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Federal Income Tax Terminology
Terms in this set (131)
The idea that when we impose a tax on something, it sets in motion a series of decisions that ultimately will redistribute the burden of the tax. As a result, the person who cuts the check to the government for the tax may not be the one most burdened by the tax.
Ability to Pay
Normative principle of taxation that the rich should pay more than the average rate of tax and the poor should pay less than the average rate of tax. This is justified because of the declining utility of income - the idea that the wealthier you are, the less each dollar lost to the tax collector diminishes your wellbeing. This is problematic in a sense that 1) gauging on liquid assets would influence people to hold illiquid assets and 2) can only gauge an individual's actual income, not their potential.
Average Tax Rate
Total Tax / Gross Income
Tells you what share of your income is taxed, and as a result, how burdensome iit is to pay your taxes
Marginal Tax Rate
Tax rate that applies to the next dollar of taxable income
Marginal Effective Tax Rate
Tax Change from $1 of Gross Income / $1 of Gross Income
Captures overall cost of earning one more dollar, by netting the benefits and downsides to determine if that individual will be better off by earning that extra $1
Average tax rate increases as gross income increases
Average tax rate decreases as gross income increases (ex. social security)
Average tax rate stays constant as gross income increases (ex. Medicare)
Overall increase in prices of all goods and services in the economy; largely has to do with the amount of money circulating.
While wages normally increase with inflation, because overall prices are increasing, there is no increase in purchasing power and ability to pay. Therefore, we shouldn't have increased tax liability.
Nominal Interest = Real Interest + Inflation
Amounts are treated as income when received in cash (or cash equivalent) and are deductible only when paid
Items are included in gross income when earned, regardless of whether the payment has been received, and items of expense are deductible when the obligation to pay is incurred, regardless of when the payment is made
Outlays and expenditures that are allowed by the Code to be subtracted from gross income under §61.
Generally, deductions are permitted for business expenses (the cost of earning gross income), but not for personal living expenses (food, and rent), with certain exceptions for some personal expenses (charitable contributions).
Deductions depend on particular taxpayer's tax rate, so the value is higher for higher bracket taxpayers. Allowing something as a deduction has the same net effect as allowing it to be excluded from T's gross income.
Statutory provisions that allow something to be directly subtracted from tax due (ex. Child Tax Credit)
Unlike deductions, tax credit has the same dollar value for all taxpayers entitled to use it. because a credit is a dollar-for-dollar reduction of the tax itself, rather than being a subtraction from gross income.
Present Value x (1 + i)^n
Future Value / (1+i)^n
Haig-Simmons Definition of Income
Sum of Taxpayer's consumption + change in wealth, each defined in terms of the market value during some specified accounting period
Income = Consumption + Change in Wealth
Y = C + Δ W
In an ideal world, this would be what we tax, but because of feasibility/policy reasons, this is not what we tax. This shows that we don't have a pure income tax, but a hybrid consumption-income tax. The difference between a consumption and income tax is the treatment of savings.
Exceptions that permit certain types of gross income not to be taxed. As a result, the tax expenditure "stands in" for government programs that could otherwise have been enacted and would have the same effect. The largest tax expenditures are employer sponsored health insurance, capital gains, benefits for employer contributions, earned income credit, and charitable credits.
Ex. Rather than permitting an exception that prevent meals and housing from being tax, government could tax all income and then establish a social benefit program that would give a return to anyone receiving non-cash income. Essentially, this is giving the taxpayer money (direct government expenditure) instead of requiring her not to pay tax on that amount.
All income from whatever source derived. (IRC §61)
"Any undeniable accession to wealth, clearly realized, and over which the taxpayers have complete dominion." (Commissioner v. Glenshaw Glass, Supreme Court, 1955).
income on which tax must be paid; total income minus exemptions and deductions
Step 1: Add up all gross income as defined in IRC §61
Step 2: Subtract from gross income any "above the line" deductions used to arrive at adjusted income
Step 3: Subtract the bigger of either the standard deduction ($12,000) or below the line itemized deductions
Benefits supplementing an employee's salary, which are normally small in value (ex. free parking or use of a company gym)
Fringe benefits are income both under the Haig-Simmons definition of income and specifically defined as income in IRC §61. Therefore, they are taxed as income. However, there are some exclusions from gross income carved out in IRC §119 and IRC §132.
No Additional Cost Services
A nontaxable fringe benefit that employer provides to employee if the two provisions in IRC §132(b) are met:
1) Services is offered for sale to customers in the ordinary course of business of the employer in which the employee is performing services, and
2) The employer incurs no substantial additional cost (including foregone revenue) in providing such service to the employee
Value of Tax Benefit = Deduction x Marginal Effective Tax Rate. Shows that the deduction saves you more the higher your wage because you will have a higher marginal effective tax rate.
Principle of Conservation of Basis
All allowable business or investment costs must be recovered and used to offset gains only once - neither more or less.
Recovery of Basis is only allowed to be recovered when the money was spent to make income, not for personal consumption.
Options for Timing of Recovery:
2) Over the Useful Lief
3) At time of Sale
Accounting concept to keep track of basis that taxpayer has not yet deducted
Amount Realized (§1001(b)) - Adjusted Basis (§1011)
Adjusted Basis (§1011) - Amount Realized ((§1001(b))
Basis (§1012) + Adjustments (§1016)
Sum of any money received plus the fair market value of the property (other than money) received
Basis of Property
Cost of property, subject to various exceptions/special rules under §1012
When transactions for one activity are placed in a basket. Baskets may operate at a net gain or a net loss individually. However, a loss in one basket may not be used to offset taxable gains from another
Level of Confidence in Tax Payment
More Likely than Not: >50%
Substantial Authority: 30-50%
Realistic Possibility of Success: 33%
Reasonable Basis: 15-30%
Consumption benefit from activities that theoretically could have taken place in the public sphere, but actually took place in the private sphere. This includes: 1) services that you provide to yourself/your household (ex. painting your own apartment or giving yourself a haircut) and 2) capital that you invest to provide durable personal consumption goods (last more than one year) that you enjoy, thereby forgoing a financial return on capital.
Note, this is excluded from income because there is no exchange involved. "A jack-of-all trades who satisfies all his needs by his own efforts owes no income tax."
Earned Income Tax Credit
A refundable tax credit that reduces the amount of tax owed by low-income earners on a dollar-for-dollar basis for a fixed percentage of their income up to a certain amount. In this particular instance, the level of credit depends on: 1) amount you work, 2) whether or not you're married, and 3) amount of children that you have.
This credit acts as a wage subsidy at first, and then as an additional tax because every dollar that you earn additionally, you lose some percentage of credit.
Incentive to work at low income levels, no incentive to work at plateau, disincentive to work at high income levels
Incentive against marrying when incomes are relatively close or extremely far apart.
IRC §441(a) requires a taxpayer to compute taxable income over a year time frame. This does not necessarily have to be a calendar year, but most of the time, it is.
Rules to reduce tax liability by reducing taxable income to help mitigate the arbitrariness of annual accounting.
Net Operating Loss
Allows businesses who suffered losses in the course of business in one year to deduct them from future years' profits.
Trade/Business Deductions - Net Income
The benefit depends on the taxpayer's marginal effective tax rate, which leads to opportunities for tax planning/arbitrage - ex. sometimes companies merge purely because one has NOL carry forwards.
An attempt to accurately measure a business' taxable income by matching a business' gross income and the expenses incurred
Claim of Right
Taxpayer includes in income money that he subsequently has to return, now subject to IRC §1341, which is a taxpayer friendly rule because regardless of which way your tax rates go, you will not be made worse off and might be made better off.
Tax Benefit Rule
This is the opposite of claim of right. In this scenario, taxpayer has previously filed a deduction and then in subsequent years, the deductible amount has been recovered/regained. This can happen for bad debts, losses by theft, worthless assets, expropriation of losses, etc. Note, the required tax adjustments under IRC §111 occur in subsequent years and does not affect the tax results for earlier years, which is not as favorable as §1341.
Under §451(c)(4)(C), considered gross income when it the payment is "actually or constructively received or if it is due and payable to the taxpayer." This is in juxtaposition to the following, which are not considered net income: amounts placed in trust, amounts placed on deposit, loans, amounts placed in escrow, and advanced commissions (which are treated as income). Courts often look to the ability of the taxpayer to withdraw from the transaction as a deciding factor. For example, in Commissioner v. Indianapolis Power & Light Co. (Supreme Court, 1990, pg. 229), the court held that interest payments made by customers to an electrical utility company was correctly not included in income because it was determined these funds were more like loans, than advance payments of the type in AAA. The court reached this conclusion mainly relying on the fact that customers could demand repayment of deposits if service was terminated.
An event that must take place before gain or loss resulting from a change in value of an asset held by the taxpayer is taken into account. Realization events do not have valuation, certainty, or liquidity issues associated with them.
Realization leads to recognition, unless a specific non-recognition provision applies. (See IRC §1001(c)).
Arguments in favor of a Realization Doctrine
Valuation: to assess gain/loss, we need to be able to evaluate your properly accurately. In the case of certain assets, this is more difficult than other cases.
Certainty: This year's appreciation might be followed by next year's decline in value. Therefore, there is no certainty that the person will actually end up with an increase/decrease in wealth.
Liquidity: Even if your property has appreciated in value, this does not mean that you have more cash and tax law should not force people to sell their assets in order to pay their taxes. This is a big concern in gentrifying neighborhoods.
An effort not to trigger a realization event and have to pay taxes on appreciated asset.
1. Buy asset
2. Rather than sell asset, borrow against it and get loan for consumption/ expenditure
3. Die and the adjusted basis of the asset becomes the fair market value when it is transferred to individual who is going to inherit it.
Financial instrument that is based on the value of underlying securities such as stocks. Offers the buyer the opportunity (but not obligation) to buy or sell—depending on the type of contract they hold—the underlying asset.
The option to buy stock at a specified price ("strike price")
The option to sell stock at a specified price ("strike price")
When an individual both buys a protective put while also writing an out-of-the money covered call with a strike price at which the premium received is equal to the premium of the protective purchased. This is not considered a realization event.
Lock in Problem
Taxpayer is locked into a capital investment when it would be more efficient for them to deploy their resources in another investment
Harvesting/ Cherry Picking Rule of Thumb
Individuals tend to sell losing investments at the end of year and maintain profitable investments.
Rules that ensure that a taxpayer disposing of property in a manner that otherwise would be a taxable event will not recognize gain or loss on the disposition of property. These rules include like kind exchanges (§1031), transfers of property between spouses (or former spouses) incident to divorce (§1041), involuntary conversion (§1033), incorporation and other transfers to controlled corporations (§351), corporate mergers (§368), corporate divisions (§355), and partnership formations/other transfers to partnerships (§721).
Like Kind Exchanges
A tax-deferred transaction that allows for the disposal of an asset and the acquisition of another similar asset without generating a capital gains tax liability from the sale of the first asset.
Simplified/ General Rule: There is no recognition on exchange of like-kind properties if both are used in trade or business or for investment
Gain Realized on Exchange of Like Kind Properties = Amount Realized - Adjusted Basis (§1001(a))
Amount Realized = Cash + Fair Market Value of Property Received + Amount of Liabilities Discharged (§1.1001-2(a))
Adjusted Basis = Adjusted Basis in the Property Exchanged (§1031(b))
Gain Recognized on Exchange of Like Kind Properties = Extent of Boot Received (§1031(b)), which includes the assumption of debt by the other party (§1.103(b)-1(c))
Basis in New Like Kind Property = Basis in Transferred Like Kind Property + Net Cash Paid + Net Liabilities Assumed + Basis in Boot Property Transferred - Fair Market Value of Boot Received + Gain Recognized - Loss Recognized
The total volume of the consideration to be received by a taxpayer is sufficiently uncertain that gain is not received until payments actually received exceed basis
Closed Transaction Approach / Present Value of Expected Payments
Treat the sum of cash payments as if it were cash received on date of sale. Therefore, the gain/loss is determined by comparing this amount with basis.
A "disposition of property where at least 1 loan payment is to be received after the close of the taxable year in which the disposition occurs." (§453(d)). Under the current rule adopted by Congress in 1980, this should be treated like an open transaction, but some portion of the basis should be allocated to every payment that is received, so that some gain/loss is recognized as each payment is received. See exact method of treatment outlined in §453.
Four Steps Process for Installment Method
Step 1: Figure out selling price and contract price
Step 2: Figure out gross profit
•Gross profit = selling price - adjusted basis
Step 3: Figure out gain vs. recovery of basis on each payment
• Gain on Each Payment = Gross Profit Ratio x Payment
Recovery of Basis = Payment - Amount of Gain Recognized
Point at Which Contract is Completed
General Rule: Delivery of title from buyer to seller marks a sale for tax purposes. If consideration is given before transfer of title, then sale is not concentrated until title is given and advanced payment will be analyzed similar to deposit.
Taxpayer cannot postpone taxation of income that is readily available to her merely by failing to exercise her power to collect it. Once the receipt is earned and within the taxpayer's control, it is includable in income, despite any efforts by the taxpayer to delay it.
A rule that recognizes the idea that some promises to pay are just as good as cash.
"If a promise to pay of a solvent obligor is unconditional and assignable, not subject to set-offs, and is of a kind that is frequently transferred to lenders or investors at a discount not substantially greater than the generally prevailing premium for the use of money, such promise is the equivalent of cash and taxable in like manner as cash would have been taxable had it been received by the taxpayer rather than the obligation." Cowden v. Comm'r.
However, note, this is tempered by §453
Economic Benefit Doctrine
A doctrine that allows taxation of income before it is actually received if the taxpayer has an irrevocable right to it. For this to apply, there must be nothing standing between you and the money except for the passage of time because the money/asset is already: 1) vested, 2) set aside, and 3) not subject to creditors.
Nonqualified Deferred Compensation Plans
A plan that defers employees' income without a statutory blessing for that deferral. Therefore, the plan must be structured in a way that defers the compensation without violating funding or constructive receipt principles.
Means that there is virtually no limit on the amount of current compensation that can be deferred and become taxable in future years.
Benefit in the form of an option given by a company to an employee to buy stock in the company at a discounted or a stated fixed price. These must be structured in a way to avoid constructive receipt and related doctrines, but the amount of compensation that can be deferred is unlimited.
Note, the employer is not allowed to recognize the deduction until the employee exercises the stock option and recognizes income.
An employee does not have income on the grant of a properly drafted nonqualified employee stock options, even with no risk of forfeiture. Instead, the option is viewed as identical in tax impact to mere promise to pay cash in the future and tax is only triggered when the employee exercises the option. At this point, the employee has ordinary compensation income equal to the spread between market value of the stock and employees excise price.
Qualified Employee Plans
Plans that allow taxpayers to defer compensation due to some statutory provision that allows the income not to be currently includable; however, the deferral is normally limited in amount. Generally, must be made to all employees and are limited in the amounts that can be deferred, but often more tax advantageous.
Defined Benefit Plan
A type of deferred compensation plan in which an employer/sponsor promises employee a specific amount in retirement
Defined Contribution Plan
A type of deferred compensation plan in which an employer promises to pay a specific amount into the fund each year, but does not make any promises regarding what benefit the employer will eventually receive
Provides that qualified plans must provide reasonably comparable benefits to all employees - the ratio of pension benefits to salary for highly compensated employees must be no greater than the ratio to rank-and-file employees. However, in practice, this does not constrain how much companies provide to executives, instead, they just do it through non-compensatory options
A personal savings plan; contributions are tax deducible up to $5,000 or $6,000 if you are over 50, and amounts withdrawn are included in income.
A personal savings plan; contributions are not tax-deductible; but when you withdraw earnings, it is not included in gross income
Real or virtual document representing a legal arrangement that involves some sort of monetary value
Amount of money that one legal person owes another
Ownership interest in an asset or set of assets
Loan holder is personally liable in the event of default. Therefore, the lender can sue the loan holder for the deficiency amount of the loan.
Loan holder is not personally liable in he event of default. Therefore, the lender's only recourse is the collateral used to secure the wealth.
Cancelation of Indebtedness Income
Occurs when any amount of debt is forgiven and no longer an obligation of the taxpayer. This amount is includable in gross income under IRC §61(a)(11). This is because when you take out a loan, the assumption is that you are going to repay it. If this later turns out not to be true, the taxpayer must take that income into account.
Wen debt was repaid for less than the amount that the lender has claimed was due and the amount that the repayment discount i) reflects a good faith dispute as to (a) the entire debt's legal enforceability, (b) the amount that had actually been borrowed, and/or (c) the amount due from the borrower, given the debt instrument's particular repayment terms.
Allowance for the decline in value of business property due to wear and tear and/or obsolescence over the useful life of an asset. Generally, allowed with respect to real property and structures built on land, but not the land itself. These deductions reduce the basis of the property to which they relate.
Compensation that you pay for the use of money. This is considered income under both Haig Simmons definition of income and the definition of income given in §61. However, the expenses are only deductible to the payor when the expense is for business and not personal use.
Original Issue Discount
Excess of Issue Price - Redemption Price Paid for Bond
A type of interest that is not payable as it accrues. This normally accrues when a debt, usually a bond, is issued at a discount. In effect, selling a bond at a discount converts stated principal into a return on investment, or interest. Can be thought of as a hidden interest component that results from holder of debt instrument paying less for note than the face amount.
The purpose of OID income is to move cash method taxpayer onto the accrual method.
Formula for Original Issue Discount
Original Issue Discount = Issue Price - Redemption Price/ Stated Maturity Price
Issuer Price: amount that purchaser pays for the note
Redemption Price / Stated Price of Maturity: principal price that will be repaid at bond's maturity date
General Rule for Note Holder: When a note's issue price < stated redemption price, then there will be OID interest. Therefore, the bond holder must include interest before the receive payment of the principal. Specifically, the bond holder must include income each year equal to the yield on the debt instrument.
Yield on Debt Instrument: when all things are considered, how much richer is the bond holder for making the investment. Calculated by discounting all future payments into the present and summing them.
Issuer of Debt Instrument
Holder of Debt Instrument
Stated Redemption Price at Maturity
Sum of all payments under the debt instrument other than qualified stated interest (Treasury Regulation §1.273-1(a))
Qualified Stated Interest
Stated interest that is unconditionally payable in cash or in property (other than debt instruments of the issuer), or that will be constructively received under 451, at least annually at a single fixed rate (Treasury Regulation §1.1273-1(b))
What is paid for the debt instrument (§1273(b))
Hierarchy for Determining:
1. If holder pays cash for debt instrument, that will be the issue price
2. If note is issued for property, look to see if the note or the property itself is traded on open market:
A. If note is traded, the price that people are paying for the note will be issue price
B. If note is not traded but property that note is being used to acquire is publicly traded, then that can be trading price
3. If debt/bond is issued for property, look to see if the debt/bonds or the property itself is traded on open market:
A. If debt/bond is traded, the price that people are paying for the debt/bond will be issue price
B. If debt is not traded but property that note is being used to acquire is publicly traded, then that can be trading price
4. If neither the notes, debt, nor property are publicly traded, then the issue price is the discounted present using value using applicable federal rates under §1274
Term Life Insurance Plan
Pay premium and in exchange insurance company promises to make payments to you / a designated beneficiary if you die within the policy window.
Amounts received from life insurance policies are not income (IRC §101(a)(1)) and payment for life insurance premiums are not deductible (IRC §264) regardless of the type of policy.
Whole Life Insurance Plan
Life insurance policy which is guaranteed to remain in force for the insured's entire lifetime, provided required premiums are paid on time.
Amounts received from life insurance policies are not income (IRC §101(a)(1)) and payment for life insurance premiums are not deductible (IRC §264) regardless of the type of policy.(a) This is why whole life insurance plans can act as a savings vehicle because when the payment is returned to your beneficiary it is tax exempt. This is not true if you put it in a regular investment account or even 401ks (but 401ks allow you to deduct contribution).
In exchange for upfront payment, you receive payments at regular fixed intervals for the rest of your life.
In order for this to be a worthy investment, you need at least a total sum of payments whose present value (for the expected remainder of your life) is greater than your principal amount. However, you might be willing to accept something like the market rate because the annuity is not just giving you a return your $100,000, but also in some sense, they are ensuring you against outliving your savings
Annuity Exclusion Ratio
Investment in Contract / Expected Return of Contract = Expected Amount/ Entire Amount Received Under Annuity
Investment in Contract: aggregate amount of premiums of consideration paid for contract - the aggregate amount received under the contract before such date if that amount was previously excluded from gross income (72(c)(1))
Expected Return: if dependent on the life expectancy of one or more individuals, that shall be computed with reference to actuarial tables prescribed by the Secretary. If it does not depend on the life expectancy, then the expected return is the amounts receivable under the contract as an annuity (72(c)(3))
Taxpayers that share economic resources and/or interests (ex. spouses, parents/ children, legal entity/owner) have incentive to redirect their income to the person who is taxed at the lowest rate. This allows the pair to get as many "starts from the bottom" as possible. Alternatively, if there is a deductible expense, then you want to direct it to the person with the higher income because amount of deduction is dependent on your marginal rate.
By allowing married couples to start filing jointly in 1948, Congress created an economic benefit to being married because married couples compute the total tax by first computing a tax on 1/2 of the total and then doubling that amount, thereby providing two starts at the bottom of the rate structure, regardless of how income was earned and regardless of who has legal claims to it. As a result, marriage reduced tax liability for spouses with different income levels and incentivizes couples not to have second earners.
When you marry an individual who has a similar income as you, it puts you in a higher tax bracket than if you simply combined the two earners.
Three Principles of Taxing Married Couples
It is impossible to have the following three principles satisfied at once: marriage neutrality (no penalties or bonuses), couple equality (couples with the same aggregate income bear the same tax burden), and progressivity (rates increase the more you make). Our system opts to satisfy couple equality and marginal tax rate progressivity at the expense of marriage neutrality
Ex. Theoretically, Congress could get rid of the issue of marriage bonus and marriage penalty by reintroducing joint filing, but doing so would reintroduce issues of income shifting (as seen in Lucas v. Earl and Pope v. Seaborn) that Congress was trying to get rid of.
Temporal Limitation Rule
A temporal limitation makes a gift ineffective for tax purposes. If the transfer will revert to transferor after some time (vertical slice), then the income will be taxed to the transferor. Alternatively, if there is not a temporal limitation but recipient receives a portion of the gift for the entire duration of the transferor's holding, then the interest is taxed to the transferee and the transferor does not retain any revisionary interest.
Formula for Computing if Shifting Income to Dependent will Save Taxes
Income x (1-tparent) < Income x (1-tcorporation) x (1-tchild)
Qualified Business Income
For all noncorporate taxpayers, this provides a deduction equal to 20% of the "qualified business income".
Two Step Analysis When Faced With Business Expense
1) Does it need to be deducted or should it be capitalized?
2) If it is capitalized, what if any depreciation or amortization needs to be taken?
Extra depreciation that does not track true economic reality but has been enacted for policy reasons by Congress - ex. Since 2001, §168(k) (pg. 183) has allowed taxpayers to deduct 50% of the cost of certain qualifying business assets in the first year. However, starting in 2017, §168(k) (pg. 183) permitted you to deduct 100% of depreciation in year 1 that was placed in service
Uniform Capitalization Rules (UNICPA)
Enacted by Congress in 1986, under these rules, the cost of producing inventory and other self-created assets must be capitalized (see §263A(b)). These costs include salaries of individuals tasked with making the self-created assets, as well as any other indirect costs (such as the allocable share of the salaries of the supervisory and administrative individuals).
General Rule for Capitalization of Repair / Maintenance Expenses
Taxpayers may take a current deduction for amounts spent on repair and maintenance of property, but the cost of improvements to the property must be capitalized (added to basis of property and recovered through depreciation deductions).
Restore to a sound state/mend
Capitalized vs. Deductibility Test
Whole expense must be capitalized if expense is caused by the passage of time and results in infrequent, and large in magnitude expenditures
Whole expense is deductible if an unexpected event occurs that results in frequent, small expenditures
Test for Deductibility of Trade/ Business Expenses
1. The expense is ordinary
2. The expense is necessary
3. The expense is paid/incurred in the taxable year in carrying on trade or business
Four Things You Need to Know to Know How Much Depreciation You are Entitled To
1. What is the property worth now?
2. What is the property's salvage value?
3. What is the property's useful life?
4. What is the method of allocating depreciation during its useful life?
Straight Line Method
Depreciation method that allows you to deduct the same amount of depreciation in dollar terms each year
250 or 150 Double Declining Method
Depreciation method that begins with the increases the straight-line percentage by a specified factor
1. Calculate % of property's basis depreciated in year 1 under the straight-line method.
2. Multiply that percentage by 2 or 1.5. Call this new percentage X%.
3. Every year, calculate the depreciation deduction that would be taken if the property were depreciated on a straight-line basis over its remaining useful life.
4. Depreciate in that year at the greater of the number in (3) - amount entitle d to if use straight line - or X% of the basis.
5. Reduce the property's basis for the depreciation.
Basis After Wash Sale
Under §1091(d), the basis in the new share = basis in share sold +/- (sale price - 2nd acquiring price).
The present value of one's remaining lifetime earning capital, reflecting one's ability to work and earn income that has economic value
General Rule About Education Expenses
Education expenses are generally not deductible and scholarships and fellowships are not income to you. Note, that there is a disconnect between the two prongs of this rule. Generally, if something is not income to you when someone else pays for it, then when you pay for it, you get to take a deduction. (See §132).
Exception to General Rule: The cost of education or training is deductible as a current expense if the aim of the expenditure is to maintain or improve skills used by the taxpayer in an existing trade or business, or if the education is required by the taxpayer's employer as a condition of continued employment.
The failure to pay or a deliberate underpayment of taxes.
The use of legitimate methods to reduce one's taxes
Substance Over Form Doctrine
IRS can look through the legal formalities of a transaction and reclassify it if they don't agree with your characterization (see Knetsch v. United States)
Business Purpose Doctrine
IRS has power to disallow a business deduction hen a transaction has no business or corporate purpose but is a mere device which is put on for the sole purpose of concealing the transactions real character, which is simply to get tax savings.
Economic Substance Doctrine
A transaction that doesn't change the taxpayer's economic situation except by the tax savings from the transaction should be disregarded for tax purposes.
A transaction that lacks a business purpose and economic substance will be ignored for tax purposes
Example: A sale by XYZ to ABC, but both XYZ and ABC are owned by the same persons
Step Transaction Doctrine
A court will combine multiple steps from a transaction rather than analyze them individually if they think that this is a better way to describe your transaction.
Asset that is previously owned by the seller is sold to someone else (usually financed by original of land) and then leased back to the first owner for a long duration.
Two Types of Deductions for Cost of Generating Income
1. Trade or Business Expenses under §162
(1) Note, whether or not something is incurred during trade or business is fact intensive inquiry - court will look at 1) is the entity incorporated?, 2) do they advertise?, 3) do they keep books and records, etc.
(2) Note, this is an example of an above the line deduction that is used when arriving at adjusted gross income.
2. Expenses for the Production of Income under §212
(1) Note, this is an example of a below the line itemized deduction, but miscellaneous itemized deductions are not allowed until 2026 under §67(g)!!
(a) Below the line deductions are often policy motivated and they are often subject to various limitations. Ex. IRC §67(a) limits itemized deductions other than those listed in §67(b) to a 2% floor. Note, §212 is not included in the definition given in §67(b) so it is subject to the limitation
General Rule for the Deductibility of Clothing Expenses
Clothes are deductible only if the following three prongs are satisfied:
1. The clothing is of a type specifically required as a condition of employment
2. The clothing is not adaptable to general usage as ordinary clothes
3. The clothing is not worn as ordinary clothing
General Rule for Home Office Deductions
General Rule: Under §280, you can only deduct a home office space meets one of the following:
1. Exclusively used as your principal place of business?
2. Is a place of business used by patients/clients/customers?
3. Is a separate structure?
General Rule for Renting Homes
If you rent your home for less than 15 years during the taxable year, then under §280A(g) do not have to include rental income in gross income
General Rule for Travel Expense
In order for travel expense to be deductible under §162, three prongs must be satisfied:
1) The expense must be a reasonable and necessary traveling expense, as that term is generally understood - this includes transportation fares, food, and lodging while traveling
2) The expenses must be incurred while away from home.
3) The expense must be incurred in the pursuit of business. This means that there must be a direct connection between the expenditure and the carrying on of the trade or business of the taxpayer or of his employer. Such an expense also must be necessary or appropriate to the development and pursuit of the business or trade.
General Rule for Travel and Entertainment Expenses
For travel and entertainment expenses to be deducted, the expenses must be deducted under §162 and not disallowed under §274.
General Rule for Legal Expenses
Corporations can deduct the cost of defending a lawsuit because it is ordinary and necessary business expense under IRC §162.
Shorthand, non-legal term referring to deductions unrelated to the cost of producing income
Rules for Charitable Contributions Made by Private Entities
1. Rule Limiting Deductions: Under §170(a), charitable contributions are deductible but only up to 30% of taxpayer's contribution base or the excess of 50 percent of the taxpayer's contribution base for the taxable year over the amount of charitable contributions allowable under subparagraph (A) (determined without regard to subparagraph (C)).
2. Rule on Carryforwards: If you make donations that exceed these caps, excess amount will be carried forward in subsequent years under §170(d).
3. Rule on Donating Property: When you donate property, the amount of contribution is the fair market value of the property and you do not have to realize gain on the disposition of property. This is an anomaly.
Rules for Charitable Contributions Made by Corporations
1. Rule Limiting Deductions: Corporations cannot deduct charitable contributions in excess of 10% of their taxable income §170(b)(2).
2. Rule About Private Benefits: For corporations, charitable contribution will be disallowed altogether if corporation obtains substantial private benefit
3. Rule About Quid Pro Quo: If the benefits received or expected to be received by the donor are substantial and greater than the merely incidental benefits to the transfer, then the transferor has received or expects to receive a quid pro quo sufficient to remove the transfer from the realm of deductibility under §170. In determining the amount of the reduction, it is the value to the donor that counts (fair market of whatever is received by donor), not the value to donee. Value dos not include psychic benefits to donors.
Rule for Personal Interest
Personal interest is only deductible if it falls within one of the categories of §163(h)(2)(A)-(F). Interest used to finance consumption is not deductible.
Qualified Residence Interest
Interest paid on debt incurred to buy, build, or improve a personal residence and that is secured by the residence is deductible under §163(h)(2)(3)
Limit of $1 million on debt principal used to exist. Now limit on $750,000 interest debt incurred after 2017 (§163(h)(3)(B)). Starting in 2025, this limit will occur regardless of when the debt was incurred.
Until 2018, individuals were also allowed to deduct the first $100,000 in interest on home equity loans.
General Rule for State and Local Taxes
General Rule: State and local taxes (SALT) are deductible under §164(a). §164(b)(5) allows you to elect deduct sales tax in lieu of income tax.
Alternative Minimum Tax (AMT)
Created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.
Alternative Minimum Tax Using From 62-51:
Taxable Income (under regular tax)
+ Preferences (ex. Deduction of SLAT)
+ Timing Adjustments
= Alternative Minimum Taxable Income
Alternative Minimum Taxable Income
- Exemption Amount
= Taxable Excess
X Alternative Minimum Tax Rate Schedule (26% or 28%)
= Tentative Minimum Tax
Tentative Minimum Tax
- Tax (under regular federal income tax) less certain credits
= Alternative Minimum Tax
General Rule About Property Related to Taxpayer's Business
Property held by taxpayer in the course of their trade or business are not capital assets under §1221.
Other sets by this creator
Succession Under Intestate Laws
Federal Rules of Evidence
Federal Income Tax Cases
Federal Income Tax Code Provisions