Law School Legal Outline Notes for Federal Tax Outline by JohnMValentine

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									INTRO. TO FEDERAL TAX OUTLINE I. INTRODUCTION 1. Gross Income-starting point in computing taxpayer‟s tax liability a. § 61(a)-items expressly included in gross income b. Gain: the amount subjected to tax i. Gain = Amount realized – Basis a. Amount realized – amount taxpayer realizes on sale/exchange b. Basis – taxpayer‟s unrecovered investment in property ii. Taxpayer gets basis back tax free a. Theory: Gain is result of investment of time/services/income in prop., not investment in prop. itself 2. Tax based on Net Amount a. . § 63 IRC – Taxable income is adjusted gross income minus deductions i. 2 Types of Deductions a. Above-the-Line/Preferred b. Itemized/Standardized 3. Determine Amount of Tax Due on Taxpayer‟s Taxable Income a. Progressive Tax Rates-diff. tax rates apply to diff. people depending on income i. Kiddie Tax-income earned by kids under 14 taxed at parents rate ii. Married Taxpayers-filed joint return and receive lower tax rates 3. Sources of Tax Law a. Internal Revenue Code-issued by IRS i. Title §26 of United States Code ii. Includes substantive and procedural rules iii. Revenue Rulings-promulgated by IRS iv. § 7805 IRC gives Sec. of Treas. authority to enforce Code provisions a. Guidance to Code in Treasury Regs. issued by Treas. Dept. b. Case Law c. Analyze by looking: 1) Code, 2) Revenue Rulings, then 3) Treas. Regs 4. Procedure/Jurisdiction of Tax Cases a. Cases in Federal Court (either fed. district ct. or U.S. Court of Fed. Claims) i. Defendant is the United States ii. Refund Dispute Cases-taxpayer has already paid tax and wants refund a. Before refund suit, first file claim, i.e. amended return, with IRS i. Can file Refund suit when IRS: a. Denies refund claim, or b. If IRS does not act within 6 months b. Cases in U.S. Tax Court i. Defendant is Commissioner of IRS ii. Taxpayer can litigate without paying tax fist c. Taxpayer can sue U.S. or Commissioner b/c IRC waives sovereign immun. II. STATUTORY OVERVIEW A. General B. Who Are Taxpayers? Individuals, Corps., Trusts, and Estates 1. Individuals 2. Corporations-separate tax paying entity; pays income tax a. Two-tiered Income Tax: Flow - thru taxation i. $ to s/h as dividends not deductible to corp. a. Double Taxation Effect-s/h and corp. pay tax on same $ b. Dividends taxable to s/h under §61(a)(7) c. B/c dividends not deductible to corp., paid out of aftertax earnings ii. $ to s/h in capacity as employee, i.e. salary, then corp. can deduct as a business expense

a. Salary taxable to employee under §61(a)(1) b. 9/2/03 handout 3. Trusts i. Income can be taxed to trust or to beneficiary of trust ii. No double taxation-trust receives deduction if $ to beneficiary 4. Estates-essentially same regime as with Trusts 5. Partnerships-a stand-alone business endeavor; not a tax payer a. Pass-thru Taxation-partners pay tax on individual returns b. Tax-Recording Entity-return filed to IRS for informational purposes c. Tax impact of p‟ship transactions on each P determined by p‟ship agr. III. GROSS INCOME: GENERAL A. What is it? 1. General Concepts of Gross Income a. Idea: Gross Income is an Accession to Wealth b. Definition: § 61 IRC-gross income is all income from whatever source derived, including, but not limited to the following items: i. Compensation for services, including fees, commissions, fringe benefits, and similar items ii. GI derived from business iii. Gains derived from dealings in property iv. Interest v. Rents vi. Royalties vii. Dividends viii. Alimony and separate maintenance payments ix. Annunities x. Income from life insurance and endowment K‟s xi. Pensions xii. Income from discharge of indebtedness xiii. Distributive share of p‟ship GI xiv. Income in respect of a decedent xv. Income from interest in an estate or trust *Very Broad; Not Exclusive Listing!* i. Refined by Treas. Regs. §1.61-__: a. -1: Gross income is income from whatever source derived. . .realized in any form ( diff. from IRC) b. -14: Treasure Trove = Gross Income for the taxable year it was reduced to undisputed possession i. To determine when possession occurs, look to state‟s prop. law ii. If nothing in state‟s prop. law, default is common law of England iii. Ex. Cesarini-H & W found money in piano, say not g.i.; court held gross income c. -14: 3P Payment of Taxpayer‟s Indebtedness (i.e. income taxes) = Gross Income to Taxpayer i. Old Colony Trust-Corp. paid federal income tax of president; court held t/p had gross income under accession to wealth idea d. -14: Awarded Damages (punitive & exemplary) = Gross Income i. Compensatory damages not gross income because no accession to wealth, i.e. just putting you back to where you were before ii. Glenshaw Glass-2 cases consolidated into 1; 2 co.‟s seeking punitive damages

c. Test for Gross Income (from Glenshaw Glass): i. An undeniable accession to wealth, a. Loan proceeds aren‟t undeniable accessions to wealth b/c paying money back! b. Illegal gains = taxable income despite obligation to repay ii. Clearly realized, and a. No realization event for treasure trove property until sale iii. Over which the taxpayer has complete dominion *Not Exclusive Criteria, but Identifying Criteria* 2. Analogical Income: Non-Cash Benefits and Imputed Income a. Treas. Regs. §1.61-2(d)(1): If Services Paid for other than in Money, Fair Market Value of Prop./Services taken in Payment = Gross Income b. Treas. Regs. §1.61-2(d)(1): If services were rendered at a stipulated price, such price will be presumed to be fair market value of compensation in absence of evidence to contrary i. Value of one side of transaction is evidence of value of other side of transaction, if parties assumed value same for both services ii. To determine value of services: a. Look at Secondary Sources, i.e. industry standard iii. Self-created value is not gross income because nothing realized a. Ex.-Tax. Atty. does own tax return c. Dean- H & W sole s/h of Corp.; Corp. owns prop. H & W live in rentfree; court held fair rental value of real estate is gross inc. to H & W b/c receipt of valuable accession to wealth in amt. of rent they‟d otherwise pay i. Stands for constructive gross income can result from receipt of taxable benefit, even w/o payment/receipt of a valuable benefit ii. See 9/2/03 Handout d. Helvering-T/p owns/lives in bldg.; court held no accession to wealth = fair rental value b/c as owner of prop. one of t/p‟s right was to occupy 3. Income from Discharge of Indebtedness a. §61(a)12-Gross income includes income from discharge of indebtedness i. Accompanies accession to wealth idea ii. Treas. Regs. §1.61-12: The discharge of indebtedness, in whole or in part, may result in the realization of income. iii. Kirby Lumber-Corp. issued bonds and re-purchased for much less; court held gross income as accession to wealth in amount not paid back to bond holder b. Exception: §108(a)-Gross income doesn‟t include amt. which would be includable in gross income by reason of discharge indebtedness of t/p if: i. still insolvent after debt forgiveness a. Insolvent-have more liabilities than assets iii. Policy behind above: No accession to wealth; t/p is just less worth off c. §108(b)(2): IRC tries to recoup gross income lost in §108(a) i. Says certain favorable tax attributes reduced in amt. equal to §108(a) exclusion from gross income a. If taxpayer has taxable inc. in a later year, §108(b) is not extinguishment, but postponement; taxpayer‟s taxable inc. in later year will be greater by amt. equal to amt. not included in §61(a)(12) by virtue of §108 ?WHAT FROM 108(b) DO WE NEED TO KNOW? d. §108(e)(5)-if seller of prop. takes back debt on prop. sold and later reduces the purchaser‟s debt, it creates a purch. price adj., but is not a discharge of indebtedness income that = gross income ii. §172 used to describe application of §108(b)


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B. Exclusions from Gross Income-General: Accessions to Wealth Not = to Gross Income 1. Gifts-§102 IRC: Gross income does not include the value of property acquired by gift…. a. §102 for income tax purposes; other fed. tax consequences can arise from transfers by gift, etc. i. Gift Tax-imposed when gift value exceeds certain threshold amt. ii. Estate Tax –imposed only to extent value of decedent‟s assets at death date exceed certain threshold amts. b. §1.102-1(a)-(b) Treas. Regs.: Prop. received as a gift not includable in \gross income i. §1.102-1(a)-(b) & §102(b)(1): Income from such prop. is includable in gross income c. Threshold Issue: Characterization-What is it? How treated for tax purposes? Has a gift actually been made? i. Look at facts to make determination a. Focus on Donor‟s state of mind! (Duberstein) b. Watch out for Compensation being claimed as gift c. Gift arises from the “detached and disinterested” generosity of the donor (Duberstein) ii. Problem arises often in Employer/Employee relationship a. Duberstein-1; corp. pres. gets car for giving leads; court holds no gift, compensation b. Stanton- church worker given $ upon retirement; court held gift c. Cases conceptually same, but ct. reaches diff. results b/c docket control issuesfactual issues best left for trial ct. d. Exception: §102(c): Gross income includes any amt. transferred by/for an employer by/for benefit of employee i. These amts. considered compensation ii. Form-Over-Substance Rule-if form of transaction doesn‟t follow substance of transaction, disregard form a. Ex. - Gift made after employ. ends, but was planned for during employ., court likely holds §102(c) governs b/c when gift made a technicality, i.e. gift made after employ. just to avoid tax iii. To avoid §102(c) prob., careful planning needed to ensure trans. properly structured as gift a. Wait to make gift until employment terminated b. Gift can‟t be for past services c. Payment made with INTENT to make gift i. Document should say “Gratuity” ii. Exception to §102(c): §1.102-1(f)(2) Treas. Regs-extraordinary transfers to the natural objects of an employer‟s bounty. . .if the employee can show the transfer was not made in recognition of the employee‟s employment 2. Inheritances: §102 IRC: Gross income does not include the value of property acquired by. . .inheritance, bequest or devise a. § 1.102-1(a)-(b): Prop. received under a will not includable in gross income i. § 1.102-1(a)-(b) & 102(b)(1): Income from such prop. is includable in gross income b. Lyeth-heir inherits under a compromise agr.; court held inheritance excludable from gross income, even thou a compromise agr. b/c he inherited b/c he was heir c. Wolder-atty. writes himself into client‟s will as payment for services; court held includable in gross income b/c amt. was compensation

i. This conduct also now prohibited by ABA MR 8.1! 3. Prizes: §74(a): Gross income includes amts. received as prizes and awards, except as otherwise provided in this section a. Exceptions: i. §74(b)-Gross income does not include amts. received as prizes and awards. . ., but only if: a. Recipient was selected without any action on his part to enter the contest, b. Recipient not required to render substantial future services as a condition of receiving the prize, and c. Recipient must immediately transfer the prize to charity ii. §74(c)-Gross income shall not include the value of an employee-achievement award a. Employee-achievement awards are excludible up to amt. of cost of award to employer that is deductible b. §274(j) Definition of Employee Achievement Awards i. Award may qualify if it relates to service or safety ii. Must be tangible prop., be awarded in a meaningful ceremony, and not disguised comp. iii. For length of service awards: employee in employer‟s service for 5+ years, hasn‟t received a length of service award for the current or any of the 4 prior years iv. For safety achievement award: only if made to other than a mgr. administrator, clerical employee , or other prof. employee, only if 10% or less of the employer‟s employees receive such awards during the year b. §74 is statutory authority for lottery winnings 4. Scholarships: §117(a): Gross income does not include any amt. received as a qualified scholarship by students at qualifying educational institutions a. §117(b)-Scholarship must be for tuition, books, fees, supplies and equipment required for courses, but not room & board b. Characterization Issue: Scholarships can be similar in nature to gifts, or can be for services performed, i.e. work grants i. If like gifts for studies, then excluded under §117(a) a. Tuition Remission-like an excludable scholarship if all you‟re required to do is go to school ii. §117(c): If compensating services performed, then include in gross inc. a. Services-teaching, research, or other services that are a condition to the grant b. Athletic scholarships may = services, but can structure so its excludable c. Qualified Educational Institution under §117(a) Must: i. Maintain a regular facility and curriculum ii. Has a regularly enrolled body of students in attendance where its educational activities are carried on d. See also §1.117-6(b),(c), and (d) Treas. Regs. (not mentioned in class) e. §127 Educational Assistance Programs: permits employee to exclude up to $5250/yr. from gross inc. for amts. paid by employer for educational assistance to employee, provided the educational assistance programs meet certain requirements i. Requirements: a. Program can‟t be discriminatory in favor of highlycompensated employees or their dependents

b. No more than 5% of amts. paid by employer can be provided to s/h/owners who owns more than 5% of stock c. Program can‟t provide employees with choice b/n educ. assis. & other renumeration includable in gross inc. d. Program does not need to be funded e. Rsnbl. notification of availability & terms of program must be provided to eligible employees ?Do We Need To Know Requirements? ii. If amt. exceeds $5250, see if employer can make 2 payments in separate years 5. Gain on Sale of Personal Residence: §121(a): t/p may exclude from gross inc. up to $250k ($500k for joint filers) of the gain on sale of personal residence if: a. §121(a) Requirement: T/p must have owned/used prop. as principal residence for pd. aggregation 2 or more yrs. during 5 yr. pd. ending on date of sale/exchange i. . Principal Residence Test: a. §1.121-1(b)(1): Whether prop. is principal residence depends on facts and circumstances i. Could be houseboat, trailer, apt., house b. §1.121-1(b)(2): If t/p has more than 1 residence, also depends on facts and circumstances; Relevant factors to determine are: i. t/p place of employment ii. principal place of abode of t/p family members iii. address listed on tax returns/drivers license, auto./voting registrations iv. t/p mailing address v. location of t/p banks, churches, etc., which t/p affiliated ii. §121(b)(3)(A): T/p can only take advantage of this § every once every 2 yrs. a. But Not a One Shot Deal! b. T/p can elect to have §121 not apply to a sale iii. Ownership/Use: §1.121-1(c): 2 or more years can be satisfied w/nonconcurrent periods time; for use, occupancy of dwelling is required, but short absences (for illness or vacation) do not interrupt a period of use b. Special Rules/Exceptions: If t/p need to sell w/o satisfying ownership/use test, or needs to use exclusion more than 1 in 2 yr. pd., arising from unemployment, health, or other unforeseen circumstances, t/p will get a prorated benefit (Treas. Regs. §1.121-1(c)) d. Homeowners are true beneficiaries from §121, but contractors, banks, loan assn. lobbied hardest for it as it promotes investing in homes! 6. Income Earned Abroad: §911: Excludes from gross income earned income (salaries, wages, commission) up to $80k if income is earned abroad by U.S. citizen or a resident alien employed abroad a. To Qualify for Exclusion: i. Amer. citizen must be bona fide resident of foreign country(ies) for uninterrupted pd. that includes entire taxable yr., OR ii. Amer. citizen/resident must be present in foreign country(ies) for at least 330 days of 12 consecutive months iii. Most litigation on §911 stems from residence requirements b. Housing Exclusion- allows for exclusion for amts. paid as reimbursement of foreign housing expenses if the housing expenses are paid for by the t/p‟s employer

i. If housing expenses not paid for by employer, t/p can deduct limited amt. of housing cost in determining gross income ii. Housing expenses include reasonable amts. paid for housing a. Includes utility bills and insurance c. Earned Income-sweat-of-brow income; does not include income from investments, i.e. dividends, interest IV. GROSS INCOME FROM EMPLOYMENT A. Fringe Benefits: §61(a)(1): Gross income means all income from whatever source derived including compensation for services, including. . . fringe benefits 1. Exception: §132(a): Gross inc. doesn‟t include any fringe benefit qualifying as: a. No-Additional Cost Service-§132(b)(1)-(2): Any service provided by an employer to an employee if: i. Service offered for sale to customers in ordinary course of the employer‟s business ii. Employee employed in the same line of employer‟s business as the service that is given iii. Employer incurs no substantial additional cost in providing such service to the employee; See 1.132-1 a. For substantial cost, see 1.132-2(a)(5) i. Cost-revenue forgone b/c service is provided to employee rather than non-employee b. Cash Rebates-exclusion applies if benefit is provided thru partial/total cash rebate of amt. paid for service; See 1.132-2(a)(3) c. Excess Capacity Services-services have to be of excess capacity to fall under exclusion; 1.132-2(a)(2) i. Ex.: Hotel rooms, plane tickets iv. Additional Fact: Employee reservation takes „X‟ out of no-additional cost service b/c potential revenue is forgone; §1.132-2 b. Qualified Employee Discount: 3 Requirements: (§132(c)) i. Definition: Discount that employee receives when purchasing goods or services that the employer offers for sale to public ii. Limitation on Discounta. For Services-excluded from income to extent doesn‟t exceed 20% of price at which services are offered to customers in ordinary course of business b. For Property-only amount equal to employers “gross-profit percentage” can be excluded from income iii. See also 1.132-3(a) and (b) c. §132(d): Working Condition Fringe-Any property or service given to an employee by the employer, the cost of which would have been deductible by the employee as a business expense if she bought the property or service herself d. §132(e): De Minimis Fringe-goods/services to employee in value so small accounting for benefit would be unreasonable/administratively impractical i. Eating Facilities: Bargains at employer-operated eating facilities will be treated under this section if: a. they are located on or near the employer‟s business premises, and b. the revenue generated from their operation normally equals or exceeds operating costs e. §132(f): Qualified Transportation Fringe: 3 Types of Qualified Trans. Fringe i. Employer-provided transit passes ii. Transportation by van from home to office, or a. (i) and (ii) have a total limit together of $100 iii. Parking near the employer‟s premises a. $175 limit

iv. Inflation Adjustments- above amounts are indexed for inflation; they‟ll increase yr.-by-yr. in reference to cost-of-living adjustment a. Designed to offset Bracket-Creep-tries to maintain constant level of net taxable income even thou gross inc. goes up; thus this tends to keep taxpayers from being pushed into higher tax brackets just b/c nat‟l. inflation v. Cash reimbursements are included under §132 for exclusion vi. Employers can offer employees a chose between cash option or one or more of the qualified transportation benefits f. §132(j): On-Premise Athletic Facilities-value of facility to employee may be excluded of it‟s on business premises of employer, operated by employer, and is used mostly by employees [g. Qualified Moving Expenses h. Qualified Retirement Planning-we did not cover these 2] *There may be other fringe benefits treated in other Code sections*. 2. Policy behind §132: Bring uniformity to treatment of fringe benefits and to relieve employers/employees/ IRS the hassle of dealing with de minimis items 3. Nondiscrimination Requirement-§132(j)(1): Exclusions for No-Additional- Cost Services, Qualified Employee Discounts, Employee Eating Facilities and Retirement Planning Services apply to highlycompensated employees only if those fringes are also offered to other employees on a nondiscriminatory basis a. Non-discriminatory basis-provided on substantially the same terms to a broad cross section of employees b. See 1.132-2(a)(4) 4. Expanded Definition of Employee: a. Includes current employees, plus: 1. Retired and Disabled Former Employees 2. Surviving Spouses of Retired/Diasbled Former Employees 3. Spouses and Dependent Children of Employees b. Expanded definition applies to No-Additional-Cost Services, Qualified Employee Discounts c. See 1.132-1(b) 5. Treas. Regs. 1.61-2(a)(1): other types of compensation includable in gross inc. unless otherwise excluded by law 6. Other Sections: §132 expressly doesn‟t apply to any fringe bene. provided for in another Code section; §132(l) ? WHAT DO WE NEED TO KNOW FROM FRINGE BENEFITS? FIX THIS SECTION!!!!! B. Meals and Lodging: §119(a): Can exclude value of meals or lodging furnished to an employee, his spouse/dependents, by the employer if: 1. Business Premises-meals or lodging furnished on the business premises of the employer a. The place of employment of the employee §1.119-1(c)(1) b. Case Law: i. Either where employee performs a signif. portion of duties or where employer conducts a signif. portion of business; from Anderson, V. ii. Residence adjacent to business wasn‟t geographically separated and thus on business premises; from Lindeman 2. Convenience of Employer-meals or lodging provided for convenience of employer-case by case analysis; depends on facts and circumstances! a.For Meals: i. Meals Furnished W/O Charge: Must be furnished for a substantial noncompensatory business reason of the employer §1.119-1(a)(2) a. Declaring meals are for noncomp. business purp. isn‟t enough §1.119-1(a)(2)

b. See §1.119-1(a)(2)(ii) for substantial noncomp. business purp. i. Generally meals furnished before/after working hours not for employer convenience ii. Meals Furnished With Charge: Not regarded as for convenience of employer if employee has a choice of accepting the meals and paying for them or not paying for them and providing his meals in another manner, §1.119-1(a)(3) b. For Lodging: i. Courts will look at industry practice to make determination ii. May over look fact industry, tax-wise, has it wrong c. Ex.-If employee required to be on-call even when not working! 3. For Lodging Only-Condition of Employment- employee is required to accept such lodging as a condition of his employment i. §1-119-1(b): Employee must be required to accept lodging in order to enable him to properly perform the duties of his employment a. Ex.-when lodging is furnished b/c the employee is required to be available for duty at all times b. Ex-employee couldn‟t perform services required of him unless he is furnished such lodging c. For the convenience of the employer d. §107: Housing Benefits to Minister of Gospel: Gross income doesn‟t include: i. the rental value of a home furnished to him as compensation, or ii. the portion of a cash lodging allowance used by the minister to rent a home e. Ex. Hatt-funeral director had to live on premises b/c town expected someone to be there 24 hours a day i. Watch out for corp. employee who‟s also s/h; if lodging as s/h includable in gross income; if lodging as employee then excludable if other tests met ii. Watch out for a sole-proprietor-they‟re not employees! 4. Purpose of §119: To keep employees on work site! Intended to cover situations in which the employee is constrained in his or her choice of eating places! C. Social Security Payments-§86 1. Frequently included in gross income 2. Taxable to the recipient above a certain adjusted gross income threshold; the greater adjusted income is above that point the greater is the percentage of inclusion of the Social Security payments D. Unemployment Compensation-§85: Gross income includes unemployment compensation. 1. Unemployment Compensation Defined-any amt. received under a law of the United States or of a State which is in the nature of unemployment compensation 2. Reason for Inclusion: It‟s a temporary substitute for wages! ?IS THIS ALL WE NEED TO KNOW ABOUT C & D ABOVE? V. GROSS INCOME from PROPERTY DISPOSITIONS A. General 1. §61(a)(3): Gross income includes gains derived from dealings in property a. §1.61-6(a): Gain realized on the sale or exchange of property is included in gross income, unless excluded by law i. Property includes tangibles and intangibles B. Basis 1. Definition - Taxpayer‟s investment in property a. All property has a basis, even if it‟s zero b. Policy: Allows taxpayer to get return on investment in property without getting taxed on that investment

2. Types of Starting Point Bases: a. Cost Basis-§1012: Basis is equal to cost of property (the Price of §102 Exclusion) i. Cost - the amt. paid for in cash or other property; §1.1012-1(a) ii. Property Purchased for Cash: Basis is amt. of cash expended for property iii. Property Acquired in Taxable Exchange: a. Exchange of Property-a sale in which amount realized paid in property rather than cash i. Both parties disposing of property, so each has either a gain or loss ii. Have to determine cash equivalent of prop. seller received in order to compute gain/loss b. Basis is determined by fair market value of property received at time of exchange c. Since FMV of Property is a Question of Fact, to determine FMV of Property Received (if parties dealing at arms length and properties exchanged assumed to be of equal value) look to: i. FMV of property received, OR ii. FMV of property disposed of *Whichever Can Be More Readily Valued* *FMV is a question of fact, so prove with best evidence available which if FMV of prop. received/disposed of* iii. Definition of FMV-§1.170A-1(c)(2): price at which the prop. would change hands b/n a willing buyer & seller, neither under any compulsion to buy/sell & both having rsnbl. knowledge of all relevant facts d. Ex. Philadelphia Park-Taxpayer deeded bridge to city in exchange for 10 yr. extension of franchise; court held basis should be fair market value of property received, here the franchise. b. Acquired from Decedent/Stepped-Up Basis-§1014(a): i. Basis of property acquired from a decedent (by will or inheritance) is generally its FMV as of decedent‟s date of death a. Appreciation itself entirely escapes income tax ii. Exception: Stepped-up basis isn‟t available for appreciated prop. that: a. Was received as a gift by decedent within one year or date of death, AND b. Passes back on donor on decedent‟s death; See §1014(e) *If applies, property will take a transferred basis* c. Gift/Carry-Over Basis-§1015(a): i. Donee of gift treated as if she stepped into shoes of donor and takes donor‟s basis in property transferred a. See Taft for explanation of this general concept (Donee responsible for tax on gain from increase in value of property during donor‟s possession of it; this doesn‟t violate the 16th Amendment) b. Just b/c transfer characterized as “gift”, have to make sure there was no consideration involved i. Ex. Farid-court held pre-nup. “gift” to fiancée-tobe transfer in exchange for her promise to marry

him & give up rights to his other prop.; her basis became FMV of stocks at time she acquired them ii. Exception: If Donor‟s basis greater than FMV of prop. at time gift made Donee has 2 possible basis calculations: a. If selling at gain, use donor‟s basis b. If selling at loss, use FMV when gift made; See §1015(a) 3. Computation of Gain or Loss: §1001(a) a. Gain/Loss from sale or other disposition of property = Amount realized – Adjusted basis i. Adjusted Basis for Determining Gain or Loss-§1011: Basis to be determined under the starting point basis provisions (See above.) ii. Adjusted Basis-§1016: requires existing basis in property be adjusted up/down depending on certain tax significant events occurring in relation to property while in taxpayer‟s hands a. For example, depreciation, improvements to prop., etc. NEED TO PUT MORE IN ON THIS b. See also §1.1001-1(a)-essentially the same as above C. Amount Realized/Relief from Indebtedness 1. Amount Realized-§1001(b): Amount realized from sale or other disposition of property is the sum of any money received, plus the fair market value of the property (other than money) received a. General Rule: Amt. realized includes FMV of services rendered in exchange for property i. Goes with above-stated concepts re: arms length transactions and FMV (Philadelphia Park) ii. Ex. International Freighting-discretionary bonuses in form of stocks are considered to be in exchange for employee services rendered; amt. realized measured by FMV of stocks at time given iii. 2. See also §1.1001-1(a)-essentially the same as above b. Abandoned Property i. A disposition of property, thus amount realized is zero ii. Consequently, t/p has a loss measured by its adjusted basis in abandoned property c. Two Components in Amount Realized: i. Cash ii. Debt Relief…see immediately below 2. Relief from Indebtedness a. General Rule: Relief from indebtedness is included in amount realized; (See also §1.1001-2(a)(1): Amt. realized from sale/other disposition of property includes amt. of liabilities from which transferor is discharged as result of sale/disposition) i. Entire amt. of debt relief included in seller‟s amt. realized even if such amt. is greater than the property‟s FMV at the time of sale/ exchange a. §1.1001-2(b): FMV of security at time of sale/disposition not relevant for purposes of determining amt. of liabilities from which taxpayer is discharged or treated as discharged; thus the fact the FMV of prop. is less than amt. liabilities it secures doesn‟t prevent the full amt. of liabilities from being treated as $ received from sale/disposition of prop b. This isn‟t gross inc. under §61(a)(12) (income from discharge of indebtedness) where gross inc. arises b/c cancelled debt; here, debt not cancelled, but just shifted to someone else as a result of their taking over the mortgage i. §1.1001-2(a)(2): Amt. realized on sale/disposition of other prop. that secures recourse liability doesn‟t

include amt. that are income from the discharge of indebtedness under §61(a)(12) c. Policy: Amt. included in amt. realized b/c debt included in t/p basis for prop. when t/p acquired prop. d. Ex. Crane-wife inherits prop. subject to mortgage; when prop. sold she had to include in amt. realized amt. of mortgage relieved + cash received i. Also notes in Crane case re: depreciation e. Ex. Tufts-t/p bought bldg. for 2 mil.; lots borrowed thru non-recourse loan; b/c fmv, prop. sold for less than amt. due on mortgage; had to use debt outstanding as amt. realized rather than price paid for property ii. Gift tax paid by donee also included in donor‟s amount realized a. Net Gift-donor transfers prop. to donee on condition donee pay amt. of gift tax arising from transfer ?IS THIS RIGHT? iii. Trigger Fact: Mortgages! a. Face value of mortgage is sellers amt. realized b. Face value of mortgage is buyer‟s starting point basis b. Above applies regardless of whether debt is: i. Recourse-borrower personally liable, or ii. Non-recourse-lender cannot go after borrower personally D. Non-Recognition of Realized Gain 1. General Rule: a. Recognition of Gain/Loss: §1001(c)-Entire amt. of gain or loss on sale, exchange of property shall be recognized; in other words, all gain or loss realized also recognized unless § says realized gain isn‟t recognized i. Realization-if prop. apprec. in value, no tax effect until prop. disposed of; when disposed of t/p cashes in on gain & has amt. realized ii. Recognition-gain/loss reported in taxable yr. of realization event b. Where realized gain involved, non-recognition favorable to taxpayer, but there must be a non-recognition provision in Code 2. Exceptions: Three Types of Non-Recognition of Realized Gain a. Spousal Transfers-§1041(a): No gain/loss recognized on transfer of prop. to a spouse, or a former spouse, but only if transfer is incident to divorce i. Basis of Prop.-§1041(b): Prop. shall be treated as acquired by transferee by gift, thus use a carry-over basis (i.e., adjusted basis of transferor) ii. Incident to Divorce-§1041(c): Trans. of prop. incident to divorce if trans. occurs w/i 1 yr. after date on which marriage ceases, or is related to cessation of marriage a. Related to Cessation of Marriage-§1.1041-1T: Pursuant to a divorce or separation agreement iv. Policy for Non-Recognition: Husband & Wife-a single economic unit v. Rule applies whether trans. of prop. is for cash or other prop., for relinquishment of martial rights or for any other consideration a. Transfers of Services-§1.1041-1T: Trans. of prop. not subject to rules of §1041 b. Transfer can be of prop. acquired after marriage ceases; see §1.1041-1T vi. See generally §1.1041-1T b. Exchange of Like-Kind Property: -§1031(a) No gain/loss recog. on exchange of prop. held for productive use in trade/business or for investment if such prop. exchanged solely for prop. of like- kind which is to be held either for productive use in trade/business or for investment; -§1031(b) If exchange also involves other prop. or $ , then gain, if any, shall be recognized, but in an amt. not in excess of the sum of such $ and the fmv of such other prop.

-Boot-an equalizing payment; used if props. don‟t have fmv -If gain involved, gain-boot is recognized i. Three Criteria for Like-Kind Prop. a. Prop. held for productive use in trade or business or for investment b. Disposition must qualify as an exchange c. Consideration received must be prop. of like kind to be held for productive use in trade of business or for investment ii. What‟s an “Exchange”? a. T/p must exchange his prop. for other prop.; transaction mustn‟t be, in form or substance, a sale for cash followed by a purchase of like-kind prop. b. From Bloomington Coca-Cola: giving for 1 thing for another; prop. transferred in return for other prop. w/o intervention of $ i. If cash paid, it may be considered as representing the purchase price of excess value of „like prop.‟ received c. Ex. Leslie-taxpayer constructed prop. and sold it to 3P at a loss and deducted difference; 3P then leased prop. back to taxpayer; issue: what kind of exchange is a sale-and leaseback? i. True-sale followed by true-leaseback: Taxpayer‟s argument, so they can deduct loss a. Court holds here ii. Like-kind exchange: a long-term lease is exchange of like-kind prop, so no gain or loss recognized; IRS argues, but taxpayer doesn‟t want b/c no deduction allowed iii. Loan-3P had legal title to prop. subject to 30-yr. lease; legal title could be viewed as security devise; no immediate tax effect on either party iii. What‟s “Like-Kind” Property? a. Def. of “Like-Kind”-§1.1031(a)-1(b): refers to nature and character of prop. and not to grade or quality a. Doesn‟t matter if land unimproved b/c that‟s grade/qual. b. Real Prop. i. “Like-Kind” interpreted broadly ii. Real prop. for real prop. is a like-kind exchange, unless real prop. in US is exchanged for real prop. outside US iii. Ex. Crichton-exchange of int. in oil, gas & minerals on undeveloped land for int. in developed city land is like-kind exchange iv. See §1.1031(a)-1(a)(1) c. Personal Prop. i. Like-Kind interpreted narrowly a. Exchange of gold for silver not like-kind b. Personal prop. used w/in US and personal prop. used outside US are not like kind ii. Exception: for tangible depreciable personal prop. a. like kind if passes strict general test, or b. if pass like-class test, meaning props. exchanged in same “Gen. Assets Class” or same “Prod. Class” iii. See §1.1031(a)-2(a): Personal prop. of a like class are considered to be of a like kind iv. Basis-§1031(d): a. For §1031(a) exchange for solely like-kind prop. basis shall be same as that of prop. exchanged; a substituted basis b. For §1031(b) exchange for non-solely like-kind prop. basis, 3 step computation involved:

i. Adjusted basis in like-kind prop. disposed of ii. Minus money amt. received iii. Plus amt. of gain recognized v. Three-Cornered Exchange-an important planning tool a. Party B wants A‟s prop., but A wants C‟s prop.; instead of B buying A and A buying C, B will buy C‟s prop. from C and exchange for A‟s prop.; this was A hasn‟t recognized inc. b/c it is a likekind exchange and will not have to pay tax immediately b. Almost always occurs where large real estate dvlp. occurring NEED LOTS MORE EXPLANATION OF LIKE-KIND EXCHANGE c. Involuntary Conversions-§1033: allows for non-recognition of gain in certain circumstances where prop. invol. converted i. Types of Involuntary Conversions Covered in §1033: a. Destruction in part/whole b. Theft c. Seizure or d. Requisition or e. Condemnation or f. Threat or g. Imminence thereof ii. Two Types of Non-Voluntary Conversions: a. §1033(a)(1): Conversion into Similar Property-If prop. invol. converted into prop. similar or related in service or use, no gain recognized. b. §1033(a)(2): Conversion into Money or Dissimilar Prop.-If prop. invol. converted into $ or prop. not similar or related in service or use to the converted prop., the gain is recognized except as provided in §1033(a)(2)(A) i. §1033(a)(2)(A): if taxpayer during the period specified purchases other prop. similar or related in service or use to the prop. so converted, at election of taxpayer, the gain shall be recognized only to the extent the amt. realized on the conversion exceed the cost of such other property ii. This scenario is more common (conversion into money and thereafter reinvests in similar prop.) iii. Meaning of “Similar or Related in Use or Service” a. Rev. Rule 76-319 (citing Rev. Rule 64-237): Physical characteristics and end uses of the converted prop. and replacement props. are closely similar i. Ex. Billiard hall and bowling alley not similar b. From Clifton Investment Co.-properties must be reasonably similar in relation to the taxpayer; ask has the relation of the taxpayer to the prop. has been changed? c. Has different meaning than §1031 „like-kind‟ property iv. For non-recognition to apply: a. there must be a gain (§1033 does not apply to losses) b. Replacement prop. must be “similar or related in use or service” to the converted prop. c. Replacement must occur within 2-yr. period provided by statute v. Basis of Replacement property is cost of replacement property minus the gain not recognized on exchange ?NEED A BETTER EXPLANATION OF INVOL. CONVERSIONS? VI. CERTAIN OTHER KINDS OF GROSS INCOME A. Dividends 1. General Rule: §61(a)(7): Gross income includes dividends

a. Dividends-amts. paid by corp. to s/h in his capacity as s/h from corp.‟s after-tax net earnings & profits b. Corp. cannot deduct dividends 2. Characterization Issue: a. If s/h is also employee, is payment dividend or salary? i. Corp. rather payment be characterized as salary b/c deductible! b. If s/h also creditor, is payment dividend or principal or int. on a loan? B. Interest 1. General Rule: §61(a)(4): Interest received by lender/creditor is Gross Income a. Interest-amt. paid by debtor to creditor/lender for use/forbearance of $ 2. Exception-§103(a): Int. paid on State/Local bond not included in gross income a. §103(b): Does not apply to private activity bond that‟s not a qualified bond, any arbitrage bond, or bonds not in registered form, etc. under §148 c. Borrowing Federal Money is not exempted from gross inc.! c. Alternative Minimum Tax-subjects some exempted interest from regular income tax to taxation under alternative minimum tax a. Report amts. of dividend/interest if above a threshold amt. (Is this what Alter. Min. Tax is?) b. 2002 threshold = 400; 2003 threshold = 1500 C. Life Insurance 1. General Rule: §101(a): Gross inc. doesn‟t include amt. received under a life insurance K, if such amts. are paid by reason of death of insured 2. Two Types of Policies: a. Term-insurance for a yr. renewable at discretion of ins. co., but no long term coverage i. Two Components of Premiums a. Cost of administering insurance b. Amt. covering risk of your death in particular yr. b. Whole Life-insured buys a policy, names beneficiary and you get for whole life i. Three Components of Premiums a. Cost of administering insurance b. Amt. covering risk of your death in particular yr. c. Gen. coiffures of ins. co. to pay death benefits for pool of policy holders ii. Ex. of Whole Life: Janitors ins.-corp. buys life ins. for all employees; since corp. pays premium they own policy and they get $ when employee dies 3. When policy is in force during insured‟s life, insured can: a. Take out a Policy Loan against policy (no tax consequences), or b. Cancel policy & Cash Surrender Value, which consists of 2 parts: i. Return of unused premium (basis, excludable) ii. Insured‟s share of investment earnings generated by common pot of money (income, includable b/c not paid by reason of death) 4. When Insured Dies, Beneficiary gets either: a. Installment Payments-over time by either i. Having insurer keep proceeds and pay periodic interest payments over set term, proceeds at end of term a. Int. payment in Gross Inc. under §61(a) b. Proceeds at end of term excluded under §101 ii. Having insurer pay portion of proceeds to beneficiary periodically and stated additional amt. to use of declining balance of proceeds over payout pd b. Lump Sum Payments 5. Two Components of Insurance Payments a. Excludable payments b/c paid by reason of insured‟s death

b. Interest equivalent-§101(c): If any amt. excluded from gross inc. is held under agreement to pay interest, interest is includable in gross income 6. §101(d)(1): Amts. held by insurer shall be prorated over period in which payments are to be made; there shall be excluded from gross income any amt. determined by proration (WHAT’S THIS MEAN?) D. Annuities 1. Definition: Contractual investment tool under which annuitant gives payor sum of $ and agrees to have payor invest it & pay him periodic payments either for term of yrs. or life of annuitant 2. Tax Effects on Annuitant (person for whose benefit annuity paid) a. Return of initial investment, tax free under basis concepts b. Income component over initial investment, include in gross income 3. General Rule: §72(a): Gross income includes any amt. received as annuity 4. Caveat: §72(b)(1): Gross inc. excludes amt. received as annuity which bears same ratio to such amt. as investment in K bears to expected return under K a. I.e., annuitant‟s investment in K/entire amt. annuitant to receive b. §72(b)(2): Any amt. received over exclusion amt. is gross income i. Occurs when annuitant lives beyond life expectancy c. §1.72-4(a): Exclusion Ratio-to determine amt. excludable, divide investment in K by expected return under K 5. §72(b)(3)(A): If annuitant dies before life expectancy, thus only part of basis returned investment free, un-recovered basis in annuity K becomes deduction a. §72(b)(3)(B): Deduction taken by person entitled to receive annuity $ VII. WHOSE INCOME IS IT? A. Assignment of Income-Who must include an amt. in gross inc.? common law governs 1. Assign. Of Inc.-attempt by t/p to shift income to another person a. Why? Progressive tax rates-those w/ higher inc. in higher tax bracket, so attempting to avoid higher bracket by transferring to those in lesser bracket i. Occurs often with family members -Assignment of Income from Services 2. If t/p has vested interest in inc. then assigns it, its taxable to t/p a. Inc. taxed to those who earn regardless of arrangements to assign b. Ex. Lucas-H & W in K that all prop. held as jt. tenants; half H inc. reported of W return b/c of K; held H to report himself all inc. he earned regardless of K 3. If t/p right to receive $ declined before ripened by possession & control, $ not taxable to t/p in gross inc. a. Ex. Giannini-Pres. of corp. refused part of salary and suggests it be donated; court held since pres. was entitled to, but refused $ and did not direct use, its excludable -Assignment of Income from Property 4. When gift made from prop‟s. income, if donor retains inc. producing prop. the inc. continues to be taxable to owner of prop. even thou owner of prop. never gets his hands on it a. Idea: If inc. from prop. given away, but prop. kept, inc. remains taxable to you b. Ex. Helvering-Dad gave son interest on bonds before interest matures, dad continued to hold; court held dad must report interest as gross inc. But differentiate from…. 5. If there‟s a valid sale of income from prop., income from prop. excludable a. Ex. Stranahan-dad owes back taxes; son pays dad $ in return for future stock dividends; court held a valid sale as it was transfer for adequate consideration, thus amt. of dividends not includable as to dad 6. Fruit-and-Tree Metaphor: If owner keeps tree producing fruit, even if he gives fruit away, tree‟s fruit still taxed to tree owner 7. Add-Ons: a. §73: Inc. of child treated as his gross inc. even thou his parents get $

b. §6013(a): Spouses can file jt. return, except for exceptions provided in §; lower rates apply if spouses file jt. return; doesn‟t matter if assignment of inc. b/c they file a jt. return B. Income in Connection with Divorce and Separation -Alimony and Separate Maintenance Payments 1. Gen. Rule-§71(a) [and §61(a)(8)]: Gross inc. included alimony or separate maintenance payments a. Alimony or Sep. Maintenance Payment-payment received by a spouse under a divorce/separation agreement b. Focuses on Recipient-so recipient will be taxed on payments c. Trigger Fact: Look for a former spouse paying support to other 2. §71 Criteria of Alimony or Separate Maintenance Payment: a. Instrument-payment must be received (or on behalf of) spouse pursuant to a decree or separation instrument; see §71(b)(1)(A) i. Payments made to 3P that benefit payee qualify b. Divorce/separation agreement mustn‟t designate payment as nonincludable/non-deductible; see §71(b)(1)(B) i. If $ not deductible/includable pursuant to agr., it trumps §71 ii. With alimony or separate maintenance payments, deductibility of payor depends on inclusion by payee c. Payor and recipient cannot be members of same house at time payment made; see §71(b)(1)(C) d. There must be no liability to make payments beyond the death of payor spouse; see §71(b)(1)(D) e. Payment must be in cash; see §71(b)(1) f. Payment must not be child support; see §71(c)(1) a. If payment is child support it‟s not included in gross inc. of recipient spouse, so not deductible from payor spouse b. Payment will be treated as for child support if its reduced on: i. Happening of specified contingency to child, or ii. Payment scheduled to be reduced at time clearly associated with such contingency 3. See §1.71-1T 4. Front-End Loaded Alimony-§71(f): a. Payments technically qualify as alimony, but look more like prop. settlements i. Single, lump sum payments ii. Disproportionately large payments during early years of payments b. If certain level of “front-loading” occurs, then excess alimony payments made in first 2 yrs. are recaptured by payor in 3rd yr. a. Payor has income, payee has deduction -Transfers of Property Between Spouses Incident to Divorce 6. Gen. Rule-§1041(a): No gain or loss recognized on a transfer of prop. from an individual to a spouse, or former spouse, but only if transfer is incident to divorce a. Incident to Divorce-§1041(c): Must occur: a. Within 1 yr. after date on which marriage ceases, or b. In relation to cessation of marriage b. Effects of §1041 Transfer: i. Transfer is non-recognition event (no gain/loss recognized); See above ii. Basis-§1041(b): Prop. treated as acquired by transferee as gift, thus a carry-over basis c. Beware of Characterization Issued b/n §1041 (prop. transfer) and §71 (alimony or separate maintenance payments) d. Policy Behind §1041: Divorce is not a taxing event!

e. With alimony or separate maintenance payments, deductibility of payor depends on inclusion by payee C. Income Producing Entities 1. 3 Types of Inc. Producing Entities: P‟ships, Corps., Trusts; See above for more ??NEED TO KNOW MORE ABOUT INCOME PRODUCING ENTITIES? VIII. DEDUCTIONS: MOVING FROM GROSS INCOME TO TAXABLE INCOME A. Deductions: The World’s Greatest Hidden Subsidy Program 1. Deductions-subtraction from gross income in determining taxable income 2. An indirect subsidy- same result could be achieved thru direct subsidy a. A form of governmental financial assistance 3. Available only thru “legislative grace”, i.e., a statute B. Adjusted Gross Income of Individual Taxpayers (AGI) 4. Several Categories of Deductions: a. Above-Line/Preferred Deduction-§62(a): Direct subtraction to get GI i. §62 identifies all Preferred/Above-Line Deductions; if it‟s not listed there, it could still be deductible, but deductible from AGI b. Itemized Deductions-§63(d): Below-line deductions; (Line is AGI) i. §63(d): Itemized Deductions means those other than deductions to arrive at AGI and deduction for personal exemptions in §151 c. Standard Deductions-§63(c): below-line deductions; a plug-figure, i.e., has no components; adjusted annually for inflation i. If itemized deductions don‟t rise to certain amt. of money, t/p can take standard deduction ii. §63(c): Standard Deduction means basic standard deduction and additional standard deduction…. d. Personal Exemptions-§151(a): Below-line deduction; Exemptions provided for in § allowed as deductions in computing taxable inc. i. §151(b)-Personal Exemptions ii. §151(c)-Additional Dependent Exemption e. AGI concept and above-listed deductions apply only to individual t/p! f. Formula: [Gross Inc. – Preferred/Above-line deductions] = AGI [Itemized or Standard Deductions - Personal Exemptions] = Taxable Inc. i. T/P only gets Itemized OR Standard Deduction! 2. §62(a): Adjusted Gross Inc. is gross inc. minus following deductions: i. Trade and Business Deductions ii. Certain Trade and Business Deductions of Employees iii. Losses from Sale/Exchange Prop. iv. Certain Deductions of Life Tenants and Income Beneficiaries of Prop. v. Deductions Attributable to Rents and Royalties vi. Pension, Profit Sharing Plans vii. Retirement Savings viii. Penalties Forfeited B/c Premature Withdrawal of Funds from Time Savings Accounts or Deposits ix. Alimony x. Reforestation Expenses xii. Certain Required Repayments of Supplemental Unempl. Comp. Benefits xiii. Jury Duty Pay Remitted to Employer xiv. Deduction for Clean Fuel Vehicles and Certain Refueling Prop. xv. Moving Expenses xvi. Archer MSA‟s xvii. Interest on Education Loans xviii. Higher Education Expenses *§62 does not authorize deductions, but simply identifies deductions authorized elsewhere in statute*

3. Taxable Inc. Def.-§63(a): Tax inc. = gross inc. – deductions allowed in chapter; also defines taxable inc. w/itemized, standards, and non-itemized deductions C. Business-Related Deductions 1. Basic Concepts: §162 a. Trade or Business Exp.-§162: Allows deduction for all ordinary and necessary business expenses paid or incurred in carrying on any trade or business, including reasonable allowance for salaries or other comp. for personal services actually rendered, traveling expenses while away from home in pursuit of trade or business, and rental payments for prop. b. Personal, Living, Family Expenses-§262(a): No deduction allowed for pers. family, living expenses c. Requirements/Definitional Issues i. Ordinary and Necessary a. Ordinary-common and accepted w/in industry, even if uncommon for t/p i. Not an expense paid for business/other purpose a. Ex. Goodwill ii. Ex. Welch-Corp‟s. bankrupt, but vol. pays debts to est. good reln. w/customers; court held payments necessary, but not ordinary b/c its extremely rare for t/p to pay unenforceable debt b. Necessary-appropriate/helpful to t/p trade/business c. Cases are VERY fact specific d. See also §1.162-(1)(a) ii. Expenses (See below) iii. Carrying-on any Trade or Business (See below) iv. Paid or Incurred during Taxable Year 2. Capital Costs/Start-up Expenses a. Requirement # 2-Expenses: Seeks to distinguish b/n expenses and capital expenditures; business expense deductible, capital expenditures notuse amortization, depreciation i. Fundamental Principle: If expenditure has benefit that occurs over 1+ yr., it‟s a capital expenditure and not currently deductible; but if benefit to business from expenditure is 1 yr. or less, it‟s deductible business expense a. Ex. Indopco-3P seeks to takeover corp.; corp. incurs expenses in takeover (banker/legal fees); court held amts. non-deductible capital expenditures b/c long-term bene. ii. Capital Expenditures-§263(a): No deduction allowed for any amt. paid out for new buildings/permanent improvements or betterments made to increase value of any prop. or estate iii. Repairs (Deductible) v. Capital Improvements (Non-deductible) a. §1.162-4: Repairs business exp. (currently deductible) if repairs don‟t materially increase value or useful life of repaired prop., but keep it in ord. efficient oper. condition can be deducted as bus exp. b. 1.263(a)-1(a)-(b): Repairs are capit. expend. (non-deduct.) if in nature of replacements that appreciably prolong life of prop. . a. See 1.263(a)-2 for list of capital expenditures c. Determination of Cap. Expen. v. Repair based on facts and circ. i. If expend. part of remodeling plan, cap. exp. (nondeduct.) a. Ex. Norwest-removal of asbestos apart of remodeling plan, so removal cost is capital expenditure and can‟t be capitalized b. Requirement # 3: Carrying-On Any Trade or Business i. Start-up Expenditures-§195(a): No deduction allowed for start-up expenses [b/c they don‟t meet carrying-on test] ii. §195(b): T/p can elect to treat start-up expenses as deferred exp. & can deduct prorated equally over a pd. not less than 60 mo. iii. §195(c)-Def. of Start-up Exp.: paid incurred in connection with:

a. investigating creation/acquisition of active trade/busin. or b. creating active trade or business, or c. any activity engaged in for profit & for prod. of inc. before day on which active trade/business begins, in anticipation of such activity becoming trade/business, and which would be deductible if incurred while carrying-on trade/bus. iv. Carrying-on means business must be up and running a. If t/p owns business & looking for another business in same field, deductible, but non-deduct. if looking for business in diff. field b. Must be employed to meet carrying-on test c. Ex. Morton Frank-expenses incurred before actually starting business not currently deductible c. Requirement # 4: Paid or Incurred during Taxable Year 3. Reasonable Compensation 1. Trade or Business Exp.-§162(a)(1): Reasonable allowance for salaries or other compensation for personal services actually rendered is deductible 2. §1.162-(8): Determination depends on facts and circumstances in each case! a. Characterization Issue: Is amt. compensation or a dividend? [Comp. deductible to employer/payor; dividend is non-deductible] b. Courts generally to hold comp. unreasonable if looks like tax avoidance c. Presumption: If employee non-controlling[i.e. non-s/h], unrelated to employer, amt. paid presumed to be bargained for reasonable comp. 3. §162(m): publicly traded corp. can deduct salaries to highly paid employees only to extent comp. doesn‟t exceed $1 mil.; See Exacto Spring 4. Travel and Commuting Expenses 1. Travel Expenses-§162(a)(2): Travel expenses while away from home in pursuit of trade or business are deductible a. Long struggle b/n this idea and idea that personal, family, living exp. non-deductible; See §262(a) and §1.262-1(a) and (b) b. §1.162-2: __ i. (a): Travel exp. include travel fares, meals, lodging, & exp. incident to travel a. Only reasonable and necessary travel exp. to t/p business and that are directly attributable to it deductible bus. exp. iii. (b)(1): Traveling exp. to from destination where t/p will engage in both business & personal activities are deductible only if trip is primarily related to t/p trade/business a. If trip primarily personal, no deducting travel exp. even if some business activ. engaged in while t/p at that destination, but exp. arising from business activ. while there deductible b. To determine if travel for trade or business depends on facts and circumstances 2. §162(a)(2) Meaning of “Home”: a. Means a tax home i. T/p regular or principal (if more than 1 regular) place of business, or ii. If t/p has no regular or principal place of business, the t/p regular place of abode in a real and substantial sense a. Ex. Rosenspan-t/p travels all yr.; home base is bro.‟s home, but he rarely stayed there; court held t/p could not deduct travel exp. b/c he had no home to be away from b. Overnight Rule-T/p is away from home only if he is away overnight (judicially created) i. T/p can only deduct meals & lodging if Overnight Rule satisfied

ii. T/p can deduct travel exp. w/o satisfying Overnight Rule 3. Commuting Expenses a. Gen. Rule -1.162-2(e): Commuting fares not business exp. thus aren‟t deductible i. Idea: Residence is personal choice, so if t/p choose to live far from work place it‟s a personal exp. i. Rev. Rule 99-7: If t/p has reg. work site, but takes temp. assign. at diff. site, t/p can deduct costs of travel to/from temp. job site a. But if temp. job location expected to last more than 1 yr., it becomes tax home and thus isn‟t deductible ii. 1.162-2: Transportation costs while on job are generally deductible (i.e., if t/p goes from tax home to another destination in same city), even thou costs of travel b/n t/p home and principal place of business aren‟t deductible 5. Meals and Entertainment Expenses-certain meal/recreation exp. incurred in business setting may be deductible even if t/p not away from home 1. §274 is an attempt to narrow scope of §162 a. Items deductible in §162 only if they meet §274 requirements b. Item must meet Ordinary and Necessary requirements of §162 first! 2. §274(a)(1)(A): No deduction for entertainment, amusement, recreation unless t/p establishes activity is: a. “Directly related”-business goes on during entertainment, or b. “Associated with”-if entertainment occurs immediately before or after business t/p trade or business 3. §274(a)(1)(B): Expenses associated with facilities for entertainment, amusement, recreation, including dues for such facilities are non-deductible a. §274(a)(3): Dues for clubs organized for business, pleasure, recreation, other social purposes are non-deductible 4. Meals-§274(k)(1): No deduction for food/beverage. exp. unless exp. isn‟t lavish or extravagant under circs. and t/p is present at furnishing of food/beverage a. Cost of entertaining client primary factor, but your meal swept under this principal, so overnight rule doesn‟t apply here b. Spouses meals can be deducted if closely related to the business activity (but are still subject to 50% limit) 5. §274(n): All deductions for meal/entertainment limited to 50% amt.spent; (Applies to meal deductions under §162 as well) a. For meals, food + tax + tip is starting pt. for 50% deduction b.50% deduction applies to face amts. of entertainment events c. Exceptions: §274(n)(2) and (3) i. §274(n)(3): Applies special percentage to indiv. deducting amts. subject to federal hours of service 6. Substantiation Requirement-§274(d): No deduction allowed unless t/p substantiates deduction by adequate records a. Replaces Cohan rule that in certain instances business and entertainment matters can be estimated 7. Exectptions-§274(e): Provides exceptions to general rule 8. See also 1.274-1 9. See also 1.274-5T for Substantiation Requirements 6. Business Losses 1. Types of Business Losses a. Aggregate Loss (aka. Operating Loss)-not authorized deduction in Code b. Stand-alone Loss-arises when prop. disposed of and basis greater than amt. realized i. Separately deductible when §165 requirements met 2. Gen. Rules:

a. §165(a): There shall be allowed as a deduction any loss in taxable year not compensated for by insurance or otherwise i. “shall”-must be taken ii. “any loss”-applies to business losses, not aggregate losses iii. “sustained”-realized, there must be actual loss iv. “during taxable yr.”-must be firmly attributed to 1 yr. a. Yr. in which loss is discovered, not incurred! v. “not compensated for”-if amt. from received equal to/less than basisloss, if amt. from received greater than basisgain a. Can be compensated for by insurance, judgment, etc. [b. §165(b): Basis for determ. amt. of deduction for loss is adjusted basis] c. §165(c)(1): In case of individual, deduction limited to losses incurred in trade or business *If item meets §165(a) quals., next must meet §165(c) quals.* *If any loss of indiv. not w/in §165(c)(1)-(3) then its non-deductible* 3. Limitations on §165 Loss Deductions a. §267(a)(1): No deduction allowed for any loss from sale/exchange of prop. b/n related persons (i.e. buyer/seller in relationship of some sort) i. §267(b) specifies 13 types of related persons a. Focus on §267(b)(1)-Members of a family ii. Beware §267(d): If seller sells to related buyer at loss thus loss disallowed under §267(b) then related buyer resells to 3P and her gain‟s less than relations disallowed loss, her gain can go unrecognized iii. Policy of §267(a)(1) from McWilliams-A tax avoidance issueclosely related parties with near-identical economic interests could transfer prop. to one another at a loss as a way to avoid paying tax iv. Form-Over-Substance Rule: Gen., if dad sells to son-inlaw loss allowed as deduction under §267(b) as parties nonrelated, but if selling to son-in-law is just way to transfer stock to daughter, then court will hold form over substance and not allow dad to deduct loss b. §280B: Demolition cost of building or any loss sustained on account of such demolition not deductible, but these amts. are to be treated as chargable to capital account with respect to land on which the demolished structure was located i. I.e., Add cost of demolition to land building was on, but since land not depreciable, t/p never gets deduction 7. Depreciation-applies to tangible property 1. Gen. Rules: §167 authorizes depreciation as a reasonable allowance and §168 provides methods for determining depreciation which are considered to be a reasonable allowance; Can only depreciate 100% of capital asset investment! a. §167(a): Depreciation deduction allowed for reasonable allowance for exhaustion, wear & tear of prop. used in trade or business, or of prop. held production of income b. §167(c): Basis on which exhaustion, wear & tear allowed is adjusted basis, i.e. starting point basis c. Idea behind §167-Over span of yrs. during which depreciable asset used in business t/p allowed to recover a ratable portion of his investment in asset equal to amt. of his capital investment in that asset that was used up during any yr. the asset contributed to generating business inc. d. §1016(a)(2) requires t/p to adjust basis in depreciable asset downward in amt. equal to amt. of annual depreciation deduction e. See also 1.167(a)-2: Depreciation allowance for tangible prop. only applies to prop. subject to wear, tear, etc. 2. Types of Depreciation:

a. Straight-Line: machine cost/useful life; allocates total cost of asset ratably to each yr. of useful life of prop.; use for residential rental prop. and nonresidential real prop. i. 4 Components of Straight Line Depreciation: a. Determine starting point basis in prop. b. Determine estimated salvage value-amt. rsnbl. assumed that will be amt. realized when prop. is at end of its life c. Salvage Value deducted/subtracted from starting point basis in machine d. Determine what estimated useful life of machine is ii. Assets with no determinable useful life are not depreciable a. Exs. Land, Goodwill-these assets are not wasting assets b. Accelerated-front-end loaded deductions i. Congress used to spur capital investment and recovery (very little recovery in last yrs. of machine life, since deductions frontend loaded, so incentive to throw out old machine early and reinvest) either by increasing amt. of deduction in 1st yrs. or by shortening writeoff period ii ACRS-§168(a): Depreciation deduction allowed by §167 will be determined by using the applicable depreciation method (§168(b)), applicable recovery period (§168(c)), and applicable convention (§168(d)) iii. Under ACRS depreciable prop. assigned to… a. Applicable Classification Pd.-§168(e): Need to ascertain to determine Recovery Period b. Applicable Recovery Pd.-§168(c): Need to ascertain to determine yrs. over which depreciation deduction spread i. Recov. Pd. for Residential Real Prop = 27.5 ii.Recov. Pd. for Non-residential Real Prop = 39 iii. Recov. Pd. for most Tangible Pers. Prop (depending on what kind of prop it is) = 3, 5, or 7 iv. Recovery Pd-used in §168 to move away from useful life which created disputes v. Once recov. pd. up, no more deprec. deductions! c. Applicable Convention-§168(d): Determines date on which prop. deemed to have been placed in service by t/p i. §168(d)(1)-Gen. Rule: Applicable convention is half-year convention, except as otherwise provided a. If asset placed in service in 2nd half of yr., only allowed ½ depreciation deduction b. Also mid-month, mid-quarter conventions d. Applicable Depreciation Methods: §168(b): i. §168(b)(3)-Straight-line: See above ii. §168(b)(1)-200% declining balance method a. Switches to Straight-line in yr. it produces greater depreciation allowance iii. §168(b)(2)-150% declining balance method: Used for any 15 or 20 yr. prop. as determined by Applicable Classification Pd. and prop. used in farming e. Bonus Depreciation-§168(k): “Qualified prop.” (as described in §168(k)(2)) allows an additional 30% depreciation in 1st yr. prop. put in service i. Starting pt. basis reduced additional 30% in 1st yr. ii. Another econ. incentive for t/p to buy new prop.

f. §168 Limitation-§280F: limits §168 ACRS depreciation on luxury (high-priced) automobiles, but not those weighing over 6000lbs. i. Not disallowing deduction extending recovery pd. ii. Idea-Business not to get major tax benefit from driving luxury cars iv. Ex. Simon-t/p antique violin bows wear-out w/t/p use, but their value increases, but court says actual value of basis irrelevant as §168 is theoretic means of matching t/p investment w/actual value 3. Election to Expense Certain Depreciable Business Assets: §179 a. Economic incentive (aimed mainly at small businesses) b. Used for tangible, personal prop. used in business; not for real estate c. §179(a): T/p can elect to deduct full cost of prop. otherwise depreciable in 1st yr. prop. in service i. If provision not elected, prop. depreciable under reg. rules ii. T/p may choose not elect if business operating at loss b/c won‟t get full benefit of deduction d. Limitation on §179(a) i. §179(b)(1): Caps amt. of deduction under §179(a) a. In 2002, cap set at $25,000 b. After 2002, cap set at $100,000 ii. §179(b)(2): Cap in §179(b)(1) is ratably reduced by amt. by which cost of §179 prop. placed in service during tax. yr. exceeds: a. In 2002, $200,000 b. After 2002, $400,000 e. §179(d)-4 charac. prop. must have to qualify for deduction under this § f. §1016(a)(2): Basis reduction applies! 8. Amortization-Depreciation for intangibles 1. Gen. Rule-§197(a): T/p may claim deduction for any amortizable §197 intangible equal to adjusted basis of asset divided by 15 years, & may begin claiming deduction in month of acquisition of intangible a. §1016(a)(2) Basis reduction applies! b. Enacted to end dispute only intangibles w/useful life can be amortized c. §197(c): Asset must be acquired by t/p and held in connection with trade or business activity i. Generally, §197 does not apply to a self-created assets (b/c there‟s no basis) d. Similar to straight-line depreciation 2. What are Intangibles? a. §197(d): goodwill, going concern value, covenants not to compete, patents, copyrights, formulas or processes, and various other intangibles, i.e. mailing lists, workforce-in-place, etc. i. Workforce not amortizable, but…. a. Workforce-In-Place (working together & expertise brought to bear separate, identifiable training expense) ii. Goodwill-likelihood customers will return to place of old business; tendency of est. business to continue a. Self-Created Goodwill-advertising, good servicenondeductible b/c no basis so nothing to depreciate b. Purchased Goodwill-has a basis so depreciable b. Those not listed in §197(d) may still be amortizable-Make Argument! c. Those not amortizable listed in §197(e), such as financial int., land, computer software, int. in p‟ship/corp./trust, sport franchises, etc. 3. See also §1.167(a)-3-essentially same as above 9. Employee Business Expenses

1. Reimbursed Employee Business Expenses-Employees often incur expenses on employers work & employer will reimburse a. If employee reimbursed dollar for dollar by employee, IRS says: i. Employee-No tax effect ii. Employer-A business expense; like employer expended $ b. Above-the-line Deductions 2. Un-Reimbursed Employee Expenses-employee business expenses outside work of employer or incurred in good faith while working for employer a. Treated as miscellaneous itemized deductions; below-the-line deduction i. For t/p to get benefit of miscellaneous itemized deduction, the deduction must exceed 2% of adjusted gross income; §67(a) ii. For t/p to benefit, must elect to take itemized over standard deduction 3. Qualification Rule: the Carrying-On Rule-employee looking for new employment can deduct expenses if carrying-on business a. Once having entered into trade/business, being unemployed does not prevent one from being considered in a trade or business b. Factors to Consider: i. Prolonged length of time away from one‟s usual employment ii. Length of time one‟s been employed a. If searching for first job, no carrying-on iii. Field of sought-after employment a. If diff. field than previous employment, non-deductible b. If in same field, whether or not successful, deductible 10. Education Expenses Paid By Employer 1. Trade or Business Exp.-§162: Allows deduction for all ordinary and necessary business expenses paid or incurred in carrying on any trade or business, including reasonable allowance for salaries or other comp. for personal services actually rendered, traveling expenses while away from home in pursuit of trade or business, and rental payments for prop. 2. §274(m)(2): No deduction allowed for travel expenses as a form of education a. Designed to preclude lawyer on cruise for convention where 1 hr./day instruction occurs 3. 1.162-5(a)__: Expenditures made by individual for education…are deductible as ordinary & necessary business expense if education: a. (1): Maintains or improves skills required by individual in his employment or other trade or business or i. Ex. Coughlin-atty. in charge of firms tax prac. goes to tax class b. (2) Meets express requirements of individuals employer, or requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship i. Ex. Hill-high school teacher takes summer classes at college to renew teaching certification 4. §1.162-5(b): Education expenses incurred to meet min. edu. requirement of new trade/business non-deductible D. Deductions Related to For-Profit Non-Business Activities 1. Gen. Rule-§212: Deduction allowed for ordinary and necessary expenses paid 1) for production or collection of income, 2) with the management or holding of prop. that produces income, and 3) with the collection or computation of tax a. Origin from Higgins where wealthy investor was held not in trade/business so can‟t deduct expenses under §162 b. Rev. Rul. 64-236: For §212 deduction, expenditure must be proximately related to production or collection of income, etc. c. Origin of Claim Doctrine-character of expend. (i.e. whether its personal or business) is determined by looking at what gave rise to expenditure i. Legal Fees-can arise for part personal and in part to protect business of investment interests

a. If origin of claim personal, legal fees not deductible even if they also protect t/p business or investment interest i. Ex. Fleischman-H legal fees to contest prenup. validity not deductible as it wasn‟t under §212(2) to maintain prop., but origin of claim was person, i.e., to set aside prenup. b. §212(3) re: tax collection sometimes allows a t/p to deduct legal fees incurred in exchange for personal tax advice, even if tax advice given with respect to divorce 2. Limitation-§274(h)(7): No deduction allowed under §212 for expenses allocable to convention, seminar, or similar meeting 3. See 1.212-1(a) and (b)-same as §212; see also §1.212(d)-(o) E. Ubiquitous Deductions 1. Interest-Overt & Covert-and Time Value of Money A. Interest-payment for use or forbearance of money 1. Gen. Rule-§163(a): Deduction allowed for interest paid or accrued during taxable yr. (why no deduction for interest on credit cards, car loans, etc.) 2. Exception-§163(h)(1): Disallows, for individuals, a personal interest deduction a. §163(h)(2): Personal interest is interest other than: i. Business interest ii. Investment interest-§163(d) a. Invest. Int.-int. attributable to prop. held for investment b. Deduction from invest. int. lim. to t/p net investment inc i. Net invest. inc. = invest. inc. – deductions assoc. w/inc. c. Invest. int. lim. gets rolled over to next avail. tax yr. to where there‟s enough net invest. inc. to offset int. iii. Qualified Residence interest: a. Debt must be secured by Qualified Residence to be deductible b. Qualified Residence need not be principal residence of t/p, but qualifying indebtedness limited to max. of 2 residences and if there are 2 one must be t/p principal residence i. Term “qualified residence” broadly interpreted c. Any int. paid or accrued on two below is deductible: i. Acquisition Indebtedness-borrowing by t/p, proceeds of which used to buy new residence or to fix up residence you already own a. Limitation on Deduction-$1million limit based on loan principal ii. Home Equity Indebtedness-any loan secured by 1 of 2 qualifying residences a. Limitation on Deduction-$100k loan principal b. T/p can do anything wanted with loan proceeds! ***Encourages Home Ownership*** iv. Interest on Education Loans-§221: deduction allowed in amt. equal to int. paid on any qual. educational loan *Since these 4 aren‟t personal interest, deductible under §163(a)* 3. Rev. Rul. 69-188: Prepaid interest (prerequisite to obtaining borrowed capital) fully deductible in Year 1 if t/p pays from own source, but if t/p pays prepaid interest from borrowed monies, total amt. of prepaid interest amortized and deducted ratably over year of loan a. Ex. Loan processing fees (a.k.a. “points”) 4. Problems with Non-Computed Interest

a. Importance of Identifying Interest Component in Installment Sale i. Interest paid by taxpayer/buyer in sale is deductible ii. Seller/taxpayer has to include interest in gross income iii. To determine Basis = total purchase price – interest a. §163(b): In installment sale, if int. not stated its to be computed at to 6% unpaid purchase price b. §7872(a): Provides when person makes loan to another person with below- market or nointerest rate, the transaction will be re-characterized to impute interest payment from borrower to lender to ensure lender includes market rate in gross inc. i. Applicable Federal Rate (AFR)-interest determined by referring to interest rate of publicly traded securities ii. No $ actually changing hands; it‟s a constructive transfer of interest from borrower to lender and then a constructive payment of interest from lender to borrower iii. §7872 Re-characterizes Loan in accordance w/Economic Substance a. Gift loans-interest payments characterized as gift from lender to borrower i. Lender must recognize int. income under §61(a)(4) ii. Borrower entitled to interest deduction under §163(a) a. Borrower does not have to include in gross income thou b/c interest is a gift under 102(a) b. Gift Treatment Depends on if Loan Certain: i. Term loan-if loan due in less than 5 yrs. ii. Demand loan-lender can demand payment at any time iii. §7872 does not apply to gift loans if outstanding principal amt. for all loans doesn‟t exceed $10k b. Non-Gift Loans: i. Compensation loans-interest payments characterized as compensation if employment relationship ii. Dividend Loan-in corp./shareholder relationship interest payment is treated as a dividend iv. See also 1.7872-1-same idea as above B. Time Value of Money 1. TVM- what a dollar today, without regard to inflation, will be worth in future given an assumed interest rate a. Interest Rate-needed to determine present value of future payment a. Int. Rate often pegged to some economically acceptable int. rate 2. Issue arises with proper amt. of deduction to be allowed where a liability arises today in connection with a payment to be made in the future 2. Taxes 1. Gen. Rule-§164(a): The following taxes allowed as a deduction: a. State and local, and foreign, real prop. taxes b. State and local personal prop. taxes c. State and local, and foreign, income, war profits, and excess profit taxes d. The GST tax imposed on income distributions e. The environmental tax imposed by §59A 2. Noted Absences: Federal income tax; federal and state excise tax (watch for item deductible as §164 business exp., i.e., gas for car); non-income state or local taxes not dealing w/real prop. (watch for item deductible as ordinary and necessary business exp.) 3. §275: No deduction allowed for following taxes: fed. inc. tax; fed. war profits and excess profits taxes; estate inheritance legacy, succession and gift taxes; income war profits and excess profits taxes imposed by authority of any foreign county; taxes on real prop. 4. §164 taxes deductible only by person upon whom they are imposed (from Cramer) 3. Casualty Losses

1. Gen. Rule: §165(c)(3): Individual allowed to claim as deduction losses of prop. not connected with trade or business or transaction entered into for profit if such losses arise from fire, storm, shipwreck, or other casualty, or from theft a. Permitted only to extent not reimbursed by insurance or otherwise (§165(a)) 2. Rev. Rul. 63-232: Nature of casualty loss is that it must be quick, sudden, unexpected 3. Casualty loss doesn‟t result from mere decline in value of prop. in absence of physical damage to prop. (from Pulvers) 4. Merely losing an item of prop does not generate a casualty loss a. Theft must be proven by t/p (from Allen) 5. Timing of Losses: a. Casualty losses-deductible for yr. in which loss is sustained i. Either yr. of casualty or yr. amt. of loss ascertained, in case where full extent of loss was not or by its nature could not be known „til subsequent years b. Theft losses-deductible in yr. which theft is discovered i. If you deduct theft loss and later recover prop., include prop. recovered in subsequent yr. in gross inc. ii. If don‟t deduct theft loss and find prop., simply don‟t deduct 6. See 1.165-7(a)-same 7. See 1.165-7(b): Amt. deductible is equal to lesser of fmv immediately before casualty reduced by fmv of prop. immediately after casualty or amt. of adjusted basis for determ. loss from sale or disposition of prop. (§1011) 4. Charitable Contributions 1. Gen. Rule-§170(a): Deduction allowed for any charitable contribution made during taxable year 2. Definition of Charitable Contribution-§170(c): a contribution or gift to or for use of (list 1-5) a. Most common are: i. §170(c)(1): A state, possession of U.S., or any political subdivision of the foregoing, or of the U.S. or D.C., but only if contribution or gift made for exclusively public purposes ii. §170(c)(4): Exclusively, religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to kids or animals 3. Determination Letters-org. wanting to qualify as a charitable org. to get such letter from IRS to let donors know they‟ll get deduction if contributing to this org. a. Publication 78 lists all org. qualifying as deductible orgs. b. Tax-exempt org. isn‟t necessarily a §170(c) charitable org. 4. 3 Steps in Analysis for Deduction under §170: a. Contribution to or for use of a charity i. Contribution-voluntary transfer of money or prop. made without donor receiving anything of value a. If donor receives partial consideration (benefit) from charity, only excess amt. of cash over amt. of consideration receives qualifies as charitable deduction i. Donate $100, get $20 t-shirt, can only deduct $20 b. If donor receives full consideration from charity, no charitable deduction allowed b. Organization has to qualify under §170(c) c. Amt. of contribution has to be determined i. See (a)(i) above ii. Part-Gift/Part-Sale-if prop. other than cash transferred to charity for part consideration a. Treated like 2 simultaneous transfers: 1 sale, 1 gift b. IRS requires t/p to apportion basis to each part of transaction

i. Half basis goes to sale, other half of basis goes to giftpart to gift can be deducted under §170 iii. If contribution made in cash, amt. of contribution is donated $ iv. If prop. other than cash contributed, the fmv of prop. contributed is potential amt. of contribution a. If prop. has appreciated in value, amt. of contribution may have to be reduced by some/all amt. of built-in gain !NEED CLARIFICATION! 5. Charitable Contribution can only be made in Cash or Property a. Services-cannot deduct value of services as charitable contribution, but.. i. Un-reimbursed exp. incurred in relation to rendering charitable services may constitute a charitable deduction ii. If exp. incident to rendering charitable services are for travel, i.e. car, $.14/mile is deductible (deduction based on mileage) 6. Cap on Charitable Contributions-§170(b): Contributions in excess of any of ceilings in this § are permitted to be carried over to the five succeeding years F. Deductions Unique to Individuals 1. Medical Expenses 1. Gen. Rule: §213(a): Allows deduction for medical expenses paid or incurred by t/p for care of t/p or his spouse or dependents as long as not compensated by insurance or otherwise, to extent these expenses exceed 7.5% of AGI a. An itemized deduction i. T/p can chose to take either itemized or standardized deduction ii. T/p will chose the deduction which creates most benefit iii. Gen., for t/p to elect an itemized deduction, the amt. of aggregate itemized deductions is to exceed the amt. of standardized deduction b. §213(b): Amt. paid for medicine/drug deducible only if prescribed or insulin 2. Medical Care-lots of litigation over what constitutes medical care a. Defintion-§213(d)(1)(A)-(C): Expenditures for diagnosis, cure, relief, or treatment of disease or bodily malfunction, for medical insurance, and for transportation and lodging while seeking care i. Amt. of lodging not lavish or extravagant while away from home primarily for and essential to medical care treated as amts. paid for med. care if provided by dr. in hospital or similar facility and there‟s no personal pleasure or recreation in travel. a. Amt. not to exceed $50/night for each individual b. Expenses for permanent improvements of residence (or for equipment) may be medical expenses, if specifically necessary for treatment of medical condition, but only to the extent the cost of improvements exceeds the increase in the value of the property i. Ex. Gerard-t/p daughter sick; t/p installed air conditioner worth $1,300 upon recommendation of dr.; prop. value increased $800; diff. b/n 2 is deductible medical expense 3. See also §1.213-1(a)(1) and (e)(1)-essentially same as above 2. Expenses of Education Paid by Individual 1. Definition of Qualified Tuition-costs of enrollment or attendance at eligible educational institution of higher education for a student who is t/p or spouse or dependent of t/p 2. Gen. Rule-§222: Individual t/p allowed above-the-line deduction for qualified tuition and related expenses paid by t/p during taxable year 3. Limitations: a. §222(c)(1): No deduction allowed under §222 for any expense deducted under other § b. §222(b): Ceiling limitation on deductible amt. is limited or erased entirely based on AGI

i. In 2002-03: Max. deduction is $3000 ii. In 2004-05: Max. deduction is $4000 G. Limitations and Restrictions on Certain Deductions 1. Hobby Losses/Activities Not Engaged In For-Profit 1. Gen. Rule: §183: If activity engaged in by individual is not-for-profit, no deduction attributable to that activity is allowed except as allowed by this § a. Is activity engaged in for profit? i. b. §183(d): Creates presumption activity engaged in for-profit if in three or more of past five taxable years, gross income derived from activity exceeds deductions attributable to that activity ii. §183 applies if t/p runs an ordinary business activity with no intent to make profit b. Deduction Allowed-§183(b): No deduction allowed for aggregate expenses over and above income from business activity i. Ex. Aggregate expenses = $100k; Income = $20k; Amt. of loss of $80k is not deductible, but first $20k is deductible 2. Rental of Personal Residence 1. Gen. Rule-§280A: No deduction allowed w/ respect to use of dwelling unit which is used by taxpayer during taxable year as a residence a. If t/p owns rental prop. that‟s not used by t/p for personal purposes at any time during the taxable year, t/p entitled to deduct all exp. associated with prop. b/c its business activity b. §280A(b): Home mortgage interest & prop. tax expenses deductible without regard to use 2. Residence-§280A(d)(1): T/p uses dwelling unit as a residence if unit used for personal purposes for a no. of days which exceeds greater of 14 days or 10% no. of days during year unit is rented at fair rental -Vacation Homes a. If dwelling is not “residence,” §280A doesn‟t apply i. Then §183 determines deductibility b. If dwelling is “residence,” deduction allowed turns on # of days rented i. If residence rented for less than 15 days during taxable year, no deductions attributable to rental activity allowed, but neither is income derived from rental included in t/p gross income ii. If residence rented for 14+ days, can deduct amt. by which gross income derived from rental of prop. exceeds deductions allowable without respect to rental residence (Similar to §183(b)) -Offices-In-Home a. Gen. Rule-§280A(a): Generally denies t/p deductions for expenses attributable to the use of one‟s home for business purposes b. Exception-§280A(c): Deductions attributable to portion of home used exclusively and on a regular basis as principal place of business for any trade/business of t/p i. For employee, business use must be for convenience of his employer if a deduction is to be allowed ii. Principal Place of Business-includes home office used by t/p to conduct administrative or management activities of business if there‟s no other fixed location where t/p conducts such activities 3. Deductions Limited to Amount of Risk 1. Gen. Rule-§465(a)(a): Limits t/p deductible losses from specific business or investment activity to amt. t/p is personally at risk a. In other words, no deduction based on loss from borrowed monies b. §465(b)(1): “At-risk”-extent of cash and adjusted basis of other prop. t/p has contributed to activity, & amts. borrowed for use in activity on which t/p personally liable

i. §465(b)(2)-“Borrowed”: Amts for use in which t/p is personally liable for repayment or where t/p has pledged prop. (other than prop. used in activity) as security for borrowed amt. c. §465(a)(2): Any losses disallowed under §465 b/c they exceed amt. t/p is personally at risk, can be carried over to future years to be deducted when t/p increases amts. at risk (think of these amts. as being placed in a suspended account) d. Before §465, t/p could deduct their basis in activity which (as we know from Crane) includes non-recourse borrowing, i.e. borrowing you‟re not personally liable for i. Tax Shelters: Allowed t/p to deduct losses far in excess of amt. one was at risk in given activity which shelters income earned in other activities from tax liability a. Occurs often in limited partnerships! e. If when t/p disposes of business any loss carry-forward from §465(a)(2) is fully deductible 4. Passive Losses 1. Gen. Rule-§469: a. Applies to any individual, estate, trust, any closely held C corp., and any personal service corp.; See §469(a)(2) b. For above-mentioned, passive activity losses and credits are disallowed; See §469(a)(1) 2. §469(c)(1)Passive Activity Defined-any business or profit seeking activity in which taxpayerowner does not materially participate a. Ex. A limited partner in a limited partnership is not be actively, substantially, materially involved in operations of partnership! i. Interest in a limited partnership (other than a general partner) regarded as inherently passive ii. Rental activity also considered inherently passive 3. Passive activity losses can only be deducted from passive activity income a. Ex. It t/p has two passive activities and one has a loss and the other has positive income in the same taxable year, loss from one passive activity activity, but t/p cannot use passive activity losses to offset non-passive 4. §469(b): Any loss from an activity which is disallowed can be “suspended” and deducted in another year in which the t/p has passive activity income 5. §469(g)(1): Any disallowed losses under §469(a) are fully deductible when t/p sells her interest in the passive activity 5. Expenses Contra Bono Mores a. Gen. Rule: For person involved in illegal activity that generates income i. Income included in gross income, but… ii. Losses incurred in generating that income cannot be deducted b. §162(c)-No deduction allowed for illegal payments to any governmental employee or illegal bribes, kickbacks to other person c. §162(f)-No deduction for any fine or similar penalty paid to the government d. § 280E-no deduction for expenses in carrying on the trade or business trafficking in controlled substances e. § 162(g)-No deduction for 2/3rd‟s portion of antitrust damages attributable to punitive damages G. Personal Deductions and Dependency Exemptions a. Deductions: i. Above-the-Line Deductions-direct deductions from gross income to arrive at adjusted gross income ii. Below-the-Line Deductions a. Two Types: i. Itemized ii. Standardized

c. Taxpayer must choose standard or itemized deduction (a sensible taxpayer will chose the larger of the two) 1. From Adjusted Gross Income to Taxable Income a. CHART Gross Income §61 -Above the Line Deductions § 62 = Adjusted Gross income - Below the line deductions (Itemized or Standardized Deductions!) = Taxable Income * Tax Rate (as appears in Code Section 1 (select appropriate one given amt. of income) = Tentative Tax - Tax Credits = Tax -Withholding (an amt. may have been paid by employers, etc.} = Payment due OR credit owned 2. Standard Deduction a. A fixed figure b. Created to simplify tax returns by according individuals an election to deduct, subject to a ceiling, an amount equal to 10% of their adjusted gross income in lieu of some deductions otherwise to be itemized 3. Itemized Deductions a. Itemized-the sum of all itemized deductions allowed to t/p i. Preferred Itemized Deductions-not externally capped or limited ii. Miscellaneous Itemized Deductions a. Must be at least 2% of AGI to be deductible b. 2% Floor is aggregate (add up all miscellaneous itemized deductions) 4. Exemptions a. What are they? Subtractions from t/p adjusted gross income and may be taken in addition to itemized deductions or the standard deductions b. 2 Components of Exemptions: a. Personal Exemption b. Dependent Exemption *Items 2 – 3 Are Taxpayer Sensitive-not all taxpayers are entitled to all deductions 5. Tentative Tax a. Determined once taxable income is arrived at b. Only a 1st determination c. Has potential to be further adjusted by such things as i. Credit a. Reduces t/p‟s tax liability on dollar-for-dollar basis b. Direct offset against tentative tax c. Not a subtraction at arriving at taxable income ii. Withholding a. No withholding on non-sweat of brow income (dividends, rent, business activity) i. Means no taxes paid in advance b. T/p must estimate tax on income not subject to wage withholdings i. If do not pay in advance, t/p subject to penalty which is equivalent of interest ii. If t/p overpays, 2 options: a. Ask IRS to send refund check in amt. overpaid

b. If next year t/p expects to have income with no withholdings as to which you will have an estimated tax, ask service to apply overpayment to next year c. Offset against tentative tax IX. TIMING: WHEN TO REPORT INCOME AND CLAIM DEDUCTIONS A. Principles and Methods 1. Annual Accounting Concept: Principle that t/p reports all or his income and deductions on annual basis 2. Taxable Years-Each t/p has taxable year, either calendar or fiscal a. Calendar Year i. Begins January 1; Ends December 31 ii. Used by most taxpayers iii. The default rule for taxpayers with no books and records a. Books and Records-formalistic concept (not receipts kept in shoe box) b. Fiscal Year-taxable year other than calendar year beginning on 1st day of the month of any month but January i. Used most often by Businesses ii. Individual who operates business separate from personal affairs can have a different tax year and method of accounting for that separately identifiable business (need books and records of business) 3. Methods of Tax Accounting-determine in which taxable year items of income, gain, loss, deduction, or credit will be properly reported a. Cash Receipts and Disbursement Method-account for items of income in year items received (receipts in cash or cash equivalent) i. Default Method Unless T/P Chooses Other Method ii. T/p reports gross income when income received actually or constructively a. Income-Actual Receipt: T/p receives cash or other property and is usually easy to identifylook for inflow to t/p, in cash or property b. Income-Constructive Receipt: T/p in constructive receipt of amts. over which she has a legal claim, and which are available to t/p without substantial limitations or restrictions, regardless of whether item of income is received in taxable year *a. Look for t/p Power and Right to Receive! *b. T/p control over timing of payment is pivotal in deciding whether constrictive receipt c. Postponed Income-if t/p has arranged in advance to be paid in future, no constructive receipt i. Why? Under K, t/p has no right to receive until later year d. Cash Equivalents: i. Promissory Notes-yes if it‟s negotiable, drawn by solvent maker with good credit method, and is accepted by t/p as payment in full a. Unsecured promise note is not cash equivalent! ii. If item can be readily transferred to another person its cash equivalent e. Cash Equivalent has to be capable to being valued! i. Notes value will be determined on FMV iii. T/p claims deductions when he or she actually pays them by cash, check, or credit card NEED HELP FROM HERE DOWN!!! b. Accrual Method-focuses on „all-events‟ test for both income and deductions -Usually used by Businesses -Some business may be required to use accrual method-i.e. businesses with inventories -§461

i. T/p includes an amount in gross income when “all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy a. I.e., T/P accounts for items of income when entitled to receive the amount, whether or not amount actually received i. When RIGHT to received payment is fixed b. Creates Account Receivablea right to incomeit‟s form of property and thus has basis ii. T/p deducts liability when all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to liability a. I.e., T/P accounts for expenses/liabilities in year in which taxpayer is legally obligated to pay expense, whether or not amount actually paid b. Obligation to Pay Arises When Item of Expense is Found Fixed and Determinable i. When all contingencies or conditions on an OBLIGATION have been removed, it must be accrued as if it had been paid c. If expense (i.e. bill) mailed, receipt occurs when mail delivered to clientnot when he chooses to open it! So accrual in year of receipt iii. Under either (i) or (ii) above, Actual later payment of obligation is not pertinent to time of inclusion iii. Two General Tests for Accrual of Income and Expense: a. “All Events” Test-income becomes reportable when all events occurred that fix right to receive it i. Ex. of Not “All Events”: Security deposit not ripe as its not accruable in year one as contingency (apt. messed up) has to occur before landlord gets payment, but last months rent will be accrued in that year b. Reasonably Accuracy Test-amount involved can be determined with reasonable accuracy iv. DO NOT NEED TO ACCOUNT FOR ACTUAL PAYMENT IN LATER YEAR! v. WATCH: Payments less than bill (billor would have have deduction in amt. of loss in year payment received and billee would have gross income inclusion in year lessor payment deemed sufficient) B. Installment Sales 1. Installment Sale-one in which at least one payment of purchase price is received other than in year of sale 2. General Rule-§453: Seller‟s gain is included in gross income only as payments are received from buyer, thereby providing Seller liquidity to pay tax on gain i. Allows gain to be spread over payment period by requiring a percentage of each payment to be included in gross income in year of receipt ii. Determine percentage by applying to installment a fraction, the numerator of which is the overall gain on the sale of property, and the denominator of which is the total sales price 3. An elective provision-it applies unless t/p chooses for it not to apply i. Election made by way t/p reports the transaction on the return for year of sale ii. If entire gain reported, t/p considered to have elected out of §453 4. Available only to both cash and accrual method taxpayers 5. Installment Method Applies Only to Gain!

a. Does not apply to deductions! b. Does not apply to depreciation recapture gain that is treated as ordinary income under § 1245 or §1250 (i.e. when recapture property is sold at gain, recapture depreciation is all reported in year of sale, even though the sale qualifies for installment treatment under § 453-any recognized gain in excess of recaptured amount is subject to installment treatment) C. Tax Benefit Rule 1. With Tax Benefit Rule-t/p deducts an item or claims a credit, based on the facts as they existed in the year of deduction or credit, and in later year an event occurs which suggests that prior deduction was incorrect a. What happens when prior tax significant event has provided benefit to taxpayer in earlier year that is reported, but is reversed in a later year? 2. General Rule-§111: Reflects idea inclusion of recovery amount in gross income in only to the extent that t/p actually received a tax benefit from the prior treatment a. Ex. If t/p gets more benefit from standardized deduction than itemized, and in later year t/p receives reimbursement reimbursement is not includable in gross income as no benefit was received in earlier year from deduction as she used standardized instead of itemized deduction 3. Simply, §111 says if a later reversal of an earlier item of income or deduction, there is an inclusion in gross income only to extent t/p received a benefit in an earlier year a. TRIGGER FACT: commercial negotiation with rebate paid to client X. CHARACTERIZATION/RECHARACTERIZATION OF PROPERTY DISPOSITION GAIN OR LOSS A. Gain or Loss 1. Logistics 2. Capital Assets Described B. Quasi-Capital Assets: § 1231 C. Depreciation Recapture: § 1245, 1250

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