Tax Final Outline (1)

8/2/2019 Tax Final Outline (1)

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Tax Final Outline

- Connect the Dots

- ALL of IRC that we talked about- Multiple Choice

- Mostly about Business expenses (above the line deductions)- Short Essays

- Concepts talked about a lot in class- Compare & Contrast (Small Essays)

- Alimony vs. Child Support- Depreciation v. Amortization (cost recovery aspects for

businesses)- 1031 vs. 1033

- Know the 10 Major cases

- Anything after 1986- Glenshaw, Lucas v. Earl, etc.

- Realized Gain = Can have it but dont put it on tax return- Recognized Gain = Actually put it on tax return

The Tax TreeIncome

Exclusions

=Gross Income

Above the Line Deductions

=Adjusted Gross Income

Personal/Dependency Exemptions

Standard OR Itemized Deductions

=

Taxable Income=

Calculated Tax Owned

Credits=

Amount of Tax

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INCOME61 What Is Income

- Income is EVERYTHING- ALWAYS broadly conceived

- Very few exclusions (ONLY by legislative grace)- Be very careful w/ exceptions- DEFAULT = income (if questioning)- If there is an exclusion MUST comply perfectly w/ the

requirements

- 3 Types of Gains & Losses/ Income- 1) Ordinary Income & Losses- 2) Capital Gains & losses- 3) 1231 Gains & Losses

- Cesarini v. US- 1957: Taxpayers buy used piano- 1964: Taxpayers find money inside the piano- Taxpayers argue for refund

- Found money

- If IS income Income in 1957- If IS income in 1964 = CAPITAL GAIN

- Any type of treasure trove is income to you. It falls under61. No statutory exemption for treasure trove!- Found money is taxable as ordinary income in the year in whichthe taxpayer attains uncontested possession of it

- Under 61 money is taxable in the year it was actually foundand that the sum is properly taxable at ordinary income rates- ***Treasure trove is GROSS income***

- Commissioner v. Glenshaw Glass- Undeniable accession of wealth, clearly realized & over whichthe taxpayer has complete dominion- The general definition of GROSS INCOME includes allamounts recovered as result of a lawsuit that represent anincrease in wealth to recipient and not merelycompensation for non-contractual losses

- Rule 22: Gross income includes gains, profits, and incomederived from salaries, wages, or compensation for personalservices- Gross Income defined as undeniable accession of wealth, clearlyrealized and over which taxpayer has complete dominion

- Old Colony Trust Co.- When Employer pays Employees taxes to IRS

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- Treat as if Cash Employee AND Employee IRS- The payment by employer of income taxes assessableagainst the employee constitutes additional taxableincome to such employee- If you pay someones taxes for services rendered it is

compensation and is NOT excludable and under 61 is taxable- Rule 213: The discharge by third person of obligation to him isequivalent to receipt by person taxed- 102(c)(1): An employer/employee relationship will look morelike income than a gift (usually a compensation for labor)- Direct v. Indirect Compensation:

- Buy employees wife a new car = INDIRECT- Bonus of $20,000 = DIRECT- This is not a gift because conditioned upon employment to

employer- Improvements to HOME are also income

- Includes:- Treasure Trove- Illegal receipts- 3rd Party Satisfaction of Obligation- Cancellation of Debt- Transfer of gain property to satisfy obligation- Prizes & Awards- Advance payments

- But NOT:

- Bargain purchases- Free samples- Unrealized appreciation in value- Imputed income- Loans/Deposits- Amounts realized from property disposition up to the basis

- Estates & Trusts = Taxable Entities

- (minus) EXCLUSIONS

- 2 Types of Methodologies- 1) Is it a true exclusion?- OR -

- 2) Is it really income?

- Can sometimes be disguised compensation- If a question looks like income & smells like income BUT is called a gift

disguised compensation = INCOME & NOT a gift

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- Inheritance

102 Gifts & Inheritances- Charley v. Commissioner: Running a horse testing program and as aresult he is effectively buying first class tickets to visit the horses/peopleand billing his clients and then cashing in on the frequent flyer milesearned

- Congress has deemed you to deduct it if they decide thatthrough statute you are able to exclude it from a taxable aspect(otherwise, EVERYTHING is income)- Travel credits do constitute taxable income!- The petitioner was wealthier after transaction than before- The ascension of wealth is the receipt of the income

- Travel credits accumulated and retained by employee in courseof employment constitute gross income subject to taxation- Frequent flier miles constitute taxable income!

- Commissioner v. Duberstein:- In order to be a giver under 102: the amounts received musthave been given a detached and disinterested generosity, out ofaffection, respect, admiration, charity, etc.- The court has indicated that a voluntary transfer of his propertyby one to another without consideration or compensationtherefore through a common-law gift is NOT necessarily a gift

within the meaning of the statute BUT where the payment is inreturn for services rendered it is irrelevant that the donor derivesno economic benefit from it- In this case: gave the individual valuable business informationand got a gift in return- RULE: the most critical consideration is the transferorsintention and what controls is the intention with which paymenthowever voluntary has been made- Any services made by employee are taxable

- 108(a)

Certain forms of COD income- 109 Lessee improvements

64(c) Employee Achievement Awards- Must relate to service OR safety

- Employed for at least 5 yrs to qualify- Less then 10% of employees have received the award during the

year

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- IF has 3 elements it will is EXCLUDABLE- 1) Length of service OR safety- 2) Part of meaningful ceremony/pomp & circumstance- 3) Must NOT be disguised compensation

74 Prizes & Awards- TAXABLE- UNLESS explicit exception/excluded- 2 Limited EXCEPTIONS:

- 1) Recognize achievements in religious, charitable, scientific,educational, artistic, literary, or civil field

- AND -- 2) MUST immediately donate/transferred it to a governmentalentity OR qualified charity

- EX: Extreme Makeover home IS taxable

117 Scholarships/ Fellowships- EXCLUDES income received from a qualified scholarship

- MUST focus on the specifics of the scholarship- Tuition & Fees = excludible- Room & Board = taxable (NOT excludable)- Contingent Employment OR other contingency= taxable (NOT

excludible)- Athletic scholarship = excludible

119 Meals & Lodging- Meals:

- Furnished by OR on behalf of employer- For convenience of employer- On business premises of employer

- Lodging:- Furnished by OR on behalf of employer- For the convenience of the employer- On business premises of employer- Employee required to accept as condition of employment

132 De Minimis Fringe:- After accounting for frequency SO small as to make accountingunreasonable or impractical

- EX: coffee doughnuts @ work OR parking

- Working Condition Fringe:- If the employee paid for the property OR services at issue, would

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the employee be entitled to deduct the cost under 162 or 167?

- YES than exclude the value of the property or servicesat issue

- Qualified Transportation Fringe:

- Transportation in commuter highway vehicle- Transit pass $100/ month aggregate limitation

- Qualified parking $175/ month aggregate limitation- On- Premises Athletic Facility

- On business premises- Operated by employer- EVERYONE is able to use it

- Substantially ALL use by employees/spouses/kids

121 Gain from Sale of Principal Residence- When you can EXCLUDE your gain from sale of principal

residence- 121(a): Elements for Exclusion

- Ownership Test MUST live in for at least 2 of 5 yrs

- Use test MUST use for at least 2 of 5 yrs- 121(b): Limitations On Exclusion

- $250K MAX Exclusion (if Single)- $500 MAX for Married Filing Jointly- ONLY on sale/exchange every 2 yrs

- 121(c): Reduced Exclusion- Applies where taxpayer flunks 121(a) OR where 121(b)(3)

applies- If you sell your home = capital asset- CAPITAL in nature- Mortgages = deductable under 121

135 Income From US Savings Bonds Used toPay For Higher Ed.- Savings bond income used to pay higher education EXCLUSION fromgross income of interest on certain federal bonds used to financeeducation costs

- Example of furthering social welfare- Government wants you to buy savings bonds, so they give you atax break if you do

= (equals) GROSS INCOME

(minus) ABOVE THE LINE DEDUCTION

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- 161 Allowance of deductions- Business Expenses- MUST be an asset used in trade OR business that is ordinary ANDnecessary AND reasonable

- EX: Transplant hospital buys helicopter Probably able to

deduct- EX: Lawyer buys helicopter Probably NOT able to deduct

162 Trade Or Business Expense- (a) ELEMENTS

- Ordinary = common & accepted . . . in the life of the group, thecommunity

- Necessary- Expense- Paid OR Incurred- In carrying on- A trade OR business

- 165 Losses

- 167 Depreciation- 2 types:

- (1) Straight line- (2) MACRS/ NEW ACERS

- Vehicles = 5 year recovery period

- 212 Investment & Rental Activity

- 179 Exclusion to Expense Certain Depreciable Business Assets

Capital Expenditure v. Expenses

162 Expenses:- EX: Painting shutters- Some are able to be DEPRECIATED- EX: Compensation for employees= DEDUCTABLE

- BUT $1 million ceiling- Certain types of compensation are NOT included in

the ceiling- Always look at reasonableness & whether or not it

would meet the cap- 244 & 172 Entertainment Expenses- Directly related to the active conduct of business

- General Phase Out If you spend $100, you can legallyDEDUCT 50%- UNLESS it is not face value

- EX: You can NOT deduct a scalped baseball ticket- CANNOT deduct alcohol

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- 4 Things to Show to Deduct a Business Expense- 1) Legit business expense- 2) That you were in fact there- 3) That it was reasonable- 4) That you an substantiate

Capital Expenditures:- EX: Plumbing- DEDUCTABLE

- Improvements

- Capitalize a cost IF it adds to the value (OR substantiallyprolongs the useful life) of an asset

- EX: Midland Empire

- Adaptations

- Capitalize a cost IF it ADAPTS property to a new OR differenceuse

- New Assets

- Capitalize a cost IF it RESULTS in the acquisition OR creationof an asset having a useful life SUBSTANTIALLY beyond thetaxable year

- If it lasts LONGER than 1 yr OR changes the building- EX: Pluming

- INDOPCO v. Commissioner(1992)

- Capitalize a cost IF it produces significant benefits thatEXTEND beyond the taxable year- FACTS: wanted to write off the merger as a business expense(immediate deduction)

- This is dealing w/ intangible issues (future benefits theentity would get)- THIS = capital improvement NOT an expense

- Home Office = DEDUCTABLE for ONLY that % that use as office

- MUST ONLY use the space as business office- NEVER deduct fixed expenses- EX: insurance or mortgage

- ONLY deduct variable expenses- EX: cable, electric, heating, internet phone bill

195 Start- Up CostsStart Up I Carrying on Business

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< ----------------------------------I------------------------------------------Consulting Fees Consulting FeesAttorney Fees Attorney FeesTravel Expenses Travel ExpensesEmployee Training Employee Training

New Buildings New BuildingEquipment Equipment

- Exacto Spring Corp. v. Commissioner (1999)- First court to abandon the multi-factor test AND adoptIndependent Invest Test as the EXCLUSIVE method of determining

whether a business may deduct compensation under 162

212 Seeking Profit BUT NOT Necessarily InTrade/ Business

- EX: rental car/ rental property- People in business of profit incentives- Opportunities where you get deductions for having a profit w/NON business activities = Passive in nature

Cost Recovery Systems- 1) Depreciation 167 OR 168

- For TANGIBLE assets- EX: Building (NOT land)

- Returns the cost of the asset back to you over the course of its

useful life (useful life is dictated by IRS)- 2 Types:

- 1) MACRS/ NEW ACRES (default)- AKA: Modified Costs Recovery System- Certain % each yr- Very front loaded (get more $ in 1st few yrs)

- 2) Straight Line- EX: Asset cost $100 - You get $10 back each year for

10 years- Vehicle = 5 yr recovery period

- 2) Amortization 197- For INTANGIBLE assets- Straight line

- EX: Patents, Trademarks, Licenses- Recover the cost over 15 yrs

- 3) Depletion- Cost Depletion = Based on the value you feel is underground

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OR- Percentage Depletion = Take a % that you deduct every yr fromyour gross sales

179 Election to Expense Certain DepreciableBusiness Assets- If you are a SMALL business

- IRS allows you to deduct $100K of capital expenditures youwould normallyhave to depreciate- Allows you to treat as a business expense you can IMMEDIATELY

deduct

- Moving Expenses- MUST Satisfy 2 Requirements:

- 1) Employed there for 29 weeks out of the year- 2) Deductions have to be for the yr it was incurred

- ALL must be reasonable= Separate set of rules of moving out of country

= (equals) ADJUSTED GROSS INCOME

(minus) PERSONAL/DEPENDENCYEXCEPTIONS- Subject to your AGI (amount of gross income)

- WANT your AIG as LOW as possible (b/c = less taxes to pay)- Subject to wacky faze-outs- Personal Commuting Mileage =NOT deductable

- 262 Personal Expenses- Charitable Contributions & Gifts- MUST be:

- 1) Qualified recipient ( 170(c)) =- 1) Federal, state or local government entity- 2) Certain religious, charitable, scientific, literary,educational, amateur sports & prevention of cruelty to

children & animals organization- 3) Certain war veterans organizations- 4) Domestic fraternal societies, orders, or associations- 5) Non-profit cemetery companies & corps

- Verifying Charitable Status Recipient- Request copy of exception letter- IRS Publication 78 (searchable online)- All IRC

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- 2) Contribution voluntary transfer of $ OR property- 3) Amount of deduction

Total deduction amountAmount deductible in yr of contribution

- 4) VOLUNTARY

- Limited to $250 per year

- Medical Expenses- MOST are NOT deductable

- EXCEPT those recommended by Dr OR disease prevention

- NOT deductable IF Voluntary

- DEDUCTABLE IF Birth defect OR fixing something from anaccident

- SUBJECT to a floor = usually about 7 %

- 213(d)(9) DISALLOWS cosmetic surgery (NO deduction)- ON THE EXAM:

- Determine if it was Dr. recommended- If it reasonable given facts/circumstances

- Even they ARE deductable subject to 7 % floor(depending on your AGI)

- 280 (a): Reductions Related to a Home & Use of that Home- If you rent your house, is that deductable? YES

- BUT w/ limitations & exceptions

(minus) STANDARD OR ITEMIZED

DEDUCTIONS- Standard = set number of deductions- Itemized = individual deductions

Add ALL itemized together- Take the HIGHER of the 2 (whichever gives you MORE deductions)

= (equal) TAXABLE INCOME

(minus) CREDITS- $ for $ Deduction- Can be refundable OR NON refundable depending on the type of credit

- EX: NON Refundable = Adoption

- Which is better $100 credit OR $100 deduction? $100 Credit- Personal Credits

- Credits for adoption = social engineering- $10K per child in the year of adoption

- Child Tax Credit $1000 per child

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- IRC 25A Allows credits, which reduce tax income but cannotgenerate refund (Clinton made this. These are credits dollar-to-dollarreduction of taxed owed)

- Allowed for student for higher education- Hope Scholarship & Lifetime Learning (EX of credits)

- Reduce tax liability- Democrats = tax credits; Republican = tax cuts

- Hope Scholarship (per student)- MUST be at an accredited institutions for 1st 2 yrs of

education- Per student credit- 100% of 1st $1000 spent on qualified tuition & fees

- AND -- 50% of the 2nd $1000 w/ a maximum of $1500- Offset by scholarships/grants/reduction- NO felony drug convictions

- Lifetime Learning Credits (per family)- For ANY postsecondary education, NO TIME LIMIT- Per taxpayer credit- 20% of ALL qualified tuition AND fees UP TO $10K

- W/ a MAXIMUM of $2000- Reduced at $40/$80K and phased out at $50/$100K- Offset by scholarship/grants/reduction

- Earned Income Credits- Working tax payer w/ low income to provide them w/ support- REFUNDABLE

- Democratic gives credits & Republicans lower taxes

Recapture of Assets- 1231 Assets, Capital in nature BUT able to depreciate in a business

- Under MACRS

- 1245 Personal OR Tangible assets

- 1250 Intangible assets OR Real Property- EX: buildings/structures on land OR the land

- What Uncle Sam giveths Uncle Sam Taketh

Insurance- NOT normally taxable

- As long as you collect it AFTER the person dies- UNLESS you sell it BEFORE the person dies

- EXCEPTION: If you sell an insurance policy prior to death AND usethe money to pay for medical expenses IF you have a terminableillness

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- 3 Parties in a Life Insurance Policy:

- 1) Insured person who dies (NEVER has income tax liability)

- 2) Beneficiary person who gets the proceeds (NEVER hasincome tax liability)

- 3) Owner person who has all the rights to the policy (MAY haveincome tax liability - IF he/she dies b4 the insured does)

- Inheritance OR proceeds from life insurance = EXCLUDED

- NOT taxed IF Paid by reason of death- HOWEVER, interest OR amount paid in annuity over the amountof the policy is TAXABLE

- People use insurance to create safe financial future

- IRC 101(a)(1): EXCLUDE the proceeds of such policies from grossincome of recipients

- BUT exclusion applies ONLY to amounts paid by reason of deathof insured

- EXCEPTION: when even though a policy is chased out during

the insured lifetime gain on the policy is EXCLUDED from grossincome

- IRC 101(c): ANY interest payments = TAXABLE like interest earnedin bank account

- IRC 101(d): take life insurance & divide by life expectancy

- Transfer for Value Rule if buy policy, the amount EXCLUDEDcannot exceed the amount paid for it

- IRC 101(g): if a terminally ill person sells his life insurance policy b/c

want money THAT gain is treated as if it has been received by reasonof death = EXCLUDABLE- If insured dies AND beneficiary takes life insurance in cash =EXCLUDED

- Formula: investment in K total investment return

- IRC 101(d): = life insurance life expectancy- Lump sum = tax FREE

- Formula = (amount received as an annuity) x (investmentin contract) (expected return)

Annuity- An Annuity = Arrangement under which 1 buys a right to futuremoney payments

- Guarantee payment- Effectively a return of capital, spread over the life of the annuity

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- CAN be NON-taxable depending on HOW it is structured- Return of your capital is NON-taxable

- The interest = TAXABLE- EX: $100/month for the rest of your life (i.e., set # for set period)

- Amount excluded CANNOT exceed amount paid for the policy

- EXCLUDABLE amount = amount of policy life expectancy- INCLUDABLE amount = yearly payment excludable amount

- If outlive the expected life expectancy ENTIRE annuity = INCLUDED- 3 Types of Annuities:

- 1) Single Life Annuity calls for fixed money payments to theannuity for her life after which all rights under the K cease

- 2) Self & Survivor fixed payments are made during life ANDcontinues after death

- 3) Joint & Survivor pays amount jointly to 2 annuitants whileboth are living AND payments continue to survivor

- Endowment K when purchaser buys right to receive amount permonth AND continue in event of death before expiration term

- Variable Annuity combination annuity w/ mutual fund concepts

AMT (Alternative Minimum Tax)- Effects individuals AND corporations ONLY- If you are wealthier, once you finish the tax return you arealtered to be an AMT- Which means you have more taxes taken out- Mitigates what you can deduct b/c you are wealthier

Child Support & Alimony- 71 (b) & (c) Child Support- Any amount specified in instrument will be reduced on child attaining aspecified age, marrying, dying, leaving school, or other contingency,then amount will be treated as fixed

EXCLUSIONS = child support, gifts, inheritance, etc which areEXCLUDED

- PayeEE spouse = EXCLUDED from income- PayOR spouse = DEDUCTABLE to you = tax neutral (b/c you

have the requirement of providing for that child regardless ofthe relationship of the parents)- Look for payment that is dropping off as result of turning 18- PayOR write check to payee to take care of the kids

- The money does NOT get taxed b/c the income of money is tosupport the children who are suppose to be taken care ofregardless of the divorce (this assumes the payOR is the primarybreadwinner)

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Alimony- Alimony 71(b)- (1) Payment in cash (or check or money order)

- (1)(A): Received by (or on behalf of) recipient under a divorce or

separation instrument- (1)(B): Instrument does NOT designate the payments as non-alimony

- (1)(C): Payor & recipient are NOT members of the samehousehold if legally separated; and- (1)(D): NO liability to continue making payments(or anysubstitute for payments) after the death of the recipient

- Alimony breaches the fruit/tree doctrine Allows you toASSIGN your income AND take a DEDUCTION

- PayOR spouse = Full DEDUCTION

- PayEE spouse = INCOME/ INCLUDABLE (by legislativegrace)

- If you represent the spouse RECEIVING the alimony wantpayOR to take out a life insurance plan as part of the divorcedecree

- So that the ex-wife becomes the beneficiary if the husbanddies & gets paid & money can be used to support thechildren (if not beneficiary, wife becomes creditor and is oneof the last to be paid upon the death)

- 71(f) Alimony Recapture Rules/Provision- If the 3rd yr of payment is LESS THEN the 1st 2 yrs IRSwill go back & reverse what was done- When inordinately large amounts of alimony & support are

paid in the 1st or 2nd yr in relation to the 3rd yr an amountis recaptured in the 3rd yr

- It takes from the amount included on the payORspouses income or yr 3 & deduction in the same yr bythe payee spouse

- ONLY way to prevent this is to have EQUAL paymentsevery yr

- PayOR spouse tries to bake in tax neutral child support &property settlement to get a deduction- EXCEPTIONS: Spouse dies OR payee spouse remarries

- Decrees for support & payment under continuingliability to pay fixed portion of income

- If amounts paid w/in yr 1, 2, & 3 are ALL w/in $15K of each

other NO recapture

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- 1041 & 1015 Property Between Spouses in a Divorce- If payments qualify as alimony OR separate maintenance, statutepermits allocation of tax in accordance w/ expressed wishes pfparties, if NOT there is NO tax (tax neutral splitting)

- EX: Have IRA that is worth $1 million & split it. You get

$500K & wife gets $500K. - Has $500 basis. If cash out get$450K. TREATED AS A GIFT

- 1) Tax Neutral- 2) Carryover basis- 3) Treated as a GIFT- IRA - Husband - Wife-$100K Basis - $50K - $50K - $500K FMV - $250K - $250K - IRC 1041: Transfer of property between spouses or incident to

divorce- General Rule: NO gain or loss shall be recognized on

transfer of property from individual to (or in the trust for thebenefit of)

- Spouse- Former spouse

- Transfer treated as a gift: TransfeEE has transferors basis- In case of any transfer of property described in (a)

- For purposes the property shall be treated asacquired by transferee as gift- Basis of transferee in property shall be adjustedbasis of transfer

- Incident of divorce: A transfer of property is incident to divorce if

such transfer:- Occurs w/in 1 yr after date on which marriage ceases

- OR -- Is related to cessation of marriage

- IRC 1041: accords almost complete tax neutrality to transfersof property between spouses & between former spouses if the

transfer is incident to divorce NO gain or loss is recognized- In a divorce, the assets are divided- Anytime you put money away pre-tax (qualified assets) aretaxable when cashed OR divided EXCEPT

- These qualified assets are divided in half in terms of value

& basis- EX: $1 million asset, each get $50K, each basis = same

- Divorce is NOT a taxable event- EX: clients get divorced & later feels bad & wants to give hermore money from a qualified asset that he received- but if he

were to open it a huge tax automatically gets invoked so heshould go back & amend the divorce decree (b/c the divorce is anon taxable event) & make it part of the order & do it that way

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Alimony Payments Made By 3rd Party- IRC 215, 682, 72- Income of alimony trusts, EXCLUDED from payORs gross incomeis TAXABLE to payee

- Paying a 3rd

party to assist spouse- Paying to 3rd entity treated as alimony- Same as trust INCLUDED to her (payeEE) & DEDUCTIONto me (payOR)

Non-Recognition- The Non-Recognition provisions of the Code POSTPONE taxation untiltaxpayer finally sells or otherwise disposes o the taxpayers property- Deferral is generally accomplished by giving the taxpayer anEXCHANGED basis in the property received in a non-recognitiontransaction

- 2 Principle Justifications for Non-recognitions:- 1) Continuation of investment in property- 2) Inability to pay the tax at realization

- EX: 1041 in divorce, property can be divided & not create ataxable event- EX: Farms & other special occupations/industries (swapping crops)- EX: Sale of personal residence- EX: Like King Exchange [1031(a)(1)]

- Exchange- Old property held for use in business OR for investment

- Solely- For property of like kind- New property to be held for sue in business OR for investment- MUST transfer real property for real property, etc.- Voluntary- Defer taxable event

- EX: Guy buys plane wants a new one instead of selling

it & creating a taxable event swap it w/ someone else defers the taxable event

- Broadly construed

- EX: Involuntary Conversion [1033]- Involuntary- Narrowly conceived- MUST set up the SAME business somewhere else- MUST be w/in a certain time frame

- If you do NOT Treated as sale/exchange = TAXABLE- If you rebuild w/in certain time = non recognition

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- EX: When MI was making 696, MI bought home &businesses to make the road

- Normally b/c of emanate domain the people would get paid= ascension of wealth- BUTTTTT:

- As long as people followed rules of 1033, they didnot have to pay taxes on the money- Some people saw it as a chance to start something

new they were taxed!

Tax Rates- MUST determine filling status:

- 1) Unmarried individual/ Single- 2) Married Filling Jointly- 3) Married Filling Separately

- Do this if 1 spouse has tax issues

- 4) Head of household- If NOT married

- AND -- Have dependents

- Tax Rates:- Progressive rate from 5%-35% depending on your BRACKET

- If someone makes $100K 1st $75K is taxed @ 5%-28%rate

- 2nd $15K is taxed @ 35% rate- Capital Gain = 15% flat rate- Ordinary Rates = 35%

Gains From Dealings In Property- Determines the amount of tax on the gain/exchange of property- 61(a)(3): Gross income includes GAINS derived from dealings inproperty- 1001(a): Formula for Computing Gain

** (Amount Realized) (Adjusted Basis) = Realized Gain **- 1001(b): Amount realized = (cash received) + (FMVproperty received)

- 1011(a): Taxpayers basis under 1012, as adjusted by1016

- 1012: Basis = generally defined as cost- 1016(a): Adjusted Basis - 27 Adjustments to

basis- INCREASE basis for IMPROVEMENTS made toproperty

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- REDUCE basis by the amount of DEPRECIATIONdeductions- Either lessens OR increases your tax

- 1001(c): Realized Gain = except as provided, ALL gains

are RECOGNIZED/ INCLUDEDTax Treatment of Taxpayer Costs- 3 Possible Natures of Income:

- 1) Capital Expenditure- 2) Expense- 3) Loss

- 3 Possible Activity to Which Costs Relates- 1) Personal- 2) Business- 3) Investment

- Capital Expenditure + Personal = NO deduction- Taxpayer gets basis

- Capital Expenditure + Business/ Investment = NO deduction- Taxpayer gets basis

- AND -- MAY get cost recovery deduction over useful life

- Expense + Personal = NO deduction- W/ very limited exceptions (EX: home mortgages)

- Expense + Business = DEDUCTION (above the line)

- Expense + Investment = DEDUCTION (below the line)

- Loss + Personal = NOT recognized- EXCEPT casualty OR theft losses

- Loss + Business = RECOGNIZED- NO limits- SOME exceptions

- Loss + Investment = RECOGNIZED

453(c): Definition of Installment Method- Income Recognized = (Payment Received) x (Gross Profit/ Total KPrice)- Installment Sale Method: (Gross Profit) / (Total K Price) = GrossProfit % (GPP)

- To determine AMOUNT INCLUDED Apply GPP to TOTALpayments received during yr

- Gross Profit (Selling Price) (Adjusted Basis)- Selling Price = Gross selling price w/ NO lessening for

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debt or selling expenses- Adjusted Basis (AB) = normal AB including sellingexpenses for non-dealer sales of real property AND casualsales of personal property

- Total K Price (Selling Price) (Qualified Debt)

- Qualified Debt = any debt secured by the property ANDany debt incurred in acquiring OR operating the property

- Any qualified debt in EXCESS of AB (OR any non-

qualifying debt) treated as payment in yr of sale(how it is treated)

- Related parties are EXEMPT (IRC tells definition of relative for THIS )- Even if they are allowed, IRS maymake you jump through hoops

to get it

165 Losses (The ONLY losses that areDEDUCTABLE)- 165(c)(1): Business

- 165(c)(2): Transaction entered into for profit- 165(c)(3): Casualty/ Theft

- MUST have a loss that falls w/in the definition of casualtyOR theft

- Business losses AND thefts = FULLY deductable- Personal losses AND thefts = subject to deductions (usuallydepends on insurance)

- MUST factor in insurance- Difference between what insurance pays & value on the

house

- McWilliams v. Commissioner

- When you have related parties you CANNOT generate a lossbecause there is a fear you are creating a fake loss- ONLY if it is reasonable, justifiable OR legit business transaction- MUST: - 1) ID related parties

- 2) Do you have a loss?- 3) Is it deductable?

- A loss attributed to an ACTUAL business transaction

- Any property held by taxpayer IS capital asset EXCEPT:- 1221(a)(1): inventory AND property held for sale to customersin the ordinary course of business- 1221(a)(2): depreciable personal property AND real propertyused in business- 1221(a)(4): receivables acquired in the ordinary course ofbusiness

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Qualified Residence Interest- 163(h)(3)(A)(i): ACQUISITION OF DEBT w/ respect to a qualifiedresidence

$1 million or LESS = deductable

- 163(h)(3)(A)(ii): HOME EQUITY DEBT w/ respect to a QUALIFIEDRESIDENCE

- Up to $100K

- 163(h)(3)(B) - (i)(I): Incurred to buy, build, or improve QR- (i)(II): Secured by QR- (ii): $1 million limit

- 163(h)(4)(A)(i): Principal residence + 1 other residence

- 163(h)(3)(C): - Not acquisition debt

- Secured by QR- (FMV Acquisition debt) limit- $100K limit

Introduction to Accounting Methods***CASHMethod***ENDS: 12/31

ACCRUAL MethodTiming Issue ENDS: Corp.decides

Has INCOMEwhen:

RECEIVED:- Constructivereceipt- Cash equivalence

EARNED:- All vents Test- Collection doubts- Contested income- Unenforceable claims- Advance payments- In yr work done NOT when collect$

MAY claim aDEDUCTIONwhen:

PAID:- When paymentoccurs- Advance

payments

OWED:- All Events Plus Test- Economic performance- Contested liabilities

- Individuals = Cash Basis Tax Payers- Do NOT take deductions UNTIL they actually happen

- Certain business entities (EX: Partnerships, C-Corps, S-Corps, LLCs)ESPECIALLY if they have inventory = Accrual Tax Payers

- End at different time depending on when they make the mostmoney

- EX: Nordstroms ends 1/31.

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529 Plan Higher education fund for your children- Can front load for gift tax purposes AND have NO income taxes

on it

6015 Innocent Spouse Relief- Depends on whether or NOT you have already been sued- KNOW what is on your joint tax return BEFORE you sign it

- 6015(b): Basic Relief- Must have filed a JOINT return- Understatement due to evil spouses error- Innocent spouse did NOT know of the understatement

- AND -- Has NO reason to know of it- Inequitable to hold the innocent spouse liable

- Innocent spouse makes timely election

- 6015(c): Apportioned Relief- MUST have filed a JOINT return- Timely election made- NO longer married OR NOT in same household for past yr- No actual knowledge of the item giving rise to the deficient

- OR -- Had knowledge BUT under duress

- 6015(f): Equitable Relief- Inequitable to hold innocent spouse liable- 6015(b) & (c) dont work

- Hobby Expenses = NOT deductible

- 183: Hobby Loss Rule- Deductions are limited to what you made a profit off of- Can ONLY loose what you have invested- If it is NOT part of my active trade / business/ not materiallyparticipating in the business = NOT a deduction- If you have a horse farm

- MUST show profit for 2 of 7 yrs = DEFENSE that it is NOT ahobby

- Helps show that it is truly a business/trade- If you have something OTHER THAN a horse harm

- Must show income on it for 3 of 5 yrs to claim a deduction

- Active v. Passive Income

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- Active = Teaching at the school- Passive = Any business profit seeking activity that the taxpayer ownerdoes NOT materially participate

- EX: Owning Starbucks & not working there- 469: Passive Activity Rules

- Prohibits certain taxpayers from certain activities- Limited/mitigating the deductions give you more income& more taxes

- 7 Ways to Determine Whether the Material Participation Test isSatisfied

- 586: Tuition payments MAY be deductable w/ regard to businessexpenses

Return of Capital Doctrine Loans & Interest- Return of capital theory, if you are returning money back it

is NOT income to that person giving the loan- Return of capital is neutral because what is given backis what you already had- IF there is interest, that is the only thing that is taxable

- Interest- ALWAYS have interest when you give things as a gift

- Otherwise they will have to pay a lot of taxes

- Loans- 7872(c): 5 NON Gift Loans

1) Between a corporation & 1 of its shareholders2) Between an employer & employee OR between an independentK & person to whom he provides services

AKA: compensation loans3) W/ a principle purpose to avid any federal tax4) Catch-all subcategory of other below-market loans

Their interest arrangements have a significant effect on anyfederal tax liability of the lender/borrower

5) To a qualifying continuing care facility pursuant to a continuingcare K

151: Personal Exemptions For Dependents- Qualified Child- 1) MUST be a child of the taxpayer (son, daughter, step, adopted

& foster)- 2) MUST have the same principle place of abode as taxpayer forMORE THAN 1 yrs

- Temporary absence is OK if for special circumstances (EX:pursuant for education)

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- 3) MUST meet the age requirement- If either under 19 at the close of the calendar yr

- OR -- Is a student who has NOT attained age 24 at end of such

calendar yr

- 4) Must NOT have provided over of individuals own supposefor calendar yr

- Qualified Relative- 1) MUST be a qualified child- 2) MUST bear the relationship listed under 152(d)(2)- 3) Person claimed as dependent may NOT have gross income inexcess of the exemption amount of that yr- 4) MUST provide over 12 of the support for that individual during

that yr

- Commissioner v. Banks (2002)- Lawyers contingency fee = INCOME

- Even if you dont get the benefit from it

- Capital Gains- Sale OR exchange = taxable event

- EX: Person sells art and they sold so many IRS said it was inventory- Inventory = subject to ordinary income- NOT inventory = Capital asset = preferential treatment

- Holding Period- Hold an asset for MORE THAN 1 yr = LONG term capital gain

- Subject to 15% tax rate- Hold an asset for 1 yr OR less = SHORT term capital gain

- Subject to ordinary income rate = 35%- EXCEPTION: If you INHERET something from grandma and you

have it for less 2 months & want to sell it automatically getLONG TERM capital gain rate

- To Determine Tax Rate . . . MUST ASK:- 1) Do you have a capital asset?

- 2) Is it for a personal or business?- 3) Short or long term?

- Short Term Capital Gain Short Term Capital Loss = Net Short TermCapital Gain/Loss- Long Term Capital Gain Long Term Capital Loss = Net Long TermCapital Gain/Loss- Net Long Term Net Short Term = Capital Gain Rate

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- Capital Gain Rate:- 693: Most = 15%- Others = 28%

- EX: Several types of collectibles on capital gain (stamps,

gems, artworks, coins)

- 1211 Capital Losses- Netting losses short term add them up

- COD = Cancellation of Debt = An ascension of wealth- EX: Become a Dr. & Join the army

- Normal Capital Assets Individuals Own:- Car, House, Bonds & Stocks, Boats- ANY personal asset ALWAYS = capital in nature

- Ordinary Income Taxation- Compensation- Any type of ascension of wealth s 61- Subject to ordinary income tax- Taxed at highest marginal rate

- When you sell an asset, you have to pay the government back for thedepreciation you took on that asset

- ANY amount you make ABOVE what you initially paid for it youkeep

- EXAMPLE: 1000(cost basis) - 500 (depreciated) = 500 (adjusted basis)

- EXMAPLE: 1200 (sold item for) - 500 (what got deprecated) = 700(gain)

- EXAMPLE: 700 (gain) - 500 (what was deprecated = taxable) = 200(actual gain)

- Gain is divided into 2 parts- (1) $500 = ordinary income (b/c that was what you deprecated it

for)- & (2) $200 = capital gain (what you made on the sale abovewhat you paid)

- Howard v. Bugbee v. Commissioner USE for debt question- Was there a valid buyer/lender relationship?- Was this a true business venture?

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- If yes CAN take losses

- If no several tax issues

- If you can prove a valid business relationship CAN treat as shortterm capital loss- When there is a debt collection:

- 1) If there a debt?- 2) If it a bad debt?

- Bad debt = is there reasonable thinking that you willNEVER collect on the debt

- 3) It is a business bad debt?

- If YES to ALL 3 FULLY DEDUCTABLE as a capital loss

Assignment of Income- Assigning income to someone else does NOT transfer tax liability

- Open Transaction Gain is based on sales for the next some yrs- Things are STILL open

- Closed Transaction Taxpayer elects out of 453

- OID (Original Income Discount)- Hidden transaction- Looks to be a return BUT there is income labiality to it- Hidden interests- A form of disguised interest- Have to go through an OID analysis

- IRD (Income in Respect of Descendent)- Based on work product- Income INCLUDED & for estate tax purposed- Earned income during life, but paid after death

- Whether or not there is an economic event?- Is there ascension of wealth?

- Salary, dividend, or some type of benefit- OR -

- Sale or exchange=

- Taxable event THAT is subject to preferential tax rate (15%)

- If NOT sale or exchange = ORDINARY income = 35% tax rate- EVERYTHING we own is typically= CAPITAL in nature

- So Whenever you EXPOSE of capital asset You DEDUCT- Own MORE THAN 1 yr = CAPITAL asset = 15% rate- Own 1 yr OR LESS = ORDINARY income = 35% rate

- EXCEPT: Inheritances

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- Masters Exception If you own a home & rent it out for LESS THEN

14 days ALL income you generated = Tax FREE

Discharge of Indebtness- If money is forgiven / If Discharge of indebtedness = INCOME

- UNLESS explicitly excluded by legislative grace- If tuition is refunded OR excused = EXCLUDABLE- Is the loan that is being forgiven a result of/ related to the acquisition,construction OR financial improvement of the house???

- B/c if it is NOT =INCOME & INCLUDABLE- Congress made AN EXCLUSION of debt for up to $2 million of ANY loanforgiven

- EVEN thought people are going to loose their house & have theirloans forgiven

- United States v. Kirby Lumber- The cancellation of debt = gross income to borrower- Freeing of assets- Symmetry

- Loan proceeds NOT included in gross income upon receiptb/c of obligation to repay- Cancellation of obligation to repay removes the reasonfrom excluding the proceeds from income

- EXCLUSIONS/EXCEPTIONS to Kirby (Safe Harbor)

- NO income If debtor is insolvent before OR after

- 1) Insolvency More money going out than coming in (moreliabilities than assets)

- If you lend me back money & I pay you back = INCOME- UNLESS it falls in an EXCEPTION

- 2) EX: Gift Donor says he will forgive & give it as a gift- Donor CAN donate UP TO $13K = GIFT & NOT generate

income- NO income liability on person GIVING the gift

- BUT income liability on person RECEIVING if gift OVER$13K

- 3) Debt Discharge INSIDE Bankruptcy Amount is appliedto reduce taxpayers tax attributes

- Directed at businesses- Carry over losses- Capital losses

- 4) Certain Reductions As Purchase Price Adjustment ifdebt has been transferred by seller to 3rd party OR if property hasbeen transferred by buyer to 3rd party

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- If you do a short sale = NO tax liability

- Discharge of Indebtedness- Income realized when indebtedness IS forgiven OR in other ways

cancelled

- EX: If a corporation has issued a $1000 bond that is laterrepurchased for $900 it increases its worth by $100

- Debt Discharge OUTSIDE Bankruptcy amount of debt isEXCLUDED up to amount that is insolvent

- ANY balance of debt discharged which is NOT EXCLUDED treated in same manner as debt cancelation

104 106 Damages for Injuries- Compensatory, if physical= NON taxable- Compensatory, if NON physical = TAXABLE- Punitive, if physical = TAXABLE- Punitive, if NON physical = TAXABLE

Income Earned Abroad- IRC 911- To qualify for EXCLUSION an American citizen MUST be resident offoreign county OR had uninterrupted period during taxable yr (@ least330 days)- Maximum exclusions = $80K AND is indexed for inflation- Exclusion could be available for housing expenses

Exclusions & Other Tax Benefits Related to Costs ofHigher Education- IRC 221: Allows interest DEDUCTION for some interest payments onqualified education loans- IRC 222: Allows DEDUCTION for qualified tuition AND relatedexpenses

- IRC 529: Qualified Tuition Programs deferred program that allowsyou to guard you money away

- Allow taxpayers to prepay higher education costs by purchasingtuition credits- Each states had it own (EX: MI MET Program)- Some time in future can use it, putting money into it and it wontbe taxable as long as use it to educate your child- Put money into a 529 Plan

- Do NOT have to pay federal OR MI taxes on it EVER (it is allpre-taxed money)

- As long as it goes to a qualified higher educationprogram for your kids

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- It is EXCLUDABLE & gives kids the incentive to go tocollege

- Raff IRA: put already taxed money in it- Trade IRA: dont pay taxes upfront and have to pay later.Forced to take distribution

- IRC 530: Coverdell educational savings accounts EXEMPT from tax- $2000 increments to pay for education in future- Contributions MUST be made prior to 18th b-day

Federal Taxes & State Activities- Governments chance to promote infrastructure- IRC 103, 115, 141, 142, 148, 149- IRC 103(a): EXCLUDES interest on ANY state OR local bond fromgross income BUT does NOT extend to private activity bongs

- Public bonds = for public services

- Private bonds = particular park or community- Qualified Bonds = EXCEPT facility bonds, etc- Private Activity bonds = obligations to finance nongovernmentalundertakings

- Part of bond used for private use- Arbitrage Bonds = ANY portion is use to acquire investmentproperty which produces yield which is high than bond

Assignment of Income- Lucas v. Earl

- Wanted to assign income he didnt make yet to his wife to avoidtax income- Ct said: although it was a valid K, money CANNOT escapetaxability from the one who earned it no matter how skillfully the Kwas devised

- Fruit of the Tree Doctrine- Taxpayer = Tree- Money earned as income = Fruit- If the fruit is coming off that tree then THAT tree pays THAT tax- The tax is assessed to the one who EARNED it (the tree)- EX: do something for someone, they give you $, you say no dont

give it to me- give it to him, I owe him money- Even though OTHER person gets the money YOU pay thetaxes

- You CANNOT assign away your tax liability

- EXCEPT alimony

162 & 263 EXPENSES- 162: Allows taxpayer to deduct expenses paid or incurred

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during taxable year

- Midland Empire Packing Co. v. Commissioner: Repairs toproperty made during taxable year are deductible as ordinary andnecessary business expense.

- The expenditure did not add value or prolong expected lifeor property- Ordinary does not need to be habitual

Income Producing Entities- 3 principal types of income: (1) partnerships, (2) corporations, & (3)trusts

- 1) Corporations 11 when corporate after tax income isdistributed as dividends to shareholders, it is taxed toshareholders in individual capacities

- Difference Between Partner & Corporation: Partner is not

insulated from partnership income a shareholder is insulatedfrom income of corporation.

- A corporation = an entity separate and apart fromits shareholders

- C-Corporation: Standard corporation, taxed at 2 levels:

- 1) At the Entity Level they file a Form 1120 ANDgenerates it

- 2) At Ownership Level dividends that aredistributed out to shareholders and they fill out a Form1040

- Traditional business entities: provide limitedliability earnings

- Sub Chapter/S-Corporation: Cannot have more than100 shareholders

- Entity Level no tax, however you do file a taxreturn and that Form is 1120S

- Shareholder Level taxed on all that flow throughearnings on Form 1040- Same limited liability as a C-Corp and is easilyrecognizable- No tax at entity level and tax attributes flow through

at entity level. Limited number shareholders, narrowdefinition of what a shareholder can be, andrestrictions on trusts and estates.

- 2) Partnerships/LLC 703 persons carrying on a business aspartners all will be liable for income tax only in their separate orindividual capacities which is determined by agreement withpartners.

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- Made up of partners with the intent to form a partnershipand they themselves create a partnership for businesspurposes- General Partnership: File Form 1065: pay no taxesbecause the partners pay all taxes, as long as general

partner is liable for everything. Partner- Limited Partnership: File their own Form 1040, onlylimited to extent of the investment. Member (can cut yourown deal)

- DO NOT become a limited partner, you want a LLC(use a limited liability company)- Choose an LLC for Sub Chapter S Entity

- LLC: Limited Liability Company

- 3) Trusts: Falls between a partnership and a corporation. Indetermining the taxable income of the trust, a deduction is

allowed for amounts required to be or otherwise paid tobeneficiaries.

- TrustOR = creates trust- TrustEE = managing document- Beneficiaries = received monies, FORM 1041

Simple and Complex Trusts- Simple Trusts: distributes everything tobeneficiaries because it is most efficient- Complex Trusts: may distribute to beneficiariesonly if necessary. Trust pays tax on this, notthat efficient.

- Most trusts are complex trusts- The taxpayer is using a trust to avoid paying income taxes- A trust is an entity that is established when the grantorwith a beneficiary (someone who benefits from the trust)and with some type of principle income or assets which arefunded in the trust

- Basis in Property Received:AB of OLD property

-Money Received (boot)

+Recognized Gain (value above the property)

-Recognized Loss

=AB of NEW property

Tax Final Outline (1)

Documents

Transcript of Tax Final Outline (1)