General



General -

Four goals of tax policy:

get money to support the government

fairness

horizontal - those similarly situated get treated alike

vertical - TPs on a scale and allocation of burden up and down scale is fair.

1913 modern tax code born

CHARACTERISTICS OF INCOME

• Accession to wealth, compensation definitely

• Treasury Regs. 1.61 - includes compensation, trust distributions, childcare compensation, prizes and awards

o Excludes gifts, compensatory damages, accident and health plan money, scholarships and fellowship grants.

• Economic Benefit Doctrine - so long as fully vested and safe from creditors, it is income.

• Basis - amount TP has invested, measured in already taxed dollars

• Time value of money: present value = future value divded by (1+r)^t, r= rate of return, t=time.

• Note Tax Court where you don't have to pay first, vs. U.S. District Court, vs. U.S. court of claims for where to file tax grievance.

EMPLOYER PROVIDED FOOD AND LODGING

119 - codified Benaglia

119(a)(1) - excluded if

Furnished by or on behalf of employer to employee, spouse, or dependants.

Re-imbursements don't count under Kowalski. Must be in kind, so no cash.

Provided for the convenience of the employer

Can be for substantial noncompensatory reason test

Courts also look at if you are on call during meals, or 24 hours.

Question of fact

If employee may or may not take then it is not excludable.

Provided on the business premises of the employer.

Note the state trooper and split in circuits if whole state is premises

Lodging excluded if.

Above three, and

Employee is required to accept lodging as a condition of her employment (in K?)

Regulation 1.119-1 - for convenience of employer requirement, can ask was there a "substantial noncompensatory reason" for the meals or lodging.

May include if on call there, short meal break, no eating places in the area, or lack of time during so eat right after.

Extras - groceries from employer's comissary count, meal allowance not excludable.

119 does not cover self-employed

FREQUENT FLYER CREDITS

IRS ignores, no deficiency asserted if you take.

FRINGE BENEFITS

• Presumptively income, unless 132 excludes.

• Employee of airline can fly on the airline on standby for free so long as there is no substantial additional cost to the employer. This includes parents and family members. §132

• 132m - can exclude qualifed retirement planning services.

• Note non-discrimination rules.

• Employee discounts cannot exceed the gross profit percentage for employer. For services maximum discount is 20% regardless of the markup.

o The excess over gross profit percentage must be included in income.

• De minimis fringe - so small to make accounting for it unreasonable or impractical.

o Must be occasional

• Meals for working late excludable if

o Provided occasionally

o Provided when the employee works overtime, and

o Provided so employee can work overtime.

• Note constructive receipt does not apply where you use qualified transportation fronge.

o Travel benefits are 100/mnth limit for mass transit and 175/mnth for parking.

• 132f - exclusion applies even if discriminatory.

• Club/gym memberships not excludable.

• For gyms excludable so long as substantially all of the patrons are employees, their spouses, and their depedent children, on site location, and operated by employer.

• Reciprocal agreements only counts where no additional cost.

• §162 may apply too, and if ordinary and necessary cost of doing business.

• Working condition fringe - exclusion allowed if person having spent the money would have been entitled to deduct it.

• Life insurance §79 - excludable up to 50k per year.

• Health insurance §106 - excludeable, no cap

• §129 - dependent care assistance up to 5k/year per family.

• Cafeteria plans §125 - exception to constructive receipt, use it or lose it applies, unreimbursed medical now includes over the counter drugs, sometimes you can only change during qualifying event.

WINDFALLS

• Includes damages

o Compensatory not included in income

o Punitive included in income

• Generally if damages replace something taxable then they are under replacement rule.

GIFTS

• §274 - Recipient does not have to claim income, but donor does not deduct.

• A gift must proceed from "detached and disinterested generosity" under Duberstein.

• If a gift is a factual determination.

• You can only deduct up to $25 for business related gifts.

• §102 - employer-employee gifts are never really gifts, so included like compensation.

• Tips and gratuities - income

• Welfare, medicaid, food stamps, disaster relief, and social security are not income

• §85 - unemployment compensation - like compensatory, not income.

• Social security - 32k or less not included , 32-49k gradual phase in for inclusion, over 44k - 85% of amoutn received included in income.

GIFT TRANSFER WITH UNREALIZED GAIN OR LOSS

• Initial gift - donor cannot deduct, recipient does not include.

• Statutory framework

o 1001 - gain is amount realized minus adjusted basis, loss is adjusted basis minus amount realized, amount realized is FMV of all stuff received in transaction. Gain is income, loss is deduction.

o 1011 - adjusting rules start

o 1012 - starting point for adjusting basis is cost of property

o 1015 - gifts - donee gets carryover basis, unless basis for a loss.

| |gain |loss |

|FMV > donor's basis |carryover basis |carryover basis |

|FMV < donor's basis |carryover basis |FMV at time of gift. |

• The loss exception - says where you will be selling for a loss you must take the FMV at the time of the gift.

• Note in between weird spot, where you calculate for gain and it is a loss, but when you calculate for loss, then you get a positive. This is where the amount realized lies between loss basis and gain basis.

• 1014 - transfers at death - FMV at decedent's death is new basis, so step up or down.

• Exchange of property for services is a recognition event.

GIFTS OF DIVIDED INTERESTS IN PROPERTY

• Donee of the underlying property gets entire basis, donee of interest income gets 0.

• For other divisions, note who has underlying property and to what extent.

• This also applies where donor keeps part of interest.

• 102b

CAPITAL GAINS

Inventory is not a capital asset, neither is income or compensation.

Basically gain or loss on the disposition of property.

Property must have income expected beyond the current tax year to be a long-term capital gain property.

Note if someone has then sells within one year it is short term capital gain property.

You can carryover capital losses indefinitely.

Note capital loss can only be offset against capital gain

RECOVERY OF BASIS/CAPITAL

• Basically allocate basis over property to decide if only part sold.

• Reg. 1.161-6 - how to apportion basis.

• Inaja still present law, but only applies in extreme cases.

ANNUITIES

• §72 - exclusion ratio - so calculate the total repayment value, and allow a pro rate recovery of basis, so you recover basis in equal amounts for each payment.

• So same interest amount and same basis adjustment each year until gone

• Life expectancy tables where for the rest of life of TP.

• If all money invested is recovered, then payment is all income. Also, if you die before all is recovered you can deduct what is left of basis.

• Where it is a loan, must include all interest in the year received.

GAMBLING GAINS AND LOSSES

• For gains all income, losses only deductible to the extent of gambling gains and no carryover.

RECOVERY OF LOSS

• §165 - losses as presumptively deductible.

• Old Colony - when someone pays taxes for another it is income.

• Look at replacement principle - if replaces something that is income, it must be included.

• Amending return requires a mistake at time of reporting, if a subsequent event renders return wrong then you deduct or include in year discovered.

RECOVERIES FOR BUSINESS AND PERSONAL INJURIES

• Two steps to keep in mind:

o §61 - general definition of income

o §104 - where recovery income, may be excludable in certain circumstances.

• 104 allows exclusion for recovery on account of personal physical injuries or physical sickness.

• Always look at triggering event - if physical injury then most of compensation will be excluded. Psychiatrist bills are medical bills and excluded.

• Can specifically exclude loss of consortium

• 105 a and b - can exclude health insurance plan recovery. Can exclude disability if nature of injury causes money recovery and not lost wages.

INCOME FROM DISCHARGE OF INDEBTEDNESS

• Loan proceeds are not income, and you get no deduction for repayment.

• Recourse (personally liabile) vs. non-recourse (property as security and is the only thing lender can go after).

• Difference between the debt value and the amount paid out is income from discharge of indebtedness.

• Use of money irrelevant, only look at loan value and repayment value.

• 108 - insolvency irrelevant

B ARGAIN SALES

• Where you sell something for below FMV, then 1001 sale.

• Cannot take loss deduction in these cases.

• Alternative approach - sale of portion at FMV, straight gift of remainder.

• 1011 - applies to apportioning adjusted basis.

• Set up ratio of sales price to FMV, then take that percent times the original basis, and then basis is amount she can recover.

• Then the rest after that basis is deducted ias a gain.

TRANSFER OF PROPERTY SUBJECT TO DEBT

• Think about depreciation, or deduction to account for decline in value of a wasting asset.

• Treat debt and cash the same for purposes of determining basis.

• Keep loan transaction and property transaction separate.

• When FMV of property is less than nonrecourse debt - majority says loan outstanding is the amount realized, same basis tooso amount invested minus depreciation deductions. (income is capital gain)

• Bifurcation - O'Connor under Tufts - property transaction gives you a loss, then debt transaction is a net gain. Income from discharge of indebtedness or regular income.

REALIZATION REQUIREMENT

• Note three steps to include gain from property in income

o Income - accession to wealth

o Realization

o Recognition

• §121 - principal residence sale as partial exception from recognition.

o Requirements are: owned for 2 years aggregate for last five years, used as principal residence for 2 years out of last five, and TP cannot have used 121 exclusion within the last two years.

o Exceptions: where sold and does not qualify under one, b/c of involuntary conversion, natural disaster, terrorism, death of TP, divorce or legal separation, or multiple births from same pregnancy

o For the exceptions, take the shortest of the three requirements and make the ration, and this gives you a percentage of otherwise allowed deduction which is allowed.

o Limit is 250k for person, 500k for couple.

• Stock split is not a realization event. §305

o Not the same if TP has choice between split and cash.

o Not the same if exchange of ordinary to preferred

• Doctrine of constructive receipt - where TP can choose between in kind and cash, then it is a realization.

• §109, §1019 - no adjustment to basis due to improvements.

• Cottage savings and section 1001- exchange of legally distinct entitlements fro realization events.

• §1031 - express nonrecognition provision for like kind exchanges.

• §551, 951 - foreign corporations as one different one.

EXPRESS NONRECOGNITION PROVISIONS

• 1033 - involuntary conversion, no required recognition if you reinvest in substantially similar within 2 years.

• Gain recognized is lesser of gain realized, or amount realized less the cost of the new property which is similar or related in use.

• New basis is cost of new property minus any unrecognized, but realized gain.

LIKE KIND EXCHANGES

• Section 1031

• Is there boot?

• Is it cash? Go to step 2.

• Is it property?

• Calculate the gain to the person transferring, then they recognize this no matter what.

• Ignore until end again. Go to step 2.

• Start with person receiving boot only, not giving.

• What is the Amount received on their like kind property total.

• Include FMV at transfer of any boot.

• Discharge of indebtedness? Mortgage? Treat as a cash boot.

• Calculate their gain received after taking out all basis.

• They must recognize the lesser of

• The gain realized, or

• The FMV of the boot.

• Any other boot in property received by person in step 2?

• Basis for that boot is the FMV at the time of the transfer

• New basis for person in step 2 for their like kind property is:

• Original basis in like kind property + gain recognized - FMV of boot received.

• Person transferring the boot

• What is the amount realized in the transfer - (what is entire value of what they are getting)?

• You must subtract any boot transferred, b/c not what they are getting.

o They must recognize the lesser of the gain realized - calculated in reference to entire basis (only basis in like kind transferred and any cash boot). And the FMV of boot which is 0.

• New basis in like kind property from number 5 is:

a. Old basis + FMV of boot transferred.

• Like kind property must be pretty much equivalent.

This applies per side and we look as long as one is using for a business purpose, or for investment.

Note TP specific in statute, so one person can qualify where other does not

If just like kind property for like kind property (no boot involved), then no one must recognize anything on the transfer, and you keep your original basis before the transfer.

Property excluded - property held for sale, or inventory, stock in trade, stock, bond, notes, other securities, evidence of indebted ness or interest, interests in partnerships, certificates of trust or beneficial interests, chose in action.

Note all real property counts

When property exchanged has debt attached you treat as cash boot

RECOGNITION OF LOSSES

• If asset long-lived you cannot deduct, but you have to capitalize

• Where asset will last beyond tax year.

CONSTRUCTIVE REALIZATIONS

• Where stock borrowed, then sold, then owe back so like diversifying.

• §1259 - constructive sale is treated as real sale.

USE OF HINDSIGHT

• Annual accounting principle, means divide by the year.

NET OPERATING LOSSES

• Fixes unfairness of the hindsight issues.

• Only applies to business losses.

• If you use §172 doing this, then you cannot take any personal exemptions.

• Only place where you can file the amended return w/o regular requirements.

• Note personal gains and nonbusiness losses offset each other only.

• Carryback two years, then forward twenty years.

• For carryback go to 2nd year back and deduct.

CLAIM OF RIGHT

• Income included when you have claim of right to it.

• Requirements

o TP receives money

o Treats the funds as its own, and

o Concedes no offsetting obligation.

o Secure from payor's creditors

• §1341 - says if TP must give back more than 3k, then TP can choose credit or deduction. One of the following allowed:

o Tax this year with a deduction, or

o Difference in tax liability b/c of error can be taken as a direct credit to this year's liability.

TAX BENEFIT DOCTRINE

• Inclusionary side of the rule - year you get recovery you must include amount of prior deduction.

• Exclusionary side of the rule - §111 - where previous deduction did not reduce TP's income, no need to include any in year of recovery. Note may not apply where carryover is a possibility.

ACCOUNTING METHODS

• Cash - when received included as income, liability occurs when liability paid.

• Accrual - income when all events occurr that fix the right to income and amount determined accurately.

• Businesses on accrual usually, people on cash.

CONSTRUCTIVE RECEIPT AND ECONOMIC BENEFIT

• Relevant to cash basis only

• When money available to TP, then it is received.

• Economic benefit applies as soon as the money is secure from the payor's creditors and fully vested.

QUALIFIED EMPLOYEE PLANS

• Four basic elements

o Contributions by employer - not taxed

o Contributions by employee - not taxed, 401k, 403b.

o Growth in account not taxed, regardless of realization events.

o All taxed when withdrawn, taxed as ordinary income.

• Retirement requires 59 1/2 years old, and under ERISA, nondiscrimination under §132.

• Other possible where for first time homebuying or college.

EMPLOYEE STOCK OPTIONS

• §422 - incentive stock options, no inclusion until sale, then capital gain inclusion.

o 2 year lapse from grant to sale required, as well as 1 year between exercise and sale.

o Exercise price must be greater than or equal to FMV of stock at time of grant.

o Limit on number of options . 100k cap on fmv of stock associated with options that are exercisable for first tiem in a given year.

o Over limit under §83.

• §83 - non-statutory options

o Ask if readily ascertainable FMV at grant.

▪ If no tax at exercise as ordinary income

▪ If yes, is it fully vested?

• If yes, makes income so tax at grant.

• If no, tp can elect

o Tax at grant as compensation and other gain is capital gain §83, no deduction later though if value lowers

o TP can include at time it becomes fully vested before exercise, or

o Taxed at exercise.

• Regulation 1.83-7 - ascertainable FMV means actively traded on established market, or if transferrable at grant, exerciseable immediately, not subject to any restrictiosn.

INCOME FROM SERVICES

• Income is attributable to person who earned except for:

• Marriage benefit and penalty, penalty happens b/c of 3 objectives

o Treat all married couples the same

o Progressive rate structure

o Neutral with respect to marriage.

INCOME FROM PROPERTY

• Back to divided interests, person who has underlying property pays tax on interest.

• Horizontal and vertical slices thing.

• §1g - limitation on family transfer, under 14 years taxed at parents' marginal rate for over 1500 parents file on return, if less than 1500 tax at 10%.

• Note example of if you give the underlying property and keep the income interest you must pay tax on the income interest.

TRANSFERS INCIDENT TO MARRIAGE

• §1041 - says transfers incident to divorce are not realization events, transfers of property between spouses or former, incident to divorce treated as gifts.

ALIMONY

• §71 - cash or cash equivalent, pursuant to divorce or separation instrument, no specific non-alimony treatment provision in agreement, not in same household, no payment after death of recipient, not child support or anything that looks like child support in substances.

• 71f - frontloading issues, look only at first three years, you can backload. Steps:

o Figure excess of year 2 = Y2-(15k+Y3), (then take total out of Y2 payment and have excess)

o Figure excess of year 1 = Y1 - (15k + average of [Y2*, Y3]), note Y2* is excess of Y2 from first step.

o On Y3 return payor must include total excess, and recipeitn entitled to deduct the same.

• Frontloading does not apply where recipient dies or remarriages, or fluctuates by %

• Life insurance may or may not qualify.

| |payor |recipient |

|property settlement 1041 |no tax consequences |no inclusion either |

|alimony (71, 215) |deduction under 215 |must be included in income |

|child support |no deduction |not included. |

CHILD SUPPORT

• General rule is no deduction for payor, no inclusion for recipient.

• Unpaid support is not deductible by recipient

CASUALTY LOSS DEDUCTIONS

• §165 - requirements

o Realization - closed and completed transaction

o Decline in FMV is measure of loss, but limit is lower of FMV or basis. TP's basis cannot be exceeded.

o $100 per casualty reduction taken like deductible. (applies once per event only).

o Deductible to extent it exceeds 10% of AGI

• Principles of casualty loss: must be sudden and unforeseeable.

• You have to take out insurance, which you must pursue so long as reasonable prospect of recovery, if you do not claim insurance, you still have to deduct.

• Gain here is capital gain, not loss.

EXTRAORDINARY MEDICAL EXPENSES

• §213 - not compensated for insurance or otherwise, for care of TP, spouse, or dependent, extent of loss exceeds 7.5% of AGI, similar to casualty.

CHARITABLE CONTRIBUTIONS

• Not 170c and 501c3

• If in cash - can take cash amount.

• If capital gain property - deduction for full FMV of property, but must be long-term capital gain property

• If short term capital gain property, limited to TP basis.

• Limits re: AGI - 50% AGI on total deductions regardless of type, 30% AGI limit on capital gain property.

• §68 phase down in itemized deduction over certain cap.

• Calculate 170, then 68.

• Not using property for use supposed, then can only deduct basis unless FMV < basis.

• Check for bargain sale above.

MIXED BUSINESS AND PERSONAL EXPENSES

TRAVEL AND ENTERTAINMENT

• §162, 212, §274

• §162 - if primary purpose is business then deductible.

• §264 - always checked, excludes good will expenditures and some substantian requriements.

o Overall flat limitation of 50% of otherwise allowable

o Business meals not lavish or extravagant

o Person from company present.

• When using §132 - 274 does not apply.

DEPENDENT CARE EXPENSES

• §21 and direct credit

o Calculate % as 35% minus 1% per 2k or fraction thereof over 15k, floor is 20k at 43k+ income.

o Then multiply this by employment related expenses.

▪ 1 kid = 3k

▪ 2 kids + =6k.

o Must be so employer can work outside home, cannot be more than lowest earner income.

• Need to also look at §129, for overall employment related expenses.

• If §129 exclusion for up to 5k in dependent care expenses cannot really use this.

COMMUTING AND MOVING EXPENSES

• §162a2 - ordinary and necessary travel expenses away from home

• No basic commuting deduction.

• Where temporary adn business location in both places deductible so long as for less than 1 year. If more or anticpated more than one year then the moment you know it is more than one year it is no longer deductible.

• Moving expenses - § 217 - distance requirement is 50 mi., needs to be certain length of time of employment.

• Above the line deductions.

CAPITAL EXPENDITURES

• §162 - ordinary and necessary business expense TP can recover cost unless modified under 263 or 264.

• All expenditures in the creation or acquisition of a long-lived asset (asset that will produce income beyond the tax year in question), indirect or direct.

• §162a - all ordinary and necessary expenses to be deducted, but

• §263a - which disallows immediate deduction for cpaital expenditures.

• UNICAP - rules of 263A codified these capitalization rules.

• Marketing and advertise is immediately deductible.

• Research and development hiring is deductible immediately under §174.

REPAIRS AND IMPROVEMENT

• Regulation 1.162-4 - if to keep in ordinary operation condition it is a repair and deductible.

• If it increases the value of the property then replacement and capital expendicture.

• §165c may apply to for personal losses as still included, but need closed and completed transaction.

• Cost to repair is measure of deduction.

DEPRECIATION

• Definition - depreciation is an allowance for the expected decline in value due to wear and tear or obsolescence of an asset used to generate income

• Only applies to wasting asset

• Must be asset used in trade or business, personal is not deductible udner 262.

• Recovery of bassis through this.

• Useful life - code might dictate specifically see 168 p. 160, on exam provided.

• Spread basis over useful life, need to look at:

o Applicable method - straight line is pro rate recover, declining balance see outline, likely not required.

o Applicable convention - mid-year for personal property, mid-month for real property. For this any time in month or year not the first or last use the midpoint.

• So divide into the needed units and multiply then get to take that each year, and must adjust basis.

• Even if you don't take you still must do deduction.

• Clock restarts for receiver when transferred, if gift though carryover basis.

• Recapture - if gain on sale of property that has been depreciated is as a result of depreciation outpacing actual value decline, then gain must be treated as ordinary income.

o Only applies to personal property usually, for real property acquired after 1986 recapture rules no longer apply.

• Note the time applies to when put in business use.

• You can only deduct up to the basis value.

• Land does not count for depreciation, but don't forget to add back in.

• When self-created under §197, no amortization.

OTHER MISCELLANEOUS DEDUCTIONS

• §166 - unrecoverable debt deductible as capital loss.

• Capital loss is up to capital gain plus 3k.

Capital Income

Houses - gain or loss

Stock sale gain or loss

Ordinary Income

Dividend payments

Interest income

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