Contents

Exam: ................................................................................................................................................................ 3 FEDERAL POWER TO TAX ........................................................................................................................... 3 INTERPRETATION & ADMINISTRATION OF FEDERAL TAX POWER ................................................... 3 REGULATIONS ........................................................................................................................................... 4 Deference .................................................................................................................................................. 4 Tp reliance on ........................................................................................................................................ 4 LITIGATION ................................................................................................................................................ 4 FORUM .................................................................................................................................................... 4 Litigation process ...................................................................................................................................... 5 Timing & limitations ................................................................................................................................. 5 Penalties .................................................................................................................................................... 5 State-law determinations in Fed tax cases: pg. 55....................................................................................... 5 TIME VALUE OF MONEY (GENERALLY) ..................................................................................................... 6 CONCEPT OF INCOME .................................................................................................................................. 6 Sale: .............................................................................................................................................................. 6 Compensation for Services: ........................................................................................................................... 7 Deferred compensation/income: .................................................................................................................... 7 Fringe Benefits: ............................................................................................................................................. 9 Illegal Gains ................................................................................................................................................ 11 Windfalls ..................................................................................................................................................... 11 Analysis: ..................................................................................................................................................... 11 Recovery of capital ...................................................................................................................................... 12 Sales: ....................................................................................................................................................... 12 Dividends, interest and rent...................................................................................................................... 12 Depreciation: (timing of recovery for long-term property & BUS EXP. ANAL) ...................................... 12 Annuities: ................................................................................................................................................ 13 Business Expenses: .................................................................................................................................. 13 Cancellation of Indebtedness ....................................................................................................................... 13 Damages and Social Welfare Payments ....................................................................................................... 14 Imputed income ........................................................................................................................................... 15 SOME EXCLUSIONS, DEDUCTIONS, AND CREDITS .............................................................................. 15 Tax Expenditures ......................................................................................................................................... 15 ABOVE THE LINE (EXCLUSIONS FROM GI to get AGI) Listed in 62 ----------...................................... 16 Tax-Exempt Interest .................................................................................................................................... 16 Gifts and Bequests ....................................................................................................................................... 16 Life Insurance Proceeds ............................................................................................................................... 17 Scholarships ................................................................................................................................................ 18 1

Prizes & Awards .......................................................................................................................................... 18 Alimony Payments ...................................................................................................................................... 19 Trade and Business deductions .................................................................................................................... 20 BELOW THE LINE (EXCLUSIONS FROM AI to get TI) deduction not in 62........................................... 20 PERSONAL EXEMPTIONS ....................................................................................................................... 20 AND Greater of either: ................................................................................................................................ 20 STANDARD DEDUCTION........................................................................................................................ 20 ITEMIZED DEDUCTIONS ........................................................................................................................ 20 67: 2% floor on miscellaneous itemized deductions [STEP 1] ................................................................ 20 Extraordinary Medical Costs.................................................................................................................... 21 Charitable Contributions & Tax-Exempt Organizations (SEE CLASS SLIDE) ........................................ 22 State, Local, and Foreign Taxes ............................................................................................................... 23 CREDITS (EXCLUSIONS FROM TI)--------------------................................................................................. 24 Child Tax Credit ...................................................................................................................................... 24 Household and Dependent Care Services Credit ...................................................................................... 25 Earned-Income Credit .............................................................................................................................. 25 Education Credits .................................................................................................................................... 26 BUSINESS AND INVESTMENT EXPENSES ............................................................................................... 26 (62 T/B ATL) ................................................................................................................................................ 26 Terms (Capital) .................................................................................................................................... 26 RECOVERING COST OF PROPERTY: Depreciation and related matters .................................................. 26 RECOVERING BUSINESS EXPENSES (in Tax year or at disposition): Capital Expenditures ................... 28 GETTING IT IN: differences between Business, Investments, and Personal Expenditures (B/T/I deductible vs. Personal non-deductible) ............................................................................................................................. 30 y Profit-Making Activities..................................................................................................................... 30 y Motive (Connecting expense to activity) ............................................................................................ 31 y Listed Property: Mixed use property .................................................................................................. 31 y Carrying On (including moving expenses).......................................................................................... 32 y Educational Expenses ......................................................................................................................... 33 INTEREST DEDUCTIONS ( and income).................................................................................................... 33 INCOME FROM DEALINGS IN PROPERTY ............................................................................................... 35 Realization/Taxable event ............................................................................................................................ 35 Realized gain or loss 1001(a) .................................................................................................................... 36 Basis of property acquired by purchase/taxable exchange ........................................................................ 36 Transactions involving mortgaged property (Basis and amount realized) ................................................. 36 Recognition by code .................................................................................................................................... 36 Characterization as capital (or ordinary) gain/loss ........................................................................................ 37 Taxable year gain or loss will be reported .................................................................................................... 38 2

TAXATION: WHO IS THE TAXPAYER ......................................................................................................... 38 Generally: .................................................................................................................................................... 38 Personal service income............................................................................................................................... 38 Marriage and income tax ............................................................................................................................. 38 Income from property .................................................................................................................................. 39 Property or Services (review)....................................................................................................................... 39 Taxation of incomre of minor children (review) ........................................................................................... 39

Exam:
y y No really long issue spotter type questions ||| Use the $$ amts printed code (not inflation adjusted numbers) ||| Cite case and statutes- mentioned in the casebook ||| Bring #2 pencil, code, case book (time value of money problems) Exam Writing Formula:

Step One: Step Two:

State the issue. Identify the rule, but don't waste time stating all of rule. y Unless Prof. states otherwise Summarize elements of the rule that are easily satisfied by the facts. State the sticking point on which this issue turns y The ambiguity in the facts that makes it a difficult question. Apply one or more of the four types of Analysis to the problem. y Reasoning by Analogy y Balancing of Factors Test y Judicial Tests y Public Policy Argument

Step Three: Step Four:

Step Five:

Step Six: Step Seven: Step Eight: Step Nine:

Contrast conflicting authority. What are the defenses? Make a conclusion.

Go to the next issue.

FEDERAL POWER TO TAX

Issue / Scope: Whether the federal government has power to tax income y Rule: The federal government has the power to tax income o 16th amendment gives Congress to levy income tax without apportioning it among the states or basing it
on Census resultsprecluding: Art 1 2 & 9 and Pollock v. FLT co. y

Analysis: Policy Arguments: James Madison stated that there was no settled concept of direct taxation when
const. adopted. 16th adopted to clarify what constitutes income and what can be taxed.

INTERPRETATION & ADMINISTRATION OF FEDERAL

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TAX POWER
REGULATIONS
Deference
Issue / Scope: Deference to Agency interpretation of code Rule: Where the statute is not clear, courts will defer to the agencys decision; Chevron y Analysis: Judicial Tests: o Agency decision must not be:  Arbitrary,  Capricious,  Manifestly contrary to the statute Issue / Scope: Whether the treasury has power to issue regulations Rule: The treasury can prescribe rules to enforce federal taxation; 26 USC 7805 y Analysis: Policy Arguments: Congress members are not tax experts and therefore defer judgment to Treasury Department specialists Issue / Scope: Whether a treasury regulation is valid law Rule: A treasury regulation is valid law unless invalidated y Analysis: invalidation test: y Procedure: y by failing to undergo a notice & comment process, Administrative Procedure Act y by failing to become proposed and finalized in 3 yrs. 16 US 7805(e) y In substance: y by failing to be: y reasonable interpretation of statute U.S. v. Correll; y Harmonious with the plain language of statute. Natl Muffler assn v. U.S.; y a permissible (reasonable) construction of the statutes plain language. Chevron Case Summaries: Chevron v. Natural Resources Defense (Sup Ct. 1984) (determining whether to grant deference to government agency's interpretation of Clean Air Act.)

Tp reliance on
Issue / Scope: Whether the commissioner must treat similarly situated TPs similarly Rule: commissioner does not have a legal obligation to treat similarly situated TPs similarly y Dissenting Rules: However in some cases the courts have held that similarly TPs will be entitled same tax treatment. IBM V. US This exception is applied narrowly. Borstein v. U.S. o Analysis: Reasoning by Did TP apply for same tax exemption as competitor, like a Analogy: sole competitor? Judicial test: How similar is party to whom PLR was issued to TP relying on PLR. Policy Arguments: furthers policy of equitable treatment Issue / Scope: TP Reliance on: P. Letter Ruling: private letter ruling cannot be used as precedence 6110 Revenue rulings: Revenue rulings are not subject to any deference nor binding on taxpayers; y Dissenting Rules: But sometimes taxpayers can utilize on in some cases if rule is favorable

LITIGATI ON
FORUM

Issue/Sc ope: Litigation

Case Summaries IBM V. US (the Court of Claims held BM was entitled to same tax exemption as its sole competitor) Borstein v. U.S. (court held TP not entitled to same treatment, where TPs do not apply for letter ruling.)

Tax Court: Fed District Ct: Ct of Fed Claims: y Prepayment forum y Pay & sue for refund y Pay & sue for refund y Interest keeps y Interest stops y Interest stops

y y y

accruing Judges are tax law experts Informal procedures for small TPs Golsen Rule (T.Ct. follows ct of appeals in circuit it sits)

y y y

accruing Jury trial Applicable Ct of Appeals Precedent may be more favorable

y y

accruing Judges have some technical expertise (hear many tax cases) Ct of Appeals for Fed Cir Precedent may be more favorable

Litigation process
Returns: Deficiency: y y returns must be filed by April 15. 6072(a); Secretary grant reasonable extension 6081(a) 30 day letter: notice of deficiency = 30 days to file appeal & if no response: 90 day letter & litigation Time limits on IRS assessments 6501 7491: burden of proof shifts where taxpayer produces credible evidence 7430: awarding of costs Claiming refund: y y 3 years after date original return filed - 6511(a) 3 years after due date of that return - 6511(a), 6513(a) 2 years after the date the tax was paid - 6511(a) Interest y if underpay, must pay interest on tax deficiency from due date at statutory rate 6201, 6621 its overpay, government pays interest on amounts of overpayment 6611, 6621

y y y

BOP Awarding costs

y y

Timing & limitations

Statute of limitations assessment of deficiency y 3 years after return filed 6501(a) y 3 years after due date of that return - 6501(a), 6501(b)(1) Special rules: y No time limit if no return, or if false or fraudulent return 6501(c)(1), (3) y 6 years instead of 3 years if substantial omission of income items - 6501(e)

Penalties
Professional responsibility CB 23-25 y Tax lawyer may be considered preparer for giving advice y Any advice must be premised on reasonable basis (giggle test= fail) y 6694 sanction: willful/reckless disregard of rules & positions lacking real possibility of being sustained on the merits y Preparers are not subject to penalty for unrealistic position (BUT SEE: effect reputation) y 7701: broad def of preparer y TP y civil and criminal y frivolous positions 6651(f), 6702, 6673 y tax evasion 7201, 7203, 7206

State-law determinations in Fed tax cases: pg. 55

A decision of a state court other than the highest is not controlling in deciding a tax issue, even if reached in litigation and binds the taxpayer CB 56 y Look to state law to determine what property rights one has (exists), then to federal law to apply the statute y Estate of Bosch:. Fed ct not bound by decisions of lower state courts. Estate of Bosch: y Look to the states highest court, and in absence of such rulingthe fed court has discretion to

determine what the highest court of the state would say Supreme Court found that where Federal estate tax liability turns upon character of a property interest held and transferred by the decedent under State law o Federal authorities are not bound by the determination made of such property interests by a State trial court. Policy: The Federal Tax Code can't be influenced by State decisions. If it were, then the Federal law would be applied differently in different States.

TIME VALUE OF MONEY (GENERALLY)

Issue / Scope: How the time value of money affects value of a dollar: Rule: a dollar received today is worth more that a dollar in the future (and costs more); 446(c); 451(a); 1.446-1(c)(1) y Tax/Code tables: o CB 840-43 o Present value = future value/(1+ r)n o Future value = present value/(1+ r)n o Policy: DEFERRAL OF TAX IS ADVANTAGEOUS BECAUSE IT IS CHEAPER TO PAY IN FUTURE WITH TODAYS DOLLAR & Can invest money today which makes it more valuable Issue / Scope: Method of accounting o CB 51 & 763 y Rule: method of accounting (some rules) o Cash method:  Items included or deducted in year cash received o Accrual method:  Items included or deducted in year  All events test: y When all the events have occurred y Which would entitle TP or payee to payment o A combination of acting methods may be used if accurately reflects income & consistently used

CONCEPT OF INCOME
Issue / Scope: Whether item constitutes GI Rule: Gross income is: y An accession to wealth y Clearly realized y Over which the TP has complete dominion; Glenshaw glass, 348 US 426 (1955); y And from whatever source derived; 61 o Divergent view:  Haig Simons Econ. definition: GI= TP value of total expenditures (+/-) the value of property y But: appreciation/depreciation recognized in calculation of wealth, hence not adopted by tax code y Analysis: Generally: any accession to wealth is GI including money, property, services; 1.61-1(a); or damages, illegal gain, and treasure trove 1.61-14(a)unless excluded by code

Sale:
(See also INCOME FROM DEALINGS IN PROPERTY & BUSINESS EXPENSES) Rule: TP will be taxed on a gain derived from his dealings in tangible or intangible ( 1.61-6(a)) property; 61(a)(3); 1001(a); 26 CFR 1.1001-1 y Analysis: Code test y Only if: y Realization event (such as a transaction) 1001(b) y Recognized by tax code 1001(c) y Only on: y Any amount over: y Adjusted basis

y or amount he paid for property (its cost) At disposition of property, 1011(a); 1012

Compensation for Services:

Rule: TP will be taxed compensation for (b/c it is) services 61(a)(1) y Analysis: o Treatment as an employee 102  Determination of whether the TP is an employee or independent contractor depends on whether employer has final say in determination of work o In cash  Fees, commissions, fringe benefits, and similar items 61(a)(1); Tips, percentage of profits, bonuses, jury fees, ad infinitum 1.61-2(a)(1)  Payment of income taxes by a 3rd party, Illegal gains, court damages, and etc. 1.61-14(a); Old colony trust v. Commissioner, 279 U.S. 716 (1929) o In kind  Include only if not subject to SUBSTANTIAL RISK OF FORFEITURE Factors (checklist) Test: Yes or no Is property paid to independent contractor or employee 1.83-(a)(1) (yes) Is property is conditioned upon the future performance of substantial of services (is it (no) transferrable?) 83 (a) & (c) y Depends upon the facts and circumstances. o TP right to decline to perform such services without forfeiture tend to establish that property not subj. to substantial risk of forfeiture y Not subject to a substantial risk of forfeiture to extent: o Employer required to pay FMV of a portion upon return of property.  TAX TREATMENT: y Included: In the year that the property vests o Unless: (b) election: included in the year that property is transferred o Unless: Arms-length transactions 1.83-1(b) & (c) [SEE BELOW] y Amount: value of the property at the time it vests (-)amount (if any) paid by the TP 1012, 1.83-2(a) o Unless: (b) election: year of transfer y Stock & stock options: o Tax treatment depends on:  Ascertainable fair market value  If not subject to substantial risk of forfeiture y Employee taxed on value in year a receipt  Basis: amount included + price she pays for stock when exercising option  EE179 ex o Does not qualify for capital gain rate y Later disposition: o May only be transferred if no substantial risk of forfeiture 83(c)(2) o Basis = value of the property at the time of inclusion 83  When not vested 1.83-4(b) o Arms-length transactions 1.83-1(b) & (c)  even if not vested: can include in income for compensation income= 83 no longer applies  if not arms length: 83 applies o Death 1.83-(f) o Employer deduction: only after employee includes it 83(h); 1.83-6(a)(1), [treatment when forfeited= income be employer (c)]

Deferred compensation/income:
Rule: Deferred compensation such is from retirement savings ( 62(a)(7)), pension plans, and education savings accounts is includible in the TPs GI y Analysis: y Time value of money tables CB 840-843

Policy: y Double taxation problem for TP Where taxed on earnings and investing income y y Led congress to enact tax-favored savings Generally for performance-based income y Types of deferred compensation: y Retirement accounts: Statutory framework: 219: deduction allowed for contributions to retirement acct; 7701a: definitions indiv retirement plan; 62: exclusion from GI; 72 Retirement savings Tax treatment Not IRA Traditional IRA 408 Roth IRA 408A Rollovers Salary TAXED EXCLUDED from GI TAXED Notes: Rollovers between contribution Included in GI Deductible Included in GI different deferred compensation plans are allowed tax free if [test]: y Earnings TAXED Compounds slower b/c tax on interest EXCLUDED from GI Compounds faster b/ no tax on interest EXCLUDED from GI y Compounds faster y b/ no tax on interest y TP job terminated 402 Transfer pension/profit-sharing plan Before receiving an early distribution & attendant penalty y To a traditional IRA or other qualified plan directly y In 60 days (vs.) if TP receives distribution, and then transfers to a qualified plan (w/ 20% w/holding tax)-3405(c) CB. 69: transfer my Roth to traditional IRA

Withdrawals

NO TAX

TAXED Allowed for education, medical expetc w/o losing tax benefits

Contribution limit

N/A

$5000 219(b)(5)(A) Catch-up contributions: for 50+yrs: $1000 in addition to $5000 219(b)(5)(B) Phase-outs: subject to limitation of 219(g) amount of $80k [see also spouses under plan] Stricter income limitations than Roth IRA if a part of employer plan; if not,

EXCLUDED from GI: if qualified distributions 408A(d), cr. ref. 72(t) (or else early withdrawal penalty) (i) Made on or after age 59 , (ii) Made to a beneficiary (or to the estate) on or after the death (iii) Attributable to the individual's being disabled (within the meaning of section 72(m)(7)), or (iv) which is a qualified special purpose distribution. Same as traditional IRA

NOTES:

then may make deductible contrib.no matter how high AGI Pensions & Education accounts: Statutory framework: 401 & 529/30 Qualified pension & profit sharing plans 401 EXCLUDED from GI 401 k: allow voluntary pre & post- tax contributions EXCLUDED from GI Compounds faster b/ no tax on interest TAXED $16,500 more than IRAs Education savings plans 529 & 530 TAXED Included in GI EXCLUDED from GI EXCLUDED from GI: If dont exceed contribution limit Contributions cant be made after beneficiary turns 18 529: Tuition Forum shop in states for education planssome better than others***

Tax treatment Salary contribution Earnings Withdrawals Contribution limit

NOTES:

y y

BIGGEST ADVANTAGE of a 401k plan is the threshold of 16,5k ALSO, the employer matches the funds Penalty-free withdrawals similar to IRA

Inalienability: ERISA 1974 requires the inalienability of pension/profit-sharing plans to employees, keeping creditors from retirement benefits o Exception in case of divorce: But the couple must get a QDRO BY JUDICIAL DECREE, Otherwise not enforceable (even if ct ordered) y Investing in employer: ERISA limits investment in employer for qualified plans, and employer mismanagement o BUT SEE: ESOP & KSOPs: (4975(e)(7))designed for employee to invest primarily in employer (use money for shareholders) Few execs so un-diversified o Retirement investing by buying employer stock not recommended**(see ENRON)

y y

Tax credits for voluntary contributions to savings plan for low-income TP 25b

y y y

Employer deduction matching: Whatever tax govt gets from employee is offset by tax deduction of employer. y But employer limited to deductions where payment is includible in employee income, to prevent tax float (taking current deductions for future payment) 267(a)(7) where emplr/emple relationship; 404a5 where not relationship 457 state employees/non-qualifd deferred compensation plans)

Fringe Benefits:
Rule: The TP must include certain fringe benefits in his GI (61(a)) unless they are otherwise excluded by other provisions in the tax code, for business interests 119, & 132 Analysis:

EXCLUSION Rule:

Meals: Excluded to extent meals are furnished on the business premises of the employer 119(a)(1)

Lodging: Excluded where employee is required to accept such lodging on the business premises of his employer as a condition of his employment. 119(a)(2) Test:  Furnished by employer to employee/spouse/dependents  For convenience of employer,  Furnished on business premises of employer,  TP reqd required to accept lodging as condition of employment.  Which is place of employment of employee  To enable him properly to perform the duties of his employment. Factors  Lodging is furnished because employee required to be available for duty at all times or  B/c employee could not perform the services required of him unless furnished such lodging 1.119-1(b)  Employee did not perform significant portion of duties in location

Analysis:

Test:

Fringe is for employee/spouse/dependents 119(a) y Meals furnished for convenience of the employer (factual determination) 1.119-1 y Meals furnished on business premises of the employer, Meals w/o charge: factors y Regarded as furnished for the convenience of the employer y If furnished for a substantial noncompensatory business reason of the employer y Factual analysis: o Mere declaration that meals are furnished for a noncompensatory business reason is not sufficient to R-B-A: prove Adams v. U.S. Ps furnished him with a house in o meals furnished to Japan, (required for his employment/duties as employee during working president). Court held: there was direct nexus hours to have employee b/t housing and business interests of employer. available for emergency Where emple housing important in Japanese call bus. Community. if not, adversely affect emplr o when meals furnished to business & premises not limited to emplyr HQ or employee b/c employer's bus compound- function as opposed to space business= employee must be restricted to a short meal period, (like 30 or 45 minutes) R-B-A: Kowalski meal cash allowance was not excludible (includible) where: food allowance paid w/o regard to whether emplye actually eating meals (not constrained in choice of food/eating plase) Rule: 132 provides that the value of the following are excluded: Analysis: (see rules 1.132-1) y Policy of Fringe Benefits o Congress wanted to encourage employers to provide benefits (like educ.) o Measuring recipients benefits would entail administrative burdens (de minimis) y De minimus fringes o Admin costs of tax outweigh benefits of tax pg. 81 y No-cost additional services o Like hotel emple staying hotel for free o Non-discrim for emples y Qualified emple discounts o See code for threshold o Non-dsicrim for emples

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y y y

y y

o Employe works in line-of-business o For goods/services normally sold to customers (not real property) Working condition fringes o Goods/services provided an employee o If the employee could deduct if paid for Qualified transport fringes: o Up to value of $175 Qualified moving expense reimbursements; Qualified retirement planning services; Qualified military realignment and closure payments 79: group term insurance: o Must provide general death benefit excludable from beneficiary income 101, cover a group of employee, excludes only the cost of covering the employee, coverage on family members up to $2000 may be excludedde minimis fringe benefit 132 106: employer contribution to accident & health plans: o For employee or employee family employer pays premium while employees can exclude premium from income 105: reimbursement for medical expenses: o For employee or family for health-related payments o Excludes reimbursements from employer provided health insurance for self insuring employer 127: employer payments under educational assistance programs 129: employer payments for dependent o Care assistance: day care for employees children while employee works o Maximum exclusion of $5000 137: employer reimbursements of employees cost of adopting a child: o Employee may exclude up to $10,000 per child

Illegal Gains
Rule: gains from illegal activities are includible in TP GI y When TP acquires earnings lawfully, unlawfully, or unethically y He has received incomeeven though he is still liable to restore it 61(a); James v. U.S. Analysis: o Code requirements: 6050I(a), (b), (c) (f):  Structuring transactions: y Prohibition on structuring transactions to evade reporting requirements (f) y 1.61-14(a): IG is a misc. item of GIlook up again  File a return: y Cash in business of +10k (a) y What should be on the return (b) y Exceptions: cash y R-B-A: o Embezzlements: James v. United o Extortion: Rutkin v. United States James v. United (1961) United States Supreme Court held that money obtained by a taxpayer illegally was taxable income, even though the law might require the taxpayer to repay the ill-gotten gains to the person from whom they had been taken. (Whether embezzling funds are included in gross income 61)overruled Wilcox Rutkin v. United States that the receipt of money obtained by extortion is taxable as income to the wrongdoer

Windfalls
Rule: If the TP must include in income any windfalls they receive y The value of treasure trove y In the year discovered y Reduced to possession 1.61-14(a) Analysis: y R-B-A: Cesarini v. U.S. (1969): y ct held that TP who bought an old piano for $15 at an auction y And later discovered $4,500 in cash, hidden in the piano y Had to include the found cash in GI

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Recovery of capital
Rule: TP are permitted to deduct the costs associated with earning income y Analysis: o Policy: not all receipts are gains ITEMS Inclusion Sales: Gain: excess amount realized Rule: A TP is includes realized & recognized gain over adjusted basis in section from the disposition of property in GI 1001 y And is allowed to recover the basis (cost) of the property, thus excluding the basis from GI Analysis: TP determines gain by: subtracting basis from the amount realized s. 1001 y Amount realized: amount realized at disposition of property y Recognition of loss or gain entire amount of gain or loss shall be recognized (see exceptions of subtitle) 1001(c) y Property taxes not taken into account 164 (d.) y Loss will be deducted from GI (see if applicable to exclusion section) Dividends, interest and rent All Rule: D/I/R is includible in the TPs GI 61 Analysis: y The TP recovers the cost/basis of these items at disposition y Recovered on the backend, instead of when TP earns income Depreciation: (timing of recovery for long-term property & BUS EXP. ANAL) Rule: TPs are permitted recover the cost of property used to earn income over the useful life of the property 167 Analysis: y Amt real/recog is includible to the extent amt exceeds cost recovery amount y An asset with a useful life that extends past a year must be capitalized 167 see (a)(c) & 1.167(a)-3(a3: intangible assets only depreciated if of limited temporal useful life, showed by experience of being estimated with reasonable accuracy) Current deduction: NONE (if deduction allowed)

Exclusion Adjusted basis (cost) 1011, 1012, 1016

Not until disposition Qualified y UNLESS: dividend income is excluded from GI 1(h)(11)(A) & (B) [dividends received from corporations (domestic or foreign)] Current deduction: ALL (if deduction allowed)

Capitalized deduction: Amt exceeding amt allowed for cost recovery

Capitalized deduction: Depreciation ratio amount ALLOWED FOR COST RECOVERY

Factors determining whether capital expense: (Hampton Pontiac vs. US) o Payment directly related to acquisition of franchise (intangible asset) o If renewable right: (indefinite nature of right) o Probability right will be renewed o Right is an intangible asset 1.167(a)-3 o NOW 197: FRANCHISE COST SPREAD

12

OUT OVER 15 YEARS BUT TP is allowed a deduction for ordinary and necessary expenses to carry on trade or business in the year the expense is made (current deduction) 162(a) Annuities: Rule: a TP must include a portion of annuity payments in GI 61, 72 Analysis: y DEFINITION: an annuity is a contract that provides for a series of payments in return for a fixed sum y To recover: o Cost of annuity / expected return (on annuity K) 72(b)= exclusion ratio (% of payment to be excluded) o What is left is includible o Annuity calculation tables 1.72--9 Business Expenses: Rule: a TP must include income from business activities 61(a)(2) y Though he may deduct certain expenses incurred in generating income from business activities Analysis: Deductions allowed per 162 Expenses: (a): deduction on all ordinary/necessary expenses paid or business y store rent, utilities, salary, even shipping y costs for acquiring the goods per 162(c): no Deductions disallowed deductions for illegal payments (bribes, kickbacks, etc) y Dixie Dairies Corp v. Commissioner (where milk sellers sold at minimum prices then offered rebates, the court held that the rebates were not illegal, and thus subject to 162 limitations, and may be deducted) y (f): no deductions for fines or penalties from violation of law y (g): no deductions for damages paid out for violations anti-trust laws y Drugs: no deductions or credit allowed for any amt incurred while carrying on business in the illegal sale of drugs 280E Method of accounting: y 1.471-3(d): if usual rules of cost computation do not apply- then may use trade practice y 1.446-1(c): general rule for methods of accounting: TP may compute TI with y

Percentage of payment exceeding exclusion by ratio If the TP outlives life expectancy, all subsequent payments included (if die early then can deduct difference)

Percentage of payment excluded by ratio Exclusion limited investment 72(b) to

Selling goods: gain from selling goods in of COGS Selling services: Gross receipts y Expenses deducted in yr actually made

Selling goods: COGS & 162 deductions Selling services: 162 deductions y Cost cant include amt disallowed under 162

Cancellation of Indebtedness
Issue / Scope: the tax consequences for debt that is discharged Rule: if a loan is discharged for less than the amount owed, the borrower must include the amount discharged in income 61(a)(12)

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Analysis: y Debt not an accession to wealth y Code Test: o Turns on whether TP was insolvent at time of discharge  Insolvency: excess of liabilities (-) fair market value of assets 108(d)(3) y Code Factors: o Many courts have held the DOI is income only if debt gave TP money, property, or services (Rail Joint Principle CB123) o Consideration for release of contract counterclaim income by Rev. Ruling o 1.61-12(a): examples  if performance exchanged for discharge  Payment at less than face value\shareholder gratuitously forgive debt- contribution to capital of corp. R-B-A: Kirby Lumber: [bond] issuing price (-) purchasing price [paid by co, retiring bond]= income o Different states, different rules for creditors y Code Factors: o Net-operating loss carryover  If deductions exceed GI: Net operating loss  NOL can be carried forward 20 yrs and back 2yrs- to deduct income in those years 172  Results in smaller deductions and more income in carryover yrs. Defer debt-discharge y EXCLUSIONS/EXCEPTIONS: Bankruptcy exclusion: 108(a) & (d) y A financially troubled TP can exclude DOI if insolvent/filed for bankruptcy y If not filed for bankruptcy, TP can exclude DOI only to extent of insolvency y Have to include exempt assets Property debt exclusion: 108(e) y Reduction of purchaser debt is treated as a price adjustment y (h) Principle residence (purchase price reduction) y (b) Reduction of tax attributes y 108e5: applies only to debt owed directly to seller of property y See exception 1017: adjustments to basis (higher the basis lower the gain and vice versa) y 1017 & 108b: reduction of property basis & 108a results in deferral rather than complete exemption y See property business indebtedness (c) Disagreement about amount: y Lender and borrower y Disagree y Borrower says amount owed is less o Difference b/t amt lender said was owed o And amount borrower pays o Doesnt have to be included in GI (N. Sobel v. Commissioner) y See also Zarin Student loan exclusion 108(f)  Unless work for school, then not excluded Cancellation as Gift exclusion 102(a) Zarin v. Commissioner: Zarin was a compulsive gambler who made extravagant bets. Casino allowed him credit in excess of amounts allowed by NJ law. His extravagant bets gave casino business. He lost several million and was discharged of most of the amt. Resort made Zarin tax-free loan (chips). Liability implies legally enforceable obligation to repay, Debt was not enforceable, as a matter of NJ law Zarin didnt have debt in which he held property. Chips arent property under 108it was an opportunity to gamble. Therefore, best viewed as disputed debt.

Damages and Social Welfare Payments

Issue / Scope: Whether legal damages paid to the TP are included in GI Rule: while damages paid to TP for replacement of gain is generally includible in GI

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Analysis: Replacement of lost profits: y Rule: replacement for lost profit is included in GI y Analysis: o Facts & circumstances indicate whether payment is reimbursement or lost profits o Sager Glove Corp v. Commissioner: pres. testified amt represented lost profits.  ct held case turns on nature of purpose for settlement Involuntary conversion of property into cash: 1033 y Rule: A TP may elect not to recognize gain from the conversion of property into cash (exclusion) y Analysis: o Code test:  Only if  Involuntary conversion due to o Destruction o Theft o Condemnation  TP must reinvest cash in property that is similar/related in use to the lost property Physical harm: y Rule: compensatory damages for physical injuries or physical sickness is excluded from GI 104(a), 1.61-14(a): y Analysis: o Medical exps for emotional distress remain excludible o Validity and payer intent not dispositive o Workers comp included (other than punitive) o Agreement should specify portion of payment for injury (Amos v. Commissioner (TC 2003; Dennis Rodman case) Issue / Scope: Whether social welfare payments are included in TP GI o Rule: social benefits payments are excluded for GI o Analysis: y Paid by state Dividend payments y Restricted to those in need y Includible o Revenue Ruling 85-39 on Alaska Benefits y Alaska gives out (mineral) dividends to retain population; analogous to gifts/welfare program which are not taxable y Govt should not expect to receive benefit Includible in incomes of upper and middle-class recipients (on a staggered basis, 86 Most SS benefits Result: low-income recipients SS payments excludible Unemployment benefits Are includible because they replace taxable wages, 85

Imputed income
Issue / Scope: Whether the govt should tax benefit not calculated in monetary gain Rule: imputed income is not generally included in the TP GI Analysis: y Imputed income are benefits created when TP performs services for self of family y Taxation of II raises problems of valuation, equity, and efficiency (effect may be to encourage people to work at home) y Examples: o Shaving, cooking, driving to work

SOME EXCLUSIONS, DEDUCTIONS, AND CREDITS

Tax Expenditures
y y To further non-tax goal: for instance, easier for legislator to hide certain tax benefits to certain people/industries (good political cover)instead of direct expenditure Notes: cutting tax expenditures= cutting tax exclusions

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Arguments o Sometimes congress enacts tax subsidies w/o critical scrutiny of costs and benefits o But tax expenditures involve less bureaucratic interference than direct subsidy plans Types of expenditures: o Reduce TI o Preferential tax rate o Credit o Defer/ delayed recognition

ABOVE THE LINE (EXCLUSIONS FROM GI to get AGI) Listed in 62 ---------Tax-Exempt Interest
Issue / Scope: Whether interest from certain government bonds are excluded from GI Rule: A TP excludes interest they receive on certain state, municipal, and other bonds from GI 103 Analysis: y Code req: o ABL deduction o Tax-exempt interest is required to be shown on the TPs return 6012(d) y Exclusion does not apply to: o Private activity bonds not qualified 141  Projects far removed from one usually considered governing o Arbitrage bonds 148  Raising revenues by paying a lower interest to TPs, then using the proceeds to invest in higher interest paying bonds  Thereby generating revenues w/o taxing residents o Unregistered bonds 149 y RBA: King v. Commissioner: govt payment for takings not interest King v. Commissioner, 77 T.C. 1113 (1981) [where held denied petitioners 103 exclusion because it considered the govt payment as a takings compensation, and not interest] Possible policy y Policy: federal govt wants to avoid imposing burdens on states and municipalities in their power to borrow funds

Gifts and Bequests

Issue / Scope: Whether gifts or bequests to the TP bonds are excluded from GI Rule: GIFTS: a TP excludes gifts from GI 102 Analysis: y Supreme Court gift test: o Transfer which stems from o Detached and disinterested  Commissioner v. Duberstein: gifts as compensation for past services not disinterested o Intent of donor o Gift may be a gift, regardless of whether there is a legal obligation Commissioner v. Duberstein, 363 U.S. 278 (1960) [where court held that the value of the Cadillac was not a gift, because the motives were not "disinterested" -- it was given to compensate for past customer references or to encourage future references] o Give deference to trier of fact to determine intention of donor. o Case results in 102c1: transfers from employer to employee are never counted as a gift o (not excluded from GI). o See also gen rule for property as compensation included in GI 83 y o 1.102-1(f) (proposed) [exclusions to 102 rule****], Tax base: o Excluded from the donees tax base o Generally income included in the donors tax base 1.102-1(e) Property gifts: (basis in property for future disposition) 1015, 1.1015-1(a)

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Gain y y y

Donor transfer not counted as a disposition= no federal income tax consequences Loss if at the time the donee received the gift y if the property has a basis greater the FMV of the property was greater/equal to o than its FMV the donors basis y at the time the donee received the gift the donee takes the donors basis. (carry-over y then, when the donee disposes of the property: o (1) the donee gets the same basis as basis concept) the donor {if this produces a gain- calc complete}; o (2) {if it doesnt produce gain} the donees basis in the property is the equal to the FMV at the time of sale/transfer by the donee o

Employer-Employee: o Rule: generally, gifts to employees are not excludible. o Analysis: However, employee achievement awards are excludible 74(c).  The code now denies business-expense deductions for most substantial gifts past $25, 274(b). (As well as transfers to widows of employees)  Tips 1.61-2(a)(1) & 6053, strike benefits are includible. y Policy: most gifts are made to family members and inclusion in the donors base is generally easier to administer. Rule: BEQUESTS: a TP excludes bequests upon the death of the donor from GI Analysis: y Basis in property o Equal to its FMV on the death of the decedent 1014, 1022 (yr acquired) y Inter-Spousal transfers: o No gain/loss recognized on transfers from spouses or former spouses. 1041 o Treated as a nontaxable gift  see also 1015e y

Life Insurance Proceeds

Issue / Scope: Whether life insurance proceeds are excluded from the TPs GI Rule: term and whole life insurance benefits are excluded from the beneficiaries GI 101 Analysis: y Code Test: o Proceeds excluded from GI if: o Received by reason of the insured death y Code failure: o When the insurance co. holds the policy proceeds  After the insured dies  And pays interest to the beneficiaries. o See also employment-owner insurance Ks 101(j) y Code exception: (amount excluded during life of insured) 101(g) o TERMINALLY ILL:  Physician certifies y Individual not expected to live longer than 24 months. o CHRONICALLY ILL:  If medical personnel certify y Individual unable to perform y at least 2 activities of daily living, y individual is disabled, y or individuals cognitive functioning so impaired o he requires supervision in order to avoid harming himself. y Exclusion applies whether payment provided by insurance co or by a viatical settlement provider

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o y

(a party who regularly pays insured individuals to assign their life insurance benefits).

Insurance investments: o Dividends from insurance policies are tax free if retained by insurer as premiums. o The benefits/excludability spills over to the investment portion of the package. o Follows different regime than annuity(?) rule, where amounts paid, exceeding contract are includible 72(e)(5)

Scholarships
Issue / Scope: Whether the scholarship may be excluded from the TPs GI Rule: a TP may only exclude qualified scholarships from GI 117; Prop Reg. 1.117-6(c)(4)[definitions] Analysis: y Code Test: o TP a degree candidate o At a 170(b)(1)(A)(ii) institution maintaining:  A regular faculty  Curriculum,  Body of students in attendance o Qualified to the extent it covers (b):  Tuition  Fees  Books  Supplies o Any amount  in excess of,  or which does not  include the qualified coverage  Is included in GI. y Compensation for services not excluded: o To the extent scholarship is compincluding teaching and research (c) o (c) May cover athletic scholarships, if participation is required as a condition for retaining the scholarshipyet to be determined by IRS o BUT SEE Educational Assistance Programs 127

Prizes & Awards

Issue / Scope: Whether a prize or award may qualify to be excluded from GI Rule: Amounts received as prizes/awards and transferred primarily in recognition of: o Religious, o Charitable, o Scientific, o Educational, o Artistic, o Literary, o Civic achievement; y OR is a employment achievement award y May be excluded from GI o Otherwise, GI includes amounts received as prizes or awards Analysis: y CODE TEST: o Prizes: 74(b)  Recipient selected without any action on his part to enter contest,  Not required to render substantial future services,  Prize/award transferred to govt or charity upfront  FMV: A TP is not stuck with the retail value of the prize or award, but the court may take a FMV or subject valuation of the prize. y Turner v. Commissioner o Employee achievement awards

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For length of service or safety y & if it doesnt cost the employer +$400), 74(c) OTHERWISE the employee must include the award as compensation for services 274(j) [definitions of employee achievement & etc]

Turner v. Commissioner, 13 T.C.M. 462 (1954) [where the tax court held that a man who received a NON-transferable reward for a radio contest was to include a substantial portion in his GI taking into account his subjective valuation.] Non-transferable award, ct finds a middle groundTP not stuck with arms-length/retail price but not subjective price he attempted to establish. If this had been transferrable, it would have at least set a floor value. Note on 1.61-21 (b): fringe benefit valuation by employee.

Alimony Payments
Issue / Scope: whether the payor may take an above-the-line deduction for a (post)marriage transfer Rule: a TP may take an itemized deduction for certain cash-alimony transfers to spouses. Analysis transfers CASH NON-CASH/PROPERTY Alimony: y No gain of loss is recognized by either party on the transfer of property 1041 Inclusion: in income of Exclusion: from GI of o (overturning Davis) 215 As payee 61(a)(8) [see payor o To a spouse also spouse-dependent above-the-line o Or former spouse defined 152] 62(a)(10)  If transfer incident to divorce Test: o Transferee assumes transferors basis in y Must be cash 71(b)(1) & (2) property y Payment pursuant to written Divorce or, Separate maintenance agreement or, o Decree  Agreement cannot stipulate that payment not includible or deductible in income Payor and payee live in separate households Payment not for child support 71(c)(1) o Payments that end with death or age of child= child support 71(c)(2) Payments cant continue after death of payee spouse 71(b)(1) Treated as alimony to extent they are equal in 1st three years payment made 71(f) EE pg 148-149 see also exceptions 1.71-1T [temp regulation on alimony payments] o CB 247: indirect alimony- insurance premiums o CB 247-48: indirect alimony- housing payments  If spouse  Makes mortgage payments  On house  Owned by the spouse y Counts as alimony y If other requirements satisfied o

y y

y y

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Child support: Neither Included nor excluded from GI of payor and payee  CB 246

Trade and Business deductions

Rule: 62 Analysis: see business expenses section analysis

BELOW THE LINE (EXCLUSIONS FROM AI to get TI) deduction not in 62 PERSONAL EXEMPTIONS
Rule: each TP receives a personal and dependent exemption 151 Analysis: y AMOUNTS o $2,000 y FILING STATUS: o Joint return: each spouse entitled to exemption  Both spouses liable for tax 6012(d)(3)  But see innocent spouse principle 6015  (CB pg. 232-33) o One spouse file: filing spouse can claim non-filing spouses personal exemption y QUALIFYING DEPENDENT 152 o CHILD: 152(c)  TP child or sibling y Or TP child/sibling descendent  18 or younger y Or 23 or younger if student  Same principle place of abode y For more than year  Does not provide more than of own support y For year o RELATIVE: 152(d)  TP child y Or TP child/sibling descendent, parent, parent ancestor, sibling, aunt, uncle, niece, nephew, cousin, or in-law  OR same principal place of abode y Member of TP household y GI less than 151 (2k) y Receives more than support from TP y Not qualifying child of TP (see LGBT)

AND Greater of either: STANDARD DEDUCTION

Rule: a TP may take the standard deduction if it is greater than the aggregate of itemized deductions 63 Analysis: (recheck the statutory volume for amounts) y AMOUNTS o $ 5,800 for unmarried couples o $ 11,600 for married couples filing a joint return

ITEMIZED DEDUCTIONS
67: 2% floor on miscellaneous itemized deductions [STEP 1] Rule: y Allowed only to extent the aggregate of deduction exceeds 2% of AGI y All items listed not subj to 2% floor o 213: medical, dental, etc., expenses o 170: relating to charitable, etc., contributions and gifts  642(c): relating to deduction for amounts paid or permanently set aside for a charitable purpose o 164: relating to taxes: allowed a deduction for local, foreign

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Extraordinary Medical Costs

Issue / Scope: Whether the TP can take an itemized deduction on medical costs Rule: the TP can take an itemized deduction on medical costs; to the extent it exceeds 7.5 % of the TPs AGI 213, 67 y 7.5 to increase to 10 % in 2013 Analysis: y Definition: o Medical care expenditure:  Amounts paid for y Diagnosis, cure, mitigation, treatment y Or prevention of disease y Or for the purpose of affecting any structure or function of the body y INCLUDING o Primarily & essential for medical care  Med insurance  Hospital lodging  Transportation o Even if not necessary  Payments to medical practitioners  1.213-1(e) [definitions/examples of med care, cap expenditures may only be included if directly related to medical expense] y Code Exclusion: o Insurance reimbursements: not included in deductions o Expenses which improve the health of the TP but not directed at diagnosing, curing, mitigating treating, or preventing a disease is nondeductible y Code Test: o Can deduct amounts actually spent on medical care o For the TP, spouse and dependents o Anything above 7.5% of AGI o PROPERTY IMPROVEMENTS  For medical purposes  Deductible to extent y Cost of improvement exceeds y Increase in the value of the property.  Service ruled improvements made to the TPs home to accommodate sick/impaired do not improve value of residence Ferris v. Commissioner, 582 F.2d 1112 (1978) [wealthy TPs build expensive pool house b/c wife had degenerative spinal disease, ct held there is no ceiling limitation on the amount of deductible medical expenses, but that any cost above those necessary to produce a functionally adequate facility did not fall in def of medical care] o OBESITY:  Obese may deduct the cost of a weight loss program  Since recognized as a disease [if classified as clinically obese*]. o COSMETIC SURGERY: (d)  Only deductible if disease necessary to correct  Congenital deformity or abnormality y Arising from injury or disease  Abortions and sterilizations deductible. o O-T-C MEDICATION:  Not deductible, unless prescription drugs or insulin. o TRAVEL & LODGING:  Travel y Primarily for and necessary for medical care is deductible. y If medical care available in area, but TP chooses to travel, not deductible (unless in hospital).  Lodging y Away from home y Deductible up to $50 per night

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o Only if not lavish Seeking treatment by physician In medical care facility. If travel on doctors orders o To more hospitable climate o Costs of travel o but not of meals and lodging (unless in hospital) o Are deductible. o LONG-TERM CARE:  Qualified long-term care services & certain premiums for qualified long term care insurance are treated as medical expenses. (7702B(c)). o SCHOOLING:  Cost of special schooling designed to rehabilitate ill/disabled  Deductible as a medical expense. o SEX CHANGES:  Deductible. See also HSA (E/E 210) (Medical benefits provided by the an employer are fully excluded from employee income 105(b)) ODonnabain v. Commissioner, 134 T.C. 34 (2010) [the Tax Court held that a taxpayers sex-change surgery and hormone therapy were deductible after the TP been diagnosed with gender identity disorder under the standards of the American Psychiatric Association] y Policy: deduction seems to invite fraudulent claims, also get $$ back on capital expenses with the disposition of the property] y 68(c) proposed leg. Overall limits on itemized deductions y y y

Charitable Contributions & Tax-Exempt Organizations (SEE CLASS SLIDE)

Issue / Scope: Whether contributions to particular organizations may be deducted as an itemized deduction Rule: a TP may take an itemized deduction for charitable contributions certain nonprofit org.s 170 Analysis: y Contribution to: Qualifying organizations: o Listed under 170(c) & 501 (TAX TREATMENT: these exempt organizations are not taxed on income from contributions & earning related to the charitable purpose. but if the organization earns income from business unrelated to org.the org will be taxed 501(b) & 511)  o 501(c)(1)-(7)[exempt organizations]; 513 [definition: unrelated trade/business]; 6113[disclosure requirement for return] (1) A State, or any political subdivision of the United States Only if the contribution or gift is made for exclusively public purposes.  o (2) A corporation, trust, or community chest, fund, or foundation  Created or organized in the United States  Organized and operated exclusively for y Religious, Charitable y Scientific y Literary, or educational purposes, y Or to foster national/international amateur sports competition y Or for the prevention of cruelty to children or animals;  No part of net earnings inures to benefit of any private shareholder or individual;  Is not disqualified for tax exemption under 501(c)(3) y By attempting to influence legislation or participate in any political campaign o (3) A war veterans organization: no part of net earnings inures to benefit of any private shareholder or individual. o (4) A domestic fraternal society under the lodge system  Only if contribution/gift to be used exclusively for: y Religious, charitable y Scientific, literary, y Or educational purposes, y Or for the prevention of cruelty to children or animals. o (5) A cemetery company owned and operated exclusively for the benefit of its members BENEFITS FOR CONTRIBUTION (QUID PRO QUO) o Deduction for full amount contributed only allowed

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 If a donor receives no substantial benefit for contribution. If the donor receives a substantial benefit  Contribution deduction is reduced by benefit received. o Donee charities must to provide donors with an estimate of the value property received by the donor in exchange for the contribution if it exceeds $75. 6115 o 170(l): contributions to universities for right to buy sports tickets: deductions limited to 80% of contribution o 1.170A-1(h)[payment in exchange for consideration- BOP on TP to show charitable contrib. or gift]; o Churches: EE 220 TYPE OF CONTRIBUTION (LIMITATIONS) 170(b) o CORPORATE CONTRIB.: contribution limited to 10% of TI o CASH:  Cash contribution limited to percentage of contribution base (AGI) y (b)(1)(A): contribution deduction limited to 50% with excess carried over five years 170(d), o Church or a convention or association of churches o Educational organization o Medical/hospital care/research/education o Govt unit/org. receiving substantial support from govt o Private foundation o 509 org y (b)(1)(B): 30% o Other org.s o PROPERTY: amount of contribution is the FMV of property at the time of contribution (Cr-Ref 170(e)(1))  Appreciated: y Donor deduct FMV value of property 170 & 1.170A-1(c)(1) o (Even though TP & org wont pay tax on appreciation) y Limitation: o if property would produce income/short term cap gains o Donor may deduct only adjusted basis in contrib. property o LONG-TERM GAIN EE221 o SERVICES: Services are not deductible 170 & 1.170A-1(g)  However unreimbursed expenses incurred in rendering services are deductible (if not childcare)  170(i)[14 cent/mile deduction for car driven in service of charitable org] o SUBSTANTIATION: must have evidence of even small contributions) if $250 or more, and donor must substantiate with written acknowledgment prepared by donee Charity (170f8). If $500 or more, by qualified appraisal (170f11). 170(f)(8); 1.170A-13(f)[substantiation of charitable contributions of $250 +]

NOT DEDUCTIBLE: If any part of the net earnings of donee organization o o Benefits private shareholder/individual Attempts to influence legislation/political campaigns (to substantial degree).

DONOR DEDUCTIONS ONLY FOR 170c ORGANIZATIONS: The donor may not qualify for the charitable contribution deduction 170c, even if the organization may qualify for tax-exempt status under 501c.

Winn v. Commissioner, 595 F.2d 1060 (1979) [court allowed TP deduction put into cousins account for missionary work of religious organization, Supreme Court denied same arguments in Davis v. U.S. Haverly v. U.S., 513 F.2d 224 (1975) [after principal took a deduction but did not included the deducted item in his income, court held that the charitable deduction for donation of property to library, after publishers gave him books (not constituting a disinterested gift), meant that the books constituted income] see also 1.170A-13(f)(3)**in class ****MUST ALSO have record for small contributions//Haverlysee class notes

State, Local, and Foreign Taxes

Issue / Scope: Whether the TP can take an itemized deduction for the payment of taxes

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Rule: a TP may take an itemized deduction for the payment of income, sales, foreign and property taxes 164(a), (b); Cr-Ref 212 Analysis y SALES TAX: 164(b)(5)(c) o American jobs creation act 2004 amended 164  allows taxpayers to elect to take sales tax deductions in lieu of deductions for state/local income taxes 164(b)(5) to sunset 2011 y PROPERTY TAX: 164(b)(1) o Acquiring  Deduction not permitted for taxes paid in connection with acquisition of property y Buyer must treat as part of cost of property  May reduce amount realized on the sale 164(a) o Disposition  When the property is sold  Property tax must be allocated y b/t buyer and seller 164(d)(1) y according to what amount of the tax y property owned by either the buyer or seller o Renters tax: If TP doesnt own the property, then cant deduct property tax Revenue Ruling 79-180 [New York renters tax is not a tax for federal income purposes even if they have interest in the propertynot owners] y TAXES/fees NOT DEDUCTIBLE: 275(a) o Federal income o Gift o Estate o Employee SS taxes o Govt fees: amounts charged for government services (not considered taxes) y TRADE/BUSINESS/GENERATING INCOME: 162(a) & 212 o (tax) Deduction allowed in the calculation of adjusted gross income o Must be directly related to trade/business: 1.62-1T(d)).  Not including services as an employee y (see also: 901 foreign tax credit), general sales tax, environmental tax.) (b)(5)(f)[Special rule for motor vehicles];

CREDITS (EXCLUSIONS FROM TI)-------------------Child Tax Credit

Issue / Scope: whether the TP is allowed a credit for children Rule: the TP is allowed a $1000 child credit for each qualifying child for which he is allowed a 151 exemption (as defined by 152) 24(a) Analysis: y Test: o TP allowed a 151 exemption for child o Child fits definition of child per 152  TP child or sibling y Or TP child/sibling descendent  Same principle place of abode y For more than year  Does not provide more than of own support y For year o And is 16 or younger 24(c)(1) y Reduction: o Credit reduced by $50 for each $1,000 o By which TP AGI o Exceeds threshold amount 24(b)(1)  $110k married joint return 24(b)(2); $55k for married filing separately 24(b)(2)  $75k single 24(b)(2)

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Refund: o Unused portion of o Credit refundable o Up to maximum of 15% o Of TP earned income above $3K 24(d) (review)CB 249

Household and Dependent Care Services Credit

Issue / Scope: whether the TP is allowed a credit dependent care services to enable TP to work Rule: the TP is allowed a credit for certain household and dependent care services incurred to enable the TP TO WORK Analysis: y Test: 21(a) o TP household includes 1+ qualifying individuals o Dependent per 152(a) o under 13yr/old o Or dependent/spouse  Physically/mentally incapable of caring for self 21(b) o Employment-related expenses incurred for care of qualifying individual  Only if incurred to enable TP to work 21(b)(2) y Amount taken into account o Limited to:  $3k if 1 Qual.Indiv. 21(c)  $6k if 2+ Qual.Indiv. 21(c) o Cannot exceed: 21(d)  Earned income (i.e. wages) y of TP single y or if marriedlesser of earned income of TP/TP spouse o Special rule permits credit where TP spouse disabled or full-time student 21(d) y Allowed credit o Equal to applicable percentage o Of employment-related expenses o TP paid during taxable year o Special rule where y Applicable percentage 21(a) o 35% o Reduced by 1% for each $2k o By which TPs AGI exceeds $15k.

Earned-Income Credit
Issue / Scope: whether the TP is a low-income worker eligible for a tax credit Rule: a low-income TP may take a credit if a worker 32 EE194 Analysis: y credit: o Percentage of TP earned income  34% if 1 qualifying child (152(c))  40% if 2+ qualifying children  7.65% if no qualifying children o Up to the earned income amt y Refund: o If credit exceeds TP tax liability o Excess refundable y Policy:

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o o o

Ability-to-pay regime To supplement income of low-income working people  Especially those supporting minor children Intended to make work more attractive to low-income TPs

Education Credits
Issue / Scope: whether a TP may take an education expense Rule: a TP may take an education credit, including the Hope or Lifetime Learning Credits Analysis: y Hope scholarship credit 25A(b) o $2000 for qualified tuition o for qualified tuition and academic fees  Not room and board o Paid to academic institution o For first 2 yrs of post-secondary education o Phased out for upper-income TPs CB: 253 o Not available if convicted of drug offense (state/fed) y Lifetime learning credit 25A(c) o Credit equal to 20% o Totaling $10k/yr o Of qualified tuition & academic fees o Paid by TP o Phased out fir upper-income TPs CB: 253 y 221 deduction for certain higher educational expenses o Allows above-the-line deduction o For same types of expenses o Creditable under 25A y Coverdell Education savings deferral and exclusion provisions y Qualified tuition program deferral and exclusion provisions y Other personal Credits o Analysis: CB 255/ EE 191 -396 o Elderly credit o Disabled credit

BUSINESS AND INVESTMENT EXPENSES (62 T/B ATL)

Terms (Capital) y Capitalize (spread cost of recovery over time) y Capital asset (not easily converted into cash, generally owned to generate profit: land, buildings, machinery) y Capital expenditure (Funds used by a tp to acquire or upgrade physical assets such as property, industrial buildings or equipment) o Outlay is made o To maintain or increase o Scope of their operations

RECOVERING COST OF PROPERTY: Depreciation and related matters

Issue / Scope: how the TP may recover the cost of an asset used to generate income, with a useful life which last which extends past the taxable year Rule: Depreciation y The cost of an asset with a useful life y Which lasts substantially longer than the taxable year y May be recovered thru depreciation deductions y In the year the asset is expected to be used in T/B/Prod. Inc.

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o If the property used in T/B or for the production of income 167 Analysis y Code test: o Check 179 o Only use in T/B/I situation o The property has a limited useful life 167  Intangible 167/ amortization & Depletion for natural property (coal, gas, etc)  Tangible 168 y Accelerated Cost Recovery System:  Analysis o Why the TP wants to use/ Favorable b/c:  Shorter recovery period y Especially for property with a long useful life  Accelerated recovery method  Assumes salvage value zero, permitting deduction of entire cost of property o MUST CLASSIFY THE PROPERTY FIRST  problem pg. 268CB  ASK WHY using the table in xv make sure that the property satisfies the 3 factors of depreciation. If any factor is different. o 1. RECOVERY PERIOD: 168(c) & (e)  1. Find class life 168 (e) [list of property to be depreciated]  2. Find recovery period 168 (c) [] o 2.DEPRECIATION METHOD: 168(b)  RULE: TP must use straight line method to depreciate real property y Straight Balance method: o Take deduction equal to amt of 1/#_useful years y May elect to use S-line method for other types of property 168(b)(3), (5)  RULE: Non-real property: if do not elect straight-line method y Declining Balance method: o 1. Straight line method deduction % determined o 2. Multiplied by D-B percentage (x 1.5 [150%] or 2 [200%]) o 3. Amount subtracted from basis of property o 4. The basis is then reduced (adjusted) 1011 & 1016 o And 1-4 repeated with adjusted basis amount o Until D-B method % amount is less than straight-line method amount w/ adjusted basis  Calc: Adjusted basis for Tax yr remaining useful life  Then: switch back to straight-line method using y 15 OR 20-YEAR PROPERTY: 150% declining balance method y OTHER PROPERTY: 200% declining balance method 168(b)(1), (2) o Unless TP elects 150% D-B method 168(b)(2)(D) o 3. CONVENTION: 168(d)  Determining when property put into service by TP VS. when acquired by TP y Thus determining when and how much depreciation deduction allowed y If not full year: o Full year amount/deduction  Determined by recovery period/convention o Divided by portion of year allowed  1. NOT REAL PROPERTY: year convention y asset deemed to be placed in service on date that is halfway thu the year 168(d)(1) & (4)(A)

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Discouraging abuse: so TP doesnt use year convention while putting property in service at end of year  year convention if significant portion of property placed in service in last 3 months of year 168(d)(3) [deemed to be placed in service halfway thru quarter prop placed in service] 2. REAL PROPERTY: mid-month convention y Deemed to be placed in service on date halfway thru month y In which actually place in service 168(d)(2) & (4)(B) o

Pg. XV tables: 179 EXPENSE ELECTION: 179 election to deduct full purchase price upfront in first year**  Aimed at small to mid-sized business  TP may make a current, itmeized deduction  The cost of 179 property y Depre)ciable tangible, personal property, or used in T/B 179(d  Placed in service  In current year  $250,000 cap  Deduction cannot exceed TI y Excess carried forward to next year  Basis in property reduced by 179 amount. 1016  EXCEPTION: (b)(1) deduction cap at $500k; (b)(2) temporary provision 168(k)(5): deduction of 100% of certain tangible property placed in service during (this) year [ignore] y 248 Corporate expenditure deduction (election) o Corporation may elect to deduct amount incurred in the creation of the corporation o Reduced by 5k by which amount exceeds 50k y See ALSO Listed Property limitations Simon v. Commissioner: (violin bow) y IRS took the position of non-acquiescencemay challenge other TPs (i.e. in other circs) y Violinists pay for bow, by bow maker. They would go down in value, but up in value b/c of collectors market. But court held that even if prop goes up in value overtime, still allowed to take depreciation. Court wants to bring certain y y

RECOVERING BUSINESS EXPENSES (in Tax year or at disposition): Capital Expenditures

Issue/Scope: whether an expense is business/ investment (current) or capital (recovered at disposition) Rule: capital expenditures add to the basis of the property, the cost of which is recovered when the property is sold Analysis: y Code policy: The TPs method of accounting should reflect the TP income; not only the overall method of accounting, but also the accounting treatment of any item 1.446. For example, expenditures for such items as plant and equipment, which have a useful life extending substantially beyond the taxable year, shall be charged to a capital account and not to an expense account. y Code test: o 162 deduction allowed (BELOW THE LINE/ Computing TI 161)  Ordinary & Necessary expenses  Incurred in tax year  For carrying on T/B o 263 Capital expenditure  Deduction disallowed  For Amounts paid (see 261) y For new buildings or; y For permanent improvements/betterments or;

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o Made to increase value of any property/estate For indirect costs of capital expenses or; o Commissioner v. Idaho CO. 428 U.S. 1 (1974;) & 263A (prop other than inventory) Commissioner v. Idaho co. 428 U.S. 1 (1974): POWER CO HAD TO CAPITALIZE EXPENSES for wages and depreciation on trucks used to construct facility 30-yr useful life (cost of trucks recovered with longer useful life of building)considered capital expenditure o See also 1.263(a)-1 y For expenses that produce significant future benefits o RE: Intangibles: INDOPCO v. Commissioner; 1.263(a)-4  To acquire, create, enhance (separate & distinct or future benefit), or defray cost to acquire intangibles INDOPCO v. Commissioner 503 U.S. 79 (1992): deduction for investment banking/legal fees incurred during year in connection with friendly takeover had to be capitalized y Benefits: o Availability of acquiring co.s enormous resources o Synergy y Code Factors: o Capital:  Expenditure materially enhances the value, use, life expectancy, strength, or capacity of asset (to condition necessitating the expenditure) Plainfield-Union Water Co. v. Commissioner, 39 T.C. 333 (1962)  Examples: 1.263(a)-2 y The cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year. Amounts expended for securing a copyright and plates, which remain the y property of the person making the payments. y Cost of defending or perfecting title to property y Architects services. y Commissions paid in purchasing securities. y Amounts assessed and paid under an agreement between bondholders. y Cost of good will in connection with the acquisition of the assets of a going concern is a capital expenditure. o Amortization of certain types of INTANGIBLE assets 15yrs 167(f),197 & for start-ups (REVIEW/EE & HB 6.02 & 6.03) o ENVIRONMENTAL REMEDIATION COSTS 1898 o Current:  Incidental repairs: to maintain in ordinary, efficient operating condition 1.162-4  Professional expenses: incurred in y Practice of his profession y Operation and repair of an automobile used in making professional calls y Dues to professional societies and subscriptions to professional journals y Rent paid or accrued for office/ office expenses y Etc 1.162-6 y R-B-A: o Repairs: (vs. improvements) Plainfield-Union Water Co: TCt found TP restoration of water pipes to original carrying capacity does not make property more valuable, useful, longer-lived=usually deemed a deductible repair per 162. Capitalization provision envisions an inquiry into the duration and extent of the benefits realized by the taxpayer. Citing Midland Empire Packing: concrete to restore normal operating condition of basement used to cure meat  May become part of cap. Exp. If part of overall rehabilitation plan  May need to capitalize if expense foreseeable at time of asset construction. Mt. Morris Drive-In (drainage system after construction of drive-in theatre) o Small items:  Professional books, furniture, equipments, instruments with short useful life  Farmers costs of small tools y

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Etc 1.162-6

GETTING IT IN: differences between Business, Investments, and Personal Expenditures (B/T/I deductible vs. Personal non-deductible)
Issue/Scope: whether an expense is business/ investment or personal Rule: a TP may take a deduction for B/T/I expenses, but generally not for personal expenses Analysis: y Deductions allowed for T/B expenses are used in calculating AI: 62, 162 (A-T-L deduction) o DEDUCTION ALLOWED FOR Ordinary and necessary expenses in carrying on any t/b 162  TP must make a showing that activity is T/B  Salaries/ comp for service y Working as an employee (but below-the-line) y NOT LISTED in 67 @ allowed only to extent aggregate of deduction exceeds 2% of AGI  Travelling expenses y Including amounts expended for meals and lodging o Other than amounts which are lavish/extravagant under circumstances  Rentals or other payments required to be made as a condition y To the continued use or possession y Of property to which the taxpayer does not own/have title y For purposes of the trade or business,  o NO DEDUCTIONS ALLOWED FOR: 162(c), (f), (g)  Charitable contributions and gifts y No deduction shall be allowed for any contribution/gift which would be allowable as a deduction under 170  Illegal bribes, kickbacks, and other payments.  Government fines or penalties  Treble damages paid in antitrust suit y Deductions allowed for production of income used in calculating TI 212 (B-T-L deduction) o For expenses incurred for:  Production or collection of income  the management, conservation, or maintenance of property held for the production of income  in connection with determination, collection, or refund of any tax o Itemized deduction  NOT LISTED in 67 @ allowed only to extent aggregate of deduction exceeds 2% of AGI y Generally, no deduction for personal expenses 262 (but see below) y Profit-Making Activities o Rule: a TP is not allowed a deduction for expenses incurred for activities not engaged in generating a profit 183 (Like expenses allowed under 162 for T/B)  If not allowed by other sections y Like 164 deduction for payments of non-federal taxes o Analysis:  Code 183 test/analysis: y Prevents TP from taking hobby losses y Does revenue exceed expenses (d) y Rebuttable presumption activity engaged in for profit if: o 3+ years o Of last 5 consecutive years o Activity earns a profit o If horse breeding:  2+ year of last 7 consecutive years y Extension election: 183(e) o TP can wait to see if presumption met o Until 5th year o If election made

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o o

SOLs on assessment Is extended until 2 years after return

 R-B-A: Larson case: breeding dogs and didnt turn a profit for past 3 years y if engaged for profit, then can deduct all of expenses y Evidence showed: o their desire to make money in venture o personal gratification and no prior exp, and no formal books o They werent wealthy and went through hardship to engage in activity y Motive (Connecting expense to activity) o Rule: a TP is not allowed deduction intended for personal expenses, instead of producing income 212 (162: T/B implied intention of generating profit), 262 o Analysis:  The court will look to the underlying/ origin of claim to determine if personal expenseeven if intended to generate/maintain income (Gilmore) y Crimes arising from Business activities: deductible per Commissioner v. Tellier (vs. non deductible is personal) Gilmore case: y Where TP incurred legal fees in divorce proceedingsto protect interest in business from estranged wife y Court says: o The fact that the consequences of divorce proceeding would have been bad for business, o Not relevant to the origin of the claim o Look to underlying claim not its consequences  Expenses to acquire alimony payments allowed as deduction 212, 1.262-1(b)(7) (Wild v. Commissioner: legal fees incurred to acquire alimony by estranged wife) y Because alimony is considered a form of income  Uniforms: The costs of certain effects used in uniforms for public officials are deductible 1.262-1(b)(8) [see military] y Court will likely hold not deductible is can use general and ordinary clothing Pevsner v. Commissioner: y Employee in high-end retail store compelled to buy expensive clothes for work o Deduction for employees b/c engaged in trade or business o She was not allowed deduction b/c court held she fell within 262personal type of expense  Was clothing for employment: yes  Is it street wear? Is it worn that way? Yesjust b/c P didnt wearb/c not her styledoesnt mean it isnt street gear= personal (general usage and adaptable as ordinary clothing) y OPPOSITE EXAMPLE: Tuxedo not (general usage and adaptable as ordinary clothing) y Listed Property: Mixed use property o Rule: TPS deductions under 168 (ACRS) subject to severe limits if listed under 280F o Analysis:  Policy: congress wanted to curtail the TPs use of the capital formation tax expenditures to subsidize personal consumption y Particularly for automobiles = 280F(a)  280F(d)(4) Listed property y Any passenger automobile & Property used as a means of transportation, y Property used for purposes of entertainment, recreation, or amusement, y Any computer or peripheral equipment (as defined in section 168(i)(2)(B)), and y Property of a type specified by the Secretary by regulations.  Threshold: y Must be predominately used in qualified business 280F(b) [business use exceeding 50%] to qualify for ACRS o If not:  Must use straight-line method/deprec.  cannot expense per 179

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If used by employee: 280F(d) o Considered T/B o Only if use for convenience of employer o Required as a condition of employment Caldwallader v. Commistioner, T.Ct: (But see fed ct. decision in 1990) y Employer did not explicitly require purchase of computer y But: o Work for employer substantially furthered by P.C. o Employer spared expense o Employer lacked funds to purchase P.C. o Employer req. satisfied y Carrying On (including moving expenses) o Rule: a TP is allowed a deduction for expenses incurred to start a business or trade o Analysis:  Seeking/moving for employment: y People employed in specific field, y Seeking job in same field 162(a)(2) CLASS EXAMPLE/pg. 386 CB: CPA incurring expenses to become Corp treasurerarguable same field (accounting financial field) y But if current employee: o Cannot take 62 ATL deduction o Subject to 67 2% floor o If independent contractor 62 y MOVING EXPENSES 217 ATL deduction for: o (a) Moving expenses in connection with the commencement of work o Distance requirement if no job yet (c)(1)(D): must be at least 50 miles from residence o Distance requirement where already have a job (c)(1)(A): no deduction unless: new principal place of worker is at least 50 miles further from old principle residence o Timing requirement: (c)(2): must have worked at job for approximately  (a): 39 weeks- 9 months  (b): 2 yrs?  Dont need to work with same original employer- just work full time in the general area  Purpose: the timing requirement is aimed at people who take short temporary job, just to take a moving deduction o Where the employer reimburses for moving expenses: 82: general rule, must include in GI  BUT: 132(a)(6) & (g) allow qualified moving expenses to be excluded fro GI where reimbursements by the employer, which would be deductible under 217 if paid by TP (for moving to commence work) o See also: 1.212-1(f) [212 disallows commuter expenses]  Starting a business/trade [differentiated] 195: Frank v. Commissioner: T.Ct. held that TP not allowed to deduct for expenses incurred in searching to acquire a new business (newspaper business) y TP found job in field searching to acquire business but y Expense not allowed because has nothing to do with employment at current job y Congress response= 195 o TP must capitalize startup expenditure unless: o Make election to deduction (b)  TP allowed a deduction for taxable year in which the active trade or business begins in an amount equal to the lesser of  Amount of start-up expenditures with respect to the active trade or business, or  $5,000, reduced (but not below zero) by the amount by which such start-up expenditures exceed $50,000, and  Remainder of such start-up expenditures shall be allowed as a deduction ratably over y

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the 180-month period beginning with the month in which the active trade or business begins.  (2) Dispositions before close of amortization period y Educational Expenses o Rule: a TP may take a deduction for expenses made to: 162(a); 1.162-5  Maintains or improves skills required by the individual in his employment or other trade or business,  Meets the express requirements of the individual's employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation o Analysis:  Minimum education requirements nondeductible 1.162-5(b)(2) (see also 1.212-1: taking special courses or training & 1.262-1 education not deductible)  Educational program which qualified TP for new trade/business nondeductible 1.162-5(b)(3) Allemeier v. Commissioner: Does education qualify TP for significantly different tasks? y Takes MBA courses as a salesman, court held that MBA did not qualify him for significantly different activities for a different job, as he already was performing what was taught in MBA program y Cases against J.D.s CLASS EXAMPLE/DISCUSSION: y If accountant and get LLM in taxation, that does not necessarily qualify for new trade or business  Should be currently engaged in the business (going straight into another education program would not qualify for adduction)  Change of duties does not qualify for new trade or business

INTEREST DEDUCTIONS ( and income)

Issue/Scope: whether the TP: y May deduct, y Must capitalize or, y Is disallowed deduction o For interest payments interst income/deduction analysis significance in bigger picture --are these deductions ATL? SUBJ the 67 misc floor? (if T/B= ATL unless employee) (if not attributable to T/B then not ATL--then itemized subj to 67(b)--not misc) Rule: y y

CURRENT DEDUCTION is generally allowed for interest on indebtedness HOWEVER payments for INTEREST ON PURCHASES must generally be capitalized  EXCEPT in the case of qualified residence interest 1. Code: 163(a): current deduction allowed for interest on indebtedness y For instance, Code: 163(b) If payments are characterized as an installment purchase of the business property, the purchaser of the property, may currently deduct the portion of the installment payments that represents interest y Code: 163(d): may currently deduct interest from debt incurred for investments (with some limits) y Code: 163(h)(2): may currently deduct acquisition and qualified residence interest [with limitations] home mortgage interest deduction 163:163h3B: acquisition indebtedness.

Crane case: have to include outstanding amount of principle on that loan as amount realized
y Code: 221(a): current deduction allowed for interest on student loans 1. Code: 461(g)(1) Points must be capitalized and deducted over the term of the loan 2. However, 461(g)(2) provides an exception for points paid to purchase or improve a principal residence, a. Code: 163(h): personal interest may not generally be deducted b. Policy: The tax treatment of interest paid by a TP varies according to the purpose of the borrowing, for instance if they are making a capital expenditure. 163 generally Analysis:

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1. 163: interest incurred to purchase a. Tax-exempt bonds b. Passive activity (renting property) c. Life insurance/annuity d. 163 (d) Investment income i. Deduction allowed shall not exceed net investment income 1. Net income: GI Expenses [rent not included]) ii. Interest in excess of limit is carried forward and treated as investment interest in next year iii. Does not apply to corporations sub.j to 11 e. Constructing real property f. Personal interest (other than qualified residence interest) 2. 163(h)(2): home mortgage interest: Code is saying it is not personal interest a. Acquisition or home equity indebtedness for qualified residence i. Allowed 2 ii. Acquisition indebtedness: acquiring, constructing, improving and secured by residence (i.e. lender can take home as security) 1. 1 million $ limit on indebtedness iii. Home equity indebtedness 1. Any indebtedness other than acquisition indebtedness secured by home 2. Doesnt matter what you use it for 3. Acquisition indebtedness means what amount you currently owe on the home****** b. Qualified residence: i. Principal residence and one other residence of TP ii. Rental property by TP (to others), if TP uses for more than 14 days or 10 percent of the days it is rented (not mentioned) c. QPR Interest: for debt incurred in: i. Below the line (b/c not in 62) 1. Then if misc. 67 a. b1: not miscellaneousdont have to worry about 2% floor ii. Acquiring 1. Debt cannot exceed $1 million (3)(B)(ii) & (Pau v. Commr: must make a showing if indebtedness other that acquisition 2. Acquisition indebtedness cannot exceed the FMV of the qualified residence iii. Constructing, iv. Substantially improving that residence; v. Or refinancing qualified acquisition indebtedness (only for amount refinanced); vi. Or Home equity indebtedness: any indebtedness other that acquisition indebtedness by qualified residence 1. HEI cannot exceed $100,000 (50k is spouse file separately) d. Home mortgage insurance premiums: i. Treated as home mortgage interest (phase-out 2011) e. Policy: TPs with 61(a)(12) discharge of indebtedness income do not usually qualify for 108 bankruptcy/insolvency. Deduction encourages home ownership. But also undermines repeal of other personal interestTP can deduct interest on loans secured by residence for purposes unrelated to home ownership 3. 221 student loan interest: a. Qualified education loan for (books, tuition, fees, supplies, and equipment required for attendance) b. Above the line- even if dont itemize deductions 62(a)(17) c. Max amount of $ 2,500 d. Not available if claimed as a dependent 4. 461 Points definition, exceptions a. 461(g)(1) Points Definition: i. Amounts a lender requires a borrower to pay ii. On the closing of a loan iii. In lieu of charging a higher interest rate b. 461(g)(2) exception tests:

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i. Payment of points is an established business practice in the area in which the indebtedness occurred ii. Points paid do not exceed the amount generally charged in the area iii. if so= current deduction

INCOME FROM DEALINGS IN PROPERTY

Analysis of property transaction:

DEALING IN PROPERTY: realization event amount of gain/loss realized 1001(a)- adjusted basis recognition 1001(c): generally yes--with exceptions (1031/121) 121 selling houses- waiting period 1.121-3 providing details for 121(c): health reas or change in location because of job--see also unforseen circumstance--like having more than one baby 1.121-4(g) election to have section not apply if loss recognized--allowable? 165 165(c) & (c)(2) only losses allowed is for i/t/b/entered into for trade or profit (c)(3) personal only is casualty loss (f): capital loss-- property was a capital asset (169/1211? everything is a capital asset unless...) 1211: allowed to deduct loss to extent of sum total of two items--something about a limit of $3k 62(a)(3)--claimes as ABL deduction character of gain or loss capital gains and losses: understand long-term capital gain gain from prop included in gi taking deductions--TI pull out long term capital gains-rest of TI goes into 1

Realization/Taxable event
y Was there a transaction involving property? o if no: end of process o if yes: look at gain or loss [next] o RULE: A compensation for services with property is a realization event:  International Freighting Corp. V. Commissioner: when an employer gave employees stock, with a fair market value greater than his basis, to employees as compensation, there is a realization event y likely because the employee was separating the property from himself and using the gain/value of the property to pay someone else/settle obligation 4.02/3Eisner V. Macomber y Held: what was taxed with the fair market value paid for the services of the employees (regardless of the fact that 1001(b): amount realized says FMV is value property [received]) ( because this is property for services, and is being given back to the employer for disposing of the stock) y disposition for a valid consideration o RULE : The act of the property becoming worthless is the realization event

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Louisiana land and exploration V. Commissioner: TP must consider the whole unit of the property interest during a realization event (context of trying to take a loss) y Taxpayer contended that drilling of hole to access minerals was the realization event for which he tried to claim a deduction on the loss y note: property does not need to be is double completely destroyed to be a transaction/realization event 1.1651(b) y Must establish absolute worthlessness of the property, cannot divide fee interest in the property in determining the interest 165: if stock becomes worthlessness it will be treated as a loss from a sale/exchange 1001: computation of gain or loss 6511(d)(1): 7 years to files a claim for refund in overpaying the taxes because did not files a deduction for the worthlessness of securities

Realized gain or loss 1001(a)

Basis of property acquired by purchase/taxable exchange
y y y y Allocation of basis issue: basis must be allocated between portions sold/retained in proportion to relative value of portions at time property is purchased 1.616(a); Inaja (CB 528) Requirement of brokers to report customers adjusted bass for stock sold. CB Update pg. 19 Analysis turns on what constitutes amount realized and adjusted basis Gain/ loss: Amount realized 1001(b) [what is received at sale] - adjusted basis [cost of property] 1011(b) o Amount realized = cash received + value of property received by taxpayer 1001(b) o Adjusted basis: of property is generally the cost of the property, adjusted further for things like depreciation/capital exenditures (amortization, exhaustion, wear and tear), [capital expenditures, or casualty losses]. 1011, 1012, 1016 If loss, is deduction allowed? o If not: end of process Crane (1947): (not cited) Amount realized by seller of mortgaged property included both the cash received from the buyer and the face amount of the mortgage to which the property was subject at time of sale. Seller had received benefit by relief of mortgage indebtedness. If property is resold for original purchase price, no gain/loss, but seller is able to depreciate property o Non-recourse debt (loans for which the borrower is not personally liable, e.g., commercial RE investments) o Sale or other dispositions of property that secures a recourse liability- may be discharged in the other person agrees to make the payments on the outstanding loan  1.1001-2(a): discharge of liability  See pg. 1722 stat volume o Parker v. Delaney (1950): include borrowed money in basis. When a mortgage is used to finance the purchase of property, that mortgage goes into the basis of the property. Then on subsequent foreclosure on the property by the lender, which is treated as a sale, the mortgage goes into the amount realized. Thus the gain is calculated by the amount realized minus the basis (which will be reduced by any depreciation taken)  Mortgage balance of sold property represented an amount realized in accordance w/ Crane. Gain is amount realized by seller acc/to Crane less adjusted basis (original cost less depreciation)  Thus, even though no cash is involved, sellers gain reflects his depreciation deductions  Advantageous to TP b/c they can defer taxes on gains until sale while deducting depreciation y Can therefore create tax shelters o Tufts (1983): T borrowed $1.85M to construct apt. building w/ no cash investment and non-recourse debt; took depreciation of $450K (basis thus $1.4M); property depreciated; sold property for nothing other than assumption of mortgage; Ts argued they realized $1.4M and no gain should be recognized. T must recognize gain of $450K b/c they realized full unpaid balance of mortgage debt. FMV is irrelevant to determine amount realized but highly relevant to determine cost. Gain or loss recognized unless non-recognition/deferral provision. o Recognized loss deductible to the extent it is allowable per 165(a)

Transactions involving mortgaged property (Basis and amount realized)

Recognition by code
y

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Noncorporate taxpayers restricted to losses incurred in trade/business; and transaction for profit; casualty losses for personal use property 165(c) Non-recognition:  Tax-free exchanges y Like-kind exchanges 1031 EE 130 o Generally not permitted to recognize loss o Nonrecognition in the business or investment property is exchanged solely for property of like kindsee regulations as wellthe nature of property o for T/B/Inot for personal use  other property must be for T/B/I  must be of like kind o Caveats:  solely for is not strictsee where exchanges of cash/boot  non-real estate property generally excluded y Other exchange-type non-recognition rules o 351: shareholder recognizes no gain or loss from transfer of assets to a controlled Corporation in exchange for Corporation stock o 721: recognize no gain or loss from transfer of property to a partnership in exchange for interest in partnership  Tax-free rollovers y Sale of principal residence 121: (check stat volume and limitations) o Taxpayer can exclude $500,000 from gross income o Of gain on the sale of o Taxpayers principal residence o See limtation calculation o test  Must have owned property and used it as principal place of residence  For least 2/5 years  Ending on the date of sale  Generally can only use exclusion for one sale in any two-year periodexcluding real estate owners  Allowance of losses 165 y If loss is not allowed by 165 analysis done o Losses incurred in a trade or business or into a transaction entered into for-profitand certain casualty losses o Does not allow capital losses y If loss is allowed by 165 then determine if barred by 267 o 267 disallows deductions for losses on sale or exchange of property to a related person o a loss disallowed to transfer cannot be deducted by transfer or when the transferee sells the property to an unrelated party o purpose: disallow deductions for ostensible losses resulting from sale of property to related parties at a bargain price y then determine if barred by 1211 

Characterization as capital (or ordinary) gain/loss

   CB 637-44 (CB 638- Definition; 642, 644) favorable treatment for capital gain unfavorable treatment for capital loss y recognized gains must usually be characterized in the year recognized y 1222: capital gain/loss = gain/loss from sale or exchange of capital assets y 1221 capital asset = property other than that excluded by 1221a1-8 (securities, unimproved land for investment, personal residence) y long-term versus short-term y 1231 assets held for more than one yearproperty used in trade or business y 61a3: capital gains must be fully included in gross income y Im recaptured again 1250 y Casebook 642 steps

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Taxable year gain or loss will be reported

TAXATION: WHO IS THE TAXPAYER

Generally:
   Code almost silent in choosing the person to be taxed As a result of income-producing event Law addressing attempts to shift income to avoid tax liability

Personal service income

Issue/scope: who is taxed on income earned? Rule:
 Income from services is taxed to the party who performed the services, and contractual assignments cannot therefore interfere with tax liability; Lucas v. Earl o BUT forced assignment by state community laws may vest a portion of earnings in the community (husband and wife) instead of the earner Poe v. Seaborn  Now Married TPs may file jointlyRevenue act 1948 (eliminated difference b/t community

property and common-law states) Analysis:  R-B-A: Lucas v. Earl, 281 U.S. 111 (1930),
  Man who reported only half of his earnings for years 1920 and 1921. Attempted to avoid tax by assigning half of his income to his wife as joint tenants with rights of survivorship Opinion income from services is taxed to the party who performed the services. (substance of the transaction, rather than the form, is controlling for tax purposes.) Tax cannot not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. [Assignment of interest doctrine]

Poe v. Seaborn, 282 U.S. 101 (1930), y Seaborn lived in Washington, which was a "community property" State. y Seaborn worked and his wife didn't. Seaborn filed separate tax returns for both himself and his wife, each reporting y y
one-half of the income he earned. The IRS disagreed assessed a deficiency. Opinion o Evidence showed Seaborn's wife had a vested one-half interest in Seaborn's income.  Washington Law: community can no more be said to be that of the husband than it could rightly be termed that of the wife."  Seaborn never had complete title to the income. The moment it was acquired, it was owned by the community. o The Court distinguished Seaborn's case from Lucas v. Earl (281 U.S. 111 (1930)). The Court felt Seaborn was different because he didn't sign a contract, he was just following the property laws of his State and didn't have a choice over whether or not to give half his income to his wife. After this case, Congress changed the tax code to allow married couples to file jointly, thereby removing the tax consequence differences between those who lived in community property States and those who lived in common-law States. Code: 73 Services of a child o Amounts received in respect of the services of a child shall be included in his gross income and not in the gross income of the parent, even though such amounts are not received by the child. o All expenditures by the parent or the child attributable to amounts which are includible in the gross income of the child (and not of the parent) o parent includes an individual who is entitled to the services of a child by reason of having parental rights and duties in respect of the child.

y


Marriage and income tax

Issue: STRUCTURING MARRIAGE TO AVOID TAX
Rule:
Analysis: CB 471/441EE 420 y Marriage penalty & marriage bonus y if marriage/divorce arranged to avoid tax, the courts may rule TPs married or divorced for income tax purposes o state law implications o CB 441 Boyter v. Commissioner  But see Rev.Rul 76-255: right to plan finances in such a way that TP will pay east amount of tax CB 442 y But see: Transactions with(out) economic substancesee CB update pg. 15: 7701: structuring finances and motive to avoid tax

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1: tax tables | 2: definitions of marriage/divorce/survivorship | 63: tax implications of married couples who take deductions, status determined by 7703| 6013: Joint returns for married couples rules and limtis | 6015: limiting damage where spouse makes understatement about tax liability | 7703: marriage status determined at end of year see also divorce and married couples living apart

Income from property

Issue: y Who pays the tax on income from property? y Income shifting Rule: TP must include income from property in his incomeeven where gifted to another 102(b); Helvering v. Horst y (Generally, tax liability for income attaches to the owner of the property. However, disposing of income already vested is the equivalent of ownershiptherefore, tax liability will attach to a (the) donor) Analysis:
y R-B-A: o Blair v. Commissioner: where TP validly assigned ownership interest in a trust to his children, the Supreme Court held that the tax liability followed the assignment o Helvering v. Horst: where TP gifted bond coupons to his son, the Supreme Court held that the tax liability remained with the father because:  He retained the bond (he retained the bond/tree which produced the interest/fruit)  The power to dispose of income is the equivalent of ownership  Paul Horst enjoyed the economic benefits of the income

y Even if he gave it to his son Code: 102(b)(2):  TP must include in income  Income from property  Where transferred as a
  devise, or Donee not taxed 1.102(e) Codified Helvering v. Horst

y y

gift, bequest,

Property or Services (review)

Right to collect future payments for services already performed is property which may be assignedHelvering v. Eubank (following Horst) y Royalites CB 491 Moore v. Commissioner Taxation of incomre of minor children (review) Issue: tax treatment of parents who try to shelter income in children y
y y 63(g): limits standard deduction OR dependent TP to greater of 500 or earned income + 250 1(g): o Applies to  Children under 18  Under 19  Student under 24 o Doesnt apply if earned income exceed child support for yr o Earned income: from performance of personal services/ self-employer  Taxed at child rate o Unearned income: investment  Taxed at parents rate 151(d)(2): (d) Exemption amount.-- 2) Exemption amount disallowed in case of certain dependents allowable to another taxpayer for a taxable year beginning in the calendar year in which the individual's taxable year begins, the exemption amount applicable to such individual for such individual's taxable year shall be zero.

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