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TAX OUTLINE
PART I: INTRODUCTION
Chapter 1: Orientation
A. A Look Forward
B. A Glimpse Backward
C. The Income Tax and the United States Constitution
Power to tax: derived from Article 1 § 8, clause 1 of the Constitution which gives Congress the right to lay
and collect taxes, imposts and excises.
Apportionment among the states: Congress has established a sum to be raised by direct taxation and the
sum must be divided among the states in proportion to their populations
16th Amendment: income taxes shall not be subject to the rule of apportionment regardless of the sources
from which the taxed income is derived. Removed the apportionment requirement
Uniformity Among the States: only requires geographic uniformity, but not everyone has to pay the same
amount or have an equal burden.
D. The Tax Practitioner’s Tools
1. Code: all tax decisions and controversies center around the meaning and provisions of the Code.
2. Bills: beginning of tax legislative process is the introduction of a bill in House.
3. Hearings
4. Committee Reports
5. Debates
6. Prior Laws
7. Treaties
Administrative Materials
1. Regulations – Where Treasury proscribes rules for the enforcement of the IRC, final regulations are
proliferations of the IRC. Generally subordinated to the IRC if they contradict; never use as a
substitute for the IRC
2. Rulings – Treasury’s answer to a specific question by a taxpayer, do not have the effect of the
regulations, but may be cited.
Judicial Materials
Court’s function is to identify the problem, determine the relevant facts and interpret and apply the Code
provisions.
1. Tax Court Decisions
2. District Court Decisions
3. Court of Federal Claims Decisions
4. Court of Appeals Decisions
5. Supreme Court Decisions
E. Tax Policy Considerations
F. The Road Ahead
PART II: IDENTIFICATION OF INCOME SUBJECT TO TAXATION
Chapter 2: Gross Income: The Scope of Section 61
A. Introduction to Income
GI – AGI Deductions = AGI
1. To determine how someone is going to file:
i. Determine marital status § 7703
ii. Determine how they will file §1(a)–(e)
iii. Use Rev. Proc. 2004-71 to determine tax
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2. § 61: Gross Income Defined: gross income means all income from whatever source derived. Includes
list of what should be included.
a. Treasure trove is specifically included in gross income – Cesarini v. U.S.
b. Courts give liberal construction in 61 because Congress intended to tax all gains except
those specifically excluded. All accessions to wealth clearly realized by the taxpayer that
the taxpayer has complete dominion over - Glenshaw Glass
c. Discharge by a third party of an obligation owed by the TP is an economic benefit to the
TP, and thus includable in GI – Old Colony Trust. §61(a)(12).
d. The rental value of a building used by the owner does not constitute income within the
meaning of the 16th. – Independent Life Insur. Co.
i. Imputed income: a flow of satisfactions from durable goods owned and used by the
taxpayer or from goods and services arising out of the personal exertions of the
taxpayer on his own behalf.
ii. Imputed income is NOT taxable.
iii. The FMV of residential property that is provided by an employee is to be included in
GI, even if the employer is the TP’s wholly-owned corporation – Dean v.
Commissioner
iv. Barter Transactions: FMV is used to determine the losses – Eisner v. Macomber
3. §62: Adjusted Gross Income Defined: deductions from gross income allowed. Deductions made above
the line
4. §63: Taxable Income Defined: must determine whether the standard deduction is greater than the
itemized deductions to determine which should be used.
Eisner: Rule (no longer good law): Said that income is whatever you earn from economic activity. Limited the
term income too much. Also said that it was a Constitutional requirement that something must be liquidated before
it is realized.
B. Equivocal Receipt of Financial Benefit
Cesarini v. United States: Found money in an old piano Said Constitution includes every accession to wealth but
Congress is able to limit what is allowed by the Constitution. Rule: Court found that treasure trove was an
accession to wealth so it should be taxed. If you find some cash you must include it in income currently. If find
item there is no realization requirement, must be taxed when you find it, even if you have to sell it to pay taxes.
 Would the results to the taxpayers in Caeserini be different if, instead of discovering $4,467 in the piano, they
discovered that the piano had been owned by Beethoven and is worth $500,000? They would only owe tax at
the time that it is sold, taxed when something is realized. It wasn’t a purposeful purchase of something
worth this value. Treasure trove is a court made rule. It would be hard to have an administrative rule
that whenever something goes up in value it is not taxed until it is realized, but that it different from
treasure troves.
Glenshaw Glass: Rule: any accession to wealth is considered income in income tax purposes.
 John has worked for Intel as an employee for 10 years, earning $40,000/year in salary. As a result of his good
work, Motorola has decided to try to hire him away from Intel by offering him $50,000/year. Intel cannot afford
to pay John more, but instead offers him 2% of the company’s stock, which is worth $20,000 and offers his wife
a used SUV, worth $15,000. John accepts, and receives the stock and car in 2005. How much income does
John report in 2005? $40,000 in salary, $35,000 in other income = $75,000. It doesn’t matter that the SUV is
given to his wife. It includes the fair market value of property when it is given. Could be different than
the value the employee places on it. All is taxable as compensation. If the car was just loaned for use as
part of compensation (company cars) you would be taxed on the fair market value of the use of the car for
that year.
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BARGAIN TRADING: trade of services still create taxable income.
 Sarah owns a summer house in Flagstaff. She rents it to Jim. Normally, she charges $4,000/summer. What are
the tax consequences for Sarah the following transactions?
a. Sarah agrees to charge only $1,000 if Jim pays for $3,000 of improvements to the house. $4,000 bc
that is the fair market value of the improvements. Improvements DO NOT get added to the
basis because it was in lieu of rent. § 109
b. What happens if Jim does the improvements himself, incurring a cost of $500 for materials? It is as
if she got $4,000 from Jim and he was paid the $2,500. $1,000 was rent and $500 was for the
cost of the materials. Taxable income still $4,000.
c. Are there any tax consequences to Jim as a result of (b) above? Jim’s income is in the from of a
deduction from rent. $3,000 if gross income, then can deduct the $500 of material costs from
that.
IMPUTED WEALTH: you don’t get taxed for self created wealth.
Veronica grows vegetables in her garden. The crop is worth $100. Does she have income when she:
a. Harvests the vegetables? No. You have consumed whatever you created. Ideal income situation
would include this as imputed income. You do not get taxed for self created income.
b. Consumes the vegetables? No.
c. Sells the vegetables for $100? Yes.
d. Exchanges the vegetables with Sam for $100 worth of clothing. Yes.
C. Income Without Receipt of Cash or Property
Chapter 3: The Exclusion of Gifts and Inheritances
A. Rules of Inclusion and Exclusion
B. Gifts
1. §102: Gifts: gross income does not include property acquired by gift, bequest, devise or inheritance.
Must look to intent.
a. If the g, b, d, or I is of income from property, the amount of such income is not excluded.
b. §102(c): Gifts from employers: shall not exclude from gross income any amount earned
from employer. Bright line rule. Look to 74(c) and 132(e) for exclusions.
c. Prizes are not excluded from GI under 74(a)
2. A transfer is a gift, excludable from GI under 102(a) if the proceeds from a detached and
disinterested generosity motivated by affection, respect, charity or similar feeling, this is up to the
court. Must look to the intent of the gift giver. Commission v. Duberstein.
a. Tips never considered disinterested generosity, always included in income.
3. Property received by an heir under a settlement agreement ending the contest of a will is received as a
result of the heir’s right and is thus excludable under §102(a). – Lyth
4. Payment for services is income, even if it is made through a bequest in a will, “look to the substance,
not the form” – Wolder
5. § 102(c) Employer – Employee benefits – Includes in GI
a. §74(a) employee achievement awards excludable
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i. Is it for length of service?
ii. Is it awarded as part of meaningful presentation?
iii. Is it awarded under conditions that do not create a significant likelihood of the
payment of disguised compensation.
b. §274(j) to determine what an employee achievement award is
 Janice owns a corporation and is its CEO. Her son works at the company. She decides to give her employees a
television set worth $100. To her son, she decides to give a set worth $500.
o
Do the employees have income as a result of the gift? Yes, because they are all employees, they are taxed
on the value of the gift.
o
Does her son have gross income and if so, how much? Son covered under two sections. § 102 (a) because
family member and employee. Proposed regulation says that this is probably allowed.
o
As Janice’s attorney, what would you advise her to do regarding this gift? Put under the tree instead.
Proposed regulation is probably how the IRS would regulate this, but not binding. Indication as to
what IRS is thinking today. But should just give under the tree and don’t have to worry about this.
o
Assume Janice wants to give something to the employees, but not have them taxed. What can she do?
Barred under 102(c). Fringe benefit under 132(e) for de minimis fringe benefit. Doesn’t help to define
fringe benefits, must look at regulations.
 Arthur decides to celebrate the start of the new semester by going to Casino Arizona. He gives the maitre d’ at
the restaurant $50 to get a table in the kitchen. After a great run at the blackjack table, as he is getting up to
leave, he gives the dealer chips worth $25 as a token of his appreciation. Does either the maitre d’ or the dealer
have income? Maitre d’ has been given income, disinterested generosity does not exist. Tips are not gifts.
Blackjack dealers do have to include tips even though could be argued that this is disinterested
generosity. Tips are always taxed.
 Randy retires after 40 years on the job. He receives a trip worth $4,000. His employer pays $2,000 of the cost,
and his fellow employees chip in to pay the other $2,000. Does Randy have income and if so how much?
$2,000 from employees, $2000 from employer both treated differently. Look at intention of the gift giver.
102(a) excludes the employee’s gift. 102(c) says that can’t have gift for employee. In 74(a) says that prizes
or awards, can fit under (b) or (c)? Must look at 274(j) to determine what an employee achievement
award is… Is it tangible, personal, property? Trip does not count as a tangible personal property, so
cannot be excluded by 274(j). But we will look further just to see if we could have counted under the other
stipulations.
 § 132(b) – No additional cost service, qualified employee test both have to satisfy the non-discrimination
requirement.
i.
Is it for length of service or safety achievement? No it is not for safety and it is not
for a length of service, instead retirement.
ii.
Is it awarded as part of a meaningful presentation? No.
iii.
Is it awarded under conditions that do not create a significant likelihood of the
payment of disguised compensation?
Identify the risks and present it to your client to determine what they want to do.
C. Bequests, Devises and Inheritances
a. Property under a will or under statutes of descent and distribution are not includible in
gross income. Reg 1.102-1(a)&(b)
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b. If not in will, must look at the context and determine whether there is any legitimate
inheritance. (is it a child receiving money?)
c. Income from such property is includible in gross income
 Consider whether IRC 102 applies in the following circumstances:
State law is going to define what an inheritance is. Why would we want to deviate from state law?
Uniformity, simplicity in one definition, maybe the federal court doesn’t agree with something that the
states allow (gay marriage, extending the benefits of marriage to the tax laws). To prevent the states from
doing something that the federal govt. doesn’t agree with. Can create federal definitions.
o
Father dies intestate (without a will) and daughter inherits $20,000 of real estate by virtue of the intestacy
laws. It is considered an inheritance under §102.
o
Father leaves nothing to his daughter in his will. She challenges the will and settles for $20,000. Similar
to Hoey case, inheritance probably, must look at the context, is there any legitimate inheritance?
Since daughter, probably inheritance. Pursuant to a written contract.
o
Father leaves his daughter $20,000 in his will stating that he does so “in appreciation of her long and
devoted service to him.” Not taxable, question of earning it, being a good daughter is not really
earning. But would want to remove this language from a will to avoid any issues with the IRS.
o
Father leaves his daughter $20,000 in his will pursuant to a written agreement whereby she agreed to take
care of him until his death. Not taxable, this was again an appreciation. But IRS might look like
services for cash, take out this language.
o
Father appoints his daughter executrix and provides in the will that she is to receive $20,000 for such
services. Considered income because she is going to work technically for the money. Do not draft a
will, assuming you are going to leave it anyway and make them the executor. They are subject to
tax in this situation.
o
Father fails to honor his agreement to leave his daughter $20,000 in his will and dies intestate. She sues
and settles for $10,000. Look at the totality of facts, there was no will, so hard to show that this is an
inheritance. Would be considered compensation. Not excluded.
Chapter 4: Employee Benefits
A. Exclusions for Fringe Benefits
1. §132: Fringe Benefits, excludes many non-cash compensations from tax. Includes examples of things
that might be considered fringe benefits.
2. When determining fringe benefits must look at, if no on any question, don’t need to move on:
a. Is there an employer/employee relationship?
b. Are the services offered for sale to customers?
c. Is the employee who receives the benefits the same as the one in which the services are
offered
d. Additional costs incurred?
e. §132 – fringe benefits excludes the following
i. no additional cost services
ii. no substantial cost to employer
iii. for sale in ordinary business
f. Qualified employee discounts:
i. Up to gross profit % - only on sale of goods
o Aggregate sales = 100k
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g.
h.
i.
j.
o Aggregate cost = 60K
o (100-60)/(100) = 40% allowed discount
ii. Must be offered to customer is in the ordinary line of business of the employer in
which the employee is performing services. To the extent that the employee would
have been able to take a 162 trade or business deduction, depends on the employer’s
experience during a representative period.
iii. De minimis fringe (e) – Regs page # 1095
o Property of service the value of which is so small as to make accounting
for it unreasonable or administratively impracticable.
o Look at cost and frequency.
iv. Qualified transportation costs
v. Qualified moving expense reimbursements
vi. Qualified retirement planning services
Retired and family members included as employees under §132(h)
Reciprocal agreements §132(i)
Exclusions for highly compensated employees are only not allowed if the nondiscrimination rules under §132(j) are met.
Discounts on property held for investment are included 132(c)(4)
 Consider to what extent the fringe benefits listed below may be excluded from gross income, supporting
your conclusion with statutory and/or regulatory authority.
o
Susan works for a conglomerate that owns a hotel chain and a shipping business. Susan works for
the shipping business. While on vacation, she stays in one of the hotels owned by her company for
free. The hotel has several empty rooms. Section 132(a)(1) Would be excluded from her income
only if she worked in the hotel line, since she works in the shipping business then included.
o
Susan works for Best Buy. In the prior year, Best Buy has $2,000,000 in sales and a $1,200,000
cost of goods sold. Susan buys a $4,000 TV for $2,000. What does this employee provision
allow employees to do, discount their goods up to the amount of profit they will receive but no
more. Discount cannot exceed gross profit percentage of the property being sold to
customers. “Excess over” means subtraction in the Code. Using 132(c)(2):
To tackle question:
i.
Is there an employer/employee agreement? 132(h), says spouse and dependent
children shall be treated like employee. If no, is there a reciprocal agreement? If no,
include, If yes…move on
ii.
Discount with respect to qualified property or service? 132(c)(4).
iii. Sale to customers? Yes
iv. Line of business? Yes
iv. How much of a discount is allowed? 132(c)(1)
What is the aggregate sales that we use? Over what period? Usually 1 yr.
(AG Sales – Cost) / AG Sales = 40% Use aggregate sales price that is usually offered
to customers.
To determine gross profit percentage: (2,000,000 – 1,200,000) / 2,000,000 = 40% = highest
amount of discount without it being taxable. (4000-2000) / 4000 = 50%, $4,000 *40% = $1,600
Maximum discount allowed. $400 would be considered in gross income.
o
Susan’s company has a bar at corporate headquarters. Every Friday, it provides a happy hour with
free drinks. See IRC 132(a)(4) and TR 1.132-6. It is a de minimus fringe benefit. Difficult to
say, hard to value. Does it count as occasional? Cocktails provided by an employer might be
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too hard to tax, probably wouldn’t be a problem. Could be allowed if the revenue generated
from their operation normally equal or exceeds their operating costs.
o
At Christmas each year, Susan’s company gives each employee a case of scotch. Have to ask
question of what would be a typical Christmas gift. Probably would not be considered a low
value holiday gift under § 132(a)(4).
o
At Christmas each year, Susan’s company gives each employee two tickets to Harkins Theaters.
Have to ask question of what would be a typical Christmas gift. Is this hard to value, that is a
clue to if it is a fringe benefit. Probably would be considered a low value holiday gifts under
Section 132(a)(4). 1.132-6 occasional tickets to a show is an example of what is excluded in
the regulations. Don’t just stop with the statute since the regulations allow it.
o
At Christmas each year, Susan’s company gives each employee a gift certificate for $20 good at
Harkin’s Theaters. Would this be considered cash and not acceptable under Section 132(a)(4)?
No real difference from last question, but this is not hard to value or difficult to keep track of.
Gift certificates are same as cash, if it looks like cash it will be includable in income. 1.132-6
says that gift certificates are never excludable.
Chapter 6: Gain From Dealings in Property
A. Factors in the Determination of Gain
1. §1001(a): Computation of Gain or Loss. G = AR – AB, L = B – AR
o AR = sum of any money received plus FMV of any property received
i. When a TP disposes of property in exchange for services, there is an AR equal to the
FMV of the services – International Freighting
o B = B under §1012, adjusted by §1016
i. Goes against §1012 logic but must be to prevent artificial loss
ii. §1016 add to basis if improvement is not deductible
2. §1001(b): amount realized from the sale shall be the sum received plus the FMV of the property
received.
3. §1001(c): unless there is a non-recognition provision, have to recognize the entire amount of the gain
or loss.
4. Must be realization event, usually the sale of property. Don’t want to force people to sell because of
liquidity problems.
5. Part Gift/part sale: the transferor has a gain to the extent that the amount realized by him exceeds his
adjusted basis in the property, no loss is sustained on such transaction.
6. A taxpayer who sells property encumbered by a non-recourse mortgage must include the unpaid
balance of the mortgage in the computation of the amount realized on the sale – Crane.
a. When a party transfer property encumbered by a non-recourse mortgage with an
unpaid balance that exceeds the FMV of the property, the transferor has realized
an amount equal to the unpaid mortgage balance – Tufts.
Cottage Savings v. Commissioner: two banks trading portfolios. Had to look at regulations to determine if this is a
realization. The Court found that there is really a low threshold, didn’t have to be very different to be a “material
difference” according to the court. Rule: Any difference in the two portfolios will trigger a realization event.
Government lost this case, but really happy about it because they will also have taxation on gains as well as the
losses.
B. Determination of Basis
1. §1012, 1014, 1015, 1041
2. Basis = cost of the property §1012
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3. Acquired from a decedent
a. B = FMV of the property at the date of the decedent’s death §1014
b. If it is within 1 year then the receive keeps his original basis.
4. Acquired by gift or transfer
a. B = the same as it would be in the hands of the donor or the last preceding owner by
whom it was not acquired as a gift §1015
b. Except if the B is greater than the FMV of the property at the time of the gift, then B will
be such FMV §1015
5. Part gift/part sale: the unadjusted basis of the property in the hands of the transferee is the sum of
which ever is greater:
a. The amount paid by the transferor, or
b. The transferor’s adjusted B for the property at the time of the transfer
6. Acquired by gift in marriage or incident to divorce §1041
a. No gain or loss shall be recognized on a transfer of property from an individual to a
spouse or a former spouse incident to divorce.
b. Property shall be treated as a gift and the B of the transferee shall be the adjusted B of
the transferor
c. Only pertains to transfer of property, not services
d. Must be within one year of divorce
7. Include options and attorneys fees (cost of acquiring the property) in basis.
8. In barter transaction in exchange for property, basis is FMV of what is received, not what you paid.
Philadelphia Parker: Page 116 – 118 in book
9. Include improvement costs in determination of basis on piece of property (capital improvements).
§1016
10. When determining basis and including mortgage loans:
a. Recourse debt: means you can go after them personally. Banks sometimes insist on
recourse loans because there is not enough security, high risk, or think it may go down.
i. include the entire value of the loan in basis, even if the loan exceeds the FMV of
the property (can recover the property and go after other assets)
b. Non-recourse debt: can only go after the value of the property. Most home mortgages
use this kind of debt.
i. exclude the entire value of the loan when determining basis IF it exceeds the
FMV of the property.
11. When valid sale exists between family members, will be treated as a gift rather than a sale because of
their relationship.
 Oscar buys a farm. What are the tax consequences of the following transactions:
Always write out the equation when you have a property sale G = AR - AB
o
o
o
He pays $150,000 for the farm and later sells it for $210,000. Basis is $150,000, so
$60,000 of Gains
What if instead of paying $150,000 for the farm, Oscar bought an option for $50,000 to
purchase the farm for $100,000. He later exercised his option and paid and additional
$100,000? Basis is $150,000, includes option because it is part of the cost of the
property. Would be paying far too much in taxes if we didn’t include the option
price, $60,000 in gains, just like (A).
What if instead of an option, Oscar paid $50,000 in attorneys’ fees to complete the deal, in
addition to the $100,000 paid to the seller? $150,000 basis can include attorney’s fees
because it cost him that to purchase the land (tax logic tells you that he is paying too
much in taxes if you exclude this amount of money from basis) critical component is
that it is money expended related to the purchase of the property, it is considered an
acquisition cost, not included in the statute technically based more on common law.
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o
o
o
o
o
Section 1016 covers adjustment to basis (not applicable for this question, whereas this
is considered cost from the statute, and common law defines cost as the acquisition
costs. $60,000 in gains
What if Oscar pays $50,000 for the option and then sells the option to another for $75,000?
Basis is $50,000, AR = $75,000 = $25,000 of gains. Option is property in and of itself
since there was no property ever purchased,
What happens if Oscar pays $150,000 for the farm and then improves it by spending
$20,000. He then sells for $200,000. AR = $200,000 AB = $170,000, GI = $30,000
Initial basis was $150,000 but did improvements to the land of $20,000. Expenses are
currently deductible, capital account is an investment recorded not in expenses, but in
an account where investments are recorded in an accounting sense. Permanent
improvements build up the basis in the property. Type of expenditure fits under Sec.
1016.
What if Oscar received the farm when it was worth $100,000 as a bonus for work done,
and his income tax was increased by $40,000 as a result. He then sells it for $200,000?
Employer gives him land worth $100,000 which he pays $40,000 in tax on. Then
purchases the land for $100,000. It is as if he got paid in cash and then bought the
land. After tax investment in the land is $100,000 AR = $200,000, Basis is $100,000 =
$100,000 included in gross income
A capital expenditure is any cost incurred regarding tangible property or assets that are to
acquire, produce, improve, or dispose of the assets; to determine whether it is capital
expenditure or an expense, if it is to keep property in operating condition and to enable the
taxpayer to use it for its’ expected useful like and purpose, then it is an expense. If it is
used to extend or prolong the useful life, or increase the property value, or adapt the
property for a different purpose, then it is a capital expenditure. § 1-263
A capital expenditure is a cost that creates more than an insignificant future benefit
to the taxpayer.
 What is Oscar’s basis in the farm if the farm has a FMV of $150,000 and:
o
o
o
o
He pays $50,000 in cash and borrows $100,000 on a recourse basis?$150,000 is the basis.
Debt is considered in the value of the money we have paid.
He pays $50,000 in cash and borrows $100,000 on a non-recourse basis? We treat nonrecourse debt just as if it was a recourse debt, even though there is no consequence to us
personally. Still would have $150,000 as the basis.
He pays $50,000 in cash and borrows $150,000 on a recourse basis? Even though you are
getting money over the FMV of the property because it is a recourse loan and can come
after you for the money that is owed.
He pays $50,000 in cash and borrows $150,000 on a non-recourse basis? See Estate of
Franklin Only thing the lender can do is seize the loan. Most lenders will not lend the
money over the FMV of the property because there is no recourse of the total money that
he leant. We sometimes see this where the seller is also the lender.
Estate of Franklin: If you're borrowing something on a non-recourse basis that is significantly more than the
value of the property, the whole loan is excluded. If the value of the property drops at ALL, the lender loses.
They can't go after you because it's NR. He will never be able to recover the full amount. The basis here is only
50K. Nothing from the NR loan is included. **if at the time of purchase you borrow on a NR basis, and it is
significantly more than the value of the property, we will exclude the entire amount of the loan from the basis.
e. Assuming you didn’t get the same answer for the foregoing 4 questions, what policy reason exists for the
difference? Rule in ESTATE OF FRANKLIN = **if at the time of purchase you borrow on a NR
basis, is significantly more than the value of the property, we will exclude the entire amount of the
loan from the basis. Cruden(??) abandonment rule - a rational person would not pay off the loan.
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C. Property Acquired by Gift
1. §1015(a): Must derive from detached and disinterested party. Will be excluded from income. The
giving of the gift is not a realization event. Rule is that the B (donee) = B (donor) with exception for
when AB > FMV, then B = FMV at time of transfer.
2. The giving of a gift is not a realization event.
 Dan purchased some land for investment for $40,000. When it was worth $60,000, he gave it to George as a
present. Dan incurred no gift tax as a result of this gift. What are the tax consequences if George later sells the
land for:
o
o
o
$70,000 AB = $40,000 AR = $70,000 G = $30,000, general rule applies
$30,000 AB = $40,000 AR = $30,000 L = $10,000, general rule applies
$50,000 AB = $40,000 AR = $50,000 G = $10,000, general rule applies
 Bill purchased some land for investment for $40,000. When it was worth $30,000, he gave it to Anne as a
present. Bill incurred no gift tax as a result of this gift. What are the tax consequences if Anne later sells the
land for:
o
o
o
o
$70,000 AB = $40,000 AR = $70,000 G = $30,000
$20,000 AB = $30,000 (FMV because less than basis) AR = $20,000 L = $10,000
$35,000 AB = $40,000 AR = $35,000 G = $0,Try and calculate a gain and a loss: G = $35,000 $40,000 = 0, L = $30,000 - $35,000 = 0 because if use FMV at time of gift is $30,000, less than
Bill’s basis. So if determining for a loss use $30,000, if determining for gain use $40,000, so
tax neutral. No gain or loss on this transaction. Only able to take the loss that is in your
hands. Never transfer depreciated property because you will destroy the loss, unless you have
some other non-tax reason.
First, apply the gain rule and give the donee the same basis as the donor. If this produces a gain,
you’re finished. If that calculation does not provide a gain, give the donee a basis equal to the fair
market value at the time of transfer. The donee realizes the amount of loss that results from that
calculation. If the gain rule does not produce a gain, and if the loss rule does not produce a loss,
the donee has neither a gain nor loss. This is a split-basis problem.
 Susan purchases a car for her business for $20,000. When it is worth $15,000, she sells it to her daughter Alice
for $15,000. Alice uses the car in her business so long that it becomes a classic and goes up in value to $30,000,
when she sells it to some third party for that amount. What are the tax consequences to Susan and Alice? Alice:
AB = $15,000 AR = $30,000 G = $15,000, but because of relationship would use the basis of $20,000
instead. So G = $10,000 Susan: AB = $20,000 AR = $15,000 L = $5,000, but disallowing the $5,000 loss
because of the relationship between Susan and Alice.
 When Alice sells as a gain, shall be recognized only to the extent that it exceeds the basis from the original
seller with the relationship.
 Sham transaction to family members in order to generate a loss. Must look to Section 267(b) complicated
rules for family members or any other people not covered in one of the relationships in the section.
D. Property Acquired Between Spouses or Incident to Divorce
1. §1041: passes the basis of the spouse, not elective. No gain or loss should be recognized to an
individual for the benefit of the former spouse.
E. Property Acquired from a Decedent
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1. §1014: property acquired from a decedent generally receives a basis equal to its FMV on the date on
which it was valued for tax purposes.
F. The Amount Realized
1. Amount realized: Section 1001(b) = Cash + FMV of the Property, statute doesn’t specify that services
aren’t included in the amount realized.
2. In a quitclaim deed to the bank after mortgage foreclosure, to determine amount realized:
a. Of non-recourse debt use FMV of the property at the time the property is used to satisfy the debt
(considered a sale or disposition).
b. For recourse debt use face value of the non recourse debt. Amount will never be taxed because the
person will never have to pay the remaining balance due on the loan, this is the way that the IRS
can tax the individual for the amount that he did not have to pay. Tufts v. Commissioner. Justice
O’Connor in that case wrote a that said that should still calculate using the fair market value, but
then the amount that is never recorded could be taxes somewhere else (cancellation of
indebtedness). Really a legal fiction, same result.
3. When make a sale to a spouse, their basis transfers §1041.
International Freighting: court saying that services should be included in amount realized.
 John buys property for $100,000, paying $20,000 cash and borrowing $80,000 on a recourse basis. The
property appreciates to $130,000. Brandy buys the land from John for $50,000 cash and assumes the $80,000
loan. What is John’s gain on sale and Brandy’s basis in the property? John’s Gain: AR – AB = ($50,000
+$80,000) – ($20,000 + $80,000) = $30,000 Include recourse debt in basis. Brandy’s Basis: ($50,000 +
$80,000) = $130,000 Use Section 1012, when assume debt as part of a transaction it is like you paid that
even if that money didn’t exchange hands. (never include interest in basis, interest is the cost of
borrowing money, not of the property itself)
 Marty buys land from Sam for $100,000. He borrows $80,000 from a bank on a non-recourse basis and uses
$20,000 of his own money.
o
What is Marty’s cost basis? AB = ($20,000 + $80,000) = $100,000, Include the loan even though it is
a non-recourse basis, ***only exception is the Estate of Franklin case where if at the time of
purchase you borrow on a NR basis, is significantly more than the value of the property, we will
exclude the entire amount of the loan from the basis.
o
Two years later, the land is worth $300,000. Marty has paid interest only on original loan. He takes
out a second loan from the bank for $100,000 on a non-recourse basis. Does he have income on taking
out the loan? No income from the loan because he has debt associated with it. When you borrow
money there is not a realization event.
o
What affect, if any, does the second loan have on Marty’s basis in the land? No, unless he makes
improvements to the house, after purchase loans are not automatically included in basis. §1016
tells us when we make adjustments to basis.
o
What is Marty’s basis if the proceeds of the second loan are used to improve the land? Basis is
$200,000, because § Section 1016 it depends on what is done with the loan. Since he is putting it
back into the house the basis is adjusted.
o
What if Marty takes the loan proceeds from the second loan and invests in stocks or goes to Vegas?
Not included because didn’t go back into the value of the house.
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Crane v. Commissioner: (p. 137) § 1014 says that basis includes the amount of the debt. Court also concerned
with depreciation. All the depreciation rules are keyed off the value of the property. If it is excluded at the time of
purchase then you exclude later.
o
What is the result if Marty sells the property when the basis is $100K, the FMV is $300,000, and the
outstanding loans equal $180,000? Assume that Marty receives $120,000 of cash and the property
transfers subject to the two loans. Taxed on $200,000 because the loans transfer so the amount
above would be considered gain. Purchaser’s basis will be $300,000 because paid $120,000 in
cash and the debt of $180,000.
o
Assume that in (f), Marty sold the land to his wife. What would the tax consequences be? See
IRC §1041.The basis would transfer to the wife.
o
What would the result be if the basis were $100,000, the land declined in value from $300K to $180,000
and then Marty transfers the land by quitclaim deed back to the bank? Is this a sale or other
disposition? Treats this as a sale or disposition, so gain or loss will be calculated. But what is the
amount realized? AB = $100,000, AR = $180,000 Gain is $80,000.
o
What if in (h) the land is worth $170,000 when the quitclaim deed is made? Question is whether the
amount realized should be the amount realized of the notes that are forgiven in exchange for the
property, or the value of the property? Would never pay any more than $170,000 for this
transaction, but forget this. Value of debt is $170,000. Most you will receive is $180,000, it as if
$10,000 that you were supposed to pay back has never been taxed. Commissioner v. Tufts case says
that would just get taxed on the amount of the notes, Justice O’Connor’s concurrence says that
instead of just assuming the FMV, calculate the gain $170K – 100K taxed at one rate, the other
cancellation indebtedness of $10K is taxed somewhere else. But in a non-recourse debt you are not
really liable for the $10K, so Justice O’Connor’s view is legal fiction, relieved of debt even when
you haven’t been. Here, use the face value of the debt in non-recourse debt to determine gain
o
What if in (h) the loans were recourse loans? $70,000 gain. By definition relieved of debt of $10,000.
G. Part Gift/Part Sale
Lindsey buys property at $75,000, transfers to John for $100,000. At the date of transfer, the FMV
is $150,000. This is a part gift/part sale problem because Lindsey transferred the property at a
value below FMW.
Before looking at transferee’s basis, must examine the tax consequences to transferor. The basic rule is
the transferor will never recognize a loss, but they can have a gain! If the transferor’s basis is less than
the FMV of the property, and if the transferee pays more than the basis, they recognize a gain.
Lindsey - AR = $100,000 less AB = $75,000 equals a GAIN of $25,000
John – The basis is going to be the greater amount of (1) the amount paid to Lindsey, or (2) Lindsey’s
adjusted basis. John’s basis is $100,000 in this example.
Lindsey buys property $100,000 transfer to John for $75,000, FMV of $150,000
Lindsey – AR $75,000, less Basis of $100,000, loss of $25,000 will be disallowed under Reg. 1001-1(e).
So there is no gain or loss, but a gift has been made to John. Gift = FMV – Amount Paid (AR)…
$150,000 (FMV) less $75,000 (Amount Paid by John) = Amount Realized of $75,000
John – Paid $75,000, but basis is $100,000 because it is the greater amount of what I paid or the
transferor’s basis.
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Look at Reg 1001 – 1(e) on page 1501… crucial statement
Chapter 7: Life Insurance Proceeds and Annuities
A. Life Insurance Proceeds
1. §101(a): gross income does not include amounts received under a life insurance contract, if such amts are
paid by reason of death of insured.
a. Term insurance: protection for a certain amount of time, usually 1 year
b. Whole life: protects for the life of the insured
2. Transfer of policy for valuable consideration – amount excluded shall not exceed an amount equal to the sum
of the actual value of the consideration and any additional premiums paid
3. Interest earned on the policy is included in GI
4. If the insurer keeps the money and pays the beneficiary over time, the increased money will be taxed §101(d)
5. If the payment occur during the life of the insured and are accompanied by a terminal illness or chronic
illness, the payments can still be excluded.
B. Annuities §72:
1. GI does not include the part of any amount received which bears the same ratio to such amount as the
investment in the K bears to the expected return under the K.
a. GI does not include the return of capital, limited to investment
b. If the payments cease by reason of death before there is an unrecovered investment in the K,
that value will be a deduction to the annuitant for his last taxable year
2. Amount include/exclude
a. Investment/aggregate payments during anticipated lifetime = exclusion factor
i. 100K investment / 140K (28 years x 5k) = 5/7
ii. 5K a month would be $3,570 of return of capital and 1.430 of taxable interest.
 Ira dies owning an insurance policy that would pay Ben, his beneficiary, $200,000. Ben had several options
in how he could receive this money.
o
What is the tax result if Ben takes it all in the current year? The entire amount (200K) is excluded
from gross income by § 101(a)(1) because the amounts are paid in response to the Ira’s death. If
you were to invest this money you would be taxed on the income that it generates.
o
What if Ben decides to leave it with the insurance company, and the insurance company agrees to pay
him $20,000 of interest per year until he opts to collect the full $200,000? Interest would be taxable
because it is not included in the § 101(a) exclusion (according to (c)). When Ben opts to collect
the 200K, that will be tax free. Leant the money like it is a savings account.
o
What if Ben leaves it with the ins co. and arranges to receive $24,000/year for the rest of his life? His
life expectancy is 25 years.101(d)(1) difference between that code and (c). 101-3-a from regs: d is
meant to cover an annuity. Out of every payment 1.3 is not taxable because you do the
calculation of $200K / $600 K = 1/3. ($600K = $24K * 25 years) If he’s paid $24K per year and
$8k of it is excludable, then $16,000 must be included and taxed as income. (interest portion)
This is bc § 101(d) has an exception that applies when the life insurance proceeds are paid in an
annuity form over a period of years.
o
How are the payments taxed if Ben outlives his life expectancy? According to Reg. § 1.101-4(c), Ben
would continue to exclude the prorated amount (from C) from taxable income. Ben would still
have $16,000 of taxable income each year.
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 Jack agrees to play football for the Cardinals. The Cardinals acquire a $1M life insurance policy on Jack’s
life. What happens if Jack dies where:
o
The Cardinals took out a 2 year policy and paid $20,000 for it? § 101(a)(1) says that any amount the
Cardinals receive on this policy would be excludable from gross income. (you must have an
insurable interest in someone to purchase a policy on their life)
o
Jack owned the policy and sold it to the Cardinals for $20,000?According to § 101(a)(2), any
proceeds received from the policy over the consideration paid ($20K) is taxable income. (neither
of the exceptions in 102(a)(2)(A) or (B) are applicable here) supporting reasons seem somewhat
elusive here – possibly an incidental effect of an effort to discourage trafficking of insurance
policies. The tax planning answer is obvious: a new policy, not a purchase of an old policy.
o
Suppose Jack is a shareholder in the Cardinals? The § 102(a)(2)(B) exception is triggered and the
proceeds are excluded from the Cardinals gross income.
 Irene purchases an insurance policy for $100,000 and pays $40,000. What happens in each of the following
situations?
o
Irene sells the policy to her child for $60,000, and when Irene dies her child collects $100,000.When
Irene sells the policy to her child, Irene recognizes a $20K gain. (there is no § 101(a)(1) exception
here bc the amount is not paid by reason of Irene’s death) When Irene dies, the child has $40K
of income ($100K-$60K). If this had been a gift to the child or a partial sale to the child, the
proceeds would be excluded by § 101(a)(2)(A).
o
Irene sells the policy to her husband for $60,000, and when Irene dies her husband receives $100,000. §
1041 says that in this situation basis would transfer between spouses. Her husband would have a
$40K basis and Irene would not have income from the transaction. When Irene dies, her husband
has no taxable income on the $100K policy. (§ 101(a)(2)(A) exception applies and therefore §
101(a)(1) applies)
o
Irene is terminally ill and sells her rights to a Viatical Settlement Provider for $80,000.Sale to a
viatical settlement provider is addressed under § 101(g)(1)(g) and (1)(A). If it is paid by reason of
Irene’s death her $40K gain on the sale is excluded under § 101(a)(1). When the settlement
provider collects the $100K of proceeds upon Irene’s death, it will have $20K of taxable income.
($100K-$80K) (according to § 101(a)(2))
Chapter 10: Separation and Divorce
A. Alimony and Separate Maintenance Payments
1. §71: Gross income includes amounts received as alimony or separate maintenance payments.
o Cash (checks, money order payable on demand) or payments to third party on behalf of
spouse.
o Under divorce decree or separation incident
o Not designated as “not alimony”
o Not members of the same household
o No liability to make any such payments for any period after death of the payee spouse
i. Voids all payments before and after death
o Not child support
i. Look to amount that stops at age 18, or other date within 6 months of 18 b-day
ii. Take out CS before alimony
o No joint return filed.
2. §215: Alimony paid for by an individual can be deducted.
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3. Questions to ask:
o Is it a cash payment? Should be yes to be alimony
o Is it received by spouse (or on behalf of spouse)? Should be yes to be alimony
o Received in a separation instrument? Should be yes to be alimony
o Are they living together? Should be no to be alimony
o Is there liability after death? Should be no to be alimony
4. Annuities:
o GI includes any amount received as an annuity under an annuity, endowment, or life
insurance contract.
i. The amount excluded shall not exceed the unrecovered investment in the contract.
ii. Any amount of the initial investment that is unrecovered at the time of the annuitant
death will be shown as a deduction on the annuitants final taxable year.
 Determine whether the following are properly alimony so as to be includible as income to the recipient
under IRC 71 and deductible for the payor under IRC 215? Unless otherwise stated, Andrew and Felice are
divorced and payments are called for in a divorce decree.
o
The decree directs Andrew to pay Felice $10,000/year for her life, or until she remarries. Andrew
pays $10,000 this year. Includable and deductible because follows all questions from above.
Yes, yes, yes, no, no.
o
Same as (A), but Andrew issues a promissory note to Felice instead of cash. Neither, because not
cash. 71(b)(1) Would manipulate the rules with a promise to pay and then could not pay,
would be getting a deduction without having paid. Transferring art would be the same as a
promissory note, because really just splitting the property.
o
Same as (A), but the divorce decree provides that payments are not income to Felice and not
deductible by Andrew. Neither because of 71(b)(1)(b). Don’t have to say that this is alimony. If
the deduction doesn’t help or parties are in the same tax bracket, may not want to do this.
o
Same as (A), but the divorce decree requires Andrew to make payments for 10 years. 71(b)(1)(d)
not going to count as alimony if don’t say something about ending after death.
o
Same as (D), but under local law Andrew does not have to continue payments after Felice’s death.
Statutory and then it would be includable and deductible. Made this the default rule in many
states, because this would allow it to be alimony.
o
Same as (A), but Andrew must pay $25,000/year. The decree requires that Andrew pay $10,000
for 10 years or until F dies, whichever occurs sooner. He must also pay $15,000 to Felice or her
estate for 10 years. Andrew pays $25,000. $10,000 because payments made to maintain
property for payee spouse will qualify as alimony only if there is some specification that the
estate payments would end at death. Since this one doesn’t pertain to that exception, only the
$10,000 is alimony since ends at death. 1.71-1T A-6
B. Property Settlements
1. § 1041(c): incident to divorce if it occurs within one year after the date on which the marriage
ceases or is related to the cessation of the marriage.
2. Questions to look at:
a. Is it within 1 year? To be incident to divorce must be yes, basis transfers in this situation.
b. Is it related to cessation?
c. It is contained in the divorce decree?
d. Is it within 6 years? If it is more than 6 years out then IRS will assume that it has nothing to do
with cessation of marriage. Only a presumption, can be rebutted.
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 Morris and Lucy get divorced. What are the tax consequences of the following transactions?
o
In Year 1, as required under the decree, Morris transfers land with a $100,000 basis and FMV of
$500,000 to Lucy. Lucy sells the land that year for $600,000.AR = $600,000 AB = $100,000 G =
$500,000 1041(c) incident to divorce if it occurs within 1 year or if it is related to the
cessation of marriage. No realization, basis transfers.
o
Same as (A), but Morris owes Lucy money, and the property is transferred to satisfy the debt. The
land has $500,000 basis and a FMV of $400,000. Lucy sells the land later for $350,000.AR =
$350,000 AB = $500,000 L = $150,000. Since it happens within 1 year of divorce it
overextends, even if it has nothing to do with the divorce. Morris loses his loss by transferring
this in the first year after divorce. If audited would have to show that this has nothing to do
with the dissolution of the marriage in order to take this.
o
What if the and in (A) were transferred in Year 4? If in year 4, out of brightline test, must figure
out if this is related to the cessation of marriage. Look at regs 1.1041-1T
o
Same as (C), but transfer is required by a written instrument incident to a divorce decree. Yes, if
within the time period.
o
Same as (C), but the transfer occurs in Year 7. Not transfer for alimony, traditional tax rules
apply. Would have to rebut the presumption. The IRS recognizes that there are some
circumstances that might take longer than 6 years so would have to prove that. Same, have 6
years to transfer.
C. Other Tax Aspects of Divorce
1. Child support
a. §71(b)(1)(D)(c): People trying to show that things are not child support, presumption
that something is support at the time that the child turns 18, etc. IRS may come in and
challenge whether or not something really is child support.
 Sean and Mary enter into a written support agreement that is incorporated into a divorce decree. They have 1
kid in Mary’s custody. What are the tax consequences of the following?
o
Sean must pay Mary $10,000/year and $4,000 is identified as child support. Sean can deduct
$6,000, Mary recognizes $6,000 as gross income
o
Sean must pay Mary $10,000/year. When their child is 21, marries or dies, the amount is reduced
to $6,000/year. Sean can deduct $6,000, Mary recognizes $6,000 as income
o
Sean must pay Mary $10,000/year, but the amount reduces to $8,000 in 2008, and $5,000 in 2012.
Sean and Mary have 2 kids. David was born on 7/17/90 and Sarah was born on 3/5/93. David = 18
in 2008, Sarah = 18 is 2012. In 2008, Sean and Mary deduct/include $5,000 in 2008 - 2012 and
$5,000 afterwards.
o
What if in (A) Sean pays Mary only $5,000 of the $10,000 obligation? IRS makes you pay child
support first before you pay any alimony.
Chapter 9: Damages and Related Receipts
A. Introduction
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1. Any damages received in a suit that are meant to replace an amount that would have been taxed
had the issue in the suit not occurred will be taxed as part of the TP’s GI.
a. Compensation for the loss of good will in excess of its cost is GI – Raytheon
i. Damages are taxable if they are in lieu of something that is also taxable
ii. What type of damages are being recovered?
iii. What are the damages attributable to?
1. Is there a gain or loss if for property?
2. Is it for lost profits?
2. Compensation for injury §104
a. GI does not include any payments received as damages on account of personal physical
injury or sickness §104(a)(2)
1. This includes any injury that is related to the physical injury (i.e. emotional distress
that was brought on by the injury).
2. Would include lost profits that were attributable to a physical injury.
3. Does not include punitive damages or other injuries not physical in nature.
b. Shouldn’t buy an annuity with the proceeds from a trial (amount would be taxable),
should have the defendant pay for an annuity and have the payments directed at the
plaintiff, that would be excludable.
Important things to note:
 As a plaintiff want to structure complaint so you can get tax-free recovery. Complaint is going to be
very important in this regard.
 IRS will look at the complaint to determine what kind of damages they will receive. If the complaint
says that all of the damages are non-physical, then different.
 If the complaint says it is about lost profits (unless for physical injury), then taxable. If plaintiff,
need to think about tax issues in the complaint so you can characterize the settlement that will give
the best tax result.
 If replacing something that is taxable then would be taxable as damages.
 Punitive damages are an exception, taxable even if they are not replacing something that would be
taxable
Raytheon Production Corp. v. Commissioner: RCA did something to destroy their business, anti-trust law suit.
Wipes out Raytheon’s unit, recovered for anti-trust violation. Rule: Goodwill has no basis. Basis is functionally
$0, so you will have to pay tax on the entire gain, paying tax on the entire amount that you get for the company, but
is considered capital gain. Taxpayer actually wins the big fight because it was not deemed lost profits, but whole
amount is taxable because goodwill has no basis. Treated as capital gain and not capital asset.
 Plaintiff brought suit and, unless otherwise indicated, successfully recovered. Discuss the tax consequences
of the following alternate situations:
o
Plaintiff sued to recover an $8,000 loan he had made to Defendant. He recovered $8,500, or which
$8,000 is for the loan amount and $500 is for interest he was owed. $500 would be taxable, $8,000
represent a return of capital. Would have been taxed if interest was paid to him.
o
What would the result in (A) be if Defendant transferred land worth $8,500, with a basis of 2K, in
satisfaction of the judgment. Defendant would have to pay tax on $6.5K. Plaintiff would have
$8K not subject to tax but the $500 would have been interest so that would have been subject
to tax. Basis for the property for the plaintiff will be $8.5K, basically what he paid for the
property. Why is this a realization event from the defendant’s stand point? If they didn’t tax
this, then no one would buy things, would just transfer property. Any time you satisfy a debt
with a piece of property there is always a realization event.
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o
Plaintiff’s suit was based on a breach of contract and tortuous interference with contract. He recovers
$8,000 for lost profits, as well as $16,000 in punitive damages. Plaintiffs would have to pay tax on
both.
Section 104(a)(2): stops the courts from deciding personal injuries on a case by base basis. Exclude damages resulting
from personal injury. Many cases trying to decide what would constitute a personal injury.
Plaintiff brought suit and successfully recovered in the following situations. Discuss the tax consequences to Plaintiff.
o
Plaintiff is a professional gymnast. She was injured in a car crash and lost the use of her leg. She
was awarded $100,000 in damages. Because it is a personal injury it would be tax free. If the
jury says that half of this is lost profits from being a gymnast, then 104(a) kicks in, still
includes lost profits, any damages, not matter what they represent are going to be tax free.
o
The same as (A), but the defendant is required to transfer to her land worth $100,000. The land
had a basis of $75,000 in the hands of the defendant. The P’s basis would be $100,000 b/c there
is a realization event and so the basis has to be $100,000.
o
In (B), what basis, if any, does plaintiff have in the land and why? She would have a $100,000
basis.
o
The same as (A), but $50,000 of the damage award is allocated as compensation for scheduled
performances plaintiff was unable to make as a result of the injury. Doesn’t matter as long as it is
related to personal injury recovery. Entire amount is excludable
o
Same as (A), but the jury also awards plaintiff $200,000 in punitive damages. $100K is excluded
and $200K is included
o
Same as (A), but the jury also awards plaintiff $200,000 for suicidal tendencies she has had
resulting from the accident. All excludable.
o
Plaintiff had an unusually squeaky voice. One fan of a competitor followed her around the country
making fun of her just before she performed. Plaintiff suffered from anxiety and stress as a result
and sued. She recovered $100,000. $100K would be taxable less any medical bills.
o
Plaintiff sues her coach for sexual harassment and recovers $200,000. $200K is taxable, unless
there are medical bills from some type of medical bills.
 Rebecca has as 20-year life expectancy. She recovers $1 million in a personal injury suit. What are tax
consequences if: (Do not solve the equation for annuities, simply discuss the tax consequences generally)
o
She takes $1 million and invests it at 5%? The interest will be considered income, and the
personal injury recovery (principal) will be excludable.
o
She takes $1 million and buys herself an annuity that pays her $100,000/year? Annuity payments
are not excludable, the lump sum was. When she buys the annuity some portion of that
payment is interest, so will have to calculate what that is to determine what is taxable and
what is excluded.
o
The defendant agrees to pay her $100,000/year? She gets this tax free, even if she is getting the
same as the annuity would pay her. She is getting more, but it is still excludable under (a)(2).
Defendant can buy the annuity for $100K and then can put the plaintiff as the recipient, 104
(a)(2) trumps the annuity rules. Have the other side buy your client an annuity because then
will get tax free.
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o
The defendant buys himself an annuity and then transfers payments to her? Would be taxable to
the defendant, would not be smart on his part because would still have to transfer the $100K
but would be receiving less than that amount after taxes.
o
The defendant buys an annuity that pays directly to Rebecca? Would not be taxable to the
recipient. Structured settlement. Can get a lot more money for client if it is done this way.
Chapter 11: Other Exclusions from Gross Income
A. Gain from the Sale of a Principle Residence
1. §121: gross income should not include gain or sale from property if such property is used as
principal residence for periods aggregating 2 years or more (in 5 year period).
a. Must be the principal residence
b. Can only apply to one sale by the taxpayer in the two year period.
c. Amount of the gain cannot exceed $250,000 for single person, or $500,000 for married
filing jointly. §121(b)
d. Must deduct the amount of depreciation taken on the property from the amount able to
be excluded.
2. Exceptions:
a. If don’t meet requirements for the subsection, use the amount which bears the ratio to
such limitations, use the shorter of (when compared to two years)
i. The aggregate periods, during the 5-year period ending on the date of such sale
or exchange, such property has been owned and used by the taxpayer as the
principal residence, or
ii. The period after the date of the most recent sale by the taxpayer to which
§121(a) applied and before the date of such sale bears to
b. If doesn’t meet time requirement but sale is made by reason of a change in place of
employment, health, or to the extent provided in the regulations, unforeseen
circumstances. §121(c)(2)(b). Use the calculation above to determine what the
maximum allowed would be to exclude.
Old rule: not the current law. When you sold a house you collected the money and the equation would be G = AR
– AB. Ended up having to buy a smaller house because you had to pay tax on the appreciated gain. If you roll the
proceeds into the next house then you wouldn’t have to recognize the gain. What do you do with basis then? If the
basis becomes the cost of the new house, then the gain will never be taxed. Gave one time exception that as soon as
you reached 55 you could sell your house and have a exclusion for gain. There was a phenomenon that they were
locked in and couldn’t sell house until after 55.
New Rule: intended consequences are that people can flip their primary residence in two years and not be taxed on
any gain.
 Determine the amount of gain that the taxpayers (a married couple filing a joint return) must include in
gross income under the following situations
o
They purchase a house for $200,000 and live in it. Several years later, they sell it for $600,000.
How much is the gain? $400,000. Is it longer than two years? Yes; Principal residence? Yes;
$500,000 is excludable since they are filing jointly since they met the requirements.
o
Same as (A), but they take the $600,000 and buy another house. Two and a half years later, they
sell that second house for $1 million? Is the second house held longer than 2 years? Yes;
Principal residence? Yes; Then they can exclude up to $500,000 since filing jointly. No carry
over basis.
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o
Same as (B), but the sale of the second house is only 1.5 years after the purchase? Is the second
house held longer than 2 years? No; Do they come under the exception of a taxpayer who
does not meet requirements by reason of a change of employment, health or unforeseen
circumstances? No, so $400,000 of gain would be taxable.
o
What would the result in (B) be if the taxpayers sold their first residence under the old IRC 1034
and second residence under the new rule? Buys a house that costs $600,000. In old rule basis
from first house would roll over of $200,000 and they would have a $300,000 gain to pay tax
on. G = AR – AB, $1M – 200K = $800K and can exclude $500K.
o
What if in (A) the residence was the taxpayers’ summer home, which they used 3 months a year?
See TR 1.121-1(b)(2).Would not be considered the principal place of residence because
principal place of residence would be considered the property that the taxpayer used a
majority of the time during the year.
o
What if the taxpayer met the ownership and use requirements and was single, instead of married.
He purchased the property for $200,000 in 1998. He then took $10,000 of depreciation on the
house because he had a home office. This reduced the basis to $190,000. He then sells the house
in 2001 for $400,000. See TR 121-1(d) and –1(e)(4), Ex. 5. Reduces the basis to $190,000.
$400,000 - $190,000 = $210,000. Total gain would be $200,000, all excludable. The $10,000
that was depreciation would not be able to be excluded. Subsection (a) would not apply, do
not get to exclude. If you took any amount of depreciation, then any amount of gain up to the
amount of gain that does not include depreciation cannot be excluded. Had the tax benefit
before when deducted depreciation.
 Joan is single. She bought a residence for $500,000. A year later, she is transferred to a new job in a new city.
She sells the residence for $600,000.
o
How much gain on the sale, if any, must she report? G = $600K - $500 = $100K. Gain can be
excluded under 121(c). Can exclude half of the $250K because she was there for 1 year and
had the exemption for change of job. X / 2 = Y / $250K. 1/2 = Y / $250 so Y = $125K.
o
What would the result be if she sold the residence for $700,000? $75,000 would be included in
income, since $125,000 of the gain would be excludable.
Chapter 8: Discharge of Indebtedness
A. §61(a)(12): says that COD income is included in Gross income.
B. §108: reduces some of the severity of the original code rule.
1. GI includes income for discharge of indebtedness if the TP is not in Chapter 11 or insolvent. §108
2. Liabilities over assets = insolvency
a. Reduce liabilities by COD. Any level if insolvency would be excluded forever.
b. If insolvent, don’t include COD income, but then can’t include what tax attributes are
affected in §108(2)
3. Assets = Liabilities + Owner’s Equity, OE = A – L, OE + derived figure
4. If appears to be a gift or bequest, then no COD, gift rules trump the COD rules (case law, not in
code) Duberstien, Kirby.
C. Steps to follow for COD problem:
1. Is there a valid debt?
a. If no, no CODI
2. Is it a settlement of the amount owed versus settlement where less than the amount owed is paid?
(If the question is how much is owed that is not COD).
3. Is it something other than COD? Is it a gift? Bequest? Barter transaction?
Once you know that it is COD, then must determine whether you can exclude it under §108.
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4. Is the person in Chapter 11? 108(a)(1)(A) / 108(B)(2)
a. If yes, then get to exclude the CODI.
b. If no, then you ask next question.
5. Is the lender also the seller?
a. If he is, then would go under 108(e)
b. If solvent and the lender is the seller, treat as a purchase price reduction.
6. If property is being used to satisfy the debt, must use the FMV of the property. Kirby Lumber.
7. If using services to satisfy the debt, would not have cancellation of indebtedness income, instead
would have income from the income received from the work, income is just reclassified.
8. Is the taxpayer insolvent? 10\8(a)(1)(2) / 108(d)(3)
9. To calculate if insolvent/solvent? (Liabilities – FMV of Assets) before discharge of the debt (he
will expect us to determine whether the taxpayer is solvent or insolvent on the exam).
a. If no, then include
b. If yes, may exclude up to the extent that you are insolvent. (otherwise people could cheat
to make it look like they were barely insolvent so that they could exclude the entire
amount).
10. How much insolvent? Can then exclude that much, but only after reducing the tax attributes
a. Would first reduce the NOL’s that you are carrying over, these are deductions against
future income. (Net Operating Losses, the losses that Congress lets you carry over)
108(b)(2)(A)
b. Then would reduce any business credits that you have 108(b)(2)(B)
i. Congress trying to normalized deductions and credits, allowed
them to reduce tax credits 33.5 cents on the dollars for credit
rather than the dollar for dollar reduction of the deductions.
c. If no NOL’s or credits to reduce, would then reduce the basis on the property (so the
government can capture the tax there).
D. Tax credit much better way to give people subsidy, credit affects people in the low and higher tax brackets.
Most credits are not refundable but can be carried over into the next year.
1. Earned income tax credit: designed for working poor, if earned a little bit of money
government will match you credit. If wipes out your taxes and there is excess actually creates
a refund.
2. Energy efficiency improvements
3. Business tax credits
Kirby Lumber: Retied the bonds they has issued and bought them back. Cancelled a part of the debt that Kirby
owned because retired the difference in value of it. Rule: Still an accession to wealth that should be taxable
because owed less money. Prior exclusion of the loan proceeds isn’t appropriate now because don’t have to
pay back the debt.
Zarin v. Commissioner: court saying that the compulsive gambler who gets relieved of debt when the casino
settles, really the amount of the debt must not be valued at what is was before.
 Several years ago, Paul borrowed $10,000 from Rich. Assuming he has not yet paid off any of the loan, what
are the tax consequences to Paul if he pays off the debt with:
o
A settlement of $7,000. We are assuming that no exception to the Kirby Lumber doctrine
applies. Paul has $3K of income. COD of $3K.
o
A painting with a basis and FMV of $8,000. Paul would have 2K of COD income under Kirby
Lumber.
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o
A painting with a $5,000 basis and an FMV of $8,000. Paul has 2K of GI under Kirby Lumber
and 3K of GI by the satisfaction of a legal obligation with appreciated property (International
Freighting Corp case), so he has 5K of total GI. $2K of COD income and $3K of gain.
o
Services in the form of painting Rich’s office, where he normally would have charged $10,000.
Paul would have 10K in income because he is being compensated (in the form of an advanced
loan or the equivalent) by Rich for his services (service income). He also happens to be
relieving his debt at the same time. No COD income but there will be income because of the
barter transaction, Re-characterized as a cash transaction.
o
Services in the form of painting Rich’s office, where he normally would have charged $8,000. Paul
has 10K income (8K in the form of services rendered and 2K of COD income under Kirby
Lumber).
o
Paul’s employer agrees to pay Rich $7,000 in full satisfaction of Rich’s claim. Paul has $3K COD
income under Kirby Lumber, employer is bypassing Paul, so it is $7K of compensation (which
is gross income).
 Marty buys land from Sam for $100,000. He borrows $80,000 from a bank on a recourse basis and uses
$20,000 of his own money. Two years later, the land is worth $300,000. Marty has paid interest only on
original loan. He takes out a second loan from the bank for $100,000 also on a recourse basis. When the
land declined in value from $300K to $170,000 Marty transfers the land by quitclaim deed back to the bank
and bank discharges all of the liability.
AB = $80K + $20K + $100K = $200K, $180K borrowed
o
What are the tax consequences? When the quitclaim deed goes back to the bank it is $170 AR,
if the bank says you don’t have to pay back the $10K remaining on the debt then you have
COD income, on a recourse debt.
Marty’s amount realized from the disposition of the land includes the amount of liabilities
which is discharged as a result of the disposition. Since the property secures a recourse
liability, then the amount realized does not include the amount that is discharge of
indebtedness. (§ 1.1001-2(a)(2)) The bank has the right to collect the unpaid debt from
Marty personally, the forfeiture of the property does not necessarily extinguish the debt. The
disposition of property results in a discharge of liability to the extent of the FMV of the
property, 170K. The amount realized is 170K and Marty will realize a gain of 70K on the
land (170K-100K). The remaining amount discharged (10K) is discharge of indebtedness
income, and Marty has 10K discharge of indebtedness income. (Reg § 1.1001-2(c)Ex.8 and
Rev.Rul. 90-16, 1990-1C.B.12) Since the land is held for investment purposes, the §
108(a)(1)(D) qualified real property business indebtedness exception to the Kirby Lumber
doctrine would not apply.
o
What difference would it make, if any, if the debt were non-recourse? AR is $170K which is the
FMV, Tufts said that non-recourse debt is the entire amount of the debt that is excluded. Non
recourse debt, the entire amount is excluded, entire face value of the loan. Can’t go after the
second loan. Not canceling the debt, in order to tax that $10K, anytime you have that $10K,
has to be the face value of the loan that is excluded. End up with $80K of gain and no COD
income.
 Denis owed Francis $5,000. Nathan, Denis’s nephew, owed Dennis $10,000. Dennis was abducted by
space aliens and did not survive the encounter.
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o
Francis failed to file a claim against Denis’s estate to recover his $5,000, and the claim was barred
by the statute of limitations. What are the tax consequences to the estate? If the statute of
limitations runs, says can’t sue to recover this. then Denis’ estate has an income of 5K COD
bc the state is economically enriched by the extinction of the indebtedness and the
beneficiaries stand to get more money than they would otherwise. It is immaterial whether
the statute extinguishes the debt or merely bars an action on it (same result as here).
o
What would the result in (a) be if Francis intentionally allowed the statute to run because she felt
sorry for Denis’s wife, who was to receive the estate. The estate would have no income. It looks
like it might bc its relieved of a 5K obligation, seemingly causing 5K of income under Kirby
Lumber. Nevertheless, this action by Francis is probably indicative of sufficient donative
intent under Duberstein to fall within the gift exception to Kirby Lumber. § 102, Reg. § 1.6112(a). This is interplay between COD and gift. Must look at the relationships of the parties.
The gifts rules trump the cancellation of debt rules (nothing in the code says this, but we
know this by case law).
o
What would the result be for Nathan if Denis’s will provided that his estate not collect the $10,000
Nathan owed Denis? Nathan has no income. This is an extension of the gift exception to the
Kirby Lumber doctrine to include bequests under § 102.
-------------------------------------------------------------------------------------------------------------------------------- Brad borrows $100,000 from Charlie to start an ambulance business. Brad buys an ambulance for $100,000
from David. Assume that Brad has no other depreciable property.
Charlie $100K  Brad, Brad buys ambulance for $100K (basis is $100k)
Assume:
Assets: $100K (ambulance), $50 (Cash)
Liabilities: $100K (loan)
Owners Equity: $50K
 What are the consequences to Brad under IRC 108 in the following circumstances?
o
Brad is solvent but Charlie compromises debt for 60K.
Since solvent, then his COD would be $40,000.
Assets: $100K, $50K
Liabilities: $60K
Owner’s Equity: $90K
o
Brad’s liabilities are $225,000 (Brad has other debt in addition to the $100,000 he borrowed
from Charlie). Assume the ambulance has a FMV of $75,000. Assume that the only tax
attributes Brad has are $50,000 of NOLs and the ambulance. Charlie relieves Brad of $40,000
of debt. See, IRC 108(a)(2), (a)(3), (b), (d)(3)
Insolvency: Assets = $75K, Liabilities = $225K, = $150K. Was he insolvent at the time
of the debt relief? Yes, insolvent by $150K (can exclude up to that amount) Since
relieved of $40K of debt, Can only have $10K of NOL after the indebtedness is
released because can’t take full $50K because of the $40K relieved. So only $10K can
be carried over to the next year.
o
Same as 2, but Brad has only $30,000 of NOLs. See IRC 108(b)(2)(E) & 1017(b)(2).Also
assuming that we have a business credit of $1,000.
Since only have $30K of NOL’s, so they are then reduced to $0. Still have $10K of
excluded income. If we had $1K of business credits, then reduce at 3to1 ratio.
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108(b)(3) (B),($1K of credits will reduce $3K of deduction) so would still have $7K
left. 108(b)(2)(E) says that if no other tax attributes then the basis is reduced (way the
IRS may capture that tax in later years, when you sell the property). Don’t need to
know how to calculate it under 1017(b)(2) since only 3 credit course.
o
Brad purchased the ambulances from Charlie, who also lent him the money, for $100,000.
Brad is solvent. Charlie agrees to compromise the debt for 60K. See IRC 108(e)(5).
Treated as purchase price adjustment to $60K, reduces the amount you paid for the
ambulance. When lender and seller are same person then functions as a price
reduction. So the basis used to be $100K, basis instead reduced down to $60K on the
ambulance.
o
Same as 6, but Brad is insolvent?
Go through the normal determining how much he is insolvent, etc…
PART THREE: INDENTIFICATION OF THE PROPER TAXPAYER
Chapter 12: Assignment of Income
Four cases define this area:
1. Lucas v. Earl: Taxpayer tried to get the employer to pay the government directly for the taxes.
Court said that if someone is paying something on your behalf then it is income to you.
Timing does matter in this case.
2. Commissioner v. Giannini: Board of Directors decided to compensate Giannini by giving him 5%
of net profits. When he had received $445K by July, said in Nov that refused any more and said
company should donate to something for good cause. Different from Lucas because he had already
earned the money from July – Nov, but hasn’t been paid yet for later period. Court said that
taxpayer has income when he directs the disposition of the money, here he didn’t specifically
say where to donate. Court differentiated this because he renounced the money, wouldn’t have
been able to sue the company for not paying him.
3. RR 66-167: husband and son were supposed to split wife’s estate when she died. Husband was
executor of estate said he didn’t wanted to receive payment (decided this after her death). Court
holds that this income is excludable from gross income. Control didn’t seem to matter as much
in this case. Should have done this before wife’s death to make clearer.
4. RR 74-581: students and professors at law schools serve as counsel, the compensation earned
instead of going to professor will go to law school. IRS determined this is not income since
money is going to the school directly. No income shifting because school is non-profit.
5. Fruit and tree:
a. If you retain any interest then you get the income.
b. You can sell the fruit for consideration
c. If give up both fruit and tree, will still be taxed on the income that was ripening while
you owned the fruit.
6. Patents and trademarks are treated as property, so when they are transferred, assignment of income
is possible.
E. Synopsis of case law:
1. Timing isn’t dispositive
2. Control important, if you control the money then you are benefiting from it. Control over the
money is a way of consuming it.
3. Must look to what is given up
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 Matilda earns $80,000/year working for X Corp. What are the tax consequences to Matilda under the
following circumstances?
o
She directs early in the year that $20,000 be paid to her parents? Taxable income, just like Lucas
v. Earl. Can’t sign away the right in that case. Parents would not be taxed because it is a gift
and gifts are not taxable.
o
She directs early in the year that X Corp. give $20,000 to any charity it chooses. Difficult question
because like Giannini because she didn’t choose the charity. But one of the differences is that
she said charity, and in Giannini he just said to use it whatever way that is beneficial so they
could have kept it. Would probably depend on the situation or the judge.
o
At the end of the year, X Corp. declares a $10,000 bonus. As soon as Matilda hears about it, she
refuses the money and directs that X Corp donate it to the charity of its choice. Similar to
Giannini where they didn’t chose the charity. Didn’t know that she was going to receive the
bonus, so seems to be closer to Giannini than last question. Is directing that it goes to charity,
is that sufficient control? But because she is directing to charity, is that ok? Probably
sufficient control because directing it to give it to charity, might instead give her the
deduction for charity. Might require that she give up all rights, no conditions that is given to
charity. Should build the analogy on an exam. Show issues and make comparisons to the
cases we read. Two issues: 1)Control 2)Timing. Is this bonus earned already? In this case
yes, compared to RR 66-167 if it is already earned you can’t disclaim it. But if you had no
idea you were getting a bonus, can you disclaim. They can’t force money on people, if you
exercise no control you probably can disclaim it. Because it was sprung on you easier to make
it appear as if it can be disclaimed. Could probably go either way.
o
Matilda gives a speech at the Rotary Club and is given a $100 honorarium. Pursuant to her
employment agreement with X Corp., she turns over the $100 to X Corp. Similar to RR 74-581, so
not taxable. 74-581 was written for professors and educational institutions, would have to
make it sound like the legal rule from this relates to other situations and not just professors
and educational institutions. IRS could try to limit this and make it sound like it just would
apply to schools. On final, would want to show how you got the answer, would want to show
the RR we followed. The $100 would be income to X corp.
Helvering v. Horst: Bond case where the father was trying to assign the interest of a coupon bond to his son for a
year. The decision in the case blocked the ability to give short term gifts of income for tax purposes. The power to
redistribute property income is equivalent to the ownership of the income itself, according to the court.
Blair v. Commissioner: Trust case, wife saying don’t need interest anymore (seems bc daughter is remainderman
on the trust that assigning income to her). Court determined this was not assignment of income since she doesn’t
have a right to the property anymore, if she had rights to it, it would be assignment of income, donees were taxable.
Stranahan: Father trying to avoid paying so many taxes in year 1, son paying to assign the right to his father’s
dividends. IRS allowed this, has a basis in the property and any amount in excess of it will be taxed. Will be treated
as ordinary income when selling the right to future income. Said that taxpayers have the right to accelerate income.
Susie Salvatore: Family arranging a sale of their gas station and land to Texaco. Mother took the entirety on the
same and then gave interest to the children. IRS saying that should have negotiated the interests before making deal
with Texaco, since it was known that she would give to kids should have done it before sold to Texaco.
 Frank owns a coupon bond he purchased for $8,000. It has a $10,000 face value and pays interest semiannually (on 4/1 and 10/1) at 8% ($400). The current value of the bond is $9,000. What are the tax
consequences if:
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o
Frank assigns to Daria all of the interest coupons on 4/2/05? Like Horst, Frank will be taxed on
the interest coupons because he does receive the benefit even though he gives them as a gift.
Would only be taxed on the coupons that already paid, not on the 10/1 coupons, whenever
they materialize.
o
Frank gives the bond and all coupons to Daria on 4/2/05? Similar to Horst, she is receiving the
bond and the interest after they are being paid out as a gift. He will be taxed on the coupons
from 4/1 then she will be taxed on the rest since she then owns the bond.
o
On 4/2/05 Frank gives Daria a ½ interest in the bond and all the coupons? Subject to taxation for
the ½ interest in the bond when it is paid and Frank is subject to the tax for the coupons that
were paid on 4/1. He is subject to tax on part of it since he still has an interest after that date.
o
Frank puts the bonds into a trust and then assigns a life interest in the income from the trust to
Daria. Would it matter if Frank had a remainder interest in the trust assets? What if the trust were
revocable? Like Blair said, if it is revocable he still retains it, it has the benefit of the tree, so
the assignment isn’t going to work. He would have to pay taxes.
o
On 12/31/04, Frank gave Daria the bond with all the coupons. Frank gives away the tree and the
fruit when one of the fruit is half ripe. Tax rule says that coupon ripened while he owned it,
must pay tax on the coupon up until the amount that you owned. Since it had gone half way
ripe, then pay tax on half of it. Must pay tax on the income that is earned on your watch.
o
On 4/2/05, Frank sells Daria the coupons for their fair market value. Similar to Stranahan, since
there was consideration for the coupons, Daria would be subject to the tax even if this is just
assignment of income.
o
On 4/2/05, Frank sells the bond and directs that $9,000 be given to his daughter. Bought it for
$8000 (AB) FMV is $9000, so Gain is $1000. He is subject to the tax because it was earned on
his watch.
o
Before 4/2/05 F negotiates the sale of the bond. He then transfers the bond to Daria, who sells it on
4/2/05. Similar to Salvatore can’t negotiate and then direct the money away, he is subject to
the tax.
 Dora patents a switch. Who is taxed on a sale if:
o
She transfers the patent to Sam, who sells it. A transfer of patent is treated as a transfer of
property. Despite the fact that there is a strong element of personal services in developing
patents. The transfer from Dora to Sara is effective in assigning to Sam the interest from the
sale.
o
She transfers the patent to Fred and enters into a contract whereby Fred will pay her royalties.
Dora then transfers right to royalties to Sam. Court treated these royalties like a transfer of
property. The courts have held that Sam would be taxed on the income. An argument can be
made that the income is ripe under Susie Salvatore, although the courts with an apparent
reluctance equate the transfer of the royalty contract to a transfer of income-producing
property, the patent itself.
PART FOUR: DEDUCTIONS IN COMPUTING TAXABLE INTEREST
Chapter 14: Business Deductions
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A. §162: Deduction: Allowed deductions for all ordinary and necessary expenses paid or incurred during the
taxable year in trade or business, including salaries and travel expenses.
i. Currently deductible questions: §162, 212, 179
ii. Ordinary and Necessary?
iii. Incurred in the tax year?
iv. Trade or business. Morton Frank v. Commissioner : Newspaper company purchase, must
already be in trade or business, can’t deduct costs that couldn’t be deducted from someone
else who is not in the business, can deduct some start up costs eventually after realized –
can deduct faster as a start up cost).
b. §212: Deduction: expenses for production of income still must be o & n, in taxable year, but for
production or collection of income, for management or maintenance of property, or for
determination or collection of tax.
c. §179: Deduction: election to expense certain depreciable business assets. Property such as tangible
property that applies to §168, and computer software. Defined in §179(d).
d. §165: Deduction: allows deductions for losses, limited to losses incurred in a trade or business,
losses incurred in any transaction entered into for profit.
e. §167: Deduction: allows deduction for depreciation
f. §168: Deduction: Accelerated Cost Recovery System.
g. §195: Deduction: Travel expenses and legal fees incurred in searching for a business to purchase
are not included (but perhaps under §195)
h. §261: Limitation: if something is both a business and personal expense then cannot be deducted.
i. §262: Limitation: denies this deduction for personal, living and family expenses
j. §263(a): Limitation: requires that people capitalize costs of making assets. Also denies this
deduction for capital expenditures = “permanent improvements or betterments” – look for scale and
how often.
i. Is it a replacement or a repair, is it adding something or making it useful again?
k. §274: Limitation: denies deduction for entertainment, amusement, recreation unless related to a
substantial and bonafide business discussion and the conduct was active conduct of the taxpayer’s
trade or business.
B. Ordinary and Necessary
a. Must not be optional. (I.e. employee not choosing to ask for reimbursement)
b. Must be in the course of trade or business
c. Should be shown to be appropriate and helpful for the development of the taxpayer’s business.
Welch v. Helvering.
d. Is it normal for that industry? Doesn’t matter that haven’t done it in past
e. Look for new job in same field
i. Use agency to look for new job, if first job can’t deduct. But courts have made an
exception for people that actually find a job Hundley (baseball player case: as long as
doesn’t pay until he finds the job). Doesn’t matter if it is successful to deduct, if in the
same field.
f. Must have a home, and be away overnight to qualify under §162.
C. Transportation (look at separately than meals, might be allowed to do one and not the other)
a. If incurred in going between TP home and temp work outside the metropolitan area where
normally lives and works
i. Andrews case: Tax court saying that he has two homes. If you have two business can
actually get away with deducting one right now, hole in the tax code.
b. Rev Rul 99-7 is referring to the commute only (home to principle place of business). It does not
refer to travel between principle place of business and other business locations. Any trips
necessary during the day away from the office.
c. Temporary means one year or less
i. Peurifoy (discussed in Rosenspan): the Supreme Court acknowledged that a deduction for
transportation and meals and lodging is allowed if a taxpayer is employed at a location
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away from home for a “temporary” rather than an indefinite or indeterminate period of
time and if the taxpayer retains a tie with the old place of business.
ii. Mitchell v. Commissioner: Where the temporary time period exceeds one year, the second
to last sentence of § 162(a) disallows any deduction. However, where the time period
realistically is expected to be less than one year, but at some point is extended, expenses
are deductible until the time period is extended.
D. Education
a. Must be incurred in carrying on trade or business and be ordinary and necessary
b. Can’t be new trade or business
c. §274(m)(2): no educational trips are deductible.
E. Misc. Business Deductions
a. §274 imposes limits on this deduction. The meal/entertainment must be directly related to
/associated with the TP’s trade/ business. This doesn’t apply to meals while “away from home”
must be “directly related to” or “associated with” the active conduct of business. § 274(a)(1).
b. Meals:
i. Can’t be extravagant or lavish (lots of discretion), must have a business purpose
274(k)(1)(A)
ii. Limited to 50% for meals §274(n)
iii. Must be away from home where sleep and rest is required (diff. from transportation)
Correll
iv. TP must be present § 274(k)(1)(B)
F. Losses
a. §165: Limits the losses to the basis §1.165-7(b)(1).
b. Must take into consideration the amount received from the insurance company
G. Uniforms
a. Only allowed if they have no general use
H. Order of events for deductions:
a. Look to §162, 167, 179, 212 to see if deductible
i. Then look to §261, 262, 263, 264 to see if there is a non-deduction principle (trump the
100’s)
INDOPCO: acquiring a new business, merging the businesses to form a slightly different company. Must capitalize
under §263 whenever there is a future benefit.
Midland Empire: to determine if it is an improvement, ask following questions:
1. Did it extend the life of the product (longevity)
2. Does it add to the value? Does the repair fundamentally alter it?
3. Change in function?
4. Increase in capacity?
Mt. Morris: drive in theater, water keeps coming onto the property. Need to make repairs. Court doesn’t allow
them to deduct even though it is a repair.
 Archie owns and operates a flower shop. He is in need of some paper to wrap flowers in. He goes to the
wholesaler and sees three different grades of paper. They sell for $1, $2 and $3/lb respectively. He
determines that all three are good enough for his purposes. Nonetheless, he decides to buy the most
expensive paper. He spends $300 on paper, when he could have gotten by with spending only $100. He
also sees a fountain that he believes might look nice in his store. In the 30 years he’s been in business, he
has never purchased a fountain. On a whim, he decides to do so. It costs $1,000.
o
How much may Archie deduct for the paper? Can deduct the full amount of the expensive
paper, IRS doesn’t make business decisions for you. Must just be integrated with the business
you are doing.
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o
May Archie deduct the $1,000 for the fountain? Determined as ordinary (doesn’t need to be
habitual as long as people in this business context) and necessary (could be shown to be
appropriate and helpful for the development of the taxpayer’s business) Welch v. Herlvering.
Buying it for his businesses requirement. Still have to look at whether this is covered under
§263.
 Erma incurs expenses as an employee of X Corp. She could have submitted her receipts and been
reimbursed. To avoid criticism from her boss, she decides not to submit her expenses and instead tries to
deduct those expenses on from her taxes. May she do so?
o
Is she engaged in a trade or business? §162. No other provision that allows me as an
employee to deduct their expenses. So court has said that any employee is engaged in a
trade or business can deduct expenses that were not reimbursed.
o
Is this ordinary or necessary? The courts that have looked at this have said no. If you
have decided not to seek reimbursement then you lost the chance to deduct. If she wasn’t
entitled to reimbursement the can deduct if ordinary or necessary. Has to deal with legal
right to reimburse not what the perception is of whether she can be reimbursed.
 Determine the deductibility under IRC 162 of the following:
o
Terry, a doctor, inherits lots of money from Dennis (who was previously abducted by space aliens).
She decides to go into the development business and spends $52,000 investigating what property to
buy. Cannot deduct expenses for a trade or business you aren’t in yet. Morton Frank v.
Commissioner.
o
Would your answer change if Terry were a developer of residential real estate and shopping
centers? Yes, since he is already in a trade or business would probably be able to deduct
expenses entering into a new business. P. 339 in notes.
-------------------------------------------------------------------------------------------------------------------------------- A landlord owns a ten-unit apartment building and incurs the following expenses. Which are deductible and
which must be capitalized?
o
$350 for painting 3 rooms of one of the apartments. Look at the size of the work done compared
to the size of the asset. There is an exception here. If decide to do piecemeal repairs on the
apartments, would always come up deductible. Need to look at comprehensive plan, trying to
rehabilitate the entire building? Simple repairs in relation to cost might be deductible, then
bigger repairs might not. Minor paint job will probably be deductible but a major paint job
every ten years would not be.
o
$1,500 for replacing the roof over one apartment. Not deductible, because seems larger than a
repair cost. Look at the language used. The IRS gets to re-characterize what you do. If said
replace, then that looks like improvement because putting in a new asset.
o
$500 for patching the entire parking lot. Yes, considered a repair if determined necessary and
ordinary.
o
$750 for adding a carport. No, couldn’t be seen as a repair, instead as an increase to the value
of the property.
If you have unreimbursed employee expenses then they are deductible. If looking for same job in
same industry then that would be a necessary expense.
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 Sam pays an agency fees to help him find a job. Are they deductible if:
o
This is Sam’s first job, and the agency can’t find him a job. No, since it is his first job, probably
cannot deduct.
o
This is Sam’s first job, and the agency finds him a job. Yes, court made an exception for people
who do find a job. Hundley tried to cheat. If you changed the facts so no payment was due.
Chodorow thinks that this is cheating, court says this works. Golson rule says if no law on
point can make own decision if no case on point even if court of appeals from other
jurisdiction.
o
This is Sam’s first job, and the agency finds Sam a job, but the fee to the agency was contingent on
the agency finding Sam employment and not due until job was acquired. Yes, because he doesn’t
pay until he has the job, then Hundley applies.
o
Sam had previously worked in same field but in different town. The agency finds Sam a job. Yes,
would be fine. P. 343
o
Is there any change to your answer to D if the agency fails to find Sam a job? No, it doesn’t seem
to matter if it was successful. P. 343
o
Is there any change to your answer to D if the agency fails to find Sam a job in his old field, but
rather finds him a job in a different field. Probably wouldn’t be allowed, needs to be in same
field. P. 343
 Charlie owns a home in Carefree and drives to work in downtown Phoenix. He eats at various restaurants in
Phoenix.
o
May he deduct the costs of his transportation and meals? No deduction. According to § 1.1622(e) and § 1.262-1(b)(5), expenses of commuting between taxpayer’s residence and place of
business, as well as meal costs even if incurred during working hours, are generally personal
expenses for which no deduction is allowed. Although commuting expenses are in some sense
connected with the taxpayer’s business, no deduction is allowed under § 162(a) since such
expenses are not required by the “exigencies of the business.” Similarly, parking fees at one’s
business are nondeductible personal expenses.
Break it down: he’s incurring a drive expense (99-7 rev rul), and he’s incurring a meal
expense (162(a)(2)) says travel away from home and Correll says overnight only. Neither of
the expenses are deductible.
o
May he deduct the cost of travel between his office and the O’Conner Court House (in Phoenix) to
file papers, try cases, etc.? Deductible. Transportation expense incurred in going from one
business location to another within the same area are deductible under § 162(a) as ordinary
and necessary business expenses. These expenses are distinguishable from commuting
expenses of the type described in the previous problem in that they are directly attributable
to the actual performance of the taxpayer’s duties. The Service’s std mileage rate allowance
for the business use of automobiles for 2004 is 37.5 cents per mile. This amount is adjusted
annually. The deduction for expenses of traveling from one business location to another is
allowable whether the taxpayer has only one employer or is self-employed. If, however, he
goes from the Court House to his residence at the end of the day, Rev. Rul. 76-453 states that
the cost is not deductible.
Rev Rul 99-7 is referring to the commute only (home to principle place of business). It does
not refer to travel between principle place of business and other business locations.
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o
May he deduct the cost of meals eaten in the courthouse cafeteria? The cost of his meals is not
deductible. He is not “away from home” under the Correll sleep or rest rule.
 Carlos resides and works in Phoenix. He drives to Tucson for a business meeting and then eats lunch
there. He comes home the same day. May he deduct the costs of travel and the meal? YES and NO. As
the Correll case holds, unless a taxpayer is away from home in a situation in which sleep or rest is
required, the taxpayer may not deduct any expense for meals. Thus he may NOT deduct the cost of
his meals but he CAN deduct the cost of his travel. Correll does not preclude a deduction for
transportation costs that are an ordinary and necessary business expense even though a taxpayer is
not “away from home” under § 162(a)(2). The same principles differentiate transportation and
meals in the determination of deductible education expenses. Such transportation costs are not
mere commuting expenses. (Rev. Rul. 99-7).
 Harry lives in Phoenix. His employer sends him to LA for 2 days a week. He is not reimbursed. May he
deduct his travel, lodging and meals? Harry can deduct his transportation and lodging and 50% of his
meals in LA. He is engaged in a single business in two locations and the expenses are incurred while
“away from home in the pursuit of a trade or business” under § 162(a)(2). As a result of § 274(n)(1)
she may deduct only 50% of her meals. In addition, since she is in travel status if she dines alone or
with family, but not with business people, she need not satisfy the § 274(a)(1)(A) “directly related to”
or “associated with” tests which are considered later in the text.
§162(a)(2) says he can deduct
§274(n) says only 50% of meals
Correll says that he has to stay overnight to get the deduction
 Tom works and lives in Phoenix.
o
Tom is asked to work in a branch office in Tucson for 8 months. May Tom deduct his commuting
expenses? This is an example of the Peurifoy doctrine which is discussed in the Rosenspan
case. In Peurifoy, the Supreme Court acknowledged that a deduction for transportation and
meals and lodging is allowed if a taxpayer is employed at a location away from home for a
“temporary” rather than an indefinite or indeterminate period of time and if the taxpayer
retains a tie with the old place of business. As a rule of thumb a definite period of up to one
year was deemed to be “temporary” and deductible, and that rule is now codified in the
second to last sentence of § 162(a). Here, Tom may deduct his expenses. Since Tom has
moved to Tucson for a definite 8 month period and will thereafter return to Phx, his
employment is “temporary” and his costs of transportation, lodging and 50% of his meals are
deductible.
o
What would happen if in month 7, Tom’s employer extends the time in Tucson to 15 months? Is
this use of the one-year indefinite rule in Mitchell v. Commissioner. **Where the temporary
time period exceeds one year, the second to last sentence of § 162(a) disallows any deduction.
However, where the time period realistically is expected to be less than one year, but at some
point is extended , expenses are deductible until the time period is extended. Therefore Tom
can deduct 7 months of expenses here. If the work assignment is realistically expected to last
more than 1 year the assignment will be considered indefinite, regardless of whether it
actually exceeds one year, then the employment will be considered temporary until the
taxpayer’s expectations changed, and indefinite thereafter.
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 A, B, C, and D became doctor, dentist, CPA, and attorney. A goes to law school to better prepare her for
her ongoing role as an expert witness. B takes a class in orthodontia, intending to specialize in that field. C
takes law school courses to aid her in her accounting practice, but does not intend to become a lawyer. D
takes an LL.M. in taxation, intending to practice in that area.
o
Which, if any, are deductible? A’s expenses are not deductible – they qualify for a new trade or
business under § 1.162-5(b)(3).
B’s expenses are deductible – Rev. Rul. 74-78 permits a dentist to deduct expenses of
orthodontic study as a change of duty within a trade or business. Expenses are incurred “in
connection with improving his skills as a dentist.”
C’s expenses are NOT deductible – Reg. § 1.162-5(b)(3)Ex.(1). It is possible her expenses
would be deductible if she were admitted for special study only and not as a degree candidate,
one who could not apply any academic credits earned towards a degree. There continue to be
a large number of cases with taxpayers attempting to deduct the cost of education leading to
the first degree in law, but the cases all deny such deduction. The predominant basis for
denial is the prohibition against qualification for a new trade or business.
D’s expenses are questionable – Johnson v. US held that a lawyer’s education in the
specialized field of tax law qualified him for a new trade or business under § 1.162-5(b)(3).
Most recently the gov has not contested the deductibility of education expenses incurred in
acquiring an LLM in taxation by lawyers already working in the tax field…. If you are
already a lawyer, you’re specializing – it’s OK.
o
Assume D’s expenses are deductible. If she lives in Seattle but goes to FL for a year, what may
she deduct in addition to tuition and books? If deductible, her deduction would include
transportation, lodging, 50% of meals, etc. § 1.162-5(e); § 274(n). Of course, if one is not
“away from home” overnight within the Correll principle, meals (there would be no lodging)
are not deductible.
o
C has a BA in education and teaches European history. Wants to take a trip to Europe. May he
deduct his expenses. C’s expenses cannot be deducted. § 274(m)(2) denies a deduction for
travel as a form of education. Note the section does not preclude deductibility of travel to
obtain education or other travel that is necessary to engage in activities that give rise to
deductible education.
 Erwin spends $100 taking 3 clients to lunch to discuss business. The cost includes $5 tax and $15 tip. They
each have 2 martinis.
o
To what extent are the expenses deductible? For business meals to be deductible, they must be
“directly related to” or “associated with” the active conduct of trade or business. § 274(a)(1).
Here the directly-related-to requirement is met as a particular business matter is on the
agenda and is discussed. Under 274(k)(1)(A) the cost of the meals must not be lavish or
extravagant. Is $100 lavish?? What about martinis?? If the above requirements are met
only 50% of the cost of meals (which includes taxes and tips) is deductible. 50% of any
portion that is not extravagant (according to the IRS – meal includes tax and tip)
o
What if the meal is simply to “touch base” with the clients? Not deductible. This fails to satisfy
the directly-related-to requirement or the associated-with requirement. §274(a)(1) you have
to be talking about specific business – it’s not just good relations type stuff.
o
What if Erwin doesn’t attend but simply picks up the tab? This would violate the § 274(k)(1)(B)
requirement and result in nondeductibility of the meals. This may not be such a bad
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consequence to Erwin. If deductibility of a business meal is denied, can’t it be argued that
Erwin has made a $25 gift to each client? If so, § 102(c) does not preclude deductibility and §
274(b)(1) would allow full deductibility if this were the only gift to each client for the year.
You HAVE to be present in order to deduct.
o
What if in (A), Erwin pays $15 for a taxi for the clients, but he gets there via subway? It is
deductible under 162 – is there a limitation? Transportation costs are not subject to the
limitations of §274(k) which applies only to the costs of meals (or entertainment). The $15
cab fare is fully deductible.
B. Business Losses § 165
1. Three losses that individuals are allowed to deduct
i. §165(c)(1): any loss incurred in trade or business
ii. Use basis to determine the loss that you are allowed to deduct, no basis, no loss
2. Allowed deductions for any loss during a taxable year not recovered by insurance
i. New AB would be AB reduced by insurance proceeds.
 TP has a car used solely for business. He bought it for $22,000. The car was destroyed when it was worth
$30,000. He received $15,000 in insurance proceeds.
o
What is TP’s deductible loss under IRC 165? Trade of business loss? Yes, casualty losses have
limitations where trade of business losses do not. Want to tax people on their ability to pay.
Basis is the cost of the property ($22,000) Only changes if you invest more money into it or if
you deduct a loss.
$22,000 – 15,000 = $7,000 loss. If he were to have recovered more than the amount that he
paid, there would be a gain. Just because something gets wiped out doesn’t mean it will
always be a gain.
o
What is the result in (A) if the car was not destroyed but rather worth $10,000 after the accident?
See TR 1.165-7(b)(1). Lesser of the amount of: TR 1.165-7 (i): $30,000 – 10,000 = $20,000 (ii):
$22,000. Because the $20,000 is less, you then subtract the amount that you received from the
insurance company. So you subtract the $15,000 from the $20,000, allowed to deduct $5,000.
Limits your loss to your basis, not going to allow you to exclude it from income and then also
have a deduction.
o
In (B), what is TP’s adjusted basis in the car, assuming TP spends $17,000 restoring the car to its
former glory. B = $22,000, have recovered $15,000 which reduces the after tax investment =
$7,000 basis before improvements and before losses. Must deduct the $5,000 loss that was
deducted. Must look at whether or not you can prolong the life of this asset or whether you
will increase the value as to the improvements to determine if it should be capitalized. If you
determined that you would capitalize it, you would add the $17,000 back in to basis.
$22,000 - 15,000 = $7,000 - $5,000 = $2,000 + $17,000 = $19,000
C. Depreciation §167 & §168
1. If used in trade or business or used to make money allowed to deduct part of the purchase price
over the course of its life.
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i. §167(a) property used in trade or business
ii. §168(a) Property held for the production of income
ii. Three theories:
1. Wear and tear theory: as it gets worn out and less valuable, doesn’t make sense to
throw it away. Whenever you get a depreciation deduction it lowers your basis
accordingly.
2. Economic theory: as it depreciates in value able to depreciate the basis
accordingly. Presumes that something is going down in value, but if not, then
couldn’t depreciate.
3. Matching theory: should be matching the cost of the machine to the income that it
generates. Some portion of the cost should be matched with the amount it brings
in.
iii. No depreciation for personal assets.
iv. Analysis for business deductibility:
1. Is it subject to wear and tear?
2. Is it something being used for profit or enterprise?
3. §168: Tangible assets
i. Determining depreciation:
1. Depreciable basis:
a. Land doesn’t depreciate, so using only amount attributable to the building.
2. Need method §168(b)
a. Straight line method (some property you are required to use this method)
§168(b)(5)
b. Double declining balance method: default rule (uses 1.5 the rate used for
straight line method) ACRS Method
i. Depends on your recovery period and your convention when
switch to straight line method:
1. Using 5 year property with half year convention, always
switch to straight line on year four.
c. Can always elect to do straight line method, but most people don’t.
3. Recovery period
a. §168(e): must figure out class life first
b. §168(c): then determine recovery period from class life
4. Convention
a. Determined the date on which the property is deemed to have been placed
in service by the taxpayer.
b. If the asset is not real property then we generally use the ½ year
convention
c. Real property is generally treated under the mid-month convention
i. §168(d) mid-month used for expensive items
ii. §168(s)(4)(c) want to look at the basis in the last quarter and
determine whether it is 40% of the basis put into service in that
year, does it exceed 60% of the basis this year. If more than 40%
of the cost of all ACRS personal property is placed in service
during the fourth quarter, the mid quarter rule is invoked.
5. Depreciable basis
a. Ignores salvage value
6. Business Use:
a. if used something for personal use and then begin using it for business use,
get to start deducting when begin using for business.
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 On 1/2/05, David buys $300,000 equipment for use in business. It has a 6-year class life and is 5-year
property under IRC 168(c). David will use the machine for 7 years. He expects it to have $30,000 salvage
value. Under each of the circumstances identified below, wow much depreciation may he take each year,
and what is his adjusted basis.
o
David elects to use the straight line method under IRC 168(b)(5).
1. SL Method
2. 5 year recovery period
3.Mid year (default), we don’t have 40% of the basis being put in at the end of the year, so
use default.
4. Ignore salvage value when determining the depreciable basis. So depreciable basis is
$300,000.
Year Opening basis SL Ded
DDB Ded
Conv Act. Ded Ending Basis
1
300K
$60K
½
$30K
$270K
2
270K
$60K
1
$60K
$210K
3
210K
$60K
1
$60K
$150K
4
150K
$60K
1
$60K
$90K
5
90K
$60K
1
$60K
$30K
6
30K
$60K
½
$30K
$0K
If this wasn’t a mid year convention, put it into service at 12/31/05 instead. Instead mid quarter
because put in at 12/31/05, use then the mid quarter, depreciate only 1/8 the first year. Then when
you got down to the last year you would then put 7/8 for the last year.
If you sell property in the middle of the year would have the same problem, wouldn’t use midyear.
o
David elects to use the accelerated ACRS method.
168(e): it is 5 yr property since falls into range, then go find recovery period: 168(c): recovery period
= 5 yrs
Put into service on Jan 2, so don’t qualify for exception, use mid-year convention which is the default
rule. Take a half year convention for first year.
To get straight line amount you divide the AB by 5: $300K / 5 = $60K. Percentage depends on
recovery period. If it is 5 years, always 20%.
Double declining rate will be 40% because it is twice the rate for straight line.
To find straight line method after first year, would refigure the straight line method every year.
Take new basis 240 / 4,5 (yrs) = $53.3K (since deducted ½ yr the year before), for second year now
$144K / 3.5 (yrs) = $41.14K, for third yr $86.4K / 2.5 = $34.56 (same as DDB) so switch to Straight
line method if equal or more. Continue to calculate this way throughout…or just use same value for
the rest of the year (end up with the same value mathematically as if continue to calculate.
Year
1
2
3
4
5
6
Opening basis
300K
240K
144K
86.4K
51.84K
17.28K
DDB
$120K
$96K
$57.6K
$34.56
$20.736K
$6.912
SL
$60K
$53.3K
$41.14K
$34.56 **
$34.56
$34.56
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DedConv
½
1
1
1
1
½
Act. Ded Ending Basis
$60K
$240K
$96K
$144K
$60K
$86.4K
$34.56K $51.84K
$34.56K $17.28K
$17.28
$0K
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** In year 4 you would go to the straight line method because the value is the same (or greater) as
using the DDB method.
Using five year property and a half year convention always switch to straight line on year four. In
seven year recovery period the year of switch changes. Depends on your recovery period and your
convention.
o
Year
1
2
3
4
5
Same as (B), but he sells the machine on December 1 of Year 5.
Opening basis DDB
300K
$120K
240K
$96K
144K
$57.6K
86.4K
$34.56
51.84K
$20.736K
SL
$60K
$53.3K
$41.14K
$34.56 **
$34.56
DedConv
½
1
1
1
1/2
Act. Ded Ending Basis
$60K
$240K
$96K
$144K
$60K
$86.4K
$34.56K $51.84K
$17.28
$34.56
Use half year convention when sold in that year according to 168(d). When you get rid of property
must use the appropriate convention. Would use $34.56 to determine gain or loss since that is what is
remaining at the time of the sale. Could also use charts in the book to determine the depreciation, but
he wants to see the schedule on the exam. Can check yourself using the charts.
If you have a capital gain that results from a depreciable asset, code not going to let this happen,
instead will make it appear as if it is ordinary income rather than capital gains. Would make you
recapture the gain. Anti-cheating provision. §1245 which doesn’t allow this.
If improvement is made to the asset, use the same recovery period as you would, regardless if you are
extending the life of the object. Treat the improvement as a new entity, could have multiple
depreciation schedules going on the same asset.
o
What if the TP elects to use IRC 179?
Will not need to know details of this section. Have to determine if this is property covered
under §179, also limitations about income. Shows there are many different ways to take a
deduction. (§§162, 195, 167/168, 263, 262, 179) If unable to deduct things that under 263 were
denied, then still might be able to deduct under 179. This is encouraging people to spend
money, get to deduct it immediately. Can get an extra deduction of $100,000 in 2005 under
§179. Maximum they can take in first year is $100,000. New starting balance would be
$200,000. Would have the $100,000 under §179, then would also have $40,000 deductions
from the DDB method (if used depreciation schedule). Whatever value is left after you take
your §179 deduction then becomes your basis for the depreciation schedule.
 In December 2004, David purchases property for $130,000. $100,000 is attributable to the building.
$30,000 is attributable to land. How much depreciation may he take if he puts the property into service on
March 3, 2005 and:
o
The property is an apartment building.
What is the depreciable basis? Don’t depreciate land, so $100,000.
Method? straight line because in 168(b)(3) says that if residential rental property then use
straight line method.
Recovery period? 168(c) says that residential rental property is 27.5 years
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Convention? Mid month convention, it is the month it is placed in service because of 168(d)
since it is real property. 5/24 is what you use.
Straight line amount= $100,000 / 27.5 = $3,636 (how much you can depreciate each year).
For first year, under mid-month convention: $3,636 * 19/24 = $2878.5
If we held it for the full 27.5 years then would calculate the last year by 5/24.
o
The property is an office building.
$100K depreciable basis
Straight line basis
Recovery period is 39 years
$100,000 / 39 =
Would use mid month convention.
Chapter 15: Deductions for Profit-Making, Nonbusiness Activities
A. Can’t deduct costs not incurred in trade or business
1. §212 allows deduction on all expenses paid or incurred during the taxable year
i. Must be ordinary and necessary
ii. For the production of income
iii. The management, conservation, or maintenance of property held for the production of
income
iv. In connection with the determination, collection or refund of any tax.
.
1. §274(h)(7) no deduction allowed under §212 for expenses allocable to a
convention, meeting, seminar
2. §212 issues:
i. doesn’t include stock commissions, those get added. subtracted to basis and will result in
gain or loss.
ii. Must be ordinary and necessary, owning a small % of stock doesn’t include going to
Hawaii for the convention.
iii. Can include legal fees investigating / protecting investment if investment is substantial
1. Most cases arise out of personal life will not apply, except for tax/alimony fees (%
allocated and substantial).
iv. Higgins: can’t deduct costs not incurred in trade or business since not engaged in trade.
Congress reacted by passing §212.
v. Bowers v. Lumpkin: Court said don’t get to deduct the cost of defending title. §263
 Sandra buys 100 shares of Sound Co. stock for $5,000, paying a $30 commission. 14 months later, she sells
the stock for $6,000, paying a $50 commission.
o
She wants to treat the $80 in commissions as an IRC 212 expense. Why? Can she? What
advantage does she get for deducting this? She will end up paying less in tax, would like to
deduct currently. Argument that this is ordinary and necessary. Commission is an acquisition
cost, so the rule is that you don’t get to deduct it currently, then instead it gets capitalized and
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added to the basis. Basis would be $5030. If she sells it for $6000, what would the result be
then? AR = $6000 - $50 (selling commission)= $5950. G = $5950 – 5030 = $920 gain.
o
What is the result if she sells the stock for $4,500 and pays a $45 commission?
There is a loss on the sale. Works the same way for losses.
Basis $5030
AR = $4500 – 45 = $4455
L = $5030 – 4455 = $575
o
Sandra own 1 share of Sound Co, worth $27, but she invests $500 in travel expenses to attend
Sound Co.’s annual meeting. Can she deduct those costs under IRC 212(2)? Not ordinary and
necessary, shouldn’t spend $500 to check out a $27 investment. No, §274(h)(7) says that no
deduction should be allowed under §212 for expenses allocable to a convention, seminar or
meeting.
o
Assume Sandra owns 10%, of Sound Co. worth $300,000, and incurs $10,000 in legal fees and
personal costs investigating the company after it hits rough waters. Can she deduct the $10,000?
Is it ordinary or necessary to investigate the company?
How much money did she spend and how much does she have at risk?
Under these facts, might be worthwhile because of the value of the property.
 Peggy meets with estate planner to make gifts and draft will. What portion of the expenses is deductible
under IRC 212(3) and IRC 212(2)? See Rev. Rul. 72-545. As long as the parts of the will were related
to the maintenance of property held for the production of income or related to the determination,
collection or refund of any tax then they would be deductible.
Miscellaneous Deductions
A. §163: allowed as a deduction all interest paid or accrued within the taxable year on indebtedness
1. Bonuses or premiums paid to lenders are not included
2. Must be compensation for the use or forbearance of money per se and not a payment for
specific services
3. §262: personal interest not deductible
a. Does not include:
i. If allocable to trade or business
ii. Any investment interest
iii. Student loan interest
iv. Qualified Resident Interest: encouraging people to go out and purchase homes.
Can deduct against their income §163(h)(3).
b. Two different types of interest
i. Acquisition indebtedness:
1. $1.0 million max
ii. Home equity indebtedness:
1. Limitation of $100K
2. Must be secured by house
3. cannot exceed equity
4. Doesn’t matter what you do with proceeds
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 George purchases a home in the current year for his residence. He borrows money to do so. What
portion of the interest on the loans described below is deductible?
o
The price of the home and FMV is $350,000. George obtains a mortgage of $250,000.
Qualified residence? Yes
It is acquisition indebtedness? Yes
Less than $1.0 million? Yes
He’s purchased a house and lives there so considered a qualified residence ( can actually
deduct second home as well). Can deduct 100% of the interest. The interest on the $250,000
loan is deductible as a qualified residence interest under §163(h)(5).
o
Same as (A), but 2 years after purchasing the home, George has paid the loan down to $200,000.
The home’s FMV is $400,000. George takes out another loan of $100,000 to improve the house.
He secures the loan with the house.
Interest on $300,000 would be deductible as acquisition indebtedness. $100,000 was borrowed
against the house and secured with house (but since it qualifies under acquisition, don’t use
the home equity indebtedness rule).
o
Same as (B), but George uses the money from the second loan to buy a Ferrari.
The second loan would be deductible as home equity indebtedness since it was not used on the
house it was not acquisition indebtedness. Do not get to deduct paying down the loan, just the
interest. If value is at $400K and the debt is $200K then has equity of $200K. Takes another
loan for $100K and secures to the house, instead uses the money to buy the Ferrari. Cannot
be home acquisition indebtedness. Requirements for home equity, shows that the FMV is
higher than his debt, and under the limitation.
o
Same as (A), but 10 years later, George has paid down the loan so that only $50,000 of original
mortgage remains. The residence is now worth $500,000. George borrows $200,000, secured by
the house. He uses $50,000 to pay off the original loan and the rest to pay personal debts.
Worth $350K and only $50K left on loan, refinances and gets the $200K loan. Pays off the
$50K and what to do with the $150K. We have paid off the home acquisition debt. $50K is
considered acquisition and the statute says that refinancing is allowed, don’t lose the status as
acquisition indebtedness. $150K, does this qualify as home equity. His equity in the house is
$450K, house is securing it, what is the maximum debt that can be considered? Only $100K,
so not all of it can be deductible. $50K is home acquisition indebtedness and $100K is home
equity indebtedness and the remaining $50 would be personal interest.
1.163-8T: interest tracing rule
B. Student Loan Deductions
1. Allows a deduction for interest paid on student loans §221
2. Limited to $2500 §221(b)(1)
3. Also limited the ration of [MAGI - $50K ($100 joint)) / $15(30 joint) to 2500. If over 1, no
deduction.
 Trey is single. He pays $3,000 in interest on a qualified student loan.
o
If Trey has Modified Adjusted Gross Income (MAGI) of $40,000, how much may he deduct?
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X = ((40,000 – 50,000) / 15000) * 2500
X=0
2500 – 0 = $25000
If under $50,000 then don’t have to do the calculation
o
What is the result if Trey has a MAGI of $57,500?
X = ((57,500 - 50,000) / 15000) * 25000 = $1250
$2500 – 1250 = $1250
o
Same as (A), but Trey is married and he and his wife jointly have MAGI of $140,000.
§1.221-1 says that a married couple cannot deduct if they make over $130,000. Reduction is
the entire amount.
-----------------------------------------------------------------------------------------------------------------------------Which of the following deductions are taken under IRC 62, as opposed to IRC 63?
o
An employee’s uniform. §63…Depends if it can be worn outside of the workplace (can’t be a
suit, could be a policeman’s uniform). This is an employee expense.
o
Employee entertainment expenses that are not reimbursed. §63…doesn’t fit under §63(a)(2).
Look at 62(a)(1) means that because he is an employee and they are not reimbursed then in
§63.
o
Same as (B), but the taxpayer is not an employee. Rather, he owns his own business. §62…would
fit under §62(a)(1) because he owns his own business and is not an employee.
o
Employee pays medical costs, makes charitable contributions and pays home mortgage. §63
(medical costs), §63 (charitable contributions), §63 (home mortgage interest).
o
Employee loses money on stock held for investment. §62(a)(3): loss on property and deducted
above the line.
o
Employee deducts 1K in student loan interest. §62(a)(17) above the line.
o
Taxpayer pays $6,000 of alimony. §62(a)(10)
------------------------------------------------------------------------------------------------------------------------------SPRING 2006 PRACTICE BIG UGLY QUESTION
During the first part of 2005, John worked for Hilton Hotels. He earned $40,000 in salary. Hilton Hotels owns a
catering business, and as part of his contract, John was entitled to a 50 percent discount on meals. The catering
business had a cost of goods sold of $500,000 for 2005. Its total sales to customers were $750,000. John purchased
$2,000 of meals, paying only $1,000.
John was also in a bad car crash. He recovered $50,000 as a damage award from the crash. The $50,000
represented $10,000 for pain and suffering and $40,000 for wages lost on account of his time spent recuperating.
In July, John quit his job and started his own business as a consultant. He was paid $50,000 as a consultant. He
took numerous clients to lunch to discuss work, incurring a cost of $3,000. He worked at home and incurred
$5,000 in expenses driving from his home to the offices of his various customers.
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He paid $5,000 of alimony to his ex-wife (previous marriage) and $5,000 in fees to his investment advisor.
John files a joint return.
F. What is John’s Gross Income?
$40,000 + $1000 + $0 + $50,000 = $91,000
Salary: $40,000 (§61(a)(1))
Fringe Benefits: (§132) Different line of business so cannot exclude (so would use $1000 of total
discount, but if it could be deducted because make argument that this is part of the same line of
business since work at the hotel (don’t really know that what area he works in), here is the
calculation.
($750,000 – 500,000) / $750,000 = $250,000 / $750,000 = 33.3%
($2,000 – 1,000) / $2000 = 50%
$2000 * .333 = $660 is excludable, $340 taxable
$0, $40,000 for lost wages because 104(a)(2) doesn’t apply because physical injury, would only get
pain and suffering for physical injury (explain but probably can assume this).
$50,000 consultant income (S61(a)(1))
G. What is John’s Adjustable Gross Income?
Possible Deductions: (need to classify them as above or below the line)
1. $3,000 §274(n) Business meals (doesn’t matter if it is extravagant, don’t assume that it is
extravagant if it doesn’t say that it is), only can deduct half = $1,500 Trade or business
deduction, not acting as an employee, §62 deduction
2. $5,000 RR 99-7 Driving (probably deductible under RR 99-7 since he was working at home
and drove to do work)Trade or business deduction, not acting as an employee, §62 deduction
3. $5,000 §72 Alimony, §62 deduction
4. $5,000 §212 Investment fees (trying to make money, so can deduct that amount) if this was
commissions on the investment would be capitalized in the cost, but assuming this is not
commissions), §63 deduction, is it an itemized deduction or a misc. itemized deduction subject
to the 2% floor (§67 laundry list of things not subject to 2% floor) so since not on list the it is
subject to 2% floor.
AGI = 91,000 – (1,500+5,000+5,000) = $79,500
H. What is John’s Taxable Income?
Assume personal exemption of 2, because he is filing jointly so assume that he is married and they
each get to have an exemption §151.
TI = 79,5000 – $4,000 (2 exemptions) - (must determine if you should use Standard deduction or
itemized deduction)
Misc. Itemized deductions = 79,500 * .02 = 1590, $5000 – 1590 = $3410, so only take $3410 for
itemized deduction
STD = $6,000
ID = $3,410
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Obviously chose $6,000 of STD since higher than ID
TI = $79,500 - $4,000 – 6,000 = 69, 500
Use tables in §1 of the Tax Code to determine tax, don’t use revenue procedure at front of the book.
Emotional distress which is tied to a physical injury is completely tax free, if no physical injury only to the
extent you have doctor’s bills.
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