2010 federal income tax outline

Federal Income Tax Outline

Taxing Formula

Start: Gross Income [GI] §61 (any exclusions?)

§62 "described" deductions [ Above the Line Deductions]

Equals: Adjusted Gross Income [AGI or the Line]

Minus: §63 "described" deductions [Below the Line Deductions]

§63 Deductions:1. Greater of

a. standard deduction OR

b. itemized deductionsAND2. Personal exemptions

Equals: Taxable Income [TI]

Times: §1 Rate

§1 Rates a. Ordinary §1(a)-(e)b. Net Capital Gain §1(h)

Tentative Tax Liability [TTL]

Minus: Tax Credits

Plus: Other Taxes

Equals: Final Tax Liability [FTL]

Times: Number of Tax Payers in the Country

Equals: Revenue to the Government (39% on pie chart; Personal Income Tax)

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§61 Gross Income

Test for Gross Income (COMMISSIONER v. GLENSHAW GLASS CO. 341. Undeniable accessions to wealth2. Clearly realized3. Over which the taxpayers have complete dominion

I. Accessions to WealthA. Payment of Taxes on Behalf of Taxpayer

OLD COLONY TRUST CO. v. COMMISSIONER - 37Payment of Taxes on behalf of a taxpayer is taxable income

B. Barter TransactionsREVENUE RULING 79-24 – 46 Fair Market Value of the Item Received

C. Discharge of DebtUNITED STATES v. KIRBY LUMBER CO. - 47Cancelation of Debt (COD) Income arises when borrower has not fully repaid what borrowed

D. Settlement/Judgment AmountsRAYTHEON PROD. CORP. v. COMMISSIONER - 50Test for Taxable Income:1. In Lieu of what is the payment being made?

a. Loss profits = Gross Incomeb. Punitive Damages = Gross Incomec. Return of Capital Not

i. What is the basis? What is the capital invested? For a purchase, what is the price?

ii. If you get more than the basis, then the excess is taxableiii. Lower the basis for excess

2. How much of the capital was taxedRaytheon's Goodwill and Its Basis in Good Will

Non-taxable recovery of capital = Basis Recovery in excess of basis = taxable Raytheon showed 0 basis for good will = 0 non-taxable recovery Expenses that go into creating Goodwill is deductable

We don’t tax the same dollars of income to the same tax payer twice - BasisWe don’t allow a tax payer to deduct the same tax dollars twice - Basis

Revenue Ruling 81-277 Payment by a contractor of a sum of money to a buyer in exchange for the release of the buyer's claims

for failure to fulfill contract. Income or Return of Capital

M agreed to build a Power plant for P for 250x dollarsDispute arisesP had paid 230x at time of disputeParties settle M pays P 40x dollars P agrees to complete payment under the K = 20x dollarsLook to Raytheon - settlement case

20x = lost profits = gross income to contractor40x = discharge of debt = return of capital Will reduce the basis to 210x

Additional payment of 50x for power plant Increase basis to 260x

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BURNET v. SANFORD & BROOKS COMPANY 59 1920 - Received 192,577

1. 16,305 = interest - §61(4)2. 176,271 = expenses

1913 - 1915, 1916 GI - exp = Loss <L> (Operating Loss)

Total Loss = 176,271 Raytheon Test:

Punitive? NO ROC? No Lost profits

Supreme Court does not take a transactional approach Look at the annual periods

Held that it was taxable income It is for the legislature to correct burdensome operation of taxes

II. Clearly RealizedA. Payment of Taxes on Behalf of Taxpayer

EISNER v. MACOMBER 62Mere appreciation or depreciation is not a realization eventPro Rata Stock Dividend

- everyone gets dividend in proportion to their percentage (all stockholders own the same percentage/no interests change)

- Is not taxableB. Realization

HELVERING v. BRUUN 72

Start Amount Realized/Received

Minus: Adjusted Basis

Equals: Gain or Loss

C. Section 1012: Basis of Property – Cost of Property The amount of capital that has already been taxed and invested in an asset Must identify basis in a piece of property

How did the taxpayer acquire the property? Purchase - 1012 - cost of property Gift - Inheritance - Compensation –

Reg. 1.61-2(d)(2) - in computing the gain or loss from the subsequent sale of such property, its basis shall be the amount paid for the property increased by the amount of such difference included in gross income

D. Section 1016: Adjustment to Basis(a)(1) Proper adjustments shall be made for expenditures, receipts or other losses properly chargeable to capital account (the capital invested in the property)

Expenditures Increase in basis

Receipts Decrease in basis

Losses Decrease in basis

When you have more than you basis = gainSee Raytheon

(a)(2) proper adjustment shall be made for exhaustion, wear and tear, obsolescence, amortization and depletion

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DepreciationE. Stepped up date of death basis

Basis is the FMV at date of deathIf they sold it there would be no GI

F. Section 1001: Determination of Amount and Recognition of Gain or Loss1001(a-b) Every time there is a sale or other disposition of Property:Realization

Start Amount Realized/Received

Minus: Adjusted Basis

Equals: Gain or Loss

G. Section 109: Improvements By Lessee on Lessor's Property GI does not include income derived by a lessor of real property on the termination of the lease

(buildings or other improvements) Over rules Helvering fact pattern

H. Section 1019: Property on which lessee has made improvements If you include income your basis increases Under 109 no income from improvements = no increase/decrease in basis

I. Sec. 1341 Amount and method of adjustment(a) If

1. There was gross income prior year, appearance of unrestricted right2. Deduction is allowable for the (current) taxable year, established after prior year there was not

unrestricted right3. Deduction exceeds $3,000

Then, the tax imposed for the taxable year shall be the lesser of:1. The (current) taxable year computed with said deduction

Or2. The amount equal to

A. The tax of the (current) taxable year computed without such deductions, minusB. The decrease in tax for the prior taxable year(s) which would result solely from the

exclusions of such item from gross income for such prior taxable year (what tax would have been, excluding deduction)

J. What is realization in the context of found property?Reg. 1.61-14 Treasure Trove

Is realized when it is reduced to the possessorHypo: What if they found a diamond ring instead of cash?

Year 1 - FMV 5K (Realization Event) §61 -Treasure Trove Treasure trove reg. - report 5K in Year 1

Year 5 - sell for 7.5K (second realization event) §1001 Section 1001

A/R = 7.5K (Amount Realized A/B = 5K __(Basis)

GI = 2.5KTheory that found property is imputed income; shouldn’t be taxed until you sell it.

Reg. 1.61-2(d)(2) : last sentenceIII. Complete Dominion

A. UNITED STATES v. LEWIS 76When you receive earnings under a claim of right and without restriction as to its disposition, he has received income which he must report on his tax return, even though it still may be claimed he is not entitled to retain the money

B. JAMES v. UNITED STATES 78Illegal income is taxable gross income

IV. Applying the Three-Prong Test 90

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A. CESARINI v. UNITED STATES 90 1957 Bought a piano $15 In 1964 discovered 4,467 in piano

Filed $4,467 as GI Requested refund in 1965 Court held they have GI Claimed it was due in 1957, and that statute had run on the return It was not undisputed possession of the Owners until 1967 Assessment was correct

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Exclusions form Gross Income

§108(a)(1)(A-E)1. In title 11 case

a. Bankrupt2. Taxpayer is insolvent

a. §108(d)(3) - excess of liabilities over fair market value of assets b. Assets v. Liabilities before the discharge

3. Qualified farm indebtedness4. Qualified real property business indebtedness (not a C corp.)5. Principal residence indebtedness discharged before 1/1/13

I. Gifts, Bequests, Devises, and Inheritances 122 A. Gifts and Inheritances

1. Section 102: Gifts and Inheritances a. GI does not include value of property acquired by gift, bequest, devise, or inheritance

The person who receives the gift102(c) There is no such thing as a gift between employer and employeeReg - 1.102

2. Gift BasisSec. 1015(a) - basis shall be the same as it would be in the hands of the donor or last preceding owner by whom it was not acquired by giftSpecial basis rule - if basis > is greater than FMV use basis to determine loss, FMV to determine gain

3. Objective Test to determine Donor's intentCOMMISSIONER v. DUBERSTEIN 123

Fact-finder must look to all the surrounding factsMust be:

1. Positive A. Proceed from detached and disinterested generosityB. Out of affection, respect, admiration , charity or the like impulses

Not2. Negative

A. Proceeding form the constraining force of any moral or legal dutyB. The incentive of an anticipated benefit of an economic nature

UNITED STATES v. HARRIS 133 K gave C and H more than .5 million dollars over several years Either K pays gift tax or C and H pay income tax

Gift tax - is a tax on the transmission of wealth, imposed on the giver of the gift C and H had an accession to wealth clearly realized, did not report because it was a

gift K has a Gift tax liability K reported small gift tax returns

TAFT v. BOWERS 141 Father buys stock 1K Gives to daughter

FMV 2K Daughter Sells 5k

Amount Realized - 5K Adjusted Basis - 1k or 2k?

Daughter has a carryover basis, steps into father's basis shoes in regards to the stock

Sec. 1015(a) - basis shall be the same as it would be in the hands of the donor or last preceding owner by whom it was not acquired by gift

Special basis rule - if basis > is greater than FMV use basis to determine loss, FMV to determine gain

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B. Inheritance1. Section 1014: Basis of Property acquired by from a decedent

1014(a) - basis shall be (if not sold, exchanged or disposed) FMV at the date of decedent's death [Stepped up Date of Death Basis]1014(f) - does not apply to deaths after 12/31/2009

2. Section 1022: Decedent after 12/31/091022(a)

1. will be treated as transferred by gift2. Basis shall be lesser of

a. Adjusted basis of decedentb. FMV at the date of decedent's death

C. Losses1. Section 165(c):

1. Incurred by trade or business2. Incurred by investments3. Losses not connected with business if it arises from fire, storm, shipwreck, other casualty, or

theft

D. Employee Benefits 146 1. Meals and Lodging 146

BENAGLIA v. COMMISSIONER 147 Was the manager of Royal Hawaiian Hotel and 2 others He and his wife got free room and free meals Essentially his living was free No gross income because it was not compensatory It was for the need or convenience of the employer

Employee received what would be GI, but for the fact it is given for the specific purposes of the employer.COMMISSIONER v. KOWALSKI 150

Police officers were getting cash allowance for meals Designated meal stations to get meals for free The payments are "undeniabl[y] accessions to wealth, clearly realized, and over which [they

had] complete dominion Court looked to Section 119 119 only applies to "in-kind" meals and lodging, not cash reimbursements

ADAMS v. UNITED STATES 161

3 Part Test:1. Employee must be required to accept as part of employment2. Lodging must be furnished for the convenience of the employer3. Lodging must be on the business premises

IRS said that that was not on the business premises Facts:

He took a lot of calls He threw business parties Court concluded: "on the business premises of the employer" infers a functional

rather than spatial unity Because he performed job functions in his house, for him it constitutes excludable

housing

E. Other Fringe Benefits 167 A. Sec. 61(a)(1)

General Rule for fringe benefits is that they are includable as GI, unless they are specifically excluded

B. Sec. 106 - Contributions by employer to accident and health plans - Excludable

General Rule: We want to avoid people converting cash compensation into non-cash compensation

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C. Sec. 85: Unemployment Compensation1. All is includable as GI

D. Sec. 86: SS and T1 Railroad Retirement Benn. 1. Parts are includable

E. Sec. 132: Certain Fringe Benefitsa. 7 Excludable fringe benefits

Under Reg. 1.132** whenever the Internal Revenue Code mentions personal property it means non-real property**

F. Section 132(c) - Employee Discounts1. Employee discount2. Qualified property or services3. To the extent that such income does not exceed

a. Property cannot exceed gross profit percentage that the Gross profit percentage

b. 20 percent of the price at which services are being offered to customerG. Section 132(c)(2): Gross Profit Percentage

i. Aggregate sales price MINUS costDIVIDED

ii. Aggregate sales price (cost)H. Reg. 1.132-3: Qualified employee discounts

1.132-3(e) discount that exceeds gross profit percentage is includable

I. Section 132(b) - No Additional Cost ServiceJ. Section 132(j)(1): Non-Discrimination Rule

- no discrimination between highly compensated employees under 132(a)(1-2) K. Section 414(q) - Highly compensated employee if GI is $110,000 or more

Reg. 1.132-8(a)(2): Consequences of Discrimination If there is discrimination then none of it is excludable from GI

L. Section 132(f): Qualified Transportation Fringe1. Any of the following provided by employer to employee

A. Transportation in commuter highway vehicleB. Any transit passC. Qualified parkingD. Any qualified bicycling commuting reimbursement

2. Limitation on Exclusion - amount of fringe benefits, which may be excluded may not exceed (look for inflation adjustments Rev. Proc. 2009-50 page xi)

A. $100 per month A and B of Paragraph 1B. $175 per month in the case of qualified parking, andC. Applicable annual limitation in the case of qualified bike commuting reimbursement

3. DefinitionsA. Qualified parking On or near the business premises of the employer

4. Inflation Adjustment - $230 is excludable for 2010Reg. 1.132-9(b)(Q&A-8) - see 1.61-21Reg. 1.61-21: Taxation and Fringe BenefitsReg. 1.61-21(a)(4)

Taxable fringe benefit is taxable for the person who the benefitNo additional cost reg.In the course of business v. foregone revenue

M. Sec. 104: Compensation for Physical Injuries and Sickness104(a)(2) - any damages (except punitive) on account of a personal physical injury or sickness are excludable

N. Section 105 and 106

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§62 Above the Line DeductionsSection 62: AGI Defined

Lists 20 Above the Line Deductions

A. Section 162(a) - Deductions attributable to a Trade or BusinessSec. 62(a)(1) Trade/Business Deductions - Above the LineSec. 62(a)(4) Rent - Above the Line

B. Section 212 - Income from investments **Keep in Mind you are judging the deductibility with reference to the activity for which the taxpayer is making the payment **

162 - Trade and Business (Deductable)212 - Investment (Deductable)183 - Hobbies (Partially Deductable) - can deduct up to the Income to wipe it away262 - Personal Expense (Not Deductable)

Deductable Personal Expense163(h)(3) - Home Mortgage164 -Property Taxes164 - Car Taxes170 - Charitable Contributions213 -0 Medical Expenses163(h) - Casualty Losses

C. Section 68: Overall Limitation on Itemized Deductions

a. This section shall not apply for taxable year after 12/31/09b. In the case of individual whose AGI exceeds applicable amount, the amount of itemized

deductions shall be reduced by the lesser of:1. 3% of the AGI over the applicable amount, or2. 80 percent of the amount of the itemized deductions otherwise allowable for such taxable year

c. Applicable AmountD. Section 151: Allowance of Deductions for Personal Exemptions

a. In the case of an individual, the exemptions provided by this section shall be allowed as deductions in computing taxable income

b. Exemption Amount1. 2,0002. Phase-out for high income taxpayers

a. Does not apply after 12/31/093. Inflation adjustment

E. Section 213: Medical Expenses1. Deduction for medical care of the taxpayer, spouse, or dependent if expenses exceed 7.5% of AGI2. Amount only if drug purchased is prescribed or insulin3. Definitions

1. Medical Care1. Diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of

affecting any structure of the body2. Transportation primarily for and essential to medical care in subparagraph (A)

Reg §1.213-1(a)(1)(ii) . . . An expenditure which is merely beneficial to the general health of an individual is not an expenditure for medical care(iii) Capital expenditures are generally not deductable, if it qualifies under Section 213 it will not be disqualified as a deduction

F. Section 151(b) - Applies if there is no joint return, spouse has no income, spouse is not a dependant, there is two deductions on the same return

G. Sec. 165 - Losses Losses on property

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On the sale or other disposition Damage on property

H. Damages Revisited 183Punitive Damages - Includable Damages for Lost Profits - IncludableDamages for return of capital - Depends on Basis

Sam’s Problem 1831. In Lieu of what were the damages paid

See list on page 184 Lost Wages Loss of future income Reimbursement of medical expenses Future Medical Expenses Pain and suffering Expenses advanced by attorney

2. 104(a)(2) is an exclusion that only applies to Injuries/Sickness Everything is excludable except: Punitive Damages are Always includable Reimbursement of medial expense: (we don’t want double benefit)

if he deducted them in a previous year he has to include them If he did not deduct them in a previous year they are excludable

For purposes of Paragraph 2 - emotional distress shall not be treated as a physical injury or sickness

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§63 Below the Line Deductions 189Deductions:

Cash Basis Taxpayer: Cash Basis Accounting: Report Items of Income when you receive them, take deductions in the year you pay them out.Doctrine of Constructive Receipt - report income when it becomes available to youAccrual Basis Accounting: Report Items of Income when you perform serviceThere must be a code section that lets you take deduction

1. Is it deductable? (What code section)2. Is it above or below the line (is it 62 or 63)

**Keep in Mind you are judging the deductibility with reference to the activity for which the taxpayer is making the payment **

A. Carole’s Problem 191GROSS INCOME:

Receipt Amount Code

Wages $200,000 61(a)(1)

Bonus $50,000 61(a)(1)

Gift - 102(a)

Interest $350 61(a)(4)

Dividends $1,000* 61(a)(7)

Lottery Winnings $2,000 61(a), Glenshaw Glass, 74(a)

Mileage Reimbursement DEFER DISCUSSION

Free Parking $3,240 132(f)(1); 132(a)(5) - Qualified Fringe; Defined 132(f)(5)(C) . . .

Total $256, 590

EXPENSES

Expense Amount Allowed Location

Alimony 30,000 215(a) 62(a)(10)

Interest on Home Mortgage 20,000 163(h)(3) 63

Real Estate Taxes 5,000 164(a)(1) 63

Personal Property Tax 500 164(a)(2) 63

State income Tax 10,500 164(a)(3) 63

Medical Expenses 12,250 213(a) 63

*Charitable Contributions 3,500 170(a)(1) 63

Theft/loss 10,100 165(a),(c)(3), and (h)(1) and (2) 63

Mileage Expense 1,000 162(a) 63

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Unreimbursed Business Expense 7,000 162(a) and 274(n)(1) 63

Safe Deposit Box Rental 150 212 63

Living Expenses 22,000 261(a) 63

*In general Section 170 allows deduction up to 50% of GI

B. Personal Itemized Deductions 197Table 1 Tax Expenditures Estimates by Budget Functions,Fiscal Years 2006–210 199The Fine Print: The Tax Bills; When Lawmakers Look Homeward 205

1. Extraordinary Expenses 207a. Section 213: Medical Expenses 207

RR 73-200 - Birth Control Pills: DeductableRR 79-162 - Smoking Cessation Program: DeductableRR 99-28 - Anti-Smoking Meds: Deductable if prescribedRR 2002-19 - Weight loss programs: DeductableChief Counsel Advice 200603025

Sex Change Operation Section 213(d)(9) - cosmetic surgery is non-deductable

OCHS v. COMMISSIONER 215 Taxpayer deducts boarding school Wife had cancer, sent kids away Education of children, is personal in nature Should have sent the wife to the sanitarium, expenses would have been deductable

C. Losses

Section 165(c)(3): An individual may deduct"losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck or other casualty . . [but] only to the extent that the amount of loss to such individual arising from each casualty . . . exceeds $100"

Accidental loss of property can now qualify as a casualtyi. Identifiable

ii. Damaging to propertyiii. And sudden, unexpected and unusual in nature

i. Sudden - a swift and precipitous event, not gradual or progressiveii. Unexpected - an event that is ordinarily unanticipated that occurs without the

intent of the one who suffers the lossiii. Unusual - an event that is extraordinary and nonrecurring, one that does not

commonly occur during the activity in which the taxpayer was engaged when the destruction or damage occurred, and one that does not commonly occur in the ordinary course of day-to-day living of the taxpayer

Rev.Proc. 2010-36 - outlines test

Casualty Losses - Reg. Sec. 1.165-7a. In General 1. Allowance of Deduction

All casualty loss of all property is determined under this reg.2. Method of Valuation

i. FMV immediately before and after casualty shall generally be ascertained by competent appraisal

ii. Cost of repairs is acceptable evidence of loss of value if the taxpayer showsa. Repairs are necessary to restore to previous stateb. Amount spent is not excessivec. Repairs do not care for more than damage sufferedd. Value of property after repairs does not exceed value before repairs

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a. Amount Deductable1. General Rule

Lesser of i. The amount which is equal to the FMV immediately before casualty reduced by

the FMV after the casualtyii. The amount of adjusted basis prescribed in 1.1011-1

Limitations on Casualty Loss - Sec. 165(h)1. $100 Limitation per casualty

Only for the amount that exceeds $1002. Net Casualty Loss allowed only to the extend it exceeds 10% of AGI

1. if personal casualty losses exceeds personal casualty gains, such losses shall be allowed for the taxable year to the extent of the sum of:

a. Amount of personal casualty gains; plusb. So much of such excess (Loss-Gain) as exceeds 10% of AGI

Loss Minus Gain Minus 10% AGI3. Definitions

1. Personal Casualty Gains Recognized again from any involuntary conversion of property described in 165(c)

(3)4. Special Rules

1. Personal casualty losses allowable in computing AGI to the extent of personal casualty gains

If 2(a) applies; Part i. applies above the line Part ii. applies below the line

D. Charitable Contributions 227Section 170 - Charitable Contributions

A. Charitable Contribution Defined Charitable Contribution means a contribution or gift or for the use ofA. Federal GovtB. Corp, trust, or community chest, fund or foundation

A. Created in USB. Organized an operated exclusively for religious, charitable, scientificC. No part of the net earnings of which inures to the benefit of any private shareholder or

individualD. Is not disqualified for tax exemption

C. Additional Qualified Charitable DoneeD. Additional Qualified Charitable DoneeE.Additional Qualified Charitable Donee

Section 501: Exemption from tax, certain corps, trusts, etc.

- 20 organizations listed which are exempt Only a few are allowed to received tax exempt charitable contributions

Section 170(8) - Substantiation requirement for certain contributions "intangible religious benefit"`

HERNANDEZ v. COMMISSIONER 227 If you receive something in exchange for contribution, it is not deductable

SKLAR v. COMMISSIONER 242 Difference in religious education and religious practice

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Profit-Making Activities: The Relationship amongTest for Trade or BusinessCommissioner v. Groetzinger 273

1. The activity has to be continuous and regular2. Primary purpose is to engage for profit3. Sporadic activity, a hobby, or an amusement diversion does not qualify

Sections 162, 212, 183, and 262 2711. Section 162(a): “Carrying on any Trade or Business”:

Section 162: Trade or Business Expenses are Deductable if they are ordinary and necessary expenses incurred in connection with a trade or

business Above - Proprietor Below - Employees

Section 212: Production of Income are Deductable if they are ordinary and necessary expenses incurred in connection with an

investment Above - Collection of Rents Below

Section 183: Hobbies/Activities not engaged in for Profit Allows some deduction and denies some deduction Question is categorizing activity in which taxpayer incurs an expense

Section 262: Personal Expenses Are not Deductable

Section 162: Trade or Business Expenses Three Types of Activities when a taxpayer can claim deductions for expenses

1. Trade or BusinessSection 162: Trade or Business Expenses

are Deductable if they are ordinary and necessary expenses incurred in connection with a trade or business

Above - Proprietor Below - Employees

2. Transactions for profitSection 212: Production of Income

are Deductable if they are ordinary and necessary expenses incurred in connection with an investment

Above - Collection of Rents Below

3. HobbiesSection 183: Hobbies/Activities not engaged in for Profit

Allows some deduction and denies some deduction Question is categorizing activity in which taxpayer incurs an expense

Section 262: Personal Expenses Are not Deductable

183(b)(1) - 183(b)(2) - below the line, miscellaneous deductions Reg. 1.183-2(b) Relevant factors to determine if activity is a hobby or not

Take in facts and circumstances, no one factor or number thereof is determinative1. Manner in which taxpayer carries on the activity2. The expertise of the taxpayer and his advisors3. Time and effort expended by taxpayer

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4. Expectation assets used will appreciate in value5. The success of the taxpayer in carrying on other similar or dissimilar activities6. The taxpayers history of income or losses with respect to the activity7. The amount of occasional profits, if any, which are earned8. The financial status of the taxpayer9. Elements of personal pleasure or recreation

Factors speak to the elements of the Groetzinger Test 165(d): Wagering Losses

Allowed only to the extent of the gains from such transactions Similar to Hobby Below the Line Are they Miscellaneous Itemized Deduction (§67)?

No, but they are below the line Can a gambler be Professional?

Until Groetziner: Trader or Business was selling goods or services to others for profit

§162(a) - allowed are all ordinary expenses … from carrying on a trade or business §212 Expenses for Production of Income for an individual, allowed deduction all the ordinary and necessary expenses paid or incurred in the taxable year -

(1) for the production or collection of income(2) for the management, conservation, or maintenance of property held for het production of income(3)in connection with the determination, collection, or refund of any tax

Below the line, miscellaneous deduction subject to 2% floor §166: Bad Debts(a) there shall be allowed as a deduction any debt which becomes worthless, ordinary loss deductable in full(d) in the case of taxpayer, when a non-business debt goes bad it is a capital loss Trade or Business - Continuity, Regularity, Intent to make profitIn 212 you have intent to gain profit, but not regular and continuousHobby - you have regular and continuous, but no intent to gain profit §162(a)(2) - allows traveling expenses (including amounts expended for meals and lodging . . . ) while away from home in the pursuit of a trade or business

"home" is the tax home or principal place of business Sometimes you can stay away from home so long you establish a new tax home§162(a): Trade or Business Expenses (examples)

(1) reasonable allowance for salaries or other compensation for personal services(2) travel expense while away from home in the pursuit of a trade or business(3) rentals or other payments required to be made as a condition to the continued use . . . of property to which the taxpayer has not taken or is not taking title or in which he has no equity

Flush Language1 Year Bight Line Rule

Commuting Expense

Reg. 1.162-2(3) Commuting Expense are not deductableReg. 1.212(f) Commuting Expense are not deductableReg. 1.262-1(b)(5) Commuting Expense are not deductable

In General (see diagram on page 289):i. Home to Principal Job - not deductable

ii. Principal Job to Second job - deductable

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iii. Temporary work location - deductable

Distinguishing a Trade or Business from a Hobby or a Personal Activity 272Excerpt from Commissioner v. Groetzinger 273Test for Trade or Business

Groetzinger Case1. The activity has to be continuous and regular2. Primary purpose is to engage for profit3. Sporadic activity, a hobby, or an amusement diversion does not qualify

SMITH v. COMMISSIONER 274 Farmer always had losses (expenses exceed income) If in a trade or business; expenses are deductable above the line If it was a hobby; look to 183 - divide into above/below deductions Court Concluded:

He was engaged in a trade or businessHiggins v. Commissioner (1941)

Stock trader lived in Paris Had office/employees in NY Court Held:

He was not in a trade or business He was an investor

Congress enacted §212 to put investors on the same field as those in Trade or Business Mary Alice’s Problem 280SMITH v. COMMISSIONER 281

Deducted childcare expense so the wife could go to work In connection with her trade or business

Court says: Caring for children is quintessentially a personal expense Normally personal expense may be deductable if they is an intimate

connection with an occupation carried on for profit (actors wardrobe) MOSS v. COMMISSIONER 282

Partners are not employees Attempted to deduct lunches

At lunch at the same place every day and discussed cases Not deductable See page 283 for business deduction of client-related business meals Rule: Sutter Rule:

The taxpayer is permitted to deduct the whole price (§274(n) now subject to 50% rule), provided the expense is "different from or in excess of that which would have been made for the taxpayer's personal purposes."

It is all a matter of degree and circumstance (the expense of a testimonial dinner would be deductable on a morale-building rationale)

Daily is too frequent, perhaps even for entertainment of clientsUS v. Correll (1967)

Traveling salesman deducted meals Supreme Court said traveling away from home requires that you be away long

enough to require sleep or rest Child Care 285Food and Lodging 286Commuting Expenses 288When Are Transportation Expenses Deductible 289Clothing 290

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Pevsner v. Commission (1980) She worked at a boutique and was required to buy stores clothing to work there Court said:

You cannot deduct cost of clothing if it is adaptable to ordinary wear on the street

Educational Expenses 290

Educational ExpensesReg. 1.162-5(a)

(1)(2)

Reg. 1.162-5(b) Are not deductable if they need min requirements for trade or business or they qualify you for a new

trade or business

2. Section 212 Activities 2903. The Meaning of “Ordinary and Necessary” 291

WELCH v. HELVERING 291 Commission agent – former employer went bankrupt – decided to pay the debt off

to restore his reputation – tried to deduct the payments he made as a necessary & ordinary expense of doing business

Commissioner said the payment weren’t deductible b/c they weren’t ordinary & necessary – these were capital expenditures, an outlay for the development of reputation and good will [p. 292]

Raytheon – talked about the creation of goodwill – had a 0 basis for its goodwill Think about – why they had a 0 basis for its goodwill What would’ve been P’s basis for the goodwill he created?

Whatever he paid toward these debts would be his basis in the goodwill

In order to take a current deduction under §162 the expense has to be “ordinary and necessary” incurred in carrying on his trade or business

Necessary – definition – “appropriate and helpful” in the judgment of the business person

The Court defers to his judgment and says it was necessary Ordinary – definition – doesn’t have to be habitual or normal – can happen once –

ordinary to Justice Cardozo is “common and accepted” This sense of the word ordinary is a sort of red herring

What Cardozo ultimately says [p. 293]: “Reputation and learning are akin to capital assets, like the good will of an old partnership…for many, they are the only tools with which to hew a pathway to success. The money spent in acquiring them is well and wisely spent. It is not an ordinary expense of the operation of a business.”

Commissioner v. Tellier, U.S. S.Ct. (1966) [footnote 129, p. 294]“The principal function of the term ‘ordinary’ in §162(a) is to clarify the distinction, often difficult, between those expenses that are currently deductible and those that are in the nature of capital expenditures, which, if deductible at all, must be amortized over the life of the asset.”

4. Ordinary Expenses Versus Capital Expenditures:Sections 162(a)/212 versus Section 263 294MIDLAND EMPIRE PACKING COMPANY v. COMMISSIONER 294

P had a meatpacking company Oil was seeping through ground into company’s basement Company reinforced the basement w/ concrete & took a deduction under §162 as

an ordinary, necessary business expense It was connected to a trade/business

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Was it necessary – appropriate and helpful? Yes Ordinary in the 1st sense – common and accepted? Yes Currently deductible expense or capital expenditure? §263(a) says: no deduction allowed for any amount paid out for new buildings or

permanent improvements or betterments done to increase the value of property Was this something that was a permanent improvement or betterment to the

building? If so it’s a capital expenditure not deductible – would’ve been recoverable through depreciation; if it did not represent a capital expenditure but rather a repair then it’s deductible as a business expense

Held it was a repair & deductible [p. 297] WOODWARD v. COMMISSIONER 298

Taxpayers attempting to purchase dissenters’ shares took it to ct. to get an appraisal value – try to deduct litigation expenses on return

Capital expenditures are not deductible [§263]. Such expenditures are added to the basis of the capital asset with respect to which they are incurred, and are taken into account for tax purposes either through depreciation or by reducing the capital gain (or increasing the loss) when the asset is sold. If an expense is capital, it cannot be deducted as “ordinary and necessary,” either as a business expense under §162 of the Code or as an expense of “management, conservation, or maintenance” under §212.

Costs incurred in the acquisition or disposition of a capital asset are to be treated as capital expenditures.

The cost of acquisition of property having a useful life substantially beyond the taxable year is a capital expenditure. Treas. Reg. §1.263(a)-2(a)

Holding: couldn’t deduct this b/c it was part of the acquisition of the stock and capital expenditures – become part of the basis of the asset

ENCYCLOPAEDIA BRITANNICA, INC. v. COMMISSIONER 301Excerpt from INDOPCO, Inc. v. Commissioner 304

5. The Concept of Cost Recovery/Depreciation:§25A – Hope and Lifetime Learning CreditsIf you’re not a high income taxpayer it’s possible to get credit for educational expenses you incur out of pocket §222 Qualified Tuition and Related Expenses

This expired at the end of 2009 §221 Interest on Education LoansIf you make under than $50k or $100k for married couples you’re eligible §263 – Capital Expenditures(a) General Rule – No deduction shall be allowed for—

(1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. This paragraph shall not apply to—[see list p. 271 of Code]

§162 deals w/ expenses which are deductible; §263 deals w/ capital expenditures which are not deductible §1016(a)(1) of the Code provides that “proper adjustment in respect of the basis of property shall in all cases be made…for expenditures, receipts…properly chargeable to capital account” [footnote p. 128, p. 294] Since you can’t deduct it you depreciate it over the years it’s used in the business Treasury Regulation §1.263(a)-1. Capital expenditures; in general.

Restates the statute §1.263(a)-2. Examples of capital expenditures

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[most important] (a) The cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year. (b) Amounts expended for securing a copyright and plates, which remain the property of the person making the payments. See section 263A and the regulations thereunder for capitalization rules which apply to amounts expended in securing and producing a copyright and plates in connection with the production of property, including films, sound recordings, video tapes, books, or similar properties. (c) The cost of defending or protecting title to property. (d) The amount expended for architect’s services. (e) Commissions paid in purchasing securities. Commissions paid in selling securities are an offset against the selling price, except that in the case of dealers in securities such commissions may be treated as an ordinary and necessary business expense. (h) the cost of good will in connection with the acquisition of assets of a going concern is a capital expenditure.If something is used up w/in the taxable year – then it’s deductible business expenses; when it has a life beyond that it’s a capital expenditure

Sections 167, 168, 179, 195, 197, and 1016(a)(2) 305Brian’s Problem 306SIMON v. COMMISSIONER 307

Professional violinists – bought bows known as Tourte bows made in the late 1800s

Ordinary – in the Welch sense but not the Tellier sense Bows hadn’t really depreciated – appreciated because they were valuable antiques Test – for the purposes of the “recovery property” provisions of §168 “property

subject to the allowance for depreciation” means that is subject to exhaustion, wear and tear, or obsolescence.

COST – SV/UL [useful life] 10,000-5,000/10 = 5,000/10=500/yr S/L ESPINOZA v. COMMISSIONER 319

Spent 58,475 Adjusted basis 824 57,651 18,517 depreciation deduction Court said depreciation still applied

Further Words about Tax Policy and Tax Reform Ideas 325Excerpt from Executive Order 13369 326Excerpt from Statement by Tax Reform Panel 326Excerpt from Toward Fundamental Tax Reform 327Tax Reform, Federal 329

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Depreciation§167 Depreciation(a) General Rule – there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)—(1) of property used in the trade or business, or(2) of property held for the production of income. §197 Amortization of Goodwill and Certain Other Intangibles [we’ll talk about this on Thurs.]When we use the term “depreciation” we’re talking about tangible assets – when we use “amortization” we’re talking about intangibles The Concept of Cost Recovery/Depreciation: §§ 167, 168, 179, 195, 197, and 1016(a)(2) [p. 305] §168 Accelerated Cost Recovery SystemLays out how to get the depreciation deduction under §167 Depreciation Depreciation§167(a)(2)When a taxpayer purchases property in connection with trade or business or property for the production of Income

IF the property is a capital expenditure, under certain conditions he is able to take a depreciation deduction

IF it is tangible property, then depreciation under §168 Start at §168(e) and classify the property Applicable method Applicable recovery period Applicable convention

Applicable Method§168(b)

1. 200% Declining balance method:2. 150% Declining balance method:

Applies to 15-20 year property3. Straight Line4. Salvage = Zero5. Election

§168(k) Bonus have been extended to 2011

To create incentives for business to buy things Get 50% off basis deduction off the bat

Buys asset in connection with the trade or business. Basis is the cost of an assetDepreciation is the recovery of basis §1016(a)(2) - your basis is going down every year by the amount of the depreciation you should have taken, even if you fail to take it Espinoza v. Commissioner (1999)

Spent 58,475 Adjusted basis 824 57,651 18,517 depreciation deduction

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Court said depreciation still applied Reg. 1.67b-1: Straight line Method

The cost or basis of the property less the salvaged value is deductable in equal annual amounts over the period of the estimated useful life of the property

SL = (Cost/Basis - Salvage Value)/Useful Life Under 168(b)(4) we treat salvage value = 0 Straight line - Cost/Useful life Under 168(e) classifies properties in respect to recovery period

1. Classification of Property2. Difference between residential and rental property3. Classification of certain property

Recovery period replaces useful life§168(d)(1) - is the half year convention, Applies to acquit ion and disposition§168(d)(4) - defines applicable conventions 168(b)

1. 200% Declining balance method:2. 150% Declining balance method:

Applies to 15-20 year property3. Straight Line4. Salvage = Zero5. Election

Reg. 1.67b-2: Declining balance method:

A uniform rate is applied each year to the unrecovered cost or other basis of the property Provided by 167(b)

Such rate shall not exceed twice the appropriate Straight line rate §179 Election to Expense certain depreciable business assets

Taxpayer may elect to treat cost of any 179 property as an expense which is not chargeable to a capital account

A deductable expense as opposed to a capital expenditure Deduction cannot make him have an operating loss

§179(b)(1) - aggregate cost which may be taken into account under §179a shall not exceed 500k (was 25k)§179(b)(2) - limitation in §179(b)(1) shall be reduced (not below 0) by amount cost §170 prop exceeds 2mil (was 800k)§179(b)(3) 179(c)(1) - election - can be applied to specific properties/don’t have to do to all properties

Specify items to which it applies Cost of items Made on return

§179(d)(1) - 179 property

1. Tangible to which §168 applies2. §1245 property in 1245(a)(3)

Property subject to depreciation which is personal property3. Acquired for purchase or use in trade or business

§280(F) - Luxury Automobile§280(F)(a)(1)(A) - the amount of depreciation for any passenger automobile

If under normal rules depreciation exceeds 280(F)(a)(1)(A) amounts, then you have a luxury vehiclei. 3,060 + 8,000 = 11,060

ii. 4,900

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iii. 2,950iv. 1,775

§168(k)(2)(F)(1) - additional 8k for the first year IS a car §179 property?§280F(d)(1) - §179 expenses cannot exceed §280(F)(a)(1)(A) limits §179(b)(5) - limits SUV limits expense to 179 expense of 500k (was 25k)SUV - not subject to 280F 14,000lbs>weight>6,000lbs and special attributes 100,000 Basis - Year 1179 Expense 25,000 under 179 as limited by 179(b)(5)75,000 basis168(k) bonus depreciation 37,50037,500 basis168(a) 37,500*(40%)/2=7,500 30,000 Basis - Year 2 (70k deductions) §167 - good will does not have a readily determinable useful life and therefore does not have amortization§197 - Amortization of Goodwill and other Intangibles§197(c) - any section 197 intangible in 197(d), acquired after Aug 10, 1993, and which is held in connection with trade or business or investment activity§197(c)(2) exclusion of self created intangibles

Does not include 197 intangible which is not described in 197(d)(1)(A-C) and created by the taxpayer∞

If you created they are not amortizableIf you purchased they are amortizable §197(a)

1. Method: "ratably" = straight line2. Recovery Period: 15 years3. Convention: beginning of the month of acquisition

[§197(f)(7) - Any 197 amortizable property shall be . . . ] important for later §195 - Startup Expenditures195(a) - except as provided, no deduction for startup expenditures 195(b)(1)(A) - if taxpayer elects, allows deduction for taxable year in which the active trade or business begins in an amount equal to the lesser of:

i. The amount of start of expenditureii. 10k (was 5k) reduced by the amount the expenditure exceed 60k (was 50k)

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I. Who Is the “Proper” Taxpayer? Introduction 337Chapter 1 Assignment of Income 339

A. Basic Principles 339LUCAS v. EARL 339

Earl (lawyer) contracted with his wife (in 1901, 12 years prior to income tax code) that earnings were joint with survivorship

He reported half, she reported half 100% reported and taxed 1930 before joint return system If each reported 50%, then they were individually taxed at a lower rate

Total tax received by govt. was less than if he had reported 100% Result:

He is taxed on all of the income from his services Cannot assign income from personal services

Taft v. Bowers (1929) Father buys stock 1K Gives to daughter

FMV 2K Daughter Sells 5k

Amount Realized - 5K Adjusted Basis - 1k or 2k?

Daughter has a carryover basis, steps into father's basis shoes in regards to the stockHELVERING v. HORST 341

Gave interest coupons on bonds to son Bond = principal Coupon = entitle bearer to interest Son collected interest Father is taxable on interest even though he did not receive the money

Like old colony Lucas v. Earl

No assignment of income from services "You cannot attribute the fruit from a different tree from which it grew"

Helvering v. Horst No assignment of income from interest Fruit/tree doctrine

Taft v. Bowers Can assign income by means of a gift Father gave the "tree" away

SALVATORE v. COMMISSIONER 344

B. Intra-Family Transfers 3481. The Kiddie Tax 348

Form 8615 3492. The Family Business 351

FRITSCHLE v. COMMISSIONER 351A Brief Introduction to Statutory Interpretation 355Interpreting Statutory Language 356Excerpt from “Plain Meaning, the Tax Code, andDoctrinal Incoherence” 358

a. Family Partnerships 359COMMISSIONER v. CULBERTSON 360

b. Family Corporations 365c. Family Trusts 367d. Intra-Family Loans 368

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DEAN v. COMMISSIONER 369General Explanation of the Revenue Provisions of theDeficit Reduction Act of 1984 373

C. C. Statutorily Sanctioned Assignments: The Concept of Family 3811. The Joint Return 3822. Alimony and Child Support 387

Frontloading Alimony If it meets all the elements of alimony; it is alimony

Payor Deducts Payee Includes in GI

If It does not say it is not deductable and includable It is deducible and includable

3. Transfers of Property Incident to Divorce 391

Phili Park Casea. When you exchange properties, if one is easy and the other difficult, value both at

the easy one b. "Fair Market value of the property received is the cost basis" (Taxed Once Already

Dollars)UNITED STATES v. DAVIS 396

Divorce Mr. Davis transferred DuPont stock to Mrs. Davis

1,000 shares FMV $82,000 Mr - A/B $75,000

Mrs. Davis let him out of Marriage in exchange for stock Mr. Davis was tax payer in the case (transferor) IRS said he had property before and after he had none

§1001 - sale or other disposition USSC said:

Accretion: Increase in value of 7,000 When is accretion taxed?

Different than Taft v. Bowers Taft v. Bowers - can assign income from property

Transfer of basis Held:

Mr. Davis is taxable A/R - A/B = G or L See Phili Park

A/R = 82,000 A/B = 75,000 Gain of 7,000

GODLEWSKI v. COMMISSIONER 4024. The Future? 406

Excerpt from “Federal Income Taxation and the Family” 407MUELLER v. COMMISSIONER 408

§7703: Determination of Marital Status At the close of the taxable year

§7703(b) - Exception for people living separately§2(b): Head of Household

Marriage Penalty/Marriage Bonus

Rate = 2x that of single 10% and 15% brackets are twice the amount

§6013: Joint Returns of Income tax by Husband and Wife§6013(a) - allows Joint returns

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§6013(d)(3) If joint return is made, tax is made on the aggregate income There is joint and severable liability

In divorce decree/agreement there is often an indemnity clause This type of indemnity agreement is only binding on the parties, not on the IRS

§6015: Relief from Joint and Several Liability on Joint Returns

Provides relief under certain circumstances(b) traditional innocent spouse relief(c) severable liability

§1(g): Certain income of children taxed as parent's income (kiddy tax) Taxes the unearned income of the child (passive investments)

Earned income is received through labor Qualified Child Taxed under parent's rate (curbs assignment of income)

Alimony and Child SupportGould v. Gould (1917)

Alimony was a personal expense and not deductable1940's§71(a): Alimony

Gross income includes amounts received as alimony§215(a): Payer of Alimony

Payment of alimony is a deduction for the payer§62(a)(10)

Alimony payment is an above the line deduction for payer General RuleIf it is alimony, it is includable and deductableIf it is a property settlement (division of joint property) no tax consequenceIF it is a transfer of cash to settle property rights, it is not includable, not deductable §71(b): Requirements for Alimony

Must meet all components(1) - cash(A) - under a divorce or separation instrument

See §71(b)(2) must be a (A) Decree(B) Written separation agreement

(B) - does not designate payment which is not includible in gross income and not allowable as a deduction under section 215

Parties have total control over the tax characterization of the payments(C) - after final decree they cannot be members of the same household(D) - no liability to make such payment after the death of the payee spouse

§71(c) - does not apply to fixed part of payment which is support of child§71(c)(2) (a) f any amount of alimony is reduced, as a contingency relating to child, then only that portion not attributable to the child is alimony(b) if contingency is clearly associated with the child, hen §71(c)(3)

If it is less than amount specified in the instrument, then the amount of the payment that does not exceed the payable amount for support ties considered payment of that support

§71(e) - does not apply if the spouses file a joint return §71(f) Re-computation where there is excess frontloading alimony payments

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(1) if there are excess alimony payments then1. Payor

Includes the amount of such excess income in gross income in the 3rd post separation year

2. Payee Allowed a deduction in computing gross income (above the line) for the amount of such

excess in the 3rd post separation year §71(f) Recompilation Where Excess Front-Loading of Alimony Payments

3rd post separation year It is a good idea to go backwards

1. §71(f)(6) - Post Separation Year 1st separation year the payor spouse made alimony payments to which

When was the first deductable alimony payment made? 2nd and 3rd are the 1st and 2nd post separation years following the 1st post separation year

2. §71(f)(5) - Exceptionsa. Separation cease by way of death or remarriage b. Does not include any decree in §71(b)(2)(C)

i. Temporary support ordersc. Fluctuating payments made not within the control of the payor spouse

i. Percentage of business, commission, etc.3. §71(f)(4) - 2nd Post Separation Year 1st

Excess for 2nd post separation year (A)-(B)

(A) amount of alimony paid by payor in the 2nd post separation year(B)Sum of i. Amount of alimony paid during the 3rd post separation year

ii. 15,0004. §71(f)(3) - Excess Payment for 1st Post Separation Year

(A)-(B)(A) amount of alimony paid by payor in the 1st post separation year(B)Sum of i. The average of

I. 2nd year payments minus 2nd year excessII. 3rd year payments

ii. 15,0005. §71(f)(2) - Excess Alimony Payments

Sum of excess of 1st year and excess of 2nd year6. §71(f)(1) - In General

If there is an excessA. The payor includes the excess in gross income in the 3rd post separation yearB. Payee shall be allowed deduct (above the line) in the amount of the excess in the 3rd year

Who gets to claim the kid/kids as dependants? 1 exemption for each child

$3,650§152: Dependant Defined

a. Dependant means1. Qualifying Child2. Qualifying relative

b. Exceptions1. Dependants ineligible2. Married dependant3. Citizen or nationals of other countries

152(c) Qualifying Child

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1. In GeneralA. Bears a relationship to the taxpayer in paragraph (2) B. Who has the same principle place of abode for > .5 of taxable yearC. Who meets age requirement of paragraph (3) D. Who has not provided over .5 of own support for the calendar year in which the taxable year of

the taxpayer beginsE.Who has not filed a joint return with the individual spouse

2. Relationship Child, grandchild, brother, sister, stepchildren, and their children

3. Age Has not attained 19 at the close of the taxable year Is a student who has not attained the age f 24 at the close of the calendar year If they are permanently disabled

152(e) - Special Rule for Divorced Parents, Etc.

1. Not Withstanding (c)(1)(B), (c)(4), or (d)(1)(C), ifA. If a child receives over 1/2 of support for the calendar year

i. from parents who are divorced or separatedii. Separated under written agreement

iii. , or live apart at all times of the last 6 months of the calendar yearB. Such child is in the custody of 1 or both parents for more than 1/2 of the calendar year

2. Requirements in paragraph 1 are met if:A. Custodial parent signs written declaration that he will not claim child for the taxable year

beginning in said calendar yearB. Non custodial parent includes such written declaration to their return for the taxable year

beginning in said calendar year152(d) Qualifying Relative

1. mensA. Who bears relationship to taxpayer described in paragraph 2B. Whose GI is less than the exemption amount

3650C. Taxpayer provides >.5 of the individuals support of the calendar yearD. Who is not a qualifying child for any taxable year

2. Relationship - an individualA. ChildB. Brother, sister, step brother, stepsisterC. Father mother or ancestor of eitherD. Stepfather or stepmotherE.Son or daughter of a brother or sister of the taxpayer (niece or nephew)F.Brother or sister of father or mother of taxpayer (aunt or uncle)G. Son in law, daughter in law, father in law, mother in law, brother in law, or sister in lawH. An individual who, for the taxable year of the taxpayer, has the same principle place of abode as

the taxpayer and is a member of the taxpayers household

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§1001 Determination of Amount of and Recognition of Gain or Loss§1001(a)

Sale or other disposition amount realized less adjusted basis = gain or loss

§1001(b) The amount realized is the sum of any money received plus the FMV of property other than money

received§1001(c)The entire amount of gain or loss shall be recognized, except as otherwise providedException to §1001(c) §1041 Transfers of Property between spouses or incident to Divorce

(a) no gain or loss on a transfer from an individual to a spouse or former spouse only if the transfer is incident to eh divorce(b) treated as a gift - applies to transferee

1. Transferred as gift2. Transferee acquires the adjusted basis of the transferor

(c) Incident to Divorce1. Occurs 1 year after the date on which the marriage ceases, or2. Is related to the cessation of the marriage

This reverses the Davis outcome When dealing with losses, you have to ask if it is an allowable loss?

§165(c)1. In trade or business2. Any transaction for profit (Stock Losses)3. Casualty Losses

§1001(c): does he recognize it? Are there any exceptions? NO exceptions (that we know of §1041) He does recognize, so he gets to deduct it

§121 Exclusion of Gain from Sale of Principal Residence§121 (a) No gross income if

During the 5 year period from the sale or exchange such property had been owned and used by the taxpayer as Principal Residence for periods aggregating 2 years or more

§121(b) Limitation1. Shall not exceed $250,0002. Special for Joint Returns $500,000

Common Non Taxable Exchanges (There is always a gain/basis rule)§1041 Transfers of property between spouses or incident to a divorce§1031 Exchange of Property held for productive use or investment§1033 Involuntary Conversions

§1033 (a)If property as a result of destruction . . . is involuntarily converted1. Into similar property, no gain shall be recognized2. Conversion into money

A. If specified in B, for the purpose of replacing, purchases similar property as that converted, at the election of the taxpayer the (realized) gain shall be recognized only to the extent that the amount realized upon conversion exceeds the cost of the purchased property

§1033 (b) Basis of Property Acquired through Involuntary Conversion1. 2. Conversions in §1033(a)(2)

Basis in new property shall be the cost of such property decrease by the A/R not recognized

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§1033(a)(2)(A) = Realized gain shall be recognized only to the extent that the A/R upon conversion exceeds the cost of purchasing similar property

Cannot recognized more than you realized

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Exceptions to the General Rule of 1001(c):1001(a) = A/R - A/B = Gain or Loss165(c) if loss, must be trade or business, investment, or casualty loss, else it is not allowedIf it is allowed, then you must recognize loss/gain under 1001(c), unless there are exceptions:

§121 Gain or loss on sale of Primary Residence Gain Deferral Sections:

Deferral takes the form of Basis, either in the form of new property or in the hands of another taxpayer

§1041 Transfers of property between spouses or incident to a divorce §1033 Involuntary Conversions

Only deals with gains If deferred, the basis in the real property must reflect the realized, but unrecognized gain You can never recognize more than you realize

§1031 Exchange of Property held for productive use or investment §1033 Involuntary Conversions§1033 (a)If property as a result of destruction . . . is involuntarily converted

1. Into similar property, no gain shall be recognized2. Conversion into money

A. If specified in B, for the purpose of replacing, purchases similar property as that converted, at the election of the taxpayer the (realized) gain shall be recognized only to the extent that the amount realized upon conversion exceeds the cost of the purchased property

B. Shall begin with the period the conversion occurred, or the earliest date of the threat or imminence of requisition or condemnation of the properi. 2 years after the close of the taxable year any part of the gain was realized

C. If the taxpayer never files amended return, then the statute of limitation on assessment never expires

Reg. 1.1022(a)-2(c)(2) If the time period expires, or is not desirable The gain shall be reported in GI Must recompute and file an amended return for the year in which he realized the gain

§1033 (b) Basis of Property Acquired through Involuntary Conversion

1. 2. Conversions in §1033(a)(2)

Basis in new property shall be the cost of such property decrease by the A/R not recognized

§1033(a)(2)(A) = Realized gain shall be recognized only to the extent that the A/R upon conversion exceeds the cost of purchasing similar property

Cannot recognized more than you realized §121(d)(5) Involuntary Conversion §1031 Exchange of Property held for productive use or investmentReg. 1.1031(a)-1(b): Definition of like Kind

Reference to nature and character of property and not to its grade or quality The fact that real estate is involved it does not matter if it is developed or not

Reg. 1.1031(a)-2 Personal property - non real property Like class are of a like kind See Reg. 1.1031(a)-2(b)(2) for asset classes

§1031(a)1. No gain or loss shall be recognized on the exchange of property

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used in trade or business, or held for investment

If such property is exchanged solely for property of like kind used in trade or business, or held for investment

Click v. Commissioner Judge the intent of the property at the time of the exchange

2. Exceptions §1031(d)

If property on this type of exchange Then the basis in the new property shall be the same as the that of the property exchanged, decreased

in any amount of money received, and increased/decreased in amount of recognized gain/loss The test is to theoretically sell and see what the gain/loss he would incur

Under 1016(a)(2) requires downward depreciation of Basis §1031(b) - BOOT - other property or money

If would be in 1031(a) but consists of property and other property or money Then the realized gain if any to the recipient shall be recognized, but not in an amount in the sum of

such money and the FMV of such other property There is a fundamental relationship between gain inclusion and basis

If you do not recognize gain in an exchange, then the basis has to reflect it If you do recognize gain, then your basis should be the FMV

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Capital Gains: May all your gains be capital

Net Capital Gain gets reduced tax rate May all your losses be ordinary

Capital Losses are limited by §1211 Capital Gains + 3,000

1. Loss - 10,0002. Is it allowed?

Look to §165(c)1. Trade or Business2. Investments3. Casualty Loss

Need to go to C before you go to F§165(f)

Losses or sale of capital assets are limited to §1211 and

a. Corporationsb. Individuals

i. Allowed to extent of gains, plus (if losses exceed gains) the lower of 3,000 or excess of losses over gains

§1212a. Corpb. Individual

i. You can carry over capital losses indefinitely3. Is it recognized §1001(c)

Exceptions §121, §1031, §1033, §10414. IF it is recognized, then you must characterize

Is it capital or ordinary Assuming it is a capital loss§165(f)

Losses or sale of capital assets are limited to §1211

a. Corporationsb. Individuals

i. Allowed to extent of gains, plus (if losses exceed gains) the lower of 3,000 or excess of losses over gains

§1212a. Corpb. Individual

i. You can carry over capital losses indefinitelyWhat is the location?Above the line§62(a)(3) - losses from sale or exchange of property §1222: Capital Gains or Losses

> 1 year = long term < 1 year = short term

(11) - Net Capital Gain Excess of the net-long-term-capital-gain for the taxable year over the net-short-term-capital-loss for

such year(7) NLTCG

Excess of long term capital gain over long term capital loss(6) NSTCL

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Excess of short-term-capital-losses over short-term-capital-gain(1) STCG

Gain from the sale or exchange of a capital asset held for not more than 1 year(2) STCL

Loss from the sale or exchange of a capital asset held for not more than 1 year(3) LTCG

Gain from the sale or exchange of a capital asset held for more than 1 year(4) LTCL

Loss from the sale or exchange of a capital asset held for more than 1 year 1001(a): Sale or other disposition

A/B - A/R = G or <L> realized If loss §165(c) is it allowed

Yes, must recognize under 1001(c) Exceptions

a. §1041b. §121c. §1033d. §1031

If none apply then you do recognize Characterize:

1. Sale or Exchange?2. Is it of a capital asset?3. What is the holding period?

§165(g)(1)

If any security become worthless during the taxable year The loss resulting shall be treated as a loss from the sale or exchange on the last day of the taxable year

§166(d)(1)(b) For non business bad debts = STCL Where any non-business bad debt becomes worthless The loss resulting shall be treated as a loss from the sale or exchange of a capital asset held for not

more than 1 year What is a capital asset?§1221 Capital Asset Defined

a. Capital asset means property held by the taxpayer, whether or not connected with trade or business, but does not include: (1) - (8)

1. Inventory2. Property used in trade or business (subject to 167 depreciation) or real property used in trade or

business3. Copyright, literary, musical or artistic composition, a letter or memorandum or similar property,

held bya. A taxpayer whose personal efforts created such property

4. Accounts or notes receivable in the ordinary trade or businessb. 3

Holding PeriodDisregard day of acquisition, include day of saleMust wait 1 year plus 1 day Tacking§1223

Like the tacking basis in a transfer

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You may tack the holding period

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Net capital Gain5. Above the Line Deductions

Ordinary Loss - Deductable in FullCapital Loss - are limited deduction

6. Applicable Tax RateNet Capital Gain §1(h) is relevant only when you are determining the tax rate In Each of the John Alternatives - 594Qualified Dividends (assume they are)§1(h)(11) - Have to have held for held for a certain period of time**You have to add the qualified Dividend to the Net Capital Gain**

Only Relevant For §1 purposes (rate determination Last to Steps of Characterization:S/E of C/A held > 1 year = LTCG §1231- Allows Capital Gain treatment on Items that are not C/A's or C/A's not disposed of by sale or exchange OR to allows Capital Losses to be ordinary

Either an item is not a capital asset because of 1221(a)(2) Or even if it is a capital asset, if it used in a trade or business or for investment and is not disposed of

for sale or exchange The section can turn it into a LTCG1. If the section §1231 gains exceed §1231 losses for such taxable year, such gains or losses shall be

treated as LTCG or LTCL as the case may be2. If the gains do not exceeded the losses then such gains and losses shall not be treated as gains or losses

from sale or exchange; therefore ordinary gains and ordinary lossesWhat is a 1231 Gain/Loss?1231(a)(3)(A) 1231 Gain - Capital Gain if Gains > Loss1231(a)(3)(B) 1231 Loss - Ordinary Loss iv Loss > Gain

i. Property used in the trade or businessii. Of the type for depreciation

iii. Held for > 1 yeariv. Real property held for > 1 yearv. Which is not:

1. Inventory2. Property for sale to customers3. Copyright 4. Publication of Govt.

Only difference is the Holding PeriodIf holding period is <= 1 year, it does not follow into §1231 Example: 602

7. 10K of realized and recognized gain on sale of violin used in business, held for 2 years Not a Capital Asset Is subject to Depreciation Is it a §1231 Asset?

(a)(3)(A) - any recognized gain for property used in trade or business YES

1231(a)(1&2) Main Preliminary Netting of Gains/Losses 1231(a)(4)(C)

In the case of any involuntary conversion (casualty) of property used in Business or C/A for > 1 year held in connection with Bus. then 1231(a) does not apply to conversion if the recognized losses > recognized gain

If losses = or < gain then 1231(a) does apply1231(a)(4)(C) - Fire Pot - Involuntary Conversions

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1231(a)(1&2) - Main PotMain Pot

8. 2K1. Capital Asset

i. No2. S/E

i. no3. 1231 Asset?

i. Subject to Depreciationi. Yes

ii. Held > 1 yeari.

§179 expensing is NOT FAVORABLE * Special Election4. Involuntary Conversion - 1231 Loss - FIRE POT

9. 5K Gain on insured loss of investment held > 5 years1. Capital Asset

i. Yes2. S/E

i. No, Involuntary Conversion3. 1231 Gain

10. 9K on condemnation of rental property held >71. Capital Asset

i. Yes2. S/E

i. No3. 1231 Gain

i. Not a Casualty Lossii. Main Pot

Do Fire Pot First5k gain > 2k loss(a)(4)(C) says doesn’t not apply if L>GSince G>L they go to main PotAll in Main Pot24K Gain 2k LossG>LAll LT Capital Gain/Loss If facts differentDo Fire Pot First5k Loss > 2k Gain(a)(4)(C) says doesn’t not apply if L>GDrop out of 1231 and are both ordinary §1245 - Depreciation Recapture

Recapturing of ordinary income we were able to reduce by depreciation deduction §1245 - Makes you apply this section to certain gains from depreciable personal property before they make it into 1231§1245(a)(1) Ordinary Income

If 1245 Prop is disposed of the amount by which the lower of A. Recomputed basis, or B. Case of sale, exchange, involuntary conversion the amount realized (or FMV)

Exceeds the A/B = Ordinary Income

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§1245(a)(2) Adjusted basis recomputed by adding (back in) all adjustments reflected in such basis on account of

depreciation§1245(a)(3) Property - any property which is or has been allowed for depreciation (167) and is:

A. Personal Property - non-real estate, non buildings

§197 - Amortization Can be over 15 year period

§197(f)(7) Treatment as depreciable

1250 - Gain from Disposition of Certain Depreciable Realty (only buildings placed in Services Prior 1986)

You are only recapturing additional depreciation1250(b)(1) - adjustments that exceed the amount of depreciation had you taken straight-line

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2010 federal income tax outline

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