Source: https://www.scribd.com/document/54377229/Spring-2010-Abreu-Tax-I-Outline
Timestamp: 2019-04-24 04:45:45+00:00

Document:
o Efficiency: goal of tax system is to have as little impact on the market & decisions people make as possible.
Syllabus # 2: The Unit of Taxation: to whom should an item of income be taxed?
want H.E. among married people (penalty/bonus) OR all people.
• Prof asks Dean to take 4mos salary & pay kid’s tuition. Does this relieve Prof of tax liability?
• Prof asks Dean to have $ put into a trust?
• Prof does not want salary & tells Temple to do whatever it like with the $$?
retains control b/c by choosing to work or not he is affecting the amt that his spouse is entitled to.
o Helvering v. Horst: TP owned bonds and assigned only the coupons to his children so as to pay fewer taxes.
Ct still charged TP (owner of the bond) w/the tax.
(so interest coupon from bonds are no gifts). So, give away the entire property (the Bonds).
assigned away all he ever had (the right to receive the income).
o What is income? What deds are allowed in measuring TI? Whose income is it? When is the income taxable?
 Fixes Macomber definition by including punitive damages and windfalls.
 RULE: any pmt paid in consideration of the services rendered by the EE is taxable against the EE as income.
6k) • ER would pay EE 41. 132 fringe)  Exclusions to GI are located in §§101-140 E. In-kind benefit transferred to an EE o In kind benefit can be either:  Tangible compensation not in for of $ OR  Compensation that is essential to performance of EE’s job (i.3k in tax.6k x 28%  So. EE would have income only after the 5 years (or when no risk of forfeiture).28) 39% to 30k you would get the same amount as 41. (the gains will be taxed at the capital gains rate) ## 5 AND 6: Statutory Exclusions: Fringe benefits. § 83 Property as PaymentYES income-but may not be right away • If person receives property in return for performance of services AND the property is o 1) non-transferable and 2) subject to a substantial risk of forfeiture at the time of transfer. The windmill returns o Loophole:  Extreme Makeover: de minimus provision in § 280(a) that allows you to exclude from income $ received if rent out house for less than 15 days each year. the FMV of property minus any amount paid1 for it IS INCLUDABLE in income o § 83(b).28/1-. Since it is income.e. Federal income tax is imposed on a “tax inclusive” basis: no deduction for Federal income taxes o Tax Inclusive Base.6k in before tax income  Applying the tax exclusive (. TP may elect to include property as income immediately (if he thinks value will increase significantly)  CON: if property forfeited. Exceptions  Statute must provide exception if Gov wants to exclude certain “accessions of wealth” from GI (102 gifts. Tax Exclusive Rates  Tax Inclusive Rate. then 650 in tax etc (total 11. If elected to claim in income now through § 83(b) even though it is still restricted he can.. then the property is treated as still owned by seller and NO income is realized by the purchaser o BUT. The amount of tax is included in the amount of TI to which rates are applied  ER wants to pay salary= 30k after tax income to EE w/28% tax inclusive rate  Applying the rate you get 8. elect to claim now and pay less. Tax Inclusive v. you get NO deduction o Tax Planning: if you think the value of stock might increase a lot. recipient must pay tax. Refers to the amount of tax paid as a proportion of the after tax value.g. chalk for teacher) o Benefits are transferred b/c EE has performed services for ER (compensatory nature)  § 61 Taxable Fringe benefits: those fringes that don’t qualify for exclusion under a specific code provision income o if taxable. FMV of prop/services taken in pmt must be included in income  RULE: Game show winnings are income and so are prizes from shows o Windmill:  Oprah Example: gives everyone a vehiclethis is income.4K. then the EE would have $50 worth of income . but if he quits before the five years and doesn’t get to keep stock. ER gives EE $100 of stock. Then. must be included at their FMV o TFB received by member of EE’s family are includable in GI of EE (not the family member) 1 for when property is exchanged for both services and some payment o e. • Paying for rent via “improvements” to houseNOT taxable to owner C. but has to work there for 5 years before he can keep it. Meals/Lodging 1.  Any in-kind benefit provided by ER as compensation for services rendered is income (Congress excludes some benefits)  § 61: if service is paid for with something other than $. when the forfeiture risk is removed or property becomes transferable. and that would produce 2. Oprah decides to pay the taxes. if an employer were to sell an employee $100 worth of stock for $50. if EE wants to pay a specific amt After TaxG=N/1-t where G=salary you must pay to achieve desired salary and N=after tax salary desired D. no deduction o Policy: income comes in many forms and system cannot distinguish b/c we would disadvantage those w/o prop o Ex. § 32 ER-PROVIDED FRINGE BENEFITS A. This is also income. Generally  Fringe Benefit.
if bike is regularly used to go to work. retirement planning services. Benefit to ER  Retired EE. military base realignment &Closure • Essential pre-req for exclusion is existence of substantial non-compensatory business purpose on part of ER for providing good/service to ER o Good/service should NOT be excluded UNLESS it is related to EE’s work & ordinarily useful to someone in EE’s position • Limitations on Tax-Free Benefits o § 132(j)(1). but adjusted for inflation (due to environmentalists)  (f)(5)(F). No-additional cost service  Requirements: • Service offered in ordinary course of business • ER incurs no additional substantial cost in offering service to EE o Flight attendant who flies in a seat that otherwise would be empty (not income) o Consumption of food/drink are excludible if incidental to primary service being provided (Reg. Qualified transportation fringe  (f)(4). Included in Exclusion • Retired EE. surviving spouse of EE who died while w/ERwife and dependent child treated as EE o § 132(d). Allows from inflation adjustment  (f)(2)(A). surviving spouse of EE who died while employed by ERwife and dependent child treated as EE • § 132(h)(3). De minimum fringe  FMV of property/service is so small that it is administratively unreasonable or impractical  Eating facilities provided by ER are de minimus if: • Located on/near business premises.132-2(a)(ii))  Policy: Benefit to ER. Special exclusion for parents and air transportation o § 132(c). §1. Non Discrimination Rule  Most FB may be available tax free to officers/owners/highly compensated EEs as long as made available on substantially equal terms to all EEs • BUT this rule only applies to: 1)No additional cost service 2)qualified EE discount • POLICY: we should not tax something that is not compensatory in nature . If EE has choice b/w cash or this fringe benefitNO income  (f)(6). AND • Revenue exceeds operation costs o § 132(f). Qualified Employee Discount  Any EE discount w/respect to qualified property or services as long as: • Services/property offered to public at large • Services may not be less than 20% of regular price • Property may not be given at less that ER cost  Policy. § 132 Fringe Benefits • § 61(a)(1). Not cutting into ER’s pocket and it feels non compensatory  § 132(h). Working condition fringe  Any property/service provided by ER to EE where benefit primarily for ER  The fringe MUST HAVE BEEN deductible from income under § 162/167 if it were not given as fringe o § 132(e). for the purchase of a bike & repair. ceiling on transit past is $100.  Statutory provision for ER FB: o § 132: excludes 7 categories of work related FB from income o § 119: Excludes certain work related meals and lodging B. Includes FB as income “except as otherwise provided • § 132(a). $20/month limit o § 132(j)(4). On premises gym and other athletic facilities  Not included in income if gym is 1)on ER premises 2)operated by ER 3)for EE’s use  If ER pays for EE’s membership at BallysIncome b/c it is additional cost to ER o Qualified moving expense reimbursement. Included fringe benefits: o § 132(b).
it IS income UNLESS there is an exclusion o Statutory: § 119 Meals/Lodging.  Adams v. • Note: A EE might be at 35% bracket might be indifferent if received $65 of tax free fringe or $100 b/c it is same amt to him. etc o Case Law: Gotcher: applies to non-EEs (see below) • NOTE: Cons of ER benefits include inefficiency of the tax system b/c it drives economic behaving AND inequality b/c people in same position pay different taxesdiffers based on what ERs can offer. BUT it is $35 less for ER if EE chooses $65 of fringe benefit 2. Ct allowed exclusion b/c his duty was continuous and req’d his presence at a moment’s call o Problem: he managed other hotels. marginal rates (ex. AND  Exists ONLY if there is a substantial non-compensatory purpose  Generally established if: • EE req’d to be on call after business hours • ER restricts ability of EEs to leave premises for meals. continue with list • Do we have an accession to wealth? o When ER provides benefit. § 119 MEALS AND LODGING • Meals and lodging furnished for the convenience of the ER is NOT INCOME • RULE: EE (and his immediate family) may exclude value of any meal/lodging IF: o Furnished to him by ER o For the convenience of the ER. if it is compensatory in nature. § 132 Fringe benefits. was considered part of business premises b/c substantial business activities performed there after hours • § 119 is a codification of Benaglia v. COMMON LAW EXCLSION: NON EMPLOYMENT FRINGE BENEFIT • Common law Exclusion: Primary Purpose test [Governs Fringe Benefits for Non-Employment Relationship] o RULE: TP does not realize taxable income when he is serving a legitimate business purpose of the party paying the expenses  NOT for ER/EE relationship  LOOK to primary purpose of expenses and intention of payor: is motive compensatory OR for business reason of provider?  Pmt of travel expenses by prospective ERNOT income . owned house in Tokyo. C o Mgr of 2 deluxe resorts in HI was allowed to live suites & eat at resort for the “convenience of ER”. there is an accession [Old Colony} o In the case of a benefit. even if not in cash or EE never sees it. as long as location is serving important business functions of the comp. as long as policy actually enforced o Furnished only on business premises of ER  Not limited to business itself. regardless of the reason. as long as EE is better off. US: Co. so the ct’s argument is inconsistent • RULE: Cash reimbursements for meals NOT excludable o Kowalski: NJ troopers who received reimbursements for meals eaten at restaurants while on duty NOT allowed to exclude from income o Requirements:  Meals require and “in-kind” transfer. and Y gets paid 55K in salary but received 5K in tax free benefit and is also at 35%) 3. it is income unless there is a provision excluding • Glenshaw Glass Qs o Is it realized? o Is there complete dominion? • If yes to all questions. NOT cash • Giving cash gives TP a level of control that “actual food” does not  May deduct as § 162(a) expense-but not as much of a benefit INCOME + FRINGE ANALYSIS • Look at § 61 first to see if in enumerated listif NOT. X gets paid 60k salary and is taxed at 35%.
One will have to pay someone else  Inefficiency: causes TPs to make economic choices differently (i.: similarly situated people pay different taxes • 2 people who make same salary. o US v. incentive to by home) Syllabus # 8: Gifts & Bequests • § 102(a). cooks.E. but control doesn’t mean “gun to head”. Disney Syllabus # 7: Imputed Income • Imputed Income: benefit derived from labor you do for yourself OR benefits from ownership of property • Main Type of Imputed Income: o Domestic services (i. there’s economic value) o Imputed income generally not taxed b/c it is administratively impractical o Policy effects of not taxing:  H. and wife took expense paid trip to Germany to tour VW facility. admiration. a car dealer. but don’t have same amt of time to work on projects at home are not really taxed equally relative to their economic gains. Ct held that husband’s expenses NOT income. it IS a giftacting out of affection. devise. Gift. Company deducted car as business expense. respect. Costs of trip split b/w TP’s ER and VW. but wife’s were  Reasoning: In order to be income. charity or like impulses o § 274(b): MAX deduction for business gifts that are excludable under § 102 is $25 per person/client • RULE: If donation given as compensation of inducementNOT gift2 o Duberstein: TP receives car as gift from a company he’s done business with in the past. and expenses otherwise would’ve been deductible (§162)  US v. already taxing donor  Administrative Concerns: impossible to keep track of every gift  Our tax system doesn’t treat receiving a gift as being realized A. it means “reasonable business purpose” o § 274(m)(3): travel expenses of a wife/dependant to be deductible ONLY if that person is an EE of TP. arguably you are saving money by not renting. GIFTS • no dollar limit on amount of gifts one may receive • NOT income to donee and NO deduction to donor • RULE: May ONLY exclude if transfer proceeds from a “detached and disinterested generosity” [Duberstein] o Must consider donor’s intentobjective reasonable person standard o If just being thankful.e. bequest. there is a bona fide business purpose. TP excluded car from GI: Court said NOT a gift • RULE: Current EE gifts from ER are NOT giftsINCOME o § 102(c): congress disallows exclusions from transfer b/w ER & EE regardless of personal relationship (conclusive presumption that ER will not be acting w/Detached & disinterested generosity) o Retirement: statute makes no mention of retired or former EEs  KEY Q: is recipient an EE at time gift is given? 2 Once there is a business motive. there must be: (Primary Purpose Test) • Economic gain • Benefit personally o ALWAYS LOOK AT INTENT OF PAYOR [was it primarily a benefit for him?] o If Primary benefit was of payorNOT income • TP must have had dominion or control o Given decision of going on trip or not o Given control over schedule or $$ spent o Note: Gotcher arguably had some control over these things.e. inheritanceNOT income o Policy Reasons:  Don’t want to doubt tax. etc) o Owning your own home:  get tax benefits for owning residential house AND imputed income not subject to tax on fair rental value of home (you own a home. Gotcher: TP. a housewife that cleans. it is income .
any income that is thrown off from that gift is taxable • No dollar limit on amount of bequests one may receive • RULE: If postpone a pmt and ask instead for it to be left w/a bequest. benefit pmts to blind. Bequests: gifts left by will • § 102 excludes bequests from income • § 102(b) says that when you become the owner of the gift. SO. When he has lotto ticket. so there is $4M worth of FRUIT. which is income to her • Arguably no one tips that much. On REMAND. court held it WAS a gift and NOT taxable. The cop controls the tree and disposition of its fruit. educational. but IRS has never sought to tax family support • RULE: Most Gov’t benefits and welfare pmts are NOT income o Includes: SS pmts. Legitimate business reason is for person giving bags to obtain exposure. assign half ownership to her. AND • Prize or award MUST be transferred to charity  E. The lotto winning is the FRUIT of that tree. charitable. not lawyer • RULE: § 74 Prizes and awards generally are included in INCOME even if gratuitous o § 74 allows an exclusion of certain prizes if NOT retained by recipient  4 Requirements: • Award must be recognition of religious. the goody bags were given to the celebrities b/c for primary purpose to benefit person giving the bags. he was awarded $20k.  Equity Issues: celebrities definitely have ability to pay • RULE: Intra-familial support is NOT income o Presumption in families is that it is a gift (too difficult to distinguish gift from support) o No specific authority for this rule. income to him. artistic. could be gift. When the ticket produces $4M each are ONLY entitled to $2M each • Not the best solution for her b/c now she has TI of $2M. C. • To give the cop income of $2m and the waitress of $2M. unemployment comp. literary. come up w/theory that the patron has income of $4M and the waitress of $2M by patron’s assignment of income to her  His accession to wealth is $4M. She has a $2M tip. US: TP was EE by church for 10 years. the Nobel Prize • RULE: tips are income o Tips are given with a compensatory motive.  The motive is evaluated objectively”reasonable person” • It is expected that waitresses work for tips • a tip to a OBGYN for delivering a baby IS income (no one expects to tip OBGYN) o HYPO: a patron wins $4M in lotto and gives a waitress $2M tip. so he is taxed.g. § 102 doesn’t include definition of EE. Maybe a gift? Detached/disinterested?  Assignment of income analysis: the cop has the lotto ticket. etc o No statutory authority to go after these pmts as income B. so it doesn’t look like a tip.  Stanton v. Ct said it was INCOME o US v. we HAVE TO SPLIT THE TREE. When he resigned. so it is still UNCLEAR o HYPOS:  Ham or turkeyNOT income b/c de minimis  B-day gift from lawyer to assistantNOT income b/c asst is EE of firm. scientific.: an atty was compensated by a transfer in the form of a bequest. the TREE. Merriam: the test IS whether the beneficiary had to perform the services in order to earn the bequest • Rev Rule 67-375: if beneficiary was req’d to perform services in order to get bequestINCOME . or civil achievement • Recipient MUST have taken NO ACTION TO ENTER CONTEST • Recipient MUST not be req’d to render substantial future services. • Reasoning: he retired & technically wasn’t an EE anymore • Problems: Congress could include former EEs as “employee” b/c in § 132(h)(1)(A) former EEs are considered EEs. it is INCOME o Wolder v. Good for him b/c now only TI=$2M • RULE: Goodie Bags at Oscars are income o Clearly an accession to wealth o Argument against: this is like Gotcher.
broker’s commissions)  Cost of permanent and material improvements (part of AB)  NOT cost to repair  No basis in human capital. • Must ask what is it that the amounts are substituting for? o If a substitute for compensation then NOT a bequest C. amortization. then not a giftINCOME • Consider any valuation questions if gift given was property Syllabus # 9: Capital Appreciation & Basis A. wear and tear. obsolescence. may proceed • Is there detached and disinterested generosity? o If YES. all of it is income) o Basis is the technical mechanism by which TPs are allowed to recover their capital investment when they sell their propertythis way you don’t get taxed twice o Basis is generally cost even if over/under paid for property  EXCEPTION for bargain purchases . I buy land for 100k (basis). but rather property. depreciation. amt to seller. etc • § 1001(b): If AR is not in cash. the amt realized is then the FMV of the property RECEIVED (think of substance. GENERALLY • Capital: capital in this context means my return on investment o Policy: should not tax what has already been subject to tax • RULE: return on my capital is NEVER taxedonly taxed on gain o EX: if I buy prop for $1k and sell for $1200. § 102(c) problemincome o If NO. supplies req’d for study o NO exclusion for scholarship money used for room and board o § 117(c) limits exclusionany portion received which represents pmt for teaching. then a giftNOT income • If a bequest/inheritance. and depletion  Note: may either adjust basis upward to reflect capital expenditure or downward to reflect tax benefits allowed to TP (i. books. IMPORTANT SECTIONS IN THE CODE: • § 1001: Gain/Loss from the sale or other disposition of property=AR-AB o The excess of the AR over the AB o Disposition: sale. My AB=$150k • § 1012: general rule is that the basis is cost to TP [except as otherwise provided] o What is the cost?  Costs associated w/acquiring property (atty fees. it’s all consumption (when I get a paycheck.: if scholarships were taxed then while rich students are getting their college paid for by their parents tax free. other fees. look to substance. research. there HAS to be a realization event) • § 1011: adjusted basis for determining the gain/loss[AB=Basis +/-(§ 1016 adjustments)] o § 1016 Adjustments:  (a)(1): capital expenditures [for improvements]. the scholarship recipient would have to pay tax GIFT ANALYSIS • Are amounts coming from ER? o If YES. Scholarships • § 117. I invest in it 50K and build on it.E. RULE: any amt as scholarship to extent that the individual establishes that such amt was used for qualified tuition and related expensesIS NOT INCOME o Qualified Expenses: Tuition & fees. etc  (a)(2): exhaustion. depreciation)  EX. only taxed on $200 gain B. is it meant to substitute for compensation? o If YES.e. exchange. or other services by student as a condition for receiving the scholarship IS INCOME • Policy: oH.
then he has AR=$175Gain. & not report any gain until she sells all of the property and it exceeds her basis  Allocate basis of whole b/w part sold & part retained in some reasonable manner AND compare AR w/portion of total basis allocated to part sold • Reg § 1. and son sells for AR=75Loss. so son’s basis is FMV=$80 and a loss=$5  Mom buys property for $100. He bought home 20 years ago for $200k.5M. the amount of price reduction is taxed and the purchaser is treated as acquiring the asset for FMV (cost basis would be FMV) • POLICY: the reduction of price is compensationINCOME o Basis is allocated when a TP acquires a lot & sells part of it. a single person. 2 ways to handle this  Apply amount she got for the portion against the entire basis. gives to son when FMV=$50. IF LOSS: carryover basis OR FMV at the time of gift-which ever is lower o Donee pays tax on gain accrued by donor o Policy  Don’t want to tax accrued income at time of gift. therefore carryover basis=$100 and $75 is income and taxed  Mom buys property for $100. Her basis then would be $1.1015-1. but basis is “carryover basis” o Property transferred in divorce is treated as exchange for release of marital rights D. HORT V. securities) C. 1. it is still applicable • § 1022 ACTUAL LAW of property acquired from a decedent=CARRY OVER BASIS (just like gifts) o § 1022(d)(1)(A) EXCEPTION: allows a step-up in basis up to $1. $200k+ $1. he sells for $75neither gain/loss • Because split in the middle of FMV and carryover basis. • • § 1041 Basis for Property Settlements in Divorce o No recognition at time of transfer. • As form of compensation.3 million for an individual and $3 million for a surviving spouse  EX. gives to son when FMV=$80. SPECIFIC BASIS: • Basis of property received in exchange for services=FMV of property • § 1015(a) Basis of property acquired by GIFT = IF GAIN: Donor’s basis [carryover basis]. Harry. necessary to consult regs-Reg. I will be taxed on $999k. o § 1014 NO LONGER IN EFFECT (IT IS GONE AND NO LONGER APPLICABLE TO PEOPLE WHO DIE NOW)  If died before 2010. they would be stuck paying tax on ALL THE ACCRUED GAIN • I bought parcel for $1k in 1940.e. COMMISSIONER .3M=$1. gives to son when FMV=$150. owns a $2M home at his death. someone is paid through a reduction of price of an asset from its FMV.3M of the $2M will apply. (suggest that these rules do not always work) • § 1014 Basis of property acquired from a decedent=FMV of the property at time of death (stepped up/stepped down basis) o Results in a “stepped up (or down)” basis for the transferee and the accrued gain (or loss) on the property will never be subjected to income tax (or available to reduce tax) o The LOCK IN effect:  It locks people in to their appreciated values until they die so that if they had acquired land a long time ago and choose to sell now. sell today for $1M. basis must be divided among part o Gain/Loss sustained on each part shall be determined at time of sale for each part and CANNOT be deferred until entire property has been disposed of • Sometimes it is impossible to allocate in a reasonable way so consideration received on sale may be credited against basis for whole property • Can also be difficult to allocate where TP has acquired similar assets at different times (i.5M b/c she can only $1. but to preserve basis so that tax is triggered upon subsequent disposition  Only want to tax things once and would rather tax recipient o HYPO:  Mom buys property for $100. He leaves home to daughter at his death.61-6(a): when portion is sole.
Gain from sale of principal residence  first $250K is NOT income  If TP is married and house owned by both. purchaser does have basis in lease equal  to amount paid E. includes expenses/improvements §1016) Syllabus # 10: Realization Requirement • RULE: Code generally taxes only realized income  NOT unrealized appreciation o POLICY  Too difficult administratively to require TP to estimate change in value of asset each year  Potential hardship of obtaining funds to pay taxes on accrued but unrealized gains o Tax deferral allowed by realization requirement is one of principal tax planning functions o May accelerate or postpone gains and losses for tax planning • CONS of requiring realization o Violates H. Thus. WAYS TP CAN ACCOUNT FOR COST FROM PROPERTY • Immediately deductible expenses: some expenditures for production of income may be “expensed”if enough income to offset deductions.E. the lease was not an interest in property. the entire amt of gain/loss on sale/exchange shall be recognized o § 1031 EXCEPTION: provides for non-recognition for like kind exchanges of property used for T/B. the exchange did not constitute a sale/exchange of property. o Under CURRENT LAW: NO portion of basis of property acquired subject to favorable lease may be allocated to lease  If purchase a lease ONLY w/o acquiring ownership in building. EX: if $300k in Stock. C: TP acquired lot from his father. tax free recovery of such income producing expenses is immediate • Capitalized: purchase price/cost taken into account ONLY when asset is sold or exchanged o EX. and does not allow TP to offset basis in property relative to AR. Since there was no basis assigned to lease. it doesn’t generate a capital gain/loss. this amount gets doubled to $500K • § 1001(b) defines AR  AR is any money received + FMV of property (other than money) received o Achieves H. court held amt received for cancellation IS INCOME o HOLDING: $140k was a substitute for rent (rent is income)substitute for income is INCOME  $140k NOT a return of capitalreceived building as devisee and amount in dispute was essentially a rental pmt (ordinary income)  Since Hort inherited the property from his father he also inherits his father’s basis (and the Bank lease had ALREADY gone into effect).: taxing cash same as property received (EX: if $300K cash. In 1933.E. basis of property giving up becomes the basis of the property received • § 1011/1012/1016 AB: cost of property (doesn’t include real prop taxes. my AR is 300k • § 1001(c) recognition. my AR is 300K. So. The year before. my AR is FMV 300K. but reported a loss for the cancellation. Unless there’s exception. Since TP made no improvements/investments to obtain the leaseNO SEPARATE BASIS • Rule: in order to allocate basis. At time acquired it was leased to a bank. Bank found it unprofitable to maintain lease and agreed w/TP to cancel lease for $140k. the bank contracted to extend lease for 15 years after current lease ended in 1932. then you can allocate basis  Nowhere in the code does it indicate that Congress intended to allow a TP to reduce ordinary income actually received by the amount of income he failed to realize o Note: to be capital gain/loss there must be a “sale/exchange of property”. must determine COST o Did you have to make an investment to property to obtain lease? o If you can show it is a separate item of property and that you have paid a separate amount. EX: if $300k in EE services. • Hort v. I bought stock and am getting dividends while I own it. . The dividend will be taxed in full w/o any offset for the capital invested • Depreciation: periodic deduction allowed for asset’s cost STATUTORY ANALYSIS FOR COMPUTING GAIN FROM THE DISPOSITION OF PROPERTY • § 61(a)(3) includes as GI “gains derived from dealing in property” • § 1001(a) defines gain from sale or “other disposition” of propertyGAIN shall be the excess of AR from AB provided in § 1011 G(L)=AR – AB o § 121. TP did not include $140k in income.
that is your profit/gain  Liquidity problem: forces owner of baseball to get rid of it quickly b/c can’t afford to keep it and pay FMV of taxation • RULE: when intent to exercise complete DOMINION over unsolicited samples is shown by donating samples and taking charitable contribution deduction. US: publisher sent TP unsolicited sample copies of textbooks. its simply that the property owned is more valuable • If you sell. the basis will remain at $15 and the rest will be gain • Baseball Hypo: Groundskeeper caught McGuire’s ball from record homerun then gave directly to McGuire who donated to Hall of Fame (charity) o First. Y has property that increases in value from $50k to $51k. a few years later. TP found $4. Court says it is INCOME o HOLDING: treasure troves are subject to taxation based on:  Not included in § 61 nor excluded by statute BUT § 61 broadly constructed to include ALL income that is not otherwise excluded  Rev Rul 61. if then sell. but entitled to a charitable contribution deduction o If you have income. TPs paid tax on “treasure” on their return then sued for refund. can argue • NO income o Never intended to exercise control o Gift from groundskeeper (detached and disinterested) • YES income o May be income. TP donated books to elementary school library and took charitable deduction worth FMV of books. 1953-1: finder of treasure trove has INCOME to extent of its value in US currency for taxable year in which it is reduced to undisputed possession • Undisputed possession: where TP uses money for his own benefit. can’t take charitable contribution • RULE: IRS only concerned w/taxing unsolicited samples when failure to tax it would provide double tax benefits • TAX PLANNING: Should donate unsolicited sample right away b/c TP able to deduct value that was never in income o Donate Immediately$20k salary and donate books worht $1k$19K income (salary – ded) o Sell books for $1k and donate $1k to charity$20k income ([salary+gain]-ded) • RULE: stock dividendsNOT income to s/h b/c there is NO realization since capital is under control of corp & s/h did not receive anything for his separate use and benefit [Eisner v.5k in cash in the piano. Macomber] . Publishers sent in hope of receiving favorable consideration and did NOT intend that books serve as compensation. Court held that receipt of books is INCOME  Holding: it is income b/c it meet Glenshaw Glass requirements: 1) unquestionable accession to wealth 2) receipt/possession indicates TP clearly realized income 3)TP exercised complete dominion over books by taking charitable deduction for donating them  POLICY: IRS does NOT want double dippingif item is not income. it is clearly taxable EVEN if it does not belong to him and he later must return it  Reg § 1. must determine if you have income  If groundskeeper caught it.  X earns $1k in salary. like the money. Both have $1k economic income. value of samples received is INCOME. it is additional property  What if discovered piano is an antique Steinway worth lots of money? • NOT income b/c NOT additional property. worth of ball (FMV) is the basis and you MUST pay tax on that. o Haverly v. but only X will be taxed right now and Y will enjoy deferral o Creates Inefficiency b/c there is an incentive to hold income that appreciates in value in a non-cash form • RULE: treasure troves that are found are TAXABLE INCOME o Cesarini: TP purchased used piano for $15. then may argue NO income • EE/agent of MLB • Not in undisputed possession • Never intended to exercise control (in giving it straight to McGuire)  IF McGuire who donated to charity.61-14: Misc items of GI include “treasure trove” o HYPOS  What if discovered diamond ring in piano? • INCOMEclearly accession to wealth AND.
Stock Dividends: issuance of additional stock for those who already have stockstockholder does not actually receive anything or realize any additional value. CSA then sold 90% interests in 252 mortgages to 4 other S&Ls while simultaneously purchasing 90% interests in 305 mortgages held by those 4 S&Ls. a hair trigger realization will more easily allow them to tax it . and so NO income • To tax stock dividend is to tax a capital increase. basis is $100stock worth $1/each • If receive 100 more shares from stock dividend—now have 200 shares. The Revenue Act is unconstitutional  Holding: Not only do you need to have an accretion of wealth. not income • Gov’t Arg: Automatic reinvestment & giving cash and offering chance to buy additional stock are the same economically • TP Arg: 1)in same position before got additional shares of stock as after [legal entitlements and relationship to corp have no changed 2) may represent increase in value of stock.1001-1: construes disposition as exchange of property for other property that is materially different than property disposed of o Cottage savings: Savings and Loan companies doing really badly. Court disagreed with Gov’t argument that properties are only “materially different” if they differ in economic substance  Holding: even though the exchange was the same FMV.. but increase in value is not taxed until sold!  Dissent: proportionate stock dividend is same as paying cash dividend and simultaneously giving s/h option to reinvest and buy additional stockmatter of form not substance  This is good law todaycodified in § 305 ~(a) says NOT income AND (b) lists exceptions  HYPO: • If pay $100 for 100 shares of stock. but basis is still $100stock now worth $100/200 shares=$0. Macomber: Revenue Act of 1916 says stock dividends are income. CSA owns a different bundle of rights and thus realization occurred  Court focuses on change in legal entitlement • Secured by different properties • Looked at old case lawmaterially different if under laws of new state b/c one state has different right than another  Note: we get from this that it doesn’t take much for realization to occur • Gov’t doesn’t completely lose b/c now for gains. basis will be different—must keep track OR elect an average cost method • RULE: an exchange of property gives rise to a realization event so long as the exchanged properties are materially different = any change in legal entitlement [whether in kind or extent] o § 1001(a): realization of property occurs only TP engages in a sale or other disposition of property o Reg § 1. but ALSO something elserealization [NOT income until severed from underlying investment] • b/c stock dividend proportional.50/each • If purchase another batch of stock. o Distribution of Dividends:  Cash Dividend • X and Y have 100 shares in corp. so it issues to s/h additional shares of stock (STOCK DIVIDEND)this is NOT income [NO dominion] o Eisner v. legal relationship to investment did not change. Corp has $200 available for distribution and distributes $100 to each s/hthis is INCOME  Cash dividend w/simultaneous option to buy additional stock • Corp wants to reinvest money so it pays cash dividend of $100 but offers X and Y chance to buy additional stockthis is INCOME [s/h has choice & exercises dominion over econ wealth]  Stock Dividend—Automatic Re-investment • Corp wants to reinvest money w/o paying cash dividend. CSA claimed loss on exchange given that interests exchanged were materially different b/c of underlying loans secured by different properties. no economic change. federal home loan bank board trying to eliminate risk of closures so responded with Memorandum R-49 which allowed S&Ls to avoid recording losses associated w/mortgages exchanged for “substantially identical” mortgages by other lenders.
but your liabilities still exceed assets. congress must provide an exception to the statute-exceptions are found in § 108 o Exceptions are NOT income  § 108(a)(1)(A-B): Bankruptcy and Insolvency • GI does NOT include discharge that occurs in Title 11 case (bankruptcy) or when TP is insolvent (unable to pay debts) o Rationale: when you are insolvent. provides that LL doesn’t not include in income on termination of lease the value of improvements UNLESS they were intended as a rent substitute Syllabus # 11: Borrowed funds and Illegal Income A. in the year of the discharge. regardless of the intention to pay back or not o Collins v. you have tax liability on the entire FMV of the income (steal 50K. then you have liability=$100  On a net basis you are not actually richer b/c of the offsetting liability to pay the loan back  To pay back the loan. TP ignored and bet $80k by embezzlement and only won $42K. there are no tax consequences o Tax issues occurs when you don’t pay it back b/c there’s a mismatch (you have an asset and no offsetting liabilityyou are wealthier) B. ILLEGAL INCOME • RULE: Illegal income is income o This allows gov’t to prosecute crime in other ways (tax evasion is easier to prove) o Reqm’t that you report illegal income does not violate 5th Am (not asking you to report where you got the $$) • RULE: if procure illegal income and get caught. When part of your debt is discharged. o § 109. but gambling also has an entertainment value (personal component) • RULE: if must pay back illegal income that was procured. still can’t be deducted b/c of § 165(d): losses for wagering transactions only allowed to extent of gains of winnings—can only offset gabling losses by gambling winnings  Purpose of §165(d) limitation on deduction: gambling loss is NOT only economic. your liabilities exceed your assets.E. C: TP was EE at betting parlor which prohibited EE betting. you have TI=50K) in order to satisfy H. I’m going to have to get $$ that is going to go through the tax system • RULE: as long as you are paying back loan. so you shouldn’t be mad that the tax system is treating you the same • TP must report all of money even though it includes amounts that he lost o Not Unfair—same thing as if he earned $80k then lost $40K at race track—can’t deduct [H. you are NOT richer just LESS poor . Court held that TP had income of $80k  HOLDINGS: • TP’s embezzlement was NOT like a loan even if he intended to pay it back b/c the was NO consensual recognition of an express/implied obligation to repay • TP must report the money as income even though he is legally obligated to return the funds b/c: o H.E: if it didn’t require it.] o Even if it’s a true economic loss. in the year of the discharged.E. then the market changes and KL bought back its debt for less money] • RULE: if you want to change the result for economic reasons. TP may take a deduction in the year of forfeiture Syllabus # 12: Discharge on IndebtednessINCOME (GI includes DOI § 61(a)(12) • § 61(a)(12): if a loan is discharged. BORROWED FUNDS • RULE: loans are NOT income (no statutory exclusion for loan exists b/c loans fit in Glenshaw Glass definition) o Glenshaw Glass Analysis: If you have loan=$100. the IRS holds that the person has incomecancellation of indebtedness o Congress enacted this to codify the result in Kirby Lumber [members of public loaned KL money via bonds. people who earned $$ illegally would be advantaged over those who earn $$ legally o You are treating the money as if it is your own and would only pay it back if you get caught.
C: casino gives TP credit. OR • Forgiveness is made by tax exempt charities (i. Commissioner determined that TP recognized $2.e. 1.9M in that year from cancellation of indebtedness  HOLDINGS: TP has $2.9M in income • TP had some obligation to pay for money owed • Equity Argument: shouldn’t reward those who accept credit and gamble it away since others would have to earn money and use their after tax dollar to go and gamble  TP’s Arg • Debts were NOT enforceable under NJ law so you can’t discharge a debt when you don’t legally have one o COURT REJECTS b/c TP treated debt like a loan • Debt was not in dispute so not a cancellation of debt o COURT REJECTS b/c settlement was reached b/c casino would rather get something than nothing • Settlement was a purchase price adjustment exempted from income by §108(e)(5) o COURT REJECTS: there is no property involved b/c chips are NOT property since they can’t be used outside of the casino—just an opportunity to gamble  DISSENT: b/c debts were unenforceable. no assets were freed up after settlement so no increase in TP’s wealth that could constitute income  NOTE: 3rd Circ overruled this decision-holding that cannot have cancellation of indebtedness w/o loan . IRS is NOT going to hit you with income  § 108(a)(1)(E): qualified principle residence indebtedness • Qualified principle residence indebtedness= Acquisition indebtedness-163(h)(3)(b)-gives you a deduction for home mortgage interest o § 163 has $1M ceiling o § 108 has $2M ceiling ($2M debt on home) o § 108(h)(3)=discharge doesn’t apply if indebtedness cancelled b/c perform services for lender or any other factor not related to a decline in value of residence or financial condition of TP o Discharge before Jan. They go to court and they settle for $500k.5M debt. then not renegotiating price  If seller has ridden into the sunset and am dealing w/bank. 2010 o THIS PROVISION CREATED FOR HOUSING CRISIS • § 108(h) tells you how much basis can be reduced for deferral • Basis can never be reduced below zero  § 108(e)(5): provides exclusion for purchase money debt reduction for solvent debtor (Purchase Price Reduction) • Purchase money debt/mortgage: when seller finances sale of property (seller acting as lender) and seller allows a reduction (renegotiation) • Requirement of section: o Must have property o Must be dealing w/original seller—if not. o As long as the discharge of indebtedness does not make you solvent. but does not forgive it • § 108 exclusion will be a freebie if you have NO assets in which basis can be reduced  § 121= exclusion of gain up to certain amounts ($250k individual) on sale of principal residence o Zarin v. I’m no longer dealing w/original seller  § 108(f): GI does not include any amount from forgiveness of certain student loans if either: • Forgiveness is contingent on student’s working for a certain period of time in certain professions for any of a broad class of ERs. TP runs up $3. universities) where a condition of loan is that student (or former student) must fulfill a public service requirement  **Exclusion in § 108 does not necessarily come for free • § 108(b) says that the amount excluded from GI under § 108(a)(1)(A-C) shall be applied to reduce tax attributes of TP as provided in paragraph 2 o Gov’t will get back by requiring TP to reduce basis in his assetsdefers income recognition.
lost wages. not income o § 104(a)(2): exclusion for “ANY” damages personal physical injury or illnessNOT INCOME  EXCLUSIONS: • Worker’s compensation o Even if the pmt represents lost wages. subject to the mortgage. it all has to be included in income as well as the amount she sold it for. $75. If you have a loan/mortgage then it is not income upon receipt (for example. Syllabus # 13: • RULE for Damages: Tax consequences of a compensatory damages award or settlement depends on tax treatment of the item for which the award/settlement is intended to SUBSTITUTE [Raytheon Production Corp. AR=100+75=175. if you borrow $100k you don’t have any income since you have an offsetting liability). worth $100. that offsets the asset  When a property is sole or otherwise disposed of. which is then reduced by $60 AB for a total gain of $115 o Here. then. AB=60. o In this case you have a general liability for the value of the property that offsets the asset. • Non-Recourse Loan: the borrower is not personally responsible for repayment of the loans. and the lender can only look to assets that secure the debt for repayment. IRS does not care  For administrative convenience • Does not matter whether settlement or suit • Does not matter whether lump sum or annuity (even though interest included) . but it is income upon discharge (for example. v. the basis depreciates to $60. if you buy an item w/that money. When that liability is discharged. FMV of property=$500k and I had basis in the property of $100kTotal TI is $400k  Amount of income for property damages=Amount received-AB  Damages replace property • Return on basis is NOT income (I will not get taxed on the first $100k of the award) • Excess over basis is income (500k-100k=400k) o If the settlement/judgment fails to specify exactly why the damages are being paid. if you are then told that you don’t have to repay the $100k) • Recourse Loan: the borrower is responsible for the repayment of the debt and if defaults on it the lender can go after the borrower’s assets. for $75. While she has the property. TP has to prove what amount are paid on account of personal injury or return of basis and what is paid for something else • EXCEPTIONS to General Rule: o Exclusions benefit the D tortfeasor o Damages received in suits to recover injury to good will generally NOT taxable  Recovery represents a return of capital. whether recourse or non recourse is included in the basis of the asset that is finances. and when she sold the property for $75. the item has basis  HUGE tax benefit  deferral allows person to take advantage of TVM as well as different income rates if they change  Crane says that recourse and non recourse debts are treated alike (both are treated as if they are cash investments)  A loan. Seeing as she made NO pmt. The securitization of the asset is the liability. o RULE: if there’s a loan b/w family members. she had a liability of $100. She then sells the property. a discharge may be treated as a gift excludable under § 102 o RULE: although you don’t have income when you borrow money. but she makes no pmts on the mortgage. Her AR=$100 (for the distinguished debt) plus $75 (from the sale of the property). C] o To the extent damages is a substitute for lost profits YOU DO HAVE INCOME  Lost profits. etc o EX: if I get $500k damages b/c tortfeasor damaged my property. you have income. she was no longer liable for the loan of $100. § 1001=AR – AB=175-60=115. any balance of the recourse or nonrecourse debt is included in the AR • EX: X has property subject to a non recourse mortgage.
“if a TP has a NCG”w/o this language you have ordinary income o RULE: TP always wants capital gains  Short term capital gains are taxable as ordinary income. however. CAPITAL GAINS AND LOSSES INCOME • Basics3 o no separate tax on capital gainjust a different tax treatment (§ 1(h))  Regular ordinary graduated/progressive rate for most income • rates top out at 35%  Capital gains essentially preferential flat rate structure • For most people most of the time. an ulcer from being upset from being discriminated against • defamation/sexual harassment/age & racial discriminationNOT excluded • RULE: punitive damages are entirely taxable income (GLENSHAW GLASS) • RULE: interest is generally taxable to the recipient • RULE: Jury may be instructed that award will not be subject to tax liability o RATIONAL:  Assumed most jurors would be sufficiently tax conscious and increase the award by the imaginary tax  Eliminates an area of doubt/speculation that may have an improper impact on damage computation • QUESTION: are the attorney’s fees that come out of a damage award income? o Arguments:  Arg that its NOT incomeit was never my money b/c I was obligated to give it to my lawyer by K  Arg that it IS incomefruit is taxed to the tree [Lucas v. it’s flat • Flat rate is 15% • Rates top out at 15% o Capital gain rate is a preferential rate that applies to NET CAPITAL GAIN (§ 1(h)(1))  PROOF: § 1(h) language. recovery is to compensate TP for loss of an item that in non- taxable (possessing good health. and an assistance to state and local municipalities . they will sweep it all togetherEXCLUDED • Emotional distress from loss of consortium or physical injury to one’s spouseEXCLUDED • Physical injury arising out of non-physical injury does NOT countNOT excluded o i. you may offset STCL against STCG so NOT limited (available to sop up losses) 3 § 103 municipal bond exclusion: interest on municipal bonds is tax exempt (incentive for people to invest in them.e. Earl] o How can we get around?  Agency Theory: allows assignment of incomebut must be an ER/EE relationship  You split the tree b/w the lawyer and you o § 62(a)(20). o Congress provided the parenthetical so as to encourage these structured settlements  Policy: creates inefficiency and makes tax law NOT NEUTRAL  RATIONALE • Recover of human capital should not be taxed (i. Congress’ attempt to fix the problem by enacting it for certain types of suits  RULE: makes damages ABOVE THE LINE deduction for discrimination suits so it excludes legal fee right away for all purposes IV CHARACTER (TYPE) OF INCOME Syllabus # 14 Capital Gains and Losses A. use of ones body. they are better than ordinary income b/c although you may not have preference for STCG.e. etc)  NON PHYSICAL INJURY • If it arises from physical injury. for lost limb) • Shouldn’t kick someone when they are down • Recoveries for non-taxable items should be tax free o In many circumstances.
Preference bears NO real connection w/TP’s real situation b/c a dollar is a dollar and H. • If have capital loss (ST or LT). Stock arguably could bring me from 15% to 35% o IN REALITY. these are taxed as ordinary income b/c the definition of NCG doesn’t treat NSTCG as CG and thus not subject to special rate o § 1222(3): LTCG = gain from the sale/exchange of a capital asset held for more than 1 year. thus taxes inflationary gain that is not accession to wealth o Alleviates results of “bunching income”. by encouraging realization. people will sell. technically would be called NLTCL o § 1222(6): NSTCL = STCL – STCG  RULE: STCG is taxed as ordinary income • If STCL < STCG. if I have gain from s/e of cap asset but there is a statute that makes this gain exempt from tax. and perhaps corporations would be more likely to pay and then more financing will be done via equity rather than debt. So. in order to come out with a NCG you must at least have LTCG above 0. Current law measures gains in nominal. we consider CG + qualified dividends • Rationale: if tax dividends are taxed at CG rate they are more attractive. but you may use preferential CG treatment • so for purposes of figuring out NCG. § 1(h) rules are complex/irrational/and inequitable and are the arbitrary result of political compromises.E would require that the same amount should pay the same • What is Net Capital Gain? o RULE: only thing that gets you preferential treatment is LONG TERM CAPITAL GAIN (LTCG) o § 1222(11): Define NCG = Net LTCG (§ 1222(7)) – Net STCL (§ 1222(6))4  Dividend Income (§ 1(h)(11)): dividends are NOT CG. then this gain is NOT taken into account in computing GI o § 1222(4): LTCL = loss from the sale/exchange of a capital asset held for more than 1 year if otherwise taken into account in computing taxable income o § 1(h)(1): caps amount on NCG • Other Provisions to Consider o § 1211: Provides a limit for deduction of capital losses 4 Observe. but 20% commission is considered investment gain (seems like a bonus) • Why the Rate Preference for a Special Category of Gain? o Encourage people to sell/buy certain investment assets for savings o Encourages Realization=gains cannot be taxed unless realized. if it is 0 you have NO NCG. you must have a LTCG to make it out w/ NLTCG to then have NCG  If you come out w/LTCL > LTCG. not real dollars. If we are encouraging realization. but would much rather have capital gain rather than ordinary income no matter what – existence of capital gains makes capital losses fully deductible  Rules of Thumb: • Salary is always treated as ordinary income • Profit on investing is GENERALLY treated as capital gain • NOTE: following these rules of thumb: hedge fund mgrs “2 and 20” deal seems unfair2%% mgt fee is salary. and the gain would be taxed. So. can I deduct that capital loss against my qualified dividends? o YES-dividends are treated as CG from 2003 Act o § 1222(7): NLTCG = LTCG – LTCL Note. 1 year you may see the realization of gains that accrued over a bunch of years. if and to the extent such gain is taken into account in computing GI  FIRST PART of definition: LTCG (§ 1001 gain=AR-AB) from the sale/exchange (need a realization event) of a Capital Asset  SECONG PART: “if and to the extent such gain/loss is taken into account”loss/gain must be taken into ordinary income or deductible Statutory Pattern: only makes into definition if it counts in computing TI. if STCG > LTCG then you must use the ordinary rate structure . technically would be called NSTCG.  Corporations do not get a rate break on upside for capital gain. Gov’t gets more revenue (Bush I theory) o Lock-in Effect=lock in effect reduces mobility of capital so providing a lower rate of tax is a good thing b/c it encourages me to sell more quickly and discourages me from holding on to the asset o Compensation for absence of inflation adjustment.
there is NSTCL • Step #2: TP must separate LTCG against LTCL o If LTCG exceeds LTCL. must got to § 165 and make sure you come out w/a loss  Limit: • Individual TP: capital losses only deductible to the extent of CG + $3K o EX: NCL=$5K. your STCG > STCL giving you a NSTCG (instead of a NSTCL)  Corporate TP: • Corps are permitted a 3 year carry back & a 5 year carry forward of capital losses to be used against past or future capital gain • Each amount carried back/forward treated as STCL Determining Tax on Individual TP’s Capital Gains Involves 3 Stage process • Step #1: TP must separate STCG against STCL o If STCG exceeds STCL. CG=0 can only deduct $3K • Corporate TP= can only deduct capital losses to the extent of capital gains o NCG and NCL are calculated in the same way by corporate and non-corporate TPs. excess L-T gain is taxed at capital gains rate o If TP has both NSTG and NLTG. there is a NLTCL • Step #3: NSTCG[L] netted against NLTCG[L] o If NSTCG exceeds NLTCL. excess S-T gain is taxable in full as ordinary income o If NLTCG exceeds NSTCL. excess capital loss offsets up to $3K ordinary income each taxable year (§ 1211)  Any excess not allowed in 1 taxable year is carried forward indefinitely until completely utilized (§1212) • S-T losses deemed to offset ordinary income before L-T loss • HYPOS o Hypo 1  TP has TI=$100K excluding capital gains/losses  LTCG = $5K (§1222(3))  LTCL = ($1K) (§1222(4))  NLTCG = $4K (§1222(7))  STCG = $2k (§1222(1)) • STCL = ($3.5k) (§1222(6)) • NCG = $2.5K (§1222(11)) • TI=100K as ordinary. $2. there is a NLTCG o If LTCL are greater. would want to realize losses and NOT realize gains • Rate Difference o EX: $5K LTCL .$5K LTCG = NO TI o § 1212: allows carryover for capital losses so that TP may carry forward unused capital losses to be deducted in future years  (NSTCL-NLTCG) will be treated as a STCL in succeeding taxable year • Means that NSTCL > NLTCG  (NLTCL-NSTCG) will be treated as LTCL in succeeding year • Means that you have a LTCL > LTCG giving you a NLTCL (instead of NLTCG) • Also.5k) (§1222(2)) • NSTCG = ($1. but they produce different tax consequences  No rate difference b/w OI and CG for corps  Policy Rationale For Limiting Deductibility Of Capital Losses That Are Otherwise Deductible • Want to avoid cherry picking o Realization requirement is the culprit here since you get to decide when to realize losses or gains o If deduction was unlimited. there is a NSTCG o If STCL are greater. NLTG is taxed at favorable rate and NSTG is taxed as ordinary income o If losses exceed gains.  First.5K at 15% .
If you have ordinary income and a capital loss. STCG is better than ordinary income.5K ordinary income b/c $2. other casualty.5k ordinary. storm. you are stuck.5k  NCG = ($2. you move from § 165(a)(c)(f) and onto additional limitations [CL deductible against CG] CAPITAL LOSS ANALYSIS: Hypo – Have a capital loss of $3k from my Google Stock • Go to § 165 first o WHY? 1222/1211/1212 do not independently allow a deduction for a loss that is not first deductible under § 165 o (a) Deduction for any loss sustained in taxable year  HYPO is obviously a loss o (c) losses limited to: 1) those incurred in T/B. 2) those incurred in transaction for profit. you can go to § 165 and make it out of § 165(c) and stop (unless wagering losses) But if you have capital loss. Okay to leave them and tax as ordinary o But if you have losses. But capital gains. you would rather have an ordinary loss b/c deductibility of CL limited to CG  For ordinary losses.5K  TI=$101. • CAPITAL LOSS DEDUCTION PRINCIPLES o If you are stuck with a loss. inflation. o Hypo 2  TP has TI of $100k excluding capital gains/losses  NLTCG = $4K  NSTCG = $1. AND o Minimum holding period must be met (1 Year) • CAPITAL GAINS PRINCIPLES o LTCG are good  = rate break  Available to sop up capital losses o STCG ≠ rate break  They are treated and taxed as ordinary income  Rationale: No policy reasons to provide a rate break for STCG b/c they don’t have lock-in. and bunching problems. shipwreck. AND 3) those of property not connected w/either 1 or 2 if such losses arise from fire. or theft  HYPO is # 2 o (f) losses from sale or exchange of Capital asset will only be allowed to extend allowed in §§ 1211/1212  HYPO will be limited by 1211/1212 o § 1211 for non-corporate TP  No word of holding period  Only to extent of gain (general rule) PLUS  If losses exceed the gain the LOWER of • $3K OR . can act as a sponge to sop up capital loss $3K at a time.5K)  TI = $97.5k can be deducted (§1211(b)) o Hypo 4  TP has TI=$100k excluding capital gains and losses  NLTCG = ($4k)  NSTCG=($2k)  NCG=($6k)  TI= $97K ordinary income because $3k can be deduced (§1211(b)) and the remaining $3k loss can be carried forward to other years (§1212(b)(1)) • Requirements for transactions to qualify for capital gains treatment: o Transaction must involve property that is a CAPITAL ASSET o Property must be transferred in a sale or exchange. $4k at 15% o Hypo 3  TP has TI=100k excluding capital gains/losses  NLTCG = ($4k)  NSTCG = $1. whether long or short.
bunching. or other property held by TP primarily for sale to customers in the ordinary course of his t/b” o EX: the soup cans on the shelf. a capital expenditure. hedging transactions. Two Primary Exclusions • (a)(1): inventory or inventory-like NOT CA =“stock in trade or inventory” of a business. that does NOT have to be connected with the TP’s trade or business. AND  Rationales for having special rate of capital gain do not apply to business profits  we would not expect lock in. supplies consumed by TP in ordinary course of business • § 1221 exclusions intended to produce o Ordinary income treatment for proceeds from everyday business activities and personal labor o Capital gains treatment for investment gains • EXAMPLES o sale of stock on stock exchange by average investor. operating stuff of business that generates ordinary profits o We exclude inventory from being a capital asset b/c  It is recurring. but net losses are not o This exception does NOT include business land b/c land is NOT depreciable • Other exclusions o (a)(3): copyright created by own efforts  Patents created by own efforts is Capital Asset o (a)(4): accounts receivable (substitute for ordinary income) o Commodities. sale of undeveloped land purchased as investment. TP reported profits from second sale as capital gains (after first sale – he was still trying to develop the property) • HOLDING: purpose of statute is to distinguish profits from the everyday operations of business from those resulting from changes in value accrued over a substantial period of time o INTENT is very important – whether TP was trying to hold to make ordinary income via rent or sell  Difficult b/c it depends on facts an isn’t a clear rule • TAX PLANNING: o To avoid the situation of distinguishing. Riddell: TP originally wanted to develop property for rental purposes. after selling real estate. §121 provides an exclusion of gain up to $250k thus this gain is NOT taken into account in computing GI  If I sell for loss  NOT CL . sale of residenceCA o My car  CA. etc o What does “primarily” mean?  Primary means “principally” or “of first importance” to the person’s business  Malat v. unless you find something that includes it o Must primarily be property (earring. it’s property I hold and it does not fall into any exception  If I sell for gain NOT CG • If my gain is $100k. • The excess of losses over gain Syllabus # 15: Defining a Capital Asset • § 1221(a): Defines capital asset broadly to include all property held by TP. IF gainCG  It’s used for personal purposes and sold for gain (AR-AB)  Go through exceptions: Not inventory. not depreciable property for T/B o My house  CA. but troubles with financing and zoning led TP to sell the property in two sales. suffering wear/tear o This is a §1231 property that may be treated as a capital gain under §1231 analysis  Net gains will be treated as capital asset. clothing) and CANNOT be services A. a TP could sell the land to a corporation that HE CREATES HIMSELF and the sale will be treated as sale of a capital asset o Avoid looking like a real estate dealer b/c then lots may look like inventory o Substitute inventory is treated as inventory  Ex: see Corn Products and Arkansas Best • (a)(2): Depreciated property in T/B  NOT CA o EX: Machine.
If loss  CL  I might not be in the T/B. the loss does not count as capital loss b/c it is not taken into account in computing taxable income  can’t deduct it • § 165 is the gatekeeper for losses  No deduction for personal losses unless casualty or theft o b/c it is personal. but stock is held for production of income  Google stock is CA property. § 165(f): deduction for losses shall be allowed only to the extent of capital gains 1211/1212 • NOTE applies to short term AND long term • § 1212(b) General Rule: only to the extent of gain PLUS (a freebie) • If losses exceed gain. if I have no other capital transactionNO deduction • Under 1212 freebie. it will take me a long time at $3k/year • Still need a positive tax liability  Remember: Capital losses are from “sale or exchange of property” and ABOVE THE LINE o Is the property a depreciable asset used for T/B?  If yes. not inventory. it cannot be deducted o My clothesCA. not inventory) o Generally. • Even though house is capital asset. must check with §165 to see if otherwise deductible STATUTORY ANALYSIS FOR PREFERENTIAL RATEDOES TP HAVE NET CAPITAL GAIN? • Is it a capital asset? o Go through § 1222 exceptions:  Not inventory? Comparable to a soup can on a shelf?  Depreciable property in T/B? o Sold for a gain?  Part 2 of definition: is gain otherwise taken into account in GI? • EX: § 121 excludes up to $250k for sale of personal residenceexcluded from GI  Long or Short term—OVER ONE YEAR? • If LTCGspecial rate • If STCGordinary income rate o Sold for a loss?  Part 2 of definition: is gain otherwise taken into account in GI? • §165 is gatekeeper for losses: for individuals. losses are limited to (1) losses incurred in T/B (2) for profits seeking activity (3) casualty (huge floor)  For individual. carry over to next year • Under general rule. If gainCG (not depreciable. not depreciable • THUS: Statute Is Designed To Be Asymmetrical o GAIN is typically included in income from sale of personal asset (Capital Asset) o LOSSES are never deductible if personal asset (b/c personal losses are not deductible b/c it’s consumption)  If loss. then apply §§ 1231/1245 analysis BELOW . all my personal property CA o My Google stock CA. not part of my business nor entered into for profit. the LOWER of o (b)(1) $3k o (b)(2) OR the excess of losses over gains  Need a carry over? § 1212 • For additional amount that you can’t deduct this year. I don’t need any other capital transactionDEDUCTION • But if I have a HUGE capital loss and no capital gain.
WHAT IS A DEDUCTIBLE ANALYSIS • In order to deduct the item. wear/tear. then take current deduction  If no: • Do you have tangible property?  § 167§ 168 • Do you have an intangible?  § 197 o Fine/Penalty paid to gov’t in T/B?  NOT deductible § 162(f)  Is primary purpose of pmt to punish? NOT deductible  Are damages paid to private party? DEDUCTIBLE  Are damages compensatory? DEDUCTIBLE . the cost gives rise to basis (still in tax system) • Selling the property: take basis into account when selling the property = limit the amount of gain or determine loss • Not selling the propertyRules for cost recovery aka Depreciation o Is the asset depreciable? (Exhaustion. Use § 1016 to increase the basis and cap. V. then you can’t deduct it all in Y1  Tangible or Intangible?  If can’t deduct in Y1. you must find authority in the statute: o Trade or Business? Deductible under § 162  First: Engaged in T/B  Second: Ordinary and Necessary? o Production of Income?  Deductible § 212  Itemizers only  Is there a profit seeking purpose w/respect to income producing property? (personal purpose NO) o Business expenditure that’s capital expenditure?  NOT deductible § 263  Is it an expense that will be valuable beyond a year • If YES. become obsolete?)  If yes. move on  If No. recovery occurs on disposition o Does exception to §162 apply = § 179?  If yes. STOP.
o 2/3 treble damage payments  NOT deductible § 162(g) o Personal?  NOT deductible § 262 Syllabus # 16: Deductions A. you have not received full accession of wealth o Others are tax subsidies for certain activities or investments  EX: immediate write off for expense to remove architectural barriers to handicapped and elderly o Other are hybrids  EX: charitable and medical deductions • Deduction v.35 bracket = $35 o A 10% TP: 200(GI) – 100(DED) = 100 x . OR  Itemized deduction • Sometimes fully allowable • Other times allowable only to extent of certain related types of income or only to the extent they exceed certain floors • Miscellaneous itemized deductions have even more limitationsmust exceed 2% floor (§ 67(a)) • Also some itemized deductions disallowed for 1) high income TPs and 2) in computing the AMT • Deductions v. INTRO • Purpose of Deductions: o Many deductions are necessary to measure income accurately  EX: business expenses – if you have to pay to earn money. (§ 162) Trade or Business Expenses  DEDUCTIBLE o § 162: allows an ABOVE THE LINE deduction (with some exceptions) for all ordinary AND necessary expenses paid or incurred in carrying on a trade OR business  Includes: 1)EE wages 2)Insurance Premium 3) office rent 4) Utilities 5) Travel expenses o Defining Trade or Business . the more valuable the deduction is o A 35% TP: 200(GI)-100(DED) =100 x . in many cases TP may prefer exclusion to a deduction b/c of limits imposed on deductionsABOVE THE LINE deductions are the equivalent of an exclusion BUT below-the-line are NOT • Corporations and Deductions o Allowable deductions serve to reduce GI to TI FINISHED • Individuals and Deductions o 1st Step: subtract allowable above-the-line deductions in reducing GI to AGI [§62(a)]  Above-the-line-deductions include: o 2nd Step: AGI is then reduced to TI by subtracting either  Standard Deduction.1 bracket = $10 B. DEDUCTIONS: ORDINARY AND NECESSARY EXPENSES 1. Exclusion of Income o BOTH remove amounts from TI o HOWEVER. Tax Credits o Deduction  $1 deduction saves a fraction of $1 depending on TP’s tax bracket • EX: $100 deduction for TP in 35% bracket = $35 savings  TP can generally use deductions ONLY to extent of her income for taxable year o Tax Credit  $1 tax credit saves $1 of taxes • EX: $100 credit for TP in any bracket = $100 of savings  Credit usable only to extent of tax liability is normally is non-refundable • Few credits are refundable so TP will get check from gov’t if he has no tax liability  Tax credit typically allowed ONLY for a specified percentage of expenditure that qualifies for credit • RULE: TP bears burden of proving his right to a deduction • NOTE: the higher the bracket.
Lobbying. cost of investment advice. TP must have itemized deductions that exceed standard deduction o § 212 expenses are misc itemized deductions and thus are subject to the 2% floor of § 67 and cannot be deducted at all under the AMT 3. usual. AND 2) TP must have primary purpose of earning income or profit even if there is no sale of goods • Commissioner v. or customary” in your line of business  doesn’t need to be habitual to you o EX: Atty’s fees for business lawsuit that may happen only once or never happens for some business. but it is expected and ordinary that you would pay someone to defend o Moral obligations are generally NOT ordinary [Friedman: lawyer made pmt on behalf of client b/c he felt guilty]  EXCEPTION: Courts may look at the unique facts of the case •Jenkins: country music store made pmts to investors of defunct Twitty Burger  Ct allowed deduction b/c country music fans demand integrity • To determine ordinary and necessary. tried to deduct as business expenses on tax form. Ct held it was not a trade or business o §212 was in response to the Higgins decision  What is T/B: 1)TP must be involved in the activity with continuity AND regularity. rather than a personal matter/need  must be a direct connection to the T/B • Gilliam v. Cardozo said NOT ordinary • Necessary: appropriate and helpful for development of TP’s business [low threshold] • Ordinary: “normal. 212 Syllabus # 17: Public Policy Limitation. Helvering: TP’s old business went bankrupt. it will not be deductible if it violates public policy o Penalties will not be deductible even if ordinary and necessary b/c it undermines the purpose of the fine  allowing deduction for willful violation of state law would frustrate state policy severely by reducing the “sting” of penalty prescribed by state legislature (federal deduction would subsidize criminal activity) o Another argument for disallowing deductibility of fines is that it makes punishment fit TP’s marginal rate NOT what the fine was designed to punish  Tank Truck: truckers universally violated PA weight limits b/c it was the better business option. TP was paying off his old company’s debts to build up his reputation. (§ 263) Capital Expenditures  RULE: capital expenditures are NOT deductible under §§ 162. And EE Business Expense 1. C: TP is investor who invested for his own accounts and made most of his money that way. must separate out 1) capital expenditure and 2) personal expenses 2. in starting his new business. The Domestic Product Deduction. The PP limitation on Deductions  RULE: Although an expense might be incurred in a T/B or other income producing activity. Groetzinger: FT gambler who spends 60-80 hrs each week wagering on dog races  T/B  Origin of the Claim Test: must make sure that the expense had its origin in a business.  What is NOT T/B: profit seeking expenses = portfolio manager managing investment. C: noted artist and teacher w/mental issues freaked out on plane ride on his way to a lecture and had to pay to defend criminal chargesCt said not ordinary for artists to be involved in altercations during flights & his actions weren’t undertaken to further business o Defining Ordinary and Necessary  Welch v. subscription to financial magazines • Higgins v. (§ 212) Income Producing Activity Expenses  DEDUCTIBLE BELOW THE LINE  § 212 allows individuals a BELOW THE LINE deduction for ordinary and necessary expenses stemming from income producing activities that do not qualify as a T/B o Enacted in response to Higgins o To take advantage of the §212 deduction. ct refused to allow . (§ 262) Personal ExpensesNOT deductible  Personal expenses are consumption so we want to leave in the tax base 4.
does not violate policy  Tellier: securities dealer incurs atty’s fees from a criminal prosecution of white collar crime related to his business. o RULE: Atty’s fees incurred in defending business. Lobbying Expenditures  Lobbying: effort to influence the public on particular issues of legislative significance  General Requirements to be Deductible o TP must have a T/B o Legislation must be of direct interest to that business  § 162(e): Lobbying expenses in T/B  deductible BUT maybe NOT deductible (depends)  Rule: lobbying expenses are different than goodwill advertising expenses 3.. they exceed 2% of the TP’s AGI for the year  EX: TP w/$100k salary and $2.5k-2k=$500)  Misc Itemized Deds are defined by what they exclude: • Interest (§163) • Taxes (§164) • Casualty and wagering losses (§165) (10% floor) • Charitable contributions (§170) • Medical expenses (§213) (7. in the aggregate. Employee Business Expense  Trade or business of an EEperforming his JOB  Steps in determining if business expenses are deductible: o EE must determine whether expenses are O and N in carrying on a t/b o Expenses that are allowable under § 162 must be further characterized as ABOVE THE LINE expenses or alternatively as itemized deductions o Certain itemized deductions are subject to limitation and may not be deductible in full  Professional expenses may generally be deducted  Whether EE business expenses are deducted above the line or are taken as itemized deductions depends on whether ER reimburses the deduction o RULE: Reimbursed expenses are deductible ABOVE THE LINE o RULE: All unreimbursed expenses are deductible ONLY if EE itemizes deductions  Rule inapplicable to performing artists  RULE: Self-employed can deduct ALL business expenses ABOVE THE LINE  LIMITS ON ITEMIZED DEDUCTIONS o Itemized Deductions: all deductions except for § 62 deductions and § 151 PE o § 67: TP can deduct “misc itemized deductions” ONLY to the extent that.5K of unreimbursed expenses • Can only deduct $500 ($100k x 2% = $2k.5% floor)  Applies primarily to unreimbursed EE bus.. ct said it was deductible • Object of federal income tax is to tax net income not sanction against wrongdoing or to reform men’s moral character  Rationale: atty’s fees are a legal right that is not meant to punish so allowing them to be deductible does not undermine PP o Congress amended §162 to specifically deny 5 types of expendituresTAX PENALTIES  §162(F): fines or similar penalties paid to a gov’t for violation of any law [MAIN PROVISION]  Portion of treble damage pmts under antitrust law following a related criminal conviction  Bribes/kickbacks to public officials  Bribes/referral fees for Medicaid/Medicare patients  Any other illegal bribe/kickback if such law is generally enforced and it subjects the payor to a criminal penalty or loss of license or privilege to engage in a T/B o Other Tax Penalties  Pmts made to third parties or charities that are substitutes for fines are treated like fines and NOT DEDUCTIBLE  §280(E): business expenses related to illegal drug trafficking  NOT deductible 2. $2. expenses under §212 . even if unsuccessful. are ordinary and necessary business expense.
2% is 2k. and gambling/casualty losses [§165]) reduced by 3% of the excess of AGI  Reduction CANNOT exceed 80% of deductions  EX: TP w/AGI of $200k and $40k deductions • Can only deduct $37K ($200k-$100k=$100k x 3% =$3k.2k  §68(c): does not include §213. §163(d): investment interest. it tells you where it goes) o General Rules: (162 tells you if it is a T/B expense) . itemized deductions (other than medical expenses [§ 213]. so misc itemized deds must exceed 2k to be deducted • Homeowner interest of 20k (§163) • Taxes 20k (164) • Unreimbursed EE expenses of $200 • Total Deds: $40. $40k-$3k=$37k) o How does 2% floor work w/3% haircut  HYPO • AGI=100k. most TPs are unable to deduct EE business expenses and expenses for the production of income under §212  Additional Notes: • 2% limitations can be ignored for purpose of § 132 (fringe benefits) • Congress amended §62 to provide an above-the-line deduction for atty’s fees and court costs in civil rights suits o § 68: caps the total amount of certain itemized deductions for high bracket TP’s (3% haircut)  Once AGI exceeds $100k + increased for inflation. investment interest [§163(d)]. • As a result. §165 losses  §68 can cause loss of up to 80% of deductions  ONLY applies to people whose AGI exceeds $100k  If married filing separate return: $50k each • MARRIAGE PENALTY  ALSO indexed for inflation (§68(b)(2)) • Must look to revenue procedure in front of book • TODAY: almost $160k Process for Answering a §162 or §212 Deduction Question  Do you have an expense?  What is its origin? o Personal consumption NOT deductible under §262 o Capital expenditure  NOT deductible under § 263 o Business Expense  DEDUCTIBLE under §162  Must be in connection w/a T/B  Must be ordinary AND  Must be necessary o Income Producing Activity  DEDUCTIBLE under §212  Must be ordinary AND  Must be Necessary  Is there anything that takes that deduction away or limits it? o Common law PP exception? (Tank Truck) o §162(f) PP exception? o Is it a lobbying expense  §162(E) limits  Is it above the line (§62 deduction) or below the line (§63 deduction)? o First look to §62 to see if it is in there (62 Does NOT give you a deduction.
we take out of it:  AGI Deds (the above the line deductions)  § 151 personal exemptions  EVERYTHING ELSE IS ITEMIZED o § 62: AGI=GI-[the following deductions]: this will tell you if the deduction is ATL OR NOT  NOTE: § 62 does NOT give you the deduction. the gov’t will not take more than 80% of deduction  Is the TP in the AMT? o CAN’T DEDUCT ANY MISC ITEMIZED DEDS THEN  Is it deductible now? APPLICATION OF ATL AND BTL ANALYSIS HYPO: law prof sues her investment advisor b/c he made her invest with Bernie Madoff.  If §162 non EE business expense  ABOVE THE LINE • If Self Employed business expenseALWAYS ABOVE THE LINE  If §162 EE business expense • If reimbursedATL • If not reimbursedBELOW THE LINE o Courts are suspicious of any expense paid by EE not reimbursed by ER (if helpful of appropriate. ER would have paid for it) • General costs of being an EE (i. Is it deductible? To what extent. misc itemized deds cannot be: o Standard deduction o Personal exemption o §62 deds o §67deds  **Unreimbursed EE bus. must determine if it is an itemized deduction  Start with ALL deductions  Then take out: • Personal exemption • §62 Deds  Everything else left is ITEMIZED deds o Second. purchasing work clothes. commuting) are generally NOT business expenses  If §212 expenseBELOW THE LINE  If the expense is BELOW THE LINE. eating. itemized deds** o Does TP’s AGI exceed $100k + inflation that would subject it to 68’s 3% haircut?  Under the haircut. is it a misc itemized ded subject to §67’s 2% floor?  Misc Itemized deds are defined by what they exclude: • All itemized deds except for the § 67 deds o Interest (§163) o Taxes (§164) o Casualty and wagering losses (§165) (10% floor) o Charitable deductions (§170) o Medical expenses (§213) (7. then. you have to arrive here w/ a deduction from elsewhere . is it limited in any other way? o § 63(d) First. She hires a lawyer and charges a retainer. Expenses and §212 expenses are misc. if it is. is it deductible? • § 162(a): has it been incurred as an O and N expense in a T/B? o The law prof is not in the business of investment • § 212: is it an O and N expense in an activity for the production of income? o Yes START THE ANALYSIS: • §63(a)FOR ITEMIZERS o TI=GI-(all deductions except the Standard Deduction) o § 63(d): begin w/everything deductible.e.5% floor) • In essence.
• Pevsner v. distinctions used to be made by IRS and courts. § 212 is not included in here and neither are the Unreimbursed EE Bus. Itemized Ded by putting in a 2% floor  Again. but now Congress has stepped in to correct “abuses” • Congress has limited certain mixed motive expenses in order to raise revenue (i. you still have to go to §68. there is an accession to wealth o but as policy matter. Gov will NOT take more than 80% (you won’t lose it all) Syllabus # 18: Distinguishing personal from business expenses (CLOTHING AND TRAVEL) • §262: Personal expenses are NOT DEDUCTIBLE • RULE: all expenses that have mixed motives MUST be placed into all one side or all another side-business v.  So if you walk away from § 67 with something left. 2) it is NOT adaptable to general usage as ordinary clothing. Laurent boutique. You can lose up to 80%.E. o § 68: “otherwise allowable” is interpreted to mean after the § 67 has chopped off the 2%. if EE receives working condition fringe from ERNO INCOME . Ct held against TP b/c clothing adaptable for general/personal wear • § 132(d): “working condition fringe”NOT INCOME o if ER gives EE a uniform. C: TP worked as mgr of Yves St. TP took ded. personal o Problems of equity and efficiency emerge from necessity of drawing this distinction  Equity: allowing business deds for personal consumption produces both horizontal and vertical inequities  Efficiency.e. none of that is deductible • The higher your AGI the les that is able to be deducted • The professor’s § 212 income producing activity expense that involved the retained for her lawyer is located here. we are going to further reduce it “once you get above the applicable amount”. EX: scrubs. Expected to wear YSL clothes to promote store image. TP didn’t usually buy/wear that kind of clothes although TP admitted she could wear them off work if TP wanted. so they are MISC itemized ded BELOW the line. Exp. GO TO STATUTE TO SEE WHAT IS EXCLUDED  If you have 100k in AGI and tally up all your Misc Itemized Deds and it equal 2k. home office and vocation homes) • Congress has also imposed numerous restrictions on the deductibility of travel and entertainment expenses • Clothing expense  generally personal and NOT deductible o RULE: clothing used for business purposes  generally NOT deductible b/c inherently personal (even though it is helpful or essential to the business activity)  EXCEPTION: clothing is deductible as a business expense if: 1)clothing req’d as condition of employment. • § 162 non EE business expenseATL NOT ITEMIZED • § 162 EE business expense o If reimbursedATL NOT ITEMIZED (§ 62(a)(2)(A)) o If notBELOW THE LINE (ITEMIZED)  General cost of being an EE generally not a §162 business expense  § 212 expense is BELOW THE LINE B/C IT IS NOT EXCLUDED BY § 67(B) o § 67: we are going to limit anything that falls under the definition of a MISC. special diner uniform (but not black/white) o Objective test is administrable (subjective would be difficult) o Objective test promotes H. AND 3) clothing is not worn for general usage • Objective test: whether a reasonable person would wear the clothes for personal use. If TP’s AGI exceeds $100k (this is Inflation adjusted and is about $166k TODAY) anything that makes it out of the § 67 will get a 3% haircut. it is subject to the 2 % floor. you are going to lose some percentage of what you haven’t lost already.
such pmt would be deductible under § 162 or §167 (depreciation)  Arguably. ct held NOT deductible b/c must be a DIRECT connection b/w expenditure and carrying on TP’s business o Court came up w/3 prong testtraveling expense ded ONLY if it is:  Reasonable and necessary  Incurred while away from home  Necessitated by exigencies of business  EXCEPTION: USSC carved out an exception for addt’l expenses that may at time be incurred for transporting job required tools and material to and from work o Commuting to temporary employment  RULE: daily transportation expenses incurred going b/w TP’s home and temp work location WITHIN metro area NOT DEDUCTIBLE  RULE: if outside metro area DEDUCTIBLE • must be temporary (less that 1 year) o commuting at the midnight hour  RULE: if ER pays an EE’s commuting expenses. o need a provision to get us there (like gift) so Congress enacted §132 o WCF=property/services provided by ER to EE to the extent that if EE paid for it. but there is a credit available o mixed business and personal o §21 allows a non refundable credit for qualifying child care expenses  Credit is very limited • Travel expensesMAY be deductible o Transportation expenses  RULE: transportation expenses DEDUCTIBLE when TP is traveling on business (cab fare from firm to ct house) o Regular commuting expenses  RULE: cost of commuting from home to work and back  NOT deductible • Rationale: work location is fixed. so cap. that is a personal choice • C v. if you live far from work. then it is treated as personal and NOT deductible . Flower: TP lived in MI. then all becomes deductible (meals and transportation) o If you don’t sleep there. would not be deductible b/c cap expcould be income  Normally we wouldn’t even try to take a deduction for clothing b/c of the 2% floor • Domestic services and child careNOT deductible. pmts constitute income and cannot deduct through §132 fringe • EXCEPTION: regs permit cost of transportation provided by ER to EEs paid on hourly basis to be valued at $1. no matter how far TP travels [US v. TP tried to deduct travel expenses. clothing may go beyond a year.50 (regardless of actual value) if transportation is furnished SOLELY due to unsafe conditions o Luxury expenses  Luxury travel and care expenses are limited by §274(m) and §280(f) respectively • Food and Lodging o § 162(a): allows deduction for O and N travel incurred while away form home in pursuit of a T/B  EE’s unreimbursed travel expenses DEDUCTIBLE as MID  EE’s reimbursed travel expenses are deductible ATL o RULE: reason you are way must be fundamentally business related (exigencies of businessnot conveniences or necessities of traveler)  Rationale: Duplicative expenses unreasonable to expect that an EE would pick up everything and move there when you are only going to be there for a few days o What does away from home mean?  RULE: away from home does NOT include any trip not requiring sleep or rest. Expcould be income  Computer/office supplies. if bought them. worked in AL. Correll] • “sleep-rest/Overnight Rule” o If have to sleep there.
arg for deduction: she’s traveling away from “home” to go to work • If NYC. court held against TP Deduction for business meals disallowed • Holding: lunches are personal and therefore NOT deductible • Commuting discussion: just as there is a natural reluctance to lighten tax burden for suburban commuters. Claim ded for transportation and apt/meals in NYC. they would not be able to deduct commuting expenses o Temporary v. ct held against TP  HOLDINGS • Her expenses were not incurred away from home b/c decision to maintain 2 homes was a personal one & not on business exigencies o Must look to Flower’s 3 prong test • Temporary work doctrine does not apply b/c TP had no business relation to Boston  Two possible “homes”: • If Boston. it is unreasonable to assume that this is a personal choice. may treat regular residence of employment as “home” and deduct cost of food/lodging at temp job  If duration is indefinite NO deduction  Temporary MUST be under 1 year  Rationale: where TP employed in location for short time. lunch chose for mtgs b/c court not in session.  What is and is not deductible? • Occasional mtgs with other business partners  YES deduction • Taking business client to lunch occasionally  YES deduction o Undeniable that taking a business client to lunch is a necessary business expense because it reduces miscommunication problems • Everyday  NO deduction o Once a week  MAYBE  EXCEPTION: Unique circumstances • Silba & Cooper: Involved LA firemen who were required to contribute to meal fund for each day they were on duty. not a luxurious place. regardless of whether they ate or even were present at first station . he is never away from home  Good HE policy: if another student attends Columbia/husband professor at NYU. met for lunch daily near the office to discuss cases. where she lived w/Husband. the result is unfair for people who spend more money on business meal  Unadministrable to deduct client meal + not his meal. small trial firm. BUT indefinite/permanent  becomes personal Syllabus # 19 Distinguishing personal from Business (ENTERTAINMENT/BUSIENSS MEALS/HOME OFFICE) A. arg against deduction: she’s traveling way from “home” to go to husband/personal (like Flowers to MI) + NYC activities are at “home” so not deductible result after ct determines that reason for two homes is personal  Construing “home” becomes problematic only when TP lives in 1 place and works in another • If the same. there is similar reluctance for people who can arrange their work schedules so they do some of their work during lunch • Consumption problem: If we disallow any deduction for business meals. Gets summer job in NYC (where she lived for 10 weeks and traveled back and forth to Boston. or in excess of what would have been made for TP’s personal purposes  Moss v. C: Moss seeks to deduct his share of law firm’s lunch expenses. Indefinite Employment  When TP leaves regular place of job to take temp job elsewhere. • This bright line test is used out of administrative necessity  Rule ignores personal consumption element of business travel UNLESS food/lodging are lavish  Home: TP’s home is his regular/principal place of residence o Hantzis v C: TP/law student attended school in Boston. BUSINESS AND ENTERTAINMENT EXPENSES  Business meals and Entertainment Expenses o RULE: TP permitted to deduct whole price of business meals with co-workers ONLY if expense was different in form.
Soliman: Soliman was an anesthesiologist who spent 30-35 hours per week with patients at 3 diff hospitals. you’re home free B. preparing treatments. None of hospitals provided him with an office. EXCEPT AS OTHERWISE PERMITTED:  3 MAJOR EXCEPTIONS:the otherwise permitted part • If home office qualifies as PPB o If TP uses office to conduct admin/management activities and there is no other fixed location of business where TP conducts these activities • If home has dedicated space where clients/customers come o EX: If you are a hairdresser and you cut hair in a special room at home. and reading medical journals (spent 2-3 hours daily here). maintaining billing records. AND 2) time spent at each place  Commissioner v. o HOLDING: Because TPs’ situation were both unusual and unique. Court held that home office was NOT deductible o §280A: generally does not allow deductions for using residence for business purposes [ONLY APPLIES TO MIXED USE PROPERTY]. HOME OFFICE EXPENSES • Home Office Expenses o TEST for whether home is TP’s PPB: 1) relative importance of activities performed. expense for meals/entertainment are subject to not only to 50% limitation but also 2% floor and 3% haircut from §§ 67 68 respectively • THIRD: must pass through other § 274 limitations • If you make it out of §274. you still have to pay for some of it out of your pocket • This is an anti abuse provision ANALYSIS FOR BUSINESS MEALS/ENTERTAINMENT • FIRST: it must fall under §162 o Meals must be ORDINARY AND NECESSARY o Keep §119 in mind: excludes value of meals provided by ER but only if on premises and for convenience of ER • SECOND: must pass through §274(n) hurdle. and other entertainment facilities • Limits deduction for leased skyboxes in sports stadium • No deduction for club dues for airlines and hotels and other clubs  §274(n): limits deduction of meals/entertainment to 50% of cost • Rationale: accommodate Pres Carter’s concerns about how hard it is to figure out personal consumption from meals and public sentiment that govt is subsidizing expect account living • If you really think it’s a business meal. he used a spare bedroom in his house for contacting patients and surgeons. expenses were business rather than personal  RULE: Cost of client’s meal  deductible • §274(a): client’s meal is deductible if directly related or associated with active conduct of a trade/business o Leg history show that business meal is directly related to active conduct of trade/business if:  TP has more than a general expectation of getting $ or a specific business benefit  TP engaged in business discussions during/directly before/after meal or entertainment  Principle reason for expense was the active conduct of taxpayer’s trade/business  §274(d): Requires TP to retain adequate documents  §274 disallows deduction of certain kinds of entertainment • No deductions with respect to hunting lodges. which limits deduction of meals to 50% o RULE: If EE is not reimbursed ER. you CAN deduct • If there is a separate dwelling unit in attached structure to house  LIMIT: Home office deduction cannot be greater than net income from activity • POLICY PROBLEMS: o It has a personal element: ie you are using your dining room to eat as well o Horizontal equity arg: create inequity for those who can work from home vs who can’t . yachts.
it was YOUR choice  Vacation Homes • §280A also applies to vacation homes • Vacation home: dwelling unit used by TP for greater of 14 days or 10% of number of days the unit is rented o Leaves potential abuse since the provision does not say anything about staying at vacation home for repairs and maintenance  does not constitute personal use! •RULE: If own house at shore that is used purely as vacation rental. Non deductible capital expenditures are not exhaustively enumerated and §263 serves as general means of distinguishing cap expenditures form current expenses  RULE: if cost is CE. immediate deduction would save TP $50 in taxes . the expenditures should be classified as capital. regs provide that 15 year life can be used in most circumstances o 3 Possible tax treatments  Immediate deduction/expensing (BEST) • Equivalent to: interest Free Loan o EX: TP in 50% tax bracket  Invests $100 in asset that will be sold in 10 years and that will produce ordinary income at time of sale  If cost deducted in year of acquisition. it is added to TP’s basis in asset then deducted over time or recovered when asset is sold • NOTE: REMEMBER § 1001. I’m not getting an accurate measurement of what it cost me to earn that $1k over 10 years  RULE: capitalization is the norm and deductions are exceptions • Deduction is legislative grace: specifically enumerated and strictly construed. are used for more than 50% for business. • I spend $1k for machine to generate 100/year for 10 years. • EX: quintessential capital expenditure is a machine which produces income over period of time. If I deduct $1k today. other than cars. Where income is generated over a period of years. that is a garden variety of §162 or §212 expense and we don’t need to look at 280A  Dual Use Property • §280F limits depreciation deductions and lease payments with respect to: o Vehicles o Boats o Airplanes o Computers o Cells • GENERAL RULE: If any of the above property. Income is gain (accessions to wealth) and NOT return of capital • Policy: we want to tax income at the right time • CAPITAL EXPENDITURES DO NOT GET IMMEDIATE DEDUCTIONS  § 1016 adjusted to basis: basis adjusted upward for capital expenditures attributable to property or downward for allowable depreciation  Expenditure that creates/adds value to asset used in profit seeking activity for futureC E  Expenditure closely to acquisition or disposition of asset  C E  Matching objective of statute: the object of §§ 162 + 263 is to match up expenditures with the income they generate in order to accurately calculate Net income. then they are exempt from limitation Syllabus # 20: Deductible expenses and capital expenditures • §263 Capital Expenditure  NO deduction in year 1 but gives rise to basis o Generally:  Note: capital expenditure is different from a capital asset  RULE: when amt must be capitalized. A current deduction is not appropriate b/c it mismatches cost of machine with the income it produces over time. must add to basis and mortise it over its useful life • If useful life cannot be determined with reasonable accuracy. o Also you are CHOOSING for convenience sake.
9% • Yield Exemption Equivalence o Reason this problem is so important is because if we give deduction now for amt you invest in asset that is going to throw off income for periods exceeding this year. it is mathematically equivalent to saying to you. If I can deduct cost in one case and not in other. but we won’t tax you on fruit.yield is exempt from tax  Situation 2: • IRS allows 100 trees to be tax free (deductible)= 100 trees to plant • Then fruit of 100 trees taxed at 30% • Get to keep fruit of 70 trees (70%)  How do we make this situation look better and more consistent with income tax? Make second situation deductible rather than tax free! • Allow offsetting deduction of capital expenditure so have NO taxable income o Same as saying business expense o If we allow current deduction/expensing of capital expenditures/investments/trees that will yield fruit for many years.92 in taxes in the initial year • Difference of $22. asset will produce $100 more ordinary income if cost of asset had been capitalized b/c basis is now zero (able to deduct $100) • Thus TP will repay at time of sale the $50 of tax saved in year of acquisition—would have had to pay $50 but able to deduct • TP essentially defer $50 of tax for 10 years • Equivalent to: Reduction of Tax Rates or Tax Forgiveness o Ex: Market rate of interest on T’s borrowing/saving/lending is 12% (or 6% after tax)  If T puts $27. he will accumulate $50 at end of 10 years after withdrawing enough $ each year to pay taxes on each year’s interest income  10 year deferral is equivalent of paying only $27.economically it is the same as saying we’re not taxing the yield o BUT politically it is not the same  2nd situation of deducting is okay and not contrary to income tax  Ratable Depreciation—Capitalization • GENERAL RULE: expenditures that produce income beyond current taxable year should be capitalized o Ask whether immediate or long term benefits dominate and also weigh administrative costs of capitalization vs.not consistent with income tax o POLICY: Situations are mathematically equivalent  Situation 1: • Get 100 trees. C) . it’s HE inequity (Encyclopedia Britannica v. expenditure o Must look to see if recurring or non recurring expenditure  Non recurring expense: expense  Recurring Expense: immediately deductible  HE ≠ PROBLEM: unfair to deduct recurring expenses.must give to IRS 30 of 100 trees= 70 trees left to plant • IRS then says that TP can keep fruit of all 70 trees.08 is in effect forgiven • T’s tax rate has effectively been reduced from 50% to 27. tax imposed: 30%.92 in bank at 12% interest rate.we’re not going to tax yield on your investment at all [completely contrary to what income tax is supposed to do] o Fruits and trees: if we say to you we will tax you on amt from tree. • When sold.
EXP. these would NOT be capitalized and can be expensed • Lincoln Savings Test: If cost creates or enhances a separate or distinct asset  CE • NS Arg: LS means “capitalize ONLY when there’s a separate or distinct asset” and b/c we are subsidiary. • Rationale for why expenses are NOT deductible: it’s a good deal for s/h. attorney fees) and wins. §263 envisions inquiry into duration and extent of TP benefits. intangible asset. building) • Costs incurred by a company in raising capital by issuing debt or stock • Costs incurred by a company in reorganizing their capital structure • Costs of entering into a new trade/business or of acquiring stock/asset of new T/B o Two Chief Functions of Tax Planning:  Deferral of tax • May cause income to be taxed at lower rates (wait until lower bracket or when income eligible for capital gains treatment instead) • May exempt income from tax permanently if hold property until death  Conversion of ordinary income into capital gains • Acquisition of Intangible Assets of Benefits: INDOPCO and its Progeny o Court have had difficulty determining appropriate treatment of expenditures of intangible property  RULE: capitalization is the statutory default. C: Unilever wants to acquire National Starch in FRIENDLY takeover by giving $ to Starch s/h in exchange for NS stock. unless the statute specifically provides a deduction. equipment. legal. tangible personal property. we are not separate or new. This makes NS a subsidiary of U. • INDOPCO v.e. real estate. court held: Investment Banking. there would be no tax on profit of investment  NOT what IRS wants • RULES: o If expenditures creates/enhances a separate and distinct asset Capitalize o If expenditure doesn’t acquire separate and distinct assetMAY have to capitalize .e. the expense is capitalized. expenses were just costs of running business as NSthus no capitalization should be req’d o COURT REJECTED: LS did not consider a situation where there was no separate or distinct asset so court must decide such treatment here • Test Court Uses: 1 year rule o If get benefit beyond taxable year.i. contract/patent) • Cost of constructing an asset (i. are you acquiring something that you did NOT have before?  If you are maintaining status quoexpense and not capital expenditure • If INDOPCO involves a hostile takeover where Starch incurred fees to defend itself (IB fees. other costs incurred in connection with Unilever’s acquisition of NS shares are not deductible as O/N business expenses CAP.i. with long tem benefits and a friendly take over o REMEMBER: you have to ask.e. cash outlays at issue are investment banking fees to broker deal and make sure deal is fair to s/h. must capitalize  Want to be sure that TP is being taxed on profit  If give deduction in Y1.  Recovery on disposition/Sale (WORST) o RULES:  ALWAYS currently deductible: • Reasonable salaries • Expenditures for existing T/B • Interest (§163) • Taxes (§164) • Repairs  ALWAYS capitalized • Expenditures to purchase an asset (stock/bond.
Extra=CE . statute always take precedence over reg • CE tangibles  §263A  CE (building of machine/building/hard asset) • CE intangibles/”Future benefits”  CE (like synergy of INDOPCO) o Costs of acquiring stock. financial instruments. capitalization is NOT required o Two bright line exceptions:  Compensation/salaries and other amounts paid to individuals (including independent contractors who perform EE like work)NOT CE  De minimis transactions costs (under $5k)  NOT CE  More flexible 12 month rule • Expenses with Respect to a NEW BUSINESS o Big issue is whether the expense is incurred to maintain existing business (which would be a deduction) OR to change/expand to a new business (this would be a CE) o § 195 start up expenditures  CE  Start Up Expenditure: outlays in connection w/investigation or creation of an active T/B that would be deductible if incurred in connection w/operation of existing T/B or §212 activity  § 195 helps to ameliorate the problem of stat up expenses • May deduct up to $5k of start up expenses in year business or activity begins OR may amortize all costs over certain period of time (usually 5 years) • If choose to deduct in Y1. tax advice.  If outlay gives you a benefit beyond taxable yearmust capitalize  If outlay does not give you benefit beyond YR 1 can deduct now  INDOPCO Regulations (§ 1. regulatory and s/h approvals. remaining expenses are deducted over 15 year period • Deductible Repairs vs.263(a)-4 & (a)-5) • So many outlays that benefits may go beyond on year. capital improvements o ANALYSIS: ask does expense restore TP to former position (maintaining it) or did it give TP something TP didn’t have before (getting something completely different or extending use or value) o RULES:  Repair Rule: expenses associated with preserving assets and keeping them in efficient condition  IMMEDIATELY DEDUCTIBLE AS O/N BUSIENSS EXPENSE under § 162 • Repair does not prolong original expected life of assets  Improvement Rule: expenses for replacement of property or “permanent” improvements made to increase value or prolong life of property  CAPITAL EXPENDITURES o Rev Rule 2001-4: costs incurred to perform work on aircraft airframe  1) Heavy maintenance: deductible incidental repairs  2) Heavy maintenance + Adding/Improving: HM=deductible. cost of conveying property  Other costs of corporate takeovers must be capitalized ONLY if occur AFTER bright line date: earlier of an agreement b/w acquirer and target • Informal advice before bright line date is deductible • In-house salaries NEVER capitalized • Expenses incurred before final decision to merge are deductible investigatory expenses o Brings back “separate and distinct” test: “property interest of ascertainable and measurable value and subject to protection by state/fed law and possession/control is intrinsically capable of being sold separate and apart of T/B”  NOW: in absence of S/D asset. structuring transaction. leases. so treasury attempted to make some bright line rules o Loved by practitioners bc administrable but hated by academics bc theoretically off o INDOPCO regs did not become final until 11 years after the case o Note: If statute and regs contradict. and IP rights  CE o Transaction costs  only CE if “facilitate” acquisition/creation/enhancement of intangible that itself must be capitalized  Inherently facilitative costs ALWAYS capitalized • Appraisals.
 3) Replacement: CE  cannot deduct HM either b/c part of general plan of rehabilitation • Capitalized b/c one of following occurred: o Adopted property for a new or materially different use o Appreciably prolonged the useful life of the property. The logical correlation: I should get basis and should be able to recover cost over lifetime. Commissioner (TC 1979): Law student/TP was paid for law rev duties. TP sought to deduct as O/N expense . took grad tax courses. expenses needs to be §162 (t/b) or 212 (prod/income) NOT 263 (cap exp) or 262 (personal). Too hard to split the personal satisfaction of education from business o Reimbursed EE expense is excludible from income (§127) o Wassenaar v. then might be less likely to pollute in the first place • Discourages new owner to clean up someone else’s pollution • §198: corrects this clash of tax/env policy Syllabus # 21: Expenses that implicate both section §§ 262 and 263 • Job Seeking Expenses o Rev Rule 75-120: expenses incurred in seeking NEW employment in SAME T/B are deductible under §162 if directly connected w/such T/B as determined by all objective facts and circumstances  if person presently unemployed. An accountant turned lawyer goes beyond maintaining skills but can establish himself in new T/B o Problems w/deduction education  Capital Expenditures: benefits last beyond the year. then passed bar & found permanent employment. but clashes for environmental policy • Polluter is rewarded b/c own pollution is deductibleif cost of cleaning up my own mess weren’t deductible. qualifying me for doing job for long period of time. worked 2L summer. replacement o TP “not carrying on” T/B  NO deduction  “law degree at night” cases fall under here. Law degree is not personal. his T/B consists of services previously performed for his pas ER as long as no substantial lack of continuity b/w time performed past employment and seeking of new employment  Expenses NOT deductible for first time job seeker  New Trade or Business: causes arbitrary distinctions  corporate exec in oil industry may deduct costs in looking for job as exec in retail industry BUT lawyer who looks for teaching position cannot deduct • Education Expenses o ANALYSIS: Objective Standard  First: have to show that you have a good §162 claim  Second: have to show that what you’re getting isn’t enabling you to begin a different business (263 cap exp) o Generally  Educational expenses are personal investment as well as professional investment  RULE: to deduct educational expenses. AND effect of work for which cost made o Environmental Cleanup Expenses  Above analysis becomes difficult in environmental remediation • Expenses to remedy TP’s own prior pollution  currently deductible as repair o Main reasoning: restoring land to its original condition o Economic reasoning: presume you knew what you were getting so you paid less for polluted piece of land  thus clean up would improve the property  This analysis is rational for tax policy. must prove that education is an O/N business expense o Expenses of maintaining or improving skills in established T/B  DEDUCTION  EX: Attorney attending NYU Tax Seminar  deductible  EX: Attorney attending 2-week course in Fed Tax  deductible  EX: Young associate sent to get LLM/CLE  deductible  Rationale: repairs vs. but intangible  amortized/suffer wear/tear  Law school has a §262 problem: in order to take current deduction. OR o Materially added to value of the property  **Must consider costs’ purpose and physical nature.
Court held against TP  Non-deductible personal expenses bc not engaged in T/B of attorney at time of expenses. grade. period]  Mandatory system of depreciation  Applies ONLY to tangible property  §168 shorten recovery period (doesn’t even use term useful life o RULE: In order to be able to depreciate an asset.goes on in perpetuity  More favorable to TP  Generally not allowed by big companies currently A. but how long the thing will be useful for the purpose for which TP bought it  EXAMPLES: • Real estate has ascertainable lifeDEPRECIABLE . Syllabus # 22: Cost Recovery Mechanism • GENERALLY o Principal mechanisms for recovery of capitalized expenditures over a number of years:  Depreciation: Cost recovery mechanism for tangible property (§167)  Amortization: Cost recovery mechanism for intangible property (§197)  Depletion: Cost recovery mechanism for land – generally used for mineral extraction • Land will at some point cease to be productive • Two ways to use depletion: o Cost depletion= generally starts from cost (price of land) and figures out depending on method some way of having TP take that cost over some period  generally thought to be theoretically sound because founded on cost o Percentage depletion= more of a tax subsidy then cost depletion. DEPRECIATION DEDUCTION DEPRECIATION DEDUCTION ANALYSIS: • If expenditure is a machine used in T/B. move on  If NONOT depreciable • Use §1016 to adjust basis downward and capital recovery occurs on disposition o Does exceptions to §162 apply =§179? if yes.unmoored from any notion of cost. incurred in T/B the cost of his masters of law degree in taxation that he pursued prior to permanent employment. it must have ascertainable useful life  Useful life=measured not by how long the thing will exist.take a percentage of what you’re selling mineral for and deduct it. thus not improving his skills  NOTE: W fails at start of analysis = has to be T/B and W is not practicing law yet. it is CE and NOT currently deductible under §162must be CAPITALIZED under §263 + gives rise to basis • Is the asset depreciable? o Does it suffer exhaustion/wear/ear/become obsolete?  If YES. then take current deduction o If §179 does not apply go to §167 – “there shall be allowed a deduction” taken in a manner stated in § 168 (168 is the accelerated cost recovery system) o Do you have an intangible? § 197 • Generally o REMEMBER: purpose of capitalization is to match up expenditures with income they generate o §167: Depreciation [gives you deduction]  Exhaustion/wear/tear property used in T/B (§162) deduction (ABOVE)  E/W/T of prop held for production of income (§262)  deduction (BELOW)  NOTE: NOT personal/consumption expenses (§262) o §168: accelerated Cost Recovery System [gives rules for timing.by statute.
property will be worth something  Under GAAP. must look at salvage value  If has salvage value. will generate income of $3K for 5 years • To be theoretically correct. look at: • Useful Life • Salvage value: $0 o tax system since 1986 assumes everything is WORTHLESS at end of period o simplification but takes us away from getting economics right  HYPO: Buy widget machine – CE • why do we want to take a portion of the cost into account even though I have no realization event? Why not wait until sell? o As policy matter we are trying to match the cost of generating income with the income that is being generated • EX: cost=$10k. must subtract that from cost then spread across useful life • Types of Depreciation o Economic: recalculate value of item each year to determine what it is actually worth  NOT used o Accounting: spreads costs over life somewhat arbitrarily • Income Tax Rule of Applying Depreciation o Depreciation is applies to the depreciable base  property’s basis (§1011)  Property’s basis is cost + any CEs added to basis under §1016 (1016 remember is adjustment to basis)  Up basis for capital expenditures  Down basis for depreciation allowable  Depreciation Allowable: if I haven’t taken the deduction. it has reduced useful life • If not depreciable. So take the deduction  At the end of the line. must look at economic depreciation – recalculate each year to determine what machine is worth. my basis is going to be adjusted anyway. but currently at 50% (has been as high as 80%)  **Varies if Congress is trying to stimulate the economy • Congress can either: . all selling price = income o Basis is then reduced periodically by the amount of allowable depreciation o Depreciation allowance depends on depreciation rate (shows method and recovery period)  Straight-line Rate  spreading costs evenly over useful life • Must always be used for real estate  Declining Balance (Accelerated) Rate: allocates a larger portion of the cost to earlier years and a lesser portion to later years  Bonus Depreciation: lets you deduct even more in 1st year then accelerated • Number varies. must wait until disposition to recover asset  RULE: when determining how to depreciate. If I sell next year for exact same cost. • Share of stock exists in perpetuity so does not have ascertainable useful lifeNOT depreciable • Land has no ascertainable useful life  NOT depreciable o EXCEPTION: Depletion • Current system uses broad categories where most business assets are give a statutory life of 3-5 years • When congress has wanted to stimulate activity in specific sectors. AB will 0. I’ve fully depreciated my property. IMPRACTICAL • What do we want to know about the machine if want to match income? o What is the machine’s useful life?  Period of time it will be productive  Way you are going to spread costs o Does it have any salvage value?  Can we sell at the end of 5 years and for how much?  In most cases.
5 months for year • HYPO: $10k cost and able to take $6k depreciation deduction b/c have bonus depreciation o What happens to basis? (general rule is basis is cost)  Should it remain at $10K? • NO – it would allow you to double recover • If sell property at end of this year for $10k – you would have paid no tax on $6k of income • § 1001: Gain = Amount realized – Adjusted Basis • Point of basis is that income gets taxed once – not more or less than once  RULE: if take a depreciation deduction.it does not have a limited and ascertainable useful life & does not suffer wear and tear that is why courts say not depreciable • If doesn’t suffer wear and tear. buying for use o Can only play music for certain amount of time (corrects 1st Arg) o Suffering wear and tear (corrects 2nd Arg) • TP purchased at such a high price because violin bow could produce a different sound- inherent musical value o Judge Gerber’s “Elvis HYPO”  Elvis buys guitar for $1. period of time during which suffers wear and tear is its useful life o EXCEPTION:  Simon v. will have indeterminate useful life • If does suffer wear and tear. we have to find a useful life. o Reduce costs of capital equipment by giving grants of subsidizing manufacturer of equipment  subsidies (gov’t cutting check). OR  Administratively difficult  Politically unpopular o Can give current deduction  This would exempt the yield from tax liability  Major cost to gov’t but major benefit to business/economic activity • CURRENT RULE: Accelerated Depreciation  use declining balance rate then eventually switch over to straight line rate • What if property not purchased on first day of year or disposed of on last day? o Personal Property: half year convention  No matter what day of year. have to reduce basis (§1016)  Suppose statute allows you to take deduction but can’t use b/c don’t have enough incomedon’t have to take it! • Depreciation and Antiques o GENERAL RULE: Antiques are NOT depreciable bc they do not have a determinable useful life  In order for expensive painting in law office to be depreciable.simply not depreciable o Can’t allow depreciation deduction for something that is going up in value! • Difference between buying for display v. Court allowed deduction because they accepted evidence that the bows can suffer wear and tear that would cause them to eventually become unplayable • RULE: Any §162 or §212 property that can suffer exhaustion. Commissioner: Professional musicians purchased two 19th century violin bows.000 .if we are protecting it from sunlight and expect that it will be hanging under museum like conditions. if not owned or disposed of for entire year. then TP will take half year’s depreciation in year of acquisition and other half in year of disposition o Real Property  TP takes one half of month’s depreciation for month of acquisition and disposition  EX: if purchase on Oct 20  depreciation allowance of 2. or obsolescence is depreciable o But we don’t measure actual wear and tear  impossible • IRS ARG o Can’t determine life of antique. wear and tear.
suffers wear and tear o Simon would allow $11K cost as basis for which depreciation will apply  BUT Gerber says that you should only allow $1K machine part of guitar as basis so should be able to depreciate $1K irrespective of collector’s value  Can have decrease in machine value and increase in collector value  BUT CURRENT RULE= COST IS BASIS OF DEPRECIATION • §179 EXCEPTION o Allows you to expense (fully deduct) any capital purchases up to certain amt if you’re a small business o Used as a stimulus provision o Congress raised the ceiling of purchase up to $250.then intangible goodwill is worth $1M o But goodwill does not have ascertainable life. but electible  May want to choose depreciation bc you may not have a lot of profits (GI) to offset that year and absorb those deduction (so deductions would be of no use!) • §280F Limits on Depreciation on Luxury Cars o Congress has attempted in §280f to do something similar to Gerber  You have a luxury car used only to commute to work (not business asset). it increases to $11.000 lbs • THEN we got Hummers! o Get to depreciate under this provision.000  With respect to mixed ownership of guitar. should be allowed to depreciate the machine part of the guitar • Simon court would allow it to be depreciable.000 lbs • Big expensive vehicle necessary for farmers.000  If sold to Mick Jagger for $11. it is not depreciable  But TPs got creative bc don’t want to not be able to recover  Decides to find useful life of goodwill individually • Ex: Work force in place (turnover every 5 years) o Able to amortize over 5 year • Ex: Customer lists  Courts were not consistent so Congress created 197 .commuting is personal expense • Not depreciable bc in order for property to be depreciable must be used in trade/business or income-producing activity  You have a business luxury car that is used in trade/business • Arguably depreciable o Ascertainable useful life o Wear and tear • Should you be able to take deductions for cost of luxury car even though you can do the same thing with an economy car?  280F: allows depreciation but limited to exclude excess cost of luxury vehicle and limited to 6.000 lbs • Truck= assumed to be with anything under 6.000  We get 2 guitars conceptually • 1) Instrument: $1. etc) o If value of assets are $1M and you pay $2M.not good!  Incentive for SUV bc that won’t be limited by pound limit in 280F o This problem ameliorated though not completely fixed by Congress • §197: Amortization of Goodwill and Certain Other Intangibles o 15 years straight-line amortization of intangible items o If buy existing asset. etc (Congress had not thought about this.  Once he buys.only thanks to lobbyists) • Car= anything under 6.000 • 2) Collector’s Item: $10.000 for 2008 (original limit was $25K!) o LIMITS:  TP’s annual total investment in capital equipment must be $800. look at value of individual items (inventory.000 or less (for 2008)  Deduction is phased out dollar for dollar for TPs who exceed the cap o Note: §179 is NOT mandatory.
you don’t have to worry about 1245 recapture  Recapture amount is in effect the depreciation you took • If did not recapture. factor that amount out o Then place all 1231 losses and gains in a box  §1001 G(L)=AR-AB o Net them up o If have net loss . but rather year by year o Must ask what transactions in 1231 assts have you had? o Then go to 1245 and see if we need to recapture  If a loss – NO need for 1245  If YES. o Gain/Loss arising from condemnations and involuntary conversions (casualty theft or theft losses) of property used in T/B o Gain/loss from condemnations and involuntary conversion of capital assets held in connection with T/B or in profit seeking activity  Real or depreciable property (land. would cause a double deduction Not bringing back an amt not in tax base  just refer to rate (recapture as ordinary income)   Any amounts recaptured don’t enter into netting process ANALYSIS: How do 1231 and 1245 work? • §1231 does NOT operate asset by asset. etc o Applies to:  Disposition of • Three types of dispositions may give rise to §1231 treatment: o Gain/loss from sales and exchanges of property used in T/B. buildings. fixtures) that is excluded form definition of capital assets in § 1221  Used in a Trade or Business  As long as property held for at least one year  OR certain property made specifically eligible for 1231 treatment • Timber/coal/minerals • Certain livestock • Un-harvested crops sold with land o Does NOT apply to other business assets denied capital against treatment § 1221 o §1231(c) Recapture: may require amounts that otherwise would be 1231 gain that would be treated as capital gain to be treated as ordinary income  RULE: TP req’d to treat as OI the excess in any year of his 1231 gains over his 1231 loss to the extent of TP’s net 1231 losses for preceding 5 years.Syllabus # 23: § 1231 and 1245 • § 1231 ASSETS o §1231 allows real and depreciable property used in a T/B to yield capital gain when disposed of at a net gain and ordinary loss when disposed of at a net loss  ALLOWS TWO BEST OPTIONS  Purpose: enacted by congress to stimulate the economy (after WWII) and get people to purchase new machines. $5K treated as Ord  Any amounts recaptured don’t enter into netting process  This provision tries to prevent TP from bunching gains from 1231 assets into 1 year and losses into another (deter cherrypicking)  REMEMBER: 1231(c) only recaptures for prior losses (doesn’t change anything if loss in subsequent year) • §1245 Recapture Provision: restores to ordinary income that portion of gain on § 1231 items with prior depreciation deductions + excludes that ordinary income from § 1231 netting process o §1245:  If you have a loss. • EX: o TP has net 1231 loss of $5K in Y1  treated as ordinary income o TP has net 1231 gain of $8K in Y2  $3K treated as CG. machinery.
 Operational losses: engaged in activity and make profit but also have costs – may have GI but cost of activity exceeds the income  thus operating at a loss • Can you deduct each amount (not asking if we can deduct bottom line loss)? • GI – Ded. but as costs incurred in trade/business or income producing activity o RULE: Use §183  RULE: Never forget about basis! .000) • Want to be able to deduct each of those costs not as losses. = TI  1. GENERALLY o Losses refer to 2 different conceptual things:  Transactional losses: occur when amount realized is less than your basis (from 1 transaction)  loss that follow realization event • § 1001: G(L)= AR – AB  300 – 1000 = (700) • § 165: gatekeeper of losses. I’m done  NO ded. AB would still be $4k  AR=$12k  § 1001=G(L)=AR – AB=12-4=8 • §1245: $6K must be kept out from depreciation deduction [above the line deduction] o Deductions above the line are always going to be ordinary income o SO $6K must be placed back into ordinary income (return of cost basis) • ULTIMATELY: We would have $6K ordinary income and $2K 1231 gain Syllabus # 24: TRANSACTIONAL LOSSES LOSSES ANALYSIS • Figure out if I have gain or loss? o Apply §1001 (gain/loss) formula: AR-AB. A. you have a loss • Can I do anything with loss for tax purposes? o Look to §165. ONLY deduct amt that exceeds it.  Then everything is ordinary (gains & losses) • If in 35% tax rate: gains at 35% but losses save you 35 cents on the dollar • YOU’RE DONE o If have net gain  Then everything is capital (gains and losses) • Losses offset capital gain – taxable at max rate of 15% • Deductions on losses will save you 15 cents on the dollor  BUT you’re NOT done  must go to 1231(c) to determine if need recapture losses from previous years o HYPO: Bought depreciable machine for $10k. • § 165 limitations: o Individual? o T/B? o For profit? o Casualty? 165(h)  De minimis amount: Is loss > $100?  Floor: Does loss exceed 10% of AGI? If Y.000) = (6.000 – (7. the gatekeeper of losses o If I don’t get out of § 165 with permission to take deduction. took depreciation of $6k  § 1016: AB=10-6=$4k • Keep in mind that even if you don’t take depreciation deduction. If AB > AR.
no deduction • Austin v. No Ded for loss b/c it was incurred on the sale of property purchased FIRST for residence o Hypo #1  Buy a share of stock for $100. no deduction • 165(c)(2)—losses incurred n any transaction entered into for profit GAMBLING LOSSES  § 165(d): allows gambling losses to be deducted to the extent of gambling gains • § 165(c)(2)—must gamble w/profit seeking motive  Cohan Rule: • If no adequate records. lose $30K. what can I deduct? o Did I intend to make a profit? (§ 165(c))  If yes. stop.000. but did contracting on side. casualty or theft o § 165(d): allows gambling losses to be deducted to the extent of gambling gains. WHEN DO LOSSES OCCUR? • § 165: RULE IS IF LOSS IS NOT DEDUCTIBLE UNDER HERE. must make “close approximation as possible”  Commissioner v. (see below.165-9(b)(1): permits a deduction if the property has been appropriated to income producing purposes  RULE: Losses from the sale of property must be allocated b/w the different uses • Deduction allowed in proportion to the business or income-producing use • Sharp v. storm shipwreck. TP took depreciation totaling $13. IT IS NOT DEDUCTIBLE AT ALL o § 165(a): any loss sustained and not compensated for by insurance (1231 losses are deductible) o § 165(c): FOR individuals. but no additional 10k deduction PROPERTY USED FOR BOTH PERSONAL AND BUSINESS  Reg. United States (3rd Cir. 1962): TP bought a plane for $54.B. MUST BE ITEMIZED • Reese v. losses are limited to:  165(c)(1)—business losses—ABOVE THE LINE DED (§62(a)(1) deduction as OI)  165(c)(2)—profit seeking activities—ITEMIZED DED (see below. Ct said TP did contracting primarily to make profit (not his t/b) so loss incurred is deductible under 165(c)(2)  Connection b/w 165 & 262 requires profit motive > personal motiveif not. § 1. go to §165.000 o TP ARG: . Used 75% of time for personal matters & 25% for business. you walk out of 165(c) ok o 165(d): can offset 30k losses to the extent of 20k gain o You have 0 TI. gambling losses) o § 165(g): If any security becomes worthless during taxable year loss from exchange/sale of capital asset  Gives you a realization event. Commissioner: TP bought home for personal reasons & sold at a loss. profit seeking activities’ losses)  165(c)(2)—losses from fire. and sell for $1  G(L)=AR-AB=1-100=(99)Loss Now. Commissioner: TP was exec. Do we make it out with a deduction? If NOT. but § 165(d) will only allow gambling losses to the extent there are gain  HYPO: I gamble and place 1 bet$20k • Accession to wealth? YES • Character? Ordinary income o not the sale or exchange of a capital asset • Suppose you. then.000. Sold plane for $35. though fictional (§ 1222 requires realization for capital assets)  Anti TP provision: making sure what should be capital loss because relates to capital asset into ordinary loss (causes TP to be stuck with capital treatment of losses) LOSSES FROM PROFIT SEEKING ACTIVITIES  § 165(c)(2) losses: can be deducted from AGI only if result from a sale or exchange of property or are attributable to property that produces rent or royalties—otherwise. Groetzinger: a professional gambler engages in a trade/business if involved in the activity with continuity and regularity and with the primary purpose of earning income or profit • RULE: Gambling expenses are deductible under § 162 as O&N expenses and can be carried back/forward under § 172.
250 business gain o HOLDING: Loss was NONDEDUCTIBLE  Deductions allowed only in proportion to business and personal use  HYPO: • Airplane: Cost=100k Dep=20k A. it will be ordinary.500 for personal portion and $500 for business portion  $26.000 depreciation was allocable only against business portion of plane.500 of cost was business (25%)  $13. leaving AB of $40. The excess will be 1231 in character.=80k (50% business use): o Business Side: Basis=100k-50k=50k  § 1016: 50k-20K=AB=30K (adjust basis downward) • AR=80K x .000 loss (AB – selling price) o GOVT ARG:  Said $40.500 of cost was personal (75%) and $13.  Said AB was $41.750 was business  THUS: TP had $14.250 of sale price was personal and $8.250 nondeductible personal loss and $8.5=40K  § 1001: G(L)=AR-AB=40K-30=10K  Is it a capital gain? (a sale/exchange of a capital asset) • § 1221: NO. UNLESS there is something that takes ordinary gain and turns it into capital o Personal Side:  50K=AB=50K  G(L)=AR-AB=40K-50K=(10K) NO DED . b/c it is depreciable • § 1245: To the extent that your gain reps a restoration of depreciation. • § 1231: This suggest the gain of 10k is ordinary.R.000 (cost – depreciation) and so he sustained $6.
but not recognized – then basis stays the same • Basis is just same basis of previous home Losses: AB>AR o Losses are realized if recognized. (then proceed to either gain or losses. is this above or below line deduction?  §62(a)(3)  §67(b)(3): 165(a) for casualty/theft losses  165(h)(4).ANALYSIS FOR TRANSACTIONAL LOSSES • Do I have a realization event? If yes. STOP. o Look to § 165 gatekeeper for losses. first go to 165 then go to 62 then go to 67 then go to 68 • HOBBY LOSSES • § 183: provision designed to restrict the deduction of losses under § 165 to those incurred in the course of a business or profit seeking activity (provides guidelines for determining whether an activity is entered into for profit) o Pro-TP provision b/c gives you ability to offset some costs to the extent you have some income in the activity  §183(a): No deduction if activity is NOT engaged in for profit. fire) – won’t recognize that gain if you reinvest it  If you take amount of realized gain from involuntary conversion and invest in similar property. §212 (income-producing activity) • Once we show he’s in business/engaging in activity FOR income. with (20k) leftover . except as otherwise provided • Must find in §162 (trade/business). if can’t find a deduction for the loss. §167 (depreciation). • Is it a gain or loss? o Apply § 1001: G(L)= AR – AB. U ARE DONE  § 165 limitations: Individual? T/B? For profit seeking activity? o If loss above 10% for casualty.must ask is it a capital asset? • Not capital asset because it is depreciable  Now we go to 1231 – loss • Never have to worry about 1245 depreciation recapture with loss but must consider 1231(c) recapture  Loss is going to be ordinary if only transaction in 1231 property that year • If trying to figure out if above or below line deduction. you can offset costs to the extent you have income •  §183(d): Rebuttable Presumption-if 3 out of 5 years you made moneyyou’re engaged in it for profit • If can’t meet presumption. his expenses are 120K • Deduct to the extent of income 100k.casualty losses may be above line as long as don’t exceed gains • Even though don’t actually have sale or exchange. accordingly) Gains: AR > AB o Realized gain will be recognized unless there is an exception that call off recognition o 1 Exception: §1033 non-recognition provision for involuntary conversions  Comes into play when have gain as a result of involuntary conversion (eminent domain. those expenses are deductible  §183(b): Even if not engaged in activity for profit. you have constructive one • 62(a): losses from sale or exchange are ABOVE THE LINE • Makes sense to treat exactly the same o What about theft?!  165(e) specifically mentions theft losses as different from casualty  Theft loss not found in 62 or anywhere else to make above the line  generally it is below the line!  But what if theft is of business property? • Then you’re not under 165 – 162 (all trade/business losses are above the line except unreimbursed EE expenses) o What about character of loss? [EX: Machine]  In order to figure out character. see Regs (2:7 year presumption for horse breeding)  HYPO: Income from profit seeking activity is 100K. what ought to be your basis in similar property? • If realized.
oil drilling. Salary=100k.166-1(c) o Debtor-creditor relationship must exist o Based on valid/enforceable agreement to pay back  No deduction for debt that was worthless when you bought it  Note: no bad debt deduction is allowed for a claim for unpaid wages or rent b/c they are treated as have zero-basis (would be excluded from GI. an engineer. deduct the left over (20k) and he will have Income=80k) see § 469 o Plunkett v. was engaged in two sports. etc. After learning truck pulling pays more he switched to it. it’s like you will not have TI • allows costs of generating income to offset income from prize  may avoid fact/circumstances evaluation if can meet presumption of making $$ 3:5 years o § 469: creates box for losses from passive activity (similar to 1231 analysis)  ATOMIC BOMBkills the shelter value by going activity by activity • If actively engaged in business (NOT passive invest)these rule do not apply • if passive investor (doing these as a limited partnership) then we create a box and these deduction only allowed to extent of income from activity o NOTE: if have client interested in taking deductions attributable to investment in real estate. Commissioner: TP. § 1. less attended. or  if income seeking activity§ 212 BELOW THE LINE (subject to §§ 67 floor and 68 haircut) o § 183 might help TP out (place all expenses in box – similar to 1231 analysis)  if you get income from the profit seeking activity. Losses for mud racing NOT deductible b/c no engaged into for profit. both of which he invested significant funds in: mud racing is cheaper. § 1. 469 will get you) BAD DEBTS • Types of Bad Debt: o Requirements  Dominant motivation for the bad debt MUST be business related (turns to facts/circumstances when both investment and business reasons exist)  Must be a loan • § 166: presupposes the existence of a bona fide debt • Requirements for Reg. ability to take deduction & use to shelter income from activities may be limited by 469 (most cases where you are passive investor. keep records. and broadly entered into for fun. otherwise there would be double benefit) o Business Debt  Types • Business Bad Debt: deductible in full as an ordinary loss . Losses for Truck pulling were b/c primary purpose was to make profit (did truck pulling upon learning of profit potential)  Reg. •(Tax shelter: can come from his regular business.183-2(b)(6) o Standard: was your PRIMARY OBJECTIVE to make money? (not just expectation/hope/wish o Did TP train.183-2(b)(6) acknowledge that losses can be incurred during the formative years of profit-oriented activities • ANALYSIS FOR OPERATIONAL LOSSES [183 determines whether loss is deductible] o Look at 1. do the activity in business like fashion? o Are there any deductions—cost incurred greater than income generated?  if activity rises to level of trade/business§ 162 ABOVE THE LINE.
so no adjustments to basis] o Does it suffer wear and tear or have ascertainable life? o If YES. •Partially worthless Bad Debt: can be deducted to the extent charged off by the TP on his books o Non-Business Debt  Types: • Partially worthless non-business debtnot deductible • Wholly worthless non-business debt: o § 166(d): if the bad debt is a non bus bad debt you get deduction above the line (no garden variety loss). ALIMONY AND SUPPORT PAYMENTS: § 71 and § 215 • RULE: Pmts are deductible as alimony on if made pursuant to a court decree or a written separation agreement 1.  Assures that the money is only taxed once  Combined. you are only going to get a STCL  Public Policy: Congress wanted to prevent TPs from lending money to friends/relatives who they knew would not repay it and then deduct loss against ordinary income • It’s sometimes advantageous for a TP to attempt to achieve a deduction as a § 165 loss (instead of bad debt)a non- business profit seeking transaction that produces a loss may be deductible against OI • Person who guarantees a loan is treated in same manner as TP who made loan directly ANALYSIS FOR BAD DEBTS • First must prove that it is a loan [HYPO: Loan $100K] • What is lender’s basis in IOU? [HYPO: $100K] • Is it depreciable? [HYPO: NO. ALIMONY DEFINED BY § 71: o § 71: payee includes alimony in income & § 215: payor deducts pmt from GI (above the line). it’s a duck Syllabus # 27: DISSOLUTION OF THE UNIT OF TAXATION A.must be a business motive! o How do we determine whether motivation was business when dual purpose?  We look at totality of circumstances • How much $ making as EE • What is size of investment in corporation o Ultimately what we’re doing is applying the “duck” test – if it looks like a duck and quacks like a duck. which would be a STCL  Not as great as ordinary loss since a CL is limited to the extent of CG + 3k  We are still going to have the inquiry “if it is really a debt or a gift?” And if so. MUST DOMINATE) • We want to give in principal a deduction.000 • Bad debt will never be deductible on terms that TP wants • Question here is: what is the TP’s motivation? o Investment is not good enough. you get the same effect as being married o § 71(b)(1)(A-D): Taxable Alimony Requirements  The payments must be in cash (not services/property) .must adjust basis • Even if realization event (declared bankrupt) – amount will be $0 • Then go to § 165: o Trade/business: NO. Income-producing activity: YES • This is NOT enoughwant to ensure not based on personal motivation and not actually a gift (BUS. but want to ensure motivation is business bad debts are thus taken out of 165 and put in 166 o 166(a) allows deduction for any debt which becomes worthless in taxable year o 166(b) limits deduction to basis o 166(d) loss will be capital  limited to extent of capital gains + $3.
• This is to distinguish b/w prop settlements and alimony • “by or on behalf”: intended to allow some 3rd party payment (instead of giving half. it is better for the parent with the lower AGI to meet this floor and take the deduction o § 152(e) solves problem that existed prior to 1984 where both parents were claiming child as dependant. but amt will be reduced by 10k when kid turns 21. Property settlement b/c you get a deduction for alimony payments (if you are in higher bracket than spouse/payee) • If it says “these payments are NOT alimony”for state purposes it is still alimony. The custodial parent was determined through facts and circumstances (what a mess). I agree to pay ex 20k/yr for alimony. • Ex. the couple agree on whom) o B/C of the 7.  Recipient received a basis in the property equal to its FMV o § 1041: provides that no gain/loss is to be recognized on any transfer of property b/w spouses or on a transfer incident to divorce b/w former spouses. Davis (the rule changed after 1984 with the inception of 1041)  TP recognized gain (not loss) on transfer of property to a spouse in exchange for the release of marital claims.  Tax Planning: • § 152(e)(1) (Dependency Exemption): goes to custodial parent or agreed upon parent (child can only be dependant of one parent.5% floor req’d by § 213. as long as it is taxed once it doesn’t matter to whom. we assume payor is in higher bracket b/c he is making payments. it is preferable to want Alimony vs. § 1001. congress doesn’t care who claims child as long as gov’t does not get whipsawed 3. Now. I will pay his rent or mortgage)  It is alimony UNLESS agreement says otherwise • Generally. gain income but have big cap loss carryovers and not paying tax b/c the loss carries over offsetting my current gainI would prefer not to do §§ 71 and 215. but for tax § 71 and § 215 will NOT apply o Normally. CHILD SUPPORT: non deductible to payor and excludable from income to recipient o § 71(c): § 71(a) will NOT apply to any part of alimony pmt that is for child support  Child support is NOT income  Policy: legal relationship w/kids does not changed b/c of the divorce  § 71(c)(2): supposed to prevent change based on some contingency related to the child. is that gain that is realized is recognized unless there is something that tells you otherwise.  The parties cannot live in the same household if they are legally divorced/separated • Intended to prevent avoidance of the marriage penalty  No liability for any pmt after the death of payee • (Reduction should only be for amounts used to support the former spouse) • Payments HAVE to stop at death  (Pmts don’t constitute child support) o § 71(f): LIMITATION (prevents structuring property settlement to qualify as alimony)  prevents a payor from frontloading alimony pmts  Recapture: any excess alimony pmts must be included in the payor’s GI in the 3rd post separation year and the recipient can deduct a like amount o § 62(a)(10): permits the alimony deduction allowed in § 215 (Above the line deduction) 2. if I have economic wealth because of non taxable municipal bonds or have cap. PROPERTY SETTLEMENTS (§ 1041): non deductible to payor and excludable to recipient o Prior Law: US v. But.(1041= the “otherwise)  A transfer is treated as incident to divorce IF • It occurs within one year after the marriage ceased • It is related to the cessation of the marriage . General rule. Looks like half of the 20k is child support. o Congress doesn’t care.
who are required to recognize larger capital gains or recapture OI when they ultimately dispose of the property in a taxable transaction o HYPOS:  #1: Judge orders wife to transfer to soon-to-be ex-husband some stock • Basis in stock is $100. except for the phase out component • § 151(a): for an individual the exemption provided by this section shall be allowed as deduction • § 151(b): exemption hence a deduction for yourself and your spouse . while thee recipient spouse. is entitled under the Davis rule to compute his/her gain/loss by reference to a basis = to its FMV  §1041 generally favorable to transferors. STANDARD DEDUCTION (§ 63(c)) • Instead of the itemized deduction a TP could take the SD o § 63(c): Standard Deduction is a flat amount that varies with marital status and may be taken regardless of whether TP actually had expenditures. he would have a loss of $50  Holding period also carries over! • Policy: No reason to allow payor to take deduction for loss because she wouldn’t be experiencing it  husband would VI. who do not have to recognize gain on the transfer of appreciated property and unfavorable to transforees. Indexed for inflation • Currently there is a marriage bonus since a married couple who only has one income winner will get twice the SD of a single income winner • Rationale for SD: o Provides base amount which you’re not taxable (floor) • To the extent of SD. DEDUCTIBLE PERSONAL EXPENSES • We allow for reasons outside general principles of tax policy and are available to higher income TPs as well and thus do not serve to exempt low income TPs (PE is available to those who itemize and do not itemize. we require carry over basis (it exists even if there is a subsequent gain/loss). §§ 63(d) 63(b) # Syllabus 25: Personal deduction and credits A. PERSONAL EXEMPTION (§ 151) 1. so if GI=20k and SD+PE=20k TI=0) • It is the same as saying that the first 20k of TI are taxed at 0 bracket o Simplificationno paper work means no auditing. there won’t be taxable income • Provides floor through the 0 bracket effect by combining SD and PE • Has to be true if TI is base and everyone gets SD and PE (no matter how high GI you have. in order to preserve ability to realize gains in the future. one spouse can transfer a loss to another spouse through carry over basis  Policy Reasons • Inappropriate to tax transfers b/w spouses (husband and wife are single unit) • Government gets “whipsawed” o Transferor will not report any gain on the transfer. FMV is $300 • Under §1041: o Husband does NOT have income o Wife does not recognize gain o Husband now has carryover basis ($100)  #2: Stock has basis of $350. just give people a deduction B. • In effect.  Recipient takes a carryover basis in the property equal to the adjusted basis of the transferor  Planning Point: for non recognition. bun UNLIKE the gift basis rule of § 1015. regardless of the transferor’s motivation/intent. Basics • Based on same policy as SD. when he/she sells. FMV of $300 • Under §1041: o Husband has carryover basis of $350 o If he sells. you get SD and PE. the transfer b/w spouses is treated the same as a gift.
if at 35% . • § 151(c): additional deduction for each individual that is a dependent (go to 152) o § 152 Dependants: rule based provisionMUST have relationship defined in statute  § 152: a dependant is a qualifying child or qualifying relative  § 152(c): defines qualifying child  § 152(d): defines qualifying relative. EARNED INCOME TAX CREDIT (§ 32) • § 32: provides a credit to low income individuals who have earnings o TP is eligible if:  Have a qualifying child. for example 2.610  § 32(b)(2)(b): the phase out amount increases only by 1k if married filing jointly . but just made it not useable for a lot of people C. EARNED INCOME TAX CREDIT (§ 32) & CREDITS 1. to have more income (EITC rises as income rises). Phase out (§ 151(d)(3)) • In the case of a TP w/AGI exceeds threshold amount . Credits • BASICS: o Deduction of $100 vs. Exemption Amount (§ 151(d)) • § 151(d)(1): exemption amount=2k • § 151(d)(4): amt in 151(d)(1) is adjusted for inflation (personal exemption is indexed) i. . an additional dollar of income costs you a loss of the EITC. even the one for yourself. in some sense. WHY? o Congress needs the revenue and it added this to broaden the base  It brings an amount that automatically had been out through a deduction back in  Policy Justification: 0 bracket effect reasoning as above • If your AGI very highdon’t need 0 bracket b/c ability to pay (makes system progressive) o getting the job done with less hissing b/c we haven’t repealed the PE. but In the case of § 151(d) you can lose them all. • § 152(d)(2)(H): 1)individual 2)same principle place of abode as T 3)member of TP’s Household (no blood or legal relationship req’d) 2.Save $35  SAVED $35 IN TAX  Deduction taken into account to get to TI  Deduction will never make something free. .$0 deduction=TI $1000 x 35%=$350-$100 CREDIT=$250  SAVED $100 IN TAX  Credit taken into account when actual tax due  Credit can give you free money • Prefer credit only if amounts are the same BUT catch is that rarely get an equivalent o Congress figures this in structuring credit • As a matter of horizontal equity.  Once you hit the phase out. o The phase out number § 32(b)(2)  § 32(b)(2)(a): phase out for 1 qualifying child is $11. • Sounds like § 68 phase out.$100 deduction=TI $900. which mechanism provides the most HE? o Credit b/c credit goes right to the bottom line—worth $100 to everyone o Credits aren’t great if don’t have tax liability to absorb o If Congress wants to. OR  b/w ages of 25 & 65 who is not another TP’s dependant • § 32(b)(2): phase out o logical b/c it’s supposed to give working poor the equivalent of 0 bracket for social security tax o As an administrative manner it has 2 perverse effects:  The incentive to cheat is. they can make credit refundable (rarely happens)  EITC. just less expensive by marginal rate o Credit: GI=$1000 . Credit of $100Which would TP prefer?  Prefer credit: deducts your tax liability dollar for dollar o Deduction: GI=$1000 .
foreign income tax credit . INTEREST (§ 163)BELOW/NOT SUBJECT TO §67 • Before 1986. TAXES: § 164 • Taxes ABOVE if incurred for T/B or investment activity. (below the line itemized deduction) B. but subject to § 68 3% haircut. looking at these numbers. all interest was deductible (didn’t matter what it was on) o To broaden the base. and to the federal gov’t o Some deductible ONLY if attributable to business or investment activity [ABOVE THE LINE]fed excise taxes/custom duties. treatment for this b/c 163(d) investment interest only deductible against invest income o We are trying to match.  § 163(h)(2)(C): any interest which is taken into account under § 469 in computing income or loss from a passive activity of the TP  § 163(h)(2)(D): any qualified residence interest (w/in the meaning of ¶ 3)  QUALIFIED RESIDENCE INTERESTBELOW/ITEMIZER • § 163(h)(3): interest paid/accrued on acquisition indebtedness or home equity indebtedness o Acquisition Indebtedness §163(h)(3)(B): Deductible on up to $1M of debt used to acquire. gas taxes licensing fees  State/local taxes paid for a T/B is also ABOVE THE LINE o Others deductible regardless of motive [BELOW THE LINE]state and local income/sales taxes. # 26: Personal Expenses Deductible for Itemizers A. to foreign countries and their political subdivisions. construct. we didn’t eliminate this we just narrowed the distinction • Business Interest § 163(a): FULLY Deductible ABOVE the line o Interest on indebtedness used to operate a trade/business is like anything other business expense o Generally deductible w/o limit except to the extent the TP is subject to passive loss rule • Investment Interest § 163(d)Deductible BELOW (unless investment provides rents/royalties) o Limited to amount of net income o Net investment income: total investment income minus investment expenses o Investment income does NOT include net capital gains or dividends UNLESS TP elects to forego preferential rate on them o Must place all investment income in a basket to determine net investment income • Personal Interest § 163(h)(3)NOT deductible o § 163(h)(1): No deduction for personal interest (PI) o EXCEPTIONS § 163(h)(2): Personal interest is ANY interest allowable as a deduction OTHER THAN  § 163(h)(2)(A): interest paid/accrued on indebtedness properly allocable to a T/B (other than the t/b of performing services as an employee)  § 163(h)(2)(B): any investment interest (w/in the meaning of § 163(d)) • Diff. In response to this. we have § 32(b)(3) which allows for an alleviation of the marriage penalty. We let you deduct the interest to extent of income so that you don’t borrow money and deduct the cost of borrowing then using that money to invest in something you’re not going to realize the gain on for a long time. I would have to be nuts to get married b/c it would cost me a lot of money including the money that is supposed to be helping get out of poverty. BELOW if personal/Not Subject to §67 • § 164: permits deductions for amt of certain tax pmts to states and localities. am in the phase out range and I am w/someone who is or isn’t an EITC recipient they have income! For tax purposes. personal property taxes. for a limited period of time. or substantially improve either principal residence or second home o Home Equity Indebtedness§163(h)(3)(C): deductible up to $100k regardless of purpose of loan as long as debt does not exceed FMV of home o Home mortgage deduction NOT subject to § 67 2% floor. still a problem  For tax purposes. stock transfer taxes. • This is a huge marriage penalty. if I am an EITC recipient.
and I get a breast augmentation. o Allowing personal deduction for taxes produces more accurate measurement of TI o Requirements:  Amount must be TAX not a USER FEE (i.5% floor. CHARITABLE CONTRIBUTIONS: § 170BELOW/ITEMIZED (not subject to 2% floor.35. arguably I can get an O&N business expense • § 62 says it is personal b/c it has a mixed motive • It is also human capital • Having floor makes these issues less important b/c you need large expenditure VIII. Deduction will never make you whole (even if I’m an itemizer). YOU HAVE TO VALUE IT: o PROPERTY:  You get a deduction FOR THE CONTRIBUTION (Donate $100 of stock. FMV=100k AR=100k Gain=80k • I donate the 100k that I got to charity • I have 80k (AR-B) in income and 100k contribution to charity o I can use the contribution to offset my income  80k is offset by the 100k. you need an appraisal  TAX SHELTER: I bought stock for 20k (my basis). MEDICINE § 213BELOW/not subject to § 67 • § 213: allows ded for med & dental expenses NOT compensated by insurance for med care of TP. spouse. It doesn’t make that cost of state taxes 0 • A credit of $100 would save me 100 cents on the dollar. The deduction is going to save you in tax whatever your marginal rate is. a water bill)  And it also has to be a tax to YOU (Paying mother’s prop taxes is not tax to me) C.e. and I have 20k leftover to offset my tax liability • INSTEAD of doing this. Foreign tax credit is a huge boom to prevent double taxation b/c we tax on a worldwide basis. Ex. subject to haircut) • § 170(a). ded=$100)  If amounts are big and it has no ascertainable value. THE ALTERNATIVE MINIMUM TAX # 28: AMT § 55 • Individuals are subject to it ONLY if the computation of the min tax produces a tax greater than that under the regular income tax computation • AMT imposed at lower rates than regular tax but with broadened tax base • It is an add-onyou pay regular tax PLUS this • CALCULATING AMT . value =$100. then you’re NOT making a charitable contribution or gift (Facts: the fixed fee charged for training/auditing was NOT a gift/contribution but an EXCHANGE) • Once you determine you have made contribution/gift. I should just donate the stock w/FMV=100k o Now I have contributed property w/basis of 20k o I get a deduction of 100k o If there is nothing else in the code. and dependants ONLY to the extent that such expenses exceed 7. General rule—allows ded for a transfer by an individual/corp of cash or FMV of prop transferred of a charitable contribution • § 170(c). $100 deduction for state taxes is going to save me $.35 of federal taxes if I can deduct it. I get to offset 100k of Ordinary income w/100k of this deduction (TAX SHELTER) D. charitable contribution means a contribution or Gift (DUBERSTEIN—“detached & disinterested generosity”) • Hernandez: If it’s a commercial type of transactions (quid pro quo).5% of AGI • Medical expenses are cut by a 7. $100 deduction for tax is going to save you $. which means that they are largely treated as consumption • Definition requires that you have a disease o Medical care does not include cosmetic surgery unless to correct a deformity  If I am an exotic dancer.
o Generally. take TI. you will do another computation  Take TI and then BROADEN THE BASE (add back a lot of the deductions)AMTI  From this you take an exemption amount to get to AMT base on which you pay the AMT  Then you will multiply the amount by either of two rates (26% or 28%) • If your regular tax is really highwill not be hurt by the AMT • Rate for capital gain is the same as in the regular tax . compute the regular tax just as you would any o Then.

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