Income Tax Fall 2014CHANNEL 41

Syllabus

Basic Structure of the Income Tax

1. Tax Policya. Income is the sum of ones consumption plus ones increase in net worth during a designated period

b. Consumption Tax does not tax savings, therefore it encourages taxpayers to save

c. Fairness

i. Horizontal Equity- persons similarly situated should be taxed in a similar fashion- make the same, pay the same

ii. Vertical Equity- persons whose situations are different should be taxed differently, make more or less pay more or less

d. Efficiency- seeks a balance between maximizing tax revenues and minimizing the social costs of taxation

e. Neutrality- tax system should avoid unnecessarily shaping behavior, income in stocks, cash or trade is taxed as equal income- so the decision to accept compensation is not influenced by having to pay taxes- it is tax neutrali. Today there are numerous tax rules that DO drive economic decisionsf. All revenues bills must originate in the house of representatives2. Marginal Rate of Tax is the tax rate at each bracket of taxable income

i. There are 7 rate brackets for individuals, the highest tax is 39.6%ii. There are 4 rate brackets for Corporations, the highest rate is 35%

3. IRS Rulings and Procedures

a. Rulings are official announcement of the IRS position on the application of a rule to a set of facts- limited in scope to those particular factsi. Not as authoritative as regulationsii. Published in the Cumulative Bulletin (C.B.)

b. Private Letters have no precedential value and can not be relied up on by other taxpayers4. Case Law

a. Three courts have jurisdictioni. Refund Tribunals-a taxpayer must first pay the asserted tax deficiency and then file an administrative claim for a refund, if the administrative claim is denied the taxpayer can then file in the District or Claims courts for refund1. US District Court (only forum with a jury option) odds of success higher here2. US Claims Court

ii. US Tax Court- the only forum a taxpayer may litigate a disputed tax claim without first having to pay the asserted tax deficiency1. Regular Decisions (significant or novel issues, binding precedent) are published in the United States Tax Court Reports (T.C.)

2. Memorandum Opinions (apply established law to the facts of the case) unofficially published by CCH and RIA

5. Mayo Found. for Med. Educ. & Research v. United States, 131 S. Ct. 704, 178 L. Ed. 2d 588 (2011) Medical foundation operating graduate medical school and state university brought action against the government for the refund of Federal Insurance Contributions Act (FICA) taxes withheld and paid on medical residents' stipends.

a. Holding: full-time employee rule promulgated by the Treasury Department, under which the services provided by one normally scheduled to work 40 hours or more for school, college, or university are not incident to and for purpose of pursuing a course of study, as required for such services to be exempt from taxation under the Federal Insurance Contributions Act (FICA), was entitled to Chevron deference, and sought to distinguish between workers who studied and students who worked, based upon number of hours that they workedChapter 2Gross Income(Omit problems 1(h) & 2)

1. The Definitions of Gross incomea. 61 definition is all income from whatever source derived

b. SCOTUS definition of income is undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion.c. Gross Income may be Realized in any Form (money, Property, or services)d. Impact of Obligations to Repay- money loaned is not accession to wealth and thus is not income within the meaning of 61

i. The most important factor to consider is whether the taxpayer enjoys complete dominion over the funds

ii. Embezzlement is income, and repayment of embezzled funds is a deductible loss2. The Realization Requirement- determines the proper timing of taxationa. Policy- gives certainty, consistency and objectivity3. Statutory Exclusions from Gross Income- IRC 101-140a. Giftsb. Discharge of Indebtednessc. Employee Benefits4. Long-Standing Administrative Practicesa. General Welfare Exclusion- govt benefits and assistance payments- IRC85i. Must be made pursuant to a govt programii. Be for the promotion of the general welfare (based on need)iii. Not represent compensation for services

b. Imputed Income-taxpayer does not have to pay tax on service that he provides for himself (ie. Mowing his lawn, growing his own food)c. Bargain Purchases- do not have to declare the difference between what was paid and the actual value (Exception for bargains made in an employment setting, 1.61-2(d)(2)(i))d. Frequent Flyer Trips- govt will not tax promotional benefits unless converted to cash5. C.I.R. v. Glenshaw Glass Co., 348 U.S. 426, 75 S. Ct. 473, 99 L. Ed. 483 (1955) Litigation settlements are included in taxable income because Congress applied no limitations as to the source of taxable receipts, not restrictive labels as to their nature.

i. Meets the requirements of

1. Accession to wealth

2. Clearly realized

3. Over which taxpayer has complete dominion

6. Cesarini v. United States, 296 F. Supp. 3 (N.D. Ohio 1969) aff'd, 428 F.2d 812 (6th Cir. 1970) taxpayers who purchased a piano in 1957, who subsequently discovered $4,500 in old currency hidden in the piano in 1964, did not have the currency reduced to undisputed possession for inclusion in gross income of treasure trove until it was reduced to undisputed possession in 1964, and therefore the US was not barred by the statute of limitations from collecting tax on such treasure trove for 1964, at ordinary income rates, and the treasure trove was not subject to capital gains treatment.

7. Old Colony Trust Co v Commissioner (279 US 716 (1929)) It is immaterial if a sum is paid directly to a third party the discharge by a third person of an obligation to him is equivalent to receipt by the person taxed- as a taxable benefit

8. Related Matters- Gross income considerations- after determining if a particular receipt is included in gross income and the proper amount that must be reported the following questions must be addressed

a. Proper timing- when is it included in gross income? Get the proper taxable year and whether the taxpayer is cash or accrual

b. Proper taxpayer- who must report the income?

c. Proper character of income- is it ordinary income or capital gain?

9. PROBLEMS:

a. 1. A- claim 75k for services rendered, $1000 claim the income 74, claim the $1500 or use of cabini. Use fair market value to determine cash value of non-cash compensation/income

b. 1. B- claim the 10k and the taxes paid as income- i. this was an accession to wealth clearly realizedc. 1. C- claim 5k for services rendered

i. not imputed income because there was an actual transfer of funds- he did not utilize his own service or property- he actually bought the property on his own behalf, not barterd. 1. D- claim 15k- treasure trove 1.1-14, according to IRS treasure trove is income when received whether it is cash or object, in the year it was found it was realized, however the increase in value is not a realized benefit that should be claimed as income until it is actually realized (in order to account for fluctuations in the market) article 84 tax notes 1299e. 1. E- claim $1800- excluding the personal consumption- imputed income (benefiting from his own labor), has to report (61a2) the sale of blueberries minus the basis, has to report the cottage swap as income as well- compensation by a third partyf. 1. F- claim 100k when caught (you have complete dominion and this was a realization event) and then 25k when soldg. 1. G- claim the 250k and the tax compensation as income i. (77a) or

ii. 280Ag- renting a home for less than 2 weeks a year1. could have argued that this was a rental and this gain was excludable as a renters improvements10. Class Notes 8/27/14a. Every tax involves the application of a rate to a basei. Tax base x rate = tax

b. Taxes Designed to apply to every conceivable situation involving commercec. Tax Policyi. Ability to Pay- everyone who gets taxed should have a means to pay the tax

1. Fairness-

a. horizontal equity- treat similar situated the same wayb. vertical equity- if people are differently situated they should be treated differently

2. Efficiency- intelligent lazinessa. Cost of collection and compliance

b. Minimize the dragon the economy

3. Neutrality- tax in a way that causes all economically equivalent transactions to pay the same amount of taxd. Structure of Income Tax see chart on page 6 of texti. Pre-exclusions gross income

ii. X tax rates

iii. Net tax liability or refund

e. Marginal Rate- highest rate of tax one pays- the more income you have the higher tax rate you pay

f. Effective Rate- take all of income and find out what percentage of your income you paid tax on

g. POLICY: Progressive tax structure built on premise that there is a Declining marginal utility of moneyh. Who Pays taxes- slides on Twen or BBi. Individuals

1. Income

2. Payroll (SSC & Medicare)

ii. Corporations

1. Income

2. Payroll

i. Tax Expenditures- Congress creates a tax deduction that reduces overall tax revenues- 1.2 trillion in estimated tax expendituresi. Tax system primary mechanism for both spending and collecting money

ii. We spend as much or more money through the tax system with outlays through a tax deduction that reduces overall tax revenues

iii. Every time you shrink the tax base the money needs to be made up elsewhere11. KEY POINTSa. The tax system is a mechanism for spending money as well as collecting it

b. Facially neutral rules often favor one group over another12. CLASS NOTES 8/27/14

a. Take Legal Accounting if have no experience with money

b. Fundamental equation:

i. Assets= Liabilities + Equity

ii. Equity= Assets Liabilities

c. Gross Income 61- see slides

i. Economic

1. net increase in wealth plus personal consumption

ii. Tax

1. Accessions to wealth clearly realized. Glenshaw Glass (punitive damages are income)

iii. NOTES:

1. Even illegal income is income for tax purposes

a. Like money laundering when the goal is to legitimize the cash

2. Like the conviction of Al Capone

iv. Code rulings 71 on define

1. Treasure trove is gross income once it has been realized

v. Excluded from income 101, 102, 121, 75-271

vi. When debt if forgiven it is income, but borrowing is not income

vii. A gift is an accession to wealth- but there is an exclusion for it 102

1. The gift must arise from detached and disinterested generosity

2. Employers can only give income- not gifts

viii. Any accession to wealth is presumed to be income- to overcome the presumption must find an exclusion

ix. Should Treasure troves be argued to be income when found or realized?

Chapter 3 Gains from Dealings in Property A. Renter reimbursed taxes do not count as income? 1001(b)(1)B. What is the tax difference in the basis of the income earned on a dividend reinvestment plan treated as an open-end fund and transferring so the account basis is determined at the time of transfer? 1012(d)(1+2)C. Gains and Losses from Dealing in Property

a. Gain form the sale or other disposition of property is the excess of amount realized over adjusted basisb. Sale or other disposition includes most transactions producing a quid pro quo

i. Selling for money or other property is a realization event

ii. Compensation by insurance is a realization event P35iii. A gratuitous transfer of property is not a realization eventiv. Transfer of property for the satisfaction of a debt is a realization event

c. Computation of Gain or Loss Realized

i. Gain realized= amount realized adjusted basisii. Loss realized= adjusted basis- amount realized

iii. Cost basis 1012= amount invested

1. Taxpayer can recover his investment (adjusted basis) to avoid double taxation

iv. Tax Cost Basis- is the fair market value at acquisition that was accounted for on tax return for gross income

v. Gift tax basis and stepped up basis- 1014 and 10151. Giftees basis is same as giftors basis at time of gift

vi. Adjustments to basis- 1016 initial basis+improvements or downward with basis-cost recovery deductions

d. Recognition of realized gain or loss

i. Unless there is an exception (nonrecognition provision) the entire gain or loss realized is recognized for tax purposes1. 1031 land exchange with higher value2. 351a or 721a exchanging land for company ownership with a higher FMV

3. 165 allows losses for business or investment property, not personal unless it is a casualty loss

e. Impact of Liabilities in Property Transactions

i. General Framework1. Basis is in total loan amount (not interest)

a. Recourse loan- the borrower agrees tobe personally liable for the debtb. Non-Recourse loan- the lenders recourse for default is limited to the asset securing the debt

ii. Philadelphia Park Amusement Co v US 126 F Supp 184; Suit by corporate taxpayer to recover alleged overpayment of income taxes for years 1944 and 1945. The Court of Claims, Laramore, J., held that where taxpayer which had franchise from city to operate passenger railway in public park exchanged a bridge for extension of its franchise, the exchange was a taxable one and taxpayer was entitled to use, as basis of extension of franchise, which taxpayer later abandoned, the fair market value of extension of franchise on date of exchange, for purposes of determining depreciation and loss due to abandonment of franchise, but since case was not argued on such theory and no evidence as to cost basis had been presented, judgment would be suspended and question of value of extended franchise remanded to court commissioner.iii. Crane v Commissioner 331 US 1 (1947); how a taxpayer who acquires depreciable property subject to an assumed mortgage, holds it for a period and finally sells it still encumbered, must compute her taxable gain.f. CLASS NOTES 8/29/14

i. An arms length transaction-

1. Between unrelated, non-conspiring parties

a. Each party is looking out for their own interest

b. Ie- not a family or employer

ii. Fair market value- the price that would be paid by a willing buyer to a willing seller both with reasonable knowledge and neither acting with compulsion 20.2021-1biii. Recourse v non-recourse debt1. Normally a person borrows on a recourse basis- personally liable2. Non-recourse borrowing is rarely employed

a. Only the property secures the debt

iv. Quiz question- A cash prize under 74a is income (rarely is the prize exclusion qualifying)v. Quiz question- General welfare exclusionvi. Quiz question- treasure trove

vii. Gains and Losses from Dealings in Property1. 1001a- computation of gain or lossa. Amount realized over adjusted basis= gain realized2. 1001b- Amount realized- what you received- money and propertya. this includes debt relief

3. FMV- what a winning buyer would pay a winning seller with knowledge and no compulsion4. Adjusted basis 1012- your costa. Cost= the FMV of the property you received, not the FMV of the property you gave is the default position b. Cost/basis adjusts under 1016a- ie. improvements on a buildingc. Cost/basis also goes down as you take depreciation adjustments

5. Basis is used to get us to ground zero after the first transaction, the next transaction (like a sale) determines if we gained or lost money6. When we know the value of one side of a taxable exchange the second side is presumed to equal the first7. Amount realized 1001b-adjusted basis 1012= realized gain 1001a

8. The gain recognizes post tax dollars

9. How do we calculate lossa. Adjusted basis - amount realized= loss realized

b. 1001c consequencesi. a realized gain or loss must be recognized unless there is a provision requiring non-recognition

ii. recognized gains and losses must be on your tax return

g. CLASS NOTES:

i. Recap 9/3/14

a. Amount realized (1001b)- adjusted basis (1012)= realized gain (1001a)

b. Amount realized is anything we get- including debt relief

c. FMV- willing buyer pays will seller both with knowledge and without compulsiond. Adjusted basis

i. Cost 1012

1. What we put out2. The FMV of what we received

3. The value of what we received in a taxable exchange

4. When one value in a taxable exchange is known and the other is not we can presume the properties are equal

a. Cash sale of real estate

b. Publicly traded securities for a patent

ii. Adjusted Under 1016(a)

e. To get a zero starting place- take the basis of what we received minus the value of what we gave up- exchanges are not always equal2. Why isnt the entire amount received in a sale gain?a. Because return of basis merely places you back where you began, there has been no increase in wealth

3. Understanding basis crucial for this course- measuring post tax dollars so we avoid double taxation4. Calculation of a loss- take the same formula and flip it: adjusted basis- amount realized=loss realized (whatever number is bigger goes on top)

5. What does 1001c tell us are the tax consequences of a realized gain or loss?a. We must recognize it unless there s a provision which requires non-recognition (eg 121, 165)

6. Conflicting motivations between business and IRS

a. How to generate profits without getting taxed- figure out a way to profit while generating losses

7. What does it mean to recognize a gain or loss? Record it on your tax return- income paid upon it or a deduction taken8. 3 steps to analyzing

a. gain or loss realized

b. gain or loss recognized

c. if recognized, character of recognized gains or losses

i. capital, or

ii. ordinary

ii. Borrowing- 1. Basis is the FMV or property acquired even if we use somebody elses money to get the propertya. Borrowing does not reduce our basis2. Basis represents post tax dollars- any recovery of basis is not income, when coupled with the concept of depreciation Crane created a tax holea. Depreciation is the decline in property value due to wear and tear and obsolences- creates a tax deductioni. The operating presumption is the property is useless at the end of the depreciation term- say ten years

b. So if you can buy a building for a 1m, and you can borrow 900k to buy it with your 100k out of pocket, and you can rent the building for 100k a year, take a depreciation deduction for 100k each year, at the end of year one you got the 100k you put up and you owe no taxes since your deductions are equal to your revenue, same in year two- and now you have 100k that you did not have when you started- c. when you get down to zero with your basis, if you then turn around a sold the building anything you get will be income- so if the building is still worth 1m- you have to pay taxes on 1m- but you still come out way aheadd. tricks- i. divorce- non-recognition event- nobody recognizes any gain or loss so person receiving gets the tax problem and whatever mortgage was not paid off

3. Crane- use somebody elses money still get a full basisa. Corrolary principle- if you transfer the property later any debt relief will be part of your debt realizedb. But what about non-recourse borrowing, should it always go into basis (along with any cash paid)?i. Almost always- authority is split on when it does notii. If the non-recourse borrowing is less than the FMV you can include the amount in the basisc. Conflicting decisions:i. Pleasant Summit: it goes into basis to the extent that it does not exceed FMV, but no further (so you get the cash and the nonrecourse mortgage up to the FMV- add the two together even if it more than the property is worth)ii. Estate of Franklin: if it exceeds FMV is does not go into basis at all1. Ie. Mortgage is 900 and building is worth 500k, if that debt was recourse it all goes into the basis- and out buyers basis; but if it is non-recourse

iii. Summary on borrowing

1. Recourse borrowing goes into basis

2. Nonrecourse borrowing a. If the borrowing is less than FMV it goes into basis

b. If the borrowing is greater than the FMV then you get into the split between Franklin and Pleasant Summith. Basis comes due each time there is a step up- so if angie Jolie buys a dress for 4k, then exchanges it for a 10k dress, she realizes the 6k at that time and her basis is at 10k moving forward

i. Whenever property exchanges hands it is an event for tax purposes- gain or loss realized, or gain or loss not-recognized- pay attention to how you structure exchanges

i. When you form an entity when you put property inside a new entity you are exchanging that property for an interest in that corporation1. There are rules that allow you to avoid recognizing gain on that transactionsii. When you give your ownership interest in your corporation for an interest in a new corporation (a merger) you are exchanging propertyiii. Liquidation of an LLC is a sale or exchange of propertyj. Pg 33 problems

i. 1.

1. A. No realization event

2. B. Amount realized- is 95k, basis was 50k, gain realized is 45k3. C. Amount realized is 95k, basis is 125k, loss realized is 30k

4. D. Amount realized 0, basis is 50k that passes to son5. E. Amount realized is 100k, basis is 50k, gain realized is 50k6. F. Amount realized is FMV, basis of 50k passes to ex-husband7. G. Amount realized is 100k, basis of 50k, if 1031a applies no gain or loss realized8. H. amount realized is 100k, basis is 50k, gain realized is 50k9. I. Amount realized is 100k, basis of 50k, if 351a applies no gain or loss realizedii. 2.

1. Amount realized is 80k, basis is 50k, gain realized is 30k2. Amount realized is 80k, basis is 70k, gain realized is 10k; 1016a13. Amount realized is 80k, tax cost basis in real estate is 50k (had to report the income to get the real estate- this is for her time only, any out of cost expenses would be tax deductible), gain realized is 30k4. Amount realized is 80k, basis is 50k (gave up property worth 50k so we assume she got property worth 50k- cash or asset acquisition is a taxable exchange), gain realized is 30kiii. 3. 1. Jacks Amount realized is 3m, adjusted basis is 2m, gain realized 1m (taxable income due to the depreciation)a. Jill assumed a debt of 3m, however must do the Pleasant Summit Franklin analysisi. 2.2m basis under Pleasant Summit

ii. zero basis under Franklin b. NOTE: Debt relief is treated as the equivalent of a cash payment

2. Jacks Amount realized is 3m, adjusted basis of 2m, still has gain of 1m as a non-recourse debta. Surrendering the property is not a way out, except

i. Bankruptcy

ii. Death

iii. Divorce- transfer property to departing spouse in divorce it is a non-realization event for the transferor

b. Had it been a recourse debt there would have been different considerations

c. Quit claim is a unilateral act

k. Bitcoini. A form of virtual currency

1. Does not have a tangible form of existence

ii. Bitcoins are property for tax purposes- if you buy a bitcoin1. If you buy $100 of bitcoin, and then buy something worth $150 you had a realization event that netted $50 in income

Chapter 4 Gifts and Inheritances (Omit Problem 1(c))a) Gift: the voluntary transfer of property to another without compensation; made in detached and disinterested generosity

b) Theory: is giving a straight transfer of wealth or consumption?i) Net zero- a gift means an increase to the recipients wealth and a decrease of the donors wealth(1) Can result in different tax collections due to individual tax brackets of donor and done

ii) Consumption- the act of giving is a consumption of ones wealth (giving instead of taking a vacation or buying something)(1) More favorable to tax collection

c) General Exclusionary Rule for Gifts and Inheritances 102(a)i) Exclusion for inter vivos giftii) Commissioner v Duberstein, 363 US 278 (1960), Taxpayer Duberstein received a Cadillac from a long-time business acquaintance. At issue was whether the Cadillac was truly a gift or a payment in exchange for business information

(1) Duberstein Test for an excludable transfer from gross income (a) the critical consideration is the transferor's intention. This is a question of fact that must be determined on a "case-by-case basis". (b) an objective inquiry that looks to "the mainsprings of human conduct to the totality of the fact of each case." On review, the trier of fact must consider all of the evidence in front of it and determine whether the transferor's intention was either disinterested or involved:(i) Gifts result from "detached and disinterested generosity" and are often given out of "affection, respect, admiration, charity or like impulses".

(ii) Contrast payments given as an "involved and intensely interested" act.

(c) Does not apply to: (i) spouses who are considered one taxable unit so when they transfer property it is not an accession of wealth(ii) prizes, awards, or scholarships(iii) income from property received by gift

(iv) gifts transferred by or for an employer, to or for the benefit of an employeed) Basis of Property Received by Gift, Bequest, Devise, or Inheritancei) The donees basis is generally the same as the donors basis- transferred basis(1) The donee also assumes the donors gains on the property(2) The donors basis is not used for a loss, where the lower FMV is used (donees loss is limited to the loss while in donees hands)e) Heirs take stepped up basis in the property equal to its FMV at the date of decedents death 1014i) POLICY: equalize tax burden for non-community property states to match the advantages of community property statesii) Exception- 1014(e) triggered only if the decedent dies within a year of the original transfer

f) Tax Planning-i) Give away properties with higher bases (that transfer) and holding on to properties with lower bases that will get the step up upon death when they transferg) Part sale part gift is a realization event for donor (the consideration recvd- full basis in the property)i) Exception for part gift to charitable organization 1011(b)

ii) No loss is ever allowed in a part sale part gift situation

2) Wolder v Commissioner, 493 F.2d 608 (2d Cir. 1974) a) FACTS: Pursuant to a written agreement, appellant taxpayer, an attorney, provided legal services to her at no charge to his client who bequeathed her stock to appellant upon her death. Appellant received the stock and cash one year after the client's death, when its value had considerably increased. b) tax court: held that the stock and cash were taxable income, underI.R.C. 61, and were not exempt as a bequest, underI.R.C. 102, and that appellant constructively received the stock and cash in the year of the client's death rather than the year in which he actually received it. Appellant and appellee Commissioner of Internal Revenue (United States) sought review. c) The court affirmed the judgment in part, holding that the gift was not excludable, under 102, as the contract was, in effect, one for the postponed payment of legal services rather than for a gift. The court reversed the judgment in part, holding that the date of the transfer of the stock was the date of appellant's actual receipt rather than the date of the client's death, as the income was not unqualifiedly subject to the demand of appellant because it was open to the residuary legatees.3) Problems pg 49a) 2. A- amount realized of 90k, transfer basis is 40k, 50k is the realized gainb) 2b- amount realized 90k, adjusted basis 30k, loss realized is 10k is taxable (even though the 10k loss at time of gift just evaporates)- second scenario- 1.1015-1a2, neither a gain or a loss if sold at 35k, daughter can recognize moms gain but cannot recognize moms lossi) using lessor of FMV on date of gift or the transfer of the adjusted basis

ii) the family may have been better off selling the property instead of gifting it so that the 10k that was lost from the adjusted basis by having to take the FMV in the gift is not lost

c) 2c- i) Catherine- part sale part gift 1.1001-1e transferor has a gain when the amount realized exceeds the adjusted basis- so she has a gain of 20k, because the adjusted basis stayed at 40kii) Elisabeth- 1.1015-4 during her sale she can use the basis of her amount paid or the transferors basis whichever is greater- so she can (1) Daughter got it with 40k in adjusted basis-so we bump the daughters basis from 40-60 so that the dollars are only taxed once

(2) We increased the mothers adjusted basis to 60k

(3) Basis is always adjusted to preserve what had not been recognized

d) 2d. donors relief of liability is treated as the amount realized- Catherines gain is still at 20k, daughters basis is 60k (same as 2c scenario)e) 2e- amount realized 90k, adjusted basis (is 1014a- stepped up) 80k, amount of gain realized is 10kf) 3a. community property 1014b6- she gets the stepped up basis in both halfs- 500k FMV step up to her adjusted basisi) 1014b6- she gets a basis step up from her own half (regardless if she inherits the other half)ii) 1014b1 governs the other half- the half that passes from him to her

g) 3b. joint tenancy in a common law state- wife gets the basis step up in the one half that came form her husband, but would keep her basis from before his death in her half- so the adjusted basis is now 300k (this scenario means she owes taxes on 200k of gain that she did not have in the community property state)

i) in joint tenancy analysis go to 1014b9- we are going to act as if she received half the property from her deceased spouseh) 3c

4) Questions 1015a- always donor basis for gain purposes, only use date of gift FMV for loss purposes when less than date of gift FMV is greater than donors basis then we always use donors basisa) RULE: what basis does the surviving spouse take in her half of the joint tenancy property- answer: she keeps her old basis in her halfb) RULE: what basis does the recipient of a bequest take? Answer: Date of death FMV

c) RULE: Dad gives kid property worth 50k with basis of 40k what is kids basis for gain and loss purposes? Answer 40kd) RULE: dad gives kid property worth 50k with basis of 40k, subject to mortgage of 20k what is kids basis for gain and loss purposes? Answer 40ke) RULE: dad gives kid property worth 50k with a basis of

i) Since donors basis less than FMV we use the donors basis for both gain and loss purposes

f) RULE: dad gives kid property worth 50k with basis of 40k subject to mort of 45k what is kids basis for gain and loss purposes. Answer 45kg) RULE- what do you do when donors basis is more than the FMV? 1015ai) Gain? Use donors basis

ii) Loss? Use FMV for soling for a loss5) when dealing with debt situations- equivalent to giving mother 60k cash and mother paying off the debt or daughter borrowing 60k form mother to pay for property-

a) step up works for stocks too!

6) Look at 1014a for bequesting property7) CLASS NOTES 9/8/14

a) What is a gift for income tax purposes?i) A transfer of property out of detached and disinterested generosity Duberstein(1) Motive of donor examined

ii) Does the recipient of a gift or bequest of property have income?

(1) No. 102a- not income to recipients

(2) Facially neutral, but who really benefits?(a) This is not capped at any specific amount

(b) This helps wealthier people more than other people, in particular people with lots of disposable wealth who can afford to make huge gifts

(i) The gift tax has been revised so that you can give anybody up to 5.5m to anyone without gift tax (so a couple can give 11m)(ii) In addition- any year you can give 14k to anyone and it does not count against your gift 5.5m

iii) Is the income from property received as a gift or bequest income?(1) Yes. 102(b)(1)

(a) Income earned from the gift is income- apt building is not income, but the rent from the apt bldg. is income

iv) Does the recipient of a gift or bequest of income alone have income?(1) Yes. 102(b)(2)

(a) This primarily is at issue in trusts- as the income comes out of the trust you are taxed on it because all you were given is income

b) What basis does the donee of a gift take in the propertyi) Donors basis for gain purposes. Lesser of donors basis or Date of gift FMV for loss purposes 1015(a)

(1) If you received property that already has gain built into it we will tax you on the gain accrued in donors hands, but if there is a loss built into it we will not let you take advantage of the donors loss

ii) What basis does the recipient of a bequest take?(1) Date of death FMV 1014(a)

(a) Anything you inherit you get a date of death FMV basis

(b) This rule has a lock in effect- causing people to hold onto property they would otherwise transfer so they can transfer the basis(c) There is the estate tax which works like the gift tax- you can leave up to 5.5m to anybody and ay no estate tax- married couple can leave up to 11m

(d) Private family foundation dedicate to charitable purpose- does carry utility for the family can have provisions like(i) Paid salaries in foundation

(ii) Pay for travel expenses to go to board meetings in exotic places

(iii) Can stipulate only family members on board

(iv) Can be courted by potential donees

(v) Even though you can not directly appropriate the use

iii) What basis does the surviving spouse take in her own half of the community property(1) She gets a Date of death FMV basis in her own half- big deal for community property states 1014(b)(6) technical way that the property passes to the surviving spouse(a) In a common law state couples typically own property as a joint tenancy- where a survivor gets the whole thing- unless left to someone else

(i) But the other party will get the step up in the half that they are deemed to receive from the deceding spouse, but keeps the old basis in the half they already owned 1014b9 SLIDES POSTED WILL DEFINITELY PUT ON TEST with 1014 b6(b) In a community property state it does not matter how the property is titled, both parties own half

(i) when the one party dies the property passes to the other party- she inherits the whole thing and gets a basis step up in the whole thing- equalizer- even though they did not technically inherit it

(c) this is a major dividing law between how married couples hold property between common law and community property states

(2) Community property

(a) Each spouse is deemed to own half of marital assets

(3) Part sale- Part gift(a) How is the donor treated if he or she sells the item for less than FMV?

(i) Sometimes it takes the form of a debt assumption- eg mom transfers the house to the kids with a less than FMV mortgage on it(ii) She has to realize gain, but only if the amount she receives is greater than her basis but will never recognize a loss 1.1001(e) WILL BE ON THE EXAMAssignment # 4

Skim Chapter 5Discharge of Indebtedness, posted supplement on websitec) Discharge of Indebtedness

i) US v Kirby Lumber- 284 U.S. 52 (1931) the repayment of a debt at less than its face amount constitutes income to the debtor(1) Codified in 61(a)(12)(a) Facts.Kirby Lumber, Plaintiff, issued bonds for $12,126,800 and received par value. Later the same year it purchased some of the same bonds back at less than they sold them for, with a difference of $137,521.30.(i) The IRS claimed that the $137k was taxable asgross income. Kirby disagreed.1. The IRS argued Congress defined the termgross incometo include "gains or profits and income derived from any source whatsoever."

2. The IRS argued that the relevant Treasury Regulation explicitly stated that when a company buys back its own bonds at less than what they sold them for, the difference is taxable.(ii) Kirby argued that all they were doing was getting rid of debt, and that's not the same as making money.

(iii) The Trial Court found for Kirby. The IRS appealed.1. The Trial Court based their decision onBowers v. Kerbaugh-Empire Co.(271 U.S. 170 (1925)), a case in which a loan repaid in devalued German marks was not considered to be a taxable gain for the taxpaying company.(iv) the Appellate Court reversed and found the profit to be taxable.1. The Appellate Court found that if a corporation purchases and retires bonds at a price less than their face value or issuing price, the excess amount of the purchase price over the issuing price is a taxable gain.2. The Court noted that Kirby had clearly made a profit on the transaction, and there was no reason why that profit shouldn't be taxable.(v) Basically, the point of this case is that since you must pay taxes when you "buy low then sell high," you are also equally liable when you "sell high then buy low."(vi) Theories to rationalize1. Kirby balance sheet theory- an increase in net worth due to the cancellation of liability

2. Discharge of the obligation removes the justification for not paying taxes at the time of the original borrowing

ii) Exceptions - statutory and judicial(1) Contested liability or disputed Debt exception(a) if a taxpayer disputes the original amount of a debt in good faith and later settles that dispute, the settled amount is treated as the amount of recognizable debt for tax purposes

(i) Preslar v Commissioner

(ii) When a debt is unenforceable the amount of the debt is in dispute- 3rd cir.

(2) Bankruptcy and insolvency exception

(a) When taxpayer has no means to pay tax, Congress added 108 to exclude discharge-of-indebtedness income in certain circumstances

(i) Title 11 cases1. Bankruptcy under chapters 7, 11, 12, or 13

2. If taxpayer under jurisdiction of the bankruptcy court and granted by court(ii) If discharge occurs when the taxpayer is insolvent

1. Maximum amount excluded cannot exceed the amount by which the debtor is insolvent

2. A taxpayer is insolvent to the extent hi liabilities exceed the fair market value of his assets determined on the basis of assets and liabilities immediately before the discharge

a. Contingency debts (like cosigning a loan) Taxpayer must prove that it is more probable than not that taxpayer will have to pay the debt in order to include it in the calculation

(3) Cancellation is a gift 102

(a) examine intent of lender, must be detached and disinterested generosity(b) forgiveness in a business setting will almost never constitute a gift(4) Forgiveness of student loans

iii) Discharge of Recourse Debt in Property Transactions

(1) If debt is more than FMV of property,

(a) FMV 100,000

(b) Adjusted basis is 80,000

(c) Loan is 120,000

(d) This generates 20k in gain (FMV-AB) and 20k discharge-from-indebtedness income (Loan-FMV)

(i) This makes a difference for 1. the 20k of discharge-from-indebtedness income can be excluded if the taxpayer is insolvent2. the 20k of gain is taxed at capital gains lower ratesiv) Tax treatment of the lender(1) Lender may be entitled to a bad debt deduction under 166d) Preslar v. Commissioner

i) Facts.Purchased 2500 acre ranch for 1m, financed by Moncor bank at $66,667 per year with 12% interest, final payment due 9/1/98

(a) Sold 19 lots and was credited 200k against the principal on their loan (no record of interest payments credited)

(i) Used the installment sales contracts (from the lots) to repay loan at 95% of stated principal contract price (regardless of actual payments received from the purchaser)

(2) 1985 Moncor declared insolvent, FDIC appointed as receiver

(a) FDIC refused to accept contracts as payment and ordered Preslars to suspend sales of cabin lot

(b) Preslars complied with suspension but made no payments

(3) Preslars filed an action for breach of contract, FDIC agrees to accept 350k as full payment

(a) Reduced the debt by $449,463, claimed under 108e5 that it was a purchase price adjustment

(i) Commissioner responds that is only when the seller adjusts the price

(4) Tax Court rules, sua sponte, invoked the contested liability doctrine because the unusual payment arrangement brought the whole debt into question

ii) Rule of Law.Taxpayers who have incurred a financial obligation that is later discharged in whole or in part, recognize as taxable income the extent of the reduction in the obligation(1) Theories

(a) Increase in wealth due to reduction in valid claims against taxpayers assets

(b) Cancellation of obligation removes the reason for the original exclusion

(2) Tax Court held the contested liability/disputed debt exception to the general discharge of indebtedness income rule rendered the write-off nontaxable

iii) Dissent.

iv) Discussion.e) CLASS NOTES 9-9-14

i) How is the donor treated if he or she sells the item for less than the FMV

(1) Corollary rule on the basis side

(a) The donee takes the donors basis for gains purposes 1015a(b) But for loss purposes we use the lessor of the loss- if loss built into gift the done does not get the benefit of the loss(i) From a planning perspective a donor is ill advised to give property with losses, give gain property where done can use the adjusted basis and sell the loss property so that the loss can be realized and deducted form income for an advantage

1. Otherwise the loss is lost forever

(c) Part sale part gifts

(i) A straight gift is not an income recognition event for the donor

1. But if the donor receives some consideration the donor may recognize if it is greater than the basis- 1001-1e WRITE THIS INTO YOUR CODEBOOK(ii) How is the donnee treated if he she buys the item for less than FMV-

1. Answer..

2. donnee has no income3. done takes the basis for the greater of either the donee basis or what they paid whichever is greater- 1015-4

a. so if donee recognizes gain goal is to only tax the gain once

b. does not want to force the donor to recognize income

(d) the basis step up is hard to justify from a pure tax policy stand point- it is a political giveaway- everyone benefits but the top 1% get the most benefit(2) questions

(i) takes donors basis for gain purposes, FMV for loss purposes(ii) bequest recipient takes date of death FMV for basis

(iii) 1014 b9 and b6 address half of the property

1. Community property state- community property surviving spouse takes date of death FMV in her half of the property as well as the half she inherited- basis step up in the whole propertya. This is true even if the husband leaves hi half to his secretary

2. Common law state- joint tenancy property surviving spouse keeps her old basis on the half of the property that she already had, if she is left the decedents half she will get the basis step up to FMV at deatha. Survivor automatically gets the decedents half- he cannot leave it to his secretary(3) Pg 49 problems(a) 1a. year one no income event, year two income from gift is taxable income

(b) 1b. the trustee has no tax- it is not to his benefit, he holds bare legal title to the assets that sit within the trust, does not hold beneficial title(i) Betty is taxed (102b2) as the income is doled out (when the trust was created she did not get anything)

(c) 1c- skipped- an employer cannot make a gift to an employee almost always deemed compensation- Walder(d) 1d gown and necklace- 10k for the use- compensation(i) swag bag- quid pro quo- Duberstein analysis (detached and disinterested generosity)- donors intent given the circumstances- payment for services- taxable compensation- section 74a says that a prize or award is in income(e) 1e given annuity, looks like compensation for past services, but no legal obligation to make the payment see 174 F2d 893. This was a gift out of love and affection- what was the real motivation of the donor for the transfer(f) 1f son is a gift, pool boy is a gift, nephew quit smoking argue that in gift tax law we do not treat a detriment to the donee as a quid pro quo situation- she wasnt getting anything so it really was a gift, (g) 2a. 102a gift; 40k AB, 90k amount realized, 50k gain realized.f) Clicker questions on gifts and Cancellation of indebtedness

8) Chapter 6Fringe Benefits (Omit problem 4)a) RULE: Congress allows exclusion of a number of fringe benefits while continuing to permit the employer to deduct the costs of those benefits

i) If a fringe benefit is not excluded in the code it is gross income under 61a1

b) POLICY:

i) To encourage employers to provide the excluded benefits

(1) Advantage: Which potentially encourages the offering of the benefits at the expense of salaries (due to the tax benefits to both the employee and the employer)

(2) Disadvantage: Can have the ancillary effect of eroding tax base, which causes higher taxes to make up for the deficit so the employees tax rate is not reduced overallii) The difficulty in valuing the benefit

iii) The administrative inconvenience for all parties in not having to account for the benefit

c) Creates Seven categories of excludable fringe benefits- we focus on fouri) No-additional-cost services

(1) Ordinary customer service that can be extended to employee at no significant cost

(2) Not available to highly compensated employees unless widely available to all employees

(3) Includes retired, disabled employees and surviving spouses of deceased employees

ii) Qualified employee discounts

(1) Not to exceed employers gross profit for goods or 20% of the retail price for services(2) Must not discriminate in favor of highly compensated employees

(3) Employee can only access exclusion within the line of business in which the employee works

(4) Includes retired, disabled employees and surviving spouses of deceased employeesiii) Working condition fringes

(1) A benefit given to an employee which if the employee paid for the benefit it would be deductible under 162 (business expense)or 167 (depreciation expense)(a) Examples include business travel, auto reimbursements

(b) Not subject to discrimination rules in favor of highly compensated employees

iv) De minimis fringes

(1) A benefit so small it is not worth accounting for(a) Examples include personal calls on a company cell phone

(b) Not subject to discrimination rules in favor of highly compensated employees

(2) Other benefits

(a) Frequent Flyer Miles(i) Will not tax as long as do not convert to cash

(b) Meals or lodging for employers convenience

(i) Excluded when those benefits are provided as a condition of employment for the convenience of the employer(ii) Includes spouse and dependents of the employee

(iii) Only available for meals and lodging when furnished on the business premises of the employer

1. An employees separate dwelling owned by the employer and serving an important business function has been found to be an employers business premises.

v) Employment related payments from third partiesd) Lodging TEST- must meet all three

i) The lodging is furnished on the business premises of the employer

ii) The lodging is furnished for the convenience of the employer, and

iii) The employee is required to accept such lodging as a condition of his employment (could not otherwise properly perform the duties of his employment)e) Converting travel credits to cash is income and taxable i) IRC 61 provides that gross income means all income from whatever source derived

f) Problems page 77

(1) Stephen Jobs

(a) No tax- in the normal course of business offered to customers, and not below cost of goods, (i) For tangible property discount equals to the gross profit percentage of 20%

(b) Same as above1.132-2a3(c) Not within his line of business, will pay tax(d) Same as a- he gets benefit of both lines 1.132-4a1iii(e) 132j- basic nondiscrimination rule(f) no tax- 132h2a dependent child exception(2) Amelia Earhart

(a) No tax- line of business(b) No tax

(c) No tax 162, travel for business(d) No tax- parents also get benefit 132h3(3) Billy Crystal See 1.162-17(b)(2); using the charley principle- the value he receives in excess of his actual cost- effectively selling his frequent flier miles(a) Taxable- Income from any source; pg 81 announcement 2002-18, 2002-1 CB 621(b) Taxable- Income from any source; pg 81 announcement 2002-18, 2002-1 CB 621(i) His partner may have recvd a gift which could also be analyzed

g) CLASS NOTES 9/15/14

i) Cancellation of indebtedness income(1) Borrowing does not increase wealth or create income

(2) But if that debt is forgiven cancellation of debt is a form of income

(a) 61a12

(3) how do we distinguish COI from amount realized(a) cancellation only arises when the lender forgives the debt

(4) every time a lender forgives a debt we do not have COI income- it depends on context

(a) it could be a gift or compensation

(b) it may depend on whether the loan is recourse or non-recourse

(i) how is a discharge treated when the lender takes back the property?

1. Relief of recourse debt, not in excess of FMV of property surrendered is amount realized

a. If debt is less than the FMV of the property the relief from the debt will be treated as amount realized

2. if we have recourse debt in excess of the FMV of the property and the lender forgives the whole debt, any forgiveness of debt above FMV is COI income 1.1001-2(a)(2) rev rul 90-16(ii) COI= cancellation of indebtedness

(iii) Recourse debt requires the lender to take further action to relieve the debt (which is a realization event) where is in non-recourse debt the lender has no additional action they can take

(5) If the debt is nonrecourse- then the full amount of the debt relief is the amount realized no matter what(a) Relief of non-recourse debt upon transfer is always amount realized (even when it exceeds FMV of property surrendered)

(6) Disputed debt doctrine applies when the amount of debt in the beginning is disputed or uncertain not to differentiate recourse v non-recourse debt(7) There are a lot of exceptions to cancellation of indebtedness rules 108- we wont force you like when you have a bankruptcy or insolvency

(a) Student loan forgiveness does not create income

(8) A lender 166 can claim a tax deduction for the part of the debt that they forgive, claims it as a loss

h) FRINGE BENEFITSi) Compensation other than wages or salary

(1) Eg, health ins, life ins, pensions plan (deferral like 401k, but when you pull the money out in 40 years it will be income) , free coffee, free parking, free gym membership

ii) How do taxes work(1) Every tax involves the application of a rate to a base

(a) When you exclude these things from income you have not lessened your tax need so the rates are bumped

(i) Any think you should try to keep the base broad so you can keep the base low

iii) 132(1) no additional cost services

(a) family members are treated as the employee- they too can get the benefit

(b) limitation- if the business has multiple lines of business, the employee can only get the benefit if they work within the ine of business for which they are receiving the product or service

(c) non-discrimination rules applies- this provision must apply to highly and lesser compensated employees equally

(d) 119 excludes meals and lodging provided to an employee by the employees employer when:(i) the employee must receive the meal for the convenience of the employer

(ii) the employee with respect to lodging is required to accept the lodging to accept the position

(iii) the meals must be provided on the employers premises

(e) excludes most employer provided health benefits 105 and 106 this is the single largest subsidy in the tax code

(i) this provision debated by economists because it has a distorted effect

1. creates bias in favor of employer provided as opposed to self financed health insurance

2. creates bias in favor of compensation paid as health insurance rather than wages

3. May encourage spiraling costs

4. Tends to favor the haves over the have nots

(ii) Elderly are the only group that we cover medical expenses for once they turn 651. And yet children are more likely to succeed if they have good health care

(2) qualified employee discounts

(3) working condition fringes

(4) de minimus fringes

9) Chapter 7Business and Investment Expense Deductions (Omit problems 3 & 4).a) CLASS NOTES 9-17-15i) Business Expenses- above the line deductions(1) Sections 162 and 212(2) In order to fairly measure income we must deduct the costs of producing revenue from the revenue

(3) Expense= an expenditure that benefits the current year only (CAPITAL EXPENDITURES ARE FOR LONGER PERIODS)(4) What deductions does section 162 authorize

(a) ORDINARY AND NECESSARY EXPENSES ARISING FROM CARRYING ON A TRADE OR BUSINESS

(5) What is deductible- difficult to be certain about(a) Spiritual advice is not tax deductible (having a minister come pray at the office)

(b) A horoscope consultation is tax deductible-

(i) Think about Welch and Twitty cases- came out differently

1. Welch paid old debts to build new business reputation- forming a business

a. Not a current expense it was a capital expense

2. Twitty paid off debts to maintain his reputation- continuing a business

(c) Liposuction could be a health or business expense- if needed for your line of work(i) This includes botox and plastic surgery

(d) Designer clothes for Nordstrom employees (case in book) only deductible if required for employment- clothing that has a specialized utility for your work in general(e) Courts look to what is customary in that type of business

(6) Current year v. future year(a) It can be a business expenditure- but if it helps to produce revenue over more than a year it is not an expense

(b) Meals

(i) 50% rule 274n1

(ii) special exception for employees 274n2, see 274e3

1. does not apply to reimbursed meals to employees- do not take deduction and do not report as income- meals includes reasonable tips

2. employees treat as a wash 1.62.2

(7) travel expenses 162a2 READ THIS RULE FOR LBAM(a) deductible when they are incurred while away form home in pursuit of business(b) taxpayers have one tax home pg 99

(i) creates a tax planning opportunity to own your home elsewhere

1. claim Idaho as tax home and when in Laguna all meals and home are tax deductible

(8) a taxpayer can have no tax home- traeling salesman without a permanent residence(a) Henderson, Rosenspan pg 99

(9) What is required for business travel for tax purposes(a) Stay overnight and it must be for business purposes, sleep or rest rule(i) You may be able to just get a hotel room to write off a day trip

1. Fly form Moscow to seattle to do business for the day- the plane tickets is deductible either way, but lunch by yourself would not be deductible because you were not away from home in the pursuit of business- unless you were having lunch with a client, generally speaking do not look behind your own choices for extravagance- look to customary business practice

(ii) Business purpose- great meaning for commuters- choosing to live farther from your business is not deductible1. writing a book in Hawaii does not justify traveling to Hawaii to write the book2. traveling to france to enrich your experience does not count either

(10) principle place of business is your tax home (not your residence)

(11) temp. assignment expenses deductible with a one year limit

(12) fees paid in the acquisition of stock are added to the cost basis of the stock, not used as a separate tax deduction

ii) Welch v Helvering 1933

(1) Expenses deemed capital outlay to buy the goodwill necessary to launch a business- not a necessary and ordinary business expense

(2) business expenses have to be necessary and ordinary ( in the line of work he is in- not that the cost incurred needs to be a regular expense, it could be once in a lifetime) to be deducted as an expense (otherwise they may be start up expenses or capital expenditures)

iii) Jenkins v. Commissioner memo

(1) Court looks to the primary motivation for making the payments- (a) For Conway Twitty there was a proximate relationship between the payments made to the holder of Twitty Burger debentures and petitioners trade or business as a country music entertainer.

(b) Petitioner was furthering his business as a country music star and protecting his business reputation

(c) He was not launching a new business

iv) Henderson v Commissioner 1998

(1) Need business reasons for having both homes in order to deduct the lessor income producing one as a business expense- otherwise it is just a commute ((2) Home means the taxpayers abode at his or her principal place of employment(3) Intent is to deduct duplicate living expenses both maintained for business reasons - there has to be required duplication(4) Factors:(a) The business connection to the locale of the home

(b) The duplicative nature of the taxpayers living expenses while traveling and at the claimed home

(c) Personal attachment to the claimed home

b) CLASS NOTES

i) Principle place of business is a taxpayers home; rev rule 75-432 (if the primary residence is elsewhere are different)(1) Note: A few cases have ruled that the primary residence is the tax home

ii) Cannot deduct lawyerly suits because in your day to day life you could wear a suit to another occasioniii) People with two businesses have a planning opportunity to deduct their expenses

(1) Inherently challenging to deduct the difference between the personal and business expenditures

iv) 262- personal family and living expenses are non deductible stands at odds with the rule that says business expenses are deductible

v) you can not be on a business trip that lasts more than a year 162a- your tax home will shift to where you have traveled to

vi) see reg 1.274-4d2v traveling days on business trips(1) if you are working on day one and day three of a business trip, day two is also treated as a working day- these down days are treated as business days for deducting your meals etc

(a) delays for whatever reason could also qualify- like a storm closes the airport and youa re stuck for a couple extra days

(b) miller- wrote an article, Taxation and the sabbatical: doctrine, planning and policy, 63 Tax Lawyer 375-410 (2010)(i) article on ssrm- free database for scholarly articles

1. can be faster publishing than a law review which helps stake out an idea while you wait for some agreed upon pfuture publish date

(2) an employee who is reimbursed does not have to report reimbursement or take a deduction- the employer will take the deduction 1.162-17b and 1.62-2c

(3) 162 does not cover investment expenses

(a) investing is not a trade or business

(b) so congress enacted 212- ordinary and necessary expenses relating to being an investor (to produce or collect income)

(i) 212 does for investing activities what 162 does for business

(ii) deductible for tax advise

(4) education subsidies ch33 in book

(a) are deductible when it is deemed to be a business expense

(i) maintain or improve skills in current employment1.162-5a1

(ii) meet employer or linesure to keep your present job1.162-5a2

(b) not deductible- education to maintain the minimum expenses for a job (JD Not deductible)

(c) or are to qualify for a new trade 1.1652-5b (LLM requirements can be deductible if meet 1.162 because it is not acquiring skills for a new trade or business)

(5) 262a personal and living expenses are non deductible- creating tension with 162 when the expenditures have both a business and personal benefit(6) office can be fancy IRS has rarely succeeded in extravagance claim- as long as there is a legitimate business expense

(7) expense- expense that benefits current year only

(8) capital expenditure- expense that benefits more than the current year

(9) 162 allows deduction for ongoing/running the business expenses- not start up

(10) Problems pg 931. Chiang Kai-Shek

a. What was subscribed to at the office for a magazine subscription is deductible- but if subscribed for at home and then brought to the office it is not deductiblei. Even though it is the same magazine- It is not the nature of the asset it is the nature of the relationship with the asset

ii. Maintain skills 1.162-5iii. Childcare expenses are not a business expense

iv. Paying homeless people to stay out of his doorway is debatable-if it were unlawful it would change the analysisv. Probably the close fall within the Pesner rule that they can be worn in other settings so not deductible

vi. Office cleaning (even if son) is deductible- TAX ADVANTAGE a child of a certain age can have an individual retirement account (he recommends Roth which is established with post tax dollars) that money can sit there and become several hundred thousand dollars

b. If it is customary to give out free samples and he has a basis then he can deduct his basis

c. If he has no basis it is harder to deduct- unless we spread all of his costs under the premise that there are no free samples so the cost can be spread across the purchases

2. Elizabeth Blackwella. Cannot deduct the cost of driving to work Flowers case; cannot deduct meals while at work because she is not with a client or having a business meal; office rent is ordinary and necessary- even two offices

i. Generally speaking the govt does not second guess the tax payers business judgment

b. Driving between the offices she can deduct the mileage, 1.162-2a deductible as a business expense- once at work traveling falls into the ordinary and necessary category (keep records of mileage and reference what you were doing and calculate the standard deduction the IRS allows) you do not have to report it because you would have to deduct it so it is considered a wash by the employee; lunch with in-house accountant or coworkers is not considered deductible Moss v Commissioner where partners held weekly meetings at a nice restaurant- the court ruled no- the meal while traveling however would have been deductible with or without a client- every meal is a business meal; however if the accountant was a third party business there may be cause to deduct half the lunchi. BNA is the go to source for a quick tax answer- sample forms are available with in the portfolios as wellii. 119 meals provided on the premises for the convenience of the employer

c. small apartment located at smaller office, IRS view is her principal place of business is measured by the larger revenue, so her smaller business travel expenses are deductibled. court accept the IRS view that where you make the most money is where your tax home is- test is where is the money being generated

3. NOTE- traveling is still 50% reimbursement, but the employee does not have to claim any income- the employer only gets 50% though

a. Some employers give a state rate (Idaho $46) for a per diem- too littlevii) CAPITALIZATION

(1) When we make an expenditure that benefits more than one year it is a capital expenditure(a) An expense only benefits the current year (a consumable item or the wages for an employee)

(2) 263a- you can not deduct a capital expenditure currently, we capitalize it instead(a) to capitalize an expenditure(i) we place it on the balance sheet as an asset

(ii) we recover the cost of an asset to offset our income, two choices

1. we depreciate it

2. we recover our basis when we sell it

(3) Balance Sheets(a) Fundamental equation(i) Assets = liabilities + equity

(ii) Equity (net worth) = assets -liabilities

(iii) Liabilities = assets equity

(b) On balance sheet(i) Left column: List assets by liquidity- the most convertible to cash go at the top/ what we own

1. Cash 150k

2. Building 100k

3. Land 100k

4. TOTAL 350k

(ii) Right column/ how we got what we own

1. Liabilities 50k

2. Owners Equity 300k

3. TOTAL 350

(c) When buying something from the left hand column cash and converting it to an asset that is not cash the balance sheet will still balance

(i) LEFT COLUMN

1. Cash 100k

2. Bulldozer 100k

3. Building 100k

4. Land 100k

5. TOTAL 400k

(ii) RIGHT COLUMN

1. Liabilities 100k

2. Owners equity 300k

3. TOTAL 400k

(d) Balance sheets are historic numbers (not the cash) but the other assets may be quite different so the balance sheet is just the starting place- (4) Capital expenditure is what you acquire that is expected to help you generate income for more than a year(a) Long lived assets (buildings machinery, IP)(b) Costs of constructing long lived assets (buildings machinery, IP)(c) Costs of improving real property-

(d) Transaction costs to acquire any of these things

(5) With depreciation we recover our basis in smaller increments which is correlated with a statutory number(6) When do we not have to capitalize

(a) We do not capitalize expenses that benefit the current period only

(b) Examples of other things we do not capitalize even though they enhance the value of the property (so these are expenses that can be deducted currently):(i) Routine repairs or maintenance 1.162-4, 1.263(a)-3(g)(1) scheduled maintenance, minor repairs, patching leaky roofs, replacing broken windows etc. but see 1.263(a)-3(i)(5) ex 13

(ii) Materials and supplies 1.162-3(a)

(7) Capitalization required for NEW ASSETS(a) A cost that results in the acquisition or production of a unit of real or personal property 1.263(a)-2(d)(1). See 1.263(a)-3(e) for definitions of unit or property- usually it means an asset having a useful life substantially beyond the taxable year

(b) Document when you are using an accountant for consultation so you cover your ass

(8) Improvements(a) A taxpayer must generally capitalize expenditures that result in an improvement to a unit of property. A unit of property is improved if the amount paid

(i) Resulted in betterment of the property 1.263-3(a)-2(j)(1)

1. Changes that

a. Fix a defect

b. Material addition to the property

c. Materially increases productivity, efficiency, strength, quality or output of the unit

(ii) Restore the property

1. Restorations are a major renovation or refurbishment of the unit 1.263(a)-2(j)(1)

(iii) Adapt the property to a new or different use Treas reg 1.263-3(a)-2(j)(1)

1. 1.263(a)-2(j)(1)

c) DEPRECIATION AND AMORTIZATIONi) We recover our cost for a capital expenditure by depreciation, amortization, or by basis recovery upon sale(1) Depreciation = The decline in value of an asset due to wear and tear and obsolescence

(a) Depreciation in a tax sense- is the gross income deduction authorized by sections 167 and 168(b) Property must be used in trade or business to qualify for deductions: Not all property owned by a tax payer gets the tax benefit of section 167 and 168- it leaves out personal use property(i) Business personal property is depreciable(ii) Personal car is not depreciable for tax purposes

(c) CALCULATE:(i) Start with adjusted basis 167(c) our cost under section 1012

(ii) ON EXAM Reduce our adjusted basis by the annual depreciation allowed or allowable by 1016(a)(2)- once we have recovered our basis investment we no longer get the depreciation

1. Not discretionary whether you take the deduction or not- you can not choose not to depreciate- you will lose your basis whether or not you claim it, 2. NOTE: a1 increases basis when you improve like adding a fence or landscapingd) Chapter 9Depreciation and Amortization (Omit problems 1(e) & 3)

e) CLASS NOTES 9-24-14

(a) In order to calculate the depreciation you must know (four things)1. THE BASIS

2. THE APPLICABLE METHOD

3. APPLICABLE REOVERY PERIOD4. APPLICABLE CONVENTION

(ii) For our purposes you only need to know two methods- (which both assume a zero salvage value 168(b)(4))1. straight line 168b1

2. double declining balance 168b3

(b) straight line method

(i) divide 100 by useful life and multiply times the same basis each year (ie. Equal deductions each year)1. get a straight line percentage- two stepsa. A ten year and basis is 200

i. 100/10-10%

ii. 200x10%-20 each year(ii) double declining basis

1. take the straight line percentage and multiply times the remaining basis

2. eg s/l-10%x2=20%

3. yr1 200x.20=40 (200-40=160 remaining basis)

4. yr 2 160x.2=32 (160-32=128 remaining base)

5. switch to s/l in year when remaining useful life divided into 100 is greater than DDB percentage

6. switch to straight line to get to zero by switching when the straight line value is more than the double declining value- double declining basis will never get you to zero

a. this is a way to get more deduction up front instead of using a straight line for all years that you can depreciate

(c) the applicable convention(i) tangible persona property- everything other than real estate

1. half year for tangible personal property 168(d)(1), (d)(4)- physical, movable property (intangible personal property does not require the physical component)a. you get the second half of the depreciation when you dispose of it

b. mid month for real estate 168d2

2. personal use property- not for business use- and is not depreciable3. the convention applies in both the year of acquisition and the year of disposition

4. half year convention has an anti abuse rule that applies the mid quarter convention

(ii) 179

1. even though this is a capital expenditure we are going to let you deduct it upfront- applies to tangible property and computer software

2. section 179 allows expensing in year of purchase in some cases 179a

a. applies to section 179 property 179d1

i. tangible personal depreciable property

ii. computer software

b. has dollar limits on purchase amount 179b1 and 2

c. has taxable income limit 179b3

d. reduce basis

3. bonus depreciation is highly volatile in congress may change before the end of the year and be retroactive(iii) framework for applying 179- apply it ahead of the regular depreciation rules, and then apply the regular rules for the same year- remember 179 will reduce your basis so it will impact the application of the regular rules1. determine the 179 property

2. apply dollar limits

3. apply taxable limit

4. etc get from slides

(iv) 168k

1. 50% bononus depreciation in year of acquisition

2. expires jan 1, 14

3. applies after 179 and before regular depreciation deduction

4. may reenact this year so should keep an eye on it

(d) Simon v Commr(i) Professional violinists buy two Tourte bows

(ii) Bows were subject to wear and tear, but they increased in value

(iii) Violinists claimed depreciation deductions

(iv) IRS challenged for lack of determinable useful life

(v) HELD: that as long as it was subject to wear and tear or obsolences1. Determinable useful life no longer applies

(vi) Eg

1. Land is not depreciable because it does not have a terminable useful life

2. Stock is not depreciable because a company has no determinable life span

ii) Problems Pg 129- see slides(1) Oriana buys equip. for 300k, 8 year class life, and a 5 year prop under 186c(a) Straight line

(i) Depreciation base $300k 167c, going down under 1016a2(ii) Method straight line

(iii) Recovery time five years

1. 168e 8 yr class life is a five year property- has a five year life

(iv) 300xpercentage of 20% x.5=30k

(v) takes six years to depreciate a five year property because we only got a half year in year one

(b) using double decline balance method, year four it would be the same deduction so switch in year five(i) 300 x .4 x .5 =60k

(ii) 40% percentage

(iii) 60k deduction

(iv) basis at end of year one 240k

(v) 240 x .4 no half life = 96k

(vi) basis at end of year two 144k and so on

(c) have to take a half year deduction because selling nov. 1 for 100k(i) amount realized is 100k

(ii) basis 69120(iii) gain realized 30,880

(iv) applicable convention applies in year of disposition as well as acquisitioniii) automobiles- NOT ON TEST(1) 280f

(a) caps auto depreciation at lower levels

(b) numbers are adjusted for inflation

(c) originally targeted luxury autos but now applies to most autos

(d) for 2014

(i) 1st yr 3160

(ii) 2nd yr 5100

(iii) 3rd yr 3050

(iv) 4th yr 1875

iv) dual use property (business and personal use) NOT ON TEST(1) 280f

(2) where personal use exceeds 50% TP must use stragith line method of depreciation 168g, 280fb1, d4

(3) only get to depreciate the business portion of property use

v) AMORTIZATION 197

(1) Allows amortization of intangibles

(2) Straight line method

(3) Straight 15 year useful life for recovery

(4) 197d1 lists included intangibles

f) what is intangible property- any item whose intrinsic value is non physical, the physical thing is merely representative of the underlying value

g) KNOW: 1.197-2b defines in more detaili) what is goodwill

(1) an intangible asset that reflects an expectation of earnings than a fair return on capital invested in the business- your reputation with your clients

ii) what is going concern value(1) the value of a business as a operating business as compared with separate sale of its assets

(a) some businesses worth more as a business than as separate assets

h) some intangibles have a determinable useful life- the ones that don't include stocks and goodwill10) Chapter 10Deductible Personal Expenses: Casualty and Theft Losses

a) 1001- a loss is when the basis exceeds the amount realizedb) deduction of losses governed by 165- authorizing business and investment lossesi) personal expenses not deductible, unless it is a personal casualty loss:(1) 165c3- if such loss arise from sudden, unexpected or unusual events like:

(a) fire, storm, shipwreck, or other casualty, or from theft

(2) for property losses only (not losses like income)

(3) The deduction is for the adjusted basis or the decline in FMV- whichever is less

(a) Minus any reimbursements for the loss (insurance)(b) Insurance payments and disaster relief grants for out-of-pocket expenses are not considered property loss reimbursements and do not reduce the deductionc) Restrictions:i) Must be over a $100 threshold to qualify for tax deduction- based on single event not each piece of damaged property in the event

(1) Multiple owners each have to pass the $100 threshold(2) Married couple s are treated like one individual

ii) The net casualty loss (loss minus reimbursements) is only deductible to the extent it exceeds ten percent of adjusted gross income 165h2A(1) Deduct ten percent of adjusted gross income form the total net loss for the tax deductible amount under a casualtyiii) The casualty tax deductions also reduce the adjusted basis for the same amount.

(1) So if the casualty deduction is a net $1600, then the adjusted basis is reduced by $1600 too

d) Chamales v. Commissioner (2000-33)i) Two elements to a casualty loss(1) Event must qualify as a casualty

(2) The damage sustained must be such that it is deductible under 165

ii) A sudden event is not limited to those flowing from nature and may include manmade eventsiii) Damage must be

(1) physical damage, not just reputational damage, or(2) permanent character changes to area (not something that will blow over in a few years)

e) Blackman v Commissioner (1987)i) Can he deduct the loss for a fire he started?ii) Courts typically disallow deduction if against public policy- like arson and domestic violence(1) Conviction of a crime is not necessary to prove frustration of public policy(2) Regular taxpayer negligence is not a bar to casualty deduction- but gross negligence isf) Problems page 147i) Judy Garland

(1) Adjusted gross income 50k

(a) $12,100 (FMV of car)- $100 threshold- $5,000 (10% of adj. gross income)= $7,000 deduction(i) NOTE: if it had been a gift use the basis of the giftor to get the lessor of basis or FMV(b) $40,000- 5,000= $35,000 deduction(c) $15,000 deduction

(d) $185,000 (minus insurance payout)

ii) Paul von Hindenburg

(1) Negligent fire

(a) Deductible loss

(b) Still may not be gross negligence

(c) May be gross negligence- in which case he would not get the deduction because his acts would frustrate public policy

iii) Alfred Kinsey(1) Sex offender moves in next door

(a) Maybe, he would have to overcome the hurdle of a lack of physical damage

(i) if the sex offender would be considered a significant irreversible change in the character of the neighborhood he could get it

(b) no. it is a temporary situation and the deduction is not meant to cover fluctuations in value11) Chapter 11Other Deductible Personal Expenses: Taxes, Interest, Charitable Gifts, Moving Expenses, and Medical Expenses (Omit problem 4).a) Itemized Deductible personal expenses include:i) Home mortgage interest 163h3Bi (applied per residence not per taxpayer)(1) Two kinds of indebtedness (qualified residence)(a) Acquisition indebtedness- to buy or improve the property secured by the property

(i) 1m limit

1. secured by the residence to improve the residence includes debt arising form the financing and points if paid from separate funds

(b) Home equity indebtedness-

(i) 100k limit

1. pg 14 and 15 of Keiths outline

(2) qualifying property (up to two)

(a) is the principal residence and one other residence selected by taxpayer(i) could be a boat or a trailer

(ii) the second property must be used for:

1. more than 14 days, or

2. ten percent of the days the home is rented out

(3) prepaid points must be capitalized and deducted over the life of the debt(a) however points, paid from funds separate than the loan, for home acquisition can be deducted 461g2

ii) State and local taxes

(1) Through 2013 may not apply nowiii) Charitable gifts 170(1) If the contribution base limit is exceeded the excess deduction carries over to the next yeariv) Moving expenses 217(1) Expenses involved in moving in order to change or find a job(2) Meals are not deductible(3) Two requirements

(a) Distance- must be at least 50 miles farther than the previous residence from work

(b) Time- must be employed at new job for at least 39 weeks in the next 12 months

v) Medical expenses 213/1.213-1e1(1) Limited to the expenses that exceed 10% of adjusted gross income(2) Most cosmetic surgery expenses are not deductible(3) To the extent that a medical improvement to property does not enhance the property it is deductible

(4) Requirements

(a) Must be an essential element of treatment

(b) Must not have otherwise been incurred for nonmedical reasons

(5) Eg

(a) Breast reconstruction after cancer is deductible

(b) Laser eye surgery is deductible

(c) Teeth whitening is not deductible

b) Problems page 163 (1) Maggie May and Rod Stewart- Married couple buys a home, loan secured by the property

(a) The points are deductible 461g2 because they came from a separate account, and the interest on the home loan is deductible up to 1m 163h2d(b) The 250k mortgage interest is deductible on their primary loan (up to 1m) and 100k is deductible on their equity line

(i) 100k reinvested is acquisition interest and falls under the 1m limit for both loans (under the FMV of home)(ii) 100k invested in education is the home equity indebtedness

(c) The interest on the 300k :(i) 100k in refinancing of acquisition indebtedness falls under the 1m rule and is deductible(ii) 100k falls under equity line (can be spent on anything)(iii) 100k is not deductible

(d) They are in the cabin for more than 14 days, and more than 10% of the days the home is out, so they can deduct the interest up to 1m

(i) Aggregate of both homes- is up to 1m limit so they get the 300k for the primary home and 700k for the cabin that would be deductible; so the last 100k can be applied to the home equity 100k and still be deductible(ii) When there are multiple owners

1. It is 1m per residence

2. And 1m per taxpayer- or entity considered one taxpayer(2) Ty Cobb; No his new job is only 45 miles from his former residence- he needed to be more than 50 miles farther from his old residence to his new job 217(3) Cole Porter; Medical expenses (a) The 20k for home modifications id deductible; under rev rule 87-106 (assuming the changes did not improve the value of the home)(b) the 10k for the elevator that exceeded the 5k home value enhancement is deductible; under rev rule 87-106 (assuming the changes did not improve the value of the home)

(c) $3,000 incidental medical expenses is also deductible

(d) $33,000 is his total deduction

(4) Baron Vladimir Harkonnen ; under 213/1.213-1e1

(a) Gastric bypass is deductible- is an essential element of treatment

(b) Liposuction is not- not an essential element of treatment, cosmetic probably not considered a deformity of his disease- but if it were he could deduct it too.12) Chapter 12The Deduction Hierarchy: Adjusted Gross Income, Taxable Income, the Standard Deduction, and the Personal Exemptions (Omit problem 3).a) Two main categories of deductions

i) Above the line (1) Above the line are Better deduction because you Always get them no matter what and you still get the standard deduction

(2) If you itemize you have to choose between itemizing and taking the standard deduction

(3) Reimbursed employee business expenses are above the line (leaves out unreimbursed employee expenses which fall below the line)

ii) Below the line

b) In the case of an individual the aggregate of an itemized deduction must exceed 2% of adjusted gross incomec) Key provisions for computation of tax are in 61, 62, 63

d) Computation Flow

i) 61 gross income

ii) 62 adjusted gross income

(1) 63a itemized deductions and 67 misc itemized deductions, OR(2) 63b standard deduction

iii) 63 a and b- personal exemptionse) Above the line: Section 62 allows for deduction to arrive at adjusted gross income-

i) it does not create tax deductions- it authorizes where deductions should be takenii) TYPES of 62

(1) Business expenses

(2) Investment expenses

(3) Attending college

f) Below the line: Section 63 allows for deductions from adjusted gross income (mostly personal expenses) less desirable because in order to take you have to give up the standard deductioni) Itemized deductions that are calculated to arrive at taxable income

(1) Must exceed 2% of adj. gross income

(2) Subtract the 2% from the itemized amount to come to what the allowable deduction is

ii) Both authorizes where deductions can be taken AND authorizes the standard deduction

iii) TYPES of 63

(1) Interest

(2) Property and state income taxes

(3) Casualty losses

(4) Medical expenses

(5) Charitable deductions

(6) Misc itemized deductions 67-

(a) 62a2- unreimbursed employee business expenses are only deductible as to the amount that exceeds 2% of adj. gross incomeg) Standard Deduction- can be taken in lieu of itemizing for below the line deductions 63 b and di) Married couple $12,200 ; listed in the annual revenue procedure 2013-15(1) 2014 goes to $12,400 for married couples (Rev Proc. 2013-35)ii) Single $6100iii) Over 64 and blind get an extra $600 eachh) 63 a and b- personal and dependency exemptionsi) everyone gets a personal exemption unless the are someone elses dependent 151b and c

ii) personal exemption statutorily set at $3900 (married people get two) (2014 will be $3950)(1) qualifying children-must share same household more than half time, who do not provide over half their own support, meeting age requirements, children who are away at school still are deemed to live at home- and educational scholarship is not considered income(a) type 152c1, c2, f1b

(i) biological

(ii) siblings and their descendants

(iii) step

(iv) adopted

(v) descendants

(b) over 18, or if a student over 23, 152c3

(c) children of divorce- 152e2/152d- custodial parent can transfer righto deduct

(2) Qualifying relative- must receive more than half of support from taxpayer and have less income than the exemption amount(a) Child(b) Descendant of child

(c) Sibling

(d) Parent

(e) Step parent

(f) Ancestor of parent

(g) niece or nephew

(h) aunt or uncle

(i) most in laws

(j) OR a person who has shared the taxpayers home for a year, receives more than half their support from taxpayer and is a member of the taxpayers household

i) problems page 175 START HERE FRIDAY(1) x

(a) not deductible- general upkeep of personal property 262(b) deductible above the line as an expense 162 or 212(c) deductible below the line itemized per 163h, 164, listed in 67 so not misc.(d) deductible above the line as an expense to making money, 162(e) deductible as on going education above the line 162

(f) then they can deduct- they cannot deduct it if they do not report it as income

(i) 1.62-2c4(g) deductible. Above the line education expense 62 and 221

(h) deductible under 215a; 62a10(i) 212 misc. itemized deduction for an individual(j) deductible as a business expense above the line 162(2) x 152c(a) deductible under dependency exemptions, meets age req, 1.152(i) if qualify for both relative and child take the child

(ii) 152f5- scholarship disregarded in this calculation

(b) same as a

(c) deductible- qualifying relationship- does not have to live with and Jed provides more than half support(d) still has to share a household, because she is no longer in the right relationship, if at had been his aunt 152d2F it would be OK- but a great aunt I snot(e) deductible below the line as a dependent 152d2H(f) 2013-17 it doesn't matter where you reside if you were lawfully married we will treat you as married for IRS tax purposes- could also qualify under 152d2H(g) basic rule 152c4B custodial parents get exemption- unless 152e deductible if arrangements were made in the divorce to transfer the exemptionj) CLASS NOTES 9/29/14i) 165c- lets us deduct business and investment losses and casualty lossesii) 262 denies deduction of personal expenses (personal, family, living)

(1) congress has run several provision counter(a) 163, 164, 170, 217, 213

iii) utility bills are not deductible when it is your personal use propertyiv) 164

(1) STATE INCOME TAXES ARE DEDUCTIBLE

(2) 164b5- authorizes deduction of sales tax instead of income tax- expired at the end of last year but may be passed again retroactively

(3) property taxes on real estate are common deductions

(a) one of the tax advantages to owning your own homev) fairness- Horizontal equity E and Vertical E

vi) Efficiency- tax but not too much

vii) Neutrality- tax equivalent transactions the same

k) Every tax involves the application of a rate to a basei) If you create a deduction and shrink your base, the rates have to go up to make up the difference

l) Progressive taxation based on ability to payi) Graduated rates- the higher your bracket the more important each deduction becomes

(1) If you are in a 10% you only save 10%

(2) But if you are in a 40% bracket you save 40% of the deduction

m) Home mortgage interest 163i) Like 165a, section 163a starts out broadly ad then cuts back

n) Qualified residence interesti) Acquisition indebtedness up to 1ms interest

ii) Home equity indebtedness up to 100ks interest

iii) Beneficiary-

o) Deductions v creditsi) Deductions reduce income BEFORE applying the tax rates

ii) Credits reduce tax liability AFTER apply