Tax 1A Outline

I. RESOLUTION OF TAX DISPUTES......................................................................................................................3

A. TRY TO RESOLVE WITH THE REVENUE AGENT. IF NOT ---.................................................................................................3
II. GROSS INCOME....................................................................................................................................................3
A. GROSS INCOME IS AN INCREASE IN WEALTH AS A RESULT OF A REALIZATION EVENT UNLESS CONGRESS HAS EXEMPTED IT...........3
B. SECTION 61 .............................................................................................................................................................3
C. TREASURE TROVE......................................................................................................................................................3
D. BARGAIN PURCHASE...................................................................................................................................................3
E. ASSUMPTION/PAYMENT OF TAXPAYER LIABILITIES............................................................................................................3
F. RECEIPT OF DAMAGES.................................................................................................................................................4
G. MISCELLANEOUS EMPLOYEE COMPENSATION.................................................................................................................4
H. LOANS.....................................................................................................................................................................4
I. BARTERS....................................................................................................................................................................4
J. FREE USE OF PROPERTY...............................................................................................................................................4
III. COMMON STATUTORY EXCLUSIONS AND LIMITATIONS TO GROSS INCOME............................4
A. GIFTS – SECTION 102................................................................................................................................................4
B. INHERITANCES – SECTION 102.....................................................................................................................................5
C. EMPLOYMENT RELATED PAYMENTS..............................................................................................................................5
D. FRINGE BENEFITS.......................................................................................................................................................5
E. LODGING AND MEALS.................................................................................................................................................5
F. PRIZES AND AWARDS..................................................................................................................................................6
G. SCHOLARSHIPS AND FELLOWSHIPS................................................................................................................................6
IV. GROSS INCOME FROM PROPERTY...............................................................................................................6
A. INTRODUCTION...........................................................................................................................................................6
B. ADJUSTED BASIS........................................................................................................................................................6
C. COST AS THE INITIAL BASIS - §1012...........................................................................................................................7
D. BASIS OF PROPERTY RECEIVED IN EXCHANGE................................................................................................................7
E. MULTIPLE PROPERTIES ACQUIRED IN A SINGLE TRANSACTION.............................................................................................7
F. SIMILAR PROPERTIES ACQUIRED IN MULTIPLE TRANSACTIONS..............................................................................................7
G. INITIAL BASIS OF PROPERTY ACQUIRED BY RELEASING A CLAIM......................................................................................7
H. INITIAL BASIS OF PROPERTY ACQUIRED AS A GIFT.........................................................................................................7
I. INITIAL BASIS OF PROPERTY ACQUIRED FROM SPOUSE OR IN DIVORCE................................................................................8
J. INITIAL BASIS OF PROPERTY ACQUIRED FROM A DECEDENT..............................................................................................8
K. ADJUSTMENTS TO BASIS.............................................................................................................................................8
L. AMOUNT REALIZED....................................................................................................................................................8
V. MISCELLANEOUS ISSUES AND GROSS INCOME......................................................................................10
A. LIFE INSURANCE......................................................................................................................................................10
B. ANNUITY................................................................................................................................................................10
C. DISCHARGE OF INDEBTEDNESS (DOI) OR CANCELLATION OF DEBT (COD) INCOME.........................................................10
D. SECTION 108..........................................................................................................................................................11
E. STUDENT LOANS.......................................................................................................................................................11
F. RELATED PARTY DEBT ACQUISITION..........................................................................................................................11
G. DAMAGES AND RELATED RECEIPTS............................................................................................................................11
H. SEPARATION AND DIVORCE.......................................................................................................................................12
I. SALE OF RESIDENCE..................................................................................................................................................12
J. INCOME FROM ABROAD..............................................................................................................................................12
K. PAYMENTS RELATED TO HIGHER EDUCATION...............................................................................................................12
L. INCOME FROM STATE AND MUNICIPAL ACTIVITIES........................................................................................................12
VI. IDENTIFICATION OF THE PROPER TAXPAYER.....................................................................................12

Tax IA Outline 1
 A. ASSIGNMENT OF INCOME FROM SERVICES....................................................................................................................12
B. ASSIGNMENT OF INCOME FROM PROPERTY...................................................................................................................13
VII. OVERVIEW OF INCOME PRODUCING ENTITIES..................................................................................14
A. SINGLE OWNER VENTURES........................................................................................................................................14
B. MULTIPLE OWNER VENTURES....................................................................................................................................15
C. CHECK-THE-BOX REGULATIONS.................................................................................................................................15
VIII. ORDINARY AND NECESSARY BUSINESS DEDUCTIONS....................................................................15
A. REQUIREMENTS FOR A DEDUCTION..............................................................................................................................15
B. §162.....................................................................................................................................................................15
C. ORDINARY AND NECESSARY REQUIREMENT.................................................................................................................15
D. WHAT IS AN “EXPENSE”?..........................................................................................................................................16
E. TRADE OR BUSINESS REQUIREMENT............................................................................................................................16
F. START UP EXPENSES.................................................................................................................................................16
G. COMPENSATION.......................................................................................................................................................16
H. TRAVEL AWAY FROM HOME.....................................................................................................................................17
I. EDUCATIONAL EXPENSES............................................................................................................................................17
J. BUSINESS MEALS AND ENTERTAINMENT.......................................................................................................................17
K. UNIFORMS..............................................................................................................................................................17
L. ADVERTISING...........................................................................................................................................................17
IX. OTHER COMMON DEDUCTIONS..................................................................................................................17
A. LOSSES...................................................................................................................................................................17
B. DEPRECIATION AND AMORTIZATION............................................................................................................................18
C. SECTION 212 – EXPENSES FOR PRODUCTION OF INCOME...............................................................................................19
D. INTEREST................................................................................................................................................................20
E. TAXES....................................................................................................................................................................22
F. BAD DEBTS.............................................................................................................................................................22
G. CHARITABLE CONTRIBUTIONS.....................................................................................................................................22
H. MOVING EXPENSES..................................................................................................................................................22
I. MEDICAL EXPENSES..................................................................................................................................................22
J. QUALIFIED TUITION AND RELATED EXPENSES..................................................................................................................22
X. RESTRICTIONS ON DEDUCTIONS.................................................................................................................22
A. PERSONAL RESIDENCE DEDUCTIONS - §280A.............................................................................................................22
B. ‘AT RISK’ RULES - §465.........................................................................................................................................22
C. PASSIVE LOSSES - §469...........................................................................................................................................23
XI. TIMING OF INCOME AND DEDUCTIONS...................................................................................................24
A. IMPORTANCE OF TIMING............................................................................................................................................24
B. METHODS OF ACCOUNTING.......................................................................................................................................24
C. TIMING OF INCOME RECOGNITION UNDER THE CASH METHOD OF ACCOUNTING................................................................24
D. TIMING OF DEDUCTIONS UNDER THE CASH METHOD OF ACCOUNTING.............................................................................25
E. ACCRUAL METHOD OF ACCOUNTING: GENERAL RULE..................................................................................................26
F. PREPAYMENTS UNDER THE ACCRUAL METHOD..............................................................................................................26
G. TIMING DEDUCTIONS UNDER THE ACCRUAL METHOD...................................................................................................26
XII. CAPITAL GAINS AND LOSES.......................................................................................................................27
A. INTRODUCTION.........................................................................................................................................................27
B. PLANNING IMPLICATIONS...........................................................................................................................................27
C. REQUIREMENTS FOR A CAPITAL GAIN OR LOSS............................................................................................................27
D. WHAT IS A CAPITAL ASSET?.....................................................................................................................................27
E. SECTION 1231.........................................................................................................................................................27
F. SALE OR EXCHANGE REQUIREMENT.............................................................................................................................28
G. DEPRECIATION RECAPTURE........................................................................................................................................28

Tax IA Outline 2
I. Resolution of Tax Disputes
A. Try to resolve with the revenue agent. If not ---
1. IRS will send a 30-day letter
2. Try tax case in
a) Tax court
(1) Do not have to pay the deficiency but it is incurring interest
(2) Judges are tax lawyers
(3) Bound by precedent of the Circuit Court in the circuit it was
tried
(4) Unified Court
b) District Court
(1) Have to pay tax first
(2) Only court where you can get a jury
(3) Bound by the precedent of the Circuit Court
(4) Judges are not tax specialists
c) Court of Federal Claims
(1) Have to pay tax first
(2) Judges are tax lawyers

II. Gross Income

A. Gross income is an increase in wealth as a result of a realization event unless
Congress has exempted it.
B. Section 61
1. Basically says that everything is taxed unless exempted.
2. In an arms length transaction, the value of what you are getting for something
establishes the value of that item.
C. Treasure Trove
1. Cesarini v. United States
a) Court says that treasure trove is gross income.
2. If no federal law to determine undisputed possession then it is within the
providence of state property law.
3. If you assume that treasure trove is taxable then the issue is when the property
was reduced to undisputed possession.
4. The realization event is when the person has undisputed possession of the
item. When you have something you did not have before and there is no way
someone can take it away from you then you have undisputed possession.
D. Bargain Purchase
1. True bargain purchase does not result in gross income.
E. Assumption/payment of taxpayer liabilities
1. Old Colony Trust v. Commissioner
a) Person would owe taxes on his compensation. Company agreed to pay
these taxes.
b) Court says this is additional gross income.
2. How can you avoid this
a) Put into settlement agreement that the violations are against the

Tax IA Outline 3
 company and not against the employee
3. Realization event in the assumption of liability is when someone assumes
your liability and agrees to pay it off.
a) Owe someone something
b) Claim against you
c) In either case, your assets are subject to a claim in the amount of the
liability. When the liability is paid off, then you assets are free and
clear.
4. Cancellation of Debt Income is NOT the same as assumption of Liability.
Under assumption of debt the creditor will be paid, just paid by someone other
than the taxpayer. In cancellation of debt the debtor is not being paid.
5. Good example of assumption of debt and when the realization event happens
– Example #2-H – page 16-16 of lecture notes.
F. Receipt of Damages
1. Commissioner v. Glenshaw Glass Co.
a) Plaintiff got regular damages and punitive damages.
2. Section 104 excludes damages for personal physical injury from gross
income.
3. Court will look at how the complaint is drafted in terms of determining the tax
consequences of damages.
G. Miscellaneous Employee Compensation
1. Frequent Flyer Miles
a) IRS has ruled they are not taxable to the employee
H. Loans
1. When you borrow money it is not gross income since it is offset by a liability
a) Security deposits are not gross income to landlord since the tenant has
the right to get the money back.
I. Barters
1. FMV of the services goes to gross income
J. Free Use of Property
1. Value of the use of the property must be declared as gross income.

III. Common Statutory Exclusions and Limitations to Gross

Income
A. Gifts – Section 102
1. Income that is a gift is excluded from gross income
2. Commissioner v. Duberstein
a) Court says the tax definition of a gift is not the same as the everyday
definition of a gift.
b) Have to focus on the intent of the giver and whether the giver gave the
gift out of “detached and disinterested generosity.” This is the court’s
definition of a gift.
(1) Have to consider all the facts.
(2) Up to the trier of fact to determine if it is a gift.
(3) Motivation of the giver has to be detached and disinterested
generosity. Intent of the donor is all that counts.
3. Look for the DOMINATE reason that explains the actions of the donor. So

Tax IA Outline 4
 long as the DOMINATE motivation is detached and disinterested generosity
then the item is a gift.
4. After Duberstein, Congress added Section 102(c).
5. Section 102(c) relates to an employee and says the transfer is NOT a gift and
thus taxable as gross income.
B. Inheritances – Section 102
1. Income from inheritance is excluded from gross income.
2. If given in gratitude for services or for services rendered then it is not
excluded.
C. Employment Related Payments
1. Retirement benefits
a) Qualified plans and non-qualified plans
b) Under qualified plan the employer can deduct costs now and employee
does not pick up as income now. Person is taxed when they retire and
collect the retirement benefit
c) Under non-qualified plan the retirement benefit is treated under the
general rules of taxation.
D. Fringe Benefits
1. In the absence of any particular statute, all fringe benefits would be taxable.
2. Section 132 tells when fringe benefits are taxed and when not.
a) Section 132 excludes certain benefits from taxation.
b) Some issues are – see §1.132-1 et seq. starting page 956 of code book.
(1) No extra cost to the employer
(2) De minimis
(3) The discrimination issue – everyone has to be able to have the
benefit (see Reg. 1.132-8(1)(2)) – does not apply to de minimis
items.
(4) Spouse and children can benefit
(5) Can’t displace a paying customer
(6) Same line of business issue.
(7) Qualified employee discount. Up to 20% for a service. Have
to report excess over 20%. If a product then apply the formula
that is described on page 97 of the casebook.
E. Lodging and Meals
1. Section 119
a) Lodging
(1) Has to be on premises
(2) Has to be for the convenience of the employer. Have to prove
it is serving an essential purpose of the employer by having the
person living on the property.
(3) Strengthen case by putting something into employment
contract that requires the person to live on the premises.
(a) State person is on duty 24 hours a day
(b) Could show that to compete with other similar
businesses in the area you have to have a person on the
premises.
b) Meals
(1) Have to consider §132 – could be a working condition fringe

Tax IA Outline 5
 benefit
(2) So long as you charge employees what others would charge
there is not a problem with the IRS. If the employer makes a
profit it is gross income to employer.
(3) Need to charge the employees enough to cover cost of running
cafeteria.
(4) If you cannot get under §132 then you try to get under §119.
(a) Is it for convenience of employer?
(5) §119 applies ONLY when the employer provides the meals. If
the employer gives money to employee to buy meal then §119
does not apply. Under §132 it does not make any difference
whether the employee is reimbursed for the meal or whether it
is furnished by employer.
F. Prizes and Awards
1. Most are gross income under §74.
G. Scholarships and Fellowships
1. §117 and §127. §117 is most important
2. Only exclusion is for tuition and related expenses. Room and board not
excludable.
3. If you have to render services to institution then it is not excludable.

IV. Gross Income from Property

A. Introduction
1. What is property?
a) Tangible personal property, real estate, intangibles like stocks,
intellectual property, company good will, secrete formula, pending law
suit are all property.
2. Overview of rules as to gross income from property
a) Difference between deriving income from the property and selling the
property.
b) §1001 – gain from sale of property. Gain = amount realized minus
adjusted basis.
c) Bundle of sticks doctrine
(1) If you give up most of the sticks then it is a sale.
(a) If one of the sticks that is given away is the right to
have any appreciation in the property then it looks like
an installment sale.
d) You can have a trade and still calculate gain or loss.
e) A like kind exchange is NOT taxed under §1031(a)(1).
B. Adjusted Basis
1. Best to have a high basis since this will maximize depreciation and reduce
gain when sold.
2. COST IS THE INITIAL BASIS – default rule
3. Get basis by paying tax on property.
a) Get bonus from employer of stock – since bonus would be taxed as
gross income, the basis is the FMV of the bonus
b) Get a gift – no tax on gift – so the basis is transferred from the giver to

Tax IA Outline 6
 the recipient.
4. All property is subject or gain or loss unless there is a statute to exclude the
gain or loss.
5. If property is destroyed, this is a disposition and the amount realized is zero so
the maximum loss is the adjusted basis.
6. Depreciation is always a negative adjustment to basis.
C. Cost as the Initial Basis - §1012
1. Cost is the initial basis unless some other code section applies.
2. Amount of debt used to acquire property goes to the initial basis.
a) Interest DOES NOT affect basis
3. If you assume a loan of the buyer the amount of the loan assumed goes to
basis.
4. Don’t get basis in property unless you can demonstrate that tax has been paid
on that money that was used to acquire the property.
D. Basis of Property Received in Exchange
1. Philadelphia Park Amusement Co. v. US
a) Property at stake was an extension of a franchise (right to run a street
car line)
b) Abandonment is a disposition of property. Amount realized is zero.
c) When you acquire property in a taxable exchange (NOT a like kind
exchange), you look at the value (FMV not adjusted basis) of what you
are getting in return to determine the initial basis.
2. If a like kind exchange under §1031, the initial basis of the new property is the
basis you had in the old property you gave up.
a) Tax free exchanges are deferrals of tax.
E. Multiple properties acquired in a single transaction
1. Have to determine the portion of sale price attributable to each item. This is
initial basis for each item.
F. Similar properties acquired in multiple transactions
1. If you are selling fungible items bought at different times you can try to
identity the specific items you are selling.
2. If you cannot identify the items you are assumed to be selling the oldest items
first.
G. Initial Basis of Property Acquired by Releasing a Claim
1. If an arms length transaction, then your basis is equal to the FMV of what you
are giving up if it were a taxable exchange
2. If this were a non taxable exchange, like damages for personal injuries, the
initial basis would be the FMV of what you get for giving up the claim.
3. See page 32 of lecture notes for example.
H. Initial Basis of Property Acquired as a Gift
1. §1015 – Get the basis from the donor.
2. General Rule for purposes of determining gain or loss is that you use the
donor’s basis and it is carried over to the donee.
3. If the gift is large enough there is a gift tax and if a gift tax is paid, you add
that amount to the basis of the gift.
4. Farid-Es-Sultaneh v. Commissioner
a) Woman gets stock from future husband and has to determine the basis
since she sells the stock.

Tax IA Outline 7
 b) She gave up her marital rights in the prenuptial which is something of
value.
c) When you give up something of value in return for stock, your cost is
the value of what you are giving up and you measure that by the value
of what you are getting. This would be the value of the stock she is
receiving.
5. Exception in §1015.
a) If the basis is greater that FMV at time of gift then the basis is the
FMV for purposes of a loss.
b) For purposes of determining a gain, you use the basis of the donor.
c) Have to go through the calculation twice to see the result. There can
be a situation where there is no gain or no loss which is a tax free
transaction (see problem (b) on page 128 of casebook). Use the chart.
I. Initial Basis of Property Acquired from Spouse or in Divorce
1. Treated as a gift – Person getting property has the basis from the donor. No
gain or loss. Section 1041.
a) See regulations starting on page 1471 of codebook.
2. U.S. v. Davis
a) This was before §1041 became law
b) Wife is giving up rights under the divorce laws.
c) Initial basis would be the FMV of the property she was getting.
d) Congress changes this rule with enactment of §1041.
3. Now wife gets basis equal to the husband’s basis.
4. Be careful of transactions that are incident to divorce. Rules apply if you are
selling to a spouse or a former spouse.
5. Look at Example 5-B and page 34 of lecture notes.
J. Initial Basis of Property Acquired from a Decedent
1. Adjusted basis goes to FMV on date of death.
2. “Basis Step Up Rule” – avoids tax on all appreciated gain.
a) This rules does not apply to corporations or certain trusts.
3. Tax planning ideas in Example 5-E and page 36 of lecture notes.
K. Adjustments to Basis
1. There can be plus or minus adjustments to basis of the property
2. Example #5-F is a good problem
L. Amount Realized
1. If you sell a property for 1 million but have a $500,000 mortgage, you will
leave the closing with only $500,000 however, your amount realized is 1
million since you have paid off a debt.
2. Receipt of property
a) Amount realized = money plus FMV of any property received.
3. Receipt of services
a) International Freighting Corp. v Commissioner
(1) When you use property as compensation you use the VALUE
of the property to determine what is deductible.
4. Costs incurred in sale
a) The costs of the seller reduce the amount realized.
b) The costs of the buyer increases the initial basis of the property.

Tax IA Outline 8
 5. Liabilities
a) Recourse and non-recourse loans
(1) Recourse loan. If default, can
(a) Sue to get amount
(b) If the loan is secured by a mortgage they can foreclose
on the property.
(c) If the value of the property has declined and does not
satisfy the amount outstanding on the loan, the creditor
can sue the borrower for the difference.
(d) Get a judgment and then pursue any other property
owned by the person who defaulted
(e) Creditor stands in line with other creditors
(2) If a non-recourse loan
(a) Buyer has no personal liability.
(b) Lender can seize the property if they have a mortgage
but if the property has declined in value they cannot sue
the person for the difference in price.
(3) Non-recourse and recourse loans are treated the same.
b) Installment Purchase - Section 453
(1) Calculate: Gain/amount realized. Take this proportion of each
payment and consider it the gain.
(2) If §453 applies the person does not realize gross income until
money is paid on the note.
(3) Example #5-K – page 39 of lecture notes
(a) Amount realized is amount of cash plus the amount of
the note.
(b) Adjusted basis of property is $100,000 and amount
realized is $500,000 so gain is $400,000 but it will
come over the term of the note which is for 5 years
(c) Since $400,000 of the $500,000 is gain, the ratio is 80%
or 80% of the selling price is gain.
(d) Take this percentage and apply it to all cash received
including the down payment.
(e) Thus 80% of each payment goes to gross income and
the other 20% is return of capital.
(4) Section 453 does not apply if you are assuming a liability. In
the case where a liability is assumed, it is treated as if you are
receiving the amount of the liability in the year of the sale.
c) Buyer’s assumption of seller’s liabilities
(1) The full amount of the liability that is assumed by the buyer
goes into the amount realized by the seller in the year of the
sale. This can never fall under §453 as an installment sale.
(2) Any liabilities assumed by the buyer go to the full amount of
the buyer’s initial basis and the seller’s amount realized.
(3) Example #6-C
(a) Several ways to handle the assumption of debt
including wrapped mortgage

Tax IA Outline 9
V. Miscellaneous Issues and Gross Income
A. Life Insurance
1. As a general rule, proceeds from life insurance are NOT included in gross
income.
2. If you elect to receive the proceeds of life insurance as an annuity then
§101(c) applies.
a) Divide base value of the contract by the life expectancy and this is
how much the person gets tax free. The remainder of each payment is
taxed as interest.
b) If the person outlives the life expectancy then they continue to receive
the amount calculated above tax free which is different from annuity
rules.
c) If person dies before the life expectancy time then there is no tax
benefit.
d) See Example #6-E – page 43 of lecture notes – using life insurance to
buy out a partner’s interest at their death.
3. §101(a)(2) – Transfer for Value
a) If life insurance policy is sold for consideration, then life insurance
proceeds that is excluded from tax is the amount the person paid for
the policy plus any additional premiums. Everything else is taxed.
4. Look at lectures notes on page 43 and 44 for examples and how to structure
for a partnership.
B. Annuity
1. Proceeds from annuity are paid at retirement. Part of each payment is a return
of capital and part is interest.
2. Look at life expectancy of the individual when they start to get the payments.
a) Divide the investment by the life expectancy. This amount is
excludable each year.
b) The rest is considered to be interest and goes to gross income.
3. If you live past the life expectancy then the whole amount is taxable each
year.
4. If you die before the life expectancy, then you deduct the amount that was not
returned in the annual payments.
C. Discharge of Indebtedness (DOI) or Cancellation of Debt (COD) Income
1. If a creditor reduces your debt, your net worth increases by the amount of the
reduction and this amount goes to gross income as per §61.
2. This income can get favorable treatment under §108 (dealing with discharge
of debt under bankruptcy, etc.). When debt is assumed by someone else it is
NOT COD income.
3. Since §108 provides favorable benefits for COD income it is important to
distinguish COD income from other types of income. Threshold question
is whether there is a reduction or discharge of debt and if it a true debt
cancellation or discharge.
4. If a family member holds the debt and reduces the debt, it may be considered
a gift and not a COD. Have to consider the motivation of the al la Duberstein.
5. In addition, if an employer/employee situation the reduction might be
considered a bonus or compensation.

Tax IA Outline 10
 6. If the amount of the liability is in dispute and the amount owed is reduced it is
NOT COD income. The debt will be treated from the beginning as being what
is negotiated.
7. Zarin v. Commissioner
8. A purchase price adjustment does not create COD in the buyer.
a) Might occur when someone agrees to pay a certain price and starts
making payments. At some time later they find there is a problem
with the item and the seller reduces the purchase price.
9. Consequences of something being COD income
a) It is included in gross income but it is a favored type of gross income
b) It is favored because of §108. Even though it is gross income, under
some circumstances you can exclude the amount from gross income.
D. Section 108
1. COD can be 100% excluded if the debtor is in bankruptcy. Has to be in a
formal federal bankruptcy proceeding
2. COD can be excluded if you are insolvent.
3. HOWEVER, if you exclude income you have to engage in tax attribute
reduction.
a) Have to take the amount of COD income you are excluding and reduce
certain favorable tax attributes IN THE ORDER they are presented in
the code.
b) §108(b)(5) – can elect to reduce the basis of property first.
c) If you are reducing the basis, you cannot reduce the basis below the
level of the undischarged liabilities.
(1) This limitation DOES NOT APPLY if you skip directly to
basis reduction. You can reduce basis to zero if you like.
§1017(b)(2).
4. See Example #6-L and notes pages 48 and 49 for a good example.
5. Insolvency
a) §108(d)(3) defines insolvency. Difference between the FMV of assets
and total amount of liabilities.
b) You can exclude the COD income up to the level of the insolvency.
What is left is gross income.
c) On amount that is excluded you have to do the same attribute
reduction as for a bankruptcy.
6. Purchase Money debt reduction - §108(e)(5)
a) Applies to original buyer and original seller.
E. Student loans
1. Very narrow and person specific. If person agrees to work in certain areas
then the debt is reduce and there is NO COD income.
F. Related Party Debt Acquisition
1. If a person who is related to the debtor acquires the debt from an unrelated
party, even though the debt is outstanding, it is treated as a cancellation of
debt.
G. Damages and Related Receipts
1. §104 – Damages for personal physical injuries or physical sickness are NOT
included in gross income.
a) If you can demonstrate a physical harm and emotional distress is the

Tax IA Outline 11
 result of the physical harm then damages for the emotional distress are
excluded from gross income.
2. Punitive damages are included in gross income as is reimbursement for lost
profits.
3. §104(c) exception for wrongful death –
H. Separation and Divorce
1. Section 1014
a) Property transfers
(1) Treated as a gift and no tax consequences
(2) Recipient gets the basis the former spouse had in the property.
2. Alimony
a) §71 – ordinary income to the recipient and a deduction to the person
paying the alimony.
b) Top of page 198 of the casebook gives the requirements for something
to be treated as alimony.
c) §71(f) – front-end loading – If too much money is paid in Year 1 and 2
it has to be recaptured in Year 3.
3. Indirect Payments
a) Payments to a third person on behalf of the ex-spouse. Still treated as
alimony.
4. Property Settlements and Child Support
a) Tax neutral.
5. Parties in a divorce settlement are given a lot of leeway in how they categorize
items in the divorce decree. However, if the payments are child support or a
property settlement you cannot call it alimony.
6. One spouse has the house and the mortgage payments. Other spouse pays the
mortgage payments. The spouse who pays the payments gets the deduction
and the other spouse has to declare the mortgage payments as income.
I. Sale of Residence
1. §121 – Gain from sale of personal residence that you have lived in for 2 years
is excluded from gross income.
J. Income from Abroad
1. Earned income can be excluded.
K. Payments related to Higher Education
1. See casebook
L. Income from State and Municipal Activities
1. Income from municipal bonds is excluded. Municipality can only use the
money from bonds for activities that support the municipality.

VI. Identification of the Proper Taxpayer

A. Assignment of Income from Services
1. Lucas v. Earl
2. Doctrine of Constructive Receipt
a) If all I have to do is pick up the money that is on the table then it is
considered that I have constructive receipt of the money and it is
taxable at that time even if I don’t take the money off the table.

Tax IA Outline 12
 3. Commissioner v. Giannini
a) He earned salary but did not want to receive salary.
b) Money is not taxed to him because he no longer had dominance over
the money.
c) If you have dominance and control over the money then the money
is taxable to you.
4. General Rule
a) Once services are rendered it will be taxed to the person who rendered
the services. If the agreement is entered into before services are
rendered, it may be taxed to the person doing the services but if the
person gives up ALL control over the money then it might be excluded
from income under Giannini.
(1) Year-end bonus – have to pay the tax since services already
rendered.
b) Contingent fees in lawsuit
(1) Courts have held plaintiff is taxed for entire amount since
plaintiff has dominance and control over the lawsuit.
B. Assignment of Income from Property
1. Two subgroups
a) Gross income from the ownership of property
b) Gross income from the disposition of property
2. Assignment of income from Property Ownership
a) Helvering v. Horst
(1) Person owns bonds and lets son get the interest due on the
bonds.
(2) Interest is taxable to father since father still owns the bonds.
(3) “Fruit and Tree” analysis
(a) “Tree” is the bond and “fruit is the coupon. Person who
owns the “tree” is the one who is taxed.
b) If a person gives up some ownership of property, they are not taxed on
the income that comes from the portion of the property they have
given up.
c) See Page 58 of lecture notes on how to use a trust to assign income.
d) Blair v. Commissioner
(1) Blair (P) was to receive the income from a trust created by his
father. P assigned interests in the trust to his children. The
trustees accepted the assignments and paid the trust income
directly to the assignees. The Commissioner held the
assignments to be taxable to P, but the Board of Tax Appeals
reversed his decision. The court of appeals revered, and P
appeals.
(2) Held: One who is to receive the income as the owner of the
beneficial interest is to pay the tax. If the interest is assignable
without reservation, the assignee thius becomes the
beneficiary. P could transfer a part of his interest as well as the
whole. Here, the assignees become the owners of a specified
beneficial interest, a form of property, and the income arising
therein is taxable to them.

Tax IA Outline 13
 e) Estate of Stranahan v. Commissioner
(1) Father sells for fair consideration his rights to receive
dividends.
(2) It is critical in this case that the transaction had real economic
consequences. If there is no economic risk in the assignment it
may not be allowed by the IRS.
f) Income is taxable to whoever owns the property unless that right
to income is sold or the property is sold.
3. Assignment of Income from Property Disposition
a) Susie Salvatore
(1) A sale by one person cannot be transformed for tax purposes
into a sale by another by using the latter as a conduit through
which to pass title. Susie owned the station when she agreed to
sell. Her conveyance to the children, when viewed as part of
the whole transaction, was only an intermediate step in the
transfer of legal title to Texaco.

VII. Overview of Income Producing Entities

A. Single owner Ventures
1. Sole Proprietorship
a) Everything goes on the individual’s personal tax form.
b) All income from business goes to individual.
2. Single Member LLC
a) If the person does not elect to be a C Corporation (check the box) then
the single member LLC is just like a sole proprietorship and
everything goes on personal tax form.
b) Limited Liability.
c) Pass through entity so gains and losses pass through to the single
member.
3. C Corporation
a) Entirely separate entity
b) Files own tax return
c) Limited Liability
d) Dividends are NOT deductible to corporation so corporation pays tax
on a dividend and the recipient of the dividend pays tax. Double
taxation.
e) Compensation is deductible to the corporation. Can only deduct a
reasonable amount for compensation.
f) There is a penalty tax if a corporation retains too much income. Have
to have a good business reason to retain income.
4. S Corporation
a) Files an election to be taxed as an S corporation rather than a C
corporation.
b) Files its own return
c) Limited liability
d) It is a PASS TRHOUGH entity. Income is not taxed at the corporate
level but is taxed to the shareholders even if the income is not

Tax IA Outline 14
 distributed to the shareholders.
(1) This gets rid of the double taxation problem with C
corporations.
e) Lot of rules and requirements for an S corporation.
B. Multiple Owner Ventures
1. Direct co-owners
a) Both are directly liable.
2. General Partners
a) Each general partner is fully liable for all the debts and obligations of
the partnership.
b) It is a pass through entity for tax purposes. Everything passes to the
partners whether there is a distribution or not.
c) Partnership agreement determines how the pass through is divided up.
3. Limited Partnership
a) Under state law there has to be at least one General Partner and the
other partners are limited partners.
b) Pass through
4. Multiple Member LLC or Limited Liability Partnership
a) Taxed like a partnership
(1) Pass through as per partnership agreement
5. C Corporation
a) Makes no difference if there are multiple members
6. S Corporation
a) Same as with single member
7. For a new venture the LLC or a LLP is the best organizational structure.
C. Check-the-Box Regulations
1. If you are a non-corporate entity like an LLC, a LLP, or a partnership, you can
elect to be taxed as a C corporation.
2. If you DO NOT check the box you WILL NOT be taxed as a C corporation.

VIII. Ordinary and Necessary Business DEDUCTIONS

A. Requirements for a deduction
1. Has to be a realization event that reduces your net worth and that fits into a
specific code provision.
2. No deduction is deductible unless Congress has said so.
3. As a general concept, Congress has said that only expenditures that are
incurred in the production of income can be deducted. However, there are
exceptions to this general rule.
4. Deductions are a matter of “legislative grace.”
B. §162
1. Three requirements
a) Ordinary and necessary
b) Incurred in a trade or business
c) Has to be an expense as opposed to a capital expenditure
C. Ordinary and Necessary Requirement
1. Welch v. Helvering
a) Welch paid some of the debts of his former employer. Commissioner

Tax IA Outline 15
 ruled these expenditures were not ordinary and necessary business
expenses but were rather in the nature of capital outlays for the
development of goodwill.
2. Ordinary = is it a common and accepted means of doing business.
a) Like a reasonable person test
b) Would a reasonable person make this expenditure in this situation?
D. What is an “expense”?
1. If you pay for something that helps to generate income over a number of
periods then you have to capitalize that expenditure.
2. Indopco v. Commissioner
a) Company incurs costs in evaluating an offer to take over the company.
Wants to deduct the costs
b) Court held that the expenses incurred would benefit the company in
the future and thus were not ordinary and necessary expenses.
c) If the expenditure generates an economic benefit that extends
beyond the current year, then you have to capitalize the
expenditure.
(1) This is consistent with the matching notion.
3. Expense will not be deductible if
a) It results in a significant benefit to the company that will last for a
number of tax periods, or
b) It is used to purchase an asset.
4. Reg 1-162.4 – cost of incidental repairs are deductible.
5. If some expenditure increases the useful life or the value of something, then it
is not deductible as an ordinary and necessary business expense.
6. If something drives down the value of an asset and there is an expenditure to
bring the value of the asset back up, that expenditure is deductible.
7. Are you increasing the value of the asset → not deductible
8. Are you restoring the value of the asset → deductible
E. Trade or Business Requirement
1. Expenses incurred for the purpose of earning a profit
2. Activity has to be ACTIVE rather than PASSIVE
3. Distinction between a business and a hobby
4. Question is did the taxpayer INTEND to make a profit. If so it is a trade or
business.
F. Start up Expenses
1. Amortized over 60 months beginning with the month the business opens.
§195.
2. Have to meet the test of §162 that it is a trade or business before you can
deduct the start up expenses.
3. Morton Frank case indicates that deductible expenses may be incurred only
in connection with the operation of an existing business.
G. Compensation
1. Compensation has to be reasonable.
2. Dividends are NOT deductible
3. If money is leaving the corporation and the IRS does not feel it is reasonable
as compensation, then the IRS will declare it a dividend.
4. How to determine the reasonableness of compensation

Tax IA Outline 16
 a) Exacto Springs case
(1) Posner – used an “independent investor” test
(a) Call the salary unreasonable only if it reduces the level
of corporate income to a point less than that which the
investors would expect as a return on their investment.
(b) Posner rejects the multiple factor test.
b) Harolds Club case
(1) Contingent compensation is ordinarily allowed as a deduction
even though it may be greater than the amount ordinarily paid,
if paid pursuant to a “free bargain” between the employer and
the individual.
(2) In this case the payment was not the result of a free bargain.
c) Salary expenses have to have a real relationship with the value of the
services rendered in order to be deductible.
d) If the bargain is reasonable when made and is a free bargain then you
don’t have to worry about the reasonableness in the future.
H. Travel Away from Home
1. §162(a)(2) allows the deduction of expenses for traveling, meals, and lodging
while away from home and in the pursuit of a trade or business.
2. Have to be away from home for at least one night to qualify.
3. Basically can deduct costs that would duplicate costs you are already
incurring at your home.
I. Educational Expenses
1. Reg. 1.162-5 and problems on page 392 with answers on page 76 of lecture
notes.
J. Business Meals and Entertainment
1. Not talking about “away from home” expenses
2. Substantiation Requirement
a) Have to have contemporaneous records
3. Business Connection Requirement
a) Expense has to be either directly related to trade or business or
associated with trade or business.
b) Reg 1.274-2 – must meet all parts of sections (i), (ii), (iii), and (iv) on
page 1053 of Code book.
4. Percentage limitation on deductions for meals.
K. Uniforms
1. If uniform is something you can use outside of your job then it is NOT
deductible.
L. Advertising
1. Deductible in the year the advertising occurs

IX. Other Common Deductions

A. Losses
1. What is a loss?
a) This is NOT an operating loss which is covered under §162. This is a
loss covered under §165
b) §165 concerns disposing of property for a loss

Tax IA Outline 17
 (1) Could be sale or stolen or some other loss that results in an
amount realized for the property to be zero.
c) Sell personal property for a loss and you cannot take a deduction. Sell
personal property for a gain and you have to show the gain as gross
income.
d) Ordinary loss is better than a capital loss.
e) Loss has to be incurred in a trade or business, §165(c)(1) or an activity
entered into for profit, §165(c)(2) or loss from fire, storm, shipwreck,
or other casualty, or from theft §165(c)(3).
(1) Casualty loss can be taken even if it is personal property.
B. Depreciation and Amortization
1. Three ways to recover costs for tax purposes
a) Deduct costs immediately under §162.
b) Depreciation
c) Reduce the gain – for those things that don’t wear out. Recover cost
when sold.
2. Type of property
a) Tangible personal property ---- ACRS or MACRS applies
b) Intangible personal property ---- §197 allows for amortization.
c) Real property --- ACRS or MACRS applies
d) §167(a) – property has to be used in a trade or business or held for
the production of income to qualify.
e) Can’t depreciate item until the business opens the door.
f) Can only depreciate items that will wear out.
(1) No land
(2) No inventory
3. Recovery Periods
a) Items are put into a class and the class determines the life over which
the item can be depreciated.
b) Residential real property --- 27.5 years --- NOT personal property
but for real property like apartment buildings used for a trade or
business.
c) Non Residential Property --- 39 year useful life.
d) Mixed property – Look at gross rental income and if 80% or more of
gross rents are from residential units then the whole building is
considered residential.
e) Tangible Personal Property --- most in 3, 5, or 7 year class.
f) Intangible Personal Property --- §197 --- 15 years useful life.
g) Have to allocated items to different groups when you purchase a
business.
4. Initial basis of a property would include
a) Cash
b) Note signed to be paid over time or in future
c) Any assumption of liabilities
d) Legal fees
e) This initial basis would have to be allocated to the various assets in the
purchase. Have to allocate in proportion to the FMV of the asset.

Tax IA Outline 18
 5. Depreciation Methods
a) Straight line
(1) Take initial basis and divide by useful life
(2) Reduce the basis each year by the amount of depreciation taken
that year.
(3) Have to use straight line method for real estate and
amortization.
b) Accelerated Methods
(1) Double declining balance
(2) 150% declining balance
6. Depreciation Conventions
a) Tangible Personal Property
(1) Assume you put the property in service at mid-year.
(2) Get ½ year depreciation the first year and ½ depreciation at end
of the number of years equal to the useful life.
(3) Exception --- 40% rule – then mid-quarter convention.
b) Real Estate
(1) Mid-month convention
(2) Done on property by property basis.
7. Churning Rule
a) Depreciation rules that are in effect when the property is put into
service are in effect until the property is completely depreciated or
sold.
b) If sold to a new party then the new party can take advantage of any
changes in the depreciation rule UNLESS the new party to whom the
property is sold is a related party. (anti-churning rules)
8. §179
a) Can deduct some of the cost of personal property (NOT REAL
ESTATE OR INTANGIBLE PROPERTY) in the first year
b) See code for amount
c) For small businesses
d) Reduce basis of property after taking the deduction.
9. §168(k)
a) Taxpayer can take 30% of any equipment and take it as a first year
deduction.
b) This deduction is IN ADDITION to §179
c) Cannot be for real estate or intangible property.
d) Has to have recovery period of 20 years or less.
e) Reduces the basis.
10. §197 – Intangible Assets
a) Depreciated over 15 years
b) Have to use STRAIGHT LINE method.
C. Section 212 – Expenses for Production of Income
1. Congress wants to tax you on your PROFITS so any expense you incur for the
purposes of generating a profit should be deductible.
2. §212 lets you deduct expenses
a) for the production of income
b) for management, conservation, or maintenance of property held for

Tax IA Outline 19
 production of income
c) in connection with the determination, collection, or refund of any tax.
(thus expense of hiring tax attorney or accountant is deductible)
3. Deduction is allowed if the expenditure is reasonable when looking at all the
facts and circumstances (Surasky v. U.S.).
D. Interest
1. Revenue Ruling 69-188
a) ‘points’ are deductible
2. Two prongs on the definition of interest
a) An amount one has contracted to pay for the use of borrowed money
or as the compensation paid for the use of the forbearance of money
and
b) must be incidental to an unconditional and legally enforceable
obligation of the taxpayer claiming the deduction.
3. Low Interest Loans - §7872
a) Imputed Interest
(1) Two transactions – interest is given by the lender to the
borrower and the borrower then gives the interest back. No
money really changes hands.
b) Gift Loans
(1) Foregone interest is the amount of interest that a person would
have charged under the Applicable Federal Rate.
(2) Two transactions
(a) Lender is treated as having made a GIFT to the
borrower of the foregone interest
(i) No income tax consequences on the gift
(b) Borrower pays the “interest” back to the lender
(i) Borrower may get a deduction – look to see if it
qualifies under §163
(ii) Lender will have to declare the amount of the
imputed interest as gross income.
(3) If loan is LESS than $100,000
(a) No difference on first step --- no tax consequences to
anyone with the GIFT of the imputed interest
(b) Amount of the interest the lender has to declare is
limited to the amount of the borrower’s investment
income. Investment income is from ANY source not
just the investment income that comes from the money
borrowed.
(4) If loan is $10,000 or less
(a) No imputed interest.
(b) No tax consequences
c) Non Gift Loans
(1) Employer/employee
(a) First step -
(i) Imputed interest is considered
COMPENSATION to the employee (borrower).
(ii) Employer gets a deduction in the amount of the

Tax IA Outline 20
 imputed interest.
(b) Second step –
(i) Employer has to recognize the imputed interest
coming back so this is a wash.
(ii) If the money the employee borrows is used for a
purpose that allows an interest deduction (like
home purchase) the employee gets a deduction.
If not no deduction.
(c) No $100,000 exception in the non gift situation
(d) $10,000 de minimis exceptions applies
(2) Loan to Shareholder
(a) Payment of interest to shareholder (borrower) is
considered a DIVIDEND. Shareholder has to declare
as gross income and company gets no deduction.
(b) Payment back to company
(i) Company has to declare as income
(ii) Shareholder may get a deduction depending
upon what the money is spent on.
4. Imputed Interest on Sale of Property
a) §1274 – if seller does not charge interest on sale of property, IRS will
treat some of the payment as interest.
b) Tax consequences
(1) Seller – interest is considered income.; Seller has to recognize
the interest over the time period of the note.
(2) Buyer – may be the type of interest that is deductible. BUT
interest is deducted over the period of the note that secures the
purchase.
5. Original Issue Discount (OID)
a) OID – interest – difference between what someone pays for a bond and
what the redemption value is. (Pay $900,000 for a bond that is
remediable for 1 million. This would be $100,000 interest)
b) Recognize and deduct the interest over the period the bond is
outstanding.
6. Tax Treatment of Interest
a) §163(a) – interest is deductible but there are exceptions
b) §163(h) – no deduction for personal interest
(1) Exceptions
(a) Borrow for trade or business – interest is deductible
(b) Investment interest is deductible
(c) Qualified Residence
(i) Interest paid on mortgage is deductible
(a) Debt has to be secured by the residence
(b) Applies to personal home and also on a
vacation home
(c) Has to be acquisition indebtedness or
home equity debt.
c) Qualified Education Loans

Tax IA Outline 21
 d) Investment Interest
(1) Deductible only to the amount of investment income.
E. Taxes
1. §164 – lists 5 specific types of taxes that are deductible
F. Bad Debts
1. If borrower cannot pay debt, borrower has cancellation of debt income and
this goes to gross income.
2. Is it TRUE cancellation of debt?
a) If a parent/child relationship then it is not cancellation of debt but
rather a gift.
b) If employer/employee then it may be compensation
c) Have to examine the relationship between the lender and the receiver
to determine if it is TRUE cancellation of debt.
3. §166
a) If a BUSINESS DEBT, then under subsection (a) where you can take a
partial deduction.
b) If a NON BUSSINESS loan you cannot take a partial deduction.
4. If the debt is a business debt it may be deducted when it become wholly
worthless, or it may be deducted when partially worthless. If the debt is non
business, such debts have to become wholly worthless before they can be
deducted and then they are treated as short-term capital losses.
G. Charitable contributions
1. Deductible if the charity is 501(c)(3).
H. Moving Expenses
1. Two situations where you can deduct
a) New job increases computing distance by more than 50 miles
b) New job more than 50 miles from home.
I. Medical Expenses
1. Only to extent they exceed 7.5% of adjusted gross income.
J. Qualified tuition and related expenses
1. See syllabus

X. Restrictions on Deductions
A. Personal Residence Deductions - §280A
1. Combined Residential and Rental Use
a) If you live in the property 14 days or less it is just rental property.
2. Home office
a) Has to be used as principal place of business for any trade or business
b) Used exclusively for business purpose.
B. ‘At Risk’ Rules - §465
1. Can deduct operating loss only to the extent that you are economically at risk
in that activity.
2. Additions to ‘at risk’ amount comes from
a) Cash
b) Put your property into the activity
c) Recourse debt
d) Non recourse debt if it is part of qualified non-recourse financing

Tax IA Outline 22
 which is borrowing in a real estate business from an unrelated
institution.
(1) Regular non recourse debt does NOT qualify.
3. If the taxpayer has loss that cannot be deducted, the loss is suspended.
C. Passive Losses - §469
1. Second limitation in addition to at risk rules that have to be met in order to
take a deduction for a loss on one activity to offset income from another
activity.
2. Three categories of activities – each considered to be in their own ‘basket’ -
a) Passive activities
b) Portfolio activities
c) Non passive activities
3. A NET LOSS from passive activities CANNOT be used to offset net income
from the other two activities.
4. A passive loss can be deducted against income for another passive activity.
Thus look for PIGs (passive activity generators).
5. Passive income CAN BE offset by net losses from the other two activities.
6. Check in lecture notes starting on page 103 for some examples; especially
examples with a pass through entity.
7. Who is affected by the Passive Loss rules
a) Individuals, estates, and trusts
b) Closely held “C” corporation impacted only by a limited amount.
c) Pass through entities are NOT impacted BUT the individuals to whom
the stuff passes ARE affected.
8. Two broad categories
a) Rental Activities
(1) Anything where the principal course of income is rental.
Could be things other than property such as rental of
equipment.
(2) General Rule: All rental activities are considered to be passive.
They are per se activity
(3) Two narrow exceptions
(a) Mom and pop exception – small investor
(b) Owner is a true real estate professional
b) All Non Rental Activities
(1) Material Participation Rule
(a) If taxpayer put in more than 500 hours per year then it
is NOT passive activity.
9. Treatment of non-deducted passive losses
a) Suspended losses can be offset in later years if the taxpayer acquires a
PIG
b) Also when you dispose of the ENTIRE ACTIVITY, the suspended
losses are freed up.
(1) If you sell to a related party it is NOT considered to be a
disposition of the entire interest.
c) When the losses are freed up they can be used to offset income from
other sources.
d) At death, the suspended losses are freed up BUT are reduced by the

Tax IA Outline 23
 amount of the step up basis.

XI. Timing of Income and Deductions

A. Importance of Timing
1. Tax delayed is tax reduced
2. Delay tax by
a) Delay in recognition of income
b) Accelerate deductions
B. Methods of Accounting
1. Cash method
a) Recognize income for tax purposes when it comes in the door
2. Accrual method
a) Have income when you have done everything needed to get the
income and you have a legal right to get the income
b) Get a deduction when you have the legal right to the deduction.
3. Choice of method
a) Anyone can be on accrual method but some taxpayers HAVE to be on
cash method
C. Timing of Income Recognition under the Cash Method of Accounting
1. General rule for when income is recognized.
a) When you get the cash or property, then it is gross income.
2. Cash Equivalent
a) Check is considered to be equivalent of cash (Kahler case)
b) Note is not like check and thus not equivalent to cash. (Williams)
c) Test:
(1) “We are convinced that if a promise to pay of a solvent obligor
is unconditional and assignable, not subject to set-offs, and is
of a kind that is frequently transferred to lenders or investor at
a discount not substantially greater than the generally
prevailing premium for the use of money, such promise is
equivalent of cash and taxable in like manner as cash would
have been had it been received by the taxpayer rather than the
obligation.”
d) How easy is it for person to turn the instrument into cash without a big
discount?
3. Economic Benefit Doctrine
a) May arise as a deferred compensation plan or a buyer putting money
into escrow for a seller to receive at a later date.
b) Test:
(1) Taxpayer has done everything necessary to earn the money
(2) Payor (could be a buyer) is obligated to pay the money and
there are no contingencies on the payer
(3) Money is set aside with a third party
(4) Money is earning interest with the third party for the economic
benefit of the taxpayer, then
(5) Taxpayer has to be taxed on the money.

Tax IA Outline 24
 c) Rabbi Trust
(1) Company puts money into a trust but trust agreement says that
company creditors can get to money in trust if need be. Keeps
person who is eventual recipient of the trust from being taxed
each year under the economic benefit doctrine.
4. Constructive Receipt Doctrine
a) If a cash method taxpayer has an unqualified vested right to receive
immediate payment, the taxpayer cannot escape the recognition of the
income by deferring the time that payment is to be made or by
otherwise turning his back on the income. The income is recognized at
the time the taxpayer has the right to immediate payment.
b) If the taxpayer agrees to the deferral of payment before his right to
the payment has been earned, the taxpayer will not recognize the
income until the date on which the deferred payment or payments are
to be made.
c) Arises when three situations exist
(1) Taxpayer has the legal right to get the money. Cannot be any
preconditions
(2) Taxpayer has to have the practical ability to get money now
(3) Taxpayer must voluntarily choose not to get the money now.
d) If a contract provides for payments in the future then the constructive
receipt doctrine does not arise.
e) If there is a contract amendment, then see if there is additional
consideration from both sides.
f) Good example --- Example #12-D and lecture notes on page 112.
5. Installment Sales under §453
a) Take ratio of amount of gain/amount realized. This is the percent gain.
Take this percent of all money, including down payment, received and
recognize for tax purposes.
D. Timing of Deductions under the Cash Method of Accounting
1. General Rule
a) When the payment is made in the form of cash or other property, then
the deduction can be taken.
2. Cash Equivalent Doctrine
a) When employer hands an employee a check it is a deduction at that
moment.
b) When you sign a credit card statement, you can take the deduction.
3. Economic Benefit Doctrine
a) When employer sets aside the money it is deductible at that time.
b) If it is income to the employee it is a deduction to the employer.
4. Constructive Payment
a) No deduction here. May have income under constructive receipt but
no deduction under constructive payment.
5. Expense v. Capitalization
a) When you prepay insurance and the benefits last over a number of
years, you deduct the expense over the time the benefit lasts.
6. Prepaid Interest
a) If you prepay interest it creates a benefit that extends into the future

Tax IA Outline 25
 and you have to deduct over the years.
E. Accrual Method of Accounting: General Rule
1. General Rule
a) Recognized as gross income when all the events have occurred that fix
the right to receive such income and the amount thereof can be
determined with reasonable accuracy.
b) Income is recognized on the FIRST to occur of
(1) Performance of the duties,
(2) Billing, or
(3) Payment
2. Examples
a) Accounts Receivable – recognize when amount is billed. Under cash
method recognize when receive the money.
b) Delinquent Account Receivable – if amount is fixed then recognize in
current year.
3. “Claim of Right” Doctrine
a) North American Oil
(1) If you get paid and claim you have a right to the payment, then
you have to report the income in that year even if there is a
dispute as to the amount or the legal right and even if you have
not received the money.
F. Prepayments under the Accrual Method
1. Under some circumstances even if you have been paid, you can defer the
income until a later year.
2. Artnell v Commissioner
a) Previous cases (Auto Club of Michigan, AAA, and Schlude case, led
to conclusion that you needed to pick up all the prepaid income in the
year it was received.
b) In Artnell, court said that since they knew when games would be
played (good predictability) they could recognize the income in a
future year for games to be played in that year.
G. Timing Deductions under the Accrual Method
1. Period Costs versus Inventory Costs
a) §461(h) – another prong for test for deductions.
(1) Have to be legally obligated to make the payment
(2) Have to be able to estimate with reasonable accuracy
(3) Cannot deduct until economic performance has occurred.
b) Conditions for economic performance
(1) Services and property provided TO the taxpayer. If liability
of the taxpayer arises out of
(a) Providing services to taxpayer by another person ---
economic performance when person provides the
services
(b) Providing property to taxpayer by another --- economic
performance when person provides the property
(c) Use of property by taxpayer --- economic performance
when taxpayer uses the property.
(2) Services and property provided BY the taxpayer. If liability

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 of the taxpayer requires taxpayer to provide property or
services, economic performance when taxpayer provides such
property or services.
(3) Tort Liabilities of the taxpayer. Economic performance occurs
when the taxpayer pays the tort damages.
(4) Exception for certain recurring items
(a) See Code – page 458.

XII. Capital Gains and Loses

A. Introduction
1. Character of the income is what is important
2. For deductions the threshold question is whether it is deductible under §165.
3. The only time you can have a capital gain or loss is when you are selling or
exchanging the property.
a) You have to transfer enough of the bundle of sticks in order for there
to be a capital gain or loss.
B. Planning Implications
1. For gains, the order from best to worse is LTCG, STCG, Ordinary Income.
2. For Losses, the order from best to worse is Ordinary Loss, STCL, LTCL.
C. Requirements for a Capital Gain or Loss
1. Has to be a SALE or EXCHANGE
2. Property that is being sold or exchanged must be a capital asset.
D. What is a Capital Asset?
1. Section 1221 says that ALL property held by the taxpayer, whether in trade or
business is a capital asset EXCEPT for the 8 listed exceptions.
2. Property is broadly defined.
3. Stautory exceptions under §1221
a) §1221(a)(1) – inventory and property held for sale to customers in the
ordinary sale or business.
(1) Inventory is NOT a capital assets since it fall under the
exception. Any sale of inventory generated ordinary income.
b) §1221(a)(2) – Property subject to depreciation or real property used in
a trade or business.
(1) Items excluded here are picked up under §1231.
4. Judicially Created Exception
a) Hort v. Commissioner
(1) If all you have is a “naked contract right to future income”, you
do not treat this as a capital asset and thus cannot get capital
gain treatment.
5. Thus, ALL property is a capital asset EXCEPT the 8 exceptions and the one
judicial exception under Hort.
E. Section 1231
1. If you sell a §1231 asset for a gain it is a capital gain.
2. If you sell a §1231 asset for a loss it is an ordinary loss.
3. Net in the hotchpot.

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 F. Sale or Exchange Requirement
1. Kenan case
a) If you transfer property to someone else to satisfy a claim they have
against you it is treated as a sale.
2. Arrowsmith Doctrine
a) If the transaction is later years arose out of a sale or exchange of a
capital asset, then the new transaction is treated as arising out of the
original transaction and if the original transaction was a capital
transaction then the later transaction is also a capital transaction.
3. §1239
a) Selling to a related party, even if a capital asset, change the transaction
into ordinary income.
G. Depreciation Recapture
1. If you are selling depreciable property, your gain, even on a capital asset, is
turned into ordinary income to the extent of you prior depreciation deductions.

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