Tax: Lilly Outline 1
General Notes
about the Ideal Tax System
·
Fair
·
Efficient
·
Administratble
Part I:
What do you include?
What can you exclude?
Gross Income
§ 61 Gross
Income Defined
·
A—all income,
from whatever source derived, including but not limited to (a huge list of
things)
·
Defined by the
USSC as “instances of undeniable accessions to wealth, clearly realized, and
over which taxpayers have complete dominion.
(Glenshaw Glass)
*The
Treasure Trove Rule § 1.61-14
Cesarini:
Case about finding money in an old piano.
This shows that Congress intended to stretch § 61 as far as it could
constitutionally go and the Court will apply the broadest possible
interpretation. The Court here
finds that the plaintiffs received the currency in the same year they got the
piano. However, if they just
realized that the piano was worth a lot, they would not be taxed until the
property was sold or exchanged (until the gain was “realized”).
·
The timing
rule: it is gross income for the
taxable year in which it is reduced to undisputed possession; and state law
determines when possession is achieved.
·
Taxable to the
extent of its value in US dollars is GI for the year in which it is reduced to
undisputed possession
·
Note—if they
would have discovered the piano was a Steinway, there would be no difference in
the finding. There is no income tax
event on the realization that the piano is expensive.
*Taxes paid
for you § 1.61-14
o
Old Colony:
Π was getting a salary, and his employer decided to pay the state and
federal tax on his salary. The
court determines that this gross income, because it is an economic benefit that
resulted in an increase of net worth.
However, it may not be income if a family member pays your taxes as a
gift.
*Punitive
damages § 1.16-14
o
Glenshaw Glass:
Punitive damages are gross income.
This includes treble damages and exemplary damages
*Frequent
flyer miles
o
Charley:
Converting frequent flyer miles to cash is income.
As of 2000, there is NO GI from frequent flyer miles UNTIL they are
cashed out
o
No gross
income if you haven’t cashed out the miles
*Prizes are
gross income too
*Illegally
gotten income is still income
*Non-Cash
Goods/Services § 1.61-2
·
If something
is paid for other than in $$, the FMV of the property or service taken in
payment must be included in GI
o
Housing
provided for by ER and EE and family housed at no cost—FMV of rental value of
housing provided is GI. Rent
avoided is the benefit received by reason of employment by a 3rd party (Dean)
*Rent
o
Obviously,
this is income—but anything tendered in exchange for allowing someone to live
somewhere is rent
§
i..e., someone
says “I’ll pay you $1,000 cash and build you a bathroom”
the bathroom is still rent., even if T builds the bathroom himself, doing
all of the labor for free
*Crops
o
When you
harvest/eat your own crops, there is no income
o
If you sell
them, you have income—if you sell them or exchange then for the equal amount of
Tuna, you still have income.
*Services
exchanged
o
If you
exchange services, with no money changing hands, this is still income—you must
report the FMV of the services received.
o
However,
services you perform for yourself (hee hee) are not income.
*Buildings you
own
o
If you live in
a building you own, it is NOT considered gross income (Independent Life Ins.
Co.)
Regs
§
1.61-1(a)—income may be realized in other forms than cash (services, etc.)
§
1.61-2(a)(1)—wages, salaries, commissions paid salesmen, compensation for
services on the basis of a percentage of profits, commissions on insurance
premiums, tips, bonuses (incl. Christmas bonuses), termination or severance pay,
rewards, jury fees, marriages fees,…are all gross income.
§
1-61-2(c)—services rendered directly and gratuitously to an organization in §
170(c) are not income
§ 1-61-2(d)—if
services are paid for in property, the FMV of the property taken in payment must
be included in income as compensation
*Revenue
Ruling 79-24
·
An individual
who owned an apartment building received a work of art created by a professional
artist in return for rent-free use of an apartment for six months by the
artist—this is gross income and the fair market value should be reported
EXCLUSIONS
FROM GROSS INCOME
Gifts/Inheritances
Gifts are
generally included in the donor’s tax base (i.e., donors usually cannot
generally deduct a gift)
§ 102
·
A—generally
ARE excluded from GI
·
B—exceptions
o
(1):
Income from property
o
(2):
Where the gift, etc. is income from property, the amount of the income is
not excluded
·
C—employee
gifts are NOT excluded (from E to EE)
o
Lawyers are
NOT considered to be the EEs of their clients
*The Dominant
Intent Test
·
Motive
required for a gift is “detached and disinterested generosity flowing from
affection, respect, admiration, charity, or like impulses” (Duberstein)
o
This is a very
fact-specific evaluation
o
Ex:
E gives her EEs a black and white TV set for Christmas; her son (also an
EE) get a color one.
§
Helpful
additional info: differences in
timing, value, etc.
·
Anything that
is a “quid pro quo” situation is included
in GI b/c there is a lack of detached and disinterested generosity.
o
If a poker
player tips the dealer, he is tipping him for a good outcome—thus, it
is income to the dealer….quid pro quo
is not always rational.
*Employee
Gifts
·
A transfer
from an E to an EE does not qualify as a § 102 gift
o
Exceptions:
extraordinary personal services—if EE can show that the transfer was not
made in recognition of the service
·
Reverend/congregation relationship is different from an E/EE relationship to
some factfinders
·
In some cases,
like when there are multiple transferors, you
can split the gift into excludable
gift parts and GI parts
o
Ex:
EE gets a $5,000 trip to HI for retirement.
ER gives $2,000 of the gift, and the fellow EEs give $3,0000.
The $2,000 from the employer is gross income (because it falls into §
102(c)) and $3,000 of it is considered a gift, excludable under § 102(a)
·
Income
generated from the gift is taxable
o
Ex:
gift of stocks: dividends
are taxable when received; gift of apartment building—rent collected is taxable
when received.
*Bequests,
Devises, Inheritances
Lyeth:
a taxpayer received an amount from the estate of his relative, but only
got it by contesting the will and suing the estate.
Receipt by reason of heirship is analogous to receipt by reason of
detached and disinterested generosity.
Wolder:
an attorney asked, in exchange for his services, to be remembered in his
client’s will, and he was. The
court found this was a payment of a debt for services performed—it was a
deferred payment of a legal bill
·
Steps
o
Determine T’s
position/relationship to donor
§
If the
succession to a decedent’s estate comes from T’s position as successor by law as
heir to the donor, then it’s excludable (Lyeth)
o
Substance over
form
§
Bargained-for
agreements: look for a K.
When there is payment of services through bequest, there is still GI.
(Wolder)
Regs
§ 1.102-1(a):
property received as a gift or under a will or under statutes of descent
and distribution are not income, even though the income from the property is
income
§ 1.102-1(b):
income from any property received as a gift, or under a will is not
excludeable from the above section
§ 1.102-1(f):
§ 102 doesn’t apply to prizes and awards, including EE achievement awards
or de minimis fringe benefits, or scholarships
Employee
Benefits
This section
is very code-reg dependent!
§ 132:
provides a list of categories—when you see facts where E is delivering something
to EE, check to see whether it fits any of the categories here.
NB:
This section does NOT include fringe benefits
*“No
additional cost” services
Definition of
an employee: currently employed
persons, retired and disabled ex-employees, surviving spouses of
retired/disabled employees, spouses and dependants of employees.
o
§ 132
(a)(1)—if E incurs no further cost by giving this benefit to EE, it can be
excluded
o
§ 132(b)
requirements
§
(1) E is in
business; E-EE relationship
·
Exception §
132(i) written reciprocal agreement—if there is one of these between E and EE,
than the direct E/EE relationship is unnecessary but you still MUST have all
other requirements (same line of business, neither E incurs substantial
additional cost, non-discriminatory basis)
o
See part (e)
of problem 1 on p. 98
§
(2) E works in
SAME line of business as that in which he is employed
·
Note—a hotel
EE whose chain is owned by a conglomerate who also owns a shipping business
cannot exclude personal use of the shipping business b/c it is not the same line
of business
·
Note—an EE who
performs services that directly benefit more than one line of business CAN
exclude things from each business
o
§
1.132-4(a)(1)(iv)
§
Comptroller
example
§
(3) No
substantial cost incurred by E
·
Forgoing
revenue is a substantial additional cost
·
Filling up
excess capacity is OK; reserving a seat or bouncing a guest is not
·
E generally
incurs no substantial additional cost if the services provided to E are
incidental
o
In-flight
services, in-flight meals, maid services
·
E must include
cost of labor incurred in providing services to EE when determining whether E
has incurred a substantial extra cost
§
(4) For use by
EE
·
Or spouse, or
dependent children § 132(h)(2)
o
Note—Use by
just a spouse/dependent child is treated the same way as use by EE under
this statute
·
EE’s parents
for AIR TRANSPORTATION ONLY §132(h)(3)
§
(5)
Non-discrimination requirement § 132(j)(6)
·
Highly
compensated EEs do not get the exclusion when the plan discriminates in favor of
the highly compensated
o
5% owners;
more than $80K; in top-paid group of EEs
o
Note—it
doesn’t matter if the employee pays the bill and receives a rebate from E—that
has no bearing on whether or not it is excluded from GI
*Working
Condition Fringe Benefits
§ 132(d):
any property or service provided to EE such that if EE paid for the
property or services, it would not be excludable under § 167 or § 162.
NB: this one is only good
for the actual employee—sorry to the spouses and kids
Requirements
(1)
EE/E
relationship
(2)
Any
property/service provided to EE such that if EE paid for property/service, it
would not be deductible under § 162 or § 167
(3)
Something
about auto salesmen—qualified automobile demonstration use is a working
condition fringe
(4)
Non
discrimination requirement does NOT apply here
Note—think of
it as part of “doing the work” i.e., EE attends a business convention in another
town and E picks up EE’s costs
*De Minimis
Fringe § 132(e)
(1) any
property or service whose value is so small as to make accounting for it
unreasonable or administratively impracticable
(2) an eating
facility provided for EEs by E is treated this way if (a) it is located on or
near the business premises AND (b) revenue derived from the facility normally
equals or exceeds the direct operating costs of that facility
·
Occasional
cocktail party; occasional copying, typing of letters—however, if E gives every
employee a case of Scotch for Christmas, the FMV of the scotch is probably not
low enough to make it impracticable to account for.
o
From §
1.132-6(e)(1)-(2)
*Qualified
employee discount § 132(c)
(1)
discount
cannot exceed
a.
for property,
the gross profit percentage of the price at which the property is being offered
by E to customers
b.
for services,
20% of the price E offers to customers
In practice
First,
determine whether this is a service of product—if it is a SERVICE, you have
income in the amount that is over 20%; if it is a PRODUCT, we have to do math
(yikes)
(2)
gross profit
percentage
a.
percent at
which
i.
excess of
aggregate sales price of property sold by E to customers OVER aggregated cost of
property to E is of
ii.
aggregate sale
price of property
b.
calculating
GPP—determined on the basis of
i.
all property
offered to customers in the ordinary course of line of business of E in which EE
is performing services
ii.
E’s experience
during a representative period
iii.
Formula:
(total sales – total cost to employer)/ (total sales) = percentage of
allowable employee discount to be tax-free
*Qualified
Transportation Fringe § 132(f)
(1) any of the
following from E to EE
(A)
transportation in a commuter highway vehicle if it is in connection with
transportation between EE’s residence and place of employment
(B) transit
passes
(C) qualified
parking
·
NOTE—you can
exclude up to $105
o
If E provides
EE with $110 worth of vouchers for commuting on a public mass transit system, $5
of that per month is GI
o
This year, the
parking limit got raised to $205
*Athletic
Facilities § 132(j)(4)
o
If E puts a
gym in the business for the use of EE and families, it IS income???
How to reconcile with p. 126? (I think I typed this wrong)
o
Requirements
§
Non-discrimination DOES NOT apply
§
Gym must be on
premises (can be gym, golf course, pool, tennis courts, etc.)
§
Must be owned
and operated by E
§
Substantially
all of the use is by EE, spouses, and children
Rental Value
of Parsonages
§ 107:
For ministers of the gospel, GI does not include (1) the rental value of
a home furnished to him as part of compensation; (2) rental allowance paid to
him as part of his compensation
Meals or
Lodging furnished for the convenience of the Employer
§ 119(A) and
see § 119(D)
·
A—excluded
from the GI of EE any meals/lodging furnished to him, spouse, or dependents by
or on behalf of E for convenience of E ONLY IF
o
(1) for meals,
if they are furnished on business premises of E
§
§
1.119-1(c)(1): business premises
mean the place of employment of EE
·
Meals/lodging
furnished in E’s home for a domestic servant IS meals/lodging on business
premises and excludeable; meals to cowhands while herding E’s cattle on
leaseland are also excluded
o
(2) for
lodging, if EE is REQUIRED to accept such lodging on business premises of EE as
a condition of his employment
Note—substance
over form in tax; even if EE and E agree to a clause n K that requires EE to
live on business premises, if isn’t at E’s convenience, no exclusion from EE’s
GI
Note—regarding
groceries—some courts say meals do NOT include groceries, so if E gives you an
allowance for groceries, that allowance is GI.
However, some courts hold the other way
Note--Hatt:
For exclusions for meals/lodging, it does not have to be an unqualified
corporation. In this case, P was
the owner and EE. When the
motivation is not to benefit EE but to conduct the business of E (within the
meaning of § 119) then EE is not penalized for having to accept this income.
·
D—for an EE of
an educational institution, GI does not include qualified campus lodging
furnished to EE
o
Exceptions (see
§ 119(D)(2))
Constructive
Receipt
Revenue Ruling
60-31: Income although not actually
reduced to T’s possession is
constructively received by him during the taxable year in which it is
credited to his account or set apart for him so that he may draw upon it at any
time. Income is NOT constructively
received if T’s control of it is subject to substantial limitations or
restrictions
Two situations
·
When E has set
aside to a 3rd party and it is not subject to E’s creditors
·
When E has
secured property so that creditors cannot get to it AND there are no substantial
limitations
o
Things that
are not substantial limitations
§
Requirement to
take out money in certain sums, writing a notice of intention to withdraw,
having to lose interest gained on the money withdrawn
·
Examples of
constructive receipt
o
When interest
coupons mature and are payable but have not been cashed
o
Athlete
signing bonus to be paid in 5 year increments
·
Caveat—EE has
to pay taxes on something which he doesn’t have money to pay taxes on it yet
·
To prevent
triggering of constructive receipt
o
E must let
creditors have priority to $$ set aside.
Gains
§ 1001(a):
the gain from sale or other disposition of property = excess of the
amount realized (AR) over the adjusted basis (AB) as provided for in § 1011
·
Gain/Loss = AR
-- AB
§ 1001(b):
amount realized (AR) = sum of any money received plus the fair market
value (FMV) of property (other than money) received.
·
AR = money
received + FMV of property
(1)
DON’T take
into account any amount received as reimbursement for real property taxes
(2)
DO take into
account amounts representing real property taxes if they are to be paid by the
purchaser
§ 1001(c):
the entire amount of gain or
loss, determined under this section, on the sale or exchanged of property is
recognized except as otherwise provided in this subtitle
§ 1011(a):
the adjusted basis is the cost at acquisition point (§ 1012)
or the original basis (§1011) +
adjustments (§ 1016)
*Adjustments
to Basis
§ 1016:
you have to adjust for
(1)
expenditures,
receipts, losses, or other items, but not for
a.
taxes or other
carrying charges in § 266
b.
expenditures
described in § 173
(2)
for
exhaustion, wear and tear, obsolescence, amortization, and depletion to the
extent that the amount
a.
allowed as
deductions in computing taxable income
b.
resulting in a
reduction for any taxable year, or any prior income BUT NOT less than the amount
allowable under this subtitle
*More on the
adjusted basis
·
for purchases
at arms-length transactions
o
§ 1012—the
basis of property shall be the cost of such property
o
Cost = FMV of
asset received
§
Initial basis
attaches to the item itself, not the amount you’ve paid
·
Determining
FMV
o
Appraisal
o
Value of the
Asset surrendered (Philadelphia Park Amusement Co.)
§
More lessons
from
·
Cost in § 1012
is a tax term with a tax meaning—think of it not as “how much I paid” but “how
much value I received”
·
Options—if you
pay for an option to buy land, then buy the land, then the option + price paid
for the land = AB
o
If you
buy/sell the option without purchasing the land, then the option is treated like
an asset in itself
*Improvements
by T on LL’s property
§ 109: these
are not included in LL’s GI
·
This is the
statutory response to the Bruin case (which I probably did not read)
*Windfalls
·
Basis is FMV
on acquisition
*Gifts
§ 1015(a):
basis of a gift in the hands of the DD is the same as it would be in the
hands of D or last preceding owner by whom it was not acquired by gift UNLESS
that basis is greater than the FMV of the property at the time of the gift; then
the basis for determining LOSS is the FMV
·
There is no
tax on making of the gift to D—so D has no loss
·
Taft:
If D gives property to DD with a FMV of $30 and an AB of $20 and DD sells
for $35, then DD technically only has a gain of $5, but the government will tax
from where D first got the property ($20) for a tax amount of $15.
This is constitutional
·
§ 1015 does
not apply to ante-nuptial exchanges because that is an arm’s length transaction;
so we use § 1012 (Faried Es Sultaneh)
*
·
Ex1:
Donor has an AB of 30, but at the time of gift, FMV is 20.
If Donee sells for $35,000, then the gain is
o
AR (35) –
AB(30) = 5,000
·
Ex2:
Donor has an AB of 30 but at the time of gift, FMV is 20.
Donee sells for $15,000. The
loss is
o
AR(15) – FMV
(20) = -$5,000
§
Note:
number should be NEGATIVE, genius
·
Ex3:
Same facts; Donee sells for $24,000.
o
Gain:
30—24 = -6,000 (so no gain)
o
Loss:
24—20 = 4,000 (so no loss, either)
*Part
·
§
1.1015-4(a)(1) AB for transferee is the GREATER of
o
(i) Amount
paid by transferee OR
o
(ii)
Transferor’s AB in the property at time of transfer OR
o
(iii)If
transferor’s AB is greater than FMV of property and FMV of property is greater
than amount paid by transferee, then FMV of the property is the unadjusted basis
*Property
Acquired between Spouses or incident to Divorce
§ 1041 (a):
No gain or loss to (1) a spouse; or (2) a former spouse, if the transfer
is incident to divorce
(b) The transfer is treated like a gift, and the transferee has the
transferor’s basis
§
No
basis-splitting here
(c) Incident
to divorce—definition
·
If it occurs
within 1 year after the date on which the marriage ceases OR
·
Is related to
the cessation of the marriage
There is a
rebuttable presumption that the transfer is
not incident to cessation of marriage
when the transfer of property is more than six (6) years after the divorce
*Property
Acquired from a Decedent
§ 1014(a):
if not sold, exchanged, or otherwise disposed of before the decedent’s
death by such a person, the basis is
(1)
The FMV of the
property at the date of decedent’s death OR
(2)
See code
·
E—Exception:
if decedent or decedent’s
spouse receives a gift of property within 1 year before decedent’s death and if
the property has appreciated, then the inheritor gets donor’s basis
o
This exception
is only for APPRECIATED property, not DEPRECIATED property
§
Ex:
F gives D a house with an AB of $100.
D dies within the year and the house is given to T in D’s will.
The house’s FMV on the date of D’s death is $150.
T’s basis in the property is $100.
Note: If the FMV on D’s
death was $50, T’s basis in the property is $50 b/c the house has not
appreciated.
*Amount
Realized
§ 1001(b):
the sum of any money received PLUS FMV of property received
International
Freighting:
even when there is no sale, when there is an exchange of something (like
stock) for something (like services) with a 3rd party that is a tax event and
gain/loss is realized on that event.
Here, T used stock of another company with basis of $16K to provide
bonuses to EEs for services performed.
FMV of stock at the time of transfer was 24K.
The court held that T had a gain of 8K because the stock was used for
services received; in effect, T gained 24K and gave it away to EEs as bonuses.
EEs had basis of 24K.
§ 212
Expenses for Production of Income
For
individuals, there is a deduction for all ordinary and necessary expenses paid
or incurred during the taxable year for
(1) the
production or collection of income
(2) the
management, conservation, or maintenance of property held for the production of
income OR
(3) in
connection with the determination, collection, or refund of any tax
§ 274(j) Items
not deductible
--no deduction
for expenses allocable to a convention, seminar, or similar meeting
*Disposition
of Property with Debt
·
Recourse
Mortgage—personal liability on debt
·
Non-Recourse
Mortgage—no personal liability on debt; debt secured by collateral (property)
o
Example:
T has an asset used for security on a debt.
The debt is a non-recourse one.
If the property is worth 300, the debt is 180, and you have an AB of 100;
and your amount realized is 300.
The basis is 100, leaving you with a 200 gain, and the debt goes away.
o
Example 2:
If the property had instead been worth 170, then the payment on the debt
doesn’t meet the full amount owed.
When the debt is non-recourse, all of the consequences are reckoned on the
property. Thus, it will be used to
satisfy the full 180. You will have
a gain of 80 on the asset.
·
Rules
o
The discharge
of debt under a recourse mortgage is GI, as there has been a clear accession to
wealth over which there is complete dominion
o
The full
amount of debt must be included in AR at the time of the disposition of property
(Crane)
o
The full
amount of the debt must be included into AR even when the FMV of the property is
less than the amount of debt (Tufts)
o
GI can come
from the cancellation of debt
Problem 1, p.
150
Mortgagor
purchases a parcel of land from Seller for $100,000.
M borrows $80,000 from the bank and pays that amount and an additional
$20,000 of cash to S giving Bank a non-recourse mortgage on the land.
The land is the security for the mortgage which bears an adequate
interest rate
(a)
What is M’s
cost basis in the land?
a.
Basis of
$100,000. This is derived from §
1012. The borrowing of $80,000 does
not create any income for M
(b)
Two years
later, the land has appreciated in value to $300,000 and M has paid only
interest on the $80,000 mortgage. M
takes out a second non-recourse mortgage of $100,000 with adequate rates of
interest. Does M have income when
she borrows the $100,000?
a.
M has paid
interest only on the $80,000, so there has been no payment on the principal;
$80,000 is still the amount owed.
Now M has an extra $100,000??
(c)
If the
$100,000 are used to improve the land?
a.
§ 1016
adjustment. The basis is increased
by $100,000
(d)
What is M’s
basis in the land if $100,000 of the mortgage proceeds are used to purchase
stocks and bonds worth $100,000?
a.
No change in
basis of property but stocks and bonds get a § 1012 basis change
(e)
What result
under the facts of (d) if when the principal amount of the two mortgages is
$180,000 and the land is still worth $300,000, M sells the property subject to
both mortgages to P for $120,000 of cash?
What is P’s cost basis in the land?
a.
M’s AR =
300,000. His AB = 100,000.
The gain is 200,000
b.
Even if M took
the 300 and paid of the debt of 180, the gain would still be 200
(f)
If M gives the
land subject to the mortgages and still worth $300,000 to his son?
What is Son’s basis in the land?
a.
AR = 180,000;
gain of 80
b.
Son has a
basis of 180
(g)
What if M
gives the land to her spouse rather than son?
What is Spouse’s basis in the land?
What is Spouse’s basis in the land after Spouse pays off $180,000 in
mortgages?
a.
Basis of 100.
The property served as security for debt for total amount of 180.
Basis of 100 with gain of 80 realized.
The spouse will take it under § 1041 with the same basis as the
transferor.
(h)
What result if
land declines in value and M just transfers it back to the bank
a.
The FMV has
declined to 180. The total value of
the property is the outstanding debt.
The AR includes 180 relief of liability achieved by transfer of property.
Realize and recognize a gain of 80 even though we don’t get any cash out
of it.
(i)
What results
to M if the land declines in value from $300,000 to $170,000 at the time of the
quitclaim deed?
a.
180—from the
Tufts case. Even though the
FMV is less than the debt, the AR is the debt.
FMV is more
than the debt: AR is the money
received plus any amount of debt.
AR on property is at least the
balance owed on the debt.
FMV is less
than the debt: two situations
|
|
AR
Recourse |
AR
Non-Recourse |
|
FMV is
greater than debt |
AR(prop) = $ received +amount of debt
AR (debt) = no cancellation of debt (COD) |
Same as recourse—AR = $ received + full balance of debt |
|
FMV is
less than debt |
AR (prop) = FMV of property
AR (debt) = COD |
AR (prop) = Balance of debt
AR (debt) = no COD |
*Gains/Losses
when selling small pieces of big land
§ 1.61-6(a)
(i) If the
lots were purchased as a single unit, then a FMV determination at purchase would
have to be made post hoc and the
percentages of value would then determine the basis for each lot
·
The equation
is always AR – AB = gain/loss
·
AR = amount
received for the small piece
·
AB = (FMV of
piece at acquisition) / (sum of all pieces at acquisition) = x%
·
Then, take x%
and multiply it with the (sum of all pieces at acquisition)
·
Since it’s
based on percentage—if one of the lot’s prices is affected by something (like an
easement) then all of the lots are affected
·
Note:
property also includes intangible things, such as goodwill
*Gift Tax
·
Allows you to
step up in basis when a percentage of
the gift tax is paid so you are not taxed twice.
The reasoning is that the increase in basis is limited to the amount that
bears the same ratio to the amount of gift tax paid as the net appreciation in
value of the gift bears to the amount of the gift.
% of gift tax
paid = net appreciation in value/amount of gift
§ 1015(d)(6)
In the case of any gift made after 12/31/76, the increase in basis provided by
this subsection with respect to any gift for the gift tax paid under chapter 12
shall be an amount which bears the same ratio to the amount of tax so paid as
(i)
the net appreciation in value of the gift bears to
(ii) the amount of the gift
So:
if you get a gift of land that was purchased by G for $200 and given to
you when it was worth $300 and G paid $60 gift tax on the transfer and you sell
it to S, then you have a basis of (net appreciation in value of gift= 100) /
(amount of gift = 300) = 1/3 x the amount of gift tax (60) = 20 for a gain of
20. S’s basis is 320 under § 1012.
Equation:
[(appreciation
amount)/(total amount of gift)] * (amount paid for gift tax) = (amount you can
add to existing basis to adjust basis)
*Discharge of
Indebtedness
§
61(a)(12)
(i) a taxpayer may realize income by the payment or
purchase of his obligations at less than their face value
(ii) when the
amount or value of debt is greater than the quantum of debt which eliminates the
debt, it is GI. If the debt is paid
off at less than face value, the difference is GI.
(Kirby Lumber) It
doesn’t matter if the mortgage is assumed because the responsibility to repay
has disappeared.
LIFE
INSURANCE PROCEEDS
§ 101:
excludes proceeds of life insurance from GI of recipients
Two types of life insurance
1. Term
insurance: this is cheap.
The policy lasts for a term only, usually less than life expectancy.
2.
Whole Life/Permanent Policy Insurance:
as long as you pay your premiums, you have insurance.
You have an investment element in your premiums; if you elect to cancel
the insurance, you can get back a “refund” of your premium payments.
·
A—100% of the
amounts received under a life insurance policy that are paid
by reason of death of insured are
excluded from the recipient’s income.
P. 155, 1 (a)
If B accepts the $100,000 in cash, all of it is excluded from his GI
o
(2) if the
policy is transferred for valuable consideration, by assignment or otherwise,
the amount excluded from GI by paragraph (1) will not exceed an amount equal to
the sum of the actual value of such consideration and premiums and other amounts
subsequently paid by transferee.
§
Exceptions to
this
·
(A) if such K
or interest has a basis for determining gain or loss in the hands of a
transferee determined in whole or in part by reference to such basis of such K
or interest therein in the hands of the transferor OR
·
(B) if such
transfer is to the insured, to a partner of the insured, to a partnership in
which the insured is a partner, or to a corporation in which the insured is a
shareholder or officer
*Exceptions to
§101(a) “100% exclusion” rule
1.
If beneficiary takes the cash surrender value.
Calculation: (Cash surrender
value) – (Total of premiums paid so far) = GI
2.
Conversion to lifetime annuities for the
insured.
Calculation: (Sums received)
-- (Premiums paid) = GI
3.
Viatical settlements—if policy holder has bought/sold policy for value
during the life of the insured, the § 101(a) exclusion is lost.
4.
Beneficiary-elected interest
payments—if B leaves all the proceeds with the insurer and only draws interest
on the amount that would otherwise be paid as a lump sum, these payments are
fully taxable. (§ 101(c)).
This does not apply when the
recurring payments eat into the principal amount of the insurance.
In that situation, § 101(d) applies.
·
C—if any
amount excluded from gross income by subsection (a) is held under an agreement
to pay interest thereon, the interest payments shall be included in gross income
*Exceptions to
the exceptions (100% exclusion applies again)
1.
Viatical settlements between spouses and divorced couples:
when it is a transfer between spouses or property settlement incident to
dissolution of marriage under § 1041, then § 1041 provides for the exclusion
from GI
2.
Viatical settlements between business partners:
when transfer is gratuitiously made
by or
to the insured or business partners,
then the proceeds are excludable (§ 101(a)(2)(B); § 101-1(b)(2)
P. 155, 1 (b)
If B leaves
all the proceeds with the company and they pay her $10,000 interest in the first
year, the $10,000 is included in his
GI
·
D—payment of
life insurance proceeds at a date later than death
o
(1) Amounts
held by an insurer with respect to any beneficiary shall be prorated over the
period or periods with respect to which such payments are to be made.
These prorated amounts are excluded from gross income.
Any other payments are gross
income
o
(2) Amount
held by the insurer with respect to any beneficiary means an amount to which
subsection (a) applies which is
§
(A) held by
any insurer provided for in the life insurance contract, whether as an option or
otherwise, to pay such amount on a date or dates later than the death of the
insured AND
§
(B) equal to
the value of such agreement to such beneficiary
·
(i) as of the
date of death of the insured AND
·
(ii) as
discounted on the basis of the interest rate used by the insurer in calculating
payments under the agreement and mortality tables
·
Calculation:
(Lump sum amount) / (life expectancy of B—according to INS co’s tables) = amount
that is excludable per year. The
rest will be taxed as GI
o
Note:
if B lives beyond calculated expectancy, he can continue to take the
exclusions even after the full amount has been received.
If B dies before the entire amount is received, he’s SOL.
o
(3) This
subsection does not apply to any amount that (C) applies to
P. 155, 1 (c)
If B is I’s Daughter and she elects to be paid $12,000 in the current year, and
$12,000 per year for the rest of her life with a life expectancy of 25 years,
you look at the amortization schedule, and divide the Principal over the payment
period. $4,000 of each annual
payment is considered part of the principal, and is thus excluded from tax, but
the other $8,000 is considered income.
P. 155, 1 (d) If I’s Daughter lives beyond her 25 year expectancy and gets
$12,000 in her 26th year, the exclusion from § 101(D) applies forever.
$4,000 will be tax-free, and $8,000 will be taxed.
Note: if you die in year 9,
there is no adjustment for dying early, so try to outlive the insurance
company’s estimate.
·
G—Treatment of
certain accelerated death benefits
o
(1)
Definition of amounts paid by reason of death of an insured
§
(A) any amount
received under a life insurance K on the life of an insured who is a terminally
ill individual
§
(B) any amount
received under a life insurance K on the life of an insured who is a chronically
ill individual
o
(2) Viatical
Settlements
§
(A) If any
portion of the death benefit under a life insurance K on the life of an insured
described in (1) is sold or assigned to a viatical settlement provider, the
amount paid for the sale or assignment of such portion shall be treated as an
amount paid under the life insurance K by reason of death of the insured
§
(B) (i) A
“viatical settlement provider” is any person regularly engaged in the trade or
business of purchasing, or taking assignments of, life insurance Ks on the lives
of those in (1) if
·
(I) such
person is licensed for such purposes in the State in which the insured resides
OR
·
(II) for
people living in states where viatical settlement providers don’t have to be
registered, if the provider meets the requirements of (ii) or (iii)
§
(ii)
Terminally ill insureds. Definition
·
(I) person
meets the requirements of §§ 8-9 of the Viatical Settlements Model Act of the
National Association of Insurance Commissioners AND
·
(II) meets the
requirements of the Model Regulations of the National Association of Insurance
Commissioners in determining amounts paid by such person in connection with such
purchases or agreements
§
(iii)
Chronically ill insureds.
Definition
·
(I) meets
requirements similar to those in clause (ii)(I) AND
·
(II) meets
standards, if any, of the National Association of Insurance Commissioners for
evaluating the reasonableness of amounts…
o
(3) Special
Rules for Chronically Ill Insureds
§
(A) Paragraphs
(1) and (2) shall not apply to any payment received for any period unless
·
(i) such
payment is for costs incurred by the payee for qualified long-term care services
provided for the insured for such period AND
·
(ii) the terms
of the K giving rise to such payment satisfy
o
(I) the
requirements of §7702(b)(1)(B) AND
o
(II) the
requirements, if any, applicable under (B)
§
(B) Other
requirements
·
(i) §7702B(g)
and §4980C
·
(ii) standards
adopted by the National Association of Insurance Commissioners which
specifically apply to chronically ill individuals
·
(iii)
standards adopted by the State in which the policyholder resides
§
(C) Per Diem
payments
·
A payment
doesn’t fall outside of (A) because they are made on a per diem or other
periodical basis
§
(D) Limitation
on exclusion for periodic payments: See § 7702B(d)
o
(4)
Definitions
§
(A) Terminally
ill individual—an individual who has been certified by a physician as having an
illness or physical condition which can reasonably be expected to result in
death in 24 months or less after date of certification
§
(B)
Chronically ill individual—excludes terminally ill individuals
§
(C) Qualified
long-term care services—see § 7702B(c)
§
(D)
Physician—see §186(r)(1)
o
(5) Exception for business related policies—this
subsection doesn’t apply to any amount paid to any taxpayer other than the
insured if the taxpayer has an insurable interest with respect to the life of
the insured by reason of the insured being financially interested in any trade
or business carried on by the taxpayer
ANNUITY
PAYMENTS
An annuity is
an arrangement under which one buys a right to future money payments; agreement
for lifetime payments.
Y = your (or
the insured’s) investment in K (money put in)
X = total
expected return on the K (money expected to get out)
Z = payment
received (you will have a number of Zs determined by your K)
Formula:
Y/X = %; X = (payment amount) * ( life expectancy.)
Apply % to Z = amount excluded from GI.
The rest of Z will be GI
§ 72(a)(b)(c)
·
A—Included in
GI
·
B—Exclusion
Ratio
o
(1)
GI does not include the amount of the investment in the K which bears the
same ratio to such amount as the investment in the K—you don’t get taxed on your
capital
o
(2) Exclusion
limited to your investment:
o
(3) Deduction
where annuity payments cease before entire investment recovered
§
(A) If
·
(i) after
annuity starting date, payments cease by reason of death of annuitant AND
·
(ii) there is
unrecovered investment in the K, that amount shall be allowed as a deduction to
the annuitant for his last taxable year
§
(B) Payments
to other persons
§
(C) Net
operating loss deductions
§ 1.72—4(a),
--9 (Table V)
Damages
i.
Damages are
taxed according to what they are replacing if they are replacing lost sums.
“In lieu of what were the damages awarded?” (Raytheon)
i.
Lost
profits/income—damages for these are GI because the profit you
would have gotten would have been GI
ii.
Recovery to
property
1.
Money received
for damaged property is NOT GI unless the amount you received IS GREATER THAN
your original basis in the property.
Any excess of damages in relation to your basis is GI
a.
NOTE:
any money you receive for damaged property that is equal to or greater
than your basis in the property adjusts
your basis in the property for gain/loss purposes
2.
Punitive
damages are GI (Glenshaw Glass)
i.
12 for damage
to the property: This money was
received by virtue of owning the property.
His basis in the building was 10.
According to the statute, any excess in damages in relation to the basis
is GI. There is a gain of 2 (12
damages – 10 AB) included in T’s GI.
ii.
15 for lost
rent due to damage: Lost rent =
lost profits. T would have been
taxed on this, so this is GI.
iii.
100 punitive
damages: According to Glenshaw
Glass this is GI.
i.
Requirements:
state system of worker’s comp. and damages are for a worker’s comp.
situation.
i.
These can be
received in lump sum or series of payment.
ii.
Emotional
Distress: you can exclude amounts
received for this if the damages are associated or attached with a personal
injury OR if they are incurred as a
result of the injury. However,
emotional damages causing physical symptoms = GI.
iii.
Under § 213,
if money is spent to treat the emotional distress, it may be deducted…
1.
§
213—generally, there is a deduction for expenses paid during the taxable year,
not compensated for by insurance or otherwise, for the medical care of T, his
spouse, or a dependant to the extent that the expenses are more than 7.5% of his
adjusted GI.
iv.
NOTE:
This is not fair to Ps because they are taxed on the entire amount of the
settlement even though 1/3 of those go to pay attorney’s fees
i.
If these are
received by an EE, they are not GI to the extent they are attributable to
contributions by the employer or were paid by the employer
i.
Civil wrongful
death actions where the applicable State law (as of 9/13/95) says that
only punitive damages may be awarded
in such an action.
LOOK THROUGH READING TO SEE IF IT ADDRESSED EMPLOYER-PAID ACCIDENT/HEALTH PLANS.
SEPARATION AND
DIVORCE
Note:
none of these statutes (§ 71, §215, § 1041) cover services or “use” of
one spouse’s property by the other.
We are aiming for a universal federal standard, but Congress says you can “have
it your way.” This
section shifts the liability to the spouse on the receiving end of the payments
and allows a deduction to the payor spouse (so Britney’s in luck; not so much
for K-Fed)
§ 71
Alimony and Separate maintenance payments
(a)
These are
specifically included in GI by the statute
(b)
These include
any payment in cash if such payment is (§ 71(b)(1))
a.
Received by
(or on behalf of) a spouse incident to a divorce instrument
b.
The instrument
does NOT designate such payment as that which is not includable in GI, and is
not allowed as a deduction under § 215 (§ 71(b)(1)(B))
i.
The IRS will
look to see what the intention of the parties is--
c.
For people who
are separated, the payee spouse and the payor spouse cannot be members of the
same household at the time such payment is made
d.
Payments do
not continue past death of either spouse
e.
The payments
MUST be in cash for this section to apply—if it is not cash, like a painting or
something, we may have a § 1041 analysis to apply.
§ 215—allows
a deduction for payor of alimony as long as the alimony is included in the GI of
the recipient.
*
·
Payments must
be in CASH (cash, check, money order)
·
Must go to the
spouse for his/her benefit (direct payment)
·
Indirect
payments are subject to the Ownership Test
o
Ownership
test: who owns the asset?
§
If the paying
spouse is making payments on his
property, no shift
§
If he is
making payments on the other spouse’s property, there can be a shift
·
Must be
pursuant to divorce instrument or decree
·
Amount CANNOT
be labeled as “non-alimony” in the divorce instrument or support decree
·
They must not
live in the same household
·
No liability
to make payments after death of payee spouse
·
Payment is NOT
child support
§ 1041
Property Settlements
·
See the
section about gains/losses, specifically § 1041(c).
Basically, there is no gain or loss on a transfer of property (just an
exchange of each other’s basis) from an individual to a former spouse if
incident to divorce.
Child Support
·
This is NOT
within the parameters of GI for § 71, so they are not GI to the payee spouse and
cannot be deducted from payor. You
can disguise child support as alimony because there is only a problem when it is
deemed child support.
Under this new statute, child support is NOT limited to minor
children—thus, you can pay child support to your kids until they are very old
(sweet).
·
Things that
are child support
o
If the
agreement says so
o
If there are
contingencies put on payments pursuant to child’s life (attainment of a certain
age, marriage, dying, leaving school) as so they are clear that the payments are
for the child
·
Two situations
for when payments that would ordinarily be alimony will be presumed to be child
support
o
When the
payments are reduced not more than 6 months before or after the date the child
reaches the age of majority
o
When the
payments are reduced on two or more occasions which occur not more than one year
before or after a different child of the payor spouse attains a certain age
between 18-24.
§
Age must be
the same for each child; does not have to be a whole number
§
Calculation:
on the date that reduction in payment first occurs, calculate the oldest
kid’s age. On the date the second
reduction occurs, calculate the next youngest kid’s age.
Then look at the two ages and try to find a middle point—the middle point
is an age. If both kids are within
that age by a year, then §71/215 doesn’t apply.
If they are not within the age by a year, then §71/215 applies.
·
Try to find an illustration
·
Payments for
less than the amount fixed in the instrument are applied to child support first
and only the amount in excess of child support payment is GI to payee.
o
Example:
Britney owes K-Fed $1,000 in child support and $1,000 in alimony.
K-Fed has no GI because the entire $1,000 is treated as child support.
This section
is most useful if you live somewhere where there’s an enormous appreciation
amount (so not
*General
Requirements (4)
·
If, in the 5
year period ending on the date of the sale, you have owned and used the property
as your principle place of residence for periods aggregating 2 years or more,
you get to exclude this from GI. (§
121(a))
·
You are
allowed to exclude no more than $250,000.
§ 121(b)(1)
·
Has not used
the exclusion in the last two years
o
You can
opt-out of the exclusion either at the time, or retrospectively (limit of 3
years back)
·
Is not an
ex-pat
*Marriage/Joint Returns
·
However, if
you file a joint return (as husband and wife) you can exclude up to $500,000 §
121(b)(2)(A) IF
o
Either
spouse meets the ownership requirement § 121(b)(2)(A)(i)
o
Both
spouses meet the use requirements § 121(b)(2)(A)(ii)
o
Neither
spouse is ineligible under paragraph (3)
·
If the spouses
do not meet the requirements above, you can only exclude up to what each spouse
would be entitled to exclude if they had not been married.
For a determination like this, each spouse is treated as owning the
property during the spouse that either
spouse owned the property.
·
Paragraph (3)
limitations
o
If you have
used this section with a 2 year period ending on date of sale, you cannot use
this section to exclude the gain.
*Other
Exceptions
·
You can claim
a reduced maximum exclusion if the
primary reason for the sale is change
in employment, health, or unforeseen circumstances.
§ 121(c)(2)(B)
o
If the primary
reason is location of employment, the employer doesn’t matter
o
§
1.121—3(c)(2) Distance safe harbor requirements
§
If your new
place of employment is at least 50 miles farther from residence sold or
exchanged than the former place of employment OR
§
If you had no
job before; if the distance between the new place of employment and the
residence sold or exchanged is at least 50 miles
§
Even if the
safe harbor is not met, you can still be qualified for a reduced maximum
exclusion if under the facts/circumstances, the primary reason for the sale is
change in place of employment. (See
examples in the regs).
o
If the primary
reason is health
o
§1.121—3(d)
§
If T, spouse,
or co-owner has to move to get treatment or facilitate diagnosis of disease,
illness, or injury
o
§
1.121—3(d)(2) If the treating
physician recommends a change of residence for reasons of health, you fall into
the health safe harbor.
o
Unforeseen
circumstances include natural or man-made disasters, acts of war or terrorism
resulting in a casualty to the residence, cessation of employment as a result of
which EE is able to collect unemployment, change in employment where you are
unable to pay, divorce, multiple births from the same pregnancy.
(There are more, and they are in § 1.121—3(d)(2)
·
Calculating
reduced maximum exclusion § 1.121—3(g)
o
Fraction *
maximum dollar limitation ($250,000 for singles, $500,000 for joint return)
§
Fraction =
[shortest of (time owned, time used as principal residence, time between now and
last §121 exclusion) in months or days] / [730 days or 24 months]
Income Earned
Abroad
§ 911:
If an individual so elects, his foreign earned income as well as his
foreign housing cost may be excluded.
·
Things not
included in foreign earned income
o
Pension/annuities paid by the
o
Received after
the close of the taxable year following the taxable year in which the services
to which the amounts are attributable are performed. § 911(b)(1)(B)(iv)
·
Limitations
o
Foreign earned
income cannot exceed amount of foreign earned income computed on a daily basis
at an annual rate equal to exclusion amount for the calendar year in which the
taxable year begins § 911(b)(2)(A)
·
Exclusion
amount
o
See table—for
2002 and beyond, it’s $80,000 § 911(b)(2)(D)(i)
·
Notes from
class
o
The former
benefit that the income came off of the bottom and that you restarted the tax
scale is no more—now the income is added to the top.
o
Ex:
You have $80,000 excludable under § 911.
You also have $30,000 in dividends/interest, which are not excluded.
You will be in the $80,000-$100,000 tax bracket for your
dividends/interest, instead of the $0-$30,000
*Housing
Abroad
·
Reasonable
expenses incurred or paid during the taxable year can be excluded.
These include utilities and insurance, but not interest and taxes that
are deductible under § 163-164. §
911(c)(3)(A)(i)-(ii)
Municipal Bond
Interest
§ 103:
Interest on any state or local bond is not GI.
·
Exceptions:
private, nonqualified bonds; arbitrage bonds; bonds not in registered
form
Part II:
Who pays the tax?
Assignment of
Income
·
If you earn
the income or own the income-producing asset, you CANNOT assign the income for
tax distribution/fragmentation benefit.
*Income from
Services
·
Whoever earns
the money pays the income tax on it, even if the compensation goes to someone
else. You cannot get rid of income
by assigning it/giving it to someone else (Lucas)
·
You may choose
not to get what you’re worth. If
you are going to do an arrangement like this, it is best to have it in place
before the services are performed.
(Giannini).
·
You may NOT
accept the funds and redirect them.
*Income from
Property
·
The property
is the generator of income. The
owner of the property which is generating the income is the taxpayer regardless
of who receives the income.
o
You can give
the property to someone else before it generates income, if you want to get rid
of it.
o
You can put
the property in a trust and have your children pay the tax on interest received
from the trust.
·
The fruit is taxed to whomever owns the tree.
(Helvering)
*Ways to Shift
Income
·
Hire your
family—you still get business deductions (salary, operation expenses) and your
children will be taxed at a minimal amount
·
Trusts
·
Entities for
tax purposes (corporations, LLC, partnerships, etc.)
Part III:
What can we deduct?
Deductions
adjust GI to determine Taxable Income (TI).
Hence, GI – Deductions = TI
You MUST have
statutory authorization to take a deduction, since they are not constitutionally
required.
Business
Deductions
Three
categories of amount spent/incurred for decutions
i.
Exceptions:
Interest payments, medical expenses, state income/property taxes
i.
You have to
set aside the expenses incurred in starting up the business and amortize them
over 180 months during the operational stage of business.
If the business ends before all deductions are taken, the rest can be
taken out as a full deduction on the last business return.
§ 162:
Trade or Business Expenses (deductible in FULL for the current taxable
year)
Six (6)
requirements for a deduction
i.
Ordinary =
foreseeable in the life of the business.
The expense should be reasonable—what is reasonable is determined by the
expected reaction to that type of expense in a like situation.
Ordinary transactions have a common or frequent occurrence in the type of
business involved.
1.
The standard
of reasonableness is very important
2.
Extraordinary
things: attorney’s fees incurred by
president of a corporation in slander suit,…
ii.
Necessary =
something that is “appropriate and helpful”
i.
§ 162
deductions are not limited to successful businesses.
Business that lose money can also take deductions.
i.
Investigatory
phase—where you are looking into the industry, but not narrowed in on a
particular transaction (Morton Frank)
1.
Fear not—some
of these expenses can be put in to § 195 start-up expenditures and amortized
ii.
Transactional
phase—attempting to purchase a specific business
i.
It is clearly
established that an EE is carrying on a trade or business in his role as an EE
ii.
EEs can deduct
unreimbursed expenses incurred in
their capacity as EEs if the expenses meet the § 162 requirements (subject to §
274 limitations)
iii.
EEs seeking
new employment—once EE has entered into a trade/business he can deduct expenses
related to looking for a new job, even if he loses his original job.
1.
not allowed if
T has been unemployed for such a period of time that there is a lack of
continuity between the past employments and their endeavors to find new
employment.
iv.
EE education
expenses § 1.162—5: these are
deductible only if incurred to maintain or improve a skill required by a current
trade or business
Capital
Expenditures
§ 263:
The general rule is that any expenditure that will yield value beyond one
year is a capital expenditure.
·
§ 263 applies
to expenditures that are improvements or upgrades which prolong the operating
life beyond which it would otherwise have (unlike a repair-maintenance outlay
which only keeps the property in operation condition)
·
These do NOT
have to be tied to property (INDOPCO)
·
Cash outlays
for lawyer’s fees, investment banking fees, and SEC fees in connection with a
corporate acquisition are capital expenditures
not necessary and ordinary
deductible expenses.
·
The following
expenditures must be capitalized
o
Amounts paid
to acquire, create, or enhance an intangible asset
§
Stock,
partnership interest, bonds, debt instruments, options, patents/copyrights,
franchise, goodwill, computer software
o
Amounts paid
to facilitate the acquisition, creation, or enhancement of an intangible.
Start-Up
Expenditures
§195:
At the election of the taxpayer, these can be treated as deferred
expenses. They will be allowed as a
deduction prorated equally over a period of 180 months beginning in the month
when active trade of business begins.
·
You can deduct
a maximum of $5,000 with a phase-out over 180 months while business is happening
·
Start-up is
any amount investigating or creating a business
·
You cannot
amortize a start-up expenditure that couldn’t be deducted under § 162.
·
Only amounts
that could have been deductible under § 162 can be amortized under § 195
·
This section
is NOT applicable to persons seeking FIRST TIME EMPLOYMENT.
o
Exception:
Hundley case—P was a major league baseball player who was taught
the tools of the trade by his father. He agreed give Dad 50% of his signing
bonus if he got signed. The court
found these were deductible because they paid for services
actually rendered in carrying on a
business.
Specific
Deductions
*Reasonable
Allowances for Salary
§ 162(a)(1)
·
Reasonable
salaries can be deducted. However,
if a salary is deemed unreasonable, the business AND the EE pay taxes on all of
it.
o
What is
“reasonable”? The Return on
Investment Test
§
The amount of
salary balanced against the rate of return (adjusted for risk); regardless of
the seemingly exorbitant nature of the salary.
A very profitable company in a challenging field may pay a lot for their
CEO
·
If the return
on investment is high due to some fact outside the control of the employee, then
the presumption disappears.
§
The factors
test was deemed unreliable because there is no direct correlation between the
factors and the determination of a reasonable salary. (Exacto)
·
The Corporate
Salary Cap § 162(m): $1M per/EE
salary cap on corporate deductions
o
Exception:
Compensation in excess of $1M is deductible
if
§
It is
performance based compensation and
§
Voted on by
shareholders
o
Private
companies that are not corporations do NOT have the limit—any reasonable salary
is deductible.
§
Primary
concern in this area is whether the company is actually paying a salary or a
dividend to the employee in question
·
Why?
Because salary is deductible by the company and dividends are not.
·
Contingent
Salaries § 1.162—7(b)(2): These are
okay if three requirements are met
o
Made pursuant to a free bargain
(arms-length transaction)
o
Under
reasonable circumstances
o
At the time of
execution
·
Contingent
salaries meeting these qualifications are deductible even if they yield higher
payments than would ordinarily be paid
·
In situations
where the company is family owned, there is not arm’s length bargain (Harold’s
Club)
·
Golden
Parachutes: payments made to an
officer/highly compensated EE (top 1% or highest paid 250 EEs) § 280G(c) or to a
shareholder who leaves the company after a change of control.
o
If the payment
is 3 times the base salary, (average of past 5 years salary) or more, the
payment is unreasonable and not allowable as a deduction under § 162
o
The recipient
of the golden parachute is also taxed an additional 20% on the excess amount.
Business
Travel Away From Home
§ 162(a)(2)
·
Section
focuses on amounts that would not ordinarily be deductible because they are
personal expenses
·
You need to
substantiate deductions under this section
·
Whoever pays
for the expenses gets the deduction—if E reimburses EE for expenses, E gets the
deduction § 274(c)(3) and (k)(2)
·
Requirements
(from Rosenspan)
o
Traveling
§
§262—commuting
to and from work is not excluded or deductible.
§
§ 162---home
to workplace exceptions
·
If you leave
home and travel outside your metro area on a daily basis to a work site that is
temporary (not more than 1 year), then you may deduct expenses
o
T must have a
principal place of business though
·
If T has a
principal place of business and other regular places of business, daily
transportation to the temporary work locations are deductible
o
Ex:
home to courthouse for an attorney
·
If you work at
home as your principle place of business within the meaning of § 280A(c)(1)(A)
then T may deduct transportation expenses to temporary work locations regardless
of the distance
§
Traveling
entirely outside of the area with work purpose at destination
·
Airfare—deductible if the principle
reason for the trip is business.
This is an all or nothing deduction
o
A reasonable
standby day will qualify as a business day even if no business is conducted on
that day (weekends, holidays) § 1.274—4(d)(2)(v).
This section is for time spent outside of the
o
First class
travel is okay
§
Luxury water
transportation (cruises) § 274(m)
·
You only get a
deduction of 2x the federal per diem amount
o
If a
conference is held on a cruise ship, this is only deductible if the ship is
registered in the
§
Travel as a
form of education is not deductible
§ 274(m)(2)
§
§
274(M)(3)—you can only deduct spouse or guest if they are an employee and
·
They are
essential
·
They would be
subject to the deduction if they went alone
§
Certain
foreign travel § 274(c)
·
You can
receive a foreign (outside of the
o
The travel is
in excess of 7 days OR
o
Personal time
is greater than 25% of the total time on the business trip
§
Meals
·
§ 262—eating
because you’re hungry or on lunch break are not excluded or deductible
·
§ 162 (further
limited by § 274(k))
o
Meals while
traveling entirely outside of home area:
meals will not get a deduction unless the trip is long enough to require
sleep. Even then, you still only
get to deduct ½ of the cost.
o
If the meal
immediately follows or is during a business transaction, you still get only ½
deduction
o
No deduction
for networking during meals
o
Meals cannot
be lavish or extravagant (§ 274(k)(1)(b))
o
At best, meals
get 50% deduction (§ 274(n)(1))
o
Get a receipt
or other proof! (§ 274(d))
§
Lodging
·
Personal days
(where no business is conducted) are not deductible
·
Business days
and nights are deductible
·
A reasonable
standby day will qualify as a business day
·
Sleeping in
your own home is not excluded/deductible.
§ 262
o
Away from home
§
To be away
from home, you must have a home.
Nomads get no § 162 consideration.
§
Generally, the
Tax Home is the same as the business headquarters of T.
(Flowers)
§
Deductions on
a “second home” are allowed as long as there is business conducted at that
location, even if it is a different business (Andrews)
o
Pursuant to
business
§
T’s trade or
business
Other
Deductions
*Entertainment
·
50%
deduction but the activity must be
directly related to business.
Business must be conducted during the entertainment, or directly preceding or
following a substantial and bona fide business discussion (including business
meetings at a convention or otherwise)
o
Must establish
that the business was substantial in relation to the entertainment. However, it
is not necessary that more time be devoted to business than entertainment.
§ 1.274—2(d)(ii)(3)
·
Tickets §
274(1)—the deduction is limited to the face value of the ticket.
If the ticket says $20 and you paid the vendor $22 then you are $2 out of
luck. Don’t forget—only 50% of the
$20 is allowed as a deduction.
·
Luxury
Skyboxes § 274(l)(2)—the deduction is limited to the face value of the
non-luxury box ticket.
·
Entertainment
facilities—NO deduction for facility used in connection with the activity
o
Ex:
dues to an athletic, social, or sporting club/organization/facility
*Dues
·
Dues paid to
professional organizations directly
related to your business ARE deductible unless some of the dues go towards a
political affiliation/contribution
o
Ex:
bar fees, union dues
*Business
Gifts
·
Deduction
limited to $25
·
See EE fringe
benefits
*Uniforms
·
These are
deductible if
o
They are
required as a condition of employment
o
They are not a
type that is applicable to a general usage
§
Firemen,
policemen, athletes, flight attendants
*Dry Cleaning
of qualified uniforms deductible
*Advertising
·
Generally
deductible UNLESS
o
Identifiable
as being for a political purpose
o
They can be a
capital expenditure if you purchase a piece of property or construct a billboard
to last for several years
*Political
contributions are NOT deductible.
Business
Losses
·
Deductible if
authorized
§ 165
·
Allows
deduction for any loss sustained during taxable year which has not been
compensated for by insurance (§165(a))
·
Limited to
trade or business loss (§ 165(c))
·
To calculate,
use the AB for determining loss in § 1011
Casualties
This is the
only personal loss allowed to be deducted.
*Total
destruction
*For things
that are not totally destroyed, loss is measured by the value before and after
the storm, limited by the AB of the property.
*Insured Items
and Offsets
·
Back to the
boat example. If your boat is now
worth nothing, but you recovered $4,000 in insurance for the boat, you only have
a loss of $2,000, because it is offset by the insurance payment.
*Business
Assets
·
Ex:
You have a basis of $6,000 in the asset, and it is totally destroyed when
it has a FMV of $4,000. There is no
insurance. Under the rule in the
reg, total destruction of property where the FMV is less than the basis, you
will be allowed to take the full basis.
*Stock Loss
·
§ 165(g):
if you can’t get anyone to buy your stock, you get a loss when you can
establish factually that the stock is worthless
Depreciation
§167 and §168
treat depreciation like an operating
expense by allowing an annual deduction for wear, tear, exhaustion, and
obsolesce of property.
Depreciations are allowed for property held for producing income.
Process
i.
Remember:
you can elect to depreciate more slowly but not more quickly.
i.
Remember:
real property does NOT get §168(k) or § 179 treatment
Details
§ 167:
Basic authorization and calculation of depreciation
i.
Inventory and
property held for sale to customer do NOT count
i.
Intangible
assets can be depreciated when their useful life is determinable.
This is called amortization instead of depreciation and is controlled by
§ 197
i.
Salvage
value—when depreciating under § 167, subtract salvage value from asset before
depreciating. When depreciating
under §168, the salvage value = 0.
i.
Property with
no determinable useful life CANNOT be depreciated, regardless of how it is used.
ii.
Under § 168,
you use the § 168(c) and § 168(e) tables to determine the recovery period
iii.
If § 168
doesn’t apply, you are kicked back to § 167.
1.
if §
167(h)—which is not even in our code
section-- does not apply, then use the useful life or class life of your
property as the recovery period.
§ 168:
Accelerated Cost Recovery System (ACRS)—this is only for
tangible property!
·
Recovery
period—determine the recovery period to determine the number of years to
depreciate over
o
Table § 168(c)
o
Methods of
depreciation
o
Conventions
§
Half year—the
applicable convention is the 1/2 year convention unless otherwise provided
·
Under the 1/2
year convention, the property is deemed to be in service in the midpoint of the
year. So in the first and last
years, you get a 1/2 depreciation
§
Mid-Month—applies to nonresidential real property, residential real property,
and any railroad grading or tunnel bore
·
Under the
mid-month convention, property is deemed to be placed into service in the
midpoint of such month it is placed in service
§
Mid-quarter—applies when the aggregate bases of depreciable property put into
use during the last 3 months of the year exceed 40% of the total amount of
depreciable property put into use in the year.
Methods of
Depreciation
*Straight Line
Depreciation § 168(b)
·
Same deduction
every year during the recovery period.
Don’t forget your convention, though!
o
Ex:
$500 depreciation over 5 years, 1/2 year convention
§
1--$50
depreciation
§
2--$100
§
3--$100
§
4--$100
§
5--$100
§
6--$50
*ACRS
(Accelerated Cost Recovery System)
·
200% declining
balance—2 X SL until SL produces bigger deduction
·
150% declining
balance—1.5 X SL until SL produces bigger deduction
*Extended SL
depreciation § 168(g)
·
Use straight
line depreciation method with recovery life listed in § 168(g)(2)(C) and
applicable convention in § 168(d)
Extra
Deductions
These are
taken before the depreciation methods are applied.
These adjust the basis.
§ 168(k)—not
in our materials
§ 179 bonus
depreciations—these can be taken at your election (they are optional)
·
Allows T to
treat some property as an expense and can be deducted in the year it is put into
service. § 179 applies to the
aggregate amount of all the properties.
§ 179 deductions can only be taken on § 168 properties that the ACRS
applies to.
·
See the
statute
Part VI:
Tax Shelters and Limitations
·
There are no
deductions for these
Hobbies
·
§ 183:
The Hobby Loss Provision
o
Goal:
don’t allow hobby losses to offset other income.
Otherwise, people could just take on a hobby and offset normal income all
the time.
o
To deduct the
annual loss, T must demonstrate that at least a significant purpose of the
venture was to earn a profit
o
How to
determine this
§
Look at
·
Facts and
circumstances OR
·
Rebuttable
presumption: § 183 is satisfied if
T produced a profit for 3 of the last 5 years
o
2/7 years if
we’re talking about racehorses
§
Amount of
deduction
·
You can reduce
your income to 0 for that activity, but you cannot offset other income
o
Note:
if you get through § 183, § 465 now applies.
§ 465 treats the activity as an asset with a basis. The amount you can
deduct through losses is limited by the amount at risk in the business.
·
§ 465:
At Risk Limitations
o
Your
deductible loses from a specific business or investment activity are limited to
the amount you have at risk in the activity.
This section applies to individuals and closely held corporations
§
Definition of
“at risk”
·
You have to be
personally liable (no non-recourse loans)
·
Debt to
relatives and other with interest in the venture and activity does not count
§
This section
applies to all business and investment activities
§
Running
tab—when you claim the deduction, you decrease the amount at risk for future
deductions
·
This is a
timing provision
o
If you get
through § 465, then § 469 applies
·
§ 469:
Passive Activity Losses
o
A person
engaged in a passive activity cannot deduct the losses except against income
from other passive activities
§
Definition:
A business in which T does not materially (regularly, continuously, or
substantially) participate
·
Automatically
considered passive activities:
limited partnership interests, rental activities
o
Objective test
§
From §
1.469—5T
·
T’s
participation is material if he participates more than 500 hours per year
·
Or at least
100 hours and his participation is not less than that of other individuals
o
Married
individuals can combine the work of both to meet these tests
o
Limited
Deductions
§
Passive
activity losses can only be used to offset income generated by those passive
activities (PIG)
§
Any remaining
loss can be carried over to the next year.
·
When you exit
the activity, you can claim the loss for these carryovers
Capital
Gains/Losses
These are
identified for special treatment.
Capital gains are income, they just get taxed at special (lower) rates.
Capital loss deductions are restricted.
·
Definition:
A capital gain/loss is
o
A gain or loss
from
§
A sale or
exchange of
·
Exception:
worthless stock is treated as a sale or exchange, dividends get same
capital gains tax rate
§
A capital
asset as defined in §1221
·
Excludes sales
of stock, real property, publications of the
·
Accounts or
notes are not capital gains
·
Your personal
property—house, car (watch our for § 121 principle place of residence)
·
If it is not a
capital asset, § 1222 doesn’t apply---use ordinary gain or loss
·
Tag things as
STCG/L or LTCG/L
o
ST:
whether a gain or loss is short term depends on the amount of time you
have had the asset. If the length
of holding was 12 months or less, it is short term.
§
If it is a
short-term capital gain, T’s normal tax rate will apply
o
LT:
if the length of holding was more than 12 months
§
If there is a
long-term capital gain, special tax rates apply
o
NLTCG =
LTCG—LTCL
§
This is the
only thing you get a break on
·
Special rates
for capital gains
o
28%--collectibles
§
Stamps, most
coins, antiques, gems, artwork, etc.
§ 1(h)(4)(a), §1(h)(1)(e)
o
25%--sale of
depreciable real property and § 1250 gains
§ 1(h)(1)(D)
o
15%--applies
to “adjusted net capital gain”. Basically this applies to everything else that
the other percentages don’t apply to—including gains on stocks, bonds,
investment land, other types of capital assets § 1(h)(1)(C)
o
10% and
15%--§1(h)(1)(b). When T has
inadequate ordinary income (when their income tax rates are less than 25%) there
is special treatment.
§
If T makes
only a little bit of money, he gets taxed at 15%
on his entire Taxable Income, then the 10% applies to his capital gains
until those capital gains take him out of the lowest tax bracket.
Limitations
for Losses
·
General rule:
capital losses cannot be used to deduct anything but capital gains.
o
Exception:
when you are an individual (so not a corporation) and you have net
capital losses, you can use at most
$3,000 of those losses to offset your
other income.
o
FIRST:
net all gains and losses within the rate classifications
o
SECOND:
any net losses let will wipe out gains in favor of T.
Use your losses to wipe out the highest taxed gains first, and then
trickle down the list.
§
Ex:
You sold an asset that would have been taxed at 15% if you had made a
gain, but you had a loss of $1,000.
You didn’t sell any other assets other than this collectable.
You sold the collectable asset and made a gain of $1,000 (since it is a
collectable, you will be taxed at 28% on the gain).
·
Result:
Net loss of 1,000 in 15% classification; net gain of 1,000 in 28%
classification. You can use your
1,000 loss from the 15% bracket against your gain made in the 28% and thus 0
capital gain.
·
Other things
o
You cannot
take a loss for the sale of your house or car
Credits
·
Earned income
tax creit
·
Congress
repays/overpays low-income taxpayers to reward them for engaging in productive
work.
·
Refunds
portions of tax collections to those who qualify by giving them credits that
offset their tax and may generate additional amounts for refunds
o
Also refunds
SS and medicare taxes
·
Process
o
Calculate tax
o
Offset it with
credits
·
As your income
goes up, you’re phased into the taxable bracket
Alternative
Minimum Tax
·
My notes say
“do the reading” –crap
·
A way of
requiring you to take your regular taxable income and add back elements that
Congress originally thought you shouldn’t have gotten but Congress thinks will
better reflect your income
·
Results:
these, plus your additional income, are subject to a flat tax of 28%
·
Clausen—this
affects high-tax state citizens, people with large families
o
A middle
income family with 10 children were forced into the AMT even though they didn’t
make a lot of money
·
Never intended
to catch people like the Clausens, but does, unfortunately
·
CA has the
same system, but indexed its alternative minimum tax so that it doesn’t catch
the low income people.