The general definition of gross income is found in Section 61(a) of the Internal Revenue Code.
The term "income" is used in the Code, but is not separately defined
Economic income is the sum of the taxpayer's change in net worth and the actual consumption of goods and services during the tax period.
The accountant's concept of income is based on the recognition principle.
False. The accountant's concept is based on the realization principle.
For any individual taxpayer, financial income and taxable income are always the same amount.
Payments must be made in cash to qualify as deductible alimony.
If two taxpayers exchange services, neither one realizes any gross income since there was not an exchange of cash.
False. Gross income is not limited to cash received. It includes income realized in any form whether in money, property, or services.
Corporate taxpayers must always use the cash method of accounting.
False. Most corporations use the accural method.
A cash basis taxpayer defers income recognition on an account receivable until it is collected.
The benefits of the group term life insurance premium exclusion are not available to proprietors and partners.
The interest on U.S. "Series EE" savings bonds must always be reported using the cash method of accounting.
False. Taxpayers may elect the accural method.
Prepaid income received is not always income in the year payment is received.
True. In some cases, an accrual basis taxpayer may be able to defer recognition of the income under Rev.Proc. 71-21.
Taxable income from personal services can be shifted to other taxpayers such as family members.
False. The assignment of income does not shift the tax liability.
In all community property states (Texas, California, etc.), income derived from separate property is separate income.
False. In Texas, Louisiana, Wisconsin, and Idaho income derived from separate property is community income.
On the sale of stock, dividends are generally taxed to the person who is entitled to receive the dividends.
Income from property must be included in the gross income of the owner of the property
If a taxpayer is entitled to receive income, which is made available to him, he cannot "turn his back" on it.
Most individual taxpayers use the cash method of accounting.
The recovery of capital doctrine means that the amount received from a sale of property is reduced by the adjusted basis in arriving at the gross income on the property sold.
There is a maximum amount of Social Security benefits that must be taxable income of an individual taxpayer.
The premiums on the first $50,000 worth of nondiscriminatorv insurance provided to an employee can generally be excluded from the employee's gross income.
If the interest rate on a loan to certain related parties is less than the Federal rate the imputed interest is the difference between the amount that would have been charged at the Federal rate and the amount actually charged.
If a group term life insurance plan discriminates in favor of key employees, the key employees must include in gross income the lesser of the actual premiums paid by the employer or the amount calculated from the Uniform Premium Table.
False. The GREATER of the actual premiums paid by the employer or the amount calculated from the Uniform Premiums table must be included in the key employee's gross income.
A cash basis taxpayer must recognize income when a check is received, even if the check is received after backing hours.
A taxpayer includes funds received from an agent (such as an auctioneer) in the year the funds are received from the agent, not in the year the agent collected the funds.
Child support payments are deductible by the payor and includible in the gross income of the payee.
An annuitant can exclude from income the amount calculated using the exclusion ratio until the annuitant has recovered his or her investment in the contract.
For a corporate dividend received by a taxpayer to be "qualified dividend income," stock on which a dividend is paid must have been held for more than 90 days during the 120-day period beginning 60 days before the ex-dividend date.
False. The stock has to be held 60 days out of 120 days.
Roberto is in the 33% tax bracket, and in 2010, he has 1,000 in dividend income from Wal-Mart stock (Wal-Mart stock is qualified stock). His tax on the Walmart dividends is $330.
False. The tax is 15% x 1,000 = 150
When govenment bonds (Series EE) are purchased by parents for their children , the children generally should file a return and elect to report the income on the accrual basis.
Luke is laid off when his job is outsourced to India. As a result, in 2010, he receives 5,000 in unemployment compensation during the year. The $5,000 is excluded from Luke's income for the year.
False. In 2010 (assuming an extension from 2009), the first $2,400 is excluded and the balance of the $5,000 is included from Luke's income for the year.
A bank deposits $500 in interest in a savings account on December 31, 2009. The depositor withdraws $2,000 on January 3, 2010. How much income must be recognized for 2009?
500. Only the interest income
On December 1 of the current year. Drew receives $9,000 for three months rent (December, January, and February) of an office building. Drew is an accrual basis taxpayer. How much income must be recognized in the current year?
The entire $9,000 is taxable when received.
Chris is a 30-year-old single taxpayer. He has one dependent child living with him. During the current year, Chris received all of the following items:
Child support $6,000
Unemployment compensation $6,400
Interest on U.S. Treasury bonds $400
Lotto Winnings (Net) $600
Of the above amounts, how much must Chris include in his gross income for 2010?
25,000 + $9,000 + $4,000 ($6,400 - $2,400) + $400 + $600 = $39,000
During the year, Dan earned a salary of $50,000 and his wife earned a salary of $40,000. If Dan and his wife file separate income tax returns, Dan would report how much income?
50% ($50,000 + $40,000) = $45,000
Which of the following is not a community property state?
Georgia is not a community property state
Pablo, a calendar year taxpayer, owns 30 percent of Wirra Corporation, an S Corporation. Wirra Corporation had taxable income of $100,000. During the year, the corporation made distributions of $20,000 to Pablo. Pablo's dividend income from other corporations was $25,000. What is Pablo's taxable income from the corporations?
30% ($100,000) + $25,000 = $55,000
Jill, a single taxpayer, received $10,000 in Social Security benefits. Her adjusted gross income was $31,000 and she had no tax-free interest income. How much of the Social Security benefits shuld Jill include in her income?
5,000 = lessor of 50%x $10,000 = $5,000, or (2) 50% x [$31,000 + 50 %($10,000)? $25,000] = $5,500
Rita, a single taxpayer, received $10,000 in Social Security benefits. Her adjusted gross income was $70,000 and she had no tax-free interest income. How much of the Social Security benefits should Rita include in her income?
$8,500 = Lesser of: (1) 85%(10,000)=8,500 or Sum of : 85% [70,000] + 50%($10,000) - $34,000] = $34,850,plus lesser of: (a) $5,000, amount from first formula or (b) $4,500 = $34,850 + $4,500 = $39,350
Judy has savings bonds (Series EE), which increased in redemption value by $600 during the current year. In addition, Judy has $1,000 in interest on her savings account at Big Town Savings & Loan. If Judy has not made any elections and she is a cash basis taxpayer, she should report taxable interest income of:
The increase in the redemption value of the Series EE bonds is not taxable.
A lawyer drafts a will for a dentist in exchange for dental work. The dentist would normally have charged $400 for this work. Since the attorney normally charges $300 for drafting a will, he paid the dentist $100 in cash. Based on this transaction, how much should the dentist include in his gross income?
400. 300 + 100
Erin, a 27 year-old cash basis calendar year taxpayer, received the following from her employer during the current year:
Group term life insurance premiums
paid by Erin's employer for 50,000
of term life coverage for Erin 2,000
Rental value of company car used
for vacation 700
What is Erin's gross income from the above Items?
$50,000 + $6,000 + 700 = $56,700
Lisa owned stock in Nulabor Corporation, which originally cost $100,000 She sold the stock for $75,000 plus 10 percent of Nulabor's income in the year of sale plus 10 percent of the next 5 additional years of income. The value of the future income cannot be determined in the year of sale. In the first year, Lisa received payments of $84,000 from the purchaser. What is Lisa's taxable gain in the first year?
The $84,000 is a recovery of capital.
In November 2009, John entered into a contract to deliver goods to a customer in March 2010 for $12,000. John uses the accrual method of accounting for both financial and tax purposes. He collected $8,000 in 2009 and the balance in 2010. John did not have the goods in stock on December 31,2009. The cost of the goods to him is $9,000. How much net inome must John report in 2009?
The income is reported in 2010
Sky Corporation sells service contracts for 12 and 24-month periods. In September 2009, the company sold $8,000 of the 12-month contracts and $10,000 of the 24-month contracts. If the company services each customer each month (October, November, and December 2009), how much income should be reported for 2009 if Sky Corporation follows Rev. Proc. 71-21.
12,000. 3/12 ($8,000)+ $10,000 = $12,000
Vicki owns 25 percent of K&A partnership. The partnership had net income of $200,000. During the year, Vicki withdrew $35,000 from the partnership. What is Vicki's reported share of net income from K&A?
50,000. 25% ($200,000) = $50,000
On July 15, the Board of Directors of Goolwa Corporation declared a $1 dividend payable July 30 to shareholders of record on July 25. As of July 15, Norman owned 1,000 shares. On July 16, he sold 700 shares to Sam for the fair market value, and he gave 300 shares to his son. How much dividend income must Norman report?
300. Norman is taxed on the dividends related to 300 shares because the gift was made afterthe declaration date. He is not taxed on the shares sold.
Dave, an employee of Purple, Inc., is covered by a group term life insurance policy that has a face amount of $60,000. The company pays all the policy premiums, which amount to $500 per year. Accordmg to Reg. Section 1.79-3, the cost of a policy for a man Dave's age is 43 cents per $1,000 per month. How much income should Dave report on his tax return?
51.60. $•43 X [($60,000 - 50,000)/$ 1,000] x 12 months = $51.60
Robert is divorced in the current year. He makes cash payments to his ex-wife of $1,000 per month. When their son, who is in his wife's custody turns 18 years-old, the payments are reduced to 600 per month. How much can Robert deduct as alimony each month?
600. The $400 is a contingent amount related to a child-and, thus, is nondeductible child support.
Nicky goes on a game show, Wheel-of-a-Deal. She wins cash of $15 000 and a new car with a fair market value of $20,000. How much income must Nicky report from these winnings?
35,000. All the winnings are income.
In the current year, Dave receives stock from his employer worth $25,000. The stock cannot be sold by Dave for seven years. Dave estimates that the stock will be worth $60,000 after the seven years. In the current year, how much income must Dave recognize?
0. The stock is restricted property
Hank retired last year after investing $100,000 in an annuity, which pays $12,000 per year. Hank had a life expectancy of ten years at the annuity starting date. What is Hank's income for the current year assuming Hank receives $12,000 during the current year?
2,000. $100,000/($12,000 X 10 years) x $12,000 = $10,000 excluded; $12,000 -10,000 = $2,000 included.
Lany, a cash basis taxpayer, paid $42,000 for an 18-month certificate-of-deposit with a maturity value of $50,000. The effective interest rate on the certificate was 12 percent. If Larry bought the certificate on June 30 of the current year, how much interest income should he report?
2,520. (.12 X $42,000) x 1/2 year = $2,520
Under a divorce decree granted three years ago, Oliver has to pay his ex-wife alimony. The cash payments are as follows:
What is Oliver's alimony deduction for 2008?
32,000. First year alimony is deductible.
Under a divorce decree granted three years ago, Oliver has to pay his ex-wife alimony. The cash payments are as follows:
What is Oliver's alimony recapture for 2010?
D = 25,000 - ($0 + $15,000) = $10,000, E = $32,000 - [($25,000 - $10,000 + 0)/2 +$15,000] = $9,500, R = $10,000 + $9,500 = $19,500
Under a divorce decree granted last year, Vance transfers appreciated property to his ex-wife. The property has a fair market value of $150,000 and an adjusted basis to Miguel of $60,000 If Miguel's ex-wife were to sell the property three years later for $160,000, how much gain should she report?
$160,000-$60,000 = $100,000
Assume during the first six months of the current year the Federal imputed interest rate is nine percent and during the second six months it is ten percent. On January 1, a father gives his son an interest-free loan of $50,000. The son has $5,000 of investment income for the year. For the current year, what is the interest income that the father must recognize, and what amount of interest expense is the son deemed to have incurred?
$4,863 = $2,250 (9% x $50,000 x 1/2 year for January 1 to June 30) + $2,613 (10% $52,250 X 1/2 year for July 1 to December 31)
Assume during the first six months of the current year the Federal imputed interest rate is nine percent and during the second six months, it is ten percent. On January 1, a father gives his son an interest-free loan of $50,000. The son has $5,000 of investment income for the year. How much of a "gift" has the father made to his son?
4,863. The imputed interest is a gift for tax purposes.
$4,863 = $2,250 (9% x $50,000 x 1/2 year for January 1 to June 30) + $2,613 (10% $52,250 X 1/2 year for July 1 to December 31)
Kathy, a cash basis taxpayer gave away Green, Inc. bonds with a face amount of $10,000 to her son. Bill. The bonds have a stated annual interest rate of nine percent. The gift was made on February 10, 2010 and interest was paid to Bill on December 31, 2010. How much interest income must Kathy recognize in 2010?
101. 9% X $10,000 X (41 days/365 days) = $101
Mabel owned the following stock on January 1,2010:
Red Corp. $200 $220
Yellow Corp. $175 $170
During the year, Mabel sold the Red stock for $215 and the Yellow stock for $180. Mabel's income under the economic concept of income is:
5. Economic income is the change in the FMV of the taxpayer's assets. ($215 - $220) + ($180-$170) = $5
Bob and Sally, a married couple, reside in Arizona. Bob owned an office building prior to their marriage. During the current year, income from the building was 20,000. Bob earned 62,000in wages and Sally earned 44,000 in wages during the current year. At the beginning of the current year, Sally inherited 100,000 from her mother, which she put in a separate account and earned 8,000 of interest. They also have a joint savings account, which earned 4,000 during the current year. What is Bob's gross income for the current year?
Bob's gross income for the current year is $75,000 [($62,000 + $44,000 + $4,000) / 2 + 20,000
Gold Corporation purchased a group term life insurance plan that covered only management and officers of the company. Mr. Gold received $250,000 of life insurance under this plan. Premiums of 43,100 were paid by Gold Corporation for Mr. Gold's insurance. The Uniform Premiums fable amount for each $1,000 of insurance for a man Gold's age is $9 annual. Mr. Gold must include in gross income:
The plan is discriminatory, therefore, the greater of the actual premiums paid or the Uniform Premiums table amount is included in income.
Peg owns a life insurance policy with a face amount of $100 000. On January1, 2010, the policy had a cash surrenderer value of $15,000 and on December 31, 2010, the cash surrender value was $16,500. During the year, Peg paid premiums on the policy of $2 500. What must Peg report from this insurance policy for 2010?
The increase in value is not taxed because of 'substantial restrictions" on the life insurance policy.
Donna, age 54, purchased an annuity for $100,000 under which she is to receive $600 per month for life. Her life expectancy is 29.5 years at the annuity starting date. Thus, her expected return is $600 x 12 x 29.5 = 212,400 and the annual exclusion amount is 3,390[($100,000/$212,400 x$7,200)]. If Donna dies after four years, how much is the deduction (if any) from the annuity on her final return?
$100,000-(4 X $3,390) = $86,440
Bill, age 57, receives an annuity distribution of $600 per month for life from a qualified retirement plan. His investment in the contract is $139,500. How much of each payment is excluded from Bill's income using the Simplified Method for Annuity Distributions from Qualified Retirement Plans?
$139,500 / 310 months = $450
Which of the following dividend distributions would qualify for the 2009 0%/15% long-term capital gain rate?
S corporation dividends
Regular dividends from a publicly traded U.S. corporation
Dividends from a corporation located in a country that does not have a tax treaty with the US
Dividends from publicly traded U.S. corporations are qualified dividends for purposes of the special 2009 0%/15% tax rate.
The U.S. tax law would favor which of the following investments?
Land that is appreciating at 9% per year.
A corporate bond that pays 9% per year.
60-month bank certificate of deposit paying 9%
A 30-year U.S. Treasury bond paying 9% a year.
The annual gain on the land would be deferred while the income on the other investments would be taxed each year.
Damon (a cash basis taxpayer) receives a check from one of his customers on December 25. The check is dated December 28, however, the customer asks Damon not to cash the check until December 30. Damon actually cashes the check on January 2 of the next year. Which of the following dates should Damon recognized the income from the check?
December 30. The check is income on the date the check can be cashed.
Steve, a cash basis taxpayer, gave his son.,Josh, bonds with a face amount of $20,000 and a 6% stated annual interest rate. The gift was made on January 31, 2010, and the interest was paid on December 31,2010. How much interest income must Steve report in 2010?
$102 = $20,000 X 6% X 31/365.
The accountant's concept of income is generally based upon the realization principle. Financial accounting income may differ from taxable income (e.g., accelerated depreciation might be used for Federal income tax and straight-line depreciation for financial accounting purposes). Differences are included in a reconciliation of taxable and accounting income on Schedule M-1 or Schedule M-3 of Form 1120 for corporations. Seventy-five percent of the excess of adjusted current earnings over alternative minimum taxable income is an adjustment for alternative minimum tax purposes for a corporation. See also alternative minimum tax and economic income.
The method under which income and expenses are determined for tax purposes. Major accounting methods are the cash basis and the accrual basis. Special methods are available for the reporting of gain on installment sales, recognition of income on construction projects (the completed contract and percentage of completion methods), and the valuation of inventories (last-in, first-out and first-in, first-out). §§ 446-474. See also accrual method, cash receipts method, completed contract method, percentage of completion method, etc.
A method of accounting that reflects expenses incurred and income earned for any one tax year. In contrast to the cash basis of accounting, expenses do not have to be paid to be deductible nor does income have to be received to be taxable. Unearned income (e.g., prepaid interest and rent) generally is taxed in the year of receipt regardless of the method of accounting used by the taxpayer. § 446(c)(2). See also accounting method, cash receipts method, and unearned income.
Alimony and separate maintenance payments
Alimony and separate maintenance payments are includible in the gross income of the recipient and are deductible by the payor. The payments must be made in discharge of a legal obligation arising from a marital or family relationship. Child support and voluntary payments are not treated as alimony. Alimony is deductible for AGI. §§ 62(10), 71, and 215. See also child support payments.
The amount of alimony that previously has been included in the gross income of the recipient and deducted by the payor that now is deducted by the recipient and included in the gross income of the payor as the result of front-loading. § 71(f ).
A fixed sum payable to a person at specified intervals for a specific period of time or for life. Payments represent a partial return of capital and a return (interest) on the capital investment. Therefore, an exclusion ratio must be used to compute the amount of nontaxable income. The exclusion ratio is used until the annuitant has recovered his or her investment in the annuity contract. Thereafter, all of the annuity payments received are included in gross income. If the annuitant dies before his or her investment is recovered, a deduction is allowed. § 72. See also qualified pension or profit sharing plan.
Assignment of income
A procedure whereby a taxpayer attempts to avoid the recognition of income by assigning the property that generates the income to another. Such a procedure will not avoid the recognition of income by the taxpayer making the assignment if it can be said that the income was earned at the point of the transfer. In this case, usually referred to as an anticipatory assignment of income, the income will be taxed to the person who earns it.
Cash receipts method
A method of accounting under which the taxpayer generally reports income when cash is collected and reports expenses when cash payments are made. However, for fixed assets, the cash basis taxpayer claims deductions through depreciation or amortization in the same manner as an accrual basis taxpayer. Prepaid expenses must be capitalized and amortized if the life of the asset extends "substantially beyond" the end of the tax year. See also constructive receipt.
Claim of right doctrine
A judicially imposed doctrine applicable to both cash and accrual basis taxpayers that holds that an amount is includible in income upon actual or constructive receipt if the taxpayer has an unrestricted claim to the payment. For the tax treatment of amounts repaid when previously included in income under the claim of right doctrine, see § 1341.
Louisiana, Texas, New Mexico, Arizona, California, Washington, Idaho, Nevada, and Wisconsin have community property systems. In Alaska, spouses can choose to have the community property rules apply. The rest of the states are classified as common law jurisdictions. The difference between common law and community property systems centers around the property rights possessed by married persons. In a common law system, each spouse owns whatever he or she earns. Under a community property system, one-half of the earnings of each spouse is considered owned by the other spouse. Assume, for example, Alice and Jeff are husband and wife and their only income is the $50,000 annual salary Jeff receives. If they live in New York (a common law state), the $50,000 salary belongs to Jeff. If, however, they live in Texas (a community property state), the $50,000 salary is divided equally, in terms of ownership, between Jeff and Alice. See also separate property.
If income is unqualifiedly available, it will be subject to the income tax even though it is not physically in the taxpayer's possession. An example is accrued interest on a savings account. Under the constructive receipt of income concept, the interest will be taxed to a depositor in the year it is available rather than the year actually withdrawn. The fact that the depositor uses the cash basis of accounting for tax purposes is irrelevant. See Reg. §1.451-2.
The change in the taxpayer's net worth, as measured in terms of market values, plus the value of the assets the taxpayer consumed during the year. Because of the impracticality of this income model, it is not used for tax purposes. See also accounting income.
Fruit and tree metaphor
The courts have held that an individual who earns income from property or services cannot assign that income to another. For example, a father cannot assign his earnings from commissions to his child and escape income tax on those amounts.
Income subject to the Federal income tax. Gross income does not include income for which the Code permits exclusion treatment (e.g., interest on municipal bonds). For a manufacturing or merchandising business, gross income means gross profit (gross sales or gross receipts less cost of goods sold). § 61 and Reg. § 1.61-3(a).
Group term life insurance
Life insurance coverage permitted by an employer for a group of employees. Such insurance is renewable on a year-to-year basis and does not accumulate in value (i.e., no cash surrender value is built up). The premiums paid by the employer on the insurance are not taxed to an employee on coverage of up to $50,000 per person. § 79 and Reg. § 1.79-1(a).
A combination of the accrual and cash methods of accounting. That is, the taxpayer may account for some items of income on the accrual method (e.g., sales and cost of goods sold) and other items (e.g., interest income) on the cash method.
For certain long-term sales of property, the IRS can convert some of the gain from the sale into interest income if the contract does not provide for a minimum rate of interest to be paid by the purchaser. The application of this procedure has the effect of forcing the seller to recognize less long-term capital gain and more ordinary income (interest income). §§ 483 and 1274 and the Regulations thereunder. In addition, interest income and interest expense are imputed (deemed to exist) on interest-free or below-market rate loans between certain related parties. § 7872. See also interest-free loans.
For tax purposes, an increase in wealth that has been realized.
Original issue discount (OID)
The difference between the issue price of a debt obligation (e.g., a corporate bond) and the maturity value of the obligation when the issue price is less than the maturity value. OID represents interest and must be amortized over the life of the debt obligation using the effective interest method. The difference is not considered to be original issue discount for tax purposes when it is less than one-fourth of 1 percent of the redemption price at maturity multiplied by the number of years to maturity. §§ 1272 and 1273(a)(3).
A partnership is treated as a conduit and is not subject to taxation. Various items of partnership income, expenses, gains, and losses flow through to the individual partners and are reported on the partners' personal income tax returns. §§ 701 and 702.
Recovery of capital doctrine
When a taxable sale or exchange occurs, the seller may be permitted to recover his or her investment (or other adjusted basis) in the property before gain or loss is recognized. See also open transaction.
The annual period over which income is measured for income tax purposes. Most individuals use a calendar year, but many businesses use a fiscal year based on the natural business year. See also accounting period and fiscal year.
-All income (legal or illegal-State v. James) from whatever source derived UNLESS there is an express exclusion under the code (Cesarini v. U.S)
Ceserini v. U.S.
-Discovery = GI
-Rule: Realization becomes taxable upon discovery of the money
-Held: The finding of a valuable instrument/item is like Ceserini & will be income upon discovery
Wolder v. Commissioner
Inheritance for Services Rendered = GI
Charley v. Commissioner
Travel credits converted into cash = GI
Commissioner v. Glenshaw Glass Co.
-Punitive Damages = Taxable Income
-Held: Punitive damages are not gifts and they are not under any exemption under the Code
Old Colony Trust Co. v. Commissioner
-Debt Relief = GI
-Holding: Employer's payment of income taxes assessed against employee constitutes "additional taxable income"
-Analysis: Any money given from employer to employee is likely presumed as income for services rendered
Commissioner v. Banks
-Held: When a taxpayer's recovery constitutes income, the taxpayer's income includes the portion of the recovery paid to the attorney as a contingent fee.
Helvering v. Independent Life Insurance Co.
- Held: GI does NOT include the rental value of your own home. You do get some kind of benefit from the use of your own building
Dean v. Commissioner
Held: The Appellate Court found that the house was legally the property of the corporation. So when the corporation let Dean live there rent free, that constituted a gain for Dean, and should be considered gross income. The fact that Dean owned the corporation was immaterial.
Revenue Ruling 79-24
- Section 1.61-2(d)(1): If services are paid for other than in money, the FMV of the property or services taken in payment must be included in income...
- Must include in GI the FMV of services received in exchange for services rendered.
- Thus, if a housepainter paints an attorney's house in return for legal services rendered, the attorney must include the FMV of the paint job in his income and the housepainter must include the FMV of the legal services in his income
U.S. v. James
- Illegal income such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21 or on Schedule C or Schedule C-EZ (Form 1040) if from your self-employment activity
If you steal property, you must report its fair market value in your income in the year you steal it.
- GI does not include the value of property acquired by gift, bequest, devise or inheritance.
- Gift is not defined in the statute - must rely on case law.
- Gift must be of a present interest in property
Income From Gifts
- Exclusion will not apply to income from property.
Example: Dividend from gift of stock would be taxable
Exclusion will not apply to gift of right to receive future income.
Employee Gifts- Section 102(c)
Subsection (a) shall not exclude from GI any amount transferred by employer to, or for the benefit of, an employee.
Exceptions to 102(c) Inclusion Rule
1. Certain traditional retirement gifts are treated as de minimis fringe benefits (See §132(e))
2. Certain employee achievement awards are freed from tax (See §74(c))
3. Exception for 'extraordinary transfers to the natural objects of an employer's bounty if employee can show that the transfer was not made in recognition of employee's employment.
Commissioner v. Duberstein
- Donor's INTENT is the key factor. Look for generosity, affection...like impulses, a gratuitous generous non-economic mens rea indicates a gift
- Held: It was at bottom a recomense for Duberstein's past services or an inducement for him to be of further service in the future. (Cadillac Case)
Why exclude gifts?
- Administratively difficult to distinguish between legal obligation of "support" and a "gift"
- Possible Policy: Most gifts occur within a family unit and tax has already been paid when the wealth was brought into the family unit. We want to encourage care of next generation through family.
Lyeth v. Hoey
- When a taxpayer acquires property interest as an heir and it is disbursed to him pursuant to a compromise agreement, such property is obtained through inheritance and exempt from income.
GI includes the receipt of any financial benefit which is:
1) Not a mere return of capital, and
2) Not accompanied by a contemporaneously acknowledged obligation to repay, and
3) Not excluded by a specific statutory provision
What's the Fair Market Value (FMV)?
The FMV is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts
- Note: It's basically what they SAY it is.
- Taxpayer recognizes no gain or loss on the transfer of property to: A spouse OR A former spouse, but only if the transfer is incident to the divorce
- The basis of the property at the time of the transfer (the transferor's adjusted basis) will carry over to the transferee and be recipient's basis
- For income tax purposes, the transfer is treated as a gift. Section 1041(b). No loss exception.
- This carry over basis occurs regardless of whether the transfer is a gift or is a sale or exchange between spouses acting at arm's length.
- Section 1041 creates a conclusive presumption that the transfer is "incident to a divorce" if the transfer occurs within a year after the date on which the marriage ceases.
- The "loss exception": IF the value of the property decreases below the Donor's basis prior to the transfer of the gift to the recipient... Section 1015(1) provides for the purpose of determining a loss the basis shall be such FMV.
Ex. Basis gets stepped down if you'll be selling that "golden bowling ball" at a loss
- For calculating a loss ONLY, it's the FMV at the time of transfer
- Note: this was implemented b/c people would use that loss as a deduction
Charitable Deduction- 170
- 170(a)(1)-There shall be allowed as a deduction any charitable contribution....allowable as a deduction ONLY if verified under regulations prescribed by the Secretary
274(A) Entertainment, Amusement, or Recreation
In General: No deduction otherwise allowable under this chapter shall be allowed for any item--
A) When you engage in entertainment, amusement, or recreation-there must be a meaningful, substantial, bona fide business discussion
Note: Section 274(n) limits most of your entertainment expenses to 50% deduction
74(C) Prizes and Awards
GI shall not include the value of an employee achievement award
Business Gifts to Customers to Bolster Goodwill
- 274(b)(1)(b) Limitation: No deduction shall be allowed under section 162 or section 212 for any expense for gifts made directly or indirectly to any individual to the extent that such expense, when added to prior expenses of the taxpayer for gifts made to such individual during the same taxable year, exceeds $25.
Note: Mailing and Packaging costs are not included
What is "Gain"
Gain is the excess of the amount realized therefrom over the adjusted basis
What is "Basis"
- Basis is the tool to determine to what extent T's capital is merely being returned to her
- Basis (unadjusted) answers the question: How much have I got into it?
-Definition: The value of taxpayer's investment in property.
What is "Cost Basis"
Philadelphia Park Amusement Co. v. United States
- Rule: Cost basis for exchange of property = FMV of object received on Date of Exchange
-Held: The cost basis of the 10-year extension of the franchise was its FMV of the thing exchanged (10 yr extension) on August 3, 1934
- Note: IF cost for thing received cannot be ascertained it's presumed that it is the same as the property given.
What is a "Substituted Basis"
-See Philadelphia Park Amusement Co.
-Substituted Basis: For income tax purposes, value of two properties exchanged in an arms-length transaction are either equal in fact or are presumed to be equal
Taft v. Bowers
- Cost basis for a gift of shares for stock = amount appreciated since Donor's purchase of stock
- Held: The IRS could tax the appreciation which occurred while the gift was in the hands of the donor, finding that nothing in the Constitution requiring Congress to tax increased capital only so far as the increase occurred while in the hands of the current owner.
Farid-Es-Sultaneh v. Commissioner
- Held: She received a cost basis since there was consideration at the time of transfer. She was NOT a donee, but a PURCHASER for fair consideration.
- Stock was not a gift. Basis was FMV of the stock when transferred
Cesarini v. United States
§61: Equivocal Receipt of Financial Benefit
* Piano Case
Treasure Trove Regulation; Reg. 61-14
Must include in gross income; items found (treasure trove) are under complete dominion of the taxpayer.
Old Colony Trust Co. v. Commissioner
§61 Equivocal Receipt of Financial Benefit
*Company pays employees' income taxes
[H]: Payments by the employer income taxes assessable against the employee constitutes ADDITIONAL taxable income against such employee.
§61 Equivocal Receipt of Financial Benefit
*Punitive Damages - Civil Suit Settlement
3 Part Test: (1) Accession of Wealth (2) Clearly Realized (3) Complete Dominion.
Commissioner v. Duberstien
§102(a) Income Tax: Meaning of "Gift"
* Cadillac Case
[H]: Whether a transfer of money or property constitutes a gift within exclusions of §102(a) is a question for the trier of fact.
Not a gift in this case and was includible in income.
U.S. v. Kirby Lumber
§108: Income from Discharge of Debt
* Stocks and Bonds Case
[H] Cancellation of debt is gross income to the borrower.
Look at: (1) Freeing of Assets (2) Symmetry
- Loans not income b/c obligation to repay
- Cancelation of obligation to repay remains reason from excluding the proceeds from income.
Zarin v. Commissioner
§108: Income from discharge of indebtedness
*Gambling Debts Case
[H]: If the debt is not legally enforceable there is no liability to repay, thus no discharge of indebtedness/ascension of wealth.
Young v. Commissioner
§1041: Property Settlements (see §1015(e))
*Property Transfers between former spouses
[H]: Multiple transfers between former spouses pursuant to a divorce/separation instrument are not taxable transfers (taxable when transferred to another party)
Lucas v. Earl
§1 *Husband Assigning income to Wife Case
[R] Taxpayer cannot escape taxation be assigning or giving away income that has been earned or will be earned by the taxpayer
Commissioner v. Giannini
A taxpayer has not realized income if he is offered compensation which he neither receives nor directs its distribution.
*Part of the problem was that there was a "ghost" behind the money and therefore the money may have been owned, but that was not the courts conclusion.
Welch v. Helvering
§162(a): Business Deductions: Ordinary and Necessary.
All ordinary and necessary expenses paid or incurred during the taxable year are deductible is made in the scope of trade or business.
Ordinary: Commonly accepted as such within a particular industry
Necessary: Appropriate and helpful
Midland Empire Packing Co. v. Commissioner
§162 Business Deductions v. Capital Expenditures
[H]: Repairs made during the taxable year are deductible as ordinary and necessary business expenses. Ordinary does not always mean annually or habitual.
§162 Business Expenses
Professional expenses in friendly takeover case
[R] Where one expenditure produces benefit beyond one year, it will likely be capital & thus deductible, but depreciable.
- capitalize a cost if it produces significant benefits that extend beyond the taxable year.
Andrews v. Commissioner
§§162(a)(2) & 274(n)(4): Business expenses, Travel away from home.
*2 Houses - expensing all costs as one
[H] Pick "Principal pace of business"/"major post of duty" & Deduct those as business expenses; cant have cake and eat it too.
6th Circuit Test: Weigh
(1) Length of time spent at each location
(2) Degree of activity in each place
(3) Relative portion of income derived from each place
Philadelphia Park Amusement Co. v. United States
§§1011&1012: Determination of Basis; Cost
[H] Cost basis of property received in a taxable exchange is the FMV of the property received in the exchange.
How is tax liability computed?
Gross income - deductions = taxable income * rates = tax - credits = liability
Define gross income.
"Any accession to wealth, clearly realized, over which the taxpayer has complete dominion. (Or, in codespeak, ""all income, from whatever source derived."""
List the most notable exclusions from gross income for employees.
"Health insurance (premium and benefits), life insurance (premiums up to $50k and benefits), child care (up to 5k), pension plans, tuition assistance (to 5.25k), no-additional-cost fringe, employee discounts ( up to profit margin for goods or 20% for services), working condition fringe, de minimus fringe, on-premises meals and lodgin (for employer's convenience), commuting allowances (within limits), employee acheivement awards (within limits and meaningful ceremony required). (NOTE: Most of these high-cost benefits must be provided without discrimination in favor of high paid employees.) "
Are gifts income? Are there exceptions to this rule?
"Gifts are not income. However, income from gifts is income. Employer to employee gifts are irrebutably presumed to be compensation, unless close family member. "
What is a gift?
"Any transfer from ""detatched and disinterested generousity,"" including bequests and devises. Tips are not gifts."
When are damages from a lawsuit involving non-personal injury income?
"Generally, it depends on what the damages are replacing. If replacing lost profits, they are taxable. If replacing property, they are treated as a sale of property. If restoring damages to propert, only the gain is taxable. Punitie damages are always income."
When are damages involving personal injury excludable?
"Damages related to physical injury or medical expenses are always excludable, even if partially replacing lost profits. Damages for emotional distress only recoverable up to amount fo medical treatment or if accompanied by physical injury."
Are scholarships income?
"Not to extent that they pay for tuition, books, fees, and supplies for a degree candidate. "
Are loans income?
"No. However, discharge of indebtedness income must be included, unless the forgiveness is a gift, used to purchase the taxpayer's principal residence, or the borrower is insolvent. "
To whom are alimony payments taxed?
"The recipient spouse only, unless the parties agree to treat it as non-alimony. (Note: Alimony payments are considered property settlements to the extent that they are unloaded disproportionately within first two years.)"
"To whom is child support taxed, and how can you tell it's child support rather than property settlement or alimony?"
Taxed to payor. Only child support if reduction is upon an event relating to a child.
"When a taxpayer takes a legitemate deduction one year and then, in a later year, something happens to make that payment non-deductible, what must taxpayer do?"
"Tex Benefit rule requires that, if the prior deduction resulted in an actual tax benefit, the amount must be included in the current year's taxes."
"When is a gain or loss on a property transaction ""realized,"" and how is that amount computed?"
Generally realized upon sale or exchange. Amount realized - adjusted basis = realized gain/loss.
"Generally, how is basis calculated? What about for lifetime gifts? Deathtime gifts?"
"Generally, basis is cost of the property. Gifts take a carryover basis. Basis in deathtime gifts is FMV at time of death (step-up or step-down basis). (Except in 2010, all gifts take carryover basis.)"
What's special about gains made on the sale of a home?
"If buyer lived in the home for at least 2 of the last 5 years, taxpayer may exclude gains on the sale, prorated for the percentage of that five years in which taxpayer lived in the home. "
"In cash basis accounting, when is income and decuctions reprted?"
When the taxpayer actually or constructively received or pays it.
When is property constructively received for the purposes of cash method accounting?
When funds have been set aside and made available for the taxpayer to obtain.
When are income and deductions reported in accrual method accounting?
Income reported when (1) all events have occurred to fix the taxpayer's right to the funds and (2) the amunt can be determined with reasonable accuracy. Deductions are taken when (1) all events have occurred to fix the taxpayer's obligation to pay and (2) the amount can be determined with reasonable accuracy.
What is the installment method of account?
"Installment sellers, other than dealers and retailers, may treat each separate payment as part gain, part return of basis."
What sorts of property transactions in which gain or loss is realized are not recognized at that time?
"all Transfers (including sales) between spouses (carryover bassi), divorvce property settlements (carryover), like kind exchanges of property of like kind used for business or investment."
"In a like-kind exchange of property used for business or investment where boot is included, what amount of gain or loss is recognized?"
"Only up to the lesser of (1) the realized gain, or (2) the amount of boot. "
What is the tax effect when a taxpayer replaced involuntarily converted property with insurance funds or damage money? Time limit?
"The new property takes the basis of the old. If there's excess funds, they are treated as boot. Replacement must occur within two years from the end of the year that the property was lost."
What is a capital gain or loss?
A dividends on corporate stock or gain or loss on the sale of a capital asset.
What produces capital gains and ordinary losses?
Sale of real estate used for business or copyright on taxpay-created msuic.
What produces capital gains and capital losses?
"Sales of stocks, bonds, and mutual fund shares, as well as any other property held as an investment."
What produces capital gains and nondeductible losses?
Assets held for personal use.
What produces ordinary income and ordinary losses?
"Sales f inventory, copyrights in non-music, most equipment."
"What produces ordinary income, nondeductible loss?"
Tho whom is income from personal services taxed?
Always to the provider.
To whom is income from one's property taxed?
"Almost always to the owner, unless held in an irrevocable trust in which granto may not change beneficiary. "
What is the kiddie tax?
All unearned income of children under 19 is taxed at the parent's highest marginal tax rate.
What is the general rule about when expenses are deductible?
"Costs of living and sales of personal property are not deductible, any ""ordinary and necessary"" expenses of making money are deductible. "
List the personal deductions.
"Personal exemption (3.6k per person), alimony paid, casualty losses (10% floor), medical expenses (uninsured only, floor of 7.5%), charitable contributions (30-50% cap, depending on income),home mortgage interest on primary home plus another (cap on interest for amounts aboce $1mil), home equity indebtedness interes (cap 100k), student loan interest (cap $2500 deduction per year), state and local taxes"
List profit-motivated deductions.
"ordinary and necessary business expenses, hobbies (deductible up to income from hobby), defendant's attorney fees if origin of claim is busines, plaintiff's attorney fees if the releif sought is nontaxable, attorney's advice if business related, tax advice, home office if used exclusively for business, vacation homes on a prorated basis, child and elder care credit, business travel expenses, business meals (only 50%), business entertainment (only 50%), specialized work clothes, education to improve or maintain skills in current profession, "
Difference between capital expenditures and current expenses?
"Capital expenditures are expenditures on property that will last for a logn time. Capital expenditures must be placed into the basis of the asset and deducted gradually through depriciation. Current expenses are other expenses, including routine repairs (but not improvements!) of capital assets. These are deductible immediately."
Are capital losses deductible?
"Only up to the amount of capital gains for that year, plus an additional $3k for indivituals.)"
What are the most important things to know about taxation of business entities?
"C-Corporations are texed twice, one on the corporate level, and again when distributed to shareholders. S-Corporation and Partnerships are taxed only once--partners pay their share of the partnerships gains each year, but no additional taxation upon distribution. "
Are gains or losses recognized when property is transferred to form a business entity?
No. The partner/shareholder gets a basis in his share of the entity equal to his contributions to the new entity.
4 categories for differentiating between personal and business expenses
-if you can use it in a personal setting for personal purposes, it is a personal expense
-if there is such a big asset, you can mathematically allocate the business expense
-if there is something you use primarily for business, but sometimes for personal, it is deductible
-where congress passes a statute because there is so much intermingling between work and personal
-Regular activities for profit
-when there is profit, it is taxable
-when you have a loss, it is considered an N.O.L.
-you can deduct this against your spouses income
-a house where you live at least two weeks of the year
-the income from this is taxable, but the loss is not deductible
subchapter C corporation
-all publicly traded companies
-and big corporations that are not publicly traded
-there is no tax deduction for dividends paid out to shareholders
-there is a salary limit for publicly traded companies
-no limit for private corporations that are not publicly traded
-income is taxed to the owner, and the owner pays the tax
-the incentive is for the owner to take a smaller salary so the business income will escape social security tax
3 situations where you can deduct lobbying expenses
1) local government- city/county
2) monitor legislation
3) de minimis- in house (less than $2,000)
-has a useful life beyond the end of the year
-you don't get the tax deduction in the year of expenditure
-improvements are considered capital expenditures
non-cash deduction in future year
1) depreciation or amortization
-if you buy an asset for $10,000, and decide it will last 5 years, you can deduct $2,000 every year for five years
-depreciation of a patent, copyright, or trademark
travel and entertainment test
1) Sec. 162- is this ordinary or necessary?
2) Sec. 274- limitation on entertainment expenses
3) special rules
special rules for travel and entertainment
-for meals and entertainment, the most you can deduct is 50%
-employee must itemize deductions
-can only deduct amount that is greater than 2% of AGI
means you were away from your home overnight
-the local use of your car
-commuting to and from your place of work is not deductible
2 ways to deduct a business expense when it comes to your car
1) actual cost method
2) travel expenses
actual cost method
-what it actually costs to operate your car
-gas, repairs, maintenance, etc.
-the IRS lets you deduct 50 cents to the mile
-so, if you drive 4,000 miles, you can deduct $2,000
-no deduction or credit shall be allowed unless the taxpayer substantiates through adequate records or by sufficient evidence corroborating the taxpayers own statement
-what you need:
3) business purpose
Sec. 162 Business Education
I. Maintain Skills
II. required by employer/law
-required to get job
-qualify for new job
-use form 3903
-if the employer covers moving expenses it is taxable income
1) moving household
2) moving family
-cannot deduct meals
legal test to determine if someone is an employee
-if someone else determines how you do your job, you are an employee
-independent contractors are not employees
1) make an adequate accounting for the expenses
2) return any excess reimbursement for allowance
-1 and 2 from accountable are not required
-all reimbursements are reported as wages... this means it goes on W-2 and its taxable
types of bad debts
1) is it really a bad debt
2) year deductible
3) amount deductible
4) is it a...
-business bad debt
-non business bad debt
1) property settlment
-in a divorce, if you want to claim the deduction and you do not have custody of the child, you have to fill out this form
-taxable income, deductible for the payor
Sec. 71(f)- recomputation where excess front-loading of alimony payments
-recapture occurs whenever alimony payments drop by more than $15,000
-only matters in the first 3 years
-if the difference between year one payments and year three payments is more than $15,000 there is alimony recapture
cost / life = depreciation
-the decline in value is greater in the first few years and then declines after that
-deduct higher depreciation in frist few year,s deduct less depreciation as time goes on
-standard tax reporter
2) regulations (legislative history)
3) explanation (by the editors)
tax law hierarchy
1) code (legislation, statutes)
2) U.S. Supreme Court decision
3) Regulations (executive)
4) U.S. Court of Appeals (Golson Doctrine)
5) Trial Court
6) legislative history
7) IRS (Agency)
a) interpretive regulation
b) legislative regulation
c) proposed regulations
a) U.S. Tax Court
b) U.S. District Court (refund only)
c) U.S. Court of Claims, Washington D.C. (refund only)
U.S. Tax Court Decisions
1) MEMO Decision
- there is a case, but no law supporting it
2) Regular Opinion
3) "S" case- $50,000 or less
-house- ways and means committee
-senate- senate finance committee
IRS (for tax research)
-private letter rulings
strict line depreciation
cost divided by the life
questions for when you have a capital asset
-when do you start depreciation?
-MACRS or amortization
what? (for a capital asset)
-determinable useful life
NOT (for a capital asset)
-land (the value will go up or down, but the land will not wear out)
when do you start depreciation?
when you begin to use it (the item)
MACRS or amortization (for a capital asset)
-MACRS is for tangible property
-amortization is for intangible property
-ex: patents, copyrights, etc.
how long? (for a capital asset)
-congress set the amount of time over which assets will depreciate
3, 5, 7, 10, 15, 20
39, 27.5(for apartment buildings with a long term lease)
how fast? (for a capital asset)
-general: the deductions are rapid (200%/150%)
-elect: straight line
-buildings are straight line only
what convention? (for a capital asset)
-general: mid-year convention
-it assumes you bought all your equipment on July 1st
-you get to deduct half a year of depreciation
-mandatory exception: if you use less than 40% of your assets by the last quarter
what you were supposed to deduct
what you actually deducted
Good: Sec. 179 "Expensing"
1) has to be trade or business property (NOT rental property)
2) applies to tangible personal property (NOT real property)
3) small business (there is a phaseout at $800,000 worth of purchases)
4) the maximum deduction you can get is $250,000
5) taxable income limitation
taxable income limitation for Sec. 179
-income can only be brought down to zero
-if you buy more than $250,000 worth of equipment in one year, the excess can be applied to next year's taxes
1) luxury cars
2) listed property
3) leasehold improvement
-puts a limitation on deductions for cars
-it usually takes more than 5 years to deduct the cost of a car
-anything over $15,300, for tax purposes, is a luxury car
-the maximum first year deduction is $3,060
-includes your car, computer, cell phone and other things you can use business or personal
-to use rapid depreciation, business use must be greater than 50%
-if not, you have to use straight line depreciation
the price you pay over the purchase price of the asset
deduction taken on the front of the 1040
schedule A, itemized deduction
two categories for non-business deductions
-investment expenses (statute sec. 212 calls is production of income)
-personal expenses (w/ statute)
-Cf. sec. 262 (generally not deductible)
-medical and dental expenses
-unreimbursed medical expenses
-only what exceeds 7.5% of your income
1) schedule A (7.5% limit)
2) what? "dr.s orders"
3) capital expenditure
4) health insurance, long term care
health insurance, long term care
-employee: itemize (7.5%)
-self-employed: for AGI
-employee: high deductible- for AGI (but pay social security)
-self employed: for AGI
-employee flex account: don't have to pay social security tax on this
-but it's use it or lose it
taxes that are deductible
-state, local and foreign real property taxes
-state and local personal property taxes
-state and local income taxes or sales/use taxes
-state and local sales taxes on a qualified motor vehicle
-foreign income taxes
taxes that are NOT deductible
-federal income taxes
-FICA taxes imposed on employees
-employer FICA taxes paid on domestic household workers
-estate, inheritance and gift taxes
-federal, state, and local excise taxes (e.g. gasoline, tobacco, spirits)
-foreign income taxes if the taxpayer chooses the foreign tax credit option
-taxes on real property to the extent such taxes are to be apportioned and treated as imposed on another taxpayer
stocks: schedule a
property: schedule e
-investment income LIMITATION
-the most you are allowed to deduct is your investment income
home mortgage (schedule)
student loan (schedule)
personal car loan, credit card, boat loan
home mortgage deduction
a) it is a deduction for your 1st and 2nd dwelling unit
-2nd home can be a vacation home
-the interest is deductible
b) "secured" by dwelling unit
c) dollar limit
dwelling unit (for a home mortgage deduction)
-a place to sleep and a toilet
-doesn't have to be attached to the ground
-winnabegos, yachts, house boats all qualify as 2nd home
dollar limit (for a home mortgage deduction)
-qualified in debt
-the amount you borrowed to acquire your home
-you can deduct the first $1,000,000
-when you use your home as collateral for your debt
-can only deduct the first $100,000
1) family: no deduction, "gift tax"
3) appraisal for property more than $5,000
4) completed gift
6) U.S. 501(c)(3) charity
7) reduce deduction by the value you receive
8) best asset to give charity: long term capital gain stock
9) maximum annual deduction
-less than $250, write a check or have a receipt for cash, property
-for more than $250, you need a contemporaneous written acknowledgment
-you need a description of what you gave
-you need a statement as to whether you got anything in return
appraisal for property more than $5,000 exceptions (gifts)
1) publicly traded stock- average for the high and low of the day you sold the stock
2) closely held stock- threshold is $10,000 before you need an appraisal
maximum annual deduction (gifts)
-50% for gifts of cash
-30% for appreciated capital gain stock
-gains (losses, $3,000)
-any activity which a) involves the conduct of any trade or business, and b) in which the taxpayer does not materially participate
3 things which are passive activities
1) trade or business in which you do not materially participate
2) rental activity
3) limited partnerships
material participation: current year
1) if you work more than 500 hours you materially participate
2) if you're the only worker, then you materially participate
3) if you work more than 100 hours and more than anyone else, you materially participate
4) aggregate participation in business
material participation: prior years
1) did you work at least 5 of the last 10 years?
2) if it is a personal service business and you participated for any of the three previous years, then you materially participated
rental (may not be passive, but not automatically treated as non-passive)
1) the average period of customer use of the property is 7 days or less
2) real estate professional- you have to work there more than 750 hours a year
3) there is a deduction of up to $25,000 if you actively participate
-for every $2 your income is over the 100,000 dollar threshold, your loss goes down by $1
-foreign tax credits
-general business credit
-jobs tax credit
jobs tax credit
-if a company hires disadvantaged individuals, you can take a tax credit for their first $6,000 in income
earned income credit test
1) investment income
2) age 25-64 (n/a children)- congress does not want students or retirees to get this credit
3) "earned income" and "AGI"
-the credit phases out at up to $48,000 if you have 3 kids
-if you have no kids, it maxes out at $13,000 and you only get a $487 credit
eligibility for child and dependent care expenses
-a dependent under 13
-a dependent or spouse who is physically or mentally incapacitated and who lives with the taxpayer for more than one-half of the year
how to compute the child and dependent care credit:
-take the lesser of amount paid for the child care, earned income, and the cap of $6,000
-then multiply that number by the percentage
lifetime learning credit
-20% credit, time the amount of tuition you pay
-the max is $10,000
-so the most credit you get is $2,000
-sale (cash sale)
the fruit of the tree doctrine
-comes from the Iseberg case
-income is the fruit of the tree
-we tax ppl when they take off the fruit
-but the growth of the tree is not taxed
computation for realized gain or loss
amount realized - adjusted basis = realized gain or loss
computation for adjusted basis
cost (or "substantial basis) + capital improvements - depreciation/MACRS - loss - cost/recovery
how to figure out the basis when you sell stock
1) specific identification- ex: you sell the stock you bought at $60 a share
2) FIFO (first in, first out)
-sell the oldest stock first
-you have a bigger profit on the oldest stock
-so this usually has a bad tax result
-when you don't have an actual cost, a number is substituted for it
-when you receive a gift, the basis is a carryover basis
-whatever the cost was to the donor, it carries over to you
-if you sell the gift for a loss, then you're basis is the less of the donor's adjusted basis or the fair market value at the time of the gift
-step up in basis
-you don't have to find out what the cost basis was
-your basis is the fair market value at the end of the day
pay tax on the gain, deduct the loss
pay tax on the gain, deduct the loss
personal use income
pay tax on the gain, cannot deduct the loss
-you sell the stock, and then buy it back a few minutes later
-did you purchase the same stock/securities in the last 30 days?
-there is no deduction for a loss in a wash sale
-if you bought the stock less than 30 days earlier and sold for a loss, no deduction
related party sale
-a sale to a brother or sister triggers these rules
-same with a spouse, grandparent, parent, lineal descendant
-the only thing you can do is to reduce the gain on the sale
Sec. 1031 like kind exchange
1) like-kind property
2) business or investment property for business or investment property
3) NOT and personal USE asset
4) mandatory (even if you wanted to, you can't recognize a gain or a loss)
-personal property- there are specific exchanges allowed
-real property- anything goes
-for tax purposes, this person is not an agent
-when the owner wants to sell and the buyer wants to pay cash, the owner gives the property to the intermediary
-then the intermediary sells it to the buyer
1) has to be sudden
2) has to be unexpected
-casualty or theft are eligible
-with theft, it isn't the year of the theft, it's the year you discover the theft
sec. 165 exceptions
1) if you expect to be reimbursed, you can't take the deduction in the year of the casualty
2) a lawsuit against a defendant
-you can't take a deduction if you think you will recover in the lawsuit
for a total disaster:
-business/investment---- adjusted basis
-personal use---lesser of adjusted basis or fair market value
-minus insurance received
for a partial disaster:
-business/investment---- lesser of adjusted basis or fair market value
-personal use---- lesser of adjusted basis or fair market value
-minus insurance received
1) gain on an involuntary conversion (condemnation)
2) elect on time
3) replace with eligible property (much stricter than 1031 like kind)
4) time- 2 years casualty, 3 years condemnation
Sec 1033 eligible property
1) trade or business (schedule C)
RULE: same functional use (very strict)
2) investor (schedule E)
RULE: taxpayer use
3) condemnation- sec. 1031
RULE: like kind, anything goes
selling your house
-if you meet these two tests, you can exclude $250,000 from your income
-it is a tax exclusion, as opposed to sec. 1031 and 1033
1) have you owned your house?
2) have you used it as your principal residence?
special rules for the selling your house test
1) can only use this law once every 2 years
2) you can convert vacation/rental into principal residence
3) there is a $500,000 limit for a married couple, one owns it and BOTH have used it as a principal residence for 2 out of the past 5 years
short term capital gain
-held for less than one year and one day
-"ordinary tax rates"
long term capital gain
-hold for at least one year and one day
-general: 15% for the 25-35% tax bracket, tax free for the 10-15% bracket
-depreciation recapture: 25% for the 25-35% bracket, 10-15% for the 10-15% tax bracket
-collectible: 25-28% fo the 25-35% tax bracket, 10-15% for the 10-15% bracket
capital assets are something that are NOT any of the following:
-accounts and notes receivable
-depreciable property or real estate used in a business
-certain copyrights; literary, musical or artistic compositions; or letters memoranda, or similar property
-U.S. gov't publications
-supplies of a type regularly used or consumed in the ordinary course of a business
how is inherited property classified?
-it is ALWAYS a long term capital gain
-applies to assets (land, depreciable property, other)
-applies to transactions (casualty loss, involuntary conversion gain)
-limits (depreciation recapture)
-sec. 1245 applies to tangible depreciable personal property
-taxed as ordinary income
-maximum tax rate is 25%
computation for depreciation recapture
-amount realized - adjusted basis = gain (or loss)
-this applies to the amount you sell equipment for over the amount you claimed for depreciation
-subtract depreciation from the cost to get the adjusted basis
2 purposes for an audit
1) to make sure it is actually correct
2) to scare everyone else
-it can often be done by mail and telephone
-answer the questions honestly, and only bring what you need
-these usually last several days
-this is a pretty significant audit
-control the flow of information
-you want to know everything the IRS agent knows, or more information
-don't have the audit at the client's place of business, have it at the law firm
-when you put an IRS agent into a room, don't pick a room with filing cabinets
3 types of IRS agents
revenue agent, revenue officer, special agent
-determines whether the return is correct
-only collects the tax
-gets involved when there is no dispute
-has only one purpose: to get the person in jail
people that can receive power of attorney
-any licensed attorney
-family member (as long as they don't charge a fee)
revenue agent report
-says the person should pay more taxes
-you have 30 days from the day you get the report to protest
-80% of these appeals are done by phone
-then the issue is done, the taxpayer has to write a check
90 day letter
-you have 90 days to appeal to one of these courts
-can only use 1 of 5 mail services to mail the appeal
-US Post Office
-UPS, Fed Ex, etc.
rules for representation in tax courts
1) represent client with zeal
2) never lie yourself
3) never permit client to lie
4) cannot reveal client confidences and secrets without client consent
5) legal position
6) mistake on return
7) due diligence
a) based on existing law
b) realistic possibility for success
c) written opinions
d) covered opinions
mistake on tax return
-duty to disclose to client, not IRS
-if you can disclose mistakes, you will build trust
you cannot ignore conflict information
value of property consumed and the change in value of savings
Eisner v. Macomber (1920) definition of income
"Income may be defined as the gain derived from capital, form labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital"
Why is Eisner v. Macomber definition of income faulty?
for not including discharge of indebtedness
Commissioner v. Glenshaw Glass (1955) Definition of Gross Income
"undeniable accession to wealth, clearly realized, and over which the tax payers have complete dominion."
not just paper wealth i.e. stock appreciation not realized
§ 61 definition of income
"all income from what ever source derived"
REG. sec. 1.61-1
includes income in any form, not limited to the enumerated items
§61 (a) (1) Compensation for services
"Compensation for services, including fees, commissions, fringe benefits, and similar items;"
Tax the fair market value of non-cash compensation
Old Colony Trust Co. v. Commissioner
Discharge of indebtedness is income. Payment by an employer to an employee of employee's taxes is taxable as income if it is compensation.
The tax-inclusive base
§ 275 (a) (1) specifically precluded a deduction for federal income taxes
Below market interest rate loan
Sec. 7872 applies to
any below-market gift loan or demand loan
Tax treatment of a below market interest rate loan
The forgone interest is treated as 1) Transferred to the lender to the borrower, and 2) Retransferred by the borrower to the lender as interest 3) On the last day of the calendar year
interest free loan in the form of a gift
callable on demand
Section 7872 c 3
diminimus exception for when the loan is less then $10,000, applies when the total principal is more than $10,000
Applicable federal rate
subsection e - gov determination of an interest rate - published rate
the benefits derived form labor on one's own behalf or the benefits from the ownership of property .
Authority for not taxing Imputed income?
None, IRS policy
United States v. Gotcher
Under section 61, there must be 1) a gain to the taxpayer and 2) the gain must be for the benefit of the employee to treat the amount as income
Property transferred in connection with performance of services
Where a taxpayer is permitted to purchase property or services at a price below fair market value because the seller is compensating the purchaser for services,
the purchaser has gross income in the amount of the discount. 83 a
No income is realized by the transferee under sec. 83
when the property is nontransferable and subject to a substantial risk of forfeiture at the time of the transfer
Sec. 83(c) (1) property is subject to a substantial risk of forfeiture if
full enjoyment of the property is conditioned upon the future performance of substantial services by an individual
Sec. 83 (b)
may elect to pay taxes on property subject to a substantial risk of forfeiture in the current year
Risk of a 83 (b) election
there is no offsetting deduction if the property is forfeited
Sec. 83(b) Election's Effect on the employer
Employer claims deduction in the year that the restrictions are lifted and the employee takes the income
Employee transfers sec. 83 property to anyone
Fair market value of the property is taxed as incomecf. reg. 1.61 (2) (d)
Timing of taxation of sec. 83 property
Income for taxation purposes Determined at the first time the person having rights in the property that are transferable and not subject to forfeiture
Sec. 83 property Basis is determine when
taxes are paid
taxed as gross income under § 61(a)(1) "compensation for services, including ... fringe benefits
How is a fringe benefit taxed?
The fair market value (plus any payment) of property transferred as compensation is gross income Sec. 83, Fair market value for the fringe benefits REG 1-61.2 D
Certain Fringe Benefits
Exclusion for No Additional Cost Service Sec. 132(b)
1. Service is offered for sale to customers in the ordinary course of business of the employer and 2. The employer incurs no substantial additional cost
No additional cost services
does not include services where labor required
Sec. 132(c) excludes qualified employee discount if
qualified property or services to does not exceed (A) in the case of property, the gross profit percentage of the price at which the property is being offered by the employer to customers, or (B) in the case of services, 20 percent of the price at which the services are being offered by the employer to customers
How are employee discounts taxed when not excluded?
only tax the amount of the discount greater than the gross profit margin
Sec. 132(d) working condition fringe
any property or services provide to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under section 162 or 167
Sec. 132(e) De Minimis Fringe exclusion
the value of the benefit is so small that accounting for it would be unreasonable and impracticable
§132 (a)(7) employers who maintain a qualified pension plan can
provide tax-free retirement planning services to their employees
Moving expenses exemption
sec.132(a)(6), sec. 132(g) excluded to the extent the employee could have deducted the expenses if paid directly under sec. 217
Meals and lodging exclusion
Sec. 119 An employee may exclude from income " the value of any meals 1) furnished to him by his employer 2) for the convenience of the employer, 3) but only if the meals are furnished on the business premises of the employer"
Meals and lodging exclusion "The business premises test"
Is the purpose of the location to do business or is there a substantial amount of business done at the location? Functional rather than spatial test
Meals and Lodging "Convenience of Employer Test"
Meals are provided for the convenience of the employer only If there is a substantial noncompensatory purpose
Sec 117 (d) Employee of a university will not be taxed on tuition discounts
life insurance fringe exlcusion
Sec 79 excludes $50,000 of group term life insurance provided by the employer
Sec 105 excludes Medical reimbursement and premiums for health insurance
Accident and health plans
Sec 106 excludes employer contributions to accident and health plans from the gross income of employees
Sec 107 excludes ministers housing
Sec 125 ?
Education expense assistance
Sec 127 excludes Education compensation Up to $5,250 a year Includes tuition, fees, and books but does not include living expenses
Sec 129 excludes Daycare for the children of the employee Limited to $5,000 a year
sec 137 Maximum amount excludible is $10,000, phased out for AGI exceeding $150,000, not available when AGI is more than $190,000, Includes adoption fees, attorney fees, and court fees
sec. 134 No taxation of the rental value of military housing
§401-404 and 410-416
Gifts and bequests Sec. 102.
Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.
property, other than real estate, left to a beneficiary in a will
real estate left to a beneficiary in a will
- property received when the decedent dies intestate
Commissioner v. Duberstein:
What is a "Gift"?- a transfer made out of detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses." the most important consideration is the intention of the transferor. Cf. Gotcher
Any transfer made as an incentive for future benefit or out of a moral obligation
is not a gift
taxable income. See reg. sec. 1.61-2(a)
Political contributions in RR 68-512, 1968-2 C.D. 41,
are not taxable if they are used for expenses of a political campaign.
Family support -
IRS has never taxed it
not taxed, unemployment, social security, state aid to the blind
Prizes and awards
generally taxable even if it was gratuitous. See regulation 1.102-1(a)
Under section 74 prizes are excludable if
1)they are not retained by the recipient 2)award in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement and 3) recipient must have taken no effort to enter the contest
Employee achievement awards -
gold watch awards §274(j)(3) not taxed if under the limit of $400 Section 74c
Scholarships and Fellowships
§117 Not taxed as income if used by degree candidates for qualified tuition and related expenses
Scholarship and fellowship "Qualified expenses"
tuition and fees for enrollment or attendance by a student enrolled in a school and fees, books, supplies, and equipment required for the course of study (no room and board)
Scholarship received for teaching, research, or other services required as a condition for receiving the scholarship is
not excludable 117 (c ): compensation
- only if it is not conditional upon playing a particular sport and does not cancel if they stop playing
not taxed, but paid back in after tax dollars
Cancellation of indebtedness
is income 108(f)
Gain or loss
= amount realized - adjusted basis: Section 1001(a)
Disposition of a portion of property
Reasonable allocation and divide the basis among the parts, Equitable division: Reg. sec. 1.61-6(a)
= (1) cash + (2) FMV of other property received: Section 1001(b)
Section 1011 (a): in general, adjusted basis = basis determined under section1012, adjusted as provided in sec 1016
cost, Sec 1012
Tax cost basis
create the basis as the amount you paid taxes on: otherwise you would be taxed twice on the same amount
you paid tax on the income you used to purchase the investment, paying taxes on the realized gain (with the cost basis) would be double taxation
Adjustments to basis
Section 1016: prescribes adjustments to basis, i.e., for capital losses, expenditures, receipts, depreciation, etc. Generally, capital expenditures increase basis, while deductable losses and depreciation reduce basis
permanent improvements to your property
Basis of property acquired from a decedent
Section 1014 (a) in general basis -FMV on date of death "Stepped up basis" (e) appreciated property acquired by decedent by gift within one year of death will have a basis equal to the basis at the time of the death
Death bed: we will give you property and you bequeath it to us
resets the basis at the time of the death, which can largely eliminate the tax burden of low basis property with large gains
Basis of property acquired by gift
Section 1015 basis of donee = basis in hands of donor (i.e., a "carryover basis"). Exception: For determining a loss, the basis is the lesser of the FMV or the donor's basis on the date or the gift. If the sale donee's disposition price is between the FMV at receipt and donor's basis at receipt, there is neither a gain or a loss See Reg. § 1.1015-1(a)(2)
Hort v. Commissioner
When computing the net gain or loss for income tax purposes, a taxpayer cannot offset the value of the canceled lease against the consideration received by him for cancellation. A lease is not part of the basis.
property is not taxed unless and until the income has been realized, Implicit in the tax law, § 1001(a) refers to a realization event, Reflected in Glenshaw Glass definition of income: "clearly realized"
Cesarini v. United States
Tres reg §1.61-14 In addition to the items enumerated in section 61 a, there are many other kinds of gross income. Treasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession
Haverly v. United States
"Claiming a charitable deduction does manifest an intent to accept the property as one's own": realization event
Eisner v. Macomber
A stock dividend is capital not income but payment in more stock
Cottage savings Ass'n v. Commissioner
There has been a disposition of properties only if the properties are materially different: different legal entitlements
sec. 72 The annuitant has income to the extent he receives more than he paid for the annuity
= principal / expected return -> the portion of each payment excluded from income, the difference being taxable income 72 (b)(1) Ratio calculated at the annuity starting date
interest accrues, but is not taxed until payments are maid under sec. 72(b)
Annuity for life
Aggregate amount is determined by the person's life expectancy under sec. 72(c) (3), Taxable Mortality gain when the person outlives the life expectancy under sec. 72(b)(2), mortality losses are deductable when the person does not live to the life expectancy sec. 72(b)(3)
Amounts paid under a life insurance contract by reason of the death of the insured are
not subject to income tax regardless of the amount of gain that actually many be involved sec. 101(a)
Proceeds received upon the termination of a cash value of a life insurance policy through surrender, rather than death
are taxable to the extent that they exceed the total cost of the policy
total Cost of a life insurance policy
cost of pure insurance + loading fee + the savings portion of the premiums paid up the the surrender date
Mortality gains and losses in life insurance
Ignored for taxation purposes
Helvering v. Le Gierse
Life insurance policy and life annuity for a single premium. Court ruled that the policy eliminated any risk to the insurer of premature death. "risk shifting are risk distributing are at the heart of insurance The policy was not life insurance under sec. 101(a) and the proceeds were subject to the exclusions for life insurance
Taxation of loans: Borrower
No income when the loan proceeds are received, No change in net wealth because there is an offsetting obligation. No deduction when principal payments are made
Taxation of loans: Lender
No deduction when making loan. No income on repayment of the loan principal - recovery of capital. Interest is income
Cancellation of debt (COD)
is income to a third party under Old Colony Trust
James v. United States
all unlawful gains are taxable
Distinguishing loans from unlawful taxable gains
Loans are identified by the mutual agreement of the parties to make a loan, which will be repaid in the future
the taxpayer used funds without permission but had expected permission would be granted by his company, and he secured his "loan" immediately, showing he had the means and intention to pay back the loan
Kirby lumber co.
held that a corporation had taxable discharge of indebtedness income when it repurchased in the market at less than par bands that had been issued earlier in the year at par. Cf. sec. 61(a)(12) taxation of the discharge of an obligation as income
Sec 108 contains a number of exclusions for discharge of debt income
Discharges in bankruptcy under chapter 11, When taxpayer is insolvent,Qualified farm indebtedness, Qualified real property business indebtedness 108(c), Qualified principal residence indebtedness, student loan forgiveness program
108(d)(3) what is insolvency
Liabilities exceed the FMV of assets immediately before the discharge, 108(a)(3) the insolvency exemption shall not exceed the amount by which the taxpayer is insolvent
Qualified farm indebtedness
From a qualified person: unrelated person; Must be a farmer: in the business of farming and half of gross receipts came from farming
Qualified real property business indebtedness 108(c)
Acquisition debt only, Required to reduce your basis
Qualified principal residence indebtedness
discharged before Jan 1 2013
borrower is personally liable for the repayment of the debt
where the borrower is not personally liable and the lender can look only to the assets that secure the debt for repayment
COD's effect on basis
The amount realized from a sale or other disposition of property includes the amount of liability from which the transforeror is discharged as a result for the sale or disposition
Damages to business interests
The tax consequences of a compensatory damages award or reimbursement depend on the tax treatment of the item for which the reimbursement is intended to substitute. judicial doctrine
Compensation for the loss of property
the compensation is amount realized and the AR less Basis is taxable gain
Compensation for lost profits
is taxable, since the expenses would be deducted and the foregone profits would have been taxed
Punitive damages are
taxable Glenshaw Glass
Taxation of law suit Settlements
What she is being compensated for must be determined, No amount will be attributed to punitive damages if the taxpayer can prove that the actual damages are more than the award
Sec. 104(a)(2) excludes from income the amount of any damages
(other than punitive damages) received (weather by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or illness
Damages for Lost wages
excludable under sec. 104
Interest paid on damages
Interest is generally
taxable under sec. 61 (a) (4)
Sec 103 excludes from income interest
on state and local obligations.