Federal Income Tax Law

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Law School

The general definition of gross income is found in Section 61(a) of the Internal Revenue Code.

True

The term "income" is used in the Code, but is not separately defined

True

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.

True

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.

True

Payments must be made in cash to qualify as deductible alimony.

True

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.

True

The benefits of the group term life insurance premium exclusion are not available to proprietors and partners.

True

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.

True

Income from property must be included in the gross income of the owner of the property

True

If a taxpayer is entitled to receive income, which is made available to him, he cannot "turn his back" on it.

True

Most individual taxpayers use the cash method of accounting.

True

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.

True

There is a maximum amount of Social Security benefits that must be taxable income of an individual taxpayer.

True

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.

True

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.

True

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.

True

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.

False

Child support payments are deductible by the payor and includible in the gross income of the payee.

False.

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.

True

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.

True.

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:
Salary $25,000
Child support $6,000
Alimony $9,000
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?
Texas
Georgia
California
Arizona
Washington

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:
Salary $50,000
Bonus 6,000
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:
2008 $32,000
2009 $25,000
2010 $-0-
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:
2008 $32,000
2009 $25,000
2010 $-0-
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:
Basis FMV
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 25
December 28
December 30
January 2

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.

Accounting income

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.

Accounting method

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.

Accrual method

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.

Alimony recapture

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 ).

Annuity

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.

Community property

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.

Constructive receipt

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.

Economic income

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.

Gross income

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).

Hybrid method

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.

Imputed interest

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.

Income

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).

Partnerships

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.

Taxable year

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.

Gross Income

-Section 61
-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

Stolen Property

If you steal property, you must report its fair market value in your income in the year you steal it.

Gifts-Section 102

- 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 checklist:

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.

Section 1014

- 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.

Section 1015

- 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"

Taxpayer's cost

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.

Glenshaw Glass

§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
Reasonable

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.

Indapco

§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.)"

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