FACTORS IN THE DETERMINATION OF GAIN 115I. § 1012 : Basis of Property = Cost

a. § 1011 : Says to use § 1012 AB to determine gain or lossII. § 1016(a)(1) : Allows TP to ↑ or ↓ AB for expenditures and losses properly attributable to capital accountsHISTORY OF INCOME TAX AND RELATIONSHIP W/ © 5-17I. The four major issues in taxation

a. Is it income? c. When is it income?b. Whose income is it? d. Rates

II. Backgrounda. History of federal income taxation (pp 5-10)

i. Laws Prior to 19391. 1791-1802 First income tax, consumption tax, small amount, repealed in 18022. 1813-1818 Income tax to fund War of 1812, consumption tax3. 1818-1861 No income tax4. 1861 Tax on income and real prop, only collected tax on real prop and $ was returned to state5. 1862-1873 Basis of present taxation, created IRS, taxed everything possible of contrib $6. 1939 Codification of existing IR laws7. 1954 Wholesale revision of IR law, several other later revisions8. 1986 broadbased, simple, fair and revenue neutral (not productive of greater or less amounts of

revenue), reduced max tax rate ↓ from 50% to 28%a. Similarities – These are all luxury goods.b. Why only those three dates? Pay off Revolutionary War, War of 1812, Civil Warc. How was the federal government raising $ -- Selling native american landd. Reason for Change – Ran out of land, clear they were re to get involved in WWIe. Could they have gone for a VAT? – Sure, b/c it is indirect (but difficult to administer) –

Income tax then only req’d 1% of population to pay9. 1913-1942 Only top 1% of the population paid taxes

a. In the middle of WWII and there is no $ b/c of Great Depressionb. 1942 :: “When the class tax became the mass tax.”

ii. Federal Income Tax1. Most ppl pay more taxes to state and local tax (property especially)2. Income Ppl pay > in federal SS tax than income tax3. How else do governments raise money – fines and penalties, user fees (i.e. hunting licenses),

natural resources directly, right to extract natural resources, borrowing, conquest, foreign aid4. Types of Taxes :

a. How do you differentiate one tax from another:i. Direct v Indirect Taxes

1. Direct Tax – Tax on the thinga. i.e. Real Property Taxes – Local taxes in U.S. b/c of © -- Whoever the taxing

authority is sends an appraiser out to evaluate each piece of property.2. Indirect Tax – Tax on the transaction in the thing

a. i.e. Real Property Transfer Tax – This juris would have real prop tax as well, may have different agency – Only applies when property is sold

ii. Tax Base – Thing that’s taxed1. Excise Tax – Amount Tax2. Sales Tax – Cost Tax

a. Difference is tax base.iii. Tax Trigger

1. Passage of Time 2. Sale/Occurrence of Event

b. Sales Tax – Indirect Tax, Cost Tax, Trigger is sale of productc. Excise Tax – Indirect Tax , Amount Tax,

i. Often used on things that the govt wants to discourage the use of

d. Wealth Taxes – Direct Taxi. i.e. Real Property Tax, Car Tax

e. Wealth Transfer Tax – Indirect Tax, Cost Tax,i. i.e. Real Property Transfer Tax, Death Tax

f. Income Tax – Not clear whether direct or indirect tax, but SCOTUS says it’s a direct tax in the late 1800s This made income tax un-©, which req’d 16th amend

i. Triggers – Passage of time & realizationg. Consumption Tax – Indirect tax on transactions, tax base is consumption, trigger is

consumption – Most popular taxes in the world and are ©, basic tax in Europei. Reason for Resistance : Regressive Tax – Rich gets richer

ii. i.e. VAT – Value Added Tax – Taxes at each stage of production – Value of Finished Product at that stage minus value of product as it arrived at that stage

1. All the final tax is embedded in the final price of the goodh. Use Tax – Some call tax, some call fees

i. i.e. Tolls on roads5. How do you choose a tax?

a. First – Dangerous endeavor (basis for several revolutions) i. Watch for : cultural sensitivity, infrastructure (can you do it?), and politics

b. Early America (Several Languages, Several Currencies)i. Excise Tax + Easy and straight forward, social impact (slaves); - Problem :

Enforcement1. British only had power over ports – Taxes on manuf b/c they wanted to

discourage manuf2. The British were limited in the availability of different tax vehicles -

ii. Wealth Tax + Not as transient, ability to pay, stable & pro government - Not enough people, not enough revenue

iii. British centered their taxes at the port – Excise Tax or Tariff/Duty 1. Stamp Act Commodity that travels, only want it to be taxed once – Put a

stamp on it (i.e. cigarettes)b. Reading Treasury Statutes

i. Regulations relating to § 61 of the statutory would be : 1.61, 2.61, 25.61ii. Prefixes for Regulations

1. 1. Income Tax2. 20., 25., 26. Gift and Estate Tax3. 301 Procedure

c. Income tax and the U.S. Constitution (pp 10-17)i. Constitution Limits ability to tax based on experience w/ British

ii. Power to Tax Art. 1, § 8 “the power to lay and collect taxes, duties, imposes and excises”1. Very extensive power w/ two qualifications : Congress must impose direct taxes by the rule of

apportionment, and indirect taxes by rule of uniformity.a. Congress can NOT lay direct taxes without UNIFORMITY and APPORTIONMENTb. According to Prof, no requirement on indirect taxes

iii. Direct Tax Tax demanded from the very person who is intended to pay it. i.e. Flat tax on all ppl1. Congress does not enact direct taxes, unless the income tax is still properly so classified

iv. Indirect Tax Tax paid primarily by a person who can shift the burden of the tax to someone else or who at least is under no legal compulsion to pay the tax. i.e. Sales tax b/c imposed on seller who may shift to purchaser and may be avoided by not buying item

1. Why have the two taxes : Indirect taxes support agrarian economy b/c they are not involved in transactions.

2. Why can federal government NOT tax land : b/c it is a direct tax and would be not work in actuality b/c colonies w/ a lot of land did not have a lot of population and would end up paying the most and since they had such a small population, the majority would vote for them

3. THESE RULES WERE PUT IN TO PROTECT SOUTHERNER’S LAND AND SLAVES .

v. Uniformity Requires that Congress not establish different rules for different states, BUT does not apply to courts (i.e. different COA have different rulings)

vi. Apportionment Among the States After Congress has established a sum to be raised by direct taxation, the sum must be divided among the states in proportion to their respective populations

1. The tax burden for each state has to be determined by the state’s population.2. Country has state A (50 ppl) and state B (10 ppl). If the country needs $60, it must make sure that

state A gives $50 and state B gives $10 BUT this does not mean that each person must give $1. It could get $50 from one person in state A.

a. One Way To Do This : Say to state A, you come up with $50b. Another Way To Do This : Per Capita Tax – Only way federal govt could administer a direct

tax other than by forcing state to make decisioni. Poll Tax : Tax you pay to vote

3. Pollock v. Farmers’ Loan & Trust Co. (SCOTUS 1895) – Held un-© a tax on income rents from real estated b/c the drafters of the consts sought to prevent the imposition of tax burdens on accumulations of property, except in accordance w/ the rule of apportionment

vii. 16th Amend Income taxes shall not be subject to the rule of apportionment regardless of the sources from which the taxed income is derived

1. Income taxes still subject to rule of uniformity2. Passed in 1913 – Allows income tax without apportionment.

viii. Due Process Congress can use taxing power in retrospective manner – Congress may impose an income tax measured by the income of a prior year or by income of the year of the enactment earned before the enactment date

1. Fifth amend is not a limitation upon the taxing power conferred upon Congress by the © ix. Self-Incrimination -- Req’ing a taxpayer to file an income tax return does not violate 5th amend req’t that

one not be req’d to witness against himself – Must raise objection in the return itselfPROCEDURE AND PROFESSIONAL RESPONSIBILITY 964I. Tax Audits / Examinations

a. Three Types (In order of preferred for TP) : Correspondence Exam, Office Exam (IRS office), Field Examb. IRS Responses After Audit

i. “No Change” Letterii. 30-Day Letter (Not Mandatory): Form letter which states the proposed adjustments – Tells TP that

w/in a stated period (usually 30 days, TP may request an administrative review1. Why it’s advisable to pursue administrative review : Vast majority of cases settle out of

court, May not get reasonable attorney fees, unreasonable failure to pursue administrative remedies is grounds for a penalty for frivolous law suits in tax court

iii. 90-Day Letter (Mandatory): After TP has asked for administrative review and it is finished : TP has a right to this letter : Letter must indicate the 90th day, by which TP must file petition in the Tax Court for a “redetermination”

1. Form 870 : Waiver of one’s statutory rt to receive a 90-day letter2. Form 872 : Authorizes an extension of the SOL period (more time for negotiation, b/c the 90

day letter will toll the SOL statute)iv. Tax Court : If this is chosen, TP gives up ability to file a claim for refund and then a suit in District

Court or the Court of Federal ClaimsII. Refund Claim by TP

a. Stars w/ amended tax return – Form 1040X – This must be done before pursuing other avenuesIII. Administrative Responses to Audit or Refund

a. Closing Agreements : Binding agreements w/ TP and administrative officials w/ regard to their liability for or payment of tax

b. Compromise Agreement : IRS allowed to compromise when there is (1) doubts as to liability, (2) doubt as to collectibility, or (3) an effort to promote effective tax administration

IV. Judicial Procedures 973a. Tax Court – Tried w/o jury

i. If TP pays < the full deficiency prior to start of trial, this is the only avenue available to him

b. Refund Suit in District Court – Must pay the claimed deficiency before suing (so as to avoid interest payments) – Get a jury trial

c. Refund Suit in Court of Federal Claims – No jury triald. Old Rule : Rebuttable presumption that IRS is right

INNOCENT SPOUSE RULES 988 – An innocent spouse generally may elect relief when the other spouse made an erroneous understatement of items of which the innocent spouse was unaware, where the spouses are no longer married or libing together or in other situations where equitable relief is justified.INTRODUCTION TO INCOME 46I. § 61 :: Gross Income = All income from whatever source derived EQUIVAOCAL RECEIPT OF FINANCIAL BENEFIT 47I. § 1.61-1 : GI includes money, property, or servicesII. § 1.61-2(d) : If exchange service for service, must include service in GIIII. Cesarini v US – pg 47 (N.D.OH 1969) – Found Money

a. Facts – TP bought used piano in 1957. In 1964, TP discover $4.5K in the piano. TP filed taxes on it under OI, and then requested refund.

b. TP’s claims for why it wasn’t income:i. Not gross income,

ii. If GI, then in 1957 when piano bought (SOL has now ran out)iii. If GI this year, then capital gains

c. Holding – Ct held that the $ was OI d. Rationale – (1) Look to § 61 and see if it falls into “all income from whatever source derived”; (2) Look in the

exclusions and see if it is in there If no specific exclusion, then it isn’te. ROL – Taxes due when treasure trove reduced to undisputed possession (undisputed possession determined

by state law, here OH law req’d “finding” it for superior title)IV. Old Colony Trust v Comm – pg 52 (SCOTUS 1929) – Discharge of Indebtedness by Third Parties

a. Facts – TP’s © paid his income tax so that TP’s net income would be $1M. The IRS says that this is taxable.b. Holding – The amt paid by TP’s © for TP’s income tax is OI to the taxpayer.c. Rationale : Tax was paid by the ER in consideration of the services rendered to it by the TP, therefore income

under § 61.V. Comm v. Glenshaw Glass – pg 54 (SCOTUS 1955) – Punitive Damages

a. Issue : Are punitive damages taxable in GI.b. Holding : Punitive damages are income.c. Undeniable accessions ot wealth, clearly realized, and over which the TP have complete dominion and

control.VI. Charley v Comm – pg 58 (9th Cir 1996) – Frequent Flyer Miles Converted to $

a. Facts – TP upgrades his seat selection using frequent flyer miles, but charges his clients for the price of a first class ticket, thus getting $ from his frequent flyer tickets.

b. TP’s Argument for Why No Tax – No taxable event has occurredc. Two Alternative Holdings on Why Income – Additional compensation from ER or Gains from dealings with

propertyINCOME W/O RECIPT OF CASH OR PROPERTY 64I. Dean v. Comm – TP living in house owned by a © of which him and his wife were the sole SH, had to include the

value of renting the house in his GIII. Rev Ruling 79-24 : Members of barter club must include the FMV of services rec’d in GIDETERMINATION OF BASISI. COST AS BASIS

a. Philadelphia Park Amusement Co v U.S. – pg 116i. Facts – Ct is trying to determine the costs basis of the 10-year extension of TP’s franchise. TP claims

that 10-year extension is worthless or cannot be determined.ii. Why Ct rejects AB=FMV Given :

iii. ROL – Measure AB by the FMV of the item RECEIVED. │ § 1012’s cost means TAX COST not economic cost

iv. ROL - Following a taxable exchange the taxpayer's basis in the property he received in the exchange is always equal to the fair market value of the property received. Therefore, a taxpayer can always determine his or her basis in something exchanged, because it will be the value of the thing it is exchanged for.Philadelphia Park demonstrates that the taxpayers' basis in the thing he/she received must be the fair market value of the thing at the time of receipt.

II. PROPERTY ACQUIRED BY GIFTa. § 1015(a) – Donee receives donor’s basis in the property unless (a) the FMV at time of gift is lower than

donor’s AB and (b) donee sells at a loss [then donee uses FMV as AB] Loss Basis Rulei. Exception to Above Rule : Reg § 1.1015-1(a) : If donee sells for a loss that is an amount < donor’s AB

and > than FMV at time of gift, then the transaction is neither a gain nor a loss.b. § 1015(d)(1)(A) – Any gift tax paid ↑ the ABc. Taft v Bowers – pg 120

i. Facts – TP rec’d stock from father. TP sold shares. TP taxed on [Price Rec’d – Price F Paid]. TP believes it should be [Price Rec’d – Mkt Value of Shares when TP Rec’d].

ii. Ct rejects TP’s argument b/c it would be contrary to Congress’ intentd. Farid-Es-Sultaneh v Comm – pg 122

i. Facts – TP receives shares as part of a pre-nuptial agreement. TP signed form saying the shares were a gift, however, TP released all of her marital rights.

ii. TP’s Argument – Basis is value on day she acquired them b/c she purchased themiii. IRS’ Argument – Basis is H’s cost basis b/c this transaction was a giftiv. Ct holds that this was not a gift, despite the fact that the signed agreement said it would and it

would be classed a gift under gift tax law.e. Part Gift/Part Sale

i. § 1.1001-1(e) : G or L for Transferor : Transferor has a gain to the extent that his AR exceeds his AB in the property. Transferor gets no loss if AR < AB.

ii. § 1.1015-1(d) : Recipient’s AB : Sum of (a) any amount of gift tax and (b) the greater of (i) amount paid by the recipient for the property or (ii) the transferor’s AB in the property.

f. Bargain Sale to Charityi. § 1011(b) – If TP does a bargain sale to charity, his AB for determining the gain from such sale is

(X/AB)=(AR/FMV)III. PROPERTY ACQUIRED BETWEEN SPOUSES OR INCIDENT TO DIVORCE

a. Introductioni. Historically IRS taxed transfers among spouses, but now they are treated as single entity w/ no tax

b. § 1041 – Accords almost complete tax neutrality to transfers of property between spouses and between former spouses if, in the latter instance, the transfer is incident to divorce.

i. Under § 1041, the basis transfers. Unlike the gift basis rule, the § 1041 transferee always takes a transferred basis, even for computing loss.

c. Incident to Divorce Req’ts (§ 1.1041-1T(b)) either:i. The transfer occurs not more than one year after the date on which the marriage ceases or

ii. The transfer is related to the cessation of marriage1. Pursuant to a § 71(b)(2) divorce or separation instrument and w/in 6 years of the date the

marriage ceases Automatically related to the cessation of marriage2. Any transfer pursuant to a divorce or separation instrument but not w/in 6 years of the date

the marriage ceases Presumed not to be related. Can be rebutted by:a. Showing that the transfer was made to effect the division of property owned by the

former spouses at the time of the cessation of the marriagei. Requires showing (a) there was some factor that impeded earlier transfer

(legal, business) and (b) the transfer was made promptly after the impediment was removed

----------------DIVORCE AND SEPARATION------------ALIMONY AND SEPARATE MAINENANCE PAYMENTS 196I. Direct Payments

a. Historically : Alimony payments nondeductible for paying spouse and were not income for receiving spouse

b. General Rule Now : Deductibility (§ 215) by paying spouse is made dependent upon includibility of the payment in the gross income of the recipient spouse (§ 71)

c. § 71 – Makes alimony payments includable │ § 215 – Makes § 71 alimony payments deductibled. Requirements for Taxable and Deductible Alimony

i. Cash, Check or Money Order (not promissory note or property) § 71(b)(1)ii. The payment is received by, or on behalf of, a spouse under a divorce or separation instrument §

71(b)(1)(A);iii. The divorce or seperation instrument does not designate the payments as a non-alimony payment §

71(b)(1)(B);iv. In the case of a decree of legal separation or of divorce, the parties are not members of the same

household at the time the payment is made § 71(b)(1)(C);v. There is no liability to make any payment in cash or property, after the death of the payee spouse §

71(b)(1)(D); and1. This can be a state statute2. If the decree calls for say 10K of 30K annual alimony to continue after death for trust for

children, then only 20K of the annual amount would deductible/includiblevi. The payment is not for child support. § 71(c)

e. § 71 and § 215 only applicable to TP in one of the following four situations: (1) Divorced; (2) Legally separated by decree; (3) Married but payments are directed by a written separation agreement; or (4) married but payments are directed under a support decree

f. § 71(f) – Alimony Recapture Provision – Useful when TP try to disguise $ settlements as alimonyi. Overview – Under § 71(f), when inordinately large amounts of alimony and support are paid in the

first or second year in relation to year three, an amount is recaptured in year 31. Application : Doesn’t reopen past years, if guilty, reverses roles in year 3 (recipient

deduction and payor inclusion).2. Simple Rule : If yr 1-3 payments are all w/in 15K of each other, no recapture

ii. Process to determine whether or not § 71(f) applies1. Determine second-year recapture under § 71(f)(4) – If the payments in the 2nd yr exceed

payments in the 3rd yr by > $15K, then there is a recapture of excess in third year2. Determine the first-year recapture under § 71(f)(3) – If the payments in the 1 st year exceed

the average payments in the 2nd yr and the 3rd year (after reducing 2nd yr payments as determined in step 1) by > 15K, then that excess amount is recaptureed in the third year.

II. Indirect Paymentsa. I.T. 4001

i. Husbands wants to deduct two different income policies:1. Life insurance policy assigned to former wife and she is irrevocable beneficiary. –Includable

in wife’s income under § 71(a) and deductible for husband under § 2152. Life insurance policy not assigned to wife and with respect to which she is only the

contingent beneficiary – Not deductible/includibleii. ROL : Spouse must be absolute beneficiary for deduction and inclusion

b. Alimony definition explicitly contemplates payments made indirectly to the payee § 71(b)(1)(A)c. General Rule : To the extent that payments are made merely to maintain property owned by the payor

spouse which is simply being used by the payee spouse, they do not qualify as indirect alimony payments.PROPERTY SETTLEMENTS 209I. US v. Davis – SCOTUS held that H was taxable on the gain in his separate property when property transferred to

wife in satisfaction of her dower rightsa. § 1041 only reverses Davis for narrow situation of interspousal transfers of property and transfers between

nonspouses incident to divorce, the holding has continued vitality in all other situations involving the transfer of property in discharge of obligations.

II. § 1041 – Reverses Davis – Provides a clear nonrecognition rule for gains and losses with respect to any transfer of property between married persons and also between formerly married parsonsa. Any transfer of property incident to a divorce will be treated like a gift

III. Young v. Comm – pg 213 (4th Cir 2001)

a. Facts : H and W divorce and H gives W a promissory note for 1.5M over 5 yrs w/ annual payments and interest. The note was secured by a deed on a 71 acre property. H defaults on loan. W sues H. H enters new agreement w/ W and gives her 59 acres (part of the 71 acres) but keeps option on property for $2.2M. H sells option and it is exercised. IRS is claiming that W owes the appreciated value of the land.

b. Holding : The transfer was related to the cessation of marriage.i. Wife’s Argument : She was not a “spouse,” but judgment creditor. BUT law looks at character of

transfer, not statusOTHER TAX ASPECTS OF DIVORCE 218I. Child Support

a. General Rule : Alimony is reduced by the amount of child support.i. A payment will be treated as payable for the support of a child of the payor spouse if the payment is

reduced (a) on the happening of a contingency relating to a child of the payor, or (b) at a time which can clearly be associated with such a contingency.

1. Where payments are to be reduced not more than 6 months before or after the date the child is to attain the ages of 18, 21, or local age of majority

2. Where payments are to be reduced on two or more occasions which occur not more than one year before or after a different child of the payor spouse attains a certain age between ages of 18 to 24 – the certain age must be the same for each such child, but need not be a whole # of years

II. Alimony Payments Made by a Third Partya. Annuity Payments – Lump sum transfer by a payor spouse that does not go directly to payee spouse but

which generates periodic income rec’d by payee – No payment by the payor, even indirectly to payee, which would qualify as alimony or separate maintenance.

i. This is b/c the income would not be includable in payor’s GI b/c payor no longer owns propertyb. Alimony Trusts – § 682 controls – Income from such trusts, excluded from payor’s gross income (property

put into trust becomes payee’s property), is taxable to payeeIII. Divorce

a. Complicated issue of what is a divorce decree, getting divorce decrees after the fact in Mexico, etc.RANDOMI. Basis

a. Functions of Basisi. Track income that was already taxed to one TP one time (§ 1012 cost)

ii. Exclude income (i.e. § 1014 date of death FMV basis)iii. Defer income § 1019/§ 109 │ § 1041(b) transfers b/w spouses │ § 1015(a) gift basis

II. Termsa. FMV : What a willing buyer and a willing seller both with full knowledge of all material facts would pay

i. Alternatives to FMV : Replacement value, stream of income (look at income generated compared to average annual interest rate, i.e. 5% return standard and the home generates 10/yr, would estimate value of house at $200, because 200(.05)=10).

III. Taxation Presumptions (Rebuttable)a. Presumption For Taxationb. Presumption Values of Items = If Conducted at Arm’s Lengthc. Presumption Against Exclusions and Deductions

THE AMOUNT REALIZED 132-152I. Definition : Sum of $ rec’d + FMV of the prop § 1001(b)

a. FMV of prop is a ? of fact – $0 FMV req’s rare and extraordinary case § 1.1001-1(a)b. Includes amount of liabilities discharged § 1.1001-2(a)

i. Ex : A borrows 10K to buy widget. Two years later, A has depreciated $3K from widget and has paid back $4K. If A sells widget to B for $1K plus B assuming payments on note, A’s AR is 7K (1K + 6K) and his AB is 7K (10K – 3K). This is true whether A is personally liable for the debt or not.

c. Int’l Freighting Corp v Comm – page 132i. Facts – TP (company) gives bonuses to employees of stock in another company. Stock cost TP 16K

but worth 25K when given. TP deducted full FMV. IRS claims TP can only deduct cost.

ii. Holding – TP can deduct FMV, but must pay taxes on the gain (25K-16K)iii. Rule – B/c shares were just compensation and not a gift closed transaction w/ clear amount

realized.iv. Rule – Include services in AR (not in statute)

d. Crane v Comm – pg 135i. Facts – TP rec’s prop via will. Prop has mortgage = to FMV of prop. TP keeps prop and records

deductions. TP cannot make payments and sells prop for 2.5K and transfers mortgage. TP claims she cannot take deductions b/c she was not personally responsible for loan. Crane was non-recourse debt that she could have walked away from.

Taxpayer IRSAR : 2.5K [3K rec’d - .5K sale expenses] AR : 257K [250K mort principal + 2.5K]Less AB : 0 [equity def’n (FMV of house rec’d – mort)] Less AB : 178K [262K FMV of home rec’d – 28K

deductions]ii. Rule – Amount of mortgage must be included in AR irregardless of personal liability.

iii. Dissent – She had nothing when she acq’d prop and only a small margin when she sold prop.iv. Rule –

1. Basis – Include debt used to purchase property in basis 2. AR – Include discharged debt in AR

e. Comm v Tufts – pg 143i. Facts – TP has mortgage on prop for 1.85M. Takes 400K in deductions. Transfers interest in property

and mortgage to S. At time of transfer, FMV of prop is 1.4M but TP still owes 1.85M.ii. Ct holds that it does not matter if TP is underwater on loan, AR = $ + Amt of Mortgage transferred

Taxpayer IRSAR : 1.4M [FMV of prop] AR : 1.85M [Amount of mortgage assumed by S]Less AB : 1.455M [1.85M – 400K in deductions] Less AB : 1.455M [1.85M – 400K in deductions]

BUSINESS DEDUCTIONS 318-349I. Requirements for a deduction § 162:

a. Ordinary “Life in all of its fullness” Welch │ Would similarly situated businesspeople think it was ridiculous? Facts and Circumstances Test Welch

b. And Necessary “appropriate and helpful” Welch │ Deference to TP herec. Expenses Expenses must last < one year │ § 263 – No deductions for capital expendituresd. Paid or Incurred When is it income?e. During the taxable year When is it income?f. In pursuit of trade or business

II. Overviewa. Two Types : (1) Above the Line and (2) Below the Line (only available for individuals and usually have limits)b. Rationales : Charity, encourage or discourage behavior, distortions of income or clearly reflected income

III. Casesa. Welch v Helvering – pg 320

i. Facts – TP worked for © that went bankrupt. TP begins working for new ©. TP uses some of his income to pay discharged debts from old © to rebuild his reputation and wants to deduct those expenses.

ii. Holding – Money paid to rebuild reputation is a capital expense, not a deductioniii. Rule – Ordinary : “Life in all of its fullness” │ Necessary – “Appropriate and helpful”

b. Midland Empire Packing Co v Comm – pg 325i. Facts – TP operated meat smoking business in basement. Basement previously leaked H20, but this

was not a problem. Now basement leaking oil from nearby factory. TP pays to have basement oilproofed, which also now keeps out water. IRS says capital expense and TP says expense.

ii. Holding – This was a repair and not a replacement and thus an expense.iii. Rule – To repair is to restore to a sound state or to mend, while a replacement connotes a

substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition.

c. Mt. Morris Drive In

i. Facts – TP has to create new drainage system to protect neighbors from flow of H20 from TP’s land. Ct holds this is a capital expense.

ii. Key Difference from Midland Packing : In Midland, the basement already existed. In Mt. Morris, the drainage did not already exist

d. § 264 – Negative Code Provisions Not Allowing Some Expensesi. No deductions for “permanent improvements or betterments” and for “any amount expended in

restoring property or making good the exhaustion thereof for which an allowance is or has been made” and for “amounts spent to adapt property to a new or different use.”

ii. Not relevant if action taken pursuant to ct ordere. INDOPCO = pg 333

i. Facts – TP is © that is peacefully taken over by another © and wants to deduct professional fees paid to facilitate transfer. TP argues that it did not create a separate and distinct asset but ct says it now only has 1 SH and benefitted from the transaction.

ii. Rule – Creation of a separate asset may be sufficient to req capitalization of an expenditure, it is not a necessary condition. – Creates a significant future benefits standard.If you enhance something enough so that you changed it, then = capital expense

iii. Lincoln Savings (Case TP in INDOPCO Relies On) – FDIC started new acct and req’d banks to contribute $ for new acct in case there was a run on the banks. Bank wanted to deduct the new $, but ct said no, because the new acct was a “creation or enhancement of an asset.”

f. Post-INDOPCO IRS Regulationsi. Generally require capitalization of:

1. An amt paid to acquire, create, or enhance an intangible asset2. An amt paid to facilitate an acquisition or creation of an intangible, and3. An amount paid to facilitate a restructuring or reorganization of a business entity or a

transaction involving the acquisition of capital, including a stock issuance, borrowing, or recapitalization

g. Morton Frank v Comm – pg 341i. Facts – TP want to deduct expenses for traveling while searching for a newspaper to buy. Ct says

that TP cannot deduct the expenses b/c the TP were not engaged in any trade or business at the time the expenses were incurred.

ii. Rule – “Pursuit” in § 163 does not equal “searching for” BUT does equal “in connection with”h. § 195 – Startup Costs

i. TP can deduct up to $5K, but amt reduces by amy amt that > than 50K (thus phases out at 55K)ii. TP must actually enter a trade or business successfully to elect § 195

f. Employment Search Costsi. Deductible, whether successful or not, so long as NOT (1) first job; (2) lengthy unemployment; or (3)

new trade or businessMISCELLANEOUS BUSINESS DEDUCTIONS 395-403I. Business Meals and Entertainment

a. Old Rule : TP rec’d a lot of leeway here and ct did not require absolute certainty.i. § 274 created to narrow § 162’s deduction for meals and entertainment

b. § 274’s Principal Limitationsi. Only get a 50% deduction

ii. Meal/Entertainment must be “directly related to” or “associated with” the TP’s trade or business1. But Leg His suggests that meals are deductible even if eaten alone if out of town

c. Sutter : Ct sustained IRS’ disallowance of a deduction for TP’s own meals at business lunches where TP couldn’t prove that the expenses incurred exceeded TP’s normal meal costs Only applied in “abuse cases where TP claim deductions for substantial amounts of personal living expenses”

II. Facilitiesa. Expenses respecting entertainment facilities are non-deductible under § 274(a)(1)(B)

i. Limitations:1. Expenses of facilities to the extent used in business for non-entertainment purposes remain

deductible

a. I.E. Airplane used for business travel and not entertainment2. Entertainment activities related to the use of such facilities remain 50% deductible if the

rules for deduction of entertainment activity expenditures are satisfieda. I.E. In ski trip, lift tickets, ski rentals and meals are deductible but not chalet cost

b. No deduction for dues to any club organized for business, pleasure, recreation, or other social purpose § 274(a)3

III. Sporting Eventsa. Scalper premiums are non-deductible and cost of skyboxes (beyond price of regular seat) are non-deductible

IV. Substantiation Requirementsa. § 274(d) – Impose stringent documentation req’ts on expenditures > $75.

V. Randoma. Uniforms : Deductible only if (1) uniforms are spec. req’d for employ and (2) not adaptable to general usageb. Advertising : Generally deductiblec. Campaign Contributions : Non-deductibled. Dues : Deductible if paid to organizations directly related to one’s businesse. Lobbying Expenses : Non-deductible

BUSINESS LOSSES 403-406I. § 165(c)(1) permits deduction of business loss only if “incurred in a trade or business”

a. Realized : Loss must be realized Loss must be evidenced by a closed and completed transaction such as a sale, or fixed by an identifiable event, such as a fire

II. Demolitions of Buildingsa. NO deduction for structure or expenses incurred in demolitionb. Costs of structure removed and expenses are added to the basis in the land (meaning not depreciated)

DEPRECIATION 406-431I. Pre-requisites for Deduction

a. § 167(a) and § 168(a) restrict the depreciation deduction to either (1) prop used in a trade or business or (2) prop held for the production of income.

i. Thus, inventory and property held for sale to customers are placed outside the scope of the section.b. Useful Life :Prop must have an identifiable useful life to the TP to qualify for a deduction │ W/o useful life

prop is “nondepreciable”i. Unless Congress makes a useful life for intangible property like goodwill

II. Relationship of Depreciation to Basisa. AB goes ↓ irregardless to whether TP claims no depreciation deduction – if adopts no method, then the SL

method is assumedb. If TP makes “erroneous” deduction that is allowed (i.e. not challenged), then AB is ↓ by erroneous

deductioni. Thus, in general, the plan has been to call for downward AB adjustment for depreciation “allowed”

but not less than the amount “allowable”ii. While “allowable” depreciation always works a reduction in basis, depreciation allowed in excess of

the amount allowable effects a basis reduction only to the extent that the excess resulted in a reduction of the TP’s taxes

III. Accelerated Cost Recovery System – § 168a. Overview

i. 1981 – Original/Old ACRS │ 1986 – Current ACRSii. Mandatory, not elective, however some elections allowed within the system

iii. Doesn’t apply to intangible property iv. If ACRS doesn’t apply, then § 167 does

b. Recovery Periodsi. Costs recovered over “recovery periods” which are generally shorter than useful lives

ii. Disregards salvage value in computation of depreciationc. Process

i. Prop is assigned a class lifeii. Prop is assigned a recovery period under the class life

d. Depreciation Methodsi. 3 yr, 5yr, 7yr, or 10yr classifications Qualify for 200% declining balance method of depreciation

w/ a switch to SL method for the year when that method yields a greater allowance1. TP can elect to use the 150% declining balance method or a SL depreciation method

ii. 15yr or 20 yr classifications Qualify for 150% declining balance method of depreciation w/ a switch to SL method for the year when that method yields a greater allowance

1. TP can elect to use a SL depreciation methodiii. Alternative (§ 168(g)) Uses SL depreciation w/ longer lives than the ACRS rules, causing a slower

depreciation of assets1. Req’d for some properties

e. Anti-Churning Rulesi. Apply if, and only if, the current ACRS rules allow the TP a more rapid writeoff in the first year the

prop is placed in service than depreciation allowed for that year by the rules under which the property was being depreciated by the related person

f. Sharp v US – (DE 1961)i. Facts – TP bought plane for $45K and made capital improvements for $10K, making plane worth

55K. Plane used ¾ for personal use and ¼ for business use. TP took $13K worth of deductions. TP later sold plane for $35K.

1. TP’s Argument : 55K – 13K depreciation = AB of 42K. Therefore, loss of 7K on sale (42K – 35K).

2. IRS’ Argument : Divide the original $55K into 15K for business use and 40K for personal use based on ¼ and ¾ . The personal use is not deductible. Therefore, subtract 13K in depreciation from $15K for business use, giving $2K of AB on business side and 40K on personal side. Now divide the $35K being paid for the plane by the ¼ and ¾ to get 9K and 25K. Then subtract the 9K in AR attributed to business and subtract the 2K of AB to get a gain of 7K. The loss on the personal use of the airplane is not deductible b/c of its personal nature and is disregarded.

ii. Holding : Ct adopts the IRS’ argument b/c the TP’s argument would suffer from a uniformity problem where TP having two business properties w/ the same cost and depreciation should pay the same taxes, if the prop are sold for the same price. The fact that one of the prop was also used for pleasure should make no difference.

iii. ROL : Allocation of the proceeds from the sale of this plane in accordance w/ its percentages of business and personal use is “practical and fair”

g. Simon v Comm (2nd Cir COA 1995)i. Issue – To what extent did the ACRS modify the useful life req’t.

ii. Facts – TP bought antique violin bows and want to claim depreciation on their use. 1. TP’s argument : Bows are depreciable b/c (1) tangible property, (2) used for trade or

business, (3) bow suffers wear and tear b/c of use2. IRS’ argument : Bows are not “property of a character subject to the allowance for

depreciation” b/c the bows have no useful life in general. Wear and tear happens to all equpment, therefore need a “determinable useful life req’t.”

iii. Holding – Ct adopts TP’s argument b/c IRS is wrong that all tangible items are subject to wear and tear.

iv. Dissent – Would retain the determinable useful life req’t for § 168 deductionsv. Meaning of “Subject to an allowance for depreciation”

1. TP and Tax Court said that the above is determined by looking at the individual TP and the individual TP’s use (almost a § 167 analysis)

2. Govt says that § 168 has created a new world and under § 168, we do not care how the property acts in your business, we just care whether or not the product is subject to an allowance for depreciation. Basically, most people would put the antique bows on display and not in fact use them. – Antique bows are not listed in the revenue procedures

IV. Depletion

a. Old Rule : TP could establish a value for certain natural resources w/in 30 days of discovery and write off that value as TP exploited the resource w/o regard to cost or other basis

b. Percentage Depletion : Determined by a stated percentage of the “gross income from the prop” subject to the allowance. – No ceiling on the amt of deductions that can be claimed and no limitation to cost or other basis or even to discovery value

SPECIAL DEPRECIATION RULES ON PERSONAL PROPERTY 431-442I. Overview

a. Most tangible personal property acquired after 1986 is subject to current ACRS rules (anti-churning still applies)

i. If prop is expressly excluded from § 168, § 167 appliesii. § 197 applies the rules for the write-off of many types of intangible properties

II. Three Alternatives Available Under Current ACRSa. If one qualifies for the 200% declining balance method, one may use the 150% declining balance method

(disregarding salvage) over the recovery period of the propertyb. Regardless of whether one qualifies for the 150% or 200% declining balance method, one may use the

straight-line method (still disregarding salvage) over the recovery period of the propertyc. Use the SL method w/ a generally extended life under the § 168(g) altnerative depreciation system

i. If any alternative is elected, the election is applied to all ACRS property w/thin the same class which is placed in service during the year of election

III. Conventiona. Current ACRUS uses the “half-year convention” – Convenience rule that treats prop as if it were palced in

service at the midpoint of the year, no matter when actually placed in servicei. If > 40% of the cost of all ACRS personal prop acquired during a year is placed in service in the 4 th

quarter of the year, the mid-quarter rule is invokedIV. Bonus Depreciation – § 179

a. Allows a TP to elect to write off a part of the cost of some depreciable personal prop as an ordinary expense deduction in the yr in which the prop is placed in service

b. Limits 2009 $250K, 2010 $125K, 2011-onward $25K │ Applies to all property, not each piece │ Limit is reduced by each dollar in excess of 2009 $800K, 2010 $500K, and 2011-onward 200K.

c. Only applicable to prop qualifying under ACRS or off-the-shelf computer software and which is acquired by purchase for use in the active conduct of TP’s business.

d. Basis of § 179 prop must be reduced before the prop is depreciated under § 168FV. Limits on Luxury Automobiles – § 280F

a. Generally cars get 5 yr recovery period, but cars costing > 12.8K by limiting deductions to a max of 12.8K over the first 5 years and $1.475K after that

b. “Listed Prop Limitation” : § 280F limits ACRS deduction for “listed property” (passenger cars, cell phones, etc) not used for > 50% of business use.

i. Listed prop w/ a business use of < 50% may only use § 168(g) alternative depreciation c. If the more-than-50-percent test is met for year that prop is placed in service, but is not met in a subsequent

year, all excess depreciation claimed in the first and subsequent years over the depreciation that would have been allowed using the alternative depreciation system is recaptured as ordinary income in subsequent years

VI. Amoritization of Goodwill and Certain Other Intangiblesa. § 197 – The AB of any § 197 intangible is “acquired” by a TP in connection w/ the conduct of a trade or

business or an activity engaged in for the production of income may be amoritized over a 15 yr period beginning w/ the month in which the asset is acquired.

i. Asset must be acquired – meaning not self-created unless it is created in connection w/ a transaction that involves the acquisition of a trade or business or a substantial portion thereof

b. Includes : goodwill (value attributable to expectation of continued customer patronage); going concern value (value attributable to the fact that the prop involves a going concern); certain specified types of intangible property that generally relate to workforce (composition of the workforce), information base (customer or subscription lists, etc), know-how (patents, copyrights, etc.), customers, suppliers, similar items (licenses, permit, right from govt, covenant not to compete, franchise, trademarks, trade name).

i. Does not include financial interest in ©,, certain financial K, patents and copyrights acquired in a transaction, much more

VII. Suggested Procedure1) § 179 – Determine if you are dealing w/ prop under ACRS. § 179 is applicable only to such prop and, to the

extent a § 179 write-off is taken, prop doesn’t receive the benefit of regular ACRS depreciation. Thus, one should make § 179 depreciation first

2) § 168(k) – Determine whether the add’tl 50% deduction is allowable under § 168(K) and whether an election out of the provision is made. The deduction may be taken in addition to a § 179 deduction, but basis adjustments are made after the § 179 deduction and prior to the § 168(k) deduction as well as after the § 168(d) deduction and prior to the regular current ACRS deduction

3) Regular Depreciation – Compute depreciation deductions under § 168 or § 167. Subject to principles of Sharp case, which allows depreciation only on that proportion of the property which is used in a trade or business or for the production of income.

4) § 280F – As a final step, if § 280F imposes limitations on the amount of depreciation or a recapture of depreciation, the limitation or recapture should be determined and applied to the computations.

SPECIAL RULES ON REALTY 442 – 446I. Residential Rental Property

a. SL Method : Depreciated using SL method (salvage value disregarded) w/ a 27.5 yr lifei. May opt for § 168(e) alternative w/ a 40-yr life │ Made on prop-by-prop basis, not class-by-class

ii. Mid-Month ConventionII. Nonresidential Real Property

a. SL Method : Depreciated using SL method (salvage value disregarded) w/ a 39 yr lifei. May opt for § 168(e) alternative w/ a 40-yr life │ Made on prop-by-prop basis, not class-by-class

ii. Mid-Month ConventionDEDUCTIONS FOR INDIVIDUALS ONLYCONCEPT OF AGI 548I. AGI only has relevance to individ TP and not to © TP, estates, trusts, partnerships, etc.

a. Usually includes social security benefits at some %II. § 62 – Lists the “Above the Lines” Deductions from GI so AGI can be calculated

a. Highly favored deductions b/c § 62 deductions allowed in entirety w/o regard to use of the standard deductb. Doesn’t authorize deductions, just ID’s deductions from other §sc. There are other deductions, but these are from AGI (so-called itemized deductions) and can be taken only as

elective itemized deductionsMOVING EXPENSES 551I. Moving Expenses

a. Rulesi. Includes cost of storage in-route, packaging and crating, lodging, and transportation. Does NOT

include meals.ii. If one TP in household is moving, all residences and members of TP’s household get deduction

iii. Must travel in a generally straight line to get deductioniv. Reimbursements : If reimbursed, then $ is included and then deducted – “washed out” – therefore,

not req’d to be reportedv. Foreign Moves : Allows the cost of storage and moving items to storage, not time req’ts if coming

back to retire in U.S. after living over seas.b. Must be:

i. Distance Req’t : > 50 miles farther than the distance between TP’s former residence and former principal place of work or > 50 miles from TP’s former residence

ii. Time Req’t : Must work > 39 wks during the 12-month period after arriving and > 78 wks during the 24-month period after arriving if self-employed

EXTRAORDINARY MEDICAL EXPENSES 556I. § 213 – Allows deduction for medical care for “diagnosis, cure, mitigation, treatment or prevention of disease”

a. Only allows deductions for amt that exceeds 7.5% of AGIb. No deduction for cosmetic surgery unless necessary b/c of congenital abnormality,personal injury, or trauma

c. Allows a limited $50 deduction for lodging while away from home if req’dd. Insurance premiums are deductible (§ 213(d)(1)(D) but self-employed individs can deduct under § 162( l)

II. § 213 [Medical Expenses] vs. § 162 [Business Expenses]a. § 162 preferred b/c there is no 7.5% req’tb. To be a § 162 expense, each of the following must be present:

i. The nature of the TP’s work clearly requires that he incur a particular expense to satisfactorily perform such work

ii. The goods or services purchased by such expense are clearly not req’d or used, other than incidentally, in the conduct of the individ’s personal activities

iii. The Code and Regulations are otherwise silent as to the treatment of such expenseIII. Raymon Gerard v Comm

a. Facts : TP wants to deduct cost of central A/C installed for daughter w/ cystic fibrosis on MD’s recommendation

b. Holding : TP can deduct the cost of the A/C minus the ↑ value of the property.c. Rationale : § 213 allows for the deduction, but § 263 excludes deductions for capital improvements.

Therefore, cannot get deduction for amt home value increases byd. ROL : When the medical care expenditure is a permanent addition to TP’s home, deductibility as a medical

expense depends upon whether it increases the value of the homei. If Home Value ↑ : Medical Expense Deduction = Cost of Medical Expense – Improved Value of Home

IV. Revenue Ruling 2002-19a. IRS holds that costs of weight loss programs are deductible for (a) ppl diagnosed w/ obesity and (b) ppl that

are recommended the program b/c of hypertension. i. TP may NOT deduct cost of reduced calorie food b/c they are substitutes for food A and B normally

consume and satisfy nutritional req’ts.QUALIFIED TUITION AND RELATED EXPENSES 567I. § 222 – Allows ATL deduction for qualified tuition and related expenses paid by TP during taxable year

a. Does NOT Include : Books, housing, sports and other feesb. Does NOT include : Amounts funded by § 117 or 127 excluded income (i.e. scholarships)c. TP must choose between § 222 deduction (up to $4K) and the § 25A credit (up to $2K).d. TP Income < $65K/$130K = $4K Max Deductione. TP Income < $80K/$160K = $2K Max Deduction

PERSONAL AND DEPENDENCY EXEMPTIONS 569I. § 151(b) – Automatic “personal exemption” for TP & spouse = 2K (indexed for inflation)

a. § 151(c) – Personal exemption for dependentsII. Requirements to have a qualifying child:

a. Child of TP (includes step-, foster, adopted), or descendent of child, or sibling of TPb. Same abode for > ½ of yearc. Less than 19 or 24 (if student)d. Individ provided < ½ of his/her own support

III. Requirements to be a qualifying relative:a. Not a qualifying childb. Related under § 152(d)(2)c. Dependent must not have earned $2Kd. TP must provide > ½ support

IV. § 152(d)(3) – Combined Support of Elderly – Those supporting elderly may agree that one of the group will be treated as though he provided over half of individ’s support for the year for purposes of the support req’t

THE STANDARD DEDUCTION 574I. Utility of Standard Deduction : Whether in the aggregate (after a 2% floor imposed on some itemized deductions

and a reduction in most itemized deductions of high-income TP) they exceed the standard deductionII. § 63 - Amt of Standard Deduction : 6K for married individ filing jointly and surviving spouses │ 4.4K for HoH │ 3K

for single individ │ 2.5K for married individ filing separately │ All are indexed for inflationa. If TP is claimed as a dependent, standard deduction may not exceed greater of (1) sum of $250 and TP’s

earned income or (2) $500.

b. Add’tl deductions allowed for elderly (> 65 before close of taxable year)and blind c. Add’tl standard deduction for state and local property taxes to the extent they are not deducted from AGI

$500/$1K.d. Standard deduction is the default and if TP wants to itemize, TP must indicate thise. One spouse cannot itemize and another spouse claim standard deduction

III. § 67 – Floor for Miscellaneous Deductions – Allowed only to the extent that their total amount exceeds 2% of TP’s AGI

IV. Comm v. Banksa. Facts – π were victorious π in other lawsuits. IRS wants to tax the contingency payments paid to attorneys as

income.b. π’s Arguments

i. Contingency is speculative & might be worth $0. │ Ct’s Response : Irrelevant that value may = $0ii. Attorneys must contribute work to win outcome. │ Ct’s Response : Not a JV, but principal-agent b/c

attorney obligated to act for π and π retains ultimate controlc. ROL – A TP cannot exclude an economic gain from gross income by assigning the gain in advance to another

party – Anticipatory Income DoctrineASSIGNMENT OF INCOME INTRODUCTION 250I. § 1(a)-(e) : Effective Tax Rates for Different Tax Filing Groups (Married Filing Jointly, Estates, Singles, Etc.)

a. § 6013(a) : No joint returns b/w married individ if have different taxable years (exception – death w/ no remarry w/in the year)

b. Generally no reason to file separately, b/c same tax owed even if one spouse earns nothing II. § 1(h) : Capital Gains RatesIII. Historically : There used to be much ↑ tax rates, so TP would play elaborate income shifting gamesIV. Tax Reform Act of 1986 : ↓ tax rates, but also ↓ ability of TP to shift income

a. Kiddie Tax – Child under 19 is taxed on all unearned income at parent’s tax rateb. Maximum tax rates for estates and trusts kick in at low levels

V. Why do we care whose income it is:a. Marginal Ratesb. AGI Limits (Lower AGI, typically means more deductible)c. Capital Gains (One thing that can’t be a capital asset is inventory. I.E. Art gallery would be taxed at an

ordinary rate if it sold a painting. BUT the studio’s child could see the painting and it would be a capital asset).

INCOME FROM SERVICES – ASSIGNMENT OF INCOME 252 --- MAKE SURE TO DETERMINE IF IT IS ASSIGNMENT OF INCOME OR ASSIGNMENT OF PROPERTY ---

I. Lucas v. Earl pg 252 (SCOTUS 1930)a. Facts – Attorney husband had a K with his wife automatically dividing half of everything they receive

between the two of them. Husband (TP) only wants to pay tax on ½ of his salary.b. ROL : Services are taxed to the party that performed the services c. Anticipatory Income Doctrine – One who is entitled to receive, at a future date, interest or compensation

for services and who makes a gift of it by an anticipatory assignment, realizes taxable income quie as much as if he had collected the income and paid it over to the object of his bounty.

d. Rationale : He was the only one who was party to the K by which the salary and fees were earnedII. Comm v. Giannini pg 253 (9th Cir. 1942)

a. Facts : TP worked as CEO for bank receiving 5% of bank’s profits. TP rec’d large amount half-way through year and then waived receiving the rest of his salary and indicated that he would prefer that the © donate his foregone salary. The © used his foregone salary to establish a foundation at Cal Berkley. IRS wants to tax the TP on his foregone income. The BoD determined that (1) TP never rec’d the $ and (2) TP did not direct the distribution of the $.

b. IRS’ Argument : Realization of income is all that is req’d, not receipt of income. IRS claims that it doesn’t matter that $ was donated, TP should be taxed even if he told © to keep the $.

c. TP’s Argument : TP has the rt to refuse property. IRS says maybe so, but here the TP had a contractual rt to the $.

d. Holding : Ct says that it cannot say a MOL that the $ was beneficially rec’d by the TP and therefore taxable.

i. Income when only one reasonable inference could be drawn from the evidence, which is that the donation is but a donation of the TP masquerading as a creature of the © to save the true donors some tax $.

e. Why This is Wrong : Ct got it wrong in not taxing Gianini’s July-November income, b/c he renounced in November after already earning it. Would have a contractual right to the $ and could sue if the BoD decided not to issue him the $.

f. Renouncement Rule (Gianini Going Forward)i. Must completely renounce (before having a contractual right to the $)

ii. Must not direct paymentIII. Revenue Ruling 66-167

a. Facts : ? over whether an executor who waives his statutory commission for serving as an executor realizes income.

b. Executor Rule : IRS says no income realization if (a) notice w/in 6 months that executor will not accept commission or (b) executor fails to claim fees at the time of usual accountings and all other attendant facts and circumstances are consistent with an intent to serve gratuitously.

IV. Revenue Ruling 74-581a. Facts : ? over whether the $ rec’d by professors for representing indigent clients as part of a law school clinic

and then instantly signing the checks over to the law school constitutes income. (Law school professors salaries cover the professors cost of participating in the clinics)

b. Holding : Not income. IRS lists other similar situations.c. Agency Law : He who acts through another acts himselfd. Agency Rule : Income you bring in as an agent for the principal is not taxable to the agent.

INCOME FROM PROPERTY – ASSIGNMENT OF INCOME 263I. Helvering v. Horst pg 263 (SCOTUS 1940)

a. Facts – TP gives interest coupons from a bond TP retains to his son. Son records the interest as income. IRS says that TP should include it as income.

b. Holding – The interest is taxable to the TPc. Reasoning – TP had economic gain when coupons vested. Realization doesn’t require TP to receive $. The

worth to the TP was derived from giving the coupons.d. ROL – The dominant purpose of the revenue laws is the taxation of income to those who earn or otherwise

create the right to receive it and enjoy the benefit of it when paid.II. Blair v. Comm pg 267 (SCOTUS 1937)

a. Facts : TP owned an income stream from a trust. TP didn’t own the residual amount in the trust. The TP’s income stream ended at his death. TP permanently assigned a portion of unearned trust income to children.

b. Holding : Not taxable to TPc. Difference b/w this and Helvering : The grant was a permanent, unequivocal grant in this case.d. Note : This is where income from services differs from income from property – Earl could not do thise. Whole Tree Transferring Rule : Complete transfer of a portion of all rights

III. Estate of Stranahan v. Comm pg 269 (6th Cir. 1973)a. Facts : TP had more available interest deductions than he had income. TP sells his son the right to receive

future dividends for a sum of $. IRS wants to tax those dividends when they are issued the next year even though they are going to the son.

b. Holding : Dividends are not taxable to TP b/c son gave ample consideration.c. Reasoning : TP’s son paid consideration to receive future income. Tax avoidance motivations will not serve

to obviate the tax benefits of a transaction. There was a risk to the son that dividends wouldn’t happen.d. Anticipatory Assignments for Value Rule [Can be done for services as well] – If you are receiving full value

for what you are assigning, then it’s allowed. Not an assignment of income, b/c just accelerated your own income.

i. Would not be okay : If at the time the father sold the dividends to his son, all the father had to do was wait for the payment, it would be too late.

IV. Susie Salvatore (TC 1970)a. Facts : TP’s husband leaves her the a gas station in his will. TP goes to sell the property and after signing the

sale agreement, conveys ½ of her interest in the property to her children. TP & Children then transfer title to

Amoco. TP then pays taxes on ½ of transaction. This would’ve been okay had she given the children the property before she signed the K to sell the property.

b. Holding : TP must pay taxes on the entire transaction.c. Reasoning : Tax liabilities cannot be altered by a rearrangement of the legal title after already K-ing for sale

of property. B/c she had already signed the purchase agreement. d. ROL : A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter

as a conduit through which to pass title.e. Ripe Fruit Problem : Fruit is “ripe” when there is a contractual/absolute right to it. Mere appreciation

doesn’t make it ripe.f. Difference b/w Salvatore and Stranahan : Stranahan’s right to the income wasn’t fixed at the time of the

transfer. Once the right is fixed, it has to be taxed to you.V. Revenue Ruling 69-102

a. Facts : TP had endowment life insurance and annuity K. Both had date at which $ would come out of the K’s. Payments were set in Year 1. In other words, all TP was do was wait out Year 1. Even if TP would’ve died, these K’s would still be paid out. In Year 1, after payments are set, TP transfers endowment life insurance to charity and his annuity to his son.

b. Difference from Stranahan – Stranahan didn’t have a right to payments, whereas this TP did.c. Difference from Blair – Children on Blair were not guaranteed income, just profit on trust. Whereas here, the

recipients were guaranteed a specific amount of income.d. Holding : The cashed out K’s are income to TP.

VI. General Rules re Property a. Keeping the Tree : Where TP keeps tree, but gives away the fruit (Horst) Taxable to TPb. Giving the Tree : Where TP gives away the entire tree (i.e. entire bond in Horst) Taxable to Recipient

i. Ripe Fruit at Time of Gift : Taxable to TP under Revenue Ruling 69-102c. Campbell v. Prothro – pg 278

i. Facts : TP transferred 100 calves to a charity, but didn’t separate his calves from the charity calves. IRS argues that no gift had occurred prior to the sale of the calves.

ii. Holding : Gain on sale of calves given to charity not attributable to the TP.d. Tatum v. Comm – pg 280

i. Facts : TP is owner of land that it rents to sharecroppers and receives a portion of harvest. TP gives the crops to charity and the charity sells them that year.

ii. Holding : TP must include the value of the crops in incomee. Difference b/w Tatum and Campbell : “Crop shares in the hands of the landlord essentially are income

assets, taxable when reduced to money or the equivalent of money, rather than, like crops in the hands of a farmer, appreciated property items not taxable if assigned to a 3rd party prior to the realization of any income.

f. General Rule for Rents, Interests on Bank Accounts, and Other Items that ↑ by Mere Passage of Time : If the income generated by property accrues ratably over time, that protion accred at the time of the gift is likewise ripe. i.e. a gift of coupon halfway between time of interest payments, TP would be taxed on ½ of interest (fruit is ½ ripe)

g. Gifts of Stock Dividends : Problem here and cts will be more apt to find ripeness on the declaration date or record date in a small, closely held ©

---FUNDAMENTAL TIMING PRINCIPLES---I. Introduction 588

a. Why Important : (1) Time value of $ │ (2) Matching Income & Deductions – “clearly reflect income” │ (3) Whipsaw – 2 TP structuring transaction so that no matter what happens the govt loses │ (4) Statute of Limitations – i.e. the case where the TP found the $ in the piano and wanted to argue that they had income back then when SOL has ran out │ (5) Changes in law

b. Taxable Year : 12-month periodi. Calendar Year : Taxable year that ends on Dec. 31

ii. Fiscal Year : Any taxable year that does not end on Dec. 31iii. TP can choose any taxable year it wants, but any changes must be approved by Comm

c. Cash Method : Normally used by individ, measures tax liability of an item at the time that $ (or equivalent) is rec’d or paid

i. “Tax shelters” may never use the cash method and generally any © (other than S ©) and partnerships (with © partners) may not use cash method

d. Accrual Method : Normally used by businesses (sometimes req’d), measures tax liability at the time the TP becomes entitled to it, i.e. where amt can be determined w/ reasonable accuracy

e. Choosing Accounting Method:i. TP can choose accounting method, but it must clearly reflect income │ Once method is picked, you

need permission to change1. If TP’s chosen method doesn’t clearly reflect income, Comm will choose one that does

ii. TP can use different accounting methods for different portions of same business or in different businesses

f. When You Filed Your First Tax Return : (1) You elected an accounting method (cash) and (2) tax year (calendar year). Would have to get permission from IRS to change.

g. Forced Methods : C © [accrual method] │ Partnerships w/ C © Partners [accrual method]II. The Cash Receipts and Disbursements Method 592

a. Described : 1.446-1(c)(1)(i) Cash Methodi. Income – Actual or constructive receipt (1.451-2)

ii. Deductions - Paidb. Receipts

i. § 451(a) – Received $ is taxable in the year rec’d.1. § 1.451(2) – Includes constructive receipt of income

a. Constructive Receipt “ Req’s income set apart for TP, credited to his account, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the TY if notice of intention to withdraw had been given. NOT applicable if TP had a substantial limitation or restruiction.

ii. Charles F. Kahler v. Comm – pg 593 (TC 1952)1. Facts : TP rec’d check on 12/31 after banking hours. TP argues for inclusion in NY’s income,

while IRS wants included in CY income2. Holding : Taxable in CY – Immaterial that delivery of check is too late for check to be cahed

in that year.3. Concurrence : Notes that TP had other options available—other banks other places that

cash checksiii. Williams v. Comm – pg 594 (TC 1957)

1. Facts : In 1951, TP receives a promissory note that was not secured by anything and contingent upon payor selling land for income. TP tried selling the note to banks, but was unsuccessful. TP claims note was not for indebtedness. TP not actually paid until 1954. TP includes in income in 1951. IRS wants included in income in 1954.

2. Holding : Taxable in 1954 – Even if the note was for indebtedness, it had no FMV (as evidenced by TP’s unsuccessful attempts to sell to banks)

iv. Cowden v. Comm – pg 596 (5th Cir 1961)1. Facts : Oil and Gas K with advance payments of 10K (immediately, 4/1951), 250K (1/1952),

and 250K (1/1953) rec’d by TP in 1951. TP then sold the K to the bank in 1952 and rec’d 487K in PV for the total 511K. TP then included income as capital gain income.

2. IRS’ Argument : Not capital gains and tax at full face value, not PV, b/c of unique circumstances.

3. Holding : Taxable at full 511K face value in 1951. – Treated as a cash equivalent. │ We are convinced that if a promise to pay of a solvent obligor is unconditional and assignable, not subject to set-offs, and standard discount rate, such promise is equivalent of cash and taxable in the manner as cash would have been taxable had it been rec’d by the TP rather than the obligation.

4. General Rule : Promise of future payments isn’t taxable immediately unless secured by notes, bonds, or other evidences of indebtedness other than the K.

a. Why Ct Ignored General Rule Here : (1) Father’s role at the bank and his belief that it = $, guarantor of the K was willing to pay immediately, guarantor of K was solvent.

v. Test for CASH EQUIVALENT (Cowden)1. Promise to Pay – K, negotiable interest2. Solvent Obligor – Obligor must be able to pay you at the very moment3. Unconditional – No other conditions must be met4. Assignable – Have to be able to assign to someone else5. No Set Off – Can’t have a situation where when it comes time to pay off the note, the

person will pay you < the face value b/c of set off for amount that you owe them6. Standard Discount – Has to be traded at a standard discount rate

vi. Test for CONSTRUCTIVE RECEIPT (1.451-2) – Ask yourself if Superman could get the car (note that Superman would never do anything illegal)? i.e. Is there any physical way any human could have gotten the $

1. Credited to his account : 2. Set apart for him :3. Otherwise made available : 4. Draw on it at any time :5. If notice of intent is given :

vii. Similarities 1. Cowden and Kahler both rec’d a cash equivalent.2. Note, general rule that executory K to make futuer payments in $ do not have a FMV.

viii. Hornung v. Comm – pg 601 (TC 1967) – This should have been constructive receipt.1. Facts : TP was MVP of Super Bowl on 12/31/1961. Magazine awarded him a car b/c he was

MVP. Magazine called TP on 12/31 and told him that he won. TP did not receive the keys or title on 12/31 and the car was in NY while TP was in WI. TP rec’d car on 1/3/1962 at a luncheon. TP didn’t have to go to luncheon to receive car. TP argues he had constructive receipt in 1961, but IRS says no.

2. Holding – TP did not have constructive receipt until 1962.3. Rationale – Car was in a different state, TP didn’t receive keys or title, dealership was closed

on that Sundayc. Disbursements

i. General Rules :1. You can’t deduct the amount until actually paid.2. If you pay too far in advance, you will not be able to take the deduction

a. Exception 1 : 461(g)(1) : Prepaid interest must be capitalized and deduct in the year that it belongs to

b. Exception 2 : 461(g)(2) : Points can be deducted immediately if you pre-pay for points using your own $

3. Check to make sure that the TP has a legal obligation to payii. § 1.461-1(a) : Expenditure which results in the creation of an asset having a useful life extending

“substantially beyond” the close of the taxable year may not be fully deducted in the year payment is made.

1. Prepaid expenses (not governed by specific statutes) may be deducted in the year they are paid, even though they span a period that touches two taxable years, as long as the expenses do not relate to a period greater than one year; i.e. amounts that do not create or enhance any right or benefit for the TP that extends beyond the earlier of (1) 12 months after the first date on which the TP realizes the right or (2) the end of the taxable year following the taxable year in which the payment is made

iii. § 461(g) – Prepaid interest/expenses shall be treated as paid in the period (i.e. capitalized), which is so allocable

1. Exception: Points – So long as 3 req’ts are met – Paid up front, associated w/ improving or purchasing your principal residence, and appropriate for your area

iv. Comm v. Boylston – pg 605 (1st Cir 1942)

1. Facts : TP prepays for multi-year ins policy and is deducting on a pro rata, as used basis. IRS argues that TP must deduct the full amount immediately.

2. Holding : Deduct expenses in the year accrued, not when paid. Otherwise, it creates a distortion of income

v. Cathcart v. Comm – pg 609 (TC 1977)1. Facts : TP wants to immediately deduct all points paid on a home mortgage, except that TP

is paying for the points w/ mortgage proceeds.2. Holding : If you pay for the points with mortgage proceeds, TP must prorate points over the

life of the loan – You have to pay for the points out of your pocket.3. Deductions is a matter of legislative grace rule.

vi. Revenue Ruling 87-221. Facts : TP is re-financing property. 80% of refinancing is going to pay off old mortgage, but

20% is going towards improvement of the property.2. Holding : TP can immediately deduct 20% of the points b/c that part of the loan is going

towards improving the property. The other 80% cost of the points must be deducted over the life of the loan.

3. Loan revenue must go towards purchasing/improving TP’s primary residence.vii. Revenue Ruling 54-465 : A check to charity is deductible in the taxable year in which the check is

delivered provided the check is honored and paid and there are no restrictions as to time and manner of payment. If you pay by check, that is considered cash. Note, considered cash when mailed.

viii. Vander Poel, Francis & Co, v. Comm –pg 614 (TC 1947)1. Facts : TP credited the salaries of some officers of the ©, but didn’t actually pay their

salaries in the TY. TP wants to include the salaries in TY under constructive payment argument.

2. Holding : TP can NOT put the salaries in TY b/c there is no such thing as constructive payment. Deductions are a matter of legislative grace and TP cannot point to where Congress allows constructive payments. Ct acknowledges that this rule defies logic.

3. Note – The executives had constructive receipt of income in TY.ix. Credit Card Charitable Donation : Old Rule – No deduction until TP pays credit card company│ New

Rule – Deductible when charge is madeIII. The Accrual Method 618

a. Income Itemsi. General Rule for Income : § 1.451-1 : Income is includible in GI when all events have occurred which

(a) fix the rt to receive such income and the amount therefore (b) can be determined w/ reasonable accuracy.

ii. Spring City Foundry Co v. Comm – pg 619 (SCOTUS 1934)1. Facts : TP sold goods to customer that has now entered bankruptcy and TP knows it will not

get paid. Accordingly, TP wants to deduct the partial worthlessness of some of its AR from its GI for the year.

2. Holding : TP can NOT deduct the bad debt from GI.iii. Rev. Ruling 70-151

1. Facts : TP won judgment against US govt in 1968. In 1969, SCOTUS denied writ, so case was closed. However, in 1969, Congress did not appropriate any money to pay the judgment.

2. Holding : Income is includible in 1969, b/c income is includible in GI when all events have occurred that fix the right to receive such income and the amount thereof can be determined w/ reasonable accuracy.

3. Rationale : Congressional appropriation is ministerial iv. North American Oil Consolidated b. Burnet – pg 620 (SCOTUS 1932)

1. Facts : TP is an oil ©. US govt claims to own part of the TP’s land and seizes TP’s 1916 income. US govt loses to TP in 1917 and then gives TP back its 1916 profits. TP claims income is taxable in 1916 (when earned) or 1922 (when litigation stops)

2. Holding : Taxable to TP when rec’d – 1917 b/c the $ became TP’s property in 1917

3. Why Not 1916 : TP didn’t have a right to demand the $.a. What if Govt’s post-1917 Appeals were Successful : TP would have deducted the

returned profits from its 1922 income4. Receiver Appointment : Receiver only pays tax if they have taken over the ©’s entire

business5. Claim of Right Doctrine (Applies to BOTH cash and accrual TP) : (1) Receipt of cash based on

a claim of right; (2) No restrictions │ Receipt must have no restrictions (other than you might have to pay it back if overturned on appeal) This means that you are taxed on the income, even though your right is not fixed b/c the litigation isn’t through.

v. New Capital Hotel v. Comm – pg 623 (Tax Ct 1957)1. Facts : Tenant makes an advance $30K payment to TP (landlord) b/c landlord asks tenant to

purchase a performance bond (would guarantee rent). Instead, tenant offers to pay for two years rent in year one (his first and last year).

2. Holding : $ taxable when rec’d b/c there was no further req’t on the TP, i.e., to hold the money or that it was a security deposit. Ct notes that the IRS’ method (the chosen method) doesn’t clearly reflect income, but that’s okay

a. Note – This is the same whether TP is cash or accrual TPb. If TP is in possession of the income and there are no restrictions on the income,

then there is income – Same for BOTH cash & accrual TPc. Post-Dated Check : Not a cash equivalent

vi. Artnell Co v. Comm – pg 625 (7th Cir) – 1. Facts : Accrual TP that is using not using an accrual method, but his accounting method does

clearly reflect income. When there wasn’t a short year, the White Sox’s tax method works perfectly. Whether prepayments for baseball games can be deferred for an accrual basis TP when amounts can be determined w/ certainty.

2. Two Short Years : November 1st to Closing of Sale in April │ April to October 31st 3. Holding – Remanded to determine whether the TP’s accounting method did accurately

reflect income enough to overcome the general rule that TP must include in GI in the year of receipt prepaid items for which services will be performed later that year.

a. Exceptions to this Rule : Periodicals and Club Duesvii. Post Artnell : Now there are several § that allow TP to do Artnell type accting – periodicals (§ 455),

club dues (§ 456), returned magazines & paperbacks (§ 458) [allows you to take in income but never report it b/c the items will be returned]

viii. Clearly Reflect Income – Not good to rely on at the start, but good at cleaning up incomeix. Claim of Right – If the TP believes that they have a legal claim to the $x. Prepayment of Services : Modern shift to allow prepaid $ for services to be included in yr that

service rendered Still does NOT apply to rent & interestxi. Prepayment of Goods : TP may defer amts rec’d as prepayments

b. Deduction Itemsi. General Rule on Deductions : § 1.461-1(a)(2) : TP can have deduction in the TY in which all the

events have occurred that establish (1) the fact of the liability, (2) amount of liability w/ reasonable accuracy, and (3) economic performance has occurred w/ respect to the liability

1. Economic Performance : § 451(h) : Occurs when property or service is provided │ Special Rules for Workers Compensation, Tort Liabilities, and Special Recurring Payments

ii. Rev Ruling 57-4631. Facts : IRS notes and wins a case against TP. TP has interest on the deficiency. TP enters into

a payment plan (w/ more interest) to pay off the deficiency. 2. Holding : The interest on the original deficiency is deductible when liability is finally

determined. The liability on the payment plan is deductible on a pro rata basis as the TP’s liability accrues.

3. Obligation to pay a liability in a litigation situation doesn’t occur until the litigation is finished

iii. Schuessler v. Comm

1. Facts : TP deducted $ to set aside for his guarantee that he will turn off and on all of the furnaces he sells for 5 year.TP charged more for this warranty.

2. AAA : This argument was rejected by AAA b/c the govt proved that AAA had no idea whether AAA will have to perform the services and at what amount.

3. Holding : TP can immediately deduct the costs b/c he had legal liabilities when he sold the services; his figures were reasonable; and the ↑ price that his customers paid indicated their eagerness to use the TP’s guarantee

4. Why Deductible : Judge knew that the clients would call the TP to have them turn on the furnace.

iv. Note 6401. Congress is motivated by revenue generating pressures which require treating receipts,

even though not yet earned, as income for tax purposes – yields > tax certainty2. Old Rule : Expenses deductible after satisfying “all events” test – (1) all the events have

occurred which establish the liability giving rise to the deduction; and (2) the amount of the liability can be established w/ reasonable accuracy

3. § 461(h) : New Rule : Req’s all events test plus economic performancev. Rev Ruling 2007-3 – Note this rule only applies to services and insurance K’s – Could argue it

doesn’t apply to goods K1. On 12/15/06, X executes K w/ Y for provision of services. K goes from 1/15/07 to 1/31/07.

Under K, X pays Y for services on 1/15/07. X uses the recurring item exception under § 1.461-5 Includible in Year 2, b/c under § 1.461-4(d)(2) economic performance on a service K occurs as the services are provided

a. TP wants to deduct in Year 1. Since economic performance will not happen, TP is relying on § 461(h)(3) – recurring item exception. IRS says that a mere executing of a K does not fix the right to pay. Since signing the K doesn’t fix the right to pay, the TP cannot satisfy the first req’t of recurring item exception.

2. On 12/15/06, X executes K w/ W, an insurance company, for insurance. K goes from 1/15/07 to 12/31/07. Under K, X pays Y for services on 1/15/07. X uses the recurring item exception under § 1.461-5 Includible in Year 2, b/c under 1.461-4(g)(4) economic performance on insurance K’s occurs when payment is made to the person to which liability is owed.

a. Recurring Item Exception : Doesn’t happen in either case b/c the fact of liability is not established in Year 1

3. An accrual basis obligor is not permitted to deduct an expense stemming from a bilateral K arrangement, prior to the performance of the contracted for services by the obligee.

4. Fact of Liability/Fixing the Liability : Mere execution of a K, w/o more, doesn’t establish a TP’s liability for services This is why TP’s can’t claim the recurring item expense

5. Problem w/ 2007-3 : When it makes the decision that an executory K does not meet the all events test, it destroyed most of the teeth of the Recurring Item Exception

vi. Recurring Item Exception 1.461-51. First 2 elements of the all events test must be met – the liability has been fixed and the

amount can be determined w/ reasonable accuracy2. Economic performance has to occur w/in the shorter of either (a) a reasonable time or (b)

8.5 months after close of the tax year in which you have accrued the item3. Items that you want to accrue must be recurring in nature & TP treats those items

consistently4. The item that you want to deduct can not be material or if material then accrual of

deduction more clearly reflects incomeIV. Forced Matching of Methods 650

a. § 267(a)(2) │ Related Accrual Payor : Related Cash Payee │ Req’s $M and AM related (defined in § 267(b)) TP to both use the $ method, i.e. no deduction until payor records income

b. § 467 – │ Related Cash Landlord : Related Accrual Tenant │ Complicated § dealing w/ rental/service income w/ > 250K consideration

RATES – THE CHARACTERIZATION OF INCOME AND DEDUCTIONS

I. Introductiona. If G or L is subject to special treatment as “capital” rather than “ordinary,” is usually dependent upon:

i. Whether it arises in a transaction involving a “capital asset”ii. Whether the capital asset has been the subject of a sale or exchange

iii. How long the TP has “held” the asset1. There are some statutory exceptions to this general rule

II. Meaning of Capital Asset 702a. § 1221 : Definition of a capital asset in the negative, i.e. what isn’t a capital asset

i. § 1221(1) : Inventory of the TP in the ordinary course of business; (this means assets can be CG in the hands of different TPs) -

b. § 1222 : Defines short and long termi. For all – Requires a sale or exchange, of a capital asset, for > 1 year

c. § 1223 : Allows you to extend holding period – Allows you to tack your holding period in land to your partnership interest upon inception of the property

d. Mauldin v. Comm – pg 702 (10th Cir 1952) – i. Facts – TP bought property originally to use as a cattle ranch. Cattle ranching never happened, so TP

sat on the property. TP later tried to sale the property. Unable to sale, TP divided the property into lots, but property still didn’t sale. City paves TP’s lots and leaves him a 25K bill to pay. TP works full time on selling enough lots to pay off the city. TP then gets into the lumber business.

ii. Issue – Can property not bought for the ordinary course of trade or business be transformed into property bought in the ordinary course of trade or business? – YES

iii. IRS – Says can’t claim capital asset b/c TP was holding the lots as inventory for sale.iv. Fact-based inquiry to determine if something is a capital asset. Factors to Consider:

1. Purposes for which the property was acquired2. Whether for sale or investment3. Continuity and frequency of sales as opposed to isolated transactions4. Facts tending to indicate that the sales or transactions are in furtherance of an occupation

of the TP, recognizing however that one actively engaged in the business of real estate may discontinue such business and simply sell off the remnants of his holdings w/o further engaging his business

v. TP’s intentions when you hold a property, determines whether it is held as CG or OIvi. FINAL RULE – It is a sale or exchange for a debtor (therefore CG), but not a sale or exchange for a

creditor (therefore OI)e. Malat v. Riddell

i. Issue – What does primarily mean in “Property held by the TP primarily for sale to customers in the ordinary course of his trade or business” – § 1221(a)(1)

ii. IRS Definition : primarily = substantiallyiii. Holding : Ct rejects, IRS’ definition and uses a literal translationiv. ROL : Primarily means “of first importance” or “principally”

f. Inclusion of Hedging Activitiesi. Corn Products : Ct held that purchasing and sales of future rights to purchase corn was an integral

part of TP’s business and not capital assetsii. Arkansas Best : Muddied the issue re ordinary/capital assets for hedging K’s – Bought stock in the

company that was supplying the ©, after the other company quit working, © sold the stock at a loss and claimed an ordinary loss

iii. Congress adds § 1221(a)(7)-(8) to clarify taxation of business hedges1. § 1221(a)(7) excludes from capital asset status any hedging transaction which is clearly

identified as such before the close of the day on which it is acquired, originated or entered into. – Purpose is to prevent TP from waiting to decide b/c TP will want loss taxed as ordinary and gain taxed as capital

THE MECHANICS OF CAPITAL GAINS 689I. Steps to Calculate Capital Gains

a. 1 – Look in § 1222 for definitions of short-term capital gain, long-term capital gain, short-term capital loss, long-term capital loss

i. Usually whether or not TP has held the asset for > 1 yearb. 2 – │ STCG – STCL = NSTCG or NSTCL │ LTCG – LTCL = NLTCG or NLTCL │ c. 3 – Net the short term gain/losses against the long term gains/lossesd. If gains, proceed to II

II. Tax Rates on Gainsa. 28% - Sell of art, antiques, gems, coins, etc.b. 25% - Sell of depreciable real property (i.e. bldgs)c. 15% - Sell of stock, bonds, investments, landd. 10/15% Rate – If TP would be taxed at 25/28% rates, but TP doesn’t have enough income to fall into those

tax bracketse. 0/5% Rate – If CG would fall in a 10/15% rate bracket, they are taxed at 0/5%

III. Randoma. Three Situations where TP has gains : (1) a net short-term gain in excess of a net long-term loss; (2) a net

long-term gain in excess of a net short-term loss; and (3) a combination of a net short term gain and a net long-term gain

i. In situations (2) and (3), the net long term gain is classified as net capital gainb. Capital gains treated as the last income TP rec’d, thus, if not for < CG tax rates, TP would be taxed at the TP’s

maximum tax rate on themc. Important Pro-TP Procedure – If there are net lossess w/in any classification, they then wipe out net gains

that would otherwise be taxed at the thighest rate or combination of rates – i.e. a loss that would’ve been taxed at 15% if it were a gain, can take away from 28% capital gains

IV. © TP – Does NOT receive lower tax rates for capital gainsa. © TP can only deduct capital losses up to the amount of capital gains.

SALE OR EXCHANGE REQ’T 710I. Keenan v Comm – pg 710 (2d Cir 1940)

a. Facts – Will calls for gift to N of $5M in $ or stock. N receives part $ and part stock. Some of the stock was in the estate before death, some of the stock was purchased later. IRS argues that distribution to N resulted in CG to the estate.

b. Estates’ Argument 1 – Delivery of the securities of the trust estate to the legatee was a donative disposition of property pursuant ot the terms of the will, and that no gain was thereby realized.

i. Ct REJECTS this argument b/c N was not a legatee – b/c she took no chance that the shares might appreciate or depreciate in value between the time of death and the time of transfer, but instead had an unvarying claim to the $ when she reached a certain age.

c. Estates’ Argument 2 – This wasn’t a sale.i. Ct REJECTS this b/c exchange and other disposition doesn’t have the same meaning as sale.

d. Holding – Trustees realized a gain by using securities to settle a claim.II. Hudson v. Comm – pg 714

a. Facts – TP “bought” a 75K judgment against Δ from π for $11K in 1943. In 1945, Δ settles the claim for $21K. TP report the income as CG, but IRS says that it is OI.

b. Holding – OI b/c when TP rec’d $ for the settlement of the judgment, they did not recover the $ as the result of any sale or exchange but only as a collection or settlement of the judgment

c. Rationale – What may have been property in the hands of the TP simply vanished when Δ paid the claim. Therefore, there was no exchange.

HOLDING PERIOD 718I. When Holding Periods Tack : Transfer property into a partnership (would receive a partnership interest that

would start anew, but you are allowed to tack your original holding time of the property transferred in); Property Rec’d by Gift, and Property Rec’d by Death

II. Rev Ruling 66-7a. Facts – Question over whether an asset will be held for the then-mandatory 6 months when the asset was

acquired on the last day of a calendar month which has less than 31 days.

b. Timing Rule – When calculating timing for a statute, the day thus designated is excluded and the last day of the prescribed period is included, unless a different intent is definitely evidenced

III. Rev Ruling 66-97a. Question – Is there a distinction between a trade effected on a registered securities exchange and a trade

made in the “over-the-counter” market?b. Trade Date – Date on which the K to buy or sell the security is madec. Settlement Date – Date on which the security is delivered and payment is tendered d. ROL – The holding period for debentures acquired by purchase, no matter which exchange, is to be

determined by excluding the “trade date” on which the debentures are acquired and including the “trade date” on which the debentures are sold.

IV. Overviewa. Gains and losses are recognized in the year of the trade date, regardless of whether the TP is a cash or an

accrual method TPb. If TP owns shares purchased at different time, IRS employs FIFO if TP is unable to identify exactly which block

of shares was soldc. Short Sales – Generally are short-term gain or lossd. § 1233(b) – Prevents short sale “against the box” – Described on 722e. § 1259 – Creates a constructive sale of appreciated positions where gain was effectively locked in, but the

gain might not otherwise be immediately recognizedf. § 1234(b) – Any gain or loss on the sale/expiration of an option is a short-term CGg. Real Estate – In the case of an unconditional K for sale, the holding period for purposes of both acquisition

and disposition is measured by the earlier of the date upon which title passes or the date upon which delivery of possession occurs and the burdens and privileges of ownership passes

72 MC Questions – Can object to any questions – 4 Hours

Topics Covered

Different Types of Taxes Wealth Wealth Transfer Stamp Excise Sales Tariff/Duties

How you distinguish one tax from another Tax Base : Wealth Tax’s base is wealth, income tax’s base is income Trigger

Direct/Indirect Taxes Direct – Tax on the thing Indirect Tax – Tax on the thing Important b/c of Art 1, § 3 of the ©, indirect taxes can be avoided if you avoid being in the marketplace Protect states w/ a lot of people and not a lot of land Apportionment – Couldn’t have direct taxes that would put a greater burden on one state than another

Hierarchy of Sources IRC – Binding more so than SCOTUS opinions b/c CON can change Regulations – Legislative Regulations – Interpretive Revenue Rulings Internal Revenue Manual – Rules that control the auditor Revenue Procedures – Internal rules of the IRS General Counsel Memoranda

Jurisdictions of Courts Trial Level Courts

o Tax Court – Only court w/ deficiency jurisdictiono District Court – Refund jurisdiction │ Only ct that provides for a juryo Federal Claims Court – Refund jurisidictiono Unethical not to forum shop

Audits and Assessment 90 Day Letter/Notice of Deficiency Form 870 – Waiver of Assessment – Don’t sign this unless you’re ready to give up deficiency jurisdiction

Statutes of Limitations 3 Years from Filing – Basic SOL 6 Years from Filing – Substantial Understatements of Income (more than 25% off) Forever – If you don’t file 10 Year Statute – Collection (IRS has that long to collect)

Different Types of Tax Returns One tax return for trusts 1041 One tax return for © A number of different tax returns for human beings

History of Taxation in the US US has not had a developed tax system for its entire history Different wars made US enter and leave taxation Rules that are in the © - All tax legislation has to start in the House of Representatives (most democratic branch)

Know meaning of GI, AGI, AMT and where to find them in the statute Taxable Income (§ 63) AGI (§ 62) Right to Tax (§ 61 & ©)

Presumption is in favor of taxation Govt only has to show incomePresumption against exclusions or deductions Must show code § to get deduction If you want to argue that something isn’t taxed:

Argument 1 : Not Income/Not Constitutional/No Realization [this used to be considered a ©-req’t Eisner : No realization on stock split │ Now realization is considered an administrative convenience (and sometimes there is tax w/o realization – but must be a code § indicating this)

Glenshaw Glass : Use this def’n when you are testing to see whether or not something is income accessions to wealth, clearly realized, over which the TP has dominion and control

o Damages – Compensatory & Punitive Damages are both Incomeo Discharges of Debto Windfallso Frequent Flyer Miles – Not taxed b/c of administrative convenience

Imputed Income Not Subject to Tax : Dean – TP transferred his house to his soley-owned ©, once he transferred the house to the ©, he had imputed income on living in the house [now his getting to live in the house is NOT imputed income]

Once you get income, deduct the following: Imputed Income Exclusions

o Gifts § 102 – There is no such thing as an EE gifto Inheritance § 102o EE Discounts § 132o Tenant Improvements § 109

Gains and Dealings in Property – Under § 1001(a), Gain = AR - AB Amount Realized – Defined in § 1001(b) [Cash + FMV of Property]

o Services – Int’l Freight – If you sell a product and what you get back is services, the FMV of the services is included in your AR

o Debt – Crane & Tufts – If as a result of the transaction, there is some debt that goes away from the property (doesn’t matter if recourse or nonrecourse), if you sold property and as a result of selling the property some debt goes with it, that debt should be included in AR

Basiso § 1012 – Basis=Cost (Philadelphia Park rule) Basis should reflect that amount of income that has

already been taxed and then is invested in the propertyo Only purchased $ goes into basis (i.e. debt not used to purchase the property does NOT go into basis)o Identification Theory of Basis – Identifies the things that we do not want to taxo § 1041 Basis on Transfers between Spouses

Nonrecognition § 1041(a) Transferred basis § 1041(b)

o § 1015 Gift Basis Generally basis transfers, except in gifts of loss property, if (1) the donor passes a loss than the

donee and (2) the donee sells the property at an even greater loss THEN there is FMV on date of gift basis

o § 1014 Inheritance FMV on Date of Death

o § 1019/§ 109 Tenants Improvements to Your Property § 109 – At the time that the improvement is created, the LL has an exclusion § 1019 – But LL has no basis in the improvement

o Transactions Prior to Marriage – B/c of the interaction between Farid Es Sutanah and Davis the person who gives appreciated property has income │ Under Davis – The person who receives the appreciated property has no income │ Under Fard Es Sutanah – The person who receives the property has FMV basis for the property

Under § 1001(c) – Realized gains are presumed to be recognititionLosses need realization, recognition [generally presumed under § 1001(c)], and allowance [§ 165(c)]

Loss in a trade or business Loss in the production of income Casualty Loss

o Losses/Deductions work for the advantage of TP (b/c of PV of $) and govt always wants to put ↑ restrictions on these

Deductions ATL – Available to all TP – Meant to clearly reflect income

o § 162 – Portal into the world of deductions – Ordinary = Not Shocking │ Necessary = Helpful │ Expense = Something that doesn’t create an asset lasting significantly beyond the year │ Carrying On = Can’t be starting a trade or business, have to already be in it │ Trade or Business = i.e. Not an investment

Capital expenditures do NOT have to be tangible assets (Lincoln Savings Bank had to capitalize an intangible account of $)

One way to get around “carrying on” req’t, is § 195 start up expenses – Once you start a business, you can actually take the deduction

o § 212 – Has to do w/ investments [stocks, bonds, i.e. stuff w/o any customer invovled]o § 215 – Alimony Paid (shouldn’t be ATL, but is)

Five Part Def’n – (1) $ payment that is not front loaded; (2) payments made under a divorce or separation agreement; (3) parties can’t generally be living together; (4) divorce agreement doesn’t call it something besides alimony

o Depreciation Old Depreciation Rules – Fights w/ the TP and IRS over useful life New Depreciation Rules – Just plug things in

§ 167 § 168Useful life Recovery PeriodPlaced in Service ConventionsSalvage Value 0

Depreciation Method 200% DB, 150% DB, SL, Alternation Depreciation Range Rules that Remain from Old System : Depreciation only applies to depreciation of properties

used in trade or business │ If used for both personal and business, depreciate the part that is used for business

BTL – Meant to subsidize some activity like home ownership or charitable contributions, unreimbursed business expenses

o Only for individuals │ Means the same thing as itemized deductionso Generally, these are limited to AGI amounts

Personal ExemptionsStandard Deduction – If your itemized deductions were not enough

Assignment of Income Did the assignment come from services or from property? SERVICES

o Only way you can successfully assign income from services – renunciate the payment before it is earned (Gianini)

o Agents (i.e. Law professor rec’ing income for working in clinics)o Executors of Estates (Have 6 months to renounce)

PROPERTY o Much easier to assign – Just give away the property i.e. give the bond and not just the coupons

Ripe Fruit Problem – Susie Salvatore – Have to pass the property prior to it earning the income Blair – Vertical slice works Horst – Horizontal slice didn’t work

Accounting There are different rules for deductions and income You can use any method which clearly reflect income The $ method emphasizes receipt

o Look at whether you have actual or constructive receipto Actual Receipt – Cash equivalents (pg 600 of the text) are included at FVo Constructive Receipt – Use Superman Standard – Could Superman have gotten the $ - Taxed at FVo NO such thing as Constructive Payment (Vanderpool)

The Accrual Method emphasizes right to receive + economic performanceo Claim of Right Doctrine (N.A. Oil) – If you receive payments under a claim of right, you are taxed on

those amounts at the time of receipt (applies to both accrual and $ method TP)

Capital Gains Tax Rateo Sale or Exchangeo Capital Asset – § 1221 is all based on what is not a capital asset (inventory, works of art that you self-

created)o Held > 1 Year