Front Loading Solutions

Formula:
a) First recapture
Y
2
Y
3
15,000 = 1
st
recapture

b) Second recapture

Problem 1:
a) 45,000 30,000 15,000 = 0
b) 60,000 (75,000/2) 15,000 = 7,500

Total recapture = 0 + 7,500 = $7,500
Front Loading Solutions Cont.
Problem 2:
a) 0 0 15,000 = (15,000) (No first recapture)
b) 100,000 0 15,000 = 85,000

Total recapture = 0 + 85,000 = $85,000
Problem 3:
a) 60,000 40,000 15,000 = 5,000
b) 80,000 ([60,000 + 40,000 5000]/2)-15,000 =
17,500
Total recapture = 5,000 + 17,500 = $22,500
Property Settlements
Current Law: Transfers during marriage, upon divorce,
or within one year thereof are considered
tax free gifts. (No income to the husband
and wife gets carryover basis.)
Child Support
Old law if you want something to be child support it
MUST be specified as such
Current law any payment upon a happening related to
a child (birthday, graduation, etc.) is child
support.
Example: H owes W $8,000 (5,000 alimony and 3,000
child support). H pays W $4,000. What are
the tax consequences?
Answer: $3,000 treated as child support and $1,000
treated as alimony.
Delinquent payments are first allocated to child support.
Gifts
What is a gift?
Transfer of property without consideration.
What is consideration?
Value or the expectation of something in return.
Gifts are fully excludable from Gross Income.
Note: It must truly be a gift. There is a rebuttable
presumption that payments made by an employer to an
employee are compensation.
Note: There is also a rebuttable presumption that
transfers between a parent and child are gifts.

Bequests and Inheritances
Example: Great Uncle dies and leaves you $100,000 in
his will.
Inheritances are FULLY EXCLUDABLE from GI.
Note: Gifts and inheritances are tax-free, but income
earned on property received as a gift or
inheritance is fully taxable.
Life Insurance
There are two types of life insurance: term insurance
and whole-life.
Example: Your great uncle dies and names you as the
beneficiary of his $100,000 insurance policy.
Life insurance proceeds paid by reason of death are fully
excludable.
Example: TP cashes in $100,000 policy (paid 30,000 in
premiums) and receives $65,000 cash
surrender value.
Tax Consequences: $35,000 is included in gross
income. $30,000 is excluded as cost recovery.
Life Insurance Problems
1. TP buys policy from friend for $30,000. He dies 5
years later and TP receives $100,000 death benefit.
What are the tax consequences.
2. Husband dies. Wife is the beneficiary on a $100,000
policy. Wife elects to take $13,000 per year for 10 years.
What are the tax consequences.
Annuities
An individual can purchase an annuity to pay a fixed
amount for the remainder of their life.

We will only deal with single life annuities, NOT joint and
survivor annuities.
Example: Individual invests $10,000 in an annuity to
pay $1,000/year starting at age 65. What are the tax
consequences when the individual is age 65 and collects
their first $1,000 payment?
Annuities
Investment in Contract
Expected Return
X
Annual
Amount
Received
=
Amount
Excluded
10,000
20 x 1,000
X 1,000 = $500 excluded
Note: This is cost recovery. If individual lives beyond 20
years. There is NO EXCLUSION from that point
on. (Cost has fully been recovered)
Note: If individual dies before recouping full cost on final
return, deduction is available for unrecouped cost
Employer/Employee Annuities
(Pensions)
Non-Contributory: No cost to be recovered; therefore
fully taxable
Contributory: Use annuity exclusion ratio, but include
only employees cost in the numerator
Damages
Compensatory
Lost wages are taxable. The wages would have been
taxed, therefore any substitute for taxable income
is taxed.
Personal injury are tax free. Brings individual back to
position prior to injury.
Punitive
ALL punitive damages are fully taxable, unless state
wrongful death statute applies.
Prizes, Awards and Scholarships
Prizes and awards
-Prizes and awards are generally taxable
-Exceptions: certain awards to employees not to exceed
$400 per award, maximum of $1,600/year
Scholarships
-Generally tuition, fees, and books are tax free.
-Generally room and board are taxable.
Note: Recipient must be a candidate for a degree
(undergraduate or graduate). Research grants to non-
degree individuals are fully taxed.
Meals & Lodging
Example: Intern is hired to work in hospital and be on
call 24 hours. He is offered the following:
a) Eat all meals in employee/doctor cafeteria cost free.
(During the year intern eats in the cafeteria-value of
meals is $8,000. NOTE: Employee doesnt have to
eat there.)
b) Live in dormitory room in hospital-cost free. Intern
does not have to live there, but must live within 4
miles of hospital. (During the year the intern lives in
the dorm-FMV $5,000)

c) What is included in employees gross income?
Meals and Lodging
Meals are tax free if:
1. Meals are provided for the convenience of the
employer; and
2. They are provided on the premises of the employer
Note: Meal money and groceries are taxable.
Must be meals!!!
Lodging is tax free if:
1. it is provided for the convenience of the employer;
and
2. It is provided on the premises of the employer; and
3. It must be a condition of employment.
Imputed Interest
The doctrine of the fruit and tree prevents income
shifting. Where the parent doesnt want to give away the
tree there used to be an alternative to shift income: an
interest free loan.
P C
Invests money
earns income
Lends $100,000 w/o interest
Demand loan;
retains ownership
of $100,000.
Imputed Interest
Government enacted the imputed interest rules to
overcome this. Where there is a loan between two
parties and there is no interest charged (or interest
charged below market rates) the government imputes
income to the lender.

Monthly the government establishes an Applicable
Federal Rate (AFR) as the market rate.

Reconsider the previous example assuming a 6% AFR.
P C
Lends $100,000 w/o interest
Deemed payment $6,000
Step 1:
$6,000
interest
income
Step 1:
$6,000
interest
deduction
Deemed gift of $6,000
Step 2:
No
deduction
Step 2:
No income
Imputed Interest
Employer/Employee Interest Free Loans
-Step 2 amount is considered to be compensation.
Corporation/Shareholder Interest-Free Loans
-Step 2 amount is considered to be a dividend.
Interest charged below AFR
-Difference is imputed interest
Additional Considerations:
Imputed Interest Exception
Where loan between Parent and Child does not exceed
$100,000 impute the lesser of normal imputed interest
OR unearned income of the child.
P C
Lends $100,000 w/o interest
Example:
Child has unearned income of $3,500.
What is the amount of imputed interest?
What if the child has unearned income of $10,500?.
Employee Fringe Benefits
Accident and Health:
- Employee can exclude the value of accident and
health plans provided by the employer. In addition,
medical reimbursements are also excluded whether
employer or employee pays for the plan.
No additional-cost services:
- Excluded from gross income. Example: airline
employee flies free on availability basis
Qualified employee discounts:
- Excluded from gross income. Example: 10%
discount if you work for Macys
Employee Fringe Benefits
Working condition fringes:
- Excluded from gross income. Examples: professional
dues paid by employer; auto given to auto salesman
De Minimis Rule:
- If too small to account for excluded from gross
income. Example: secretary types personal letter for
employee
Foreign Earned Income
If an individual earns income abroad it is subject to
tax of BOTH the U.S. and the foreign country in
which it is earned. (Double Tax)
To alleviate a portion of this double-tax the
government allows individuals to exclude up to
$80,000 annually for Foreign Earned Income. (Does
NOT apply to to Unearned income.)
Foreign Earned Income
To be eligible for the exclusion the individual must
EITHER be:
b) Meet the physical presence test (must be in the
foreign country at least 330 days during ANY
consecutive 12 months).
If you are in the foreign country for less than the entire
year, the exclusion must be prorated on a DAILY BASIS.
a) A bona-fide resident of that foreign country.
or
Foreign Earned Income
Example: Individual moved to Japan 11/1/11 and stayed
until 10/31/12. What is excluded in 2011 and 2012?


Forgiveness of Debt
You owe me $10,000 and I tell you to forget it. Your
wealth has been increased by $10,000.

Remember basic accounting formula:
Assets Liabilities = Capital (Net Worth)

If the liabilities decrease, your capital (net worth)
increases. Therefore the governments general rule is:
to the extent that there is forgiveness of debt the debtor
must include the forgiveness in gross income.
Forgiveness of Debt
EXCEPTIONS:
1) Gifts parent forgives loan to a child (Remember the
presumption that transfers between related parties are
gifts) caveat employer/employee forgiveness
2) Bankruptcy federal bankruptcy statute allows debtor
fresh start by relieving debtor of most debts. If this
was to result in taxable income, how could debtor pay
the tax?
3) Insolvency individual is insolvent if liabilities are
greater than assets at fair market value
Forgiveness of Debt - Insolvency
Example:
Individual has assets of $50,000 and liabilities of
$100,000. If creditors get together they could force an
individual into bankruptcy, but the expenses (trustees
fees, attorneys fee, accounting fees, etc.) could eat up
most of the assets. Therefore, the creditors agree to
release $40,000 of their debt. Does the individual have
$40,000 of income?
Forgiveness of Debt - Insolvency
Example:
Same facts as previous example. What if the creditors
agree to forgive $60,000 of debt so that:
Forgiveness 60,000
Assets 50,000
Liabilities 40,000
Does the individual have $60,000 of income?