income tax outline share

7/31/2019 Income Tax Outline Share

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Process

1. Compute GI 61; exclusionsNon-recognition; 1031

2. Compute AGI 62; GI less certain costs of earning income/others (like alimony paid by TP)

3. Compute taxable income 63; AGI less sum of (personal exemptions) + greater of ((standard deduction) OR (itemized

deductions))Remember, personal exemption and standard deduction are adjusted for inflation 151: TP allowed personal exempt for: (i) TP; (ii) spouse; (iii) each dependent 63(d): Itemized deduction = all deductions other than personal exemption and those in 62

4. Compute tax liability for TPs taxable income 1(a)-(d) TRs

Progressive, as TI increases, TR increasesMarginal TR = TR applicable to last dollar of TIEffective TR = TL / TIZeroTR ifTI not greater than sum of (personal exemptions) + (standard or itemized

deductions)

5. Reduce tax due by creditsCredit: direct reduction in tax; while deduction/exclusion reduces TPs TI by amount equal to multiplying deduction by TPs TRIf credits > tax due, tax refund; if tax due > credits, TP owes tax

Capitalization

Ordinarily, expenses incurred in T/B or production or income deducted in same year. But, whereexpense creates asset that lasts beyond year expense incurred, expense must be capitalized

If asset has useful life, basis is depreciated over those years. If no useful life, no depreciation (land)Time Value of Money/Tax Deferrals

$ received today is worth more than $ in future; $ paid today costs more than $ paid in future Drives point of tax planning: accelerate deductions; defer as much tax liability as possible

Tax PR Standard of care for tax advice: your advice = more likely than not based on existing law Whereas ordinary standard of care is no frivolous claims Attorney misconduct if attorney fails to file tax returnTax Procedure

Treasury Department oversees IRS. Head of IRS = commissioner Rev. Rul. = IRSs view on particular issue Rev. Proc. = internal practice and procedures of IRS Both Rev. Rul. + Proc. published in weekly Internal Revenue Bulletin Private letter ruling applies only to TP who requested. Redacted versions published; non-citable Audit (only 1-2% of tax returns)

o If agent finds deficiency, issues Revenue Agents Report & 30-day letter 30-day ltr notifies TP of 30 days to file admin appeal TP can pay asserted deficiency (want to pay soon b/c deficiency accrues

interest)o IRS issues statutory 90-day ltr ifdeficiency unresolved in appeals process; TP doesnt

respond to 30-day ltr 90 days to file petition w/ Tax Ct TP doesnt have to pay deficiency to litigate before Tax Ct Tax Ct decisions appealable to App. Circuit where TP resides If TP doesnt file pet w/ tax ct, IRS can begin collection

o If TP pays asserted deficiency, can petition for refunded in District Court where TPresides or Federal Claims Court in Washington D.C.


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DC allows jury trials; Federal Claims allows precedent from Ct. App. Fed. Cir.

(which may be favorable to TP)

3 year statute of limitationso If TP omits substantial amt of income, 6 yearso If TP files fraudulent return, no SoL

If TP takes frivolous position in futile attempt to deny obligation to pay, civil & crim penaltiesElements of Tax Liability (TL)

Tax formulao (GI)(Above the line Deductions) = (AGI)o (AGI)(Below the line deductions + exemptions) = (TI) o (TI 63) X (TR) = (TL)o (TL)(Credits) = (Tax Due)

Gross Income (GI) [61] all income from whatever source derivedo Typically:

Wages, salaries, dividends, interests, gains from sale of investmentso Glenshaw Glass Elements

(1) Accession to wealth (2) Clearly Realized (3) Complete dominion & control

o Realization (Clearly Realized) (1) Transaction or Event (2) Changed legal relationship w/ property/wealth (3) Sufficiently fixed/definite E.g., Barry Bonds baseball hypo (was clearly realized)

Appraisal doesn't satisfy realization unless done contemporaneously w/ transaction(not just sale, but any transaction affecting ownership of collateral)

o Cesarinifinding money F: Found $$ in piano (treasure trove) (1) Accession to wealth? Yes, getting the piano & its money inside improved TP's wealth (2) Clearly realized? Yes, it's simple cash so there is no dispute over what it's worth. (3) TP's have complete dominion?

State law determines this Property has to be found first before tax code is applicable. If you don't know it exists, it's not

reduced to your undisputed possession. Year found is when you have legal rights, which is when you owe tax on it

o Old Colony Companys payment of employees taxes constituted taxable income for employee Since pmt was in exchange for employees services, not gift

o Landlord-Tenant Tenant performing work in lieu of rent pmt = income to landlord Landlord giving rent discount in exchange for tenants work = income to tenant

o James Illegal gain is income despite obligation to make restitution

Exclusions from GIo Specific exclusions found in 101-139Eo Items excluded from GI do not enter into computation of taxo 102 Gifts, Bequests & Inheritance excluded

Duberstein test (gifts) (1) Detached and disinterested generosity (2) Out of affection, respect, admiration, charity, or like impulse, (3) Lack of obligation is not sufficient to constitute a gift (4) Transferor's intention is key

102(a): Exclusions Sec. (b) Must include in GI anything derivedfrom bequest


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Sec. (c) Employee gifts excluded (i.e., included in GI)

o Exceptions: (1) Given for safety/length of service; (2) Achievement award( 74(c))

o Death benefits; Annuities 101 (life insurance)

Generally, benefits as result of death not GI

If not as a result, interest/gain = GIo Exception: Terminally ill; chronically ill (limited)

Sec. (a)(2)(B) partners in LLP can take life insurance policy out on other partners& benefits not included in GI: Facilitates buyouts when a partner dies

If insurance company holds benefits after death for benefit of beneficiary, interestpaid as result = GI

72 (annuities; certain death benefits) Sec. (b): Can recover % of each annuity pmt equal to cost of contract divided by

expected returno $4k contract, $5k expected payout. 80% of each payment excluded

If TP lives passed expected payout period, all future pmts are included in GI If TP dies before term ends, TPs estate and deduct unrecovered basis in annuity

o Prizes, awards 74

Sec. (a): Prizes, awards, scholarships, fellowships included in GI Sec. (b)/(c): Exclude above only when:

Winner never receives award; or Employee achievement award relates to length of service or safety:

o 1) Tangible personal property, part of meaningful ceremony, and notdisguised compensation

o 2) Length of service minimum 5 years employmento 3) Safety awards qualify only if given out to less than 10% of employees

per year, and not to management or administrative staff Allen McDonnell: Employee trip to Hawaii to monitor other employees was not an award b/c

employee was sent for a business purpose, was randomly selected for trip, did not engage invacation-like activities, was not selected to go based on work performance, and was notprecluded from going again in the future due to being selected from current trip

Point: expenses paid by company for employee (flight, room and board, meals) werenot GI for employee

o Scholarships 117 Sec. (b): Scholarship $ spent on tuition, books, supplies, equipment. Not room & board. Sec. (c): If obligation to perform services, subtract value of services from scholarship amount

to get value of scholarship not included in GIo Watch out for (1) payments for services disguised as gift; (2) interest income disguised as life

insurance death benefits; (3) payments for services disguised as scholarship

Gain from dealing in property 1001o Sec. (a): G = ARAB

AR ( 100(b)) = any money received + FMV of any property received in exchange AB ( 1011(a)); basis = cost if purchased (1016)

Basis under 1012 adjusted by 1016o Sec. (c): Recognition of G/L

Entire amount G/L realized from sale/exchange is recognized See Like-Kind Exchange 1031 (not recognized)

o Carryover Transfer Basis Gifts ( 1015(a))

Recipient gets donors basis Part sale/part gift = Regs 1.1015

o E.g., family member sells another a piece of land at less than FMVo Buyers basis = greater of (what buyer paid) or (transferred basis).


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If sale is for less than basis or FMV, regs stop buyer from taking L,

and buyer must take sellers basis

Special rule for loss property If AB > FMV @ transfer, & donee sells for L, donee's basis = FMV of property at

time given

Note, odd situation where AR falls between AB and FMV at transfer (so itstechnically a loss b/c AB > AR)

No G or L. Objectives

Preserves Donor adjusted basis Preserve Donor pre-gift gain Prevent Donor from transferring pre-gift loss In a family setting, if losses were transferrable, would be transferred to family

members that pay highest taxes Special basis rule for death 1014(a)(1)

Recipients basis in property received = FMV at time of deatho Donors G/L disappears at death; unlike gifts where G/L transfers to

recipient

Y? Too hard to determine AB of property when original owner is deado Discharge of indebtedness 108

Discharge (cancellation w/o full repayment) included in GI 61(a)(12)

Basically, Discharge = income for DR b/c DR get money for nothing Zarin: Disputed debt not included in GI

If bonafide dispute existence/enforceability of debt, settlement = determination ofvalue of debt and reduction is nota discharge of indebtedness

Settlement of disputed $1mn debt for $100k. Result = value of indebtedness is$100k. Does not mean there is $900k discharge of indebtedness

Statutory Exclusions (1) Price renegotiation: 108(e)(5) w/seller (and not a 3rd party) is not a discharge

of indebtednesso AB adjusted accordinglyo Tax Benefit Rule: If propertys basis is reduced by depreciation/tax benefit

to $0 and subsequent renegotiation, then value depreciation below $0 is

included in GI (2) Debt reduction from bankruptcy/insolvency is not discharge of indebtedness.

108(a)(1)(A), (B)o Bankruptcy: full extent of reduction is not discharge of indebtedness

108(a)(1)(A); (d)(2)o Insolvency : once assets > liabilities again, further reductions in

indebtedness = discharge, include in GI

(3) Certain student loan forgiveness (encourages public service work) (108(f)) (4) Debt forgiveness via bequest under 102 (stated in will) is not a discharge of

indebtedness (i.e., not GI) Recourse & nonrecourse loans

In two-transaction loan w/ recourse, debt forgiveness for recourse debt is also treatedas GI from discharge of indebtedness. Regs. 1.1001-2(a)(2); 61(a)(12)

Non-recourseLender cant pursue anything other than collateral

o CraneAR on sale of collateral includes relief from nonrecourseliability principal amount; limit: FMV of property

RecourseLender can go after other assets outside of loans collateral o AR =

Transaction 1 FMV of collateral (limited by 121; No G ondisposition of principal residence)

Transaction 2 Any further discharge of debt balance remainingafter FMV of collateral is applied to debt

o Principal Residence Exclusion


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Gain cap, ownership & use thresholds: 121(a), (b)(2)

$500k gain max if MFJ; $250k otherwise During 5 year period prior to sale, TP must have used as principal residence for

aggregate of 2 yrs, Sec. (2)(5)(A): Involuntary conversions = treated as sale of property

Destruction, theft, seizure, condemnation, requisitiono

E.g., home burns down and insurance co gives TP $1mno Damages.

Process 1. Identify nature of claim

o Origin of claim, in lieu of what were damages awarded for?o Amos: If settlement lacks express language stating what amt paid pursuant

to agreement was to settle,payors intent determines

2. Analyze taxation of injury 3. Statutory exclusion?

o 104(a)(2): Physical injury damages Requirements: (1) non-punitive; (2) recd by suit/agrmnt; (3) on

account ofpersonal physical injuries/sickness

So no freestanding NIED/IIED claims

TP doesnt have to be person directly injured; wife can exclude $awarded on account of husbands PI Examples:

Breach of Ko Damages compensating CR for loan principal = no GI b/c simply return of

capitalo Damages compensating CR for interest DR should have paid = GI

(61(a)(4))o Lost profits = GI. 61(a)(2)o Punitive damages = GI (Glenshaw Glass)o Damages compensating for damage to goodwill: value in excess of basis =

GIo Divorce & Separation

71, 215: Alimony GI to payee; deduction to payor 71(b) Requirements

o (1) Payment recd under divorce/separation instrument o (2) Instrument not designate payment as not includible in payees GI and

now allowable as 215 deductiono (3) If separated, not members of same household at time payment made;

ando (4) No obligation to pay after payees death

Note, req to pay for specified time (e.g., 10 years) will fail thisb/c spouse could die w/i period but oblig continues

Sec. (b)(2): Divorce or Separation instrumento Divorce/separation decree or written instrument incident to decree;o written separation agreement; oro any other decree requiring a spouse to make support pmts to other

Tax planning opportunityo If payee spouse is in lower tax bracket, ask for something more before

agreeing to treat as alimony (b/c alimony exclusion = better tax treatmentfor payor, but bad for payee since payee has to include in GI)

o If payee in higher tax bracket, ask for something before agreeing NOT totreat as alimony

o Party recing property settlement wants property w/ highest AB so less Grealized on sale


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Recapture

71(f)o Purpose: Prevent nondeductible property settlements from being masked as

deductible alimony paymento Provision recaptures yr 1&2 deductions/income inclusions in yr3

Does not restart after yr 3 recap (so n/a to rear loading)

Also, if payments for all 3 yrs w/i $15k of each other, no recapo Computation (see highlighted portion p211) 2nd year - (3rd year + $15,000) = $ recaptured from 2nd year 1st year - (Avg. 3rd year & (2nd year - $ recaptured) + $15,000) =

$ recapture from 1st year Child Support

71(c): Specifically cut out of alimony Regs. 1.71-1T(c); Gould

o Excluded from payees GIo Non-deductible personal expense of payor

Property Settlement 1041: G/L notrecognized by payor if incident to divorce Payee treats as gift w/ transferred basis

o Loss property can be transferred incident to divorce, unlike gifts Tax planning opportunity

o Trap: Transferred basis means all property w/ same FMV is not equivalento Opportunity: If C can absorb a gain (i.e., has offsetting losses), bargain for

gain property for cheap from other partyo Medical expenses provided by ER not included in EEs GI. 106

Deductionso Items subtracted from GI

Personal living expenses generally disallowed $ value of deduction is same as $ of exclusion

o Trade or Business Deductions 162 requirements for deduction of business expenses

(1) Ordinary (2) Necessary (3) Paid or incurred in taxable year (4) Carrying on T/ B

Expense vs. capital expenditure (Regs. 1.162-1(a)) Directly connected to T/B, not capital in nature

o E.g., salaries, rent, advertising, repairs Maintenance and repairs deductible (Regs. 1.162-4)

o Must capitalize if: (1) materially add to value of property; or (2)appreciably prolong propertys life. See also263(a) below improve

o E.g., recurring activities performed to keep in ordinarily efficient operatingcondition over useful life. 1.263(a)-3T(g)(1)

Capital Expenditure ( 263(a)) No current deduction, increase AB instead. 1016(a)(1) Expense gives significant future benefit Acquiring property ( 1.263(a)-1T(a)(1); -2T(d)(1))

o De minimus exception -2T(g) Creating property ( 263A Improving/restoring property ( 1.263(a)-1T(a))

o Betterment of property [1.263(a)-3T(d)(1), (h)(1)] TEST: Ameliorates material condition/defect that existed at time TP

acquired property or property was produced;


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Results in material addition (i.e., enlargement) to property; or Results in material increase in capacity, productivity, efficiency,

strength, quality, etc.o Restoring property [1.263(a)-3T(d)(2), (i)(1)]

Return to functioning/replace major componento Adapt to new/diff use [1.263(a)-3T(d)(3)]

Not original intended ordinary use Ordinary

Normal, not extraordinary, common and accepted in the community Necessary

Doesnt have to be required Appropriate & helpful Show deference to TPs judgment about whether expense = necessary

Carrying On Must be engaged in T/B; exploring/investigating is not enough Trade or Business defined:

o Higgins: Carrying on T/B is part of carrying on analysis: facts toconsider: Profit-pursuing; extent, duration, frequency; significance(essential vs. administrative)

Three types of T/B expenses

195: Start-up costs may be elected after T/B startso Covers start up expenditures

Investigation, creation/acquisition, certain pre-opening costso Permitted deductions

One-time $5k Rest covered ratably over 180mos

263(a): Transactional costs not deductible; capitalize reqd 162(a): Operational costs

162(a)(1): Reasonable salaries are deductible Goal: prevent disguised dividends Defining reasonableness

o Determined when salary terms seto

Multi-factor test (T.C. & many circuits) (seeExactos rejected test)o Independent investor test (7th Cir. - Exacto Springs)

1) TP's intent (is owner's salary intended to be a salary or adividend? I.e., no need to move to next step if the employmentcontract calls CEOs payment a divident)

2) Compare rate of return to owner's salary, If rate is high, hard toargue against high salary

Focuses on company's actual rate of return compared to anticipatedrate of return

o Ct rejects multifactor test used in other jurisdictions which examined: a) Type and extent off services rendered; b) Scarcity of qualified employees; c) Qualification and prior earning capacity of the employee; d) Contributions of employee to the business venture; e) Net earnings of employer; f) Prevailing compensation paid to employees w comparable jobs; g) Peculiar characteristics of employer's business

o Harolds Club: No free bargain where portion of TPs salary disallowed asunreasonable where partner-father shared familial relationship w/ otherpartners (sons) and dominated their decisions

Regs. 1.162-7: Compensation for personal services deductible if reasonable andpurely for services; if payments not in exchange for services, not deductible


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(b)(2): Contingent payment resulting in greater than amt ordinarily paidmay be

deductible if:o Paid pursuant to free bargain b/w employer and employee made before

services are tendered, and employer not influenced by anything other thansecuring fair & advantageous terms

Regs. 1.162-8: Treatment of Excessive Compensationo

If non-deductible for business b/c resemble stockholding / distribution ofearnings, excessive pmts treated as dividend income for TPo If pmt for property, treated as capital expenditure for recipient

$1 million cap for publicly traded corporations 162(m)o Applies to CEO & 4 highest paid employeeso NO LIMIT on performance-based compensation

E.g., restricted stock, stock options Test: Must be approved by independent directors and shareholder

vote Deductions for Employee Education Not Recoverable

Exceptions: (Regs. 1.162-5(a))o Skills required in T/B (Coughlin)OR-o Express requirement of employer (Hill)

Exceptions inapplicable to: (Regs. 1.162-5(b))o Minimum education requirementso Qualify for new T/B

Exampleso Law school so doctor can improve as EW = not deductible

Authority: Regs. 1.162-5(b)(3)o Orthodontics so dentist can specialize = deductible

Authority: Regs. 1.162-5(a)(1); Rev. Rul. 74-78o Law school so CPA can improve tax accounting = not deductible

Authority: Regs. 1.162-5(b)(3) Ex. (1)o LLM in tax so lawyer can specialize = probably deductible

Authority: Regs. 1.162-5(a)(1) Business meals/entertainment (special rules)

(1) Need connection to T/B. 274(a)(1)o Directly related to 1.274-2(c)o Associated with 1.274-2(d)

(2) Special meal requirements. 274(k)o Not lavish or extravagant;o TP must be present

Deduction limited to 50% of otherwise deductible amount. 274(n) Substantiation is required. 274(d)

o No deduction allowed for travel, entertainment, amusement, recreation, orgift expenses unless TP substantiates by adequate records/evidence the amtof expenses, the time and place, business purpose, and business relationshipto TP of persons entertained....

Business clothes/uniforms Start w/ personal, nonbusiness expenses = not deductible. 262(a). Test:Hamper

o (1) Required for employmento (2) Not suitable for general or personal use; ando (3) Not actually used for personal wear

IRS wont challenge deduction of protective/safety-related clothes. IRS Pub. 17 Advertising

Generally deductible during the year in which they occur even if benefits ofadvertisement may extend over several years


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However; expenditure related to advertisement may constitute capital expenditure

and therefore not be covered by 162o E.g., buying land on which to advertise, constructing a billboard

Business Property Losses. 165 Three main requirements:

o (1) Realization; (2) Recognition; (3) 165 permits

Amount of loss 165(b)o If destroyed: AB - AR = Lo Casualty loss rules 165(c)(3) (fire, storm, shipwreck)o If damaged: L = lesser of (FMV before(FMV after(+ any insurance $

recd)) or (ABany insurance $ recd)

Deductible to extent not covered by insurance If losses exceed income, business is unprofitable for year and losses can be

deducted against other types of income like investments, other business, orsalaries.

If no other source of income to deduct from, loss can carry over to anothertaxable year. 172 carryback 2 years; carryforward 20 years

Depreciation ( 167; 1016(a)(2)) Definition: Gradual recovery of investment in property over its useful life

oAB = TPs unrecovered, after-tax investment in property. 1011(a)

o Not 100% accurate, property may even increase in valueo Must reduce AB by greater of (deprec. taken) or (deprec. allowed)

Requirements 167(a)o (1) Use

T/B; or Held for production of income Mixed use assets (Sharp)

o (2) Consumable Subject to exhaustion, wear and tear

Thus, land is not depreciable Salvage value is always $0 under 168(b)(4)

o (3) Determinable useful life (of whether required) IRS says this is requirement. 1.167(a)-1(a), (b) Courts in Simon andLiddle disagreed Congress & IRS effectively set most useful lives under

168(e); Rev. Proc. 87-56.

Depreciation begins when property is placed in serviceo (1) Readiness,o (2) Availability, ando (3) capability to perform assigned function. 1.168(a)-11(e)(1)

MACRS's 3-step approach ( 168(a))o Step 1. Applicable recovery period (codified useful life)

Based on property class 168(c) Based on class life ( 168(e)(1))

o Rev. Proc. 87-56's massive class life table Default class life if not listed in IRC or Rev. Proc. = 7

years

Some classes set by statute ( 168(e)(3))o E.g., race horse is "3-year property"

Residential real property -- 27.5 years Nonresidential real property -- 39 years

o Step 2. Applicable convention (when does it start?) Impacts acquisition and disposition years Half-year convention ( 168(d)(4)(A))

Deemed to start/stop at middle of year


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Default for personal property ( 168(d)(1)) Personal property = real property or fixture

Mid-month convention ( 168(d)(4)(B)) Deemed to start/stop at middle of month Required for real property ( 168(d)(2))

Mid-quarter convection ( 168(d)(4)(C)) Deemed start/stop at middle of quarter Special rule for personal property ( 168(d)(3)) Evaluated on year-by-year basis Invoked when >40% of basis placed in service in last 3

months of tax year

Applies to all personal property acquired that year Justifications for treating real and personal differently:

Amt of personal property transactions is gigantic, need aless-accurate rule to reduce administrative nightmare

Amt of real property transactions is less, so a more-accurate rule can be utilized w/o creating administrativenightmare

o Step 3. Depreciation method (how is it depreciated?) Rev. Proc. 87-57 depreciation tables (TWEN) Straight line ( 168(b)(3))

Deduct same amount per year Required for real property

150% declining balance ( 168(b)(2)) Accelerated method Bigger deductions in early year Switches to SL in later year Required for 15- and 20-year property

200% declining balance ( 168(b)(1)) Even more accelerated method Default for all other depreciable property

TP may elect slower methods 168(b)(2)(D), (3)(D) 179 Small Business Depreciation

o Qualifying property (179(d)) (1) Tangible, personal property; (2) Purchased for T/B ( 1245 property) (3) Used in T/B

o Can reduce up to values in 179(b)(1) 2012 max adjusted for inflation to $139k

o Phase out limits in 179(b)(2) 2012 phase out adjusted for inflation to $599k

o In any event, cannot exceed T/Bs TI ( 179(b)(3))o Expense deduction is not included in AB ( 179(a)(3))

168(k) Bonus Depreciationo Immediate deduction on qualified property

For us, property w/ no more than 20 year recovery periodo Amount: 50% of ABifacquired after 2007 and placed in service before

2013 (168(k)(1))o Federal stimulus

Amortization of intangibles 197o Acquired intangibles only

Goodwill & going concern value Patents, copyrights, trademark Licenses, franchises


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Customer lists, supplier lists

o 15-year straight line depreciationo Sec. (e) lists items that cant be amortized under 197

o Nonbusiness, profit-making activities Deductions Begin: w/o T/B there can be no 162 deductions Key Statutes

212: Expenses for production of incomeo Deduction allowed for (1) ord/nec expenses (2) paid/incurred (3) in taxable

year: (a) for production/collection of income, (b) management,conservation, maintenance of property held for production of inc, or (c) inconnection w/ determination, collection, or refund of any tax

Production of income most important factor Still subject to 263 capitalization requirement

Deduction for losses from nonbusiness, profit-making activity 165(c)(2) nonbusiness losses

o Transaction must have been entered into for profit Mixed personal/profit use

TEST:o (1) Compute business:personal ratioo (2) Apply ratio to ABo (3) Apply ratio to ARo (4) Subtract business-AR from business-AB

Overlapping use Sharps timeline Different timesLowry; Regs. 1.165-9

167(a)(2) depreciationo Exhaustion, wear & tear, obsolescence on property held for production of

income

197(c)(1)(B) amortization of goodwill & other intangibles (over 15 years) Exam Review Hypo: TPs personal home has fallen $20k in value. Wants to deduct

loss in value so converts home into rental property. These rules switch out TPs basisin property to lesser of (1) FMV at time of conversion, or (2) AB at time ofconversion

o Only applies if asset initially personal then converted to businesso Deductible Personal Expenses

Generally, no personal deductions allowed. 262. Exceptions:

Interest: 163o Defn: compensation for the use or forbearance of moneyo Interest payments recd by CR are GI for CR. 61(a)(4)o No deduction for personal (163(h)(1))o CAN deduct if non-personal 163(h)(2)

Connected to T/B; Investment interest (163(d)); Interest on debt for certain favored activities

Buying a home (163(h)(3)) Higher education (221)

o Limitations Borrowing to construct business/investment property. 263A(f) Borrowing to purchase property earning tax-exempt income

Tax exempt bonds (265(a)(2))prevents double benefito Interest Related to Home

Qualified Residence Interest (163(h)(3)) Rule: Principal residence + 1 (h)(4) Acquisition indebtedness (163(h)(3)(B))


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o (1) Debt incurred in acquiring, constructing, or

substantially improving TPs qualified residenceo (2) Residence secures debt (h)(3)(B)(i)(II)o (3) Up to $1mn of debt

Refinancing debt = acquisition indebtedness up to amtrefinanced

oExcess refinanced amt = home equityindebtedness if satisfies test below

Home equity indebtedness (163(h)(3)(C)): TESTo (1) Loan secured by homeo (2) Home equity + acquisition indebtedness L, losses treated as capital losses (netted against gains)o Restrictions on Deductions: Hobby Losses & PALs

Restrictions aimed at tax shelterscreate artificial (noneconomic) losses that shield othersources of income from tax liability

Hobby losses. 183 MEANS NOT ENGAGED IN FOR PROFIT Business-like activities that have personal appeal (smile test) Hobby losses = deductible to extent of hobbys GI Rebuttable presumption whether activity is engaged in for profit

o Presumption activity = engaged in for profit, if 3+ of past 5 consecutiveyears, GI derived from activity > deductions attributable to activity

o 1.183(C)(i) -- Comm'r may overcome presumption Regs. 1.183-1(b)(1)(i): Taxes & qualifying residence interest are deductible Exam Review If you flunk T/B test, move to hobby loss analysis


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o 1.183-2 gives factors to consider for whether TP engaged in for-profito Most common expenses to try to deduct: Mortgage interest (TP claims

hobby property as principal residence +1, and taxes) Passive Activity Limitations. 469

Abuse: Use of losses from passive investments in other peoples active trades orbusinesses to shelter your current-year active income

PALs can only offset income generated from passive activities

Defn (469(c)(1)): T/B activity in which TP doesnt materially participateo Exception for portfolio income not generated from T/B. 469(e)(1)

Materially participate Regular, continuous, substantial involvement in T/Boperations (469(h)(1)).

o More than 500 hours per year. Regs. 1.469-5T(a)(1)o More than 100 hours per year, IF no one else worked more. Regs. 1.469-

5T(a)(3)

Ownership of limited partnership interest alone is not material participation in LLPsT/B. 469(h)(2)

o Partners report partnerships T/B activity. 702(a)o Limited Partners role is defined by state law

469(g): Loss from disposition of TPs entire interest in passive activity treated asloss not from passive activity

o Prev. yrs excess losses that were carried forward get to be deducted in fullonce entire interest is disposed of

Exam ReviewPAL only applies to T/B doesnt apply to hobby loss Illegal Activity

Illegal activity is not deductibleo Bribing government officials. 162(c)o Drug trafficking. 280E

Gambling Exception: ( 165(d)) -- L allowed to extent of any G Home Office

During taxable year, cant use room set aside for B for any other reason Special rule for rental use 280A(g):

o If dwelling used by TP as residence and is rented for less than 15 daysduring year, then no deductions allowed and income derived excluded fromGI

o 109: GI doesnt include lessees improvements to propertyo Deductions for individuals only

62: Adjusted Gross Income = GI for individuals only minus listed deductions Items in 62 = above the line deductions

o Best deduction b/c always beneficial, drives down AGIo E.g., student loan interest. 62(a)(17); alimony pmt ( 62(a)(10))

Below the line deductions Itemized deductions vs. standard deduction + personal exemption ( 151) Itemized deductions

o Qualifying uniforms ( 63(d))o Medical expenses, property taxes on home, charitable contributions, home

mortgage interest ( 63(d))o If persons home becomes rented, taxes and interest are elevated to above the

line deduction under 62(a)(4) Standard Deduction 63(c)

TP can elect standard or itemized 2012 Standard: $5,950 single; $11,900 MFJ Why? Easy for TP to administer, rather than tracking reqs for itemized

o Ensures poor dont have to pay tax as well Itemized Deductions 63(d)

All deductions except: above line in 62(a) and personal exemptions in 151


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Misc. itemized deductions; subject to 2% AGI floor

o Itemized deductions not listedin 67(b) 1.67-1T(a)(1): common examples

TEST:o (1) Is deduction permitted?o (2) Does aggregate value of all itemized deductions exceed 2% AGI?

Can only deduct value in excess of floor

o (3) Does aggregate value exceed standard deduction? Cant itemize if taking standard

Personal Exemptions 151 Per person, fixed amt deduction ($3.8k, Rev. Proc. 2011-52) Includes TP, spouse, dependents 151(b), (c); TIN/SSN reqd ( 151(e)) No duplication on multiple returns 151(d)(2) Dependent 152(a)

o Qualifying child (152(c)); Child or grandchild of TP. (c)(2) Same principal place of abode as TP for > tax yr Younger than TP claiming dependent, under 19 or a student under

24

Student defined 152(f)(2) Dependentdoesnt provide more than ofown support; and

Hasnt filed JR w/ own spouse o Qualifying relative (152(d));

Relationship enumerated in (d)(2) Note (H) catchall Dependents GI < exemption amount TP provides over individuals support Not a qualifying child E.g., TP is paying for TPs nieces, nephews, etc.

o Divorced parents (152(e)) Example: Family of four gets 4 X $3.8k

Medical expenses deduction 213 Test (Sec. (a)):

o (1) Subtract any value compensated by insuranceo (2) Deduct excess over 7.5% AGI FLOOR

Medical careDiagnosis, cure, prevention, treatmento Some weight loss programs (food is not deductible)o General health isnt enough (Regs. 1.213-1(e)(1)(ii)o Covers transportation, health insurance premiums, not purely cosmetic

surgeryo Cosmetic surgery qualifies only ifperformed to repair congenital

defect/abnormality caused by accident/deforming diseaseo Cost of capital improvements = medical expense if cost > value

improvements add to home Education expenses. 222

Qualified tuition & related expenses: enrollment fees, but not books, nonacademicfees, or personal expenses

Ceilings 222(b):o $4k if AGI < $65k ($130k if MFJ)o $2k if AGI < $80k ($160k if MFJ)

No double benefits 222(c) (e.g., scholarship exclusion under 117) Tax Rates ( 1table)

o U.S. uses progressive tax structureo Once standard deduction + personal exemptions exceeded, positive rates in 1 take effecto Marginal TRRate applied to last dollar of TIo Average TR (effective TR)TL / TI


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o TP Classifications

MFJ (7703) Need to be married by the last day of the tax year. If spouse died, use date of death for tax year

o In which case, surviving spouse for next two years HOH (2(b)

Not married or surviving spouse, has dependents at home MFS (7703)

Single (1(c) )Indirect TR increase. 68 If AGI exceeds applicable amount ($100k in code, $166 for 2009), itemized deductions

reduced by lesser of:

3% of (AGI - $166.8k)or- 80% of itemized deductions

Itemized deductions excluded from above rule: Medical expenses ( 213) Investment interest ( 163(d)) Casualty, theft, gambling losses ( 165(a), (c), (d) respectively)

Sunset killed it in 2010; comes back 2013o Another indirect TR increase. 151(d)(3)

Personal exemption phase-out:

2% reduction for every $2,500 of AGI over $166.8k ($250k MFJ) Same phase out as above (151(d)(3)(F)); also 2009 figures

o Preferential TRs Capital gains Qualified dividend income. 1(h)(11)

Divs from domestic corporations Must own more than 60 days before ex-dividend date Taxed at NCG TR but becomes ord inc in 2013

Kiddie Tax ( 1(g)) Seeassignment of income below. Childs net unearned income taxed at parents

marginal TR.o Assignment of Income

Defn: Current attempt to shift future income to another TP (typically to family/charity) Why? Reduce aggregate TL of group; indifferent who has wealth in group. Charities

are exempt from most income tax

E.g., stock appreciation, future interest & dividends Court-created test:

If TP fails test, assignment is still valid but TP must pay tax on future income whenlater realized by assignee

Earl: Husband controlled his income b/c he determined if he was going to earn it and what hewas going to do with it. Therefore, even though he assigned 50% of his earnings to his wife, itwas income to him and not to her.

Seaborn: assignment is valid for tax purpose in community property states. Giannini (9th Cir.): TP realizes income when able to direct its disposition even if TP

never recd income directly.TP disclaimed future compensation for 2nd half of year, told

company to do something worthwhile with it. No realization b/c at time of donation TPcouldnt direct disposition. Rev. Rul. 74-581:

Fees awarded to law students/clinical faculty members representing federaldefendants dont have to be included in GI when, pursuant to employment agreementw/ school, any such fees must be turned over to the school.

One of few exceptions toHorst(income taxed to those who earn it) DOMA: Codes treatment of gays. Doesnt recognize SSM, no MFJ for them

o Assignment of income: Property


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Fruit/tree metaphor. Fruit = accession to wealth (whats assigned); Tree = complete dominion

over wealth (control over source of wealth, retained by TP usually); ripeness = clearlyrealized.

Horst(F: TP kept bond, gifted interest coupon to son) Power to dispose of income is equivalent to ownership of it. Interest coupons

detached from bonds and given to TP's son as gift constituted realization of income

for TP Income = realized when assignor, who owns/controls source of income, also controls

its disposition (i.e., can divert payment from self to others if assignor so chooses) Blair: Trust owned income property; TP owned income interest in trust; TP assigned right to

receive part of future income valid assignment, taxable to assignee b/c assigneesbecame owners of income

Stranahan: TP sold son right to receive $123k in future dividends for $115k. Assignment forconsideration = valid.

Rationale: TP is free to arrange his financial affairs to minimize tax liability --> taxavoidance motives do not nullify otherwise valid transactions.

Consideration is what differentiates this case from Earl, Horst, and Lake Susie Salvatore

H: Mother can't get around tax consequences of $295k sale of gas station by deeding1/2 interest in property to her five children and claiming only $115k of proceeds asLTCG. All gain from sale taxable to mom.

F: Mother deeded 1/2 interest in gas station after contracting for sale but before salewas finalized. No consideration

Was really just using children as conduit to reduce tax liability Court Holdings Co.

Corporation bought apartment. Entered into K to resell, found out adverse taxconsequences. Declared liquidating dividend. Transferred apt to shareholder whotried to sell individually.

H: A sale by one person [TP] cannot be transformed for tax purposes into asale by another [TPs shareholders] by using the latter as a conduit through

which to pass title.o Capital Gains/Losses

Deductibility of CLs. 1211(b) Deduction limited to capital gains + $3k ordinary income

NCG TR: 1(h) Typically 15%; sunset provision means 20% starting 2013 NCG = (Net long term capital gain) - (net short term capital loss) Net Long Term Capital Gain (NLTCG)

o Elements (1) G from (2) sale or exchange of (3) capital asset (4) held more than 1 year

o Rest is ordinary income/loss. 64, 65 Except 1231 gains.

3 Step Netting Processo 1) Short term CGShort term CL = net STCG/L ( 1222(5), (6))o 2) Long term CG Long Term CL = net LTCG/L ( 1222(7), (8))o 3) Net LTCGNet STCL = NCG ( 1222(11))

Cant be less than $0 Net short term capital gains = ordinary income treatment under TR tables ( 1(h),

1(a)-(d)) Collectible gains/losses ( 1(h)(5))

Work of art, rug, antique, metal, gem, stamp, alcoholic beverage (think vintage wine,not Budweiser/Miller High Life)


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28% TR 1(h)(1)(E)

o Tax as ord inc if treatment would result in TR < 25% ( 1(h)(1)(A)(ii)) Adjusted NCG ( 1(h)(3))

Ordinarily, 15% TR 0% TR if would be taxed at less than 25% if treated as ord. inc. [1(h)(1)(B)] 20% (and 10%) after 12/31/2012

Deducting Capital Losses 165(f) Losses allowed to extent under 1211 and 1212 1211 Losses on sale/exchanges of capital assets allowed up to extent of gains, plus

(if losses > gains) lower of(1) $3,000 or (2) excess of losses over gainso Most you can deduct against ordinary income: $3k

Carryoverso STCL carryover: 1212(b)(1)(A)

If Net STCL > Net LTCGo LTCL carryover: 1212(b)(1)(B)

If Net LTCL > Net STCGo The (up to) $3k deduction against ord. inc. above is hit first by STCL

carryover. 1212(b)(2)o LTCL carryover = 28% TR loss 1(h)((4)(B)(iii)

Determining if property = capital asset or T/B asset

Winthrop: Seven pillars of capital gains treatmento Nature and purpose of acquisition and duration of ownershipo Extent and nature of TPs efforts to sell o Number, extent, continuity and substantiality of the saleso Extent of subdividing, developing, and advertising to increase saleso Use of a business office for saleso Character/degree of supervision/control exercised by TP over sales peopleo Time and effort TP habitually devoted to sales

Sale or exchange Requirements:

o Sale: Transfer of property for moneyo Exchange: Transfer of property for property or serviceso Transfer must be to another party

Abandonment of property is not sale or exchange of that property Yarbo exception: abandoning property subject to

nonrecourse mortgage = exchange 165(g)(1): worthlessness is not enough Foreclosure = sale.Hammel

o Property must survive! Kenan: F: Trust obligated to pay beneficiary $5mn at age 40. Paid using appreciated

securities; appreciation occurred after death.o Who benefited from appreciation: Trusto Sale or other disposition: Yeso Sale or exchange: Yes, exchange by Trusto Beneficiarys basis: $5mn

Hudson: TP purchased judgment in 1943. In 1945, DR paid TP full settlemento Sale or other disposition: Yeso Is judgment a capital asset: Yeso Sale/exchange: No. Sale generally understood to mean transfer of

property for money. TP didnt transfer anything to DR. If TP had transferred judgment to someone other than its DR

it would have been a sale. PROPERTY MUST SURVIVE SALE

Holding Period Starts day after acquisition [Rev. Rul. 66-7]


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Includes day of disposition [Rev. Rul. 66-7] Significant dates:

o Stocks & bonds: trade date [Rev. Rul. 66-97];o Real estate: earlier of title transfer or possession and ownership

benefits/burdens pass [Rev. Rul. 54-607]

Transferred holding period & basis. 1223(2) Substituted basis property: 1223(1)o Transferees basis in transferred property attaches to property transferee

receives in exchange for transferred property E.g., like-kind exchanges [1031(d)]

o Transferees holding period in received property gets to start fromtransferees holding period in transferred property

Inherited property: 1223(9)o Holding period always > 1yr

Special characterization ruleso Substitute for ordinary income doctrine:

Overrides literal reading of 1221(a); 1222 in order to protecting the revenue from artfuldevices

Two-step process (Lattera)

1) Temporal carve outo Horizontal carve out ord inc (Hort)

Transfer portion of income stream, but keep income-producingproperty

o Vertical go to step 2 Complete transfer of some/all property

2) Characterization/nature of propertyo Right to income already earned ordinary (Watkins)o Right to earn income capital (Metropolitan Bldg)

Hort: Property = building lease contract. TP agreed to lease for 15 years. Recd $140k a yearlater to cancel lease

H: TP had $140k ordinary income b/c TP retained the income producing property(the building), classic horizontal carve out

Metropolitan Building: Property = lease itself (TP didnt own building). TP sold leasehold for$137k.

H: TP had $137k of capital gain. Sold its right to earn income, vertical carve out. Watkins: TP won lottery. Sold right to future payments for $2.6mn.

H: TP had $2.6mn ord inc b/c payment recd foralready earned, future incomeo Sale of T/B ( 1060(a))

Seller wants LTCG & ordinary losses, buyer wants fast basis recovery Seller:

1231 Recharacterization Best of both worlds: net gains = LTCG, net losses = ordinary Section (a)(3): 1231 gains/losses are recognized gains/losses from sale/exchange or

involuntary conversion

Qualifying property requirements ( 1231(b)):o

(1) Used in T/B;o (2) Depreciable under 167, or real propertyo (3) Held > 1yr;o (4) Falls under 1221(a)(2)

Special compulsory/involuntary conversion rule:o 1231(a)(3)(A)(ii)(II)

1245 Recapture Portion of gain from sale of depreciated property must be recognized as ord inc How much:

o For sales/exchanges/involuntary ARAB


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1245(a)(1)(B)(i)

o Other disposition FMVAB 1245(a)(1)(B)(ii)

Max recapture amt: total allowed depreciation ( 179) Limitations ( 1245(b); Regs. 1.1245-4(a)(3))

o Gifts: Doesnt apply may apply to part-gift/saleso

Transfers at deatho 1031 like-kind exchanges

o Bad Debt TEST:

(1) Is there a bona fide debt?o DR-CR relationship based on a valid and enforceable obligation to pay a

fixed or determinable sum of money. [1 .166-1(c)]o Bugbee: Substance is what matters: did both parties intend to create an

enforceable repayment obligation when debt was createdo Watch out for loans to family/friends

(2) Is the bona fide debt a bad debt (worthless or partially worthless)?o Worthless or partially worthless. 166(a)o Factors (Regs. 1.166-2(a)):

DRs financial condition; SI in collateral?; Bankruptcy (1.166-2(c)(1))

o Pointless collection lawsuit not reqd. Regs. 1.66-2(b) (3) Is this a business or nonbusiness bad debt?

o Business debt 166(d)(2) = ordinary income deduction Debt created/acquired in connection w/ T/B Debt whose loss incurred in T/B

o Nonbusiness = everything else = STCLo Mixed-motive debts: Shareholder = employee situation

Proximate relation test: Regs. 1.166-5(b) Dominant motive = key. Generes DRs use of funds = irrelevant. 1.166-5(b)

Resulting deductiono Wholly worthless ABo Business bad debts ordinary deduction 166(a), above the line (

62(a)(1))o Nonbusiness bad debts Total worthlessness reqd ( 166(d)(1)(A))

STCL ( 166(d)(1))o Charitable Contributions

Below the line, itemized deduction. 67(b)(4); 170 TEST:

(1) Is it to a qualified charity?o Listed in 170(c): Government, entities organized and operated

exclusively for religious, charitable, scientific, literary, or educationalpurposes

Note reqs for domestic fraternal society under 170(c)(4)o Public ( 509(a)(1); 170(b)(1)(A)(i)-(iv))o Supporting organizations ( 509(a)(2), (3))o Private foundations ( 509(a))o Note, simply b/c organization is 501(c) does not necessarily mean

contributions to it are tax deductible

(2) Was there a contribution?o Contribution or gift to or for the use of [a qualified charity]. 170(c)o Requirements: Voluntary transfer & no quid pro quo

If TP recd somethingin return, subtract FMV of recdo Mix purpose xfers:


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If cash, excess over value recd = deductible If property, part gift/sale ( 1011(b)) AB prorated b/w gift and

sale

(3) Amt contributed?o Depends on what is contributed and type of charityo Cash to any charity: amt of casho

Services: $0 (Regs. 1.170A-1(g))o Double dip problem w/ property gifts Double dip allowed to public charity get to deduct FMV of

property instead of AB + you dont have to recognize gain Only allowed where property related to charitys purpose

o If donating property to public charity Noncapital asset: AB (170(e)(1)(A))

1231(b) property = capital asset ST capital asset: AB LT capital asset thats tangible personal property unrelated to

charitys purpose: AB. 170(e)(1)(B)(i) Other property: FMV (Regs. 1.170A-1(c)(1))

E.g., stock held more than 1yr (4) Any limitations?

o Contribution base = AGI ( 170(b)(1)(G))o If contribution is to public charity:

Limit = 50% of contribution base. 170(b)(1)(A) 30% limit for LTCG property

o Carryover 170(d)(1) Excess contributions carryover up to 5 additional years Retain status, consumed in FIFO manner

Recognitiono G/L must be recognized to be included in GI. Nearly all G/L are recognized thanks to 1001(c)

Regs. 1.61-6(b) G/L is usually deferred; recognized at later date Examples: Spousal property transfers ( 1041), Like-Kind ( 1031)

o Like-kind Exchanges Justification: Liquidity issues; continuation of investment in property class Nonrecognition requirements ( 1031(a)):

(1) Exchange of property; (2) Old & new must be held for production of income in T/B, or investment; (3) Old & new must be in same property class (i.e., like-kind)

o Same nature/character not grade/quality. Regs. 1.1031(a)(1)(b).o All real property = same class. Regs. 1.1031(a)-1(c)

E.g., ranch/farm like-kind with city real estate; leasehold & realestate; improved & unimproved real estate

Exception: Domestic and foreign not like-kind Excluded property:

Inventory, stock Personal property ( 1.1031(a)-2(a)) not on exam Consequences of pure like-kind exchange:

Nonrecognition of G/L. 1031(a)(1) Substituted basis w/ old property. 1031(d) Tacked holding period to old property. 1223(1)

Consequences of Impure exchanges Cash & non-like-kind property (boot)

o Liability assumption = cash recd. 1.1031(d)-2 G recognized up to boot amount. 1031(b)

o Cash, non-like-kind, liabilities transferred w/ property Adjusted Basis


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o (AB in original)(cash recd) +/- (Amount of recognized G/L)o First allocated to boot property up to FMV, rest to like-kind

Still tacked holding period. 1223(1) 3-way transactions (where you cant find the perfect match)

Hypo: B wants As property, but A wants Cs property. B buys Cs for cash. A thenexchanges w/ B.

Timing = key. 1031(a)(3). 180 days to complete exchange.

4-way swaps (where B wont touch Cs property)o Qualified Intermediary steps in & arranges dealo 1.1031(k)-1(g)(4)(iii)

Property transferred for serviceso Review: FMV of property recd in exchange for services = GI. 1.61-2o Complications: Restrictions on property create timing & characterization issueso 83:

EEs compensation for services = increase in unrestricted wealth (Wealth Increase) = (FMV of property)(EEs cost) Unrestricted when EE controls property, no possibility of reverting back to ER ER cant deduct EEs compensation until EE recognizes income

o Regs. 1.83-3(e): All non-cash property is coveredo EE compensated w/ ERs stock restricted, stock options

Options: Incentive ( 422) vs. non-qualified ( 1.83-7) Why pay ee w/ stock? No direct cost to er (its other shareholders that suffer)

Performance-based compensation via stock not subject to compensation limit in 162(m).

o Restrictions on property: Substantial risk of forfeiture ( 1.83-3(c)):

Right to keep property conditioned, directly or indirectly, upon the futureperformance . . . of substantial services by any person . . . .

If stock has vesting period, there is substantial risk of forfeiture Non-transferability ( 1.83-(d)):

Transfer contractually prohibited: Often permitted only to family members, trusts forthe benefit of family, and family-owned entities

If permitted, transferee receiving property must face substantial risk of forfeitureo Restricted Stock

GrantER issues restricted stock to EE No tax consequences [83(a), (h)]

ForfeitureEE loses restricted stock No tax consequences [see 83(a), (h)]

Vestingone or both restrictions lapse Tax consequences:

o EE has ordinary income [83(a)]o FMV of stockamount paid by EE (if any)o EEs basis is FMV [1012; 1.61-2(d)(2)(i)]o EEs holding period starts [83(f)]o ER gets 162 deduction equal to EEs income [83(h)]

Sale of vested stocknormal rules apply 83(b) election at time of grant:

83(a) is cut off [83(b)(1)]; no tax consequences at vesting If EE elects w/i 30 days of transfer:

o EE includes FMV less amount paid for stock in GI for yr recd o EEs basis is FMV [1.83-4(b)(1)]o EEs holding period starts @ election [1.83-4(a)]o ER gets 162 deduction equal to EEs income [83(h)]

Risk: IF forfeiture occurs, no offsetting deduction permitted! [83(b)(1)] Benefit: By the time stock has vested, if EE sells G taxed at CG TR


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o Nonqualified stock options

Usually no readily ascertainable FMV unless options are traded on stock exchange Never for our class

@ Grant: No tax consequences. 1.83-7(a) @ Vesting: No tax consequences. 1.83-7(a) @ Exercise (i.e., when EE uses options to buy ERs stock)

EE will only exercise when exercise price is

o less than (or at least equal to) stocks FMV If purchased ER stock is unrestricted:

o Tax consequences are same as Vesting ofrestricted Stock where no83(b) election was made

If purchased ER stock is restricted:o No tax consequences until restricted stock vestso Can make 83(b) election for restricted stock

Sale of vested ER stock Normal rules apply (e.g., 1001, 1222) Taxable Year

o Period over which TI computed. 441(a)o Types: (1) Fiscal year matching annual accounting period (any yr that doesnt end 12/31); (2) calendar

year Calendar applies to most TPs ( 441(g))

o Tax Value of Money: Money available today is worth more than same amount in future Why? B/c it can earn interest in the interim Tax planning: Defer tax payments to future year in order to reduce tax cost in todays dollars

(1) Defer GI (2) Accelerate deductions

Creditso Subtracted directly from tax dueo While $$ value of deduction/exclusion depends on TPs applicable TR ($5k deduction @ 15% TR =

$750), value of credit is dollar-for-dollar b/c = reduction in tax itself rather than subtracted from GI

Accounting Methods: Casho Receipt of income: Can be actual or constructive (1.446-1(c)(1)(i))

Constructive Receipt ( 451; 1.451-2(a)): Not actually recd, but (1) Made available to TP during taxable year; and (2) No substantial limitations or restrictions on receipt

Hornung: Purpose of constructive receipt = prevent TP from choosing yr of inclusion bycontrolling yr of receipt

While TP notified he won corvette in yr 1, there was no way for him to receive ituntil yr 2 so TP could not include as income in yr 1 (TP wanted yr2 b/c much bettertax consequences then)

Cowden F: "Bonus" is upfront payment for mineral lease. Buyer wanted to pay bonus up

front. Seller said "wait, let's divide up bonus and have you pay it over period of yearsin future

H: No constructive receipt b/c at time K formed, TP not yet earned the $o Income can be cash or property

If property FMV of property in exchange for services = GI ( 1.62-2(d)(1)) Kahler: Receipt of check = income unless restricted

Check is pmt and mailing is sufficient, but no bouncing. Rev. Rul. 54-465. CC = pmt too. Rev. Rul. 78-38

o Dont wait until credit loan is paid; and repayment itself not deductible Watch out for payee financing (Cathcart)

Williams: Note evidencing future intention to pay was simply a change from A/P to NotePayable, TP showed no FMV

o No constructive payment doctrine (Vander Poel) Cant borrow pmt from payee (Cathcart)


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o Expenses incurred in creating an asset

Capitalization & Timing If asset has useful life beyond close of taxable year, cant deduct expenses in taxable

year. Regs. 1.461-1(a)(1)o Prepaid expenses [1.263(a)-4(d)(3), (f)(1)]

E.g., rent, insurance premiums

Capitalized if prepayment acquires right that extends beyond either: 12 months from start of benefit, or End of taxable year following payment year

o Prepaid interest [461(g)] Interest payment put on accrual method Mortgage points exception Must be qualified residence interest [163(h)(3)] Prorated points on mixed-use loans [Rev. Rul. 87-22]

Tax Planning Goals Goal: Reduce TL by decreases GI (exclusions) and increase deductions (above and below) Change who gets taxed: Assignment of income

o Accelerate deductions Deduct capital losses

Get lower CG rates Avoid recapture

Categorical Review of T/B, Hobby, PAL (Exam review)1. Is TP engaged in T/B?2. If no hobby3. If yes is it passive or active?

a. Passive = T/B TP doesnt materially participate inBasis in Newly Constructed Building Includes (self-constructed = black hole)

Salaries & other expenses ( 263A(a)) Depreciation of equipment used.IdahoPower; 1.263A-1(e)(3)(ii)(I) Interest on construction loans ( 263A(f)) Taxes on property ( 263A(a))

E&E

Imputed income owning things that have rental value that you keep for yourself, performing services foryourself that someone on the market would charge for. Not taxed b/c administrative nightmare andseriously questionable policy grounds.

income tax outline share

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