483 (unstated interest) or OID rules – installment method applies to what remains

Transactions under §453 - § 453(a), (d)(1) – gain from installment sale of prop recognized under installment method unless tpayer elects not – but denied in certain circums

Installment sale - § 453(b)(1) – disposition of prop under terms were at least 1 payment rec’d in yr subsequent to yr of dispo

Installment method - §453(c) – recognize portion of gain in yr received – total amt of payments rec’d during table year X (“gross profit ratio” gross profit / total K price )

Gross proft = selling price – adjusted basis Reg. § 15A.453-1(b)(2)(v) – ANYTHING RECAPTURED and taxed as ord inc

/

Total K price = selling price – (any qualifying indebtedness assumed by buyer Reg. § 15A.453-1(b)(2)(iii)

“qualifying indebtedness ” – generally dealing with debt taken at time of indebtedness – if it’s taken subsequently,

IF THE RATIO IS HIGHER THAN 1, it’s because debt relief exceeds basis – that’s taxed as ord income and ratio is just one

§453 does not apply to:

losses

recapture income – § 453(i) - to the extent attributable to depreciation, taxable currently, not via installment method ... remember to take that ( i.e, gain would be characterized as ord income under §§ 1245 or 1250)(– “recapture income” – any gain in excess of recapture inc recognized in accordance w/ installment method

dealer dispos – 453(b)(2) – gain from dealer dispos or dospos of pers prop inventory may not be reported –

Second Disposition by related person – § 453(e) – if sale made to related person who disposes of it w/in 2 yrs, amt realized by seller in 2nd sipos treated as rec’d by first seller

Election – § 453(d) once installment sale made, realized gain recognized according to these rules unless taxpayer elects out w/ respect to one or more sales made dyring taxale year on or before return due; once made, only revocable w/ IRS consent – amt realized is then determined under OID

“open transaction doctrine” – if impossible to determine DMV, may be treated as open until actual payments exceed basis – recover basis first - Burnet v. Logan – hard to imagine still being very possible –

Judicial Doctrines

Claim of Right Doctrine

Must include in income amts received if has a claim to amt and unrestricted use of it, even if may be obligated to return it later North American Oil Consolidated v. Burnet

If later repaid, can’t recalculate income but can take deduction in year of repayment

Exception – 1341(a) if included in earlier yr bec appeared unrestricted rt (“semblance of a right” not error or embezzlement), and deduction allowable now bec did established that she did not have, and deduction exceeds 3k, can use one of 2 methods:

1) compute tax liability for current year, taking deduction

2) compute liability w/o deduction, but subtract amt by which tax liability in earlier year would have been reduced if repaid amt had not been included in

Does not apply to inc derived from sale of inventory - 1341(b)

Tax Benefit Rule

If deduction taken which later proves improper, must include in gross income any amt later recovered

Exclusionary – 111(a) if prior deduction did not reduce liability, recovery of amt deducted previously need not be included

Inclusionary – inc in amt of prior deduction must be included 111(b)

Alice Phelan Sullivan Corp v US – transferred prop to charity, took deduction, later it was returned – although it just recovered capital it had to include the amt of the previous deduction in income

However, to the extent the prior deduction did not reduce the amt of income tax in the prior year, it’s excludible 111(a)

Similarly, if there is a downward price adjustment of an already taken deduction, then inc. in tax liability required to the extent the prior credit resulted in a tax benefit 111(b)

Nonrecognition Provisions – normally, gain realized is recognized in taxable year (1001(a), (c)) but certain exceptions which postpone recognition

Improvements by lessee on lessor’s property excluded, even when lessee - 109

If improvements were not part of the rent for the use of the property 109

Reg §1.109-1(a): the more it increases the value of the

If excluded, basis may not be increased on account of the improvements – § 1019 (postpones recognition of gain, does not actually result in an exclusion)

Must be “fixtures” (not moveable furniture & equipment) to be excludible

(previously, Bruun had established that before this statutory relief, this was recognized income)

Like-kind exchanges 1031 – exchanged solely for other qualifying property of a like kind

Must be an “exchange,” distinguished from a “sale”

Qualifying property – held for productive use in a trade or bus or held for investment – like for like 1031(a)(1) – does not included

Stock in trade, held primaryily for sale

Stocks, bonds, notes

Securities or evidences of indebtedness

Interests in partnership

Certs of trust or beneficial interests

Choses in action

Like kind – nature/character, not quality (1.1031(a)-1(b), (c) – real estate for real estate, etc,., doesn’t matter if unimproved for improved, etc.

If not solely in kind – “boot” received in excess of like kind property recognized 1031(b) – but loss not recognized 1031(c)

Deferred exchanges – 1031(a)(3) - nonrecognition applies even if different time – even 3P transactions - but must not treated as like-kind if:

It is not identified as property to be rec’ed on or before 45 days after transfer other prop

It is received more than 180 days after transfer

Received after due date of tax return for year exchanged occurred

Liabilities/debt relief –

liability assumed in the transfer treated as boot to transferor and is recognized

BUT only if it is less than or equal to realized gain

So do realized gain = FMV rec’d + debt relief – debt assumed – old basis

Recognized gain is boot (as NDR) UNLESS it is greater than realized gain. Recog. Gain is the lesser of NDR and realized gain. Can only recognize as much as you realize.

New basis = old basis + NDR – recog. gain

Related persons – 1031(f) - “recapture rule” may require recognition, if:

1) between related persons, AND

1031(f)(3) – members of family, or idns/entities w/ close econ ties

2) either party disposes of prop w/in 2 years

recognition on date of later transfer

1031(f)(2) – does not apply if:

occurs in compulsory/involuntary conversion

after death of related party

neither exchange nor disposition had tax avoidance purpose

ONLY RECOGNIZE BOOT/NDR UP TO AMT OF REALIZED GAIN

§ 1031(d) Calculating Basis: (keep your original basis) basis of prop relinquished - $/boot received + recognized gain

only the boot is currently recognized

so the gain will be recognized later when you sell it

keep your original basis, take into account money you received, but then take out what was currently recognized

Involuntary conversions § 1033 –

1033(a)(1), (2) gain (but not loss) nonrecognized if:

1) prop converted into “similar or related service or use” as involuntarily converted prop

2) prop converted into $ or other prop which is then used to purchase similar property w/in time limit (2 years + whatever was left of taxable year in which loss occurred)

1033(a) – comp or invol conversion if:

partially or totally destroyed

stolen

seized

requisitioned

condemned

sole/exchanged under threat or imminence of seizure, requisition or condemnation

sold pursuant to fed reclamation laws 1033(c)

certain livestock destroyed by disease or sold on acct of drought, flood, certain weather conds 1033(d), (e)

Conversion of Similar Property – nonrecognition of gain is mandatory, need not be elected – but loss is allowed to be recognized 1033(a)(1)

Conversion into $/dissimilar property – 1033(a)(2) – must purchase similar property or acquire control of corp that owns it – if so, must elect nonreconition – only to extent that cost exceeds amt realized

Purchase – only if unadjusted basis of prop is it cost basis – gift does not qualifty 1033(a)(2)(A)(ii)

Qualifying corp stock – control = 80% voting power and shares 1033(a)(2)(A) and (E)(i)

Period for replacement – w/in period beginning with date of disposition or earliest threat and ending 2 years after close of 1st taxable yr in which any part of the gain is realized 1033(a)(2)(B)

“Similar property” – not defined

Owner-Users – close functional similarity

Owner-investors – reasonably similar in their elation ot the taxpayer

Condemnation of Real Property – not as strict – like kind or similar 1033(g)(1) – period extend to 3 years 1033(g)(4), but no corp stock 1033(g)(2)

Basis – reflect extent to which gain was not recognized – basis of prop involuntarily converted – holding period of the old period is “tacked” onto holding period of new property

If converted into similar prop directly – basis = converted property 1033(b)(1)

If converted into $ or dissimilar prop – basis = cost – gain not recognized 1033(b)(2)

If converted into corp stock – if basis decreased bec of nonreconition, basis of prop owned by corp is to be decreased by same amt – 1033(b)(3)

Presidentially Declared Disaster – no gain recongized upon receipt of ins proceeds covering unscheduled pers prop in residence – 1033(h)(1)(A)(i) – all other proceeds treated as common pool, when portion used to purchase similar/related, may elect to nonrecognize – does not mater whether item is similar to particular item 1033(h)(1)(A)(ii) – 4 year limit 1033(h)(1)(B)

Transfer between spouses or incident to divorce - § 1051(a) – no gain or loss recognized

Unstated Interest – special rules when $ borrowed w/o payment of reasonable rate of interest

Loans with Below-market interest rates – treat for tax purposes as through reasonable rate of interest has been paid § 7872 – aimed at intrafamily loans, employee fringe benefits, etc.

Does not apply to loans to which §§ 483 or 1274 apply

Borrower considered as receiving gift/income in amt of interest computed, and in some sits entitled to deduction for amt of foregone int retransferred to lender § 163

Lender treated as having made gift/paid income, and will also have int inc in forgone interest

Determination of “reasonable” is by reference to “applicable federal rate” § 7872(f)(2)

“below-mkt loan” if loan calls for no interest or less than applicable fed rate

“foregone interest” = extent to which fed rate exceeds interest § 7672(e)(1), (2)

Gift Loans – below-mkt loan in nature of gift, such as family § 7872(f)(3) – forgone interest considered gift, subject to the gift tax § 7672(b)(1), (d)(2) - forgone interest considered periodically transferred from borrower to lender, included in gross income and generating deduction § 7872(a)(2)

Term Gift Loans – made for specific period of time

amt of foregone int is PV, w/ discount value = fed rate, of all required payments

for purposes of gift tax, lender deemed to make gift = total amyt of foregone int on date of loan § 7872(b)(1), (d)(2).

But for purposes of income tax, deemed to pay payments of foregone int attributable to pay payments of forgone int attributable to each calendar yr the loan is outstanding, on the last day of calendar year § 7872(a)(2)

Unlike term nongift, in which it’s all due initially

Demand Gift Loans - borrower may be required to repay the loan at any time (so impossible to compute foregone int at the time)

Foregone int compute 12/31 of each year loan is outstanding – gift in that amt deemed made on that date, int deemed immediately retransferred by borrower to lender as int § 7872(a)

Exceptions

De minimis - on any day total amt of outstanding loans do not exceed 10k, unless proceeds used to acquire inc-producing assets §7872(c)(2)

Not earning/investing - gift loan less than 100k made directly between inds, amt of int imputed may not exceed net income from investments for the yr (none if such income does not exceed 1k) § 7872(d)(1), 163(d)(4)

unless primary purpose was avoiding fed tax § 7872(d)(1)(B)

Nongift Loans – some nongift loans also subject, forgone interest considered periodically transferred from borrower to lender, included in gross income and generating deduction § 7872(b)(2)

determined by relationship twixt lender & borrower § 7872(c)(1)

“Compensation-related loan” = employee, independent Ker providing svs § -> forgone int is compensation 7872(c)(1)(B)

“Corporation-shareholder loan” = corp & shareholder -> forgone int is dividend § 7872(c)(1)(C)

also if purpose is to avoid tax or have significant effect on tax liability § 7872(c)(1)(C)

Term nongift loans - forgone int = deemed transferred on date of loan § 7872(b)(1) – int deemed repaid annually under rules applicable to Original Issue Discount on an annual basis §§ 7872(b)(2), 1272

Demand nongift loans – same rules as gift loans § 7872 (a) – consider foregone int as additional compensation

Exception for de minimis - nonfigt loans which are comp-related laos or corp-sholder loans on any day total amt of outstanding loans does not exceed 10k, unless pprose is tax avoidance § 7872(c)(3)

Original Issue Discount – recognizing that when you buy, promising to pay portion in the future, you’ve effectively borrowed money from seller – int shd ordinarily be paid – “zero coupon bonds” §§ 1274-75

Deferred Payments for Property

Debt Instruments Without Adequate Stated Interest

determine “adequate” by comparing interest with “applicable fed rate” § 1274(c)(2), (d)

if not equal, portion recharacterized as int, ompute at rate equal to applicable – computed on daily basis, compounes seminannually, included in inc of seller as int in taxable year § 1272(a)(1), (3); § 1274(b)(2), (d)(1)

Debt Instruments With Adequate Stated Interest – adequate amt, but does not provide for payment approp intervals

Force buyer/seller to account for amts of int annually § 1272(a)(1), (3)

Exceptions § 1274(c)(3)

Farm, less than $1m

Principal res

Selling price less than 250k

Publicly traded

Certain patents

Land sales between related persons

-> in which case we go to §483

Loans – where borrowed amt is less than amt to be repaid – OID = excess of amt required to be paid at maturity over price for which it was issued § 1273(a)(1) – recharacterize portion of this amt as int and accrue discount on a daily basis §§ 163(e), 1272(a)(1) & (3)

Market discount bonds - § 1276(a), unlike zero coupon bonds, ord income need not be recognized until sold (so unlike the rest of the rules this doesn’t affect timing, it’s to keep gain from being capital gain rather than ord income) – gain is ordinary income to the extent of “accrued market discount ” pursuant to §1276(b), either choose simple way or accurate way:

Mulptiply mkt discount when acquired bond by fraction = days held / days between purchase and redemption date

Using OID number

Interest on Certain Deferred Payments – if one of § 1274(c)’s exceptions apply, int may be imputed under § 483 – RARE ALMOST NEVER GOING TO HAPPEN, like for smaller scale transfer of property - treat portion of deferred payments as int

§ 483 does not affect timing of includsion – taxpayer’s acting method controls – will not require imputing int payments on a yearly basis by a cash-method taxpayer except to extent she receives cash (cf. OID rules)

exceptions for sales or prop for 3k or less, patents, situations where OID applies § 483(d)

int imputed at max rate of 6% compounded seminannually on certain transfers of land twixt related parties § 483(e)

max discount rate is 9% compounded semiannually, in cases of debt intstuments w/ stated principa of 2.8m or less which are given in consid for sale of prop other than most items of new tangible prop used in trade/bus or held for producing inc §§ 483(g)(2); § 1274A(a), (b)

Special Rules related to

Annuities

Exclusion ratio = investment in the K / expected return under K 72(b)(1)

Investment in K generally amt of premiums paid 72(c)(1)

Expecture return – multiply amt of payments by number of payments called for under K or acturarial value 72(c)(3)

Total amt limited by investment in annuity K 72(B)(2) and (4)

If death before payments received equaling investment, then deduction allowe for unrecovered amt 72(B)(3), (4)

Deferred Compensation –

Nonqualified DC plans – no limit on amt of comp deferred to future years (Rev. Rul. 60-31) –

mere “promise to pay” not taxable

But if placed in a trust/escrow out of control of employer, employee taxed when money paid ... to escrow agent?

But only if no risk of forfeiture and right to withdraw

Minor v US – doctor and deferred comp plan – but merely credits fund, mere promise to pay funds – not income at that time

§409A – taxable when bargained for if plan allows to accelerate benefits or shields assets upon deterioration of financial health

§ 402 – qualified deferred compensation plan –

employees not req’d to include until receive payments (401(k))

employers enitled to deduction for amts paid

earnings on funds paid into it and invested not taxed

Roth 401(k) – employee taxed on amts paid into, but distribs tax-free

BUT may not discriminate – comp benefits to all employees

BUT § 83(a) - Special rules for prop (such as corp stock), subject to restriction or risk of forfeiture – inc = excess of FMV at time of transferrable over amt paid

CASE – Minor?

§ 83(b) – employee may elect to include FMV – amt paid at the time of transfer, rather than waiting until prop becomes transferrable

IRAs - § 408 –

5k year may be set aside, and claimed as a deduction

includible when paid out

Roth IRA - § 408A –

Non deduction when paid in

But no income when paid out

Gross inc must be below 150k

Stock Options

Com’r v LoBue – yes they are income

Incentive Stock Options - § 422 – capital gain to employee upon sale of stock, no ded by employer, if:

Requires employee to retain stock at least 2 years after option, and 1 year after receving stock § 422(a)(1)

Option price no less than the FMV at time option granted § 42(b)(1)

Pursuant to plan approved by sholders, after receiing info about how many shares and which employees plan covers § 422(b)(1)

$100k ceiling on value of stock that as yet unexercised options constituting ISOs can cover § 422(d)

“effectively elective” outside of 100k ceiling

ER: only collective idiocy could explain the deep mystery of why anyone uses these

§ 83 (in response to growth of nonstatutory stock options):

Income upon receipt of the option:

§ 83(a) Mandatory includability if it has a “readily ascertainable FMV” (rare) unless:

Nontransferable AND

Subject to substantial risk of forfeiture

Conditioned on employment, etc.

(in which case it is includable when either of those conditions lapse) § 83(a)(2)

§83(b) Elective includability if doesn’t meet 83(a), in which case FMV of prop determined w/o regard to any restictions other than those that will never lapse

§83(b)(1): BUT that means you run a risk – because you can’t deduct later if

Preq to both mandatory and elective if, when granted, option lacks a readily ascertainable FMV § 83(e)(3)

Income upon exercise of the option if lacks readily ascertainable FMV when granted

Only applies to grants of stock for services rendered - not sales

Amt realized: FMV – amt paid

§83(h): ded to emp’r in amt of amt realized

Pensions (qualified employer retirement plans) – same but to determine excluded basis, “simplified” method – investment / anticipated payments 72(d)

Who is the proper taxpayer?

Alimony, Child Support, and Prop Settlements

Alimony - §§ 71, 215 – ded allowed for amt paid, included in inc of recip – interdependent

DEFINITIONS: IF ALL OF (§ 71(b), (c)(1) & (e)):

In cash

Received under a divorce or separation instrument (§ 71(b)(2)):

Decree of divorce or separate maontenace or written instrument incident

Written sep agreement OR

Jud decree requiring that support or maintenace payments be made

Re’d directly by spouse/former souse or 3P for her behalf

Not designated as nonalimont in instrument

Not members of the same household at time payment made (if under final decree of divorce/separation)

No liability to make payment or substitute after death of payee

Not for child support

Don’t file jt return if still married

Default rule can be flipped electively – §71(b)(1)(B) – no ded, no inclusion if both parties agree in instrument

Front-loading rules – § 71(f) - 2 additional limits to prevent parties to structure prop settlement to qualify as alimony:

Amt of “excess alimony payments” required to be included in payor’s income in 3rd post-separation yr – recipient entitled to ded - § 71(f)(1)

“excess alimony payments” = anything more than 15k difference between year 2 and 3

For year 2, EAPY2 = Y2 payment – (Y3 – 15)

For year 1, EAPY1 = [([Y1 - [([Y2-EAP1] + Y3)/2] – 15

EAP = EAPY1 + EAPY2

EXCEPTIONS for temp alimony (§71(f)(5)(B)), psments ease upon death (§71(f)(5)(A), or payments fluctuate (§71(f)(5)(C))

Indirect Alimony – payments to 3P on behalf of spouse may qualify if all other reqs satisfied §71(b)(1)(A)

§61(a)(10): may be subtracted from gross inc and therefore not subject to limits on itemized deds

Child Support – not treated as alimony to extent it’s fixed as amt payable for child support - § 71(c) – no ded, no inc

“fixed” if it would be reduced on contingency (child’s age, marrying, dying) “clearly associated” § 71(c)(2)

Diez-Argulles – can’t deduct value of child support payments owed but not paid

Transfers of Property Between Spouses or Incident to Divorce - § 1041(a) – no gain or loss, no deduction, transferred basis

Treaed as if acquired by gift, value excluded under 102 – basis will be same as in hands of transferor § 1041(b)

Incident = w/in 1 yr or is” related to cessation of marriage” §1041(c)

Pursuant to instrument AND

transfer occurs w/in 6 yrs of cessation

Nonrecontion rule does not apply if prop transferred to a trust and liability es on prop exceeded adj basis

(previously, Davis and Es-Saltaneh held that it would be recognized gain at the time)

Income-splitting/Marriage

Earl – personal service inc taxed to person who does the work - not allowed to assign inc to wife pursuant to K between them to share inc and prop =ly

Whether services are to be rendered in future (Earl)

Or already completed at time of designation (Eubank – trust from prior work)

EXCEPTIONS:

Uncompensated services in kind apparently allowed to be excluded

BUT NOT where tp is member of family partnership

Although OK where employee of family corp

Patents, copyrights, etc free of the general rule – donee reports inc as his own

Blair – Gifts of inc-producing prop - effective to shift future income to donee (In Blair, transferred some portion of trust and could no longer take it back), EXCEPTIONS:

donee has right to take prop back (Corliss) or use for himself to meet own obligations (Wells)

Donee has right to redesignate donee at his own discretion (i.e., short-term, limited number of payments) – Clifford, Horst

Horst – could still retain control in asset

Reservation of powers to manage and dispose of trust prop treated as = continue ownership (Clifford)

BUT Poe v. Seaborn – allowed inc-splitting that was pursuant to WA’s cmty-prop law (limited to just to two, not to future deps)

And then, in 1948, extended to all states ...

Marriage Penalty

§1(a): separate rate schedule for married tps

compute tax on ½ total income, double it

§1(c): separate rate schedule for unmarried tps

§1(g): “Kiddie Tax” – unearned inc of child under 18 (24 if student) taxed as though to parent

§1(g)(1): tax liability is greater of:

amt computed using rates applicable child, OR

amt computed by adding to the parent’s taxable inc the amt of the child’s net unearned inc, and using rates applicable to parents (“allocable parental tax”)

net unearned inc = unearned inc – (child’s st ded amt ($950) + (the greater of st ded amt ($950) OR if itemizes, deds directly connected with producing the unearned inc) (§1(g)(4)))

(remember the limits on deds)

§1(g)(7): elective if all inc from int & divs, and between (($900) OR if itemizes, deds directly connected with producing the unearned inc)) – and 10x that

Characterizing Income

Policy arguments

Bunching

Lock-in effect

Inflation

Order:

casualty netting

overall §1231 netting

§1231(c) recapture of previous year loss deds

§1245/1250 recapture

Overall netting

Characterizing

§1221: cap asset = “all property”, with exceptions:

If Prop, one of eight exceptions?

§1221(a)(1): inventory or stock-in-trade of a bus, prop held primarily for sale to customers in ord course of t/b

“primarily for sale”

Malat v. Riddell – primarily = “of first importance,” “principal”

Biedernharn – wrt real estate, Winthrop factors (substantiality/frequency of sales, improvements, soliciatation & ad efforts, brokers activities) indicate ord inc in his real esate subdivision efforts – contuinous, vigorosously improved, substantial frequent sales – cannot write BLL but in red letters “once and investment does not mean always an investment”

Gangi v. Com’r – selling condo units, but still not rising to level of holding properly primarily for sale – wasn’t primary intent

“to customers”

added to prevent stock speculator from trading on own acct

Biefeldt – not a specialist, not a dealer, merely a trader speculating on price fluctuations – cannot claim ord loss (and therefore offset unlimited amt), limited to 3k limit for cap expenses

Related to the tp’s bus -> substitutes for inventory

Corn Products – futures trading was not separate & apart from manuf operation – vitally impt – so must treat as ord losses

Arkansas Best – CP doesn’t mean it’s a motive test or that all things related to bus are not cap assets – listed exceptions are exclusive – CP did not mean a general exemption from cap-asset status for all assets acquired for bus purposes – just that hedging transactions that are an integral part of inventory-purpose system fall w/in inventory exclusion – as substitutes for inventory

Reg. §1.2221-2: now allow ord gain/loss for broad variety of hedging transactions – but tp must identify in advance (Reg §1.2221-2(e)

§1221(a)(2) real prop or dep’le prop used in a t/b

BUT §1231 SPECIAL RULES FOR FIXTURES

§1221(a)(3) creative works – material subject to copyright, letters and memoranda (elective for some musical works) or similar held by creators –

for letters, memoranda – also to those for whom prepared – designed to deny charitable deds for contributing papers to museums/libraries (Nixon)

Regs. §1.1221-1(c)(1): “similar” = , any other prop eligible for copyright, but not patent/invention, or design protected only under patent and not copyright law

§1221(a)(4) accts rec’le

§1221(a(8): supplies

Is it Property?

Goodwill

Baker – State Farm employee had no ownership of any asset, and goodwill must attach to an asset, so standing alone it doesn’t qualify as cap asset

Right of Privacy or of Exploitation

Miller – selling movie rights to Glen Miller’s life story is ord inc, not cap gain – Universal didn’t pay for “property,” they paid for protection against such a property rt later being declared

Might help her case that CA later called it a prop right? (Maybe, but IRS doesn’t necessarily need to care.)

Patents and Copyrights

§1235: patent is L-T Cap asset, regardless of holding period, attachment to underlying prop, etc.

§1221(3) & §1231(b)(1)(C): author of copyrighted material cannot gain Cap Gain treatment, but purchaser can

Touchstone: substitute for ord inc?

Can’t let people easily turn ord inc streams into property to get cap gain treatment

Sale of a Business/Fragmentation vs. Unification

Williams v. MacGowan (2nd Cir 1945, L.Hand) – when you sell a business, you sell all the bits and pieces separately – allocate cost to each portion, whatever’s left over must be goodwill - Congress meant to comminute elements of a business – cash, receivables, fixtures, inventory – all are ord inc except possibly the receivables depending upon whether depreciable

Parties to agree upon allocation and report that to IRS

“Sale or Exchange” Requirement

sale = transfer of prop for a fixed price in money or its equivalent (Schelbe, cited in Baker)

Regs. §1.1001-1: “exchange” = exchange of prop for another prop that is materially different either in kind or in extent

Baker – State Farm agent returning property in exchange for noncompete, etc. – key is deciding whether the benefits and burdens of ownership have passed – factors:

Whether legal title passes

Baker – never had legal title to SF’s materials, no indication he received payment in exchange for hiring employees or for his telephone number

How parties treat the transaction

Present obligation to execute a deed, obligation to make payments

Whether right of possession is vested

Who pays prop taxes

Which party bears risk of los or damage

Which party recives profits from op and sale

Baker – denied -

Correlation with Prior Related Trans

Recapture of ord income deductions - Merchants National Bank – judicially created analogue to recapture rule – took ded from ord inc for bad debt, but then later turned good – then later can’t claim compete cap gain

Same principle applies to other losses (casualty, etc.)

Analogue to tax benefit rule

Arrowsmith (USSC, 1942) – liquidated corp, and then in later years, there was a judgment vs corp, which inds paid – not allowed to claim ord loss, because not based on any ord bus trans of theirs apart from the liquidation of the company – must

7. Special Provisions

Options - § 1234(a) – gain/loss from sale or exchange of option is cap gain/los if prop would be a cap asset in tpayer’s hands

Dividends - §1(h)(11) – div inc taxed as though it is net cap gain (15%), but cap losses cannot offset dividend inc bec not classified as cap asset

§165(g)(1): Worthless securities

§166(d)(1)(B): nonbusiness bad debts

Quasi-Capital Assets – “Fixed” Assets (§1231) – land, buildings and machinery

Is §1231 property? (gains and losses arising from

sale of prop used in t/b or

from invol/compulsory conversion of prop used in t/b or

any cap asset hld for more than a year and held in connection w/ t/b

net casualty losses/gains:

§1231(a)(4)(c): If losses from §1231 assets involving casualties exceed gains, remove from calculation (those considered ord), then net

If losses do not exceed gain, all are included, along with other §1231 gains and losses, and losses and gains netted

If final result is:

NET LOSS – all §1231 gains & losses ord

§1231(a)(1) : NET GAIN – all gains and losses are capital

§1231(c): except to extent of unrecpatured §1231 losses during pervious 5 years

Recapture of Depreciation

Recapture all or portion of deds taken from ord inc (depreciation) when sold

§1245:personal tangible prop:

§1245(a)(3): applies to all depreciable prop other than RE – anything subject to depreciation under §167 (even if taken via ACRS or amoritization)

1245(a)(3)((D): not RE but some items that are considered RE under local law (greenhouses)

gain on sale taxed as ord inc to the full extent of prior dep deds, §§ 1245(a)(1) & 61: ord inc =

lower of

recomputed basis OR

§1245(a)(2)(A): adj basis + all adjustments from dep/amorization

if computing basis based on basis of other prop (i.e., like-kind), must include deds from it as well – including §179 deds

§1245(a)(2)(B): if can demonstrate amts allowed exceed amts allowable, can use that instread

amt realized (if sold, exchanged or converted) or FMV (if otherwise disposed)

MINUS adjusted basis

EXCEPTIONS:

§1245(b)(1) & (2): gift, transferred at death

§1245(b)(4): if like-kind or involuntary conversion, ord inc recognized only to extent of of sum of:

(1) gain required to be recognized via §§1031 & 1033 +

(2) excess of FMV of non-§1245 property over (1)

§1250: real prop: requires recapture of the accelerated portion of dep taken wrt real prop to be recaptured upon sale – multiply “applicable percentage” to lower of “additional depreciation” or gain on property

NOW WE RECAPTURE JUST LIKE §1245, BUT RATHER THAN BEING ORD INC WE TAX AT 25% RATE VIA §1(H)

§1250(c): applies to real prop which is or has been subject to dep allowances under §167

excluding any §1245 property

improvements to bldgs dep’le, not land itself

§1250(b): “additional depreciation” = excess of

dep adjs attributable to specific periods of time after 12/31/63 OVER

amt of deds that would have been allowed via straight-line

§1250(b)(5): must use useful life and salvage value, or if ACRS, straightline using recovery period

§1250(b)(1): if holding period of 1 year or less, means all dep adjs, not just those in excess

§1250(e): “applicable percentage”

§1250(a)(1)(B)(v): 100% for most real prop depreciated since 1975

§1250(d): same exceptions as in §1245

§1245(b)(1) & (2): gift, transferred at death

§1245(b)(4): if like-kind or involuntary conversion, ord inc recognized only to extent of of sum of:

(1) gain required to be recognized via §§1031 & 1033 +

(2) excess of FMV of non-§1245 property over (1)

§1244: small bus stock -

Treatment of Capital Gains and Losses

1. Capital Gains

Taxed via §1(h), normally at lower rates

§1(h) & §1211: netting

first w/in each rate class (28%, 25%, 15%)???

net long-term (held >1 yr) / short-term (§1222) / vs each other

net gains in both -> ST taxed as ord, LT usually 15%

net losses in both -> offset vs up to 3k of ord inc (unlimited carryforward)

what type is carried forward? LT, you use up the ST §1212(b)(2)

net gains in one, losses in other -> offset loss vs gain:

excess of S-T -> ord rates

excess of L-T -> 15%

loss exceeds gain -> offset vs 3k of income, unlimited carryforward

Dividends - §1(h)(11) – div inc taxed as though it is net cap gain (15%), but cap losses cannot offset dividend inc bec not classified as cap asset

2. Cap Losses

§1211(a): ded allowed only up to amt of cap gain

§1211(b): ded cap losses to extent of cap gain inc, plus 3k of ord inc – unlimited carryforward

Computing Liability

Gross Inc

- “Above the Line” deds (trade/bus)

= AGI

- personal exemptions

- itemized OR standard ded

= taxable inc

x tax rate

= tax owed

- credits

Adjusted gross income

Gross income – (§62(a) bus/investment deductions (“above the line” deds) + personal exemptions) OR gross income – (itemized deds including personal exemptions

Gr

Taxable income

Standard ded – subtract from adj gross income to arrive at taxable income

§63(c)(2) – 11.4k married, 5.7k hh, 3k single

§63(c)(3) & (f) - “additional standard ded” for 65+/blind

§63(c)(4) – amt of st ded allowed to tpayer for whom dep ded may be claimed limited to greater of $500 or the sume of $250 and ind’s earned income

Limits:

§63(c)(5): amt of st ded allowed to tp for whom dep exemption may be claimed by another tp is limited to greater of $500 or ($250 _ earned inc)

§63(c)(4): amts adjusted for COL

§63(c)(6): st ded = zero for:

1) married ind filing sep return whose spouse itemizes

2) nonres alien

3) ind filing return for a short period of less than 12 mos bec of a chance in his txable yr

Itemized Deds – won’t have to know --

§68(a) – if gross income exceeds 100k, itemized deds must be reduced by 3% of excess amt, up to max of 80% of itemized deds

68(d) – appliea fter applying any other limits, including imisc itemized ded limits

68(c) but otherwise allowable deds )med expenses, investment int, casualty losses) not limited

68(f) & (g) – phased out by 2010?

MISC Itemized Deds - §67(a): only to extent total amt exceeds 2% of AGI

§67(b): misc itemized deds = all other than certain enumerated, including:

int

taxes

casualty losses

charitable contribs

extraordinary med expenses

significantly, subject to the floor include:

exmployee deds via §162

inc producing via §212

other than prop held for rent or royalties

Whitten v Com’r (TC Memo, 1995) – losses incurred wrt appearance on Wheel of Fortune at best misc itemized deds

attys fees for lawsuits Com’r v Banks

§62(a)(20): except discrim suits & whistelblowers – allowed above the line

REMEMBER §162 deds (other than employee-reimbursement) are ATL

Misc itemized means may not be deducted in calculating AMT

Overall limitation. §68(a): if AGI exceeds $159,950 (2008-9) itemized ded must be reduced by 3% of that excess amt, up to max of 80% of itemized deds – does not apply to:

Med expenses (has its own limits)

Casualty losses (has its own limits)

Investment int

Personal Exemptions

§63(a) & (b)(2): subtract deds allowable under 151 whether uses standard ded or itemizes

§151(d)(3): reduction for high-inc: reduced by 2% for each $2500 of AGI in excess of threshold amt – phased out by 2010?

Alternative Minimum Tax: §55

§55(b)(2): Alternative Minimum Taxable Income (AMTI) = taxable inc + “items of tax preference” (which get added back in):

§56(a)(1) & (b)(1): adjustments to taxable inc =

recomputing depreciation deds

disallowing misc itemized deds, personal exemption ded, st ded, and deds for taxes

§57(a): tax prefs include

deds for depletion and intangible drilling costs,

limited tax exempt int and

7% of amts excluded from sale of certain sm bus stock

§55(b)(1)(A)(i)(I): tent min tax computed at rate of 26% of excess of AMTI over exemption amt

§55(b)(1)(A)(i)(II): jumps to 28% for amt over $175k

§55(d)(1) & (3): exemption rate defined (currently, first $75k exempt altogether)

§55(a): AMT = excess of tent min tax over regular tax

“AMT Creep” - Didn’t index to inflation, and much lower rates now than in the 60s, so while initially some ½ % of tpayers paid, but soon it will be close to a third – but now it generates too much revenue

Tax Credits – not going to test on mechanics of these

Nonrefundable Personal credits (only up to amt of liability)

§21: hh & dep care services necy for gainful employment tpayer who maintains a hh which includes one or more qualifying ins allowed credit = applicable percentage of emp-related expsnes paid durintaxable yr

qual = deps under 13, deps or spouse incapable

% = 35% reduced by 1 for each 2k by which adk gross income exceeds 15k (cannot below 20%)

amt subject to the percentage limited to 3k for 1 qualifying ind, 6k if 2+ (so MAX TOTAL CREDIT is $2100)

emp related expsnes = hh services and care of qyal ind, if incurred to be employed

Smith v. Com’r (1940) – had not previous allowed this

§21(d)(2): student spouse counts for period fulltime student, but limits percentage more

§21(b)(2)(A): not camp

overruling Zoltan v Com’r, which had allowed it

Cf. §129: DCAP (dep care assistance program) - permits emp to make up to 5k available for child-care expense through DCAP – as part of 125 cafeteria plan – but have to choose - tax-planning choice

§22: elderly/disabled – 15% of eligible inc:

qualified ind:

55 or older, OR

has retired on diability and when retired was totally and perm’ly disabled

max amt of eligible inc (“credit base”) is $5000 (max credit $750) for unmarried d taxpayers 65 and older

alts for others

credit base reduced by ½ of AGI which exceeds :

$7500 for unmarried tpayers

$10k for married jt

$5k married sep

must be reduced by amts received as pension, annuity or disability bens which are excluded from gross inc under SSA or certain other provisions

§23: adoption expenses

§23(a)(3): max credit per child 10k

§23(a)(3): available

if incurred in yr prior to adoption-> yr adoption finalized

if incurred yr of adoption or later -> yr incurred

special needs available for 10k in yr adoption final regardless of whether tp has incurred expenses

§23(d)(3): determined by st agency to place w/ adoptive parents because of specifi factor or condition like ethinicity or handicap

§23(b): phase-out ratably for tp with AGI above 150l, fully at 190k of mod gross inc

§23(f): must provide name age and TIN for child

§23(b)(3): no credit for any expense for which ded / credit allowed under other prov, or for which funds are received under fed, st or local program

23(d)(1)(D): nor expenses which qualify for reimb under emp adiption assitance program

§23(d)(1): “”qual adoption expenses” = rle & necy attors fees, ct costs, adoption fees related to adoption of child

incapable of caring for self or

under 18 and not child of spouse

§24: child tax credit

§24(c)(1): “qual child” = under 17 who satisfies reqs of 152(c)

§24(a): 1k per child

§24(b) phased out

for mod adj gross inc in excess of certain threhold amts:

110k jt

75k ind

55k married filing sep’ly

phased out at rate of $50 for each 1k of mod adj gross inc in excess of threshold

§24(d): refundable to limited extent

§25A: Hope Scholarship and Lifetime Learning Credits

Hope scholarship credit

§25A(b)(1): max per student credit of $1500

100% credit for each students first 1k

50% credit for second 1k

§25A(f)(1): tuition and academic fees nu tp, spouse or deps while pursuing post-sec ed on at least half-time basis

§25A(b)(2): limited to first 2 yrs of ed, only for max two tax yrs for each student

Lifetime Learning credit – as alt to HSC

§25A(c)(2): tp, spouse or deps

§24A(c)(1): amt = 20% of qua led exps paid by tp during any yr of ed (not just 2 yrs)

§25A(C)(1): x credit per tp in any year limited to 2k

§25A(c)(2)(B): includes instruction for acquiring or improving job skills

§25A(g)(3): only parents claiming child as dep on return are eligible to claim

§25A(c)(2)(A): only one credit wrt any one student per year

Income:

§25A(d)(2)(A) and (B): mod AGI of 40k or less (80k) jt entitled to max credit for both

§25A(D)(2)(A) and (B): max credit phased out between 40-50k (80-100 jt)

§25A(h): HSC limits and inc limts indexed for COL, inc limits for LLC also indexed but max credit amts will not be

Miscellaneous nonrefundable credits – after using the above first

Refundable Credits (above

Tax withheld on wages

§32: Earned Income Tax Credit (EITC)

you will be baffled by the rules – good policy to require this for low-inc tpayers

Alternative Systems

Consumption Tax –

Policy arguments – inc tax discourages savings, “punishes” those who don’t consume, tax based on people’s use of resourcs

Types

Andrews cash-flow model

Investments deductible when made - departure

Wages/salaries/int taxable received, as now

Deductions justified just as now

Bus/investment loans inc to borrower when received, repayments and int mde deductible

Consumer credit – in thy treated like bus loans, but A suggest ignoring entirely for simplicity

Consumer durables – ded for purchase price (viewing good as a type of invesmtnet), rather than just cap recovery overtime

Owner-occupied housing – in thy, ded for purchase price, inc in amt of imputed rental inc – but since this might be hardship on elderly homeowners, treat as consumer durables

Art, unimproved RE, mixed consumption/investment – assume purchased for investment

Cash balances – unless large, leave them out, treat as consumed (as current law)

Gifts and bequests – no consumption tax liability

Yield-Exempt model – tax earnings when earned but impose no tax when later consumed

Wage tax – with adjustments to avoid objection that labor is being taxed fully over (exempting first amt earned, etc)

Sales tax and VAT

Current system closer to pure income tax but certain elements echo consumption tax:

Deferral of income

IRA

insurance