ContentsExam:.......................................................................................................................................................................3

FEDERAL POWER TO TAX.................................................................................................................................3

INTERPRETATION & ADMINISTRATION OF FEDERAL TAX POWER......................................................4

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............................................................................................................15

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....................................................................................................................24

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

Profit-Making Activities..........................................................................................................................30

Motive (Connecting expense to activity).................................................................................................31

Listed Property: Mixed use property.......................................................................................................31

Carrying On (including moving expenses)..............................................................................................32

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..........................................................................................................................................37

Characterization as capital (or ordinary) gain/loss............................................................................................37

Taxable year gain or loss will be reported.........................................................................................................38

TAXATION: WHO IS THE TAXPAYER..............................................................................................................382

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: 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: State the issue.

Step Two: Identify the rule, but don't waste time stating all of rule. Unless Prof. states otherwise

Step Three:

Summarize elements of the rule that are easily satisfied by the facts.

Step Four:

State the sticking point on which this issue turns The ambiguity in the facts that makes it a difficult

question.

Step Five: Apply one or more of the four types of Analysis to the problem.

Reasoning by Analogy Balancing of Factors Test Judicial Tests Public Policy Argument

Step Six: Contrast conflicting authority.

Step Seven:

What are the defenses?

Step Eight:

Make a conclusion.

Step Nine:

Go to the next issue.

FEDERAL POWER TO TAXIssue / Scope: Whether the federal government has power to tax income

Rule: The federal government has the power to tax incomeo 16th amendment gives Congress to levy income tax without apportioning it among the states or

basing it on Census results—precluding: Art 1 § 2 & 9 and Pollock v. FLT co. 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.

3

INTERPRETATION & ADMINISTRATION OF FEDERAL TAX POWERREGULATIONSDeferenceIssue / Scope: Deference to Agency interpretation of code Rule: Where the statute is not clear, courts will defer to the agency’s decision; Chevron

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 regulationsRule: The treasury can prescribe rules to enforce federal taxation; 26 USC §7805

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 lawRule: A treasury regulation is valid law unless invalidated

Analysis: invalidation test: Procedure:

by failing to undergo a notice & comment process, Administrative Procedure Act by failing to become proposed and finalized in 3 yrs. 16 US § 7805(e)

In substance: by failing to be:

reasonable interpretation of statute U.S. v. Correll; Harmonious with the plain language of statute. Nat’l Muffler ass’n v. U.S.; a permissible (reasonable) construction of the statute’s 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 TP’s similarlyRule: commissioner does not have a legal obligation to treat similarly situated TP’s similarly

Dissenting Rules: However in some cases the courts have held that similarly TP’s will be entitled same tax treatment. IBM V. US This exception is applied narrowly. Borstein v. U.S.

o Analysis: Reasoning by Analogy:

Did TP apply for same tax exemption as competitor, like a 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 §6110Revenue rulings: Revenue rulings are not subject to any deference nor binding on taxpayers;

Dissenting Rules: But sometimes taxpayers can utilize on in some cases if rule is favorable

LITIGATIONIssue/Scope: Litigation Case SummariesIBM 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 TP’s do not apply for letter ruling….)

FORUM

Tax Court: Fed District Ct: Ct of Fed Claims:

4

Prepayment forum

Interest keeps accruing

Judges are tax law experts

Informal procedures for small TPs

Golsen Rule (T.Ct. follows ct of appeals in circuit it sits)

Pay & sue for refund

Interest stops accruing

Jury trial Applicable Ct of

Appeals Precedent may be

more favorable

Pay & sue for refund

Interest stops accruing

Judges have some technical expertise (hear many tax cases)

Ct of Appeals for Fed Cir

Precedent may be more favorable

Litigation processReturns: returns must be filed by April 15.

§6072(a) ; Secretary grant reasonable extension §6081(a)Deficiency: 30 day letter: notice of deficiency = 30 days to file appeal & if no

response: 90 day letter & litigation Time limits on IRS assessments § 6501

BOP §7491 : burden of proof shifts where taxpayer produces credible evidence

Awarding costs §7430 : awarding of costs

Timing & limitations Statute of limitations assessment of deficiency

Claiming refund: Interest

3 years after return filed § 6501(a)

3 years after due date of that return - § § 6501(a), 6501(b)(1)

Special rules: No time limit if no return,

or if false or fraudulent return § 6501(c)(1), (3)

6 years instead of 3 years if “substantial omission” of income items - § 6501(e)

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)

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

PenaltiesProfessional responsibilityCB 23-25

TP

Tax lawyer may be considered preparer for giving advice

Any advice must be premised on reasonable basis (giggle test= fail)

§6694 sanction: willful/reckless disregard of rules & positions lacking real possibility of being sustained on the merits

Preparers are not subject to penalty for unrealistic position (BUT SEE: effect reputation)

7701: broad def of “preparer”

civil and criminal frivolous positions §6651(f),

6702, 6673 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

5

Look to state law to determine what property rights one has (exists), then to federal law to apply the statute

Estate of Bosch:. Fed ct not bound by decisions of lower state courts.Estate of Bosch: Look to the state’s highest court, and in absence of such ruling—the 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 lawo 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 cost’s more); §§446(c); 451(a); 1.446-1(c)(1) Tax/Code tables:

o CB 840-43o 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 TODAY’S DOLLAR & Can invest money today which makes it more valuable

Issue / Scope: Method of accounting o CB 51 & 763

Rule: method of accounting (some rules)o Cash method:

Items included or deducted in year cash receivedo Accrual method:

Items included or deducted in year All events test:

When all the events have occurred 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 INCOMEIssue / Scope: Whether item constitutes GIRule: Gross income is: An accession to wealth Clearly realized Over which the TP has complete dominion; Glenshaw glass, 348 US 426 (1955); And from whatever source derived; § 61

o Divergent view: Haig Simons Econ. definition: GI= TP value of total expenditures (+/-) the value

of property But: appreciation/depreciation recognized in calculation of wealth, hence not

adopted by tax code 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 Analysis: Code test

Only if: Realization event (such as a transaction) §1001(b)

6

Recognized by tax code §1001(c) Only on:

Any amount over: Adjusted basis or amount he paid for property (its cost)

At disposition of property, §§1011(a); 1012Compensation for Services: Rule: TP will be taxed compensation for (b/c it is) services § 61(a)(1) 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 transferrable?) § 83 (a) & (c)

(no)

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

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:

Included: In the year that the property vestso Unless: (b) election: included in the year that property is transferredo Unless: Arms-length transactions § 1.83-1(b) & (c) [SEE BELOW]

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 Stock & stock options:

o Tax treatment depends on: Ascertainable fair market value If not subject to substantial risk of forfeiture

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 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 applieso 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:

7

Rule: Deferred compensation such is from retirement savings (§ 62(a)(7)), pension plans, and education savings accounts is includible in the TP’s GI Analysis:

Time value of money tables CB 840-843 Policy:

Double taxation problem for TP Where taxed on earnings and investing income Led congress to enact tax-favored savings Generally for performance-based income

Types of deferred compensation: 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 contribution

TAXEDIncluded in GI

EXCLUDED from GI Deductible

TAXED Included in GI

Notes: Rollovers between different deferred compensation plans are allowed tax free if [test]:

Earnings TAXEDCompounds slower b/c tax on interest

EXCLUDED from GI Compounds faster b/ no tax on interest

EXCLUDED from GI Compounds faster b/ no tax on interest

TP job terminated § 402 Transfer pension/profit-

sharing plan Before receiving an early

distribution & attendant penalty

To a traditional IRA or other qualified plan directly

In 60 daysWithdrawals

NO TAX TAXEDAllowed for education, medical exp…etc… w/o losing tax benefits

EXCLUDED from GI: if qualified distributions §408A(d), cr. ref. 72(t) (or else early withdrawal penalty)(i) Made on or after age 59 ½,(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.

(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

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

Same as traditional IRA

8

of §219(g) amount of $80k [see also spouses under plan]

NOTES: Stricter income limitations than Roth IRA if a part of employer plan; if not, then may make deductible contrib.—no matter how high AGI

Pensions & Education accounts: Statutory framework: §401 & 529/30

Tax treatment

Qualified pension & profit sharing plans §401

Education savings plans §§529 & 530

Salary contribution

EXCLUDED from GI401 k: allow voluntary pre & post- tax contributions

TAXED Included in GI

Earnings EXCLUDED from GI Compounds faster b/ no tax on interest

EXCLUDED from GI

Withdrawals

TAXED EXCLUDED from GI: If don’t exceed contribution limit

Contribution limit

$16,500 

more than IRA’s

Contributions can’t be made after beneficiary turns 18§529: TuitionForum shop in states for education plans- some better than others***

NOTES: 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 benefitso Exception in case of divorce: But the

couple must get a QDRO BY JUDICIAL DECREE, Otherwise not enforceable (even if ct ordered)

Investing in employer: ERISA limits investment in employer for qualified plans, and employer mismanagemento 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)

Tax credits for voluntary contributions to savings plan for low-income TP §25b Employer deduction matching: Whatever tax gov’t gets from employee is

offset by tax deduction of employer. But employer limited to deductions where payment is includible in

employee income, to prevent tax float (taking current deductions for future payment)

9

§267(a)(7) where empl’r/empl’e relationship; §404a5 where not relationship 457 state employees/non-qualif’d 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, & 132Analysis: EXCLUSION

Meals: Lodging:

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

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)

Analysis: Test: Fringe is for

employee/spouse/dependents §119(a)

Meals furnished for convenience of the employer (factual determination) §§ 1.119-1

Meals furnished on business premises of the employer,

Meals w/o charge: factors Regarded as furnished for the

convenience of the employer If furnished for a substantial

noncompensatory business reason of the employer

Factual analysis:o Mere declaration that

meals are furnished for a noncompensatory business reason is not sufficient to prove

o meals furnished to employee during working hours to have employee available for emergency call 

o when meals furnished to employee b/c employer's 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 emply’e actually eating meals (not constrained in choice of food/eating plase)

Test: Furnished by employer to

employee/spouse/dependents For convenience of employer, Furnished on business premises of

employer, TP req’d 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

R-B-A:Adams v. U.S. P’s furnished him with a house in Japan, (required for his employment/duties as president). Court held: there was direct nexus b/t housing and business interests of employer. Where empl’e housing important in Japanese bus. Community. if not, adversely affect empl’r business & premises not limited to emply’r HQ or bus compound- function as opposed to space

Rule: 132 provides that the value of the following are excluded:Analysis: (see rules § 1.132-1)

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)

De minimus fringes

10

o Admin costs of tax outweigh benefits of tax pg. 81 No-cost additional services

o Like hotel empl’e staying hotel for freeo Non-discrim for empl’es

Qualified empl’e discountso See code for thresholdo Non-dsicrim for empl’eso Employ’e works in line-of-businesso For goods/services normally sold to customers (not real property)

Working condition fringeso Goods/services provided an employeeo 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 excluded–de 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 paymentso 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 workso 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 When TP acquires earnings lawfully, unlawfully, or unethically He has received income–even 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:

Prohibition on structuring transactions to evade reporting requirements (f) § 1.61-14(a): IG is a misc. item of GI—look up again

File a return: Cash in business of +10k (a) What should be on the return (b) Exceptions: cash

R-B-A: o Embezzlements: James v. Unitedo 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 WilcoxRutkin 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

The value of treasure trove In the year discovered

11

Reduced to possession §1.61-14(a)Analysis:

R-B-A: Cesarini v. U.S. (1969): ct held that TP who bought an old piano for $15 at an auction And later discovered ≈ $4,500 in cash, hidden in the piano Had to include the found cash in GI

Recovery of capitalRule: TP are permitted to deduct the costs associated with earning income

Analysis: o Policy: not all receipts are gains

ITEMS Inclusion ExclusionSales: Rule: A TP is includes realized & recognized gain from the disposition of property in GI 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 Amount realized : amount realized at

disposition of property Recognition of loss or gain entire

amount of gain or loss shall be recognized (see exceptions of subtitle) § 1001(c)

Property taxes not taken into account § 164 (d.)

Loss will be deducted from GI (see if applicable to exclusion section)

Gain: excess amount realized over adjusted basis in section §1001

Adjusted basis (cost) §1011, 1012, 1016

Dividends, interest and rentRule: D/I/R is includible in the TP’s GI § 61Analysis: The TP recovers the cost/basis of these

items at disposition Recovered on the backend, instead of

when TP earns income

All Not until disposition UNLESS: Qualified

dividend income is excluded from GI §1(h)(11)(A) & (B) [dividends received from corporations (domestic or foreign)]

Depreciation: (timing of recovery for long-term property & BUS EXP. ANAL)Rule: TP’s are permitted recover the cost of property used to earn income over the useful life of the property § 167Analysis: Amt real/recog is includible to the extent

amt exceeds cost recovery amount 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)

Factors determining whether capital expense: (Hampton Pontiac vs. US)

o Payment directly related to

Current deduction:NONE (if deduction allowed)

Capitalized deduction:Amt exceeding amt allowed for cost recovery

Current deduction: ALL (if deduction allowed)

Capitalized deduction: Depreciation ratio amount ALLOWED FOR COST RECOVERY

12

acquisition of franchise (intangible asset)

o If renewable right: (indefinite nature of right)

o Probability right will be renewedo Right is an intangible asset

1.167(a)-3o NOW §197: FRANCHISE COST

SPREAD 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, 72Analysis: DEFINITION: an annuity is a contract that

provides for a series of payments in return for a fixed sum

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 includibleo Annuity calculation tables

1.72--9

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 to investment § 72(b)

Business Expenses:Rule: a TP must include income from business activities § 61(a)(2) Though he may deduct certain

expenses incurred in generating income from business activities

Analysis:Deductions allowed per §162Expenses: (a): deduction on all ordinary/necessary expenses paid or business…

store rent, utilities, salary, even shipping

costs for acquiring the goodsDeductions disallowed per §162(c): no deductions for illegal payments (bribes, kickbacks, etc…)

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)

(f): no deductions for fines or penalties from violation of law

(g): no deductions for damages paid out for violations anti-trust laws

Drugs: no deductions or credit allowed for any amt incurred while carrying on business in the illegal sale of drugs § 280E

Method of accounting:

Selling goods: gain from selling goods in of COGSSelling services: Gross receipts

Expenses deducted in yr actually made

Selling goods: COGS & §162 deductionsSelling services: §162 deductions

Cost can’t include amt disallowed under §162

13

1.471-3(d): if usual rules of cost computation do not apply- then may use trade practice

1.446-1(c): general rule for methods of accounting: TP may compute TI with…

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

Debt not an accession to wealth 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)

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 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 EXCLUSIONS/EXCEPTIONS :

Bankruptcy exclusion: § 108(a) & (d)

A financially troubled TP can exclude DOI if insolvent/filed for bankruptcy

If not filed for bankruptcy, TP can exclude DOI only to extent of insolvency

Have to include exempt assetsProperty debt exclusion: § 108(e) (purchase price reduction)

Reduction of purchaser debt is treated as a price adjustment

(h) Principle residence (b) Reduction of tax attributes 108e5 : applies only to debt owed directly to seller of

property See exception § 1017: adjustments to basis (higher the

basis lower the gain and vice versa) 1017 & 108b: reduction of property basis & 108a results

in deferral rather than complete exemption See property business indebtedness (c)

Disagreement about amount: Lender and borrower Disagree Borrower says amount owed is less

o Difference b/t amt lender said was owedo And amount borrower payso Doesn’t have to be included in GI (N. Sobel v.

Commissioner) See also Zarin

14

Student loan exclusion § 108(f) Unless work for school, then not excludedCancellation 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 didn’t have debt in which he held property. Chips aren’t property under 108—it was an opportunity to gamble. Therefore, best viewed as disputed debt.

Damages and Social Welfare PaymentsIssue / Scope: Whether legal damages paid to the TP are included in GIRule: while damages paid to TP for replacement of gain is generally includible in GIAnalysis: Replacement of lost profits:

Rule: replacement for lost profit is included in GI 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 settlementInvoluntary conversion of property into cash: §1033

Rule: A TP may elect not to recognize gain from the conversion of property into cash (exclusion)

Analysis:o Code test:

Only if… Involuntary conversion due to

o Destructiono Thefto Condemnation

TP must reinvest cash in property that is similar/related in use to the lost propertyPhysical harm:

Rule: compensatory damages for physical injuries or physical sickness is excluded from GI §§ 104(a), 1.61-14(a):

Analysis:o Medical exp’s for emotional distress remain excludibleo Validity and payer intent not dispositiveo 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 GIo Analysis:

Dividend payments Paid by state Restricted to those in need Includible

o Revenue Ruling 85-39 on Alaska Benefits Alaska gives out (mineral) dividends to retain population;

analogous to gifts/welfare program which are not taxable Gov’t should not expect to receive benefit

Most SS benefits Includible in incomes of upper and middle-class recipients (on a staggered basis, § 86Result: low-income recipients SS payments excludible

Unemployment benefits

Are includible because they replace taxable wages, § 85

Imputed incomeIssue / Scope: Whether the gov’t should tax benefit not calculated in monetary gainRule: imputed income is not generally included in the TP GI

15

Analysis: Imputed income are benefits created when TP performs services for self of family Taxation of II raises problems of valuation, equity, and efficiency (effect may be to encourage

people to work at home) Examples:

o Shaving, cooking, driving to work

SOME EXCLUSIONS, DEDUCTIONS, AND CREDITSTax Expenditures 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 Arguments

o Sometimes congress enacts tax subsidies w/o critical scrutiny of costs and benefitso But tax expenditures involve less bureaucratic interference than direct subsidy plans

Types of expenditures:o Reduce TIo Preferential tax rateo Credito Defer/ delayed recognition

ABOVE THE LINE (EXCLUSIONS FROM GI to get AGI) Listed in §62 ----------Tax-Exempt InterestIssue / Scope: Whether interest from certain government bonds are excluded from GIRule: A TP excludes interest they receive on certain state, municipal, and other bonds from GI §103Analysis:

Code req:o ABL deductiono Tax-exempt interest is required to be shown on the TP’s return § 6012(d)

Exclusion does not apply to:o Private activity bonds not qualified §141

Projects far removed from one usually considered governingo 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 residentso Unregistered bonds §149

RBA: King v. Commissioner: gov’t payment for takings not interestKing v. Commissioner, 77 T.C. 1113 (1981) [where held denied petitioner’s 103 exclusion because it considered the gov’t payment as a takings compensation, and not interest] Possible policy

Policy: federal gov’t wants to avoid imposing burdens on states and municipalities in their power to borrow funds

Gifts and BequestsIssue / Scope: Whether gifts or bequests to the TP bonds are excluded from GIRule: GIFTS: a TP excludes gifts from GI §102Analysis:

Supreme Court gift test: o Transfer which stems fromo “Detached and disinterested”

16

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

o 1.102-1(f) (proposed) [exclusions to 102 rule****], Tax base:

o Excluded from the donee’s tax baseo 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)o Donor transfer not counted as a disposition= no federal income tax consequences

Gain Loss if at the time the donee received the

gift the FMV of the property was

greater/equal to the donor’s basis the donee takes the donor’s basis.

( carry-over basis concept )

if the property has a basis greater o than its FMV

at the time the donee received the gift then, when the donee disposes of the

property:o (1) the donee gets the same basis as

the donor {if this produces a gain- calc complete};

o (2) {if it doesn’t produce gain} the donee’s basis in the property is the equal to the FMV at the time of sale/transfer by the donee

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. Policy : most gifts are made to family members and inclusion in the donor’s base is generally easier

to administer. Rule: BEQUESTS: a TP excludes bequests upon the death of the donor from GIAnalysis:

Basis in property o Equal to its FMV on the death of the decedent §1014, 1022 (yr acquired)

Inter-Spousal transfers: o No gain/loss recognized on transfers from spouses or former spouses. §1041o Treated as a nontaxable gift

see also 1015e

Life Insurance ProceedsIssue / Scope: Whether life insurance proceeds are excluded from the TPs GIRule: term and whole life insurance benefits are excluded from the beneficiaries GI §101Analysis:

Code Test: o Proceeds excluded from GI if:o Received by reason of the insured death

Code failure:o When the insurance co. holds the policy proceeds

17

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

After the insured dies And pays interest to the beneficiaries.

o See also employment-owner insurance K’s §101(j) Code exception: (amount excluded during life of insured) §101(g)

o TERMINALLY ILL: Physician certifies

Individual not expected to live longer than 24 months. o CHRONICALLY ILL:

If medical personnel certify Individual unable to perform at least 2 activities of daily living, individual is disabled, or individual’s cognitive functioning so impaired

o he requires supervision in order to avoid harming himself. Exclusion applies whether payment provided by insurance co or by a

viatical settlement provider o (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)

ScholarshipsIssue / Scope: Whether the scholarship may be excluded from the TPs GIRule: a TP may only exclude qualified scholarships from GI §117; Prop Reg. §1.117-6(c)(4)[definitions]Analysis:

Code Test : o TP a degree candidateo 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.

Compensation for services not excluded : o To the extent scholarship is comp—including teaching and research (c) o (c) May cover athletic scholarships, if participation is required as a condition for retaining

the scholarship—yet to be determined by IRSo BUT SEE Educational Assistance Programs §127

Prizes & AwardsIssue / Scope: Whether a prize or award may qualify to be excluded from GIRule: Amounts received as prizes/awards and transferred primarily in recognition of:

o Religious, o Charitable, o Scientific, o Educational, o Artistic,

18

o Literary, o Civic achievement;

OR is a employment achievement award M ay be excluded from GI

o Otherwise, GI includes amounts received as prizes or awardsAnalysis:

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 gov’t 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. Turner v. Commissioner

o Employee achievement awards For length of service or safety

& if it doesn’t 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 ground—TP 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 PaymentsIssue / Scope: whether the payor may take an above-the-line deduction for a (post)marriage transferRule: a TP may take an itemized deduction for certain cash-alimony transfers to spouses.Analysis transfersCASH NON-CASH/PROPERTYAlimony : Inclusion: in income of payee §61(a)(8) [see also spouse-dependent defined §152]

Exclusion: from GI of payor §215 As above-the-line §62(a)(10)

Test : Must be cash §71(b)(1) & (2) Payment pursuant to written

o 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 can’t 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

No gain of loss is recognized by either party on the transfer of property §1041

o (overturning Davis)o To a spouseo Or former spouse

If transfer incident to divorceo Transferee assumes transferor’s basis

in property

19

payments]o CB 247 : indirect alimony- insurance

premiumso CB 247-48 : indirect alimony- housing

payments If spouse Makes mortgage payments On house Owned by the spouse

Counts as alimony If other requirements

satisfiedChild support: Neither Included nor excluded from GI of payor and payee

CB 246

Trade and Business deductionsRule: §62Analysis: see business expenses section analysis

BELOW THE LINE (EXCLUSIONS FROM AI to get TI) deduction not in §62 PERSONAL EXEMPTIONSRule: each TP receives a personal and dependent exemption §151Analysis:

AMOUNTSo $2,000

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 spouse’s personal exemption QUALIFYING DEPENDENT §152

o CHILD: §152(c) TP child or sibling

Or TP child/sibling descendent 18 or younger

Or 23 or younger if student Same principle place of abode

For more than ½ year Does not provide more than ½ of own support

For yearo RELATIVE: §152(d)

TP child Or TP child/sibling descendent, parent, parent ancestor, sibling, aunt, uncle,

niece, nephew, cousin, or in-law OR same principal place of abode

Member of TP household GI less than §151 (2k) Receives more than ½ support from TP Not qualifying child of TP (see LGBT)

AND Greater of either:STANDARD DEDUCTIONRule: a TP may take the standard deduction if it is greater than the aggregate of itemized deductions §63Analysis: (recheck the statutory volume for amounts)…

AMOUNTSo $ 5,800 for unmarried couples

20

o $ 11,600 for married couples filing a joint return

ITEMIZED DEDUCTIONS§67: 2% floor on miscellaneous itemized deductions [STEP 1]

Rule: Allowed only to extent the aggregate of deduction exceeds 2% of AGI All items listed not subj to 2% floor

o §213: medical, dental, etc., expenseso §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

Extraordinary Medical CostsIssue / Scope: Whether the TP can take an itemized deduction on medical costsRule: the TP can take an itemized deduction on medical costs; to the extent it exceeds 7.5 % of the TPs AGI §213, §67

7.5 to increase to 10 % in 2013Analysis:

Definition: o Medical care expenditure:

Amounts paid for Diagnosis, cure, mitigation, treatment Or prevention of disease Or for the purpose of affecting any structure or function of the body— 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]

Code Exclusion: o Insurance reimbursements: not included in deductionso Expenses which improve the health of the TP but not directed at diagnosing, curing,

mitigating treating, or preventing a disease is nondeductible Code Test:

o Can deduct amounts actually spent on medical careo For the TP, spouse and dependents o Anything above 7.5% of AGI o PROPERTY IMPROVEMENTS

For medical purposes Deductible to extent

Cost of improvement exceeds 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

Arising from injury or disease Abortions and sterilizations deductible.

21

o O-T-C MEDICATION : Not deductible, unless prescription drugs or insulin.

o TRAVEL & LODGING: Travel

Primarily for and necessary for medical care is deductible. If medical care available in area, but TP chooses to travel, not deductible

(unless in hospital). Lodging

Away from home Deductible up to $50 per night

o Only if not lavish Seeking treatment by physician In medical care facility. If travel on doctor’s orders

o To more hospitable climateo 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)) O’Donnabain v. Commissioner, 134 T.C. 34 (2010) [the Tax Court held that a taxpayer’s 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]

Policy: deduction seems to invite fraudulent claims, also get $$ back on capital expenses with the disposition of the property]

68(c) proposed leg. Overall limits on itemized deductions

Charitable Contributions & Tax-Exempt Organizations (SEE CLASS SLIDE)Issue / Scope: Whether contributions to particular organizations may be deducted as an itemized deductionRule: a TP may take an itemized deduction for charitable contributions certain nonprofit org.’s §170Analysis:

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)

501(c)(1)-(7)[exempt organizations]; 513 [definition: unrelated trade/business];

6113[disclosure requirement for return]o (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

Religious, Charitable Scientific Literary, or educational purposes, Or to foster national/international amateur sports competition 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)

22

By attempting to influence legislation or participate in any political campaign …

o (3) A war veteran’s 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:

Religious, charitable Scientific, literary, Or educational purposes, 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

If a donor receives no substantial benefit for contribution. o 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. § 6115o § 170(l): contributions to universities for right to buy sports tickets: deductions

limited to 80% of contributiono 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 TIo CASH :

Cash contribution limited to percentage of contribution base (AGI) (b)(1)(A): contribution deduction limited to 50% with excess carried over five

years 170(d), o Church or a convention or association of churcheso Educational organizationo Medical/hospital care/research/educationo Gov’t unit/org. receiving substantial support from gov’to Private foundationo §509 org

(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: Donor deduct FMV value of property §§ 170 & 1.170A-1(c)(1)

o (Even though TP & org won’t pay tax on appreciation) Limitation:

o if property would produce income/short term cap gainso Donor may deduct only adjusted basis in contrib. propertyo 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]

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 Benefits private shareholder/individual

o Attempts to influence legislation/political campaigns (to substantial degree).

23

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 cousin’s 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//Haverly—see class notes

State, Local, and Foreign TaxesIssue / Scope: Whether the TP can take an itemized deduction for the payment of taxesRule: a TP may take an itemized deduction for the payment of income, sales, foreign and property taxes §§ 164(a), (b); Cr-Ref 212Analysis

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

PROPERTY TAX: § 164(b)(1)o Acquiring

Deduction not permitted for taxes paid in connection with acquisition of property 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

b/t buyer and seller §164(d)(1) according to what amount of the tax property owned by either the buyer or seller

o Renters tax: If TP doesn’t own the property, then can’t deduct property taxRevenue Ruling 79-180 [New York renters tax is not a tax for federal income purposes even if they have interest in the property–not owners]

TAXES/fees NOT DEDUCTIBLE: § 275(a) o Federal incomeo Gifto Estate o Employee SS taxeso Gov’t fees: amounts charged for government services (not considered taxes)

TRADE/BUSINESS/GENERATING INCOME: § 162(a) & 212o (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 (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 CreditIssue / Scope: whether the TP is allowed a credit for childrenRule: 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:

Test: o TP allowed a §151 exemption for child

24

o Child fits definition of child per §152 TP child or sibling

Or TP child/sibling descendent Same principle place of abode

For more than ½ year Does not provide more than ½ of own support

For yearo And is 16 or younger §24(c)(1)

Reduction: o Credit reduced by $50 for each $1,000o By which TP AGIo 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)

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

Household and Dependent Care Services CreditIssue / Scope: whether the TP is allowed a credit dependent care services to enable TP to workRule: the TP is allowed a credit for certain household and dependent care services incurred to enable the TP TO WORKAnalysis:

Test: §21(a)o TP household includes 1+ qualifying individualso Dependent per §152(a)o under 13yr/oldo 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) 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)

of TP single or if married—lesser of earned income of TP/TP spouse

o Special rule permits credit where TP spouse disabled or full-time student §21(d) Allowed credit

o Equal to applicable percentageo Of employment-related expenseso TP paid during taxable yearo Special rule where

Applicable percentage §21(a)o 35%o Reduced by 1% for each $2ko By which TPs AGI exceeds $15k….

Earned-Income Credit Issue / Scope: whether the TP is a low-income worker eligible for a tax credit

25

Rule: a low-income TP may take a credit if a worker §32 EE194Analysis:

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 Refund:

o If credit exceeds TP tax liabilityo Excess refundable

Policy :o Ability-to-pay regimeo To supplement income of low-income working people

Especially those supporting minor childreno Intended to make work more attractive to low-income TPs

Education CreditsIssue / Scope: whether a TP may take an education expenseRule: a TP may take an education credit, including the Hope or Lifetime Learning CreditsAnalysis:

Hope scholarship credit §25A(b)o $2000 for qualified tuition o for qualified tuition and academic fees

Not room and boardo Paid to academic institutiono For first 2 yrs of post-secondary educationo Phased out for upper-income TPs CB: 253o Not available if convicted of drug offense (state/fed)

Lifetime learning credit §25A(c)o Credit equal to 20%o Totaling $10k/yro Of qualified tuition & academic feeso Paid by TPo Phased out fir upper-income TPs CB: 253

§221 deduction for certain higher educational expenseso Allows above-the-line deductiono For same types of expenseso Creditable under §25A

Coverdell Education savings deferral and exclusion provisions Qualified tuition program deferral and exclusion provisions Other personal Credits

o Analysis: CB 255/ EE 191 -396o Elderly credito Disabled credit

BUSINESS AND INVESTMENT EXPENSES(§62 T/B ATL)Terms (“Capital…”)

Capitalize (spread cost of recovery over time) Capital asset (not easily converted into cash, generally owned to generate profit: land, buildings,

machinery) Capital expenditure (Funds used by a tp to acquire or upgrade physical assets such as property,

26

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 mattersIssue / 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 yearRule: Depreciation

The cost of an asset with a useful life Which lasts substantially longer than the taxable year May be recovered thru depreciation deductions In the year the asset is expected to be used in T/B/Prod. Inc.

o If the property used in T/B or for the production of income §167Analysis

Code test: o Check §179o Only use in T/B/I situationo The property has a limited useful life §167

Intangible § 167/ amortization & Depletion for natural property (coal, gas, etc…) Tangible § 168

Accelerated Cost Recovery System: Analysis

o Why the TP wants to use/ Favorable b/c: Shorter recovery period

Especially for property with a long useful life Accelerated recovery method Assumes salvage value zero, permitting deduction of entire cost

of propertyo 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

Straight Balance method : o Take deduction equal to amt of 1/#_useful

years 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 Declining Balance method:

o 1. Straight line method deduction % determinedo 2. Multiplied by D-B percentage (x 1.5

[150%] or 2 [200%])o 3. Amount subtracted from basis of propertyo 4. The basis is then reduced (adjusted) § 1011 &

1016o 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

27

using 15 OR 20-YEAR PROPERTY: 150% declining

balance method 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

Thus determining when and how much depreciation deduction allowed

If not full year: o Full year amount/deduction

Determined by recovery period/conventiono Divided by portion of year allowed

1. NOT REAL PROPERTY: ½ year convention asset deemed to be placed in service on date that is

halfway thu the year §168(d)(1) & (4)(A)o Discouraging abuse: so TP doesn’t use ½ year

convention while putting property in service at end of year

¼ 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 Deemed to be placed in service on date halfway thru

month In which actually place in service §168(d)(2) & (4)(B)

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

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

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]

§248 Corporate expenditure deduction (election)o Corporation may elect to deduct amount incurred in the creation of the

corporationo Reduced by 5k by which amount exceeds 50k

See ALSO Listed Property limitationsSimon v. Commissioner: (violin bow) IRS took the position of non-acquiescence—may challenge other TPs (i.e. in other circ’s) 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

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

28

ExpendituresIssue/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 soldAnalysis:

Code policy: The TP’s 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.

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)

For new buildings or; For permanent improvements /betterments or;

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 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 intangiblesINDOPCO 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

Benefits :o Availability of acquiring co.’s enormous resourceso Synergy

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 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 property of the person making the payments.

Cost of defending or perfecting title to property Architect’s services. Commissions paid in purchasing securities. Amounts assessed and paid under an agreement between bondholders. 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

Practice of his profession29

Operation and repair of an automobile used in making professional calls Dues to professional societies and subscriptions to professional journals Rent paid or accrued for office/ office expenses Etc… §1.162-6

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 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 personalRule: a TP may take a deduction for B/T/I expenses, but generally not for personal expensesAnalysis:

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

Working as an employee (but below-the-line) NOT LISTED in §67 allowed only to extent aggregate of deduction

exceeds 2% of AGI Travelling expenses

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 To the continued use or possession Of property to which the taxpayer does not own/have title For purposes of the trade or business,

o NO DEDUCTIONS ALLOWED FOR: §162(c), (f), (g)

Charitable contributions and gifts 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

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 Generally, no deduction for personal expenses §262 (but see below…) Profit-Making Activities

o Rule : a TP is not allowed a deduction for expenses incurred for activities not

30

engaged in generating a profit §183 (Like expenses allowed under §162 for T/B) If not allowed by other sections

Like §164 deduction for payments of non-federal taxes o Analysis:

Code § 183 test/analysis: Prevents TP from taking hobby losses Does revenue exceed expenses (d) Rebuttable presumption activity engaged in for profit if:

o 3+ yearso Of last 5 consecutive yearso Activity earns a profito If horse breeding:

2+ year of last 7 consecutive years Extension election: §183(e)

o TP can wait to see if presumption meto Until 5th yearo If election madeo SOL’s on assessmento Is extended until 2 years after return

R-B-A:Larson case: breeding dogs and didn’t turn a profit for past 3 years if engaged for profit, then can deduct all of expenses Evidence showed:

o their desire to make money in ventureo personal gratification and no prior exp, and no formal bookso They weren’t wealthy and went through hardship to engage in activity

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), 262o Analysis:

The court will look to the underlying/ origin of claim to determine if personal expense—even if intended to generate/maintain income (Gilmore)

Crimes arising from Business activities: deductible per Commissioner v. Tellier (vs. non deductible is personal)

Gilmore case: Where TP incurred legal fees in divorce proceedings—to protect interest in business from

estranged wife 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 claimo 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)

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] Court will likely hold not deductible is can use general and ordinary clothing

Pevsner v. Commissioner: Employee in high-end retail store compelled to buy expensive clothes for work

o Deduction for employees b/c engaged in trade or businesso She was not allowed deduction b/c court held she fell within §262—personal type of

expense Was clothing for employment: yes Is it street wear? Is it worn that way? Yes—just b/c P didn’t wear—b/c not

her style—doesn’t mean it isn’t street gear= personal (general usage and adaptable as ordinary clothing)

OPPOSITE EXAMPLE: Tuxedo not (general usage and adaptable as ordinary clothing) Listed Property: Mixed use property

31

o Rule: TP’S 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 Particularly for automobiles = §280F(a)

§280F(d)(4) Listed property Any passenger automobile & Property used as a means of transportation, Property used for purposes of entertainment, recreation, or amusement, Any computer or peripheral equipment (as defined in section 168(i)(2)(B)),

and Property of a type specified by the Secretary by regulations.

Threshold: Must be predominately used in qualified business §280F(b) [business use

exceeding 50%] to qualify for ACRSo If not:

Must use straight-line method/deprec. cannot expense per §179

If used by employee: §280F(d)o Considered T/Bo Only if use for convenience of employero Required as a condition of employment

Caldwallader v. Commistioner, T.Ct: (But see fed ct. decision in 1990) Employer did not explicitly require purchase of computer But :

o Work for employer substantially furthered by P.C.o Employer spared expenseo Employer lacked funds to purchase P.C.o Employer req. satisfied

Carrying On (including moving expenses)o Rule: a TP is allowed a deduction for expenses incurred to start a business or

tradeo Analysis:

Seeking/moving for employment: People employed in specific field, Seeking job in same field §162(a)(2)

CLASS EXAMPLE/pg. 386 CB: CPA incurring expenses to become Corp treasurer—arguable same field (accounting financial field)—

But if current employee:o Cannot take §62 ATL deductiono Subject to §67 2% flooro If independent contractor ≠ §62

MOVING EXPENSES §217 ATL deduction for:o (a) Moving expenses in connection with the commencement of worko Distance requirement if no job yet (c)(1)(D): must be at least 50

miles from residenceo 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? Don’t 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 deductiono Where the employer reimburses for moving expenses: §82:

general rule, must include in GI

32

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)

TP found job in field searching to acquire business but Expense not allowed because has nothing to do with employment at current job 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 the 180-month period beginning with the month in which the active trade or business begins.

(2) Dispositions before close of amortization period… 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? 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 Cases against J.D.’sCLASS EXAMPLE/DISCUSSION:

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:

May deduct, Must capitalize or, 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: CURRENT DEDUCTION is generally allowed for interest on indebtedness HOWEVER payments for INTEREST ON PURCHASES must generally be capitalized

33

EXCEPT in the case of qualified residence interest1. Code: §163(a): current deduction allowed for interest on indebtedness 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

Code: §163(d): may currently deduct interest from debt incurred for investments (with some limits)

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

Code: §221(a): current deduction allowed for interest on student loans1. 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 deductedb. 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:1. §163: interest incurred to purchase…”

a. Tax-exempt bondsb. Passive activity (renting property)c. Life insurance/annuityd. § 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 §11e. Constructing real propertyf. Personal interest (other than qualified residence interest)

2. § 163(h)(2) : home mortgage interest: Code is saying it is not personal interesta. Acquisition or home equity indebtedness for qualified residence

i. Allowed 2ii. 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 home2. Doesn’t matter what you use it for3. Acquisition indebtedness means what amount you currently owe

on the home******b. Qualified residence:

i. Principal residence and one other residence of TPii. 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 miscellaneous—don’t have to worry about 2% floorii. Acquiring

1. Debt cannot exceed $1 million (3)(B)(ii) & (Pau v. Comm’r: “ must make a showing if indebtedness other that acquisition ”

2. Acquisition indebtedness cannot exceed the FMV of the qualified residenceiii. 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

34

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: TP’s 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 interest—TP 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 don’t itemize deductions §62(a)(17)c. Max amount of $ 2,500d. 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 payii. On the closing of a loaniii. In lieu of charging a higher interest rate

b. § 461(g)(2) exception tests:i. Payment of points is an established business practice in the area in which the

indebtedness occurredii. Points paid do not exceed the amount generally charged in the areaiii. if so= current deduction

INCOME FROM DEALINGS IN PROPERTYAnalysis 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 baby1.121-4(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 losscapital gains and losses:understand long-term capital gaingain from prop included in gitaking deductions--TIpull out long term capital gains-rest of TI goes into §1

Realization/Taxable event35

Was there a transaction involving property? o if no: end of processo 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

likely because the employee was separating the property from himself and using the gain/value of the property to pay someone else/settle obligation ¶4.02/3—Eisner V. Macomber

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”)

“disposition for a valid consideration” o RULE : The act of the property becoming worthless is the realization event

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)

Taxpayer contended that drilling of hole to access minerals was the realization event for which he tried to claim a deduction on the loss

note: property does not need to be is double completely destroyed to be a transaction/realization event § 1.165–1(b)

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 securitiesRealized gain or loss § 1001(a)Basis of property acquired by purchase/taxable exchange Allocation of basis issue: basis must be allocated between portions sold/retained in proportion to

relative value of portions at time property is purchased § 1.61–6(a); Inaja (CB 528) Requirement of brokers to report customers adjusted bass for stock sold. CB Update pg. 19Transactions involving mortgaged property (Basis and amount realized) 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

36

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, seller’s gain reflects his depreciation deductions Advantageous to TP b/c they can defer taxes on gains until sale while deducting

depreciation 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.”

Recognition by code Gain or loss recognized unless non-recognition/deferral provision.

o Recognized loss deductible to the extent it is allowable per § 165(a) Noncorporate taxpayers restricted to losses incurred in trade/business; and transaction

for profit; casualty losses for personal use property § 165(c)o Non-recognition:

Tax-free exchanges Like-kind exchanges § 1031 EE 130

o Generally not permitted to recognize losso Nonrecognition in the business or investment property is exchanged solely

for property of like kind–see regulations as well–the nature of propertyo for T/B/I—not for personal use

other property must be for T/B/I must be of like kind

o Caveats: “solely for” is not strict—see where exchanges of cash/boot non-real estate property generally excluded

Other exchange-type non-recognition ruleso § 351: shareholder recognizes no gain or loss from transfer of assets to a

controlled Corporation in exchange for Corporation stocko § 721: recognize no gain or loss from transfer of property to a partnership

in exchange for interest in partnership Tax-free rollovers

Sale of principal residence §121: (check stat volume and limitations)o Taxpayer can exclude $500,000 from gross incomeo Of gain on the sale ofo Taxpayers principal residenceo See limtation calculationo 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

period–excluding real estate owners Allowance of losses § 165

If loss is not allowed by 165 analysis doneo Losses incurred in a trade or business or into a transaction entered into

for-profit–and certain casualty losseso Does not allow capital losses

If loss is allowed by 165 then determine if barred by 267o §267 disallows deductions for losses on sale or exchange of property to a

related persono a loss disallowed to transfer cannot be deducted by transfer or when the

transferee sells the property to an unrelated party

37

o purpose: disallow deductions for ostensible losses resulting from sale of property to related parties at a bargain price

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

recognized gains must usually be characterized in the year recognized 1222: capital gain/loss = gain/loss from sale or exchange of capital assets 1221 capital asset = property other than that excluded by 1221a1-8 (securities,

unimproved land for investment, personal residence) long-term versus short-term 1231 assets held for more than one year–property used in trade or business 61a3: capital gains must be fully included in gross income I’m recaptured again 1250 Casebook 642 steps

Taxable year gain or loss will be reported

TAXATION: WHO IS THE TAXPAYERGenerally:

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 incomeIssue/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 TP’s may file jointly —Revenue 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), Seaborn lived in Washington, which was a "community property" State. Seaborn worked and his wife didn't. Seaborn filed separate tax returns for both himself and his wife, each

reporting 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

38

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.

Marriage and income taxIssue: STRUCTURING MARRIAGE TO AVOID TAXRule:Analysis: CB 471/441—EE 420

Marriage penalty & marriage bonus if marriage/divorce arranged to avoid tax, the courts may rule TP’s married or divorced for income tax

purposeso state law implicationso 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

But see: Transactions with(out) economic substance—see CB update pg. 15: §7701: structuring finances and motive to avoid tax

§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 propertyIssue:

Who pays the tax on income from property? Income shifting

Rule: TP must include income from property in his income—even where gifted to another §102(b); Helvering v. Horst

(Generally, tax liability for income attaches to the owner of the property. However, disposing of income already vested is the equivalent of ownership—therefore, tax liability will attach to a (the) donor)

Analysis: 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

Even if he gave it to his son Code: § 102(b)(2):

TP must include in income Income from property Where transferred as a

gift, bequest, devise, or

Donee not taxed § 1.102(e) Codified Helvering v. Horst

Property or Services (review) Right to collect future payments for services already performed is property which may be assigned

—Helvering v. Eubank (following Horst) 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

§ 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 Doesn’t apply if earned income exceed ½ child support for yro Earned income: from performance of personal services/ self-employer

39

Taxed at child rateo 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.

40