SURVEY OF INCOME TAX SLIDES
BRIEF HISTORY
CODE STRUCTURE
COURT SYSTEM
TOP 100 TAX CASES
TOP 40 TAX DOCTRINES
TOP 100 SECTIONS
TAX ETHICS
ON-LINE TAX AUTHORITIES
OFFICIAL TAX AUTHORITIES
TAX LL.M. PROGRAMS
5 SUGGESTED READINGS
INDEX
TAX HUMOR
NAVIGATION INSTRUCTIONS
50 IMPORTANT FORMS
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
(ALPHABETICAL ORDER)
1. Above the Line deductions: The “line” is line 37 on Form 1040. Section 62
lists about two-dozen deductions which, when subtracted from gross
income, produce “adjusted gross income.” These are “above the line”
deductions. Mostly they involve trade or business expenses (other than
employee business expenses) plus moving expenses, alimony, section
212 rent related expenses, and retirement savings. Below-the-line
deductions are subject to section 63 and section 67 itemization limitations.
The phrase “above the line” does not appear in the Code and no such
actual line exists: this is, however, common tax terminology.
2. Adjusted Basis: An asset’s basis often increases or decreases: it thus
“adjusts.” Section 1016 provides the rules for adjustment. For example,
an increase in the adjusted basis of a building results from the addition of
a second floor. The section 1012 cost basis would include the original
cost of the building. The taxpayer would capitalize – i.e., adjust the
building basis upward – the construction cost of the second floor addition.
Similarly, a decrease in the adjusted basis of the building would result
from depreciation, allowed by section 167, on the building used in a trade
or business. The taxpayer would subtract the depreciation expense from
the building’s basis and thus adjust it downward.
3. Accrual Method: Section 446 permits taxpayers to use the “accrual”
method of accounting. Accrual taxpayers recognize income when “all
events” have occurred such that they have a right to the earnings and the
amount can be determined with reasonable accuracy. Accrual taxpayers
take deductions when “all events” have occurred such that they are
obligated to incur the cost and the amount can be determined with
reasonable accuracy. The main goal of the accrual method is to match –
in the same year – income with the costs of producing that income. The
© Steven J. Willis 2008. All Rights Reserved.
1
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
accrual method, as used for Generally Accepted Accounting Principles,
differs significantly from the accrual method as used for tax purposes.
4. Adjusted Gross Income: Section 62 defines Adjusted Gross Income –
often abbreviated as AGI – as gross income minus specifically listed
deductions. These deductions constitute “above the line” deductions.
5. Alimony: Per section 71, alimony recipients have income. Per section
215, alimony payers receive a deduction. Section 71 defines alimony by
listing four requirements. The section permits taxpayers to disguise
property settlement payments as alimony for tax purposes; however, a
complicated “frontloading” formula discourages such disguise attempts.
Similarly, the section permits child support payments to be disguised as
“alimony”; however, very complicated regulations make this difficult if more
than one child is involved. Taxpayers also may elect not to treat
payments as alimony.
6. Allowable: Deductions are matters of legislative grace: the constitution
does not require them. Interstate Transit Lines v. Commissioner, 319 U.S.
590 (1943). Hence, some section must “allow” a deduction for it to be
permissible. The term “allowable” refers to what is permissible, as
opposed to what the taxpayer actually reported as a deduction. Be
careful, as many code sections disallow that which is otherwise allowed.
7. Allowed: The term “allowed” refers to what the taxpayer actually reported
as a deduction, as opposed to what the taxpayer could have properly
reported, i.e., the amount “allowable.”
8. Alternative Minimum Tax: Section 55 imposes an alternate system on
taxpayers: they must pay at least the amount of tax imposed by the
section. Section 55 adjusts, for its purposes, the definition of gross income
and of allowable deductions. Known as the AMT, this system affects
many upper-middle income taxpayers.
9. Amortization:
Similar to depreciation (used for tangible property),
amortization is the process which allocates an intangible asset’s basis as
a deduction to the years of its useful life. Section 197 provides a 15-year
amortization period for some intangibles. Similarly, section 195 provides
for the amortization of start-up expenses over 180 months. Both
provisions provide for ratable amortization, which is the equivalent of
© Steven J. Willis 2008. All Rights Reserved.
2
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
straight-line depreciation. Section 467(f) provides a more complicated
method for amortization of pre-paid rent.
10. Amount Realized: Section 1001 defines the amount realized in relation to
the sale or exchange of property. It includes the amount of cash received
John Hine
plus the fair market value of property received. From this number, the
taxpayer must subtract his adjusted basis to determine the amount of his
gain or loss.
11. At Risk: Expanded in 1984, section 465 limits the deductibility of losses
from activities to the amount the taxpayer is “at risk” with regard to the
activity. A taxpayer is “at risk” with regard to an activity to the extent he
contributes cash to it or to the extent of his adjusted basis in property
contributed to it. Also, a taxpayer is at risk to the extent he is personally
liable for debt borrowed with respect to the activity or he has pledged
property to secure such debt. He is not “at risk” to the extent he uses nonrecourse debt. Essentially, this provision limits deductions attributable to
the use of non-recourse debt and thus lessens the importance of the
Crane decision. It has successfully reduced the use of many tax shelters.
12. Attributable To: Many code sections impose consequences which are a
function of an activity or an amount’s relationship to another activity,
amount, or event. A common relationship test involves one item being
“attributable to” another. Similarly, many provisions use “allocable to” as
the relationship trigger. Other tests include: clearly attributable to, clearly
and directly allocable to, properly allocable to, associated with, and
effectively connected with. Indeed, at least eighteen different relationship
tests appear in the code. Attributable to is by far the most common, with
“allocable to” being a distant second. No section defines these tests.
Some significant authority exists suggesting that they each have different
meanings; however, ranking them in terms of their reach is not an easy
matter. Tax students and practitioners should pay heed to such tests,
even if they are not easily deciphered.
13. Attribution: Equity ownership (corporate or partnership) is often “attributed”
to a person related to the nominal owner. Similarly, equity owned by an
entity is often attributed to the owner’s of the entity. As a consequence, a
person without actual ownership beyond a specified level may be treated
as having such ownership and resulting consequences. Sections 267 and
318 contain the most commonly used “attribution” rules.
© Steven J. Willis 2008. All Rights Reserved.
3
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
14. Basis: Section 1012 sets an asset’s basis as its “cost.” Section 1016 then
requires various basis adjustments. Under section 1001, gain or loss
from a sale or exchange equals the amount realized minus the adjusted
basis of the item.
15. Below the Line Deductions: The “line” is line 37 on Form 1040. Section 62
lists about two-dozen deductions which, when subtracted from gross
income, produce “adjusted gross income.” These are “above the line”
deductions. Mostly they involve trade or business expenses (other than
employee business expenses) plus moving expenses, alimony, section
212 rent related expenses, and retirement savings. All other deductions
are “below the line.” Below-the-line deductions are subject to section 63
and section 67 itemization limitations. The phrase “below the line” does
not appear in the Code and no such actual line exists: this is, however,
common tax terminology.
16. Capital Asset: Per section 1221, every piece of “property” is a capital
asset other than seven specific exceptions. Capital assets generate
capital gains and losses if, and only if, such gains and losses result from
the “sale or exchange” of the asset. The word “property” is not clearly
defined.
17. Capitalization: This accounting term describes the process of debiting an
asset account corresponding to a credit reflecting the cost. Capitalization
occurs when an expense is inappropriate. Per section 441, generally, a
taxpayer must “capitalize” an expenditure which creates an asset with a
life extending substantially beyond the end of the year. Section 263 and
the corresponding Treasury Regulations provide extensive rules for
capitalization of both tangibles and intangibles (separate regulations
apply).
18. Cash Method: Section 446 permits taxpayers to use the “cash” method of
accounting. Cash method taxpayers recognize income when they receive
an item which constitutes “earnings.” The North American Oil Claim of
Right Doctrine adds further gloss to this concept. Cash method taxpayers
take deductions when they “pay” a deductible item. Several doctrines help
define receipt: Constructive Receipt, Cash Equivalence, and Economic
Benefit. Such doctrines – which are each part of the Top 40 Doctrines consider taxpayers subject to them to have received income. Generally
Accepted Accounting Principles do not permit the cash method of
accounting for financial purposes. Tax law permits it because it is simple
to use.
© Steven J. Willis 2008. All Rights Reserved.
4
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
19. Casualty: Section 165(c)(3) allows a “casualty” loss deduction for
individuals. Specifically, the section refers to “fire, storm, shipwreck, or
other casualty . . . .” While no section defines “casualty,” most cases limit
the meaning to “sudden” events, similar to fires and storms. Hence, a
flood might cause a “casualty,” while a drought probably would not.
20. Charity: Generally, tax lawyers use this term to denote an organization
described in section 501(c)(3) of the Internal Revenue Code.
Contributions to such organizations are deductible for income tax
purposes per section 170. The category includes, inter alia, churches,
scholls, hospitals, and educational organizations.
21. C Corporation: A corporation organized pursuant to subchapter C of
Chapter 1 of Subtitle A is a “C Corporation.” It is a taxpayer. In contrast,
a corporation organized pursuant to subchapter S is an “S Corporation,”
which is not a taxpayer; instead, it is a “pass-thru entity.”
22. Child support: Per sections 71 and 215, “child support” is neither includible
by the recipient nor deductible by the payor. Payments labeled as child
support are child support. Also, under section 71(c), payments which are
subject to a reduction in amount on the happening of a contingency which
is either “related” to a child or which “can clearly be associated with a
contingency involving a child” are considered child support. Complicated
regulations permit the disguising of child support as alimony; however,
when more than one child is involved, they are very difficult to follow.
23. Complex Trust: Section 661 deals with Complex Trusts. It allows a
deduction to the trust for income either required to be distributed currently
or actually distributed. Otherwise, the trust is a taxpayer. The name –
complex trust – is deserved. Accounting for distribution of previously
taxed-to-the-trust amounts can be daunting. In contrast, section 651 deals
with Simple Trusts, which are “pass-thru” entities.
24. Cost of Goods Sold: Often referred to as CGS, the cost of goods sold
formula is: beginning inventory plus purchases minus ending inventory.
That formula forms the basis of a periodic inventory system – one under
which the user relies on periodic counts of inventory. Under a perpetual
inventory system, the user keeps track of each purchase and sale and
continually computes CGS.
The user must still periodically count
inventory to determine losses from theft or spoilage. Cost of goods sold is
© Steven J. Willis 2008. All Rights Reserved.
5
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
not a deduction; instead, it constitutes a “reduction” of amount realized to
determine gross income. This aspect is significant in relation to the
section 1312 mitigation circumstances of adjustment.
25. Credit: Congress permits taxpayers to reduce the dollar amount of tax
owed by an item called a “credit.” Such items differ from deductions in
that they reduce tax owed dollar-for-dollar rather than by a percentage
equal to the taxpayer’s marginal tax rate. For example, if a taxpayer is
subject to a marginal tax rate of 35%, a $1000 tax credit saves him $1000.
In contrast, a $1000 deduction saves him only $350 in tax owed.
26. Deduction : A deduction is an amount subtracted from gross or adjusted
gross income for purposes of determining taxable income. This might
involve a current business expense or a loss. Deductions are not
automatic: they must be “allowed” by some code section.
27. Dealer: A dealer is a person who sells property in a trade or business.
This status is in contrast to that of an “investor,” who hold property for
capital gain. Sections 512(b)(4), 1221 and 1231 each refer to “property
held primarily for sale to customers in the ordinary course of a trade or
business.”
In tax parlance, taxpayers who hold such property are
“dealers.” The line between dealer and investor status can be difficult to
draw. See the decision in Bynum v. Commissioner, 46 T.C. 295 (1966).
28. Deferred: Income and deductions which are otherwise taxable or allowed
may be “deferred” to a later period. Thus, they differ from “excluded”
income or “disallowed” deductions, each of which is permanent. For
example, section 469 “defers” excess passive losses until the taxpayer
has sufficient passive income. Section 453 “defers” gain on an installment
sale until later years.
29. Depreciation: Per section 167, taxpayers may deduct an allowance – an
“expense” – to reflect a portion of the cost of a capitalized tangible asset.
Section 168 provides a modified accelerated cost recovery system
(MACRS) to determine the amount allowed each year. Whether tax
depreciation reflects “loss in value” or “cost recovery” is the subject of
some academic debate. Regardless, under section 1016, an asset’s
adjusted basis must decrease by the greater of the depreciation allowed
or allowable.
Just as “depreciation” applies to tangible property,
“amortization” applies to intangible property.
© Steven J. Willis 2008. All Rights Reserved.
6
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
30. Disallowed: Deductions are matters of Legislative Grace: i.e., they are not
constitutionally required. Hence, no deductions are permitted unless a
code section “allows” them. But, many code sections then “disallow”
deductions otherwise allowed. Interstate Transit Lines v. Commissioner,
319 U.S. 590 (1943). Common disallowance sections are 183, 262, 265,
267, 274, and 280A. In some instances, what appears to be a
disallowance is actually a deferral provision.
31. Distribution: Section 301 covers C corporation “distributions.” This is a
broader term than “dividend.” A distribution is a transfer of money or
property to a shareholder with respect to the stock ownership. To the
extent the corporation has earnings and profits, the distribution is a
dividend. Non-dividend distributions reduce the basis of the shareholder’s
stock. Distributions in excess of basis are treated as amount realized from
the sale or exchange of property. Under section 302, a distribution may
be in redemption of a shareholder’s stock; in such a case, the tax
consequences differ from those of a pro-rata distribution. Section 311
deals with the tax consequences to the corporation of a property
distribution. Section 312 describes the impact of a distribution on earnings
and profits.
32. Dividend: Section 316 defines a dividend as a corporation distribution out
of its earnings and profits accumulated since 1913 or for the current year.
Under section 301(c)(1), the amount of a distribution constituting a
dividend is taxable to the recipient.
33. Earnings and Profits:
“Earnings and Profits” is the tax term for
undistributed income in a C Corporation. Section 312 describes the
impact of various types of distribution on E & P. For financial accounting,
the term Retained Earnings applies to a similar account. For state law
purposes, the term “earned surplus” often applies.
34. Economic Performance: Section 461(h) adds an “economic performance”
test to the traditional “all events” test for determining the accrual of
deductions. Essentially, accrual method taxpayers may not deduct
expenses until the latest of “all events” or “economic performance.” The
subsection describes four “principles” to be used in determining whether
economic performance has occurred.
© Steven J. Willis 2008. All Rights Reserved.
7
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
35. Employee: Section 3121(b) weakly defines “employment” as service by
an “employee.” Further elucidation appears in Treasury Regulations and
cases. Generally, an employee is one whose time and effort is directed by
the employer. In contrast, an independent contractor tends to manage his
own time and effort with less supervision than that of an “employee.” The
line between the two can be fine; however, the consequences can be
significant. Employee wages are subject to Subtitle C taxes, while
independent contractor income is not. Independent Contractors, however,
are responsible for the section 1401 self-employment income tax under
Subtitle A.
36. Employment Tax: Imposed by Subtitle C, employment taxes are imposed
on the wages of individuals. Wages, in turn, are remuneration paid to
employees – a term not defined by the Code. Employment taxes include
the section 3101 social security tax and the section 3111 Medicare tax.
Non-employees – independent contractors – must pay an additional
income tax on self-employment under section 1401.
37. Estate Tax: Imposed by Section 2001, the estate tax applies to the fair
market value of the “taxable estate” of decedents who are citizens or
residents of the United States. Per section 2101, an estate tax also
applies to non-residents who are not citizens of the United States, but with
a different definition of taxable estate. Subtitle B of the Internal Revenue
Code imposes both the estate tax and the related Gift Tax; hence, neither
is an “income tax,” which is the subject of Subtitle A.
38. Expense: The verb use of “expense” is in contrast to the infinitive “to
capitalize.” These are accounting terms. Under both the cash and
accrual methods of accounting, taxpayers should expense short-term or
nominal costs. Nominal is a relative term – significantly a function of the
taxpayer’s income and assets. Short-term generally refers to an item with
a life not extending substantially beyond the end of the current year.
Section 263 provides rules and extensive Treasury Regulations covering
the process of capitalization versus expensing. Other sections, such as
179, permit generous expensing of some items, including some with long
lives.
39. Fiscal Year: Under section 441, the term "fiscal year" means a period of
12 months ending on the last day of any month other than December.
This contrast with a “calendar year,” which ends on December 31. Per
section 442, a taxpayer may, with permission, change his taxable period.
© Steven J. Willis 2008. All Rights Reserved.
8
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
40. Gain: Under section 1001, taxpayers must recognize all gain from the
sale or other disposition of “property.” It then defines “gain” as the amount
realized less the “adjusted basis” of the property.
41. Gift:
A gift is a transfer motivated “primarily” by “detached and
disinterested generosity.” “Love and affection” are common indicators of a
gift motive. Commissioner, v. Duberstein, 363 U.S. 278 (1960). Section
102 excludes gifts from gross income. Subtitle B, however, imposes a gift
tax on the amount of gifts in excess of an annual exclusion.
42. Gift Tax: Imposed by Section 2501, the gift tax generally applies to the fair
market value of “property” gifts by both residents and non-residents of the
United States. Subtitle B of the Internal Revenue Code imposes both the
Gift Tax and the related Estate Tax; hence, neither is an “income tax,”
which is the subject of Subtitle A.
43. Gross Income: Gross Income is essentially the beginning point for
determining a person’s tax. Essentially, it equals gross receipts minus
cost of goods sold. For activities not involving inventories, it is simply
gross receipts. Section 61 requires the inclusion in gross income of “all
income from whatever sourced derived.” Contrast this with section 62
defining “adjusted gross income” and section 63 defining “taxable income.”
This language also appears in the 16th Amendment, which grants
Congress the power to impose an income tax. The Supreme Court further
refined the term as involving “Undeniable accessions to wealth, clearly
realized, and over which the taxpayers have complete dominion.”
Commissioner, v. Glenshaw Glass, 348 U.S. 426 (1955). This imposes
two factors: a wealth increase and a sufficient realization event.
44. Hobby Loss: Although the term “hobby loss” does not appear in the Code,
many tax authorities use it. They refer to a loss disallowed by section 183
because the activity generating the loss is not “engaged in for profit.”
Section 183 applies a for profit presumption for activities which generate
profits in three of five consecutive years. The term “hobby” in relation to
losses appears in several Treasury Regulations, particularly those under
section 183 and 212.
45. Holding period: Section 1223 defines the “holding period” for property.
This is the amount of time the taxpayer/owner has held the property. In
some cases, the time property was held by a predecessor in title can be
© Steven J. Willis 2008. All Rights Reserved.
9
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
“tacked on” to a current owner’s holding period. The holding period of
property is particularly important in determining whether gain or loss
resulting from the sale or exchange of the property is long-term or shortterm (if the property is a capital asset).
46. Imputed: The code sometimes “imputes” – or attributes – income or a
character that a transaction does not explicitly have. For example, section
7872 imputes interest on a below market loan; i.e., it recognizes the
economic reality of the transaction as a gift or payment offset by interest.
Similarly, section 4942 “imputes” a minimum amount of income on
otherwise underperforming assets for purposes of the private foundation
excise tax on the failure to distribute income. Section 1274 “imputes” a
principle amount for a transaction involving deferred payments for
property.
47. Including: This is a term indicating an illustrative list – a non-exhaustive
list of examples illustrating a prior point. Exhaustive lists – such as that in
section 1221 – omit the word “including.”
48. Independent Contractor: This is a worker who does not rise to the level of
an “employee.” As such, the payor of income is not responsible for
various employment taxes, such as those imposed by Subtitle C for social
security and Medicare; instead, the independent contractor is responsible
for a “self-employment” tax under section 1402 of Subtitle A. Note that the
employment taxes appear in Subtitle C, while the self-employment tax
appears in Subtitle A and is thus an income tax.
49. Individual: An individual is a human being. Compare this term to
“person,” which includes humans as well as corporations and some trusts.
50. Inheritance Tax: Many states impose a tax on inheritance, with the tax
being owed by the recipient. In contrast, the Internal Revenue Code
imposes – through Subtitle B – an Estate Tax, with the tax being owed by
the estate.
51. Innocent Spouse: Pursuant to section 6015 and Form 8857, a person
may seek “innocent spouse” relief from a deficiency if the spouse did not
know and had no reason to know of the understatement and holding the
spouse responsible would be inequitable.
© Steven J. Willis 2008. All Rights Reserved.
10
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
52. Installment Method: Section 453 provides for the installment method of
accounting. It provides: “a method under which the income recognized for
any taxable year from a disposition is that proportion of the payments
received in that year which the gross profit (realized or to be realized when
payment is completed) bears to the total contract price.”
53. Insurance company: Subchapter L of Chapter 1 of Subtitle A applies to
“insurance companies.” Section 801 applies to “life insurance companies”
and section 831 applies to all other “insurance companies.” Section 816
defines insurance company as “any company more than half of the
business of which during the taxable year is the issuing of insurance or
annuity contracts or the reinsuring of risks underwritten by insurance
companies.” That definition is not facially very helpful. Subchapter L
provides some very favorable rules for “insurance companies,” whatever
they are.
54. IRA: Section 408 provides for Individual Retirement Accounts. In general,
these are available for persons not otherwise covered by qualified
deferred compensation plans.
55. Itemized Deductions: Per section 63, all deductions not listed in section
62 are “itemized deductions.” Individuals may deduct them only to the
extent they exceed the standard deduction. These are also known as
“below the line” deductions.
56. Joint Return: Married persons may combine their income and deductions
onto a single return per section 6013, which is then subject to generally
favorable rates under section 1. Section 7703 provides some rules for the
determination of marital status.
57. Like Kind: Per section 1031, a taxpayer generally must not recognize
income or loss resulting from the exchange of property for “like kind”
property. Pursuant to treasury regulations, “like kind” refers to its “nature,
character, or class of the property, not to its grade or quality.” As a result,
real property is like kind to other real property even if one is improved and
the other is not. The term “like kind” is in contrast to the term “similar use
property,” which appears in section 1033.
58. Listed Property: Section 280F(d)(4) lists seven categories of property
which it deems “listed property.” Such assets are subject to less than
favorable rules under sections 280F, 168, and 274.
© Steven J. Willis 2008. All Rights Reserved.
11
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
59. Marked to Market: Section 1256 contracts are treated as sold at their fair
market value at the end of each year. This section casts doubt on the
constitutional significance of the Helvering v. Independent Life Insurance
Company decision.
60. Method of Accounting: This is a sometimes controversial term. Section
446 permits various methods of accounting, such as the cash method and
the accrual method. Each must clearly reflect income. Taxpayers may
not change accounting method without permission – which is sometimes
automatic. A change of accounting method results in section 481
adjustments, which can be unpleasant. This begs the question of what
constitutes a “method of accounting.” The government has successfully
argued in some cases that an erroneous or forbidden method is
nevertheless a method of accounting such that a taxpayer may not correct
it in future years without being subject to section 481. See, Diebold v.
Commissioner.
61. Miscellaneous Itemized Deductions: Section 67 imposes a two percent
floor on itemized deductions not listed in the section. One large category
involves employee business expenses. Because the 2% threshold is so
high, few taxpayers successfully deduct these items.
62. Net Operating Loss: Section 172 provides a carry back and carry-forward
deduction for net losses; hence, taxpayers may receive a refund for prior
taxes or may reduce income in future years. NOL is a common way of
referring to these. Generally, NOLs may be carried back two years or
forward 18 years. Computing an NOL is not difficult; however, transferring
an NOL to another taxpayer can be daunting.
63. Non-recognition transaction: Several code sections provide that gain or
loss is not recognized in specific transactions or events. Section 1031
provides for non-recognition in like-kind exchanges.
Section 1033
provides for non-recognition for involuntary conversions. Section 1041
provides for non-recognition for transfers between spouses or transfers
incidence to divorce.
64. Ordinary and Necessary: Sections 162 and 212 each allow deductions for
certain “ordinary and necessary” expenses. Generally, ordinary connotes
“everyday” and “common” as opposed to unusual or extraordinary.
“Necessary” generally prompts a business judgment test, which is easily
satisfied.
© Steven J. Willis 2008. All Rights Reserved.
12
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
65. Ordinary Income: Section 64 defines ordinary income as all income other
than capital gain or section 1231 gain. Ordinary income is generally
subject to the highest rates of tax.
66. Over: Oddly, the code uses the phrase “A over B” to denote subtraction: A
minus B. For example, section 170(b)(1)(B)(ii) refers to the “excess of 50
percent of the taxpayer's contribution base for the taxable year over the
amount of charitable contributions allowable under subparagraph (A).” In
plain English, this requires the subparagraph A amount to be subtract from
50 percent of the contribution base.
67. Paid: The word “paid” is not easily defined. Critical for the cash method –
deductions are not allowed unless “paid” – the term generally refers to the
taxpayer transferring money or property or services to satisfy an
obligation. However, when the taxpayer uses borrowed sums to satisfy an
obligation, the concept of “payment” becomes less clear. See the
Battlestein and Burgess cases. Similar uncertainty results if a taxpayer
uses future services or the future use of property or a remainder interest in
property to satisfy an obligation. In some cases, all such transaction may
substantively be loans. “Pre-payments” also present difficulties: they, too,
are economically loans. In some cases, such as under section 467, prepayments must be treated as loans for tax purposes; hence, for those
cases an amount cannot be paid in advance.
68. Partnership: This is a pass-thru entity described in Subtitle A, Chapter 1,
Subchapter K. Section 761 loosely defines a partnership as including a
syndicate, group, pool, joint venture, or other unincorporated organization
carrying on a trade or business, that is not classified as a trust, estate, or
corporation. A partnership results when two or more persons join to carry
on a trade or business. Per Treasury Regulation section 301.77012(c)(1), “the term partnership means a business entity that is not a
corporation . . . and that has at least two members.” An agreement
merely to share expenses is not a partnership.
69. Passive Activity: Section 469 limits passive activity losses to the amount
of passive activity income. It defines a passive activity as a trade or
business activity in which the taxpayer does not “materially participate.”
Significantly, it also includes rental activity as passive. The enactment of
this section in the 1980’s negatively impacted the use of many tax
shelters.
© Steven J. Willis 2008. All Rights Reserved.
13
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
70. Pass-thru entity: This term includes partnerships, S Corporations, and
Simple Trusts. They are persons under tax law; however, they are not
themselves taxpayers; instead, their income, gain, losses, credits, and
deductions “pass through” to their respective owners and beneficiaries
who themselves report the items.
71. Person: The term person includes humans as well as corporations,
complex trusts, partnerships, associations, and estates.
Section
7701(a)(1) defines it. It is in contrast to the term “individual,” which refers
to human beings.
72. Personal Holding Company: Subtitle A, Chapter 1, Subchapter G, Part II
deals with personal holding companies. They impose an additional
income tax on undistributed personal holding company income. The
definition is complicated and appears in sections 542 and 543.
73. Personal Property: Personal property includes assets other than real
property. These are movable items or intangible items. Do not confuse
this term with personal use property.
74. Personal Use Property: These are items used for non-business or nonproduction of income use. They include one’s clothing, home, furniture,
automobile, and the like. Section 262 generally disallows deductions for
personal use. Except in the case of casualty losses under section 165(c),
losses on personal use property are routinely not allowed.
75. Phase Out: This is not a tax term of art; instead, it is a political term. It
does appear in at least one regulation provision, however. The term
refers to the reduction of tax benefits (deductions, lower brackets,
exemptions) as a function of other factors. For example, under section
179(b)(2), the limitation on the section 179 election is reduced as the
value of section 179 property placed into service increase. In other words,
the benefit “phases out” gradually. Many other tax benefits are subject to
similar phase outs.
76. Primary Residence: This is not a defined tax term; however, several
regulations use it (without definition) as do many Court decisions
© Steven J. Willis 2008. All Rights Reserved.
14
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
(including at least 11 recent appellate decisions and several Tax Court
decisions). The proper tax term is “principal residence.”
77. Principal Residence: This term appears in sections 121 (exclusion of gain
on sale of principal residence) and 163 (dealing with interest deductions).
Ostensibly, section 121 provides the definition; however, it does so by
referring to the term itself (use as a principal residence in two of five
years). Treasury Regulation 1.121-1(b)(2) provides a list of six facts and
circumstances to help elucidate the meaning.
78. Private Foundation: All charities are presumed to be private foundations
unless they satisfy one of four tests under section 509.
Private
Foundation status – as opposed to Public Charity status – is not favorable.
It subjects the charity to excise taxes under section 4940 through 4945, to
lower contribution deduction amounts under section 170(e), to lower
contribution deduction limitations under section 170(b), and to more
onerous reporting requirements.
79. Production of Income: Section 212 allows deductions incurred for the
“production of income.” This type of activity is in contrast to a “trade or
business” with regard to which deductions are allowable under section
162. In most cases, whether an activity involves the production of income
rather than a trade or business is unimportant; however, sometimes that is
not the case. The two categories are not easily distinguished.
80. Property: This is a commonly used and rarely defined tax term. For
example, all “property” is a capital asset unless specifically excluded by
section 1221, which fails to define property. Generally, tangible and
intangible things with value constitute property. However, unrealized
income rights – which are indeed property under state law – are not
property for many tax purposes. Generally, services are not property;
however, occasionally the code specifically includes services as property.
E.g., section 1273. What constitutes “property” for purposes of section
1041 has been controversial since the enactment of the section.
81. Qualified Plan: This is a type of pension, profit sharing, or stock bonus
plan that meets the requirements of section 401 and following provisions.
Generally, contributions to qualified plans are deductible by the
contributor, but not includible by the plan or by the beneficiary at the time
of contribution.
In contrast, rules involving non-qualified deferred
compensation are quite different. For non-qualified plans, generally no
© Steven J. Willis 2008. All Rights Reserved.
15
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
compensation deduction is allowed until the time of inclusion by the
recipient.
82. Recapture: Taxpayers receive many tax benefits which exceed what is
justified by their then economic cost. Political and policy reasons support
such benefits. Several code sections, however, provide for the “recapture”
of such benefits. For example, section 1245 characterizes as ordinary
income, any gain from the sale of depreciable personal property to the
extent of prior depreciation. Such gain results because the property did
not lose value commensurate with the depreciation expense. Section
1250 requires a more limited recapture of accelerated depreciation on real
property.
83. Related Party: This is not a consistently defined term for tax purposes;
indeed, it varies greatly. Sections 267, 318, 1563, and 4946 each define
“related party” differently. Many other code sections cross reference to
one of these definitions. At least nine different code sections use the term
“related party.” At least seventy-one different sections use the term
“related person.” At least twenty sections use the similar term “member of
the family.”
84. Reorganization: Section 368 describes seven types of corporate
reorganization. These include mergers, acquisitions of stock, acquisitions
of assets, recapitalizations, and changes of form,
85. Roth IRA: Under section 408A, ROTH IRAs are treated as IRAs in that
the accounts are not taxable on their income. Contributions to such
accounts, however, are not deductible – in contrast to contributions to IRA
accounts.
86. Sale or Exchange: This is a common-sense term. Its significance lies in
the section 1222 definition of capital gain or loss as being gain or loss
resulting from the “sale or exchange” of a capital asset. Hence, sale or
exchange treatment is critical for capital treatment. Some code sections
impute sale or exchange treatment. For example, per section 1271, the
collection of a note is generally a sale or exchange.
87. S Corporation: This is a pass-thru entity described in Subtitle A, Chapter
1, Subchapter S. Section 1361 defines the term. It is an electing small
business corporation with 100 or fewer shareholders, all of whom are
© Steven J. Willis 2008. All Rights Reserved.
16
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
individuals (or an estate) and none of whom are non-resident aliens.
cannot have more than one class of stock.
It
88. Self-employment tax: Section 1401 of Chapter 2 of Subtitle A imposes an
income tax on self-employment income. This tax is generally equivalent to
the social security and Medicare taxes imposed on employment income by
Subtitle C. Self-employment refers to circumstances in which a taxpayer
is not an employee. Generally, an employee is one who is subject to the
direction and control of his employer. While the tax rate generally does
not differ between the employment tax and the self-employment tax, other
issues are critical. Employment taxes fall half upon the employer and half
upon the employee, while self-employment falls entirely upon the earner.
Also, the self-employment tax is an “income tax” imposed by Subtitle A
and subject to all procedural rules applied to income taxes. In contrast,
Subtitle C employment taxes are subject to different procedural rules.
89. Similar Use: Per section 1033, a taxpayer generally must not recognize
income or loss resulting from the reinvestment of involuntary conversion
proceeds into property which has a “similar use” to the property destroyed,
taken, or stolen. Treasury regulations do not clearly define “similar use”;
however, they provide some examples. The term “similar use” is in
contrast to the term “like kind,” which appears in section 1031 and which is
generally more liberal.
90. Simple Trust: Section 651 deals with Simple Trusts, which are a type of
“pass-thru” entity. For such a trust, all income is “required” to be
distributed at least annually; hence, the income is taxed to the beneficiary
rather than to the trust. The trust is not a taxpayer. In contrast, section
661 deals with Complex Trusts, which are taxpayers.
91. Special Allocation: Under section 704(b), partnership may specially
allocate items of income, gain, deduction, credit, or loss to partners. Such
allocations may deviate from the partner’s relative partnership interest;
however, to be respected, they must have “substantial economic effect.”
Therein lays the great complexity of partnership tax law. Treasury
regulations defining those three words comprise approximately 100 pages
of almost incomprehensible rules.
92. Substantial Authority: Section 6662 relieves taxpayers of some penalties
for underpayment of tax if the taxpayer had “substantial authority” for his
position. Substantial authority if the weight of the authorities supporting the
© Steven J. Willis 2008. All Rights Reserved.
17
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
position is “substantial” in relation to the weight of authorities supporting
contrary positions. It includes statutes, temporary, proposed, and final
regulations, revenue rulings and revenue procedures, tax treaties, court
opinions, legislative history, including General Explanations of tax
legislation prepared by the Joint Committee on Taxation, private letter
rulings and technical advice memorandums, actions on decisions and
general counsel memorandums, and IRS press releases, notices, and
announcements.
93. Taint: This is not a tax law term of art. However, it is commonly used to
describe the negative qualities associated with some assets. For
example, depreciated property is “tainted” by the potential of section 1245
or 1250 recapture. Generally, taint follows the property in transactions
resulting in a transferred basis, such as a gift.
94. Taxable Income: Section 63 defines taxable income as adjusted gross
income (defined by section 62) minus personal exemptions and either
itemized deductions or the standard deduction. Section 1 imposes the
income tax rates on taxable income.
95. Tax Bracket: Under section 1, taxpayers are subject to various brackets.
Thus the first dollars of income are subject to lower rates than are latter
earned dollars during a given year. Current individual brackets are 10%,
15%, 25%, 28%, 33%, and 35%. As recently as 1981, the top bracket
was 70%. As recently as 1961, the top bracket was 94%.
96. TIN: Taxpayer Identification Number. For most taxpayer, this is the social
security number. Taxpayers may also apply for a TIN for various trades or
businesses.
97. Trade or Business: Sections 162 and 167 prominently use this term, but
fail to define it. Generally a trade or business connotes an activity that
produces income from labor or industry of the taxpayer. It differs from an
activity for the production of income, under section 212, which is generally
more passive. It also differs from an activity entered into for profit under
section 165. Sections 511 through 514 use the term in relation to
charities, but exclude things – such as the production of interest income –
which are not generally considered to rise to the level of a “trade or
business.” Also, section 469 introduced the concept of an active versus a
passive trade or business, which further confuses the terminology. Justice
© Steven J. Willis 2008. All Rights Reserved.
18
INTRODUCTION TO TAX SCHOOL
TOP 100 TAX TERMS
Cardozo poetically remarked, in Welch v. Helvering, that “life in all of its
fullness” would answer the riddle as to the meaning of the term.
98. Transaction for Profit: Section 165 allows losses from activities for the
production of income, trades or businesses, as well as transactions for
profit. It thus creates a third important category of activity. Section 167
does not allow depreciation of property held in a transaction for profit,
while it does allow such deductions for trade or business property and for
production of income property. Distinguishing the three categories is not
always a simple tax matter.
99. 1231 Property: Generally, section 1231 property includes depreciable
property used in a trade or business. Gains and losses from section 1231
property are subject to a complicated netting process. Generally, net
gains are treated as long-term a capital gain – which is quite favorable.
Similarly – and also generally – net losses are treated as ordinary losses,
which is also very favorable to the taxpayer. In a general sense, all
property is either capital, ordinary, or 1231. Other characters exist, but,
these are the three main ones.
100. Wash Sale: Under section 1091, a loss on the sale or exchange of
securities is disallowed if the taxpayer acquires (or contracts to acquire)
substantially identical securities within 30 days before or after the
transaction.
© Steven J. Willis 2008. All Rights Reserved.
19