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Gross Income: The Scope of Section 61
o Sec 61 defines gross income as all income from whatever source
derived, minus statutory exclusions
o Equivocal Receipt of Financial Benefit
Commissioner v. Glenshaw Glass Co.
Two cases were consolidated and sought to ask whether
punitive damages were includable as income
Income is present whenever there is an undeniable
accession to wealth, clearly realized, and over which
the taxpayer has full control
Here, both the actual damages and punitive damages is
considered income
Cesarini v. United States
Taxpayer buys a piano and later finds a large sum of
money in it; At first claims the money as income, but
changes his mind
Here, the money is income because it fits the definition
It now becomes the taxpayers burden to point to
an exception
This is a windfall which is taxed
If you bought a chest hoping something valuable
is inside and there is, it is not a windfall and
would be taxed upon disposition
Old Colony Trust Co. v. Commissioner
Company agreed to pay employee's income tax on his
salary earned; IRS sought to include it as income
Because the tax payment was in return for services
rendered, it was considered income
It makes no difference the form of payment
"The discharge by a third person of an obligation
to him is equivalent to receipt by the person
taxed"
This goes to any payment of obligations owed by
the taxpayer
Charley v. Commissioner
Through a complicated process, plaintiff would purchase
coach tickets but client would pay for first class; TA
would give the difference to plaintiff
Court saw the case in two ways:
Because the TA sent the money to the employer,
who then gave it to plaintiff, the money could be
viewed as additional compensation from the
employer, thus bringing it into the definition of
income
Alternatively, it could be viewed as a disposition
of personal property by plaintiff because in effect
he sold his frequent flyer miles for the cash
Loans are not income because they are linked with the duty to
repay, and thus there is no accession to wealth
Wealth acquired illegally is still income
o Income Without Receipt of Cash or Property
Helvering v. Independent Life Ins. Co.
The rental value of a building that is being used by the
owner is not income
Revenue Ruling 79-24
When services are paid for with something other than
money (barter), the fair market value of the property or
services taken in payment is income
This includes when services or goods with equal
fair market value are swapped
Value is the fair market value - what a
reasonable buyer would pay
Dean v. Commissioner
To secure a corporate loan, owners were required to
place the title to their house in the company; They still
lived their (the corporation paid the mortgage) and the
IRS sought to include the rental value that they didn't
have to pay as income
The court held that this was income
Exclusion of Gifts and Inheritances
o Section 102 - Gifts and Inheritances
Section A - Gross income does not include the value of property
acquired by gift, bequest, devise, or inheritance
Section B - The income derived from property not taxed under
Section A is gross income
Section C - Property transferred from employer to employee is
includable in gross income
Sections 74 and 132 create exceptions to this rule
o The Income Tax Meaning of Gift
Commissioner v. Duberstein
Taxpayer 1 received a Cadillac for a sales tip; Taxpayer
2 received $20,000 upon retirement; Neither wanted to
pay taxes
Rule: For tax purposes, a gift is something given out of
detached and disinterested generosity given out of
affection, respect, admiration, charity or like impulses
If the gift can be characterized as being given in
return for services rendered, it is not a gift (quid
pro quo)
o Gifts to Employees (Exceptions to Section 102(c))
Section 102(c) provides that gifts from employers to employees
are includebale in gross income unless excluded in sections
74(c) and 132(e)
Section 74(c) - Employee Achievement Awards
Exclude from gross income if the value of the award
does not exceed the amount the employer can take as a
deduction
Section 274(j)
Is the gift an employee achievement award?
An employee achievement award is an
item of tangible property given in return
for safety achievements or length of
service, awarded in a meaningful
ceremony, with no hint of disguised
compensation
Length of service awards are given
every five years
Part of a qualified plan, or a non-qualified plan?
274(j)(3)(b)
To be qualified, the plan must be written
and not discriminate against lower paid
employees
Amount of exclusion
Qualified - Average cost of all gifts given
by employer to all employees does not
exceed $400 and the total received by
individual employee cannot exceed $1600
If you don't meet this, it becomes
non-qualified award
Non-Qualified
Total received by the employee
cannot exceed $400
Section 132 E - De Minimus Fringe
A de minimus fringe benefit is any property or service,
the value of which, after taking into account the
frequency it is offered, is so small as to make accounting
for it unreasonable
Examples: Free coffee, limited copies, limited use
of secretary, occasional cocktail parties,
traditional birthday or holiday gifts, drinks (Gift
certificates are not de minimus per 1.132-
6(c))
Proposed Regulation 1.102-1(f) would exclude a
gift given from income if it could be considered
family
The higher the fmv, the larger the presumption
that the gift is disguised compensation
Company cafeterias can be excluded from gross income
if the cafeteria covers its costs and the cafeteria does
not discriminate against non highly compensated
employees
o Bequests, Devises, and Inheritances
Lyeth v. Hoey
Heirs at law contest will and receive money in a
settlement; State law defines who inherited, and
because they did not "inherit," IRS wants tax
Rule: When there is a settlement of a will, and a
taxpayer receives a payment in the settlement because
of his status as an heir, Section 102 applies and the
income is not includable in gross income
Wolder v. Commissioner
Attorney is paid for his work by requesting that the
client include him in her will
Rule: Looking to the substance of the transaction, if it is
compensation for services rendered it does not fall
within the exception in Section 102
"A transfer in the form of a bequest was the
method that the parties chose to compensate
Wolder for his legal services, and that transfer is
therefore subject to taxation, whatever its label"
Employee Benefits
o Section 132 - Certain Fringe Benefits
Section B - No Additional Cost Services
An employee can receive a service provided by employer
for free and not include it in gross income if the service
is offered to customers, the employee works in that line
of business, and there is no substantial additional cost,
including lost revenue
The same line of business requirement is to
prevent unfair situations with employees of
conglomerates
Note that if there is a written agreement between
companies in the same line of business,
employees can take advantage of the other
company's services - Treas. Reg. 1.132-2(b)
Section C - Qualified Employee Discount
If property is being sold to an employee at a discount,
the discount may not exceed the gross profit percentage
Gross Profit Percentage equals:
(aggregate sales price - cost)/ Aggregate Sales Price
If services are being sold to an employee at a discount,
the discount cannot exceed 20% of the price offered to
customers
The property must not be real property or property held
for investment and must be within the employee's line
of business
Section E - De Minimus Fringe
A de minimus fringe benefit is any property or service,
the value of which, after taking into account the
frequency it is offered, is so small as to make accounting
for it unreasonable
Examples: Free coffee, limited copies, limited use
of secretary, occasional cocktail parties,
traditional birthday or holiday gifts, drinks (Gift
certificates are not de minimus per 1.132-
6(c))
Proposed Regulation 1.102-1(f) would exclude a
gift given from income if it could be considered
family
The higher the fmv, the larger the presumption
that the gift is disguised compensation
Company cafeterias can be excluded from gross income
if the cafeteria covers its costs and the cafeteria does
not discriminate against non highly compensated
employees
Line of Business
If the employee performs work in more than one line of
business, that employee is eligible for discounts or no
additional cost benefits within any lines of business
where he has substantial involvement - Treas. Reg.
1.132-4(a)(1)(iii)
If an employee performs duties that directly benefit
more than on line of business, the employee is treated
as performing services in all such lines - Treas. Reg.
1.132(a)(1)(iv)
Section (H)(2)
The spouse and dependant children are treated as if
they were the employee
Gains from Dealings in Property
o Basis
Section 1001 - Determination of Amount of And Recognition of
Gain or Loss
Section A - Computation of Gain or Loss
Gain from a sale of property equal the amount
realized minus the adjusted basis
Loss from a sale of property equals the adjusted
basis minus the amount realized
Section B
Amount realized from a sale of real property
equals that amount of money received plus the
fmv of any property received
Section C
Except as otherwise stated, recognize all gains or
losses on the sale of property
__________________________________________________
__________
We need a realization event
The satisfaction of a debt with appreciated
property counts
Destroyed Property
Section 1033 allows for non-recognition of
destroyed property and insurance
settlements if similar property is
purchased
Basis is whatever the original basis
was
Section 1011(a) - Adjusted Basis For Determining Gain or Loss
Adjusted basis equals basis plus any adjustments
allowed under Section 1016
Section 1012 - Basis of Property - Cost
The basis of property shall be the cost of the property,
not including any real property taxes
So, if you purchase an option to buy a house for
$50k and then exercise the option for an
additional $100K, your basis is $150k
Amount borrowed is still considered part of the
cost
Philadelphia Park Amusements Co. v. United States
Rule: While Section 1012 says that the basis of
property is the cost of such property, the basis of
property received for property is the value of the
property received
This is necessary to ensure that neither
party is under or over taxed
Estate of Franklin
Rule: The Prudent Investor Rule states that if at
the time of purchase, the amount you borrow on
a non-recourse basis outstrips the value of the
property, none of the loan is includable in basis
So, recourse debt is includable in basis
and non-recourse debt is includable if it
does not outstrip the fmv of the property
Section 1015 - Basis of Property Acquired by Gifts and
Transfers in Trust
Section A
If the property is acquired by gift, the basis is the
same as it would be in the hands of the donor
(transferred basis)
However, if the basis is greater than the fmv at
the time of the gift and you are calculating a loss,
use the fmv of the gift at the time of transfer
This prevents losses from being
transferred
Section 1016 - Adjustments to Basis
Section A
Adjust basis for expenditures, receipts, losses, or
other items properly chargeable to capital
accounts and for the exhaustion, wear and tear,
obsolescence, amortization, and depletion of
property
Expenditures are chargeable to capital
accounts if it is money that improves the
asset
Money spent on services
(gardening . . .) does not qualify
Look for permanent changes to the
property
The depreciation adjustments allow tax
free recovery of investment before
realization event
Taxes are not includable as basis
Section 1019 - Property on Which Lessee has Made
Improvements
If property is excludable from gross income under
Section 109, it does not affect the basis of property
Section 109 - Improvements by lessee on Lessor's
Property
If a lessee improves the property of a lessor,
there is no effect on the lessor's gross income
upon termination of the lease
The combination of these two sections really only delays
when the tax is paid
Section 267 - Losses with Respect to Transactions Between
Related Taxpayers
Section A
Taxpayers cannot take losses (but do take gains
unless covered by Section 1041) on sales to
people listed in section b, which are family
members and the like
This is to prevent the transfers of losses
Section B
This section lists the relationships
Section D
On a future sale, the gain can be recognized to
the extent it exceeds the previous loss
Thus, the loss that was denied before can
be taken now
Part sale, part gift (Check to see if the sale is for less than FMV)
Transferor's Gain
Per Treas Reg 1.1001-1(e), transferor has a gain
to the extent that the amount realized exceeds
his adjusted basis in the property
But, there is no loss if the amount realized is less
than the adjusted basis
Transferee's Basis
For determining gain
Basis is the greater of:
The amount paid by transferee
The transferor's adjusted basis for
the property at the time of the
transfer
For determining loss
Not greater than the fmv of the property
at the time of transfer
Property Acquired Between Spouses or incident to Divorce
Section 1041
Section A
No gain or loss shall be recognized on
transfers of property from an individual to
a spouse or former spouse incident to
divorce
Section B
The transfer is treated as a gift and the
basis of the transferee is the adjusted
basis of the transferor
This is true even if computing a
loss
Section C
Transfer of property is incident to divorce
if it occurs within one year after the date
the marriage ends or is related to the
cessation of the marriage
Policy reasons for statute
The IRS views the taxable entity as the
marriage, not the individuals
Contrary view would create a tax barrier
for divorce
Note that this section is similar to Section 267,
but that section only covers losses while this
section covers both gains and losses
Property Acquired from a Decedent
Section 1014 - Basis of Property Acquired From a
Decedent
The basis of property acquired from a decedent is
the fair market value at the time of the
decedent's death (stepped up basis)
The consequences of this rule is that the
losses and gains evaporate
Note that Section 1041 would not apply
when a husband dies leaving property to a
spouse - step up the basis
However, if a person transfers appreciated
property to a decedent within a year before his
death and the donor receives the property back
from a decedent upon death, the donor's basis is
the adjusted basis in the hands of the decedent
(no upward adjustment of basis)
o Amount Realized
Section 1001(b) says that amount realized is equal to the
amount of cash plus the fair market value of any property
received
International Freighting Corporation v. Commissioner
Bonus plan paid employees $24k worth of stock which
cost $16K
Rule: While Section 1001(b) says to include the fair
market value of property received in amount received,
property must include services as well
Because there is a presumption of equal dealing,
the value of the services received (and thus the
amount received) is deemed to equal the fair
market value of the property received
Crane v. Commissioner
Taxpayer receives property encumbered with a non-
recourse loan when husband dies
Rule: Because section 1014 steps up basis when
property is acquired from a decedent, taxpayer's basis is
the value of the property, undiminished by any
mortgage
So, if the property is worth $200k and has a
$200k mortgage, the basis is still $200k
Rule: When determining amount realized when a
purchaser has bought property subject to a mortgage,
amount realized equals any cash or property received,
plus the face value of the mortgage
The treatment is the same for recourse and non-
recourse loans
Commissioner v. Tufts
Partnership had a $1.8M non-recourse loan for property;
After deductions, adjusted basis was $1.4M; Once the
fair market value of the property was less than $1.4M,
the property was sold for assumption of loan
Rule: The assumption of the non-recourse loan by the
purchaser must be included in the amount received of
the taxpayer, even when the fair market value of the
property is less than the mortgage
Non-recourse loans are treated the same as
recourse loans
Treas Reg 1.1001-2(a)(4)(iii)
Includes as a disposition a gift to which satisfaction of
liabilities is a part
Apply part gift part sale rules
Life Insurance Proceeds and Annuities
o Life Insurance
There are two types of life insurance
Term Life Insurance
This is life insurance for a set term of years and if
you die within the term, you get paid
Whole Life Insurance
Higher premiums are paid, and a portion of the
payment contributes to the cash surrender value
The amount attributable to cash surrender
value grows tax deferred
Section 101 - Certain Death Benefits
Amounts payable on a life insurance contract by reason
of death are not included in gross income
However, if the life insurance policy is transferred for
valuable consideration, one may only exclude the
amount attributable to the consideration
But, don't apply this part if there is another
method for determining basis (such as Section
1041) or the transfer is to the insured, a partner,
a partnership, or a corporation in which the
transferor is a shareholder
The interest paid on any amount held by an insurer that
is otherwise excludable under subsection (a), is not
excludable
When the insurer is paying beneficiary the proceeds for
a certain time period, the payments must be prorated so
that only the prorated portion is excludable principal and
the remainder is taxable interest
The amount held is equal to the amount payable
at death
Unlike subsection (c), this section applies when
the payments consist of principal and interest
If the specified period is life and the taxpayer
outlives his life expectancy, the exclusion ratio
continues, unlike the case in annuities
But note that there is no unrecovered
principal deduction as in annuities
Divide principal into term to know what is tax
free
Subsection (g) allows for early payments in the case of
terminal or chronic illness that do not have to be
included in gross income
o Annuities
Section 72 - Annuities
As a general rule, the amounts received under an
annuity contract are includable in gross income
However, it does not include the portion of the payment
that can be considered return of capital
Ratio = (Amount Paid/Total Expected Payments)
x Payment Amount
Note that unlike life insurance proceeds, once the
principal is recovered, everything is taxed, even
if the term is exceeded
If the beneficiary dies before the principal is fully
recovered, the unrecovered portion is a deduction on the
final income tax return
Separation and Divorce
o Section 71 - Alimony and Separate Maintenance Payments
The general rule is that amounts received as alimony or
separate maintenance payments are includable as gross income
Alimony or separate maintenance payments are defined
as:
Cash payments (checks and money orders are
OK, but not promissory notes)
Made under an instrument of divorce or
separation
Instrument does not designate the payment as
something other than alimony
If the document says it is not alimony, it
is not alimony
Payee and payor are not members of the same
household
Payments do not continue after death
Be careful - if payments are required for
10 years, that means 10 years even if
death, and thus are not deductible
There is no filing of joint returns
Child support is not includable as alimony because it is a
personal living expense
If alimony and child support are combined, only
the portion allocatable to alimony is excludable
But note that if the payment is not sufficient to
meet full obligation, count child support first
Payments can be made on behalf of the ex-spouse
(thus, one spouse can pay rent payments and still
qualify)
But, payor can't own the property the other
spouse is using
Excess alimony payments are thought to be property
settlements and thus not excludable from the payor's
gross income
Calculate as follows:
Second Year Formula
2d Year - (3d year + 15,000)
First Year Formula
Total excess is the sum of the two excesses
The formulas only apply to the first three years
and only for front loading; back loading is OK
Exceptions to Recapture
If front loading is the result of death, it is
ok
Damages and Related Receipts
o Raytheon Production Corp. v. Commissioner
Raytheon sues RCA for various anti-trust violations and is
awarded damages; The main question here is what are the tax
consequences
Rule: To determine the effect of damage awards on tax
liability, the essential question to ask is: "In lieu of what were
the damages awarded?"
If lost profits, the award is taxable
Per Glenshaw Glass, punitive damages are
income
If lost capital, the basis of the capital award is not
taxable, but any gain is
Lost capital includes loss of goodwill
If the basis is hard to determine (as here), the
basis is fixed at zero
o After parties agree on a settlement amount, the characterization of the
award has important tax effects
But, only the parties are bound by the agreement
The IRS will look to the substance of the settlement to
determine tax liability
So, make sure the complaint is carefully drafted
o If appreciated property is used to pay damages, recharacterize as a
cash transaction
Payor "sells" property and takes any gain
Payee's basis has to be the amount the property is being used
meet
This is in line with the payor's realization event
o Damages for Personal Injuries
Section 104 - Compensation for Injuries or Sickness
Gross income does not include:
Amounts received under workers' compensation
acts as compensation for personal injuries or
sickness
Amount of any damages (but not punitive
damages) received (by suit, agreement) on
account of personal injuries or phusical sickness
Can be either a lump sum or periodic
payments
While typically lost profits are includable
as income, if they can be linked to
personal injury or sickness, Section 104
would exclude them from income
If emotional harm can be linked to the
personal injuries or sickness, any amount
of award attributable to them can be
excluded
If emotional harm damages do not
meet the exclusion, one does not
have to pay taxes on the portion of
award that relates to medical
expenses
Amounts received via accident or health
insurance for personal injuries or sickness that
are not attributable to employer contributions
Amounts received for personal injuries or
sickness resulting from military service in any
country
Amounts received as compensation for personal
injuries or sickness as a result of terrorism or war
Structured Settlements
The best situation for plaintiff and defendant is for
defendant to purchase an annuity that pays directly to
plaintiff
While under annuity rules the interest is taxable,
Section 104 provides that it would not be taxable
Thus, the defendant can pay the award for a
cheaper amount
Discharge of Indebtedness
o United States v. Kirby Lumber Co.
Defendant sold bonds at $1.2 million and later repurchased
some of them; The difference between the sale price and the
repurchase price was $137,000 less than the sale price, thus
relieving the Defendant of an obligation at less than face value
Rule: "If the corporation purchases and retires any of such
bonds at a price less than the issueing price or face value, the
excess off the issuing price or face value over the purchase
price is gain or income for the taxable year"
Two arguments for taxation here:
There is an accession to wealth because defendant is
$137,000 better off by repaying his obligations at less
than he was obligated to
$137,000 has been freed up
Because the bonds were loans whose proceeds are not
taxed, Defendant has to be taxed on the lessening of the
obligation otherwise the tax free loan is converted into
tax free gain
o Zarin v. Commissioner
Plaintiff gambled on credit at casino; Casino illegally provided
him credit to a total of $3.5 million; Plaintiff and casino settled
the debt for $500,000; IRS wants the difference taxed
Rule: To have indebtedness that can be cancelled, debtor must
be personally liable for the debt or hold property subject to the
debt
If a loan is illegal, personal liability does not attatch
Regarding casino chips, they are evidence of the casino's
debt to player, so player does not hold them subject to
his debt to the casino
Rule: The contested liability doctrine says that if a taxpayer
in good faith disputes the amount of a debt, a subsequent
agreement by the parties on the amount of the debt is treated
as the amount of the original debt for tax purposes
Here, because of the illegal nature of the debt, it can be
disputed in good faith
o Section 108 - Income from Discharge of Indebtedness
If taxpayer is insolvent or in a chapter 11 proceeding,
discharged debt is not included in income, but only up to the
amount of the insolvency
Section 108(d)(3) says to determ9ine insolvency by
subtracting fmv of assets from liabilities and if liabilities
are greater than assets, insolvency results
If Section 108(a) applies, certain tax attributes need to be
reduced
Net Operating Losses
General Business Credits
Minimum Tax Credit
Capital Loss Carry Over
Basis Reduction
Look to Section 1017 to determine how to reduce
basis
Reduce basis of property in the first
taxable year following the discharge
Determine how much reduction is needed:
Basis of all property owned after
the discharge minus all liabilities
after the discharge equals the total
amount of reduction (Sec.
1017(b)(2))
Consider cash here
Basis must exceed liabilities to
have a reduction in basis
Passive activity loss and credit carryovers
Foreign tax credits carryovers
Loan Financed by Seller
If a loan is financed by a seller and the buyer is
SOLVENT, and the reduction of the loan would typically
be a cod, the reduction in the loan is a reduction in
purchase price (Thus, basis is reduced
o When a debt is paid for in something other than cash, recharacterize
as a cash transaction and the lender's basis is the amount of the debt
If services are used, the value of the services is equal to the
amount of the debt
o Discharge of Indebtedness and Recourse and Non-Recourse Loans
If there is a recourse debt that is satisfied by deeding property,
the amount realized on the transfer is the fair market value of
the property
This is necessary because the lender can go after the
debtor personally
If the lender chooses to forgo collection of the
remainder, that amount is subject to the cancellation of
indebtedness rules
If there is a non-recourse debt that is satisfied by deeding
property, the amount received is the face value of the loan
o Cancelation of indebtedness can arise by operation of law
Example: X owes W money; X dies and W fails to file a claim
for repayment from estate and statute of limitations expires
This cancels the debt owed
o Note that a loan can be converted to a gift, and thus not subject to cod
taxation, if the relationships of the parties support it
Also, Section 102 can apply
Exclusion of Gain from Sale of Principal Residence
o Section 121 - exclusion of Gain from Sale of Principal Residence
If a residence has been owned and used by taxpayer as a
principal residence for two of the preceding five years, a gain
does not have to be recognized
This statute can only be used once every two years
Gain limited to $250,000 for singles, $500,000 for
married couples
Only apply $500k exclusion if:
Either spouse meets ownership
requirement
Both spouses meet the use requirements
Neither spouse has used Statute in past 2
years
If a sale or exchange happens before two years is met and it
occasioned by employment, health, or unforeseen
circumstances, prorate the exclusion
Number of months in house/24
If depreciation has been taken on property, recapture that by
not including as an exclusion any amount attributable to
depreciation
Assignments of Income
o Income From Services
Lucas v. Earl
Taxpayer entered in contract with wife before he was
entitled to any money giving her 50% of his earnings
Rule: Anticipatory agreements do not change tax
liability; Whoever has earned the money must pay taxes
on it
Commissioner v. Giannini
Taxpayer is entitled to portion of profits as salary, but
only takes a small amount of what he is entitled to; He
tells the company to do whatever they want with it;
Company creates a foundation at UofC and the IRS
wishes to tax taxpayer on what was given to the
university
Rule: When one does not receive money and does not
control its disposition, it is not beneficially received by a
taxpayer and thus he owes no taxes on it
Control is the key component: If the taxpayer
said: "Don't pay me, pay him," tax would be due
Rev. Ruling 66-167
Taxpayer serves as executor of wife's estate and is
entitled to a portion of the estate as compensation;
Taxpayer elects not to take entitlement and the IRS
questions whether he should pay taxes on what he was
entitled to
Rule: Where one renders services with the intent that
they be gratuitious, there is no tax liability on what he
would have been entitled to
Timing, purpose, and effect of waiver can show
that a benefit was received, likely from controling
where the money went
Methods of waiving: Formally saying so within 6
months of appointment, implied waiver by not
including commissions in filings
Rev. Ruling 74-581
A law school professor works at a clinic and per a federal
statute, is paid for representing a client; Professor signs
check over to school and so the issue is whether the
professor is taxed on the money
Rule: When the income is endorsed directly to an
employer per an earlier contract with the employer, it is
not income to taxpayer
o Income from Property
Helvering v. Horst
Father transfers interest coupons from bonds to son
shortly before they came due; The IRS wishes to tax
father on the interest the coupons represent
Rule: Because the power to dispose of income is equal
to owning it, the transfers of rights to income is treated
as if the donor earned it and thus he is taxed on such
income
Here, it does not matter when the income is
earned because the coupons represent the rights
to such income and taxpayer has received the
benefit of the income by giving it to son
Blair v. Commissioner
Taxpayer had a life interest to income from a trust; The
interest was assigned to his children and the IRS sought
to tax the taxpayer on the income
Rule: The valid assignment of an interest without
reservation will not cause donor to be taxed
Note the difference if the taxpayer had given only
a portion of the income
Estate of Stranahan v. Commissioner
Taxpayer was taking a large loss so wished to accelerate
future income to offset the loss; He sold future rights to
dividend income to son for valuable consideration;
Consideration was reported as income by father and son
reported dividend income; IRS feels taxpayer should be
taxed
The outcome of this case depends on how it is
characterized
If it is a loan, father is taxed
If it was a valid sale, son is taxed
Rule: Although the general rule is that assignment of
income from property retained by taxpayer will not end
tax liability, where the income is sold for valuable
consideration, the taxpayer will escape liability
Note that this was not a loan because the son
took the risk that the company would go
bankrupt
Susie Salvatore
Salvatore owns a gas station that Texaco wants to buy;
Before the sale, Salvatore transferred shares in the
property to her children; On their tax returns, the
children reported their shares and Salvatore reported
her share of the gains from sale
Rule: This case shows how the IRS looks to the
substance of the transaction to see that this transfer
was really designed to lower tax liability
Dividend Situations
The key in determining tax liability depends on who
owns the stock on the date of record
Note that the right to the dividend cannot be the only
thing transferred, the stock must be transferred as well
Business Deductions
o Section 162 - Trade or Business Expenses
One may deduct from gross income all ordinary and necessary
expenses paid or incurred during a taxable year in carrying on
any trade or business, including:
Reasonable salaries for services rendered
Traveling expenses while away from home in the pursuit
of business
Rentals for business property
Ordinary and Necessary
Only ordinary and necessary expenses are currently
deductible, thus making capital expenditures not
currently deductible, per section 263
Welch v. Helvering
Taxpayer worked with a company that went
bankrupt and once it emerged from bankruptcy,
obtained grain contracts with Kellogg; To
reestablish good will, taxpayer paid the debts of
the bankrupt company and seeks to deduct those
payments
Rule: An expense is necessary if it is helpful in
carrying on business
Rule: Ordinary does not necessitate habitual
expenses, but rather looks to the community
This is where this case failed
Expenses
Commissioner v. Idaho Power Co.
Rule: Cost associated with acquiring an asset,
such as construction costs, are capital
expenditures and are not deductible
This includes wages paid in constructing,
even though those are normally currently
deductible
Midland Empire Packing Co. v. Commissioner
Company paid money to line floor with concrete
to prevent oil from leaking into building which
was disrupting storage activity
Issue is whether this is a capital
expenditure or an expense
Rule: Repairs keep the property in an efficient
operating condition and do not add value or life
to the property. They are a currently deductible
expense.
This case qualified as a repair and was
deductible
Rule: Improvements or additions prolong the life
of property, increase its value, or create a new
use for property. These are capital expenditures
that are not currently deductible.
Mt. Morris Drive-In Theater Co. v. Commissioner
When the theater was built, the drainage system
was not properly installed and needs to be
repaired; Is this an expense or capital
expenditure?
While this looks like a repair, it was treated as a
capital expenditure because it creates a system
for fraud because builders would improperly
construct things so they could be "repaired" and
deducted instead of depreciated over time
INDOPCO v. Commissioner
Taxpayer was being acquired by another
company; To facilitate the transaction
accountants, bankers, and attorneys were hired;
Taxpayer wished to deduct these expenses while
the IRS characterized them as capital
expenditures
Rule: If an expenditure creates or enhances an
asset or the benefit from the expenditure reaches
beyond the tax year, it is a capital expense
Depreciate or amortize over the life of
asset; If no life, deduct upon disposition
INDOPCO created a rule where many previously
deductible expenses could be capitalized because their
benefit is long lasting. Thus, the IRS allows some long
term benefits to be deductible:
Advertising, repairs, training costs . . .
So…..
Capital expense if an improvement or a situation
where the benefit is realized longer than as year
Per Section 1016, increase basis for capital expenditures
Carrying on any trade or business
Morton Frank v. Commissioner
Taxpayer was looking to buy a business and
traveled around the country seeking a suitable
candidate; Now wishes to deduct those expenses
and IRS says no
Rule: Because the statute presupposes an
existing business, expenses of investigating to
purchase a new business are not incurred while
carrying on a business
Because they are not deductible expenses,
looks to section 195 to determine if they
are allowable start up expenditures
Expenses while seeking employment
The costs of a job search can be deducted if:
If payment to a recruiter is contingent on
finding employment and not due until that
time, Hundley v. Commissioner supports
deducting the expense because at the
time of payment, taxpayer is carrying on a
business
If you are looking for a job in the same
type of business as currently employed,
the costs are deductible even if
unsuccessful
If first job, the costs of searching will not
be deductible
Consider the time between employment
Reasonable Salaries (Sec. 162(a)(1))
Exacto Spring Corporation v. Commissioner
Rule: A salary should be based on the rate of
return investors seek. If the sought after return
can be met which a certain salary, that salary is
reasonable. The thought is that no reasonable
investor would pay a salary that would hurt the
rate of return.
Note that this test is not widely used
Harolds Club v. Commissioner
Rule: While a salary might seem high, if it was
paid via a free bargain and was reasonable when
it was decided upon, a deduction will be allowed
Free bargain may not be present if there
is a strong family relationship
Travel Away from Home (Sec. 162(a)(2)) [Must meet
documentation requirements of Section 274 and 50%
limitation]
Rosenspan v. United States
Traveling salesman attempts to deduct travel
expenses but he has no home and spends all his
time on the road; His argument is that the
corporate home should be his home
Rule: In order to deduct travel expenses while
away from home, one must have a home
United States v. Correll
Rule: Travel away from home requires a
taxpayer to be gone overnight and eats alone
Andrews v. Commissioner
Taxpayer has two businesses, one in New
England and the other in Florida; He has a house
in each state and seeks to deduct the duplicate
living expenses from the Florida as travel away
from home
Rule: "Where business necessity requires that a
taxpayer maintain two places of abode, and
thereby incure additional and duplicate living
expenses, such duplicate expenses are a cost of
producing income and should be deductible"
Revenue Ruling 99-7
Rule: Commuting expenses are generally not
deductible, however:
Deductible if the work place is temporary
and outside the metropolitan area
Temporary means not expected to
last, and does not last, longer than
a year
If one discovers employment will
outlast a year, no more deduction
If there are multiple work locations, there
can be a deduction for commuting to a
temporary work place regardless of
location
If the residence is the taxpayer's primary
place of business, he can deduct travel to
other work locations
Education Expenses
Hill v. Commissioner
Taxpayer was a teacher and it to keep
certification needed either college courses or a
test over five books; Seeks to deduct the cost of
the courses, IRS says hell no
Rule: If the education expenses are required by
an employer, even if there are other options,
they fit within the necessary and ordinary
language of section 162
Coughlin v. Commissioner
Tax attorney attended overnight conference and
seeks to deduct the tuition and travel expenses;
Guess what, IRS says no deduction
Rule: A professional need to acquire knowledge
in order to perform ongoing work will create a
deductible expense
If the expense allows taxpayer to work in
new field, even if he does not intent to do
so, it will not be deductible
Section 274(m)(2) provides that travel as a form of
education is not deductible
Business Meals and Entertainment With Clients
Section 274 - Disallowance of Certain Entertainment
Expenses
No deduction is allowed for entertainment,
amusement, or recreation expenses unless the
taxpayer establishes that the expense was
related to, or preceded or followed a business
event, the active conduct of business
No deduction under sections 162 or 212 for any
traveling expense, any item considered
entertainment, amusement, or recreation unless
the expense is collaberated
Attendance at conventions - Sec. 274(h)
Business Meals - Sec. 274(k)
Food and drink can be deducted if the
expense is not lavish under the
circumstances and the taxpayer is present
at the meal
Entertainment Tickets - Sec. 274(l)
Amount deductible cannot exceed the face
value of the ticket
However, does not apply to certain
charitable sporting events
If the tickets are for a skybox, only
the seats are deductible and the
amount is limited to non-skybox
seats
Food and beverage expenses and entertainment,
amusement, or recreation expenses are limited
to a 50% deduction - Sec. 274(n)
o Section 195 - Start-up Expenditures
Generally, no deduction for start up expenses, except as
provided in this section
If a taxpayer elects to apply this section, the deduction will be
FIRST YEAR: Whichever is less: Start up expenses or
$5000 reduced by the amount of start up expenses that
exceed $50k
This applies to the first year deduction
Per the phase out, if your expenses are over
$55k, you would deduct zero in year one
REMAINDER: Divide the rest by 180 and take that
amount each month
What happens if business is sold before 180 months?
Deduct what remains per 165 as a business loss
Start Up Expenses
Investigating the creation or acquisition of an active
trade or business
Creating an active trade or business
Any activity engaged in for profit in anticipation of the
activity becoming an active trade or business
Must make election in first year, if you do not, you're fucked
Make sure that the trade or business actually starts
o Section 165 - Losses
A deduction is allowed for any loss sustained during the year
that is not compensated by insurance
So, after finding out what loss is allowed, subtract what
was given by insurance
The basis for determining loss shall be the section 1011
adjusted basis for loss
In the case of individuals, the loss is limited to:
Losses incurred in a trade or business
Losses incurred in any transaction entered into for
profit, though not connected with a trade or business
Losses of property not connected with a trade or
business or a transaction entered into for profit, if such
loss arises from causalty
Per Treas. Reg. 1.165-7(b)(1), when there is a
causalty loss the amount of the loss deductible is
the lesser of either:
FMV before the loss minus the FMV after
the loss
OR
The section 1011 adjusted basis, unless
the property is used in trade or business
or for the production of income and is
totally destroyed and the FMV is less than
the basis. In that case, use the higher
adjusted basis.
Determine basis in non-destroyed property by
subtracting insurance proceeds and loss
Note that when property is not totally destroyed, the insurance
proceeds will reduce the basis
o Sections 167 and 168 - Depreciation
Section 167 - Depreciation
There shall be allowed as a depreciation deduction a
reasonable allowance for the exhaustion, wear and tear,
and obsolescence
To qualify, property must be used in the trade or
business or be property held for the production of
income
Land does not fit in these categories
because it is not subject to wear and tear
and is thus not deprecible
Section 168 - Accelerated Cost Recovery System
To depreciate elligible property, you must determine:
The depreciation method
The recovery period
The convention
The adjusted basis
Depreciation Method
200 Percent Decline Balance Depreciation
Method
Determine the straight line depreciation
percentage and double it; Apply that
percentage as the deduction, and reduce
basis accordingly; Switch to straight line
when the straight line percentage will
result in higher deductions
This method is the general method which
applies to most property
150 Percent Declining Balance Method
This is similar to the 200 Percent Declining
Balance Method, except use 150% instead
of 200%
This applies to the following property:
15 or 20 year property not
requiring the straight line method
Any property used in a farming
business
Any property that does not require
straight line method which
taxpayer wishes to elect to use this
provision
Not that if this election is
taken, it applies to all
property in the class and
cannot be revoked
Straight Line Depreciation Method
Divide years to depreciate over the cost of
the property to get the percentage; Apply
that percentage every year
This method applies to the following
property:
Nonresidential real property
Residential rental property
Any railroad grading or tunnel bore
Elected property
Not that if this election is
taken, it applies to all
property in the class and
cannot be revoked
10 year property described as
single purpose agricultural
structure or fruit or nut tree
Water utility property
Qualified leasehold improvement
property
Qualified restruant property
Applicable Recovery Period
3 year property is recovered in 3 years
5 year property is recovered in 5 years
7 year property is recovered in 7 years
10 year property is recovered in 10 years
15 year property is recovered in 15 years
20 year property is recovered in 20 years
Water utility property is recovered in 25 years
Residential rental property is recovered in 27.5
years
Nonresidential real property is recovered in 39
years
Railroad gradings or tunnel bores are recoverable
in 50 years
Applicable Conventions
Generally, apply the half year convention
Mid-Month Convention
Nonresidential real property
Residential rental property
Railroad grading or tunnel bore
Mid-Quarter Convention
If the aggregate bases of property that
was placed into service during the last 3
months of a year is equal to 40%, use the
mid-quarter convention
However, this section does not apply to
property covered by the mid-month
convention or property placed into service
and disposed of in the same year
Classification of Property
Residential Renal Property
Any building or structure if 80% of the
gross rental income is from dwelling units
Non-Residential Real Property
This constitutes section 1250 property
which is not residential rental property or
property with a class life of less than 27.5
years
3 Year Property
Any race horse which is more than 2 years
old at time placed in service
Any horse, other than a race horse, that is
more than 12 years old when placed in
service
Any qualified rent to own property
5 Year Property
Automobile or light truck
Seni conductor manufacturing equipment
Computer based telephone central office
switching equipment
Qualified technological equipment
Section 1245 property used for research
and experimentation
Certain power equipment (look at statute)
7 Year Property
Rail road tracks
Motorsports entertaiment complex
Any Alaska natural gas pipeline
Any property which does not have a class
life and is not residential rental property
10 Year Property
Single purpose agricultural structure
Tree or vine bearing fruit or nuts
15 Year Property
Municipal wastewater plant
Telephone distribution plan and
comparable equiment used for 2 way
exchange of voice or data
Section 1250 property used to sell gas
Qualified leasehold improvement property
Qualified restruant property
Initial clearing and grading land
improvements with respet to gas utility
property
20 Year Property
Initial clearing and grading land
improvements with respect to electric
utility transmission and distribution
Simon v. Commissioner
Taxpayer had an antique violin bow which had
substantially appreciated while being used; As the
property was used in business and had been subject to
wear and tear, taxpayer seeks to depreciate it and the
IRS says no because it appreciates
Rule: Because depreciation only requires that property
be subject to wear and tear of exhaustion, it does not
matter if the property appreciates while being used to
qualify for the depreciation deduction
o Section 179 - Election to Expense Certain Depreciable Business Assets
A taxpayer may elect to treat qualified property as an expense
not chargable to a capital account
Limitations
Expense cannot exceed $25,000, or $100,000 if
between 2002 and 2008
If the property costs more than $200,000, or $400,000
if the property is purchased between 2002 and 2008,
reduce allowable deduction
o Section 212 - Expenses for the Production of Income
Individuals are allowed to deduction all the ordinary and
necessary expenses paid during the taxable year for:
The production or collection of income
For the management, conservation, or maintenance of
property held for the production of income
In connection with the determination, collection, or
refund of any tax
Higgins v. Commissioner
Taxpayer lived off his many investments and incurred
many costs that were associated with managing them;
Taxpayer seeks to deduct them as business expenses
Here, the court found that these were not business
expenses and thus not deductible. This was a watershed
case that encouraged Congress to pass Section 212
which would have allowed the deductions.
Bowers v. Lumpkins
Taxpayer purchased stock and the state attorney
general sought to invalidate the sale; Over a number of
years, taxpayer incurred attorney's fees and sought to
deduct those
Rule: Attorney's fees that are expended to defend title,
protect title, recover property, or develop property are
not ordinary and necessary and thus are capital
expenses that are attributable to the cost of property
This is the same result as under section 162, as
section 212 incorporates it
Surasky v. United States
Taxpayer owned a significant share of a corporation and
sought to influence its management; In order to do this,
he contributed money to a proxy battle so he could get
his way; IRS says this is not an ordinary or necessary
expense
Rule: Deductions of expenses under section 212 are
allowed if incurred in the exercise of reasonable business
judgment in an effort to produce income, even if the
expenditure is far from the proximate cause of the
income
Rev. Ruling 64- 236
This ruling modifies Surasky by declaring that the
IRS will require the expenditure to be the
proximate cause of the income generated
Meyer J. Fleischman v. Commissioner
Taxpayer is getting divorced and wife is trying to
invalidate pre nup; Husband wants to deduct the
expenses of fighting this under section 212 on the
theory that he is conserving property
Rule: In determining the deductibility of expenses, do
not look to the effect of a claim, but rather the origin of
the claim
Thus, these expenses were not deductible, but
any expense regarding alimony would because of
the tax effects
Here, note Section 212(3) and the tax planning
provision
Random Section 212 notes
Any commissions paid are costs of acquisition added to
basis
Upon sale, any commissions reduce the amount
received
In determining if travel expenses to corporate meetings
are deduct, look to see if they are ordinary and
necessary
It is not ordinary and necessary for a small time
investor to go to these meetings
Section 271(h) prohibits deductions for seminars
Conversion of Non-Income Producing Property to Income
Producing Property
Horrmann v. Commissioner
Taxpayer received house from mother when she
died and he moved in; A few years passed and
he determined the house was too expensive and
he left; Tried to rent and sell the property, and
finally sold it for $20.8k (worth $60k when he got
it; $45k at abandonment)
Rule: To depreciate and take deductions for
property that was previously personal, the
property must be converted to property held for
income. While mere abandonment of such
property is not sufficent, efforts made to rent the
property are indicative of the conversion even if
the property is never rented.
Rule: In order to take a loss on property, the
transaction must have been entered into for
profit. When property has been used as a
personal residence, conversion here requires
more than abandonment and listing the property
for sale or rent. The property needs to be sold or
rented to convert it.
Lowry v. United States
Taxpayer owns a house and decides he does not
need it any longer; Shuts house down to personal
use; Opens and closes house for seasons; Puts
the house up for sale for more than FMV and
does not try to rent it
Rule: To convert property, it is not necessary to
rent it if it is clear the house was being held not
residentialy, but rather for the post conversion
appreciation
Consider:
Length of time the taxpayer
occupied the house
Availability of house for personal
use after conversion
Recreational character of property
Attempt to rent
The sale price must be a significant price
o Interest
Section 163 - Interest
All interest paid or accrued on indebtedness is deductible
However, if a case of a taxpayer other than a
corportation, the amount allowed as a deduction
for investment interest shall not exceed the net
investment income of the taxpayer for the
taxable year
If the taxpayer is other than a corporation, there is no
deduction for personal interest paid
The following are the allowable deductions for
personal interest:
Interest paid on indebtedness allocable to
a trade or business
Investment interest
Qualified residence interest
Qualified Residence Interest
Acquisition Indebtedness
Acquisition indebtedness is debt which is
incurred in acquiring, constructing, or
substantially improving a qualified
residence and is secured by the residence
Refinancing indebtedness qualifies
to the extent of what is refinanced
There is a $1,000,000 limit
Home Equity Indebtedness
Home equity indebtedness is debt that is
not acquisition indebtedness that is
secured by a qualified residence to the
extent that the debt does not exceed the
FMV of the residence minus the amount of
acquisition indebtedness
There is a $100,000 limit
Qualified Residence
This is the principal residence of the
taxpayer and any one other residence
Rev. Ruling 69-188
Rule: Interest is the amount one has contracted
to pay for the use of ome and is the
compensation paid for the forbearance of the use
of the money
Thus, a negotiated bonus or premunim
paid to a lender to obtain a loan is interest
Look to see if the funds were obtained to
pay the fee
If not, it is interest
Section 221 - Interest on Educational Loans
Individuals are allowed a deduction for an amount equal
to the interest paid for qualified educational loans
The amount of the deduction cannot exceed $2500 and
is adjusted based on Modified Adjusted Gross Income
(MAGI - $50k (or $100k if married))/$15k (or
$30k if married)
This means that if your MAGI is over
$65k, or $130k if joint return, there is no
deduction
Determine MAGI by figuring AGI without regard to
sections 199, 221, 222, 911, 931, 933, and after
applying sections 86, 135, 137, 219, and 469
Qualified Education Loans
Needs to be solely used to pay higher education
expenses
The funds must be expended for the taxpayer,
spouse, or dependent
The funds are expended within a reasonable time
of incurring debt
Section 7872 - Treatment of Loans with Below-Market Interest
Rates
In the case of any below-market loan which is a gift loan
or a demand loan, the forgone interest shall be treated
as transferred from the lender to to borrower and
retransfered by the borrower to the lender as interest
The transfer is made on the last day of the year
If it is not a gift or demand loan, the lender is treated as
having transferred and the borrower is treated as having
received on the date of the loan an amount equal to the
excess of the amount loaned minus the present value of
all payments which are required to be made under the
term of the loan
Classify gift and demand loans as follows:
Gift Loan - Was the loan a gift?
Compensation Related Loans - Below market
loans between employer and employee or
independent contractor and a person the
contractor provides services to
Corporation Shareholder Loans
Tax Avoidance Loans
J Simpson Dean v. Commissioner
Personal Expense Deductions
o Section 213 - Medical, Dental, Etc. Expenses
Non insurance compensated medical expenses of taxpayer,
spouse, or dependent to the extent that the expenses exceed
7.5% of AGI
All drugs must be prescribed or insulin
Medical care means amounts paid for:
The diagnosis, cure, mitigation, treatment, or prevention
of disease, or for the purpose of affecting any structure
or function of the body
Essential medical transportation
Section 7702B(c) qualified long term services
Insurance
Medical care does not include cosmetic surgery unless it is
necessary to fix a deformity arising from a congenital
abnormality, personal injury, or disfiguring disease
Non lavish lodging, under $50, can be deducted
Raymon Gerard v. Commissioner
Daughter needed an air conditioner because of her
health condition; The issue was whether it can be
deducted as a medical expense because it increased the
value of the house
Note that because it improved the house, it is a
capital expense
Rule: When there is a medical expenditure that is a
capital expenditure, it is only deductible to the extent
that the expenditure exceeds the increase in the value
of the house
Revenue Ruling 2002-19
Are uncompensated amounts paid for participation in
weight loss programs that have been ordered by doctors
as treatment for disease deductible?
Rule: While participation in weight loss programs to
improve appearances are not deductible, the costs of
doctor ordered programs are
Note that this does not extend to food purchases
o Section 170 - Charitable Deductions
Deductions are allowed for any charitable contribution made in
the tax year
A charitable contribution is a gift to a government or
foundation
Foundation must be organized under US law,
operate for certain charitable goals, no income
from donation inures a private benefit to
shareholder, no political issues
Contribution Base
Contribution base is AGI without any section 172 net
operating loss
Limitations on Amount of Deductions
Donation limited to 50% of contribution base for:
Church or association of churches
Educational organization with regular faculty and
curriculum and has regular students
An organization whose principal purpose is
medical care, education, or research
An organization which gets majority of funding
from state or national government or from
contributions from the general public and is
operated to benefit a college or university
A governmental unit
A section 170(c)(2) organization whose funding
comes from the government or general public
A private foundation as described in Section
170(e)
A section 509(a)(2) organization
Donation limited to 30% of contribution base, but total
cannot exceed 50% of contribution base for all other
charities
Sales to charitable organization - Section 1011(b)
If there is a section 170 deduction by reason of a sale,
the adjusted basis shall be determined by the following
ratio:
The portion of the adjusted basis which bears the
same ration to the adjusted basis as the amount
realized bears to the FMV
X = AR/FMV; X(adjusted basis) = Basis
for determining loss or gain
Charity's basis is cost plus what was received
Bringing Deductions Together
o Section 62 - Adjust Gross Income Defined
Adjusted gross income is gross income minus deductions
allowed by this chapter
These are above the line deductions
Any deduction that is not covered here becomes a
section 63 below the line deduction
Allowable Deductions
Trade or Business deductions not by an employee
State taxes from operating property are
deductible here; however, state income taxes are
deducted per section 63
Reimbursed Expenses of Employees
Per Treas. Reg. 1.62-1T(e)(1), only expenses
reimbursed per agreement or expense allowance
are deducted here
If the expense is not reimbursed, deduct under
section 63
Certain Expenses of Performing Artists
Certain Expenses of Officials
Certain Expenses of Elementary and Secondary School
Teachers
Certain Expenses of Members of Reserve Components of
the Military
Loss from the Sale or Exchange of Property
Deductions Attributable to Rents and Royalties
Certain Deductions of Life Tenants and Income
Beneficiaries of Property
Pension, Profit Sharing, and Annuity Plans of Self
Employed Individuals
Retirement Savings
Penalties Forfeited Because of Premature Withdrawal of
Funds from Time Savings Accounts or Depositis
Alimony
Reforestation expenses
Certain Repayments of Supplemental Unemployment
Compensation Benefits
Jury Duty Pay Given to Employer
Clean Fuel Vehicles and Refueling Property
Moving Expenses
Archer MSA
Interest on Education Loans
Higher Education Expenses
Health Savings Accounts
Costs Involving Discrimination Suits
o Section 63 - Taxable Income Defined
Taxable income equals AGI minus either the standard deduction
or itemized deductions
Standard Deductions
Generally, standard deduction means the basic standard
deduction plus any additional standard deduction
Basic standard deduction
If the taxpayer is filing a joint return or is a
surviving spouse, the basic standard deduction is
$9700
If the taxpayer is a head of household (sec.
2(b)), the basic standard deduction is $4850
All other cases result in a standard deduction of
$3850
Additional Standard Deduction for Aged and Blind
The additional standard deduction is $600 if
taxpayer is 65, spouse is 65, taxpayer is blind,
spouse is blind
Add them all up
If not married or a surviving spouse, use
$750
An individual is not elligible for the standard deduction
if:
Spouse files separate return and itemizes
Taxpayer is a non-resident alien
Estate, trust, or partnership
Itemized Deductions
Itemized deductions are deductions other than those
used to determine AGI (sec. 62) and the section 151
personal exemptions
Section 67 - Two Percent Floor on Itemized Deductions
Itemized deductions can only be taken to the
extent they exceed 2% of AGI
However, this limitation does not apply to the
following deductions:
Section 163 interest deductions
Section 164 tax deductions
Casualty or theft losses under section 165
or wagering losses under section 165
Section 170 charitable deductions
Section 213 medical expenses
Impairment related work expenses
Defined in section 67(d)
Section 691(c) estate tax deduction
Deductions allowable from personal
property involved in short sale
Section 72(b03) deduction where annuity
payments cease before investment
recovered
Section 68 - Overall Limitation on Itemized Deductions
If AGI exceeds $100,000, itemized deductions
are reduced by the lessor of:
3% of the excess of AGI minus $100,000
80% of the amount if itemized deductions
allowable
However, this limitation does not apply to the
following:
Section 213 medical expenses
Section 163(d) investment interest
Casualty losses
Apply this section last
Capital Gains
o Mechanics
Step One: Netting and other Determinations
o Net short term capital gains against short term capital
losses
If there as any short term capital gain, it is taxed
as ordinary income
o Net long term capital gains against long term capital
losses
Step Two: Determine Capital Gain Net Income
o Capital gain net income is the excess of all capital gains
from sales or exchanges minus the losses for such sales
Step Three: Determine Net Capital Gain
o Net capital gain is the figure which receives special tax
treatment
If this is zero, no amount of capital gains are
entitled to favorable tax treatment
o Net capital gain is determined by taking the net long
term capital gain and subtracting the net short term
capital loss
Step Four: Determine Net Capital Loss (Gives you carry
over)
o Net capital loss is determined by taking the losses from
sales or exchanges of capital property and subtracting
the allowable loss amount under section 1211(b)
This is total losses, not net losses
When finding gains in Section 1211(b), use
regular gains, not nets
Step Five: How Large a Deduction
o Capital losses are allowed to the extent of capital gains
plus any excess not over $3000
Ex: Capital gains = $100,000 Capital losses =
$102,000: Full loss allowed
Ex: Capital gains = $100,000 Capital losses =
$105,000: Current deduction is $103,000 with a
$2000 remainder
Step Six: What to do with any Remainder
o If there is a net capital loss:
Start with Sec. 1212(b)(2)(A) and add $3000 to
short term capital gain (NOT NET)
The excess of the net short term capital loss over
the net long term capital gain for such year shall
be a short term capital loss in the succeeding tax
year
The excess of the net long term capital loss over
the net short term capital gain for such year shall
be a long term capital loss in the next tax year
o Characterization
Section 1221 - Capital Asset Defined
Capital assets are property held by the taxpayer but
does not include:
Stock in trade
Property which is used in trade or business that is
of a character which is subject to the allowance
for depreciation or real property
Copyrights . . .
Accounts receivable
Hedging transactions
Section 1223 - Holding Period of Property
If the basis in the property is the same as the property
exchanged and the property exchanged was a 1221
capital asset
If the owner's basis is the same as the transferor's
basis, one may tack on the transferor's ownership
If property is acquired through section 1040 and the
property is disposed of within one year of decedent's
death, and the person buying the property is an heir,
then the person making the sale is deemed to have held
the property for more than one year
Section 1271 - Treatment of Amounts Received on Retirement
or Sale or Exchange of Debt Instruments
Amounts received by the holder on retirement of any
debt instrument shall be considered as amounts
received in exchange therefor
Defining a Capital Asset
Mauldin v. Commissioner
160 acres of land bought for cattle ranching, but
land was never used for that purpose; Land
ultimatly subdivided; Plaintiff admits that for two
years he was in the business of selling land, thus
denying him capital gains treatment; However,
plaintiff contends that in year three, he was in
the lumber business and thus any sale of the land
was for investment purposes and should have
capital gains treatment
Rule: To characterize as capital gains income,
the sale must not have been in the furtherance of
an occupation of the taxpayer
Here, because of the subdivision and
substantial income derived from the sale,
plaintiff was involved in the sale of land
Subdivision alone does not destroy capital
treatment, examine section 1237
Malat v. Riddell
Partnership buys land to either rent or sell;
Interior lots subdivided and sold and reported as
ordinary income; Exterior lots eventually sold and
plaintiff wants capital gains treatment
Rule: If the property is being held for
appreciation (invvestment) it is entitled to capital
gains treatment; however, if offered for sale in
the regular course of business, it will be ordinary
income
Section 1237 - Real Property Subdivided for Sale
Subdivided property is entitled to capital
treatment if:
The land was not previously held for
business
Once in business, always in
business
No structures have been built that
enhance value
Minor enhancements OK, but not
grading
Held for five years
Section 1236 - Dealers in Securities
If you are trading for yourself, you are not
working with customers and capital treatment is
alright
But, if you are a dealer, you will not get capital
treatment
Sale or Exchange Requirement
Kenan v. Commissioner
Decedent devised $5m and will allows securities
to be given to meet the devise; Devise ends up
being part cash and part securities; IRS says
trustees have capital gains on the exchange
For starter, note that devisee's basis would be
value of claim surrendered
Rule: Because the devisee had a claim against
the estate and the estate used appreciated
property to settle such claim, it realized capital
gains on the transfer
The exchange is the claim for the money
and securities
The stock survived the exchange
Hudson v. Commissioner
A person was owed $75,000 and sells that
judgment to taxpayer for $11,000; The judgment
was fulfilled for a total of $21,000; IRS wants this
to be ordinary income
Rule: Because the settlement of the claim
extinguished the debt, nothing was transferred
and the gain is not entitled to capital gains
treatment
The judgment did not survive the
exchange
Judicial Gloss on the Statute
Hort v. Commissioner
A lease was canceled for $140,000; This amount
was less than what would have been received for
the full term lease; Two questions: 1) is this
ordinary income or capital gain; 2) did the
taxpayer realize a loss due to the fact that the
full value of the lease was not realized?
Rule: Because the payment was in satisfaction of
the right to future income and the right to future
income was not effected by the payment, the
amount realized must be included in ordinary
income and not capital income
Note that the income producing asset was
not sold
Metropolitan Bldg. v. Commissioner
Leasee subleased building to subtenant;
Subtenant wants to work directly with owner and
buys out the lease for leasee; Does this result in
ordinary income or capital income for the leasee?
Rule: Because the income producing asset was
fully exchanged, the disposition resulted in a
capital gain
