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Individual Income Tax

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					                              Individual Income Tax

I. Some Characteristics of Income

   A. Noncash benefits
      1. Meals and Lodging provided to EE
         a. Exclusion of Meals §119(a)(1)
            i. The value of meals furnished to an EE by her ER may be excluded
                from GI only if the meals are furnished on the business premises of the
                ER and if they are furnished for the convenience of the ER
                 Business premises: generally the place of employment of the EE;
                    the place where the EE carries on significant employment duties.
                    See Reg. §1.119-1(c)(1)
                 Convenience of the ER: substantial noncompensatory business
                    purpose for providing the meals and the meals are provided w/o
                    charge or a flat fee is charged, if the EE has a choice b/t accepting
                    the males and paying for them or of not paying and providing her
                    meals in another way, any which are furnished are not for the
                    convenience of the ER. See Reg. § 1.119-1(a)(3)(i)
            ii. Additional considerations
                 Cash allowances or reimbursements for meals are not included
                 Meals provided to the EE’s family are excluded if they meet the
                    above requirements as well
                 If lodging is excluded, the meals furnished on the business
                    premises is also excluded. See Reg. §1.119-1(a)(2)(i).
         b. Exclusion of Lodging
            i. Excluded if: furnished on the business premises, furnished for the
                convenience of the ER and the EE is required to accept the lodging as
                a condition of his employment. §119(a)(2).
                 Additional requirement that the EE be required to accept as a
                    condition of employment: this seems to mean that the EE by
                    required to accept the lodging in order to enable him to properly
                    perform the duties of his employment. See Reg. §1.119-1(b).
         c. Faculty housing is excluded § 119(d)
         d. Rental value of parsonages § 107
      2. Other Fringe Benefit Statutes See Reg. § 1.61-21 and § 1.132-1 to 8
         a. Group-term life insureance §79
         b. Contributions by ER to accident/health plans § 106
         c. Fringe benefits in general §132; 7 different categories
            i. No additional cost services
                 Of a type offered for sale to customers in the ordinary course of the
                    ER’s line of business in which the EE is performing services and
                    the ER incurs no substantial additional cost in providing the
                    service. § 132 (a)(1), (b); See Reg. § 1.132-2(b)




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         ii. Qualified EE discounts
               “qualified property or services” includes services or property
                  which are offered for sale by the ER to the nonemployee customers
                  in the ordinary course of the ER’s line of business in which the EE
                  works § 132(c)(1, 4)
               “EE discount” is the difference in the price of property or services
                  which are provided to the employees and the price at which the
                  same services are offered to customers §132 (c)(3)
               EE is only entitled to exclude an amount equal to the “gross profit
                  percentage” of the price at which the property is offered for sale to
                  the customers
         iii. Working condition fringe benefits
         iv. De minimis fringe benefits
         v. Qualified transportation fringe benefits
               B/t residence and place of employment: $60 per month for ER-
                  provided transportation in a commuter highway vehicle or for any
                  transit pass
               Qualified parking: $155 per month for parking at or near the ER’s
                  business
         vi. Qualified moving expenses
         vii. Athletic facilities
      d. Cafeteria plans §125
         i. See Reg. § 1.125-1
   3. Another Approach to valuation
      a. Benefits in the employment setting are usually either wholly excludable
         (as under §119 and 132) or lese included at their fair market value w/o
         regard to any argument that they were worth less to the TP
      b. Turner v. Commissioner adopts a different approach with respect to the
         valuation of tickets won on a quiz show.
         i. The court said that the TP did not have to include the full amount as
              GI, but must include an “appropriate value”
         ii. The amount is included upon receipt of the tickets

B. Imputed Income
   1. Property other than cash
      a. Owner-occupied housing: benefit is not taxed b/c of valuation problems
   2. Services
      a. Not taxed on benefit of services that you perform for yourself
      b. But are taxed on benefit of services that are received as part of an
          agreement to trade services. See Reg. § 1.161-2(d)(1)




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C. Windfalls and Gifts
   1. Punitive Damages
      a. Comm. V. Glenshaw Glass Co.
          i. Damages which compensate for losses are included in GI under
               §61(a)(2)
          ii. Damages which are punitive are also included in GI b/c §61 is a catch-
               all which covers money received from “any source”
          iii. See also Reg. §1.61-14(a)
   2. Gifts §102
      a. A “gift” is made if the trier of fact determines that the dominant reason for
          the transfer (transferor’s intention) was “out of affection, respect,
          admiration, charity or like impulses”
      b. §102(c): precludes gift treatment in the case of any transfer b/t EE and ER,
          except for “employee achievement’ awards which are accepted under
          §74 (c)
   3. Gifts: some applications
      a. Tips: included in GI on the theory that they are compensation for service.
          See Reg. § 1.61-2(a)(1)
      b. Payment to surviving spouse: can be considered a gift
      c. Prizes, awards and scholarships
          i. Prizes and awards = GI
                Some can be excluded if they are made primarily in recognition of
                   religious, charitable, etc. achievements and it is transferred by the
                   recipient w/o nay possession or use §74(b) and See Reg. §1.74-
                   1(b)
          ii. Scholarships and fellowships: §117
                Are considered GI unless provided for degree candidates for
                   tuition, fees, books, supplies and equipment
                Free room and board = GI
      d. Bequests
          i. Excluded under §102
      e. Welfare
          i. Excluded as not within the contemplation of §61
      f. Social Security
          i. EE pays taxes on his contributions when they are made, but not on
               those contributions made by ER
          ii. For amounts due, see §86 (based on total income)
      g. Alimony v. Gift
          i. Pmts are deductible by the payor and taxable to the recipient (child
               support and property are treated differently). See § 71 and 215




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   4. Transfer or unrealized gain by gift while the donor is alive
      a. Taft v. Bowers
         i. A buys stock for $1,000 and gives it to B when the FMV is $2,000; B
              then sells the stock in a later year for $5,000
         ii. B claims that he only owes tax on the appreciation while he owned the
              stock ($3,000)
         iii. Gov’t says that he owes tax on the total appreciation ($4,000)
         iv. Implications of the transaction:
               When A buys it for $1,000: no GI at that point and her basis is cost
                  (§1012)
               When the gift to B is made: no tax consequences for A; no
                  consequences to B when received b/c of §102; B’s basis is $2,000
                  b/c of §1015
               When B sells the stock: subtract basis from sale price and tax on
                  that amount
                   Look to §61: tax b/c it’s a disposition of property
                   Then to §1001(a) to determine amount of gain
                   Adjusted basis: §1016
                   If no adjusted basis: §1011
                   Amount realized is defined in §1001(b)
         v. As a general rule
               Use the donor basis, unless it was sold for a loss, then you use the
                  lesser of the FMV or the donor’s basis
   5. Transfers at Death
      a. Under §1014, the basis of property acquired by reason of death is the
         FMV on the date of death or at the election of the executor under §2032
         on the optional valuation date
      b. The effect is that the value of the property is either “stepped- up” or
         “stepped-down” at the date of death

D. Recovery of Capital
   1. Sales of Easements
      a. Inaja Land Co. v. Comm.
          i. TP paid $61,000 for land and then the gov’t paid him $50,000 to
               release off claims against them and grant an easement
          ii. The issue was whether or not this was a recovery of capital or GI
          iii. The court held that it was to be treated as a recovery of capital b/c it
               was an amount paid for damages and an easement and not for any lost
               profits
          iv. TP must apply this amount towards a reduction in the cost basis of the
               property §1016
   2. Life insurance
      a. §101(a) excludes from GI amounts paid under a LI policy by reason of
          death to the insured




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   3. Annuities and Pensions
      a. Look to Reg. 1.72-9 for tables on life expectancy
      b. §72: exclusion ratio which is applied to each payment until the initial
         investment is recovered
         i. equals the investment in the contract divided by the expected return
      c. Pensions
         i. ER contributions are not treated as part of EE’s investment
   4. Gains and losses from gambling
      a. All gains are taxable, but losses are only deductible only to offset gains
         from the same year §165
   5. Recovery of loss
      a. Clark v. Comm.
         i. TP paid $20,000 too much in taxes based on the advice of counsel
         ii. TP then sued counsel and recovered the amount of the overpayment
         iii. The gov’t said that this was payment of taxes by a 3 rd party and should
              be taxed
         iv. TP said that it was compensation for damages
         v. H: compensation for damages caused by negligence and not included
              in GI

E. Annual accounting and its consequences
   1. The use of hindsight
      a. Burnet v. Sanford
         i. Co. reported GI for 1913-1916 and included payments made under a
              contract
         ii. In 1915, work on the contract stopped and in 1916 suit for filed
         iii. Judgment in favor of TP was affirmed in 1920 and the TP was
              awarded money damages
         iv. The TP attempted to claim that the amount awarded was a recovery of
              loss and that the transaction was a loss as a whole
         v. H: taxes are imposed by year and not transaction so the amount
              awarded in 1920 was to be included in the GI for that year
      b. In response, §172 was adopted
         i. Allows carrying a loss 2 years back and 20 years forward




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   2. Claim of right
      a. North American Oil v. Burnet
          i. TP was awarded money in 1917, but the matter was not fully settled on
               appeal until 1922
          ii. H: report in 1917 when money was received under a claim of right and
               then report a deduction if later required to return that amount
      b. U.S. v. Lewis
          i. TP brought suit seeking refund of overpayment b/c he had reported an
               employee bonus as income and then later was forced to return part of
               the bonus
          ii. Gov’t says that he should just take a loss in the year that he repaid the
               money
          iii. H: for gov’t; TP received money under a claim of right and should
               therefore just take a deduction in the year that he repaid the money
          iv. Amended returns are generally only allowed to correct mistakes that
               should have been known or were known at the time that the return was
               filed
      c. Congress subsequently enacted §1341
          i. Start by taking a deduction in the year that the repayment is made;
          ii. But if that deduction exceeds $3,000, the tax is the lesser of the
               amount determined by claiming a deduction on the ordinary manner or
               by foregoing the deduction and claming a credit in the yea r of
               repayment for the tax that would have been saved by excluding the
               item in the earlier year
   3. Tax benefit rule
      a. TP claims a deduction in an earlier year and then in a later year the
          deducted amount is in some sense recovered
      b. Under §111:
          i. If a deduction did not reduce the TP liability for any year and any loss
               carryovers resulting from it have expired w/o being used, the recovery
               for the amount deducted need not be included in GI

F. Recovery for personal and business injuries
   1. Basic rules
      a. For TP other than individuals: damage awards for lost profits are taxed in
         the year received; same is true for punitive damages
         i. If award is for destroyed or damaged property: GI for that which
             exceeds basis in the property; this amount is deferred to the extent that
             it is reinvested in similar or related uses
      b. For individuals: awards are generally tax-free provided it is attributable to
         personal injuries §104; does not extend to punitive damages
         i. Individuals are still taxed on recovery for harm to property
   2. Deferred payments and structured settlements
      a. Interest in not included in GI either




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   3. Medical expenses and other recoveries and benefits
      a. Medical expenses are deductible only to the extent that they exceed 7.5%
         of AGI §213
      b. Recoveries under medical insurance are excluded §104(a)(3)
      c. If the ER pays premiums: the ER can deduct but EE doesn’t include in GI
         under §106/162 (the same is true under a reimbursement plan §105(b))

G. Transactions Involving Loans and “income from discharge of indebtedness”
   1. Loan proceeds are not income
      a. The rationale is that they don’t improve one’s condition b/c of the
          corresponding liability
   2. True discharge
      a. U.S. v. Kirby Lumber
          i. TP issued bonds and then purchased some back at an amount less than
               face value
          ii. Is the difference in price included in GI?
                Yes, it is an accession to income and is included under §61
          iii. For the purchaser of the bonds:
                They can claim a loss of the difference in the buy back amount and
                    the face value under §165(c)(2)
   3. Relief provision: §108
   4. Misconceived discharge theory
      a. Zarin v. Comm
          i. TP and casino settled lawsuit for $500,000 and the true amount of the
               debt incurred was $3,435,000
          ii. Gov’t said that the difference was GI
                Under §108, this was a discharge of indebtedness
          iii. Most courts would have agreed with the gov’t but this court apparently
               felt sorry for the TP b/c he put on evidence that he was a compulsive
               gambler and “couldn’t help it”, so they held for the TP and ruled that
               the difference did not have to be included in GI
                The court simply held that the amount that the TP and casino
                    settled for was the original amount of the debt
          iv. Court holds that there is a 2 prong test that must be met in order to fall
               under §108 (at least one must be met)
                Valid enforceable debt §108(a)(1)(A); or
                Debt subject to property §108(d)(1)(B)




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   b. Diedrich v. Comm.
      i. TP made gift of stock on the condition that the donee pay the gift tax
      ii. I: does this result in GI?
      iii. Tax liability for gift tax falls on donor under §2502 and an economic
           benefit is received if the donee pays it instead
      iv. H: it is GI to the extent that the gift tax paid by the donee is more than
           the donor’s AB of in the property
      v. Donee’s basis in the property is the cost paid or the amount of the gift
           tax (what they paid to get the property)
      vi. For donor
            Should treat it as a sale of stock for the amount of the gift tax that
               the donor paid
            Under §1001 this is the AR
            The gain is then the AR-AB
5. Transfers of Property subject to debt
   a. Crane v. Comm.
      i. TP inherited land with an unpaid mortgage balance of $262,042.50
            The FMV of the property was the same
            B/c of §1014: the FMV is the basis in the property
            Bt/ the years 1932 and 1938, the TP took deductions on the
               property totaling $25,000
            In 1938, TP sold the property for $2,500
      ii. The TP claimed that the only “property” that she owned was the equity
           in the land and that her AR was $2,500 and her AB was $0
      iii. The gov’t says that the basis was the FMV- the depreciation that
           should have been taken
            They claimed that the AR included the principal amount still owed
               on the mortgage
            The gain was therefore $23,502.90
      iv. Steps
            Unadjusted basis
                Basis is the FMV b/c of §1014
                Using only the equity in the property would permit a negative
                    basis in some cases
            Adjustments under §1016 and 1011
                Subject to physical exhaustion so depreciation permitted under
                    §167
            Amount realized §1001
                Should include the principal amount of the mortgage




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       b. Comm. v. Tufts
          i. I: must the value of the unpaid mortgage by included n AR if it
              exceeds FMV of property
          ii. TP took at a loan (nonrecourse) in the amount of $1,851,500 and the
              partners contributed $44,212
               Deductions were taken in the amount of $439,972
               AB= $1,455,740
                   (1,851,500 + 44,212) – 439,972
               Each partner then sold to Bayles
                   All reported a $55, 740 loss
               Gov’t says that they should have reported a $400,000 gain
                   Liability assumed – AB
               Rule: AR should include the mortgage amount even if it exceeds
                  the FMV of the property
                   Total amount realized: $1,851,500-$1,455,740

H. Illegal Income
   1. Rule: the fact that gain results for illegal income does not result in exclusion
       for GI
   2. Gilbert v. Comm.
       a. Gilbert directed that corporate funds be used to supply for margin call
       b. He intended to repay and executed a promissory note pledging personal
            assets to cover the debt
       c. When the deal fell through, the Co. claimed a loss of the amount of money
            that the TP had w/d from them and the TC held that the TP had GI based
            on the rule that an embezzler is considered to have GI
            i. Victim’s of embezzlement can deduct under §165
       d. This court held that this case was different b/c
            i. The TP had acknowledged an obligation to repay
            ii. It was done for the benefit of the company
            iii. Therefore, this is not GI

I. Interest on State and Municipal bonds
   1. basic concepts
       a. under §103, interest is exempt
       b. usually pay a lower rate of interest
       c. Concept of arbitrage §265

J. Gain on sale of a home
   1. Under §121, certain gains are excluded from GI
      a. Principal place of residence for at least 2 of the 5 preceding years
      b. Usually limited to $250,000 for single and $500,000 for joint
      c. Can’t be applied more than once every 2 years




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II.      Problems of Timing
      A. Constructive receipt and related doctrines
         1. Basic Principles
            a. Amend v. Comm.
                i. TP executed contract and delivered goods in Year 1, but received
                     payment and reported it in GI during Year 2
                ii. The gov’t says that the amount should be included in GI in Year 1 b/c
                     the TP could request payment/had right to demand payment then
                      Rule of constructive receipt: income is received or realized when it
                         is made subject to the will and control of the TP and can be except
                         for his own action or inaction educed to actual possession
                iii. TP says that he had no right to payment until Year 2 under the terms of
                     a valid contract
                iv. TC agrees with TP
                      No right to receive payment until Year 2 so no GI until then
            b. Rule now: §453(b)(1)
                i. Unless TP elected out, the rule would produce the same result
                ii. But under this section, if TP could have demanded payment in Year 1,
                     he would still be required to report it then regardless of when he
                     received it
            c. Pulsifer v. Comm.
                i. Dad purchased sweepstakes ticket in his name and the names of his 3
                     minor children
                ii. When he won, the money in the name of the children was put into a
                     bank account where it would become theirs at the age of 21 or if their
                     father made application in their behalf
                      Father made this application and was granted the money
                iii. The only question is WHEN must this amount be included in GI?
                      Under the economic benefit theory: taxable on the economic and
                         financial benefit derived from the absolute right to income in the
                         form of a fund which ahs been set aside for him in trust and is
                         beyond reach of PAYOR’S creditors
                          Here this occurred when the money was placed in the bank




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2. Retirement Benefits
   a. U.S. v. Drescher
       i. Co. purchased an annuity payable to TP and they deducted that amount
            from their taxes, but not the salary of the TP
       ii. Gov’t says that it is GI in the year of purchase under §61(a)
       iii. TP says that it is GI when payments are received
       iv. Court holds that it is GI when purchased b/c the EE received an
            economic benefit
       v. Problem of valuation
             Should be less than premium but more than zero
             But it could actually be worth more b/c of the security aspect
       vi. TP is treated as if he received the cash amount and used that to
            purchase an annuity
             B/c it is taxable when purchased, so portion of the payments
                 received will be excluded from GI
3. Deferred Compensation
   a. Minor v. U.S.
       i. TP entered into fee agreement with physicians corporation where a
            trust was established and deferred payments were to be made when
            certain conditions were met
       ii. TP reported as GI only the portion of the fees that he received and not
            what went into the trust account
       iii. Gov’t says that under the economic benefit doctrine he should report it
            all in the year that it was earned
       iv. Gov’t concedes that the doctrine of constructive receipt does not
            apply; see Reg. §1.451-2(a)
       v. Court holds that the economic benefit doctrine doesn’t apply either b/c
             The trust assets are still subject to the creditors of the payor
             B/c the corporation is settlor and beneficiary, the trust is
                 unfounded and results in no taxable benefits
   b. Al-Hakim v. Comm.
       i. TP negotiated a contract with a team for his client
       ii. Fee was to be paid in 10 years and they structured a deal where the
            client made a loan to the TP in the full amount of the fee and then
            payments due were credited against the loan
       iii. Court held that it was a valid loan agreement
       iv. Now under §7872 this would be treated differently
   c. Comm. v. Olmsted
       i. Life insurance agent negotiated new contract that provided a different
            fee arrangement
       ii. Gov’t said that the FMV of the new contract should be included in GI
            b/c it was a disposition of property
             Under the new contract the TP gave up or disposed of his rights to
                 renewal commissions
       iii. Court held that it was a restructuring of the contract and not a
            disposition within the meaning of §1001


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4. Qualified EE plans
   a. EE is not taxed until receipt of money
   b. ER can take a deduction upon payment to fund
   c. Look at §162, 404, 501 and 72
5. Stock options, restricted property and other employment compensation
   a. Stock options are included, it’s just a matter of when to include them
   b. 3 ways to determine when its included:
      i. upon receipt of option
            TP treated as if cash was received in this year (FMV of option) and
                that cash was used to purchase the option
            The ER gets a deduction in this year
            Upon exercise of option, no more GI and FMV (from year 1) is
                added to the amount actually paid for the stock in the year
                exercised; this equals the basis in the stock
            This basis is used to determine the gain/loss when the stock in sold
      ii. upon exercise of option
            no tax consequences in the year the option is granted
            Treated as receiving cash when the option is exercised; amount is
                the difference b/t the stock price and the option price at the time
            The ER gets a deduction in that same amount
      iii. upon sale of option
            no tax consequences in the year it is granted nor in the year that it
                is exercised
            The gain/loss is included in GI when the stock is sold for more/less
                than the exercise price.
   c. Look at §442, 83, 422, and 1014 (steps up basis)
   d. Cramer v. Commissioner
      i. EE was given stock options that had vesting and transfer requirements
      ii. When he received them, they had a FMV of $50/share; the company
           was later bought out and he got $163/share for them
      iii. I: is this compensation (taxable at 39.6%) or long-term capital gain
           (taxable at 20%)?
      iv. Under §83, it must have a readily ascertainable value and this stock
           did not so it is compensation
      v. See Reg. 1.83-7(b)(2).




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B. Transfers incident to marriage and divorce
   1. Property settlements
      a. Transfers incident to divorce and separation
          i. U.S. v. Davis
                H agreed to transfer to W 1,000 shares of stock as part of
                  settlement
                Was the transfer a taxable event?
                   TP says that this is a non-taxable division b/t 2 co-owners
                   Gov’t says it is the transfer in settlement of independent legal
                       obligation
                   Gov’t wins on this point b/c W is not a co-owner b/c she is
                       only entitled to settlement that is “reasonable” not ½ of the
                       property (Event is taxable)
                What is the amount of taxable gain?
                   Property received was the release of W’s marital rights
                   These rights are judged to be of equal value with the property
                       that they exchanged for them
                   The market value is AR by H and the tax basis in the property
                       for W
          ii. Now look to §1041
                No gain or lass hall be recognized on transfers of property b/t
                  spouses or incident to divorce
      b. Antenupital Settlements
          i. Faria-Es-Sultaneh v. Commissioner
                TP received stock worth $800,000 prior to marriage
                The pre- nup called it a gift
                At the time of the transfer
                   Donor’s basis was $.15 and the FMV was 10
                TP later sold the stock for $19/share
                Gov’t said the donor’s basis should be used to calculate gain/loss
                  b/c it was a gift (§1015)
                Court says that b/c it was contingent, this was actually a
                  “purchase” of the stock and that the basis for the TP would be cost
                   Since the transfer was for the relinquishment of rights, the
                       FMV at the time of the transfer is presumably the value of what
                       was given up by the TP, so this is the cost
                   Basis is therefore $10
                This case was decided before §1041, but this transfer was made
                  prior to marriage, so it probably won’t apply anyway




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2. Alimony, child support and property settlements
   a. Basic scheme
      i. Certain pmts received by payee are taxable under §71 and are
           deductible by the payor under §215
      ii. Child support payments are neither deductible from nor included in GI
   b. Rules
      i. Alimony payments must meet certain conditions to qualify
            Must be in cash
            Received under “instrument” of divorce or separate maintenance
               (no oral agreements and no unmarried couples)
            Parties must not agree to the contrary
            Parties must not be members of the same household
            Payments must stop at death of payee
            Payments must not be for child support
            Must be roughly equal for the first 3 years
                Payments can’t be front- loaded
                If the payment in the first year exceeds the average of the 2nd
                   and 3rd year by $15,000: the excess is not alimony
                   a. Formula:
                       i.       Excess Alimony Payments (EAP) = EP for 1 st post-
                            separation year + the EP for the 2nd post-separation year
                       ii.      EP for 1 st post-separation year = Pmt. made –
                            [{(Pmt. made in 2nd year – EP for 2nd year) + Pmt. made
                            in 3rd year}/2] + $15,000
                       iii.     EP for 2nd post-separation year = Pmt. made – (Pmt.
                            made in 3rd year + $15,000)
3. Child support obligations in default
   a. Diez-Arguelles v. Commissioner
      i. TP ex-H owed her $4,325 in back child support in 1978 and $3,000 for
           1979
      ii. The TP treated the $4,325 as a non-business bad debt and deducted it
           as a short-term capital loss under § 166(d)
      iii. TP claimed that the “out-of-pocket” expenses in excess of the support
           she was provided served as the basis in the property
      iv. H: for the gov’t; no deduction allowed.




                                     14
III.      Personal deductions, exemptions and credits
       A. Introduction
          1. Mechanics of personal deductions
              a. Assorted itemized deductions (benefits are phased out as AGI rises §68)
                 i. Casualty losses
                 ii. Medical expenses
                 iii. Charitable donations
                 iv. Interest
                 v. State and local taxes
                 vi. Alimony
              b. Or you can choose to give up itemized deductions and take a standard
                 deduction instead
                 i. §63 lists standard deduction amounts
              c. In addition to itemized/standard deductions, TP can also take a personal
                 exemption
                 i. §151
                 ii. benefits of this are phased out as AGI rises above certain threshold
                      amounts

       B. Casualty Loss          §165(c)(3)
          1. Limited to losses that in the aggregate exceed 10% of AGI after a reduction by
             $100 “floor” for each individual
          2. Dyer v. Commissioner
             a. TP claimed a casualty loss for a vase which was broken by his cat
             b. Insurance had refused to cover the loss of the vase
             c. The term “other casualty” loss in the statute should be construed to mean
                 losses similar to losses caused by fire, shipwreck and storm
             d. H: for gov’t; no deduction allowed
          3. Blackman v. Commissioner
             a. TP intentionally set fire to home but was never actually found guilty in a
                 court of law
             b. He tried to claim a $97,853 casualty loss deduction for the loss of the
                 house
             c. Gov’t claimed that allowing a deduction would be against public policy
             d. H: gross negligence on the part of the TP will bar any deduction; found for
                 gov’t and no deduction is allowed here b/c TP was grossly negligent




                                              15
C. Extraordinary medical expenses          §213(a)
   1. Overview
      a. Deductible to the extent that the exceed 7.5% of AGI
   2. What is “medical care”? §213(e)
      a. Taylor v. Commissioner
          i. TP was instructed by his doctor not to mow his lawn b/c of his
               allergies
          ii. He spent $178 to have his lawn mowed and claimed a medical expense
               deduction
          iii. Gov’t says that this is a non-deductable personal expense under §262
               and not a medical expense
          iv. H: for gov’t, TP did not carry burden of proof to establish that lawn
               services were a necessary medical expense
      b. Ochs v. Commissioner
          i. TP sent his kids to boarding school b/c of his wife’s medical condition
          ii. Tried to claim a medical expense deduction for the cost
          iii. Gov’t disallowed and said that it was a personal expense under §262
          iv. H: for gov’t; no deduction
      c. Expenses for elevators, pools, etc. are currently deductible if they are
          necessitated by illness, though only to the extent that they do not add to
          the value of the house

D. Charitable contributions
   1. Overview           §170
      a. Individuals and corporations can claim deductions for any contribution
          made to charity, payment of which is made during the taxable year
      b. Section 170 limits allowable deductions for individuals for gifts made to
          churches, educational organizations, medical institutions and certain
          publicly supported organizations as listed in §170(b)(1) to 50% of the TP
          “contribution base” (generally AGI)
      c. Other deductions are limited to 30% of AGI
      d. Corporations are limited to 10% of AGI but can carryover excess for 5
          years
   2. Contributions of capital gain property
      a. If property would produce long term capital gain, the deduction is limited
          to the FMV of the property
      b. If short-term capital gain, the TP’s basis in the property can be deducted




                                       16
         3. Gifts with Private objectives or benefits
            a. Ottawa Silica Co. v. United States
                i. TP donated land to school district and claimed a deduction of
                     $415,000
                ii. With the contribution however, the TP also received the benefit of
                     having roads and other improvements added which increased the value
                     of property that they still had
                iii. Gov’t said:
                      No deduction b/c of benefits
                iv. Rule: if the donation is not made exclusively for public purposes (i.e.,
                     the donor receives a substantial benefit in return), then there can be no
                     deduction
                v. H: no deduction; TP can add the value of the property given the basis
                     of the remaining property


IV.      Allowances for mixed personal and business outlays
      A. Controlling abuses of business deductions
         1. Hobby losses
             a. Nickerson v. Commissioner
                i. TP bought farm for $40,000 and 10 acres for $10,000
                ii. Farm was in poor condition and TP hired a tenant farmer to work the
                     land
                iii. TP intended to move to the farm in several years when he retired
                iv. TP claimed losses under §162
                      Gov’t said that it was not allowed b/c of the limitation in §183 that
                         deductions are not allowed if the activity is not for profit
                v. The court here said that it was sufficient if the TP could show that he
                     had a reasonable expectation of making a profit
                      TEST: primary purpose
                vi. Limitations now in Code
                      §469: limits deductions from passive activity to losses which offset
                         gains from other passive activity and
                      Look at Reg.
                          1.469-5T
                          1.183-2(b)
                          1.183-2(a)
         2. Home offices and Vacation homes
             a. §280A begins by denying all deductions and then lists specific exceptions
                which are deductible
                i. Start by looking at §162: does it qualify under this section?
                ii. If yes, then look to §280A
             b. In General for deductions:
                i. Business §162
                ii. Individual §212
                iii. Personal 262


                                              17
3. Income unconnected to trade/business
   a. Moller v. United States
       i. TP relied on income from investments to live and managed these
            investments 40+ hours a week
       ii. I: was this activity a “trade or business” so that the TP could deduct
            the expenses of his home office under §280A?
       iii. In order to qualify for the deductions, the TP must be engaged in a
            trade or business as defined in §162 (even if the activity is for the
            production of income as defined in §212)
       iv. The court held that since the TP was an investor who was interested in
            the long term production of the stocks, he was not in a trade or
            business and the deductions were therefore denied
   b. Whitten v. Commissioner
       i. TP won cash and prizes on a game show
       ii. He claimed a deduction for the amounts that he spent while attending
            the taping of the show (claimed them as losses from gambling which
            can be offset against gains from gambling)
       iii. Court says that this is not a gambling loss but is eligible for deduction
            under §67 if it meets the other requirements (here the TP did not)
             Total amount of deductions under this section must exceed 2% of
                AGI in order to receive any deduction (if not more than 2%, you
                lose it all).
4. Office decoration
   a. Henderson v. Commissioner
       i. TP purchased a print and a plant for her office and ded ucted them
            under §162(a) as ordinary and necessary business expenses
       ii. Court held that these were non deductible personal expenses under
            §262
5. Automobiles, computers and other listed property
   a. Where listed property is under 50% or less for business purposes,
       depreciation is limited to straight-line using the normal useful life
   b. Business use requirement in only met if the use is “for the convenience of
       the ER and required as a condition of employment”




                                     18
B. Travel and Entertainment expenses
   1. Question Presented
      a. Rudolph v. United States
          i. ER paid for trip to NYC for EE and wife
          ii. Gov’t claimed that this was GI
          iii. Court found that the “primary purpose” of the trip was pleasure and
               therefore it should be included in GI
   2. §274
      a. includes requirements of §162 and imposes additional requirements for
          travel and entertainment
      b. Requirements
          i. “directly related” to business
          ii. limited to 50% of the cost of meals and entertainment
          iii. no spousal deduction unless: spouse is an EE of person claiming
               deduction, there was a bona fide business purpose and additional
               expenses would be deductible
          iv. some expenses must be substantiated; see Reg. §1.274-5T
   3. Business lunches
      a. Moss v. Commissioner
          i. TP attempted to deduct the cost of meals when he and other partners in
               the firm met and had lunch everyday to discuss cases; used §162
          ii. Court would not allow b/c under §262, this was a personal expense
                no “business objective” (no benefit to the firm b/c not w/client)
   4. More on entertaining customers
      a. Danville Plywood Corp. v. Commissioner
          i. EE took deduction for trip to the Super Bowl b/c he said that they were
               entertaining clients there
          ii. In order to be deductible, an entertainment expense must:
                Be ordinary and necessary business expense under;
                    Must be “common and accepted” in the community and
                    Appropriate for the development of the business
                Be “directly related to” or “associated with” the active conduct of
                   the TP business

C. Child care expenses
   1. Smith v. Commissioner
      a. TP wanted to deduct the cost of babysitting services
      b. They claimed that “but for” the cost of the sitter , the wife would not be
          able to work and pursue gainful employment
      c. Court disallowed the deduction on the grounds that it was a personal
          expense
   2. But now see §21
      a. Allows a tax credit for child care
      b. Credit is a percentage of the amount spent up to $2,400 or $4,800.




                                        19
D. Commuting Expenses
   1. Commissioner v. Flowers
      a. TP worked for a company whose office was in Mobile and he chose to live
         in Jackson
      b. ER allowed him to remain in Jackson and work in Mobile on the condition
         that he pay all of his expenses in traveling back and forth
      c. TP claimed a deduction for meals, hotels and travel from Jackson to
         Mobile on his tax return
      d. The court held that before the deduction could be allowed, it must satisfy a
         three prong test (See Reg. §1.162-2(e) and 1.162-1(b)(5))
         i. Reasonable and necessary
         ii. Incurred while “away from home”
         iii. Incurred in the pursuit of business and necessary and appropriate
      e. Rule: Travel expenses in the pursuit of business can only arise w/in the
         meaning of §162 if the business forced the TP to travel and to live
         temporarily at some place other than his home
   2. Hantzis v. Commissioner
      a. TP lived in Boston and worked for the summer in NYC
      b. She attempted to deduct the cost of living, transportation and meals while
         in NYC
      c. Court denied the deductions b/c:
         i. Not incurred away from home b/c only personal reasons forced her to
              keep 2 homes; therefore NYC was her home for purposes of §162
               Must establish a business connection to “home” and temporary
                  location or it becomes the “home”
   3. Rev. Ruling 94-47
      a. Holding:
         i. Daily transportation expenses incurred in going b/t a TP residence and
              work location are nondeductible commuting expenses
         ii. 3 exceptions
               can deduct expenses to a temporary work location outside the
                  metropolitan area
               if TP has one or more regular work sites, the cost of traveling b/t
                  residence and a temporary work location in the same trade or
                  business is deductible
               if TP residence is the principal place of business w/in the meaning
                  of §280A(c)(1)(A) then deductions are allowed for travel to any
                  other work site




                                       20
E. Clothing expenses
   1. Pevsner v. Commissioner
      a. TP claimed deduction for clothes purchased for work
      b. Court disallowed the deduction b/c the clothes could be worn outside of
          work (even though this TP stated that she never did)
      c. Rule: Cost of clothing is deductible only if:
          i. Clothing is of a type specifically required as a condition of
               employment
          ii. It is not adaptable to general usage as ordinary clothing
          iii. It is not worn as personal clothing
      d. Under §162, this can be deducted as a cost, but b/c of §262, no deduction
          is allowed

F. Legal Expenses
   1. United States v. Gilmore
      a. H incurred legal expenses in attempting to fight property settlement during
          divorce
      b. He claimed a deduction as the cost of conserving property under §212(2)
      c. H: in order to fall under §212, the nature of the claim must arise in
          connection with profit seeking activities
          i. §212 provides for deductions in that are ordinary and necessary to
              conserve property
      d. In this case the need for conservation arose out of a personal relationship,
          not one for profit seeking

G. Expenses of Education
   1. Carroll v. Commissioner
      a. TP attempted to deduct the cost of college classes under §162 as an
         expense “relative to improving job skills to maintain his position as a
         detective”
      b. Under Reg. §1.162-5, the test for determining whether the cost of
         education may be deducted is:
         i. Whether the education maintains or improves skills REQUIRED for
             the job
      c. In this case, the TP was not allowed a deduction b/c the courses were too
         general and were therefore properly classified as personal expenses falling
         under §262 (no deduction)




                                       21
V.      Deductions for the cost of earning income
     A. Current expenses v. Capital expenditures
        1. Encyclopedia Britannica v. Commissioner
           a. TP paid company to develop a manuscript and deducted that amount under
               §162 as a cost of doing business
           b. I: was this an expense that was deductible under §162 or a CAPITAL
               expenditure which is not deductible all at once under §263
           c. Court held that b/c the payments were identified with a specific tangible
               asset they were capital expenditures which should be deducted over the
               useful life of the product
               i. Court also noted that the payments were not “normal and reoccurring”
        2. Revenue Ruling 85-82
           a. TP wanted deduction for payment for land that he purchased which
               already had crops growing on it
           b. H: no deduction under Reg. §1.162-12(a) except for the purchase of young
               seeds and plants
           c. Even though the price of the land arguably included the previous owners
               cost for these things, the purchaser is not allowed a deduction

     B. Repair and Maintenance Expenses
        1. Midland Empire Packing Co. v. Commissioner
           a. TP paid to have cement lining put in basement to keep it from leaking oil
               and attempted to take a deduction as “ordinary and necessary” under §162
           b. Gov’t says: capital improvement which is recoverable only through
               depreciation
           c. Court held that it was a repair and was ordinary and necessary so it is
               deductible under §162
               i. This was even though the repair made the property more useful
           d. See Reg. §1.461-1(a)
        2. Revenue Ruling 94-38
           a. TP replaced contaminated soil and built a water treatment facility
           b. Attempted to deduct both as §162 as ordinary and necessary costs of doing
               business
           c. H: the cost of replacing the soil could be presently deducted, but the water
               treatment facility had a longer useful life and must be deducted over that
               period
               i. The cost of replacing the soil is a repair under §162 and not a capital
                   expense under §263
        3. Norwest Corp. v. Commissioner
           a. TP removed asbestos during a remodeling project and claimed deduction
               as ordinary and necessary under §162
           b. Gov’t says that this was a general plan of rehabilitation and the expe nses
               must be capitalized under §263
               i. Under Reg. §1.162-2, remodeling must be capitalized over 39 years
               ii. §263 requires capitalization of all costs incurred to
                    adapt property to new use



                                            22
                 prolong life of property
                 add value to property
       c. H: “but for” renovation no removal would have been necessary so it must
           be capitalized as part of the renovation
C. Inventory accounting
   1. Used to match cost with revenues
   2. Includes all finished or partly finished goods and those raw materials and
       supplies acquired for sale or that will becomes part of merchandise intended
       for sale
       a. See Reg. §1.471
       b. Gross profit = COGS-Gross Receipts
   3. Cost of goods sold
       a. (BI + cost of goods purchased or produced) – inventory still on hand
   4. Valuation of inventory
       a. Cost Reg. §1.471-3
       b. Cost or market whichever is lower Reg. §1.471-4
   5. Inventory cost
       a. FIFO is the general rule
           i. Use of cost valuation and FIFO often produces the closest picture of
                what is actually going on
       b. Under LIFO, only the cost valuation method is permitted

D. Rent payment v. installment payment
   1. Starr’s Estate v. Commissioner
      a. TP had contract for rental payments of sprinkler system
          i. Provided for payments during first 5 years and then renewal payments
              of $35 per year for 5 years after that
      b. Contract was structured to be a purchase agreement disguised as rental
          i. TP attempted to take a deduction for rental payments under §162(a)(3)
      c. Court held that this was really just an installment contract and not a rental
          agreement
          i. This was a capital expenditure so depreciation must be taken over the
              useful life of the system
          ii. In addition the TP could deduct a portion of the contract payments as
              interest on the contract
               Normal selling price of the system was $4960 and under the
                  contract the TP paid $6200, so the difference was interest

E. Goodwill and other assets
   1. Welch v. Helvering
      a. TP decided to pay debts of his company to help reestablish goodwill with
         customers after filing for bankruptcy
      b. He attempted to claim them as a deduction under §162
      c. Gov’t said that these were not ordinary or necessary business expenses
         and were capital expenditures which were made in attempt to establish
         goodwill


                                        23
      d. H: for gov’t
         i. Not an ordinary expense
         ii. Produced benefits beyond the current tax year so it was a capital
              expense
   2. Goodwill in general
      a. Amounts paid for goodwill are recoverable only upon the sa le or
         disposition of the business
      b. §197 provides for a 15 amortization of goodwill acquired through
         purchase
   3. Education
      a. Reg. §1.162-5 adopts an objective test for determining whether it is a
         capital or current expense
      b. If already qualified to practice a profession, 2 types of education expenses
         are allowed
         i. Education that “maintains or improves skills”
         ii. Education that is “expressly required by ER or by law”
      c. Under Reg. §1.212-1(f), expenses incurred to in seeking employment or in
         placing oneself in a position to begin rendering personal services for
         compensation are not deductible under §212
      d. Busniess expenses of EE, including the cost of employment related
         education, can be deducted only to the extent that in the aggregate they
         exceed 2% of AGI (see §67)


F. Ordinary and necessary
   1. Extraordinary behavior
      a. Gilliam v. Commissioner
          i. TP was traveling to teach at another school and took medication before
               leaving
          ii. On the plane, he began acting strangely and attacked another
               passenger
          iii. He attempted to claim a deduction for the expenses paid in settling the
               lawsuit arising from this incident
                Claimed under §162 as an expense arising out of a business trip
          iv. Test for deduction under §162
                Ordinary
                Necessary
                Expense of carrying on a trade or business
          v. H: for gov’t, no deduction
                Not ordinary
                Activities not directly related to the trade or business
   2. Reasonable compensation
      a. §162(a)(1) provides for a deduction for “reasonable salaries and other
          compensation for personal services”
      b. The section has been used mostly to disallow deductions for salaries
          thought to be unreasonable


                                        24
     3. Costs for illegal or unethical activities
        a. §162 (c), (f), and (g)
           i. flatly prohibit any deduction for fines or similar penalty paid to a gov’t
                for violation of any law
        b. Stephens v. Commissioner
           i. TP claimed a deduction for payment of restitution under §165(c)(2),
                which covers deductions for losses for activities entered into for profit
           ii. Gov’t claimed that TP’s restitution was punitive as well and that there
                should be no deduction allowed
           iii. I: would allowing a deduction frustrate public policy
                 Since this does not fall under the specific things stated in the
                    statue, it would not violate public policy

  G. Depreciation and the investment credit
     1. General principles
        a. Any depreciation system revolves around the spreading or allocation of
            cost over time and has 3 elements
            i. Determination of useful life
            ii. Taking account of salvage value
            iii. The application of a method of allocating the cost, in excess of salvage
                 value over useful life
        b. Under the straightline method, an equal portion of the total cost of the
            asset is allocated to each year
        c. Depreication is allowed by §167
            i. Not allowed for personal property
        d. Tangible property is covered under §168
            i. The tables for useful life are on p. 1740-1741
        e. Intangible property is covered under §197
            i. Usually use 15 years as useful life

Note: the class notes from 06-28-01 have important examples


  H. Depletion and intangible drilling costs
     1. look at §611, 613(b) and (c)




                                          25
VI.      The splitting of income
      A. Income from services: diversion by private agreement
         1. Lucas v. Earl (general rule)
             a. TP had contract with W to split all income 50%
             b. TP claimed only ½ of the total GI that he earned and W claimed the other
                half (this was before filing joint returns was permitted)
             c. H: GI is taxable to the person who earned it
                i. Can’t attribute fruits to a different tree than which they grow
             d. Note however that there is an exception for partnership agreements
             e. This case was a bad case from the standpoint that the TP was not trying to
                avoid taxes (contract was made before there was even an income tax
                imposed), he was just trying to provide for his spouse

      B. Income from services: diversion by operation of law
         1. Poe v. Seaborn
             a. H and W live in a community property state and they filed separate tax
                 returns and each claimed ½ of their property
             b. Gov’t claims that all the property should be claimed by H b/c he controls
                 all the property
             c. H: since both H and W have a vested ½ interest in the property, it is proper
                 for each of them to report ½ of it as GI
                 i. This is different than diversion by agreement b/c by law the property
                      never belonged to H, it belongs to the community
         2. This case resulted in the adoption of a joint return system and different tax
             rates for married persons filing separate returns

      C. Income from services: more on diversion by private agreement
         1. Armantrout v. Commissioner
             a. TP received salary and had the option of having money contributed to a
                college savings plan for kids through ER
             b. Gov’t claimed that the amounts contributed should be included in GI b/c
                they were made based solely on the employment relationship
             c. H: payments were “generated” by services performed and are therefore
                compensation which is included in GI based on §83 (property transferred
                in connection with services performed)
                i. Selection for the program was based on EE performance
                ii. Really just a way to divert earnings to education of child
         2. Note
             a. Services
                i. Taxed by earner
             b. Property
                i. Taxed to owner




                                             26
D. Transfers of Property and income from property
   1. Blair v. Commissioner
      a. TP assigned the right to receive income from a trust to his children and
          claimed that they should be taxed, not him
      b. Gov’t said that TP was still taxable
      c. H: for TP b/c a complete transfer of all rights was made and therefore the
          children were the beneficiaries
          i. Note that this is different than assigning the income year to year. In
              that case, the TP would have maintained an interest in the trust and it
              would still be taxable to him
   2. Helvering v. Horst
      a. TP detached interest coupons from bond and gave them to his son to cash
          in upon maturity
      b. TP claimed that GI was taxable to his son who actually received the
          benefit of the coupons
      c. Gov’t said:
          i. Taxable to the donor
          ii. TP still derives worth/benefit from the coupons by giving the proceeds
              to the son
      d. H: for gov’t
          i. TP must include amount of coupons in GI b/c he realized the benefit of
              the income

E. Services transformed into property
   1. Helvering v. Eubank
      a. TP assigned right to receive renewal commissions to agency in
          termination of his contract
      b. Gov’t said:
          i. He should include the amounts in GI
      c. H: for gov’t
          i. Based on reasoning in Horst
          ii. Assignor received benefit of commissions and should therefore pay
               taxes even though the money was never actually received by him
   2. Heim v. Fitzpatrick
      a. TP assigned to various family members the royalty payments from a
          patent
      b. TP claims that this is a transfer of income producing property under Blair
          and therefore, the family members should pay all taxes
      c. H: for TP
          i. Rights assigned were more than just to money, so it was an assignment
               of income producing property




                                       27
VII. Capital Gains and Losses
    A. Background
       1. Taxation is divided b/t OI and CG
       2. CG is divided into LTCG (assets held for more than 1 year) and STCG (assets
          held for 1 year or less) §1222
       3. Maximum tax rate for LTCG is 20%, but there are different rates for different
          assets

   B. Statutory Framework
      1. CG/CL arises from the “sale or exchange of a capital assets) §1222
          a. Must meet both elements
              i. Sale or exchange; and
              ii. Capital asset
      2. Capital asset is defined as:
          a. All property with 5 specific exceptions which are non-capital assets
              i. Inventory/stock in trade, of a business and property held primarily for
                   sale to customers in the ordinary course of a trade or business
              ii. Real property or depreciable property used in a trade or business
              iii. Copyrights and similar property held by their creators (not those
                   purchased by others0
              iv. Accounts receivable acquired in the ordinary course of a trade or
                   business; or
              v. U.S. gov’t publications held by someone who received them free of at
                   reduced costs

   C. Policy
      1. Rationale for Favorable treatment of CG
          a. Bunching
             i. Allows for a fairer taxation since the value of the asset has increased
                 over the years and would have been taxable at a lower rate at some
                 point in its life
          b. Lock- in
             i. Higher tax rates tend to encourage people to hold onto assets rather
                 than sell them
          c. Inflation
             i. Mitigates treatment of gains only attributable to inflation and not true
                 gains in value
          d. General incentive
             i. Provide incentive to saving, investment and growth
          e. Incentive to new industries
             i. New industries tend to generate CG so favorable treatment helps
                 growth
          f. Unrealized gains are not taxed
          g. Double-tax on corporate earnings
             i. Reduces taxes paid by shareholders when they sell stock




                                           28
   2. Rationale for the limitation on deduction of CL
      a. Capital losses are only deductible to the extent of CG, plus $3,000 of any
          excess amount
      b. Prevents reorganization and reporting of “false” losses to offset gains
      c. Forces TP to recognize equal amounts of gains and losses
      d. Unrestricted allowance of CL would reduce tax revenue

D. Property held “primarily for sale to customers”
   1. Sale to “customers”
      a. Van Suetendall v. Commissioner
          i. TP bought and sold securities and lived on the interest income
          ii. TP claimed that all the securities sold were non-capital assets and
               therefore produced ordinary income/losses
                Attempts to use §1221(a)(1) to classify them as assets held for sale
                    to customers
          iii. Gov’t says that all were capital assets and that the limitations on losses
               in §1211(b) applies
          iv. H: the assets are capital, not ordinary and therefore the losses are only
               deductible to the extent of the gains
                These were assets which were not held for sale to customers b/c he
                    sold them to other brokers and dealers and not to the general public
          v. These were capital b/c:
                Property
                Not within any exception
   2. “Primarily for sale”
      a. Biedenharn Realty v. United States
          i. TP was a corporation organized to hold and manage family
               investments
          ii. They claimed that real estate that was sold in different parts and
               developed into a subdivision was a capital asset b/c it was held
               primarily for investment purposes
          iii. I: was property “held for sale” to customers in the ordinary course of
               its trade o business under §1221?
          iv. Factors to consider
                Substantiality and frequency of sales
                     Sales over long period of time indicate OI
                Improvements
                     Numerous improvements indicates OI
                Solicitation and advertising efforts
                     More frequent tends to show OI
                Broker’s activities
          v. Gov’t claims that TP entered into real estate business to liquate what
               was once an investment property
          vi. H: this property has no become “property held for sale” and therefore
               all income from it is OI
                OI even though the original intent was investment property


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E. Transactions related to the TP regular business
   1. Corn Products Refining Co. v. Commissioner
      a. TP claimed purchases/sales of corn futures was capital transactions under
          §1221
          i. Claimed that the buying/selling was a separate business
      b. H: this activity was an integral part of the TP business and the gains/losses
          were therefore OI
      c. Rule: congress intended for profits/losses from everyday operation of a
          business be considered ordinary income
      d. Hedging transactions can be thought of as purchasing insurance
   2. Arkansas Best Copr. V. Commissioner
      a. TP owned stock and bank and sold part of it and claimed an ordinary loss
          i. It was claimed as ordinary b/c the TP had no capital gains to offset so
              the loss would be useless
      b. Gov’t said that this was a capital transaction resulting in CL
      c. H: for gov’t
          i. Regardless of the original intent in purchasing the stock, it falls within
              the literal definition of §1221 and is not covered by any of the
              exceptions so it is a CL

F. Substitutes for ordinary income
   1. Payment for cancellation of a lease
      a. Hort v. Commisioner
           i. TP received $140,000 for cancellation of rental agreement
                 TP did not include this in GI but instead deducted a loss for the
                    overall loss of rental payments (did not take an actual deduction
                    b/c of other losses)
           ii. Gov’t says:
                 All should be included in GI
           iii. H: for gov’t
                 Not return of capital, just b/c lease is property
                 This is nothing more than a substitute rental payment
      b. If TP receives money as advance payment of rent, it is treated as GI
      c. If TP is lessee who pays rent for several years in advance, lessee must
           carry that amount forward and spread it out over the term of the lease (not
           allowed to deduct the entire amount at once)
   2. Sale of interest in a trust
      a. McAllister v. Commissioner
           i. Life estate interest in trust was sold to satisfy debts of estate
           ii. TP claimed that it was a capital asset and she reported a capital loss of
                $8,790.20 (AR-value of the life estate)
           iii. Gov’t claims that this is an advance payment of income and should be
                reported as OI
           iv. H: for TP




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                  The sale of the life estate is capital b/c it is the entire right and
                   interest in that estate
   3. Oil payments
      a. Commissioner v. P.G. Lake
          i. TP accepted oil royalties to satisfy debt
          ii. Reported the amount as LTCG
          iii. Gov’t says that this was OI
          iv. H: for gov’t
                The lump sum payment is a substitute for what would be OI in the
                   future so it is OI (merely a change from future income to present
                   income)
   4. Bootstrap sale to charity
      a. Commissioner v. Brown
          i. TP structured transaction to sell company to charity as a sham
          ii. H: b/c transaction was at arm’s length, it will be given effect
      b. To fix this situation, Congress enacted rule that unrelated business
          activities of charities are taxed

G. Other claims and contract rights
   1. Theatrical production rights
      a. Commissioner v. Ferrer
          i. TP claimed that payments received for movie production rights were
              capital gains and not OI
          ii. H: this portion of the transaction was capital
   2. Right of Privacy or of Exploitation
      a. Miller v. Commissioner
          i. TP contracted to sell dead H’s life story and claimed that the proceeds
              were capital gains
          ii. Court says that this in OI
               Simply b/c it is something paid for does not make it capital
               This is not a “sale of property” so it is not covered by §1221
   3. Patents and Copyrights
      a. §1221(3) and 1231(b)(1)(c)
          i. no CG treatment for authors
          ii. doesn’t apply to persons who buy the copyright from the actual writer,
              etc.

H. Bail-out of Corp. Earnings
   1. Gregory v. Helvering
       a. TP owned all stock of United Mortgage which owned 1000 shares of stock
          in another company
       b. She sought to reorganize United and transfer the stock to the subsidiary
       c. She then liquated the subsidiary and transferred all the stock to herself and
          claimed a capital gain
       d. Gov’t said that b/c this was an illusory reorganization, the stock should be
          treated as a regular dividend and be taxed as OI


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       e. H: for gov’t
          i. Transfer must be part of or “in pursuance” of reorganization and this
              was not

I. Fragmentation v. Unification of collective assets
   1. Williams v. McGowan
      a. TP bought out business partner and then sold the business
      b. He claimed OI
      c. Gov’t claimed that it was CA
      d. H: the business should be split into separate components and then the
          treatment of each part should be decided.
          i. Fixtures=OI
          ii. Inventory=OI
          iii. Receivables=for the court to decide upon remand

J. Correlation with prior related transactions
   1. Merchants National Bank v. Commissioner
      a. TP wrote off notes as bad debt and took a deduction under §165 as an OI
          i. Bank is in the business of selling loans so this is inventory
      b. They then sold the notes to a collection company
          i. They reported this as CG
      c. H: must be consistent in treatment
   2. Arrowsmith v. Commissioner
      a. TP liquated and divided corporation and then were forced to pay judgment
          out of their earnings
          i. Reported the earnings as CG
          ii. Deducted the judgment as OL
      b. Gov’t said
          i. This is part of the original liquidation so it should be treated as CL
      c. H: the judgment was required b/c of the liquidation and should therefore
          be treated as a CL
      d. The CL is limited by §165(a), (c)(2), (f), and 1211
          i. Can only deduct to the extent of CG or $3,000 (above the line)

K. Requirement of Sale or Exchange
   1. Helvering v. Hammel
      a. TP wanted to deduct payments made towards purchase of land as OI b/c
          the land was sold at a forced sale
      b. Court held the “sale” includes forced sale and so the deduction is a CL
          under §1211




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