Tax

Tax: Lilly Casebook Problems

Tax I

Professor Lilly

Casebook Problems

WEEK 1

Problems p. 63

Internal Revenue Code: Section 61

Internal Revenue Code: Section 61; Regulations: Sections 1.61-1, -2(a)(1), -2(d)(1), -14(a)

1. Would the results to the taxpayers in the Cesarini case be different if, instead of discovering $4,467 in old currency in the piano, they discovered that the piano, a Steinway, was the first Steinway piano every build and it is worth $500,000?

Yes, the results would be different. The value of the new piano would not have to be reported as gross income.

2. Winner attends the opening of a new department store. All persons attending are given free raffle tickets for a digital watch worth $200. Disregarding any possible application of I.R.C. § 74, must Winner include anything within gross income when she wins the watch in the raffle?

Store raffle problem. If they win the prize, shouldn’t it be income? Yes it should be income; the raffle is a promotion, so there is no detached generosity involved.

3. Employee has worked for Employer’s incorporated business for several years at a salary of $40,000 per year. Another company is attempting to hire Employee but Employer persuades Employee to stay for at least two more years by giving Employee 2% of the company’s stock, which is worth $20,000, and by buying Employee’s spouse a new car worth $15,000. How much income does Employee realize from these transactions?

Employee realizes $35,000 in excess of his normal salary. This equates to gross income of $75,000. See regulation 1.61-2(d)(1) Compensation paid for other than in cash. The form of payment does not change the characterization of something as income.

4. Insurance Adjuster refers clients to an auto repair firm that gives Adjuster a kickback of 10% of billings on all referrals.

(a) Does Adjuster have gross income?

Yes the Adjuster has gross income. See § 1.61 -2(a).

(b) Even if the arrangement violates local law?

Yes, illegal earnings are subject to taxation as well. James v. US – illegal gain is income, despite a legal obligation to make restitution. . §161-14, illegal gains constitute gross income.

5. Owner agrees to rent Tenant her lake house for the summer for $4,000.

(a) How much income does Owner realize if she agrees to charge only $1,000 if Tenant makes $3,000 worth of improvements to the house?

$4,000. Just as in compensation, the form of the payment does not pay the characteristic of the payment. If rent is involved, it does not matter what form the rent takes, it is still rent.

(b) Is there a difference in result to Owner in (a), above, if Tenant effects exactly the same improvements but does all the labor himself and incurs a total cost of only $500? Does the landlord care?

No. It is irrelevant to the landlord how the improvements got there.

If the tenant gets credit for paying 3,000 in rent for only 500 dollars of improvements, the tenant gets credit for gross income. The 2500 difference is an accession to wealth clearly realized by the tenant of which he has dominion. Not as rent but as paying the rent for an amount less than what was owed.

6. Flyer receives frequent flyer mileage credits in the following situations. Does Flyer have gross income?

(a) Flyer receives the mileage credits as a part of a purchase of ticket for a personal trip. The credits are assignable.

This does not create a tax event. The credits do not constitute gross income. There is no income just because you bought a plane ticket with your money and you get extra benefits.

(b) Flyer receives credits from Employer for business flights Flyer takes for Employer. The credits are assignable.

(d) Same as (c), above, except Flyer uses the nonassignable Employer provided credits to take a trip.

This would probably be gross income because it seems to be analogous to redeeming the frequent flier miles for cash.

Problems p. 66

1. Vegy grows vegetables in her garden. Does Vegy have gross income when:

(a) Vegy harvests her crop?

No. This is an example of imputed income.

(b) Vegy and her family consume $100 worth of vegetables?

No. This is an example of imputed income.

Yes. §61- Gain derived form dealings in property.

(d) Vegy exchanges $100 worth of vegetables with Charlie for $100 worth of tuna which Charlie caught?

Yes. This falls under regulation 1.61-2(d)(1) compensation paid other than in cash.

2. Doctor needs to have his income tax return prepared. Lawyer would like a general physical check up. Doctor would normally charge $200 for the physical and Lawyer would normally charge $200 for the income tax return preparation.

(a) What tax consequences to each if they simply swap services without any money changing hands?

Both will have gross income in the amount of $200. See regulation 1.61-2(d)(1) provides that if services are paid for other than in money, the fair market value of the property or services taken in payment must be included in income.

(b) Does Lawyer realize any income when she fills out her own tax return?

Yes, the lawyer realizes gross income of $200. See regulation 1.61-2(d)(1).

Problems p. 78

Internal Revenue Code: Section 102(a) and (b) first sentence

Regulations: Sections 1.102-1(a), (b)

1. Our system of self assessment requires the taxpayer to make the initial determination of gift or income, and tax administration procedures give the commissioner the power to challenge that decision. If a judicial controversy develops, why is the decision of the trial court so important, and what role may an appellate court play?

All of the facts are established in the lower court. When the matter comes to appeal, only issues of law are at issue. Therefore it is important to establish your factual basis in the lower courts.

2. At the Heads Eye Casino in Vegas, Lucky Louie gives the maitre d’ a $50 dollar tip to assure a good table, and gives the croupier a $50 “toke” after a good night with the cubes. Does either the maitre d’ or the croupier have gross income?

The maitre d’ definitely has gross income. The $50 dollars was in exchange for a service and it was not a detachable or disinterested gesture of generosity. The croupier also has gross income in the amount of $50 because the regulations specifically state under §61 that tips are gross income.

Problems p. 80

Internal Revenue Code: Sections 102(c); 274(b). See Sections 74(c); 132(e); 274(j)

Proposed Regulations: Section 1.102-1(f)

1. Employer gives all of her employees, except her son, a black and white television set at Christmas, worth $100. She gives Son, who also is an employee, a color television set worth $500. Does Son have gross income?

A single person can only have one dominant intent. A single item from a single donor cannot be bifurcated. It is either all an employement related transfer and all income or all §102 gift. You cannot say 100 dollars is an employee gift and 400 is a §102 gift. Need to ask what is the motivation here? Which hat is the employer wearing? §102(c) applies to transfers from employees to employers.

Under §102 employee gifts are not excluded from gross income. §102 states that in general gross income does not include the value of property acquired by gift, bequest, devise, or inheritance, however any amount transferred by or for an employer to, or for the benefit of an employee shall not be excluded.

Regulation §1.102-1 (f)(2) states that section 102(c) shall not apply to amounts transferred between related parties (e.g. father and son) if the purpose of the transfer can be substantially attributed to the familial relationship of the parties and not to the circumstances of their employment.

2. The congregation for whom Reverend serves as a minister gives her a check for $5,000 on her retirement. Does Reverend have gross income?

Yes, the reverend has gross income under §102(c). This is not detached or disinterested generosity, it is a gift by the congregation which pays the Reverend’s salary, and thus employs him.

Is the relationship here employer employee? Depends partly on religion that is involved. Sometimes congregation hires minister, sometimes minister appointed from central office. Cases have come up, frequently with such minister situations. There has been a tendency in the cases that the reverend cases generate a gift.

3. Retiree receives a $5,000 trip on his retirement. To pay for the cost of the trip, Employer contributed $2,000, and fellow employees of Retiree contributed $3,000. Does Retiree have gross income?

Yes. The retiree has gross income from at least from the employer point of view. Employee has $3,000 as a gift and then $2,000 as gross income.

This is a case involving multiple donors and a single recipient. Must we analyze each piece separately to determine the intent of each donor? Under Duberstein, yes, we must. $2,000 from employer will not be detached and disinterested, and it will be gross income to the employee. With respect to the other $3,000 it is necessary to analyze the motivation of what other employees were.

Problems p. 88

Internal Revenue Code: Section 102(a), (b) first sentence, (c).

Regulations: Section 1.102-1(a), (b).

1. Consider whether it is likely that § 102 applies in the following circumstances:

(a) Father leaves Daughter $20,000 in his will.

Yes, §102 applies here because Daughter is receiving the money as a result of a gift, devise, or bequest.

(b) Father dies intestate and Daughter receives $20,000 worth of real estate as his heir.

Yes, §102 applies here because Daughter is receiving the money as a result of a gift, devise, or bequest.

(c) Father leaves several family members out of his will and Daughter and others attack the will. As a result of a settlement of the controversy Daughter receives $20,000.

It is likely that §102 applies here. See Lyeth v. Hoey.

(d) Father leaves Daughter $20,000 in his will stating that the amount is in appreciation of Daughter’s long and devoted service to him.

No contract, no obligation, recognition, allowable. As long as it does not arise to an obligation or an enforceable claim or some other arrangement. It is likely that this will be fine.

(e) Father leaves Daughter $20,000 pursuant to a written agreement under which daughter agreed to care for Father in his declining years.

§102 does not apply because this is not detached and disinterested. The money is in exchange for a service and would be considered gross income. Furthermore according to Lyeth, this is not a gift but rather a contract. Where a bequest is made by contract to satisfy and obligation, its receipt is income, taxable under §61 of the Internal Revenue Code of 1954, and not excludable under §102.

(f) Same agreement as in (e), above, except that Father died intestate and Daughter successfully enforced her $20,000 claim under the agreement against the estate.

§102 does not apply because this is not detached and disinterested. The money is in exchange for a service and would be considered gross income.

(g) Same as (f), above, except that Daughter settles her $20,000 claim for a $10,000 payment.

§102 does not apply because this is not detached and disinterested. The money is in exchange for a service and would be considered gross income.

(h) Father appointed Daughter executrix of his estate and Father’s will provided Daughter was to receive $20,000 for services as executrix.

§102 does not apply because this is not detached and disinterested. The money is in exchange for a service and would be considered gross income.

(i) Father appointed Daughter executrix of his estate and made a $20,000 bequest to her in lieu of all compensation or commissions to which she would otherwise be entitled as executrix.

Case law suggests that it still comes up on the form of a bequest and it is not entirely in the form of compensation. Other argument, Duberstein, clearly made in anticipation of services performed….this is all fact based. Must look at all the circumstances, you can’t tell with i whether it will be income or not.

2. Boyfriend who has a mental problem with marriage agrees with Taxpayer that he will leave her “everything” at his death in return for her staying with him without marriage. She does, he doesn’t, she sues his estate on a theory or quantum meruit and settles her claim. Is her settlement excludable under § 102.

No, because there is not a valid marriage. Suit brought on basis of quantum meruit. No marriage, no heir, not a relation as defined by law. Only basis for claim is that services are performed and payments received. It is a contract claim for the value of the services performed. It is certainly not an inheritance in the §102 sense.

3. If the Wolder case arose today, would § 102(c) apply to resolve the issue?

§102c relates to employer/employee relationships. Was Wolder an employee of his client, or not? Typically consider employer, employee more narrowly than one who performs professional services to another. I.e. a lawyer is usually not considered an employee of one who hires him. So §102c would not apply, since there is not employer employee. Wolder and Duberstein not governed by §102c.

Problems p. 98

Internal Revenue Code: Section 132 (omit (j)(2) and (5), (m), and (n)). See Sections 61(a)(1); 79; 83; 112; 125.

Regulations: Sections 1.61-1(a), -21(a)(1) and (2), (b)(1) and (2).

1. Consider whether or to what extent the fringe benefits listed below may be excluded from gross income and, where possible, support your conclusions with statutory authority:

(a) Employee of a national hotel chain stays in one of the chain’s hotels in another town rent-free while on vacation. The hotel has several empty rooms.

This may be excluded from Employee’s gross income. Under I.R.C. §132 (b)(2) this is a no additional cost service. Short answer, so long as person is not highly compensated, this would count as exclusion.

(b) Same as (a), above, except that the desk clerk bounces a paying guest so Employee can stay rent-free. See Reg. §§1.132-2(a)(2) and (5).

This may not be excluded from the Employee’s gross income because it does not meet the §132 exclusion criteria. This benefit incurs additional cost. Airline employee is the same type of situation.

(c) Same as (a), above, except that Employee pays the bill and receives a cash rebate from the chain. See Reg. § 1.132-2(a)(3).

This may be excluded from Employee’s gross income. See Reg. § 1.132-2(a)(3) states that “the exclusion of a no additional cost service applies if the service is provided through a partial or total cash rebate of an amount paid for the service.

(d) Same as (a), above, except that Employee’s spouse and dependent children traveling without Employee use the room on their vacation.

This may be excluded from Employee’s gross income. See I.R.C. §132(h)(2): In general—“any use by the spouse or a dependent child of the employee shall be treated as use by the employee.”

(e) Sane as (a), above, except that Employee stats in the hotel of a rival chain under a written reciprocal agreement under which employees pay 50% of the normal rent.

This may be excluded from Employee’s gross income. See I.R.C. §132(i): Any service provided by an employer to an employee of another employer shall be treated as provided by the employer of such employee if—

(1) such service is provided pursuant to a written agreement between such employers, and

(2) neither of such employers incurs any substantial additional costs (including foregone revenue) in providing such service or pursuant to such agreement.

Here a written agreement exists so (1) is satisfied, and no additional costs are being incurred. Thus this may be excluded from Employee’s gross income.

(f) Same as (a), above, except that Employee is an officer in the hotel chain and rent-free use is provided only to officers of the chain and all other employees pay 60% of the normal rent.

This question depends on whether or not the officer is a highly compensated individual. In order to be a highly compensated individual, the individual must be either a 5% owner, or have compensation above $80,000 AND be in the top paid group of employees (defined as being in the top 20%) for the year in which compensation is paid (see I.R.C. §414(q)).

(g) Hotel chain is owned by a conglomerate which also owns a shipping line. The facts are the same as in (a), above, except that Employee works for the shipping line.

This depends on whether or not the employee as a shipper is involved in the hotel business. For example if the Employee ships to the hotel, then this discount can be excluded from gross income. If the employee’s shipping is too remote from the hotel then he/she is ineligible form excluding the discount from his/her gross income.

Line of business problem. The hotel is not a ship…Our employee does not work in that line of business. Employee does have gross income.

(h) Same as (g), above, except that Employee is comptroller of the conglomerate. See Reg. §1.132-4(a)(1)(iv).

The Employee may exclude the value of the hotel room since he performs services that directly benefit more than one line of business. If one employee works in several types of businesses, that employee can get a benefit in any of those lines of business since the work touches both lines of business. This seems to be a special benefit to those who control the business, at odds with the non discriminatory clause supra.

(i) Employee sells insurance and employer Insurance Company allows Employee 20% off the $1,000 cost of the policy.

We can answer this given the facts of this problem. This must be a service, otherwise we couldn’t answer it without a gross profit percentage. P. 94 says it is a service. Congress says that insurance products are services and they are allowed a 20% discount, period. The allowable discount is 20%, this is a 20% discount, so it qualifies.

(j) Employee is a salesman in a home electronics appliance store. The prior year the store had $1,000,000 in sales and a $600,000 cost of goods sold. Employee buys a $2,000 video cassette recorder from Employer for $1,000.

What is the concept for not awarding money over 40% Any money over 40% looks like a substantial cost. What congress is allowing the business to give away is the profit. If the employer gives more, the employer is incurring a substantial additional cost, and Congress will not allow employee to acquire this tax free. Employer can give away as much as the profit and the employee will not have any tax.

(k) Employee attends a business convention in another town. Employer picks up Employee’s costs.

working condition fringe. Amount provided by the employer to permit the employee to do the employees job. Doesn’t matter if every employee gets this benefit. Consider it a business trip. Employer pays your airfare and hotel and gives 125 per diem to spend on other necessary elements. Might not even be a benefit.

(l) Employer has a bar and provides the Employees with happy hour cocktails at the end of each week’s work.

De minimis –Not discriminatory because it is given to all employees

Not needed for employees to do job

Too small in value for Congress to bother keeping track of. What is De minimis? Must go to regs. Something so small as to make it unreasonable to account. Is weekly sufficient to qualify as occasional? Exclusion as de minimis is occasional cocktail parties. Can’t answer this question on the basis of the facts provided.

(m) Employer gives Employee a case of scotch each Christmas. See Reg. § 1.132-6(e)(1).

This is an infrequent occurrence. It happens once a year. The question here is value. Reg. § 1.132-6(e)(1) states that examples of de minimis fringe benefits include traditional birthday or holiday gifts of property (not cash) with a low fair market value. This is a gift of property given during the holiday, the question is as to the value of the gift.

(n) Employee is an officer of corporation which pays Employee’s parking fees at a lot one block from the corporate headquarters. Non-officers pay their own parking fees. Assume there is no post-2001 inflation.

This may fall under a qualified transportation fringe. 132(f) excludes qualified parking.

(o) Employer provides Employee with $110 worth of vouchers each moth for commuting on a public mass transit system. Assume there is no post-2001 inflation.

Similar notion that there should be some dollar limit on this, otherwise it might be too generous. The allowable excludable amount is $100 a month. Therefore there is 10 dollars per month as taxable income because it exceeds the allotted amount. Available to you in the back of you statute book. Page 1868. Revenue procedure 2070.

(p) Employer puts in a gym at the business facilities for the use of the employees and their families.

The gym is excluded because Congress said so. However there are provisions. There are no non-discriminatory requirements. If you feed them you have discrimination issues, but if you make them sweat, you don’t.

Problems p. 103

Internal Revenue Code: Sections 107; 119(a). See Section 119(d).

Regulations: Section 1.119-1

1. Employer provides Employee and Souse and Child a residence on Employer’s business premises, having a rental value of $5,000 per year, but charging Employee only $2,000.

(a) What result if the nature of Employee’s work does not require Employee to live on the premise as a condition of employment?

Since the nature of Employee’s work does not require Employee to live on the premises as a condition of the employment, then Employee does not get to exclude the money from his gross income. See §119(a)(2). Employee would have gross income of 3,000.

(b) What result if Employer and Employee simply agreed to a clause in the employment contract requiring Employee to live in the residence?

Then this would be excludable from gross income since the employee is required to accept such lodging on the business premises of his employer as a condition of his employment.

(c) What result if Employee’s work and contract require Employee to live on the premises and Employer furnishes Employee and family $3,000 worth of groceries during the year?

The living arrangements would not be counted as gross income because under §119(a)(1) living on the premise is required, however the groceries would be considered gross income. It seems as though the groceries are furnished as a means of additional compensation, as discussed in 1.119-1(a)(2). The meals are not furnished during working hours and are provided in a lump sum.

(d) What result if Employer transferred the residence to Employee in fee simple in the year that Employee accepted the position and commenced work? Does the value of the residence constitute excluded lodging?

No. This seems like an accession to wealth clearly realized.

2. Planner incorporated her motel business and the corporation purchased a piece of residential property adjacent to the motel. The corporation by contract “required” Planner to use the residence and also furnished her meals. Planner worked at the motel and was on call 24 hours a day. May Planner exclude the value of the residence or the meals or both from her gross income?

Possibly, this is a case law issue.

3. State highway patrolman is required to be on duty form 8 a.m. to 5 p.m. At noon he eats lunch at various privately owned restaurants which are adjacent to the state highway. At the end of each month the state reimburses him for his luncheon expenses. Are such reimbursements included in his gross income? See Commissioner v. Kowalski, 434 U.S. 77.

According to C. I. R. v. Kowalski, “In the absence of a specific exemption, the cash meal-allowance payments are included in gross income under § 61(a), since they are “undeniabl[y] accessions to wealth, clearly realized, and over which the [trooper has] complete dominion.”

WEEK 2

Problems p. 118

Internal Revenue Code: Sections 1001(a), (b) first sentence, (c); 1011(a); 1012

Regulations: Section 1.001-1(a)

Internal Revenue code: Sections 109; 1011(a); 1012; 1016(a)(1); 1019.

Regulations: Sections 1.61-2(d)(2)(i); 1.1012-1(a)

1. Owner purchases some land for $10,000 and later sells it for $16,000.

(a) Determine the amount of Owner’s gain on the sale.

The gain is equal to the Amount Realized (AR) over the Adjusted Basis (AB) pursuant to IRC § 1001. In the case at hand the AR is equal to $16,000 and the AB is equal to $10,000. Thus the gain is $6,000.

(b) What difference in result in (a), above, if Owner purchased the land by paying $1,000 for an option to purchase the land for an additional $9,000 and subsequently exercised the option?

Options are added to the price paid for the land when computing AB. Thus the AB would still be 10,000, this amount would represent the $1,000 option plus $9,000 for the purchase. The gain would still be $6,000.

(c) What result to Owner in (b), above, if rather than ever actually acquiring th eland Owner sold the option to Investor for $1,500?

Here the option would just be treated as an asset. Thus the AR would be $1,500 and the AB would be $1000. This would result in a gain of $500.

(d) What difference in result in (a) above, if Owner purchased the land by making a $2,000 cash payment from Owner’s funds and an $8,000 payment by borrowing $8,000 from the bank in a recourse mortgage (on which Owner is personably liable)? Would it make any difference if the mortgage was a non-recourse liability (on which only the land was security for the obligation)?

The borrowed funds go into the basis of the land. Thus the basis would still be $10,000 and the gain would still be $6000.

(e) What result in (a), above, if Owner purchased the land for $10,000, spent $2,000 in clearing the land prior to its sale, and sold it for $18,000?

The gain would be $6000. The original basis is $10,000. After the $2,000 in improvements the adjusted basis is $12,000. (See Reg. 1.1016-2). Since the AR is $18,000, the gain is $10,000.

(f) What difference in result in (a), above, if Owner had previously rented the land to Lessee for five years for $1,000 per year cash rental and permitted Lessee to expend $2,000 clearing the property? Assume that, although Owner properly reported the cash rental payments as gross income, the $2,000 expenditures were properly excluded under § 109. See §1019.

Property sold for $16,000, property still has $10,000 adjusted basis, gain is still $6,000.

Rationale: §109 is the income element, where the landlord receives improvement upon the termination of the lease and it is not rent, then gross income does not include that amount when the landlord gets the property back. Tentative improvements on real estate do not count as gross income.

In regards to the basis of such improvements: §1019 addresses the basis consequences. If a landlord does not have income as of §109, then he/she gets no basis either.

(g) What difference in result in (a), above, if when the land had a value of $10,000, Owner, a real estate salesperson, received it from Employer as a bonus for putting together a major real estate development, and Owner’s income tax was increased $3,000 by reason of the receipt of the land.

The receipt of this as compensation produces gross income. Since this produces gross income upon receipt it should acquire a basis equal to what has been reported, so it has a basis of $10,000. So when it is sold, the gain on the sale should be $6,000. If you don’t like the answer, then substitute ‘property’ for ‘cash.’ There is $10,000 on receipt of the property and when the property is sold for $16,000, there is a gain of $6,000.

(h) What difference if Owner is a salesperson in an art gallery and Owner purchases a $10,000 painting from the art gallery, but is required to pay only $9,000 for it (instead of $10,000 because Owner is allowed a 10% employee discount which is excluded from gross income under § 132(a)(2)), and Owner later sells the painting for $16,000?

Owner has an adjusted basis of $9,000. Upon sale Owner has an AB of $16,000 and therefore a gain of $7,000.

2. In an arm’s length exchange, Sharp exchanges some land with a cost basis of $6,000 and a value of $9,000 with Dull for some non-publicly traded stock with Dull owns and in which Dull has a basis of $8,000 and is worth $10,000 at the time of the exchange.

(a) Consider Sharp and Dull’s gains on the exchange and their respective cost bases in the assets they receive.

Sharp: AB: $6,000 AR: $10,000 Gain: $4,000

Dull: AB: $8,000 AR: $9,000 Gain: $1,000

Sharp: Land, basis $6,000. (California) No reason to change that. To determine gain or loss, but compare amount realized with amount being disposed of. Amount realized is the amount of money received and the fair market value of any property received. FMV is $10,000, and Sharp’s gain is $4,000 and such gain is immediately recognized. Sharp now has stock which was received in the amount of land. Basis issue. Under §1012, what are his costs. Philadelphia Park, cost is the value of item received which is $10,000.

Dull: (Florida) Sold stock AB of $8,000. AR is fair market value received: $9,000. Dull has a gain of $1,000 and that gain is both realized and recognized immediately. Dull now has the land and the land has a basis. Basis of the land is the fair market value of that land. And that FMV is determined to be $9,000.

(b) What results in (a), above, if the value of Dull’s stock cannot be determined with any reasonable certainty?

Problems p. 125

Internal Revenue Code: Section 1015(a). See Sections 1015(d)(1)(A), (4) and (6).

Regulations: Section 1.1015-1(a)

1. Donor gave Donee property under circumstances that required no payment of gift tax. What gain or loss to Donee on the subsequent sale of the property if:

(a) The property had cost Donor $20,000, had a $30,000 fair market value at the time of the gift, and Donee sold it for:

(1) $35,000?

AR = $35,000

AB = For gain via a gift the AB is “transferred” §1015(a), so the AB here would be $20,000.

The Gain is $15,000.

(2) $15,000

The gain here is 0. AR = $15,000, AB = $20,000, Gain = 0. Basis exceeds amount realized.

If viewing as a loss and the basis exceeds the FMV, the FMV is used instead of the basis to compute loss. Here, the basis does not exceed the FMV so in order to calculate a loss, the calculation would occur as follows: AR = $15,000 and AB = $20,000. Loss is AR – AB which is $5,000.

(3) $25,000

Gain: AR = $25,000, and AB = $20,000, gain of $5,000.

Loss: AR = $25,000, and AB = $20,000. The loss would be 0.

(b) The property had cost Donor $30,000, had a $20,000 fair market value at the time of the gift, and Donee sold it for:

(1) $35,000?

AR: $35,000, AB: $20,000, Gain = $15,000

(2) $15,000?

AR: $15,000, AB: Since basis is greater than FMV, FMV is used to compute the loss and AB = FMV so AB = $20,000. Loss is AR – AB = -$5,000.

(3) $24,000?

Gain: AR: $24,000 – AB: $30,000 = 0.

Loss: Again, use split basis, since basis is greater than the FMV. So to computer loss the AR would be $24,000 and the AB: would be the FMV or $20,000 so the loss would also be 0.

2. Father had some land that he had purchased for $100,000 but which had increased in value to $200,000. He transferred it to Daughter for $100,000 in cash in a transaction properly identified as in part a gift and in part a sale. Assume no gift tax was paid on the transfer.

(a) What gain to Father and what basis to Daughter under Reg. §§ 1.1001-1(e) and 1.1015-4(a)(1)?

Father has a gain of $0. His AR is $100,000 and his AB is $100,000.

Daughter has a basis as follows: Since the sale price is the same as the basis, according to example in Reg. 1.1015-4(b) her basis would be $30,000.

(b) Suppose the transaction were viewed as a sale of one-half of the land for full consideration and an outright gift of the other one half. How would this affect Father’s gain and Daughter’s basis? Is it a more realistic view than that of the Regulations: Cf. §§ 170(e)(2) and 1011(b), relating to bargain sales to charities.

Problem p. 128

Internal Revenue Code: Section 1041(a) and (b)

Regulations: Section 1.1041-1T(a) and (d)

1. Andre purchased some land ten years ago for $4,000 cash. The property appreciated to $7,000 at which time Andre sold it to his wife Steffi for $7,000 cash, its fair market value.

(a) What are the income tax consequences to Andre?

Andre does not have any income tax consequences. § 1041(a) states that no gain or loss shall be recognized on a transfer of property from an individual to a spouse.

(b) What is Steffi’s basis in the property?

Steffi’s basis in the property is that of the transferor, or $4,000. Transfers between spouses are treated as gifts (see §1041(b)—transferee has transferor’s basis).

The gain would be whatever exceeded her basis. If she sold if for the FMV, she would have an AR of $7,000 and an AB of $4,000 and thus a gain of $3,000.

(d) What results in (a)-(c), above, if the property had declined in value to $2,000 and Andre sold it to Steffi for $3,000?

There is no split basis here, so Steffi would still have a basis of $4,000. Andre would have a gain of 0 and would not get credit for the loss. Andre has a realized loss of 1 because he has a basis of 4 and sold it for 3. 1041A says he cannot recognize the loss. His loss recognized is 0. No split basis here, but for (c) above, Steffi would get to recognize the loss when she sells it outside of the marriage.

(e) What results (gains, losses, and bases) to Andrew and Steffi if Steffi transfers other property with a basis of $5,000 and value of $7,000 (rather than cash) to Andre in return for his property?

Andre would have a basis of $5,000 in the property he received. Steffi would not have tax consequences.

Problem p. 130

Internal Revenue Code: Sections 1014(a), (b)(1) and (6), (e)

Regulations: Sections 1.1014-3(a); 20.2031-1(b)

1. In the current year, Giver holds two blocks of identical stock, both worth $1,000,000. Giver purchased the first block years ago for $50,000 and the second block more recently for $950,000. Giver plans to make an inter vivos gift of one block and retain the second until death. Which block of stock should Giver transfer inter vivos and why?

Giver should transfer the second block via inter vivos gift, because the second block has a much higher basis. This will minimize the gain or maximize the loss on future sales, both of which are positive connotations to the taxpayer. If the second block is given the receiver will have a basis of $950,000 (as opposed to $50,000). Then when the first stock is transferred after death, under §1014 the basis is the FMV or $1,000,000. This is a win/win situation.

Problem p. 150

Internal Revenue Code: Section 100(b)

Regulations: Section 1.1001-1(a), -2(a), (b), (c) Examples (1) and (2)

1. Mortgagor purchases a parcel of land from Seller for $100,000. Mortgagor borrows $80,000 from Bank and pays that amount and an additional $20,000 of cash to Seller giving Bank a nonrecourse mortgage on the land. The land is the security for the mortgage which bears an adequate interest rate.

(a) What is the Mortgagor’s cost basis in the land?

The basis would be $100,000. The borrowing of the money does not affect this and does not create any income for M. §1012.

(b) Two years later when the land has appreciated in value to $300,000 and Mortgagor has paid only interest on the $80,000 mortgage, Mortgagor takes out a second nonrecourse mortgage of $100,000 with adequate rates of interest from Bank again using the land as security. Does Mortgagor have income when she borrows the $100,000? See Woodsam Associates, Inc. v. Commissioner, 198 F.2d 357 (2d Cir.1952).

This would be a §1016 adjustment. The basis is increased by $100,000. Shouldn’t this increase the basis of the land? Think about the tenant clearing the land at a cost of 2000. As long as it is an improvement to the property, a betterment, and investment, it goes into the basis of the property. Basis would then be 200.

(d)What is Mortgagor’s basis in the land if the $100,000 of mortgage proceeds are used to purchase stocks and bonds worth $100,000?

There is no change in the basis of the property, but the stocks and bonds get a §1012 basis treatment. The contrast. Not required to invest it in the property. Monetized real estate investment in stocks and bonds, no effect on basis of the land.

(e) What result under the facts of (d), above, if when the principal amount of the two mortgages is still $180,000 and the land is still worth $300,000, Mortgagor sells the property subject to both mortgages to Purchaser for $120,000 of cash? What is Purchaser’s cost basis in the land?

Purchaser’s cost basis in the land is what he paid, or $120,000. The property is subject to the mortgages. What is gain or loss from this? AR, Crane amount of money received and amount received. AR of 300, AB is 100, gain of 200 will be realized and recognized. Any cancellation of indebtedness income? No. Buyer will take over debt. Disposition of land is 200,000. Purchaser has a cost basis of 300.

(f) What result under the facts of (d), above, if instead Mortgager gives the land subject to the mortgages and still worth $300,000 to her Son? What is Son’s basis in the land?

Amount Realized = 180; a gain of 80.

The son has a basis of 180.

Part sale, part gift. What is the AR here? Mortgagor, aka seller is being relieved of 180 of liability. Crane says this is the amount realized. Basis of 100, so mortgagor would have gain realized recognized.

(g) What result under the facts of (f), above, if Mortgagor gives the land to her Spouse rather than to her Son? What is Spouse’s basis in the land? What is Spouse’s basis in the land after Spouse pays off the $180,000 of mortgages?

§1041-gives to spouse. No gain or loss, change of basis to the spouse, spouses basis is 100 in land, same as mortgagor. Basis is still 100 after paying off mortgage. Paying off debt has no effect on basis at all.

(h) What results to Mortgagor under the facts of (d), above, if the land declines in value from $300,000 to $180,000 and Mortgagor transfers the land by means of a quitclaim deed to Bank? See Parker v. Delaney, 186 F.2d 455 (1^st Cir.1950).

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 M doesn’t get any cash out of it.

(i) What results to Mortgagor under the facts of (h), above, if the land declines in value from $300,000 to $170,000 at the time of the quitclaim deed?

$180,000. Tufts case: Even though the FMV is less than the debt, the AR is the debt.

Tufts case. Still have gain of 80 all of it attributed to land, no cancellation. Contrast this with problem 2 on p. 177.

2. Investor purchased three acres of land, each acre worth $100,000 for $300,000. Investor sold one of the acres in year one for $140,000 and a second in year two for $160,000. The total amount realized by Investor was $300,000 which is not in excess of her total purchase price. Does Investor have any gain or loss on the sales? See Reg. § 1.61-6(a)

Yes, the investor takes gain in the sales. According to § 1.61-6(a) the total cost of the property is apportioned among the divided lots. Thus, the AB of the lots is $100,000. From this the gain realized from the sale of the acre in year one is $40,000 and the gain from the sale in year two is $60,000.

3. Gainer acquired an apartment in a condominium complex by inter vivos gift from Relative. Both used it only as a residence. It had been purchased by Relative for $200,000 cash and was given to Gainer when it was worth $300,000. Relative paid a $60,000 gift tax on the transfer. Gainer later sells the apartment to Shelterer.

(a) What gain or loss to Gainer on his sale to Shelterer for $320,000?

Gainer has a gain of 100. Since this is a gift, donee has the donor’s basis of 200, but since donor has paid a gift tax the basis can be adjusted. The adjustment is as follows: [(appreciation amount)/(total amount of gift)]*(amount paid in gift tax) = (amount you can add to existing basis to get adjusted basis). In the case at hand, the property has appreciated $100,000. The formula is [($100,000/$300,000)]*$60,000= $20,000. Donee can add $20,000 to his basis, so instead of having basis of $200,000 and a gain of $120,000, donor has an adjusted basis of $220,000 and a gain of $100,000.

Gainer AR of 320. What is the AB? Donors basis was 200. How much of the 60 if any can be added to the donees basis? Basis to gainer at the time of the sale is 220, and the gain is 100. Illustrates operation of 1015. (100/300)x60. Gift tax has been paid, adjustment does allow step up in basis to donee.

(b) What is Shelterer’s basis in the apartment?

Shelterer’s basis is $320,000, which is the purchase price. This is an arms length transaction.

Problems p. 177-(only 1 and 2)

Sections 61(a)(12), 102(a), and 108(a)

Regulations: Sections 1.61-12(a); 1.1001-2(a), 2(c) Ex. (8)

(The following regs do not have corresponding problems)

Internal Revenue Code: Sections 72(a), (b), (c)

Regulations: Section 1.72-4(a), -9(Table V)

1. Poor borrowed $10,000 from Rich several years ago. What tax consequences to Poor if Poor pays off the so far undiminished debt with:

(a) A settlement of $7,000 of cash?

Poor would have GI of $3,000. This cancellation of debt.

(b) A painting with basis and fair market value of $8,000?

Poor would have GI of $2,000.

COD part of this: There was a debt of 10. As a result of transferring value of 8, the debt goes away. There is still 2 of cancellation of debt income. On the numbers the debt is extinguished for less than the amount owed and that is the COD. We have seen these scenarios before.

Poor would have GI of $2,000.

(d) Services, in the form of remodeling Rich’s office, which are worth $10,000?

Debt being cancelled in full from services. What about the value of services, isn’t that compensation in income for performing services? As a result of performing services, debt is discharged. Payment for work performed. 10,000 for gross income, none of it from cancellation of income, all of it for compensation for services. Old Colony case.

(e) Services that are worth $8,000?

2 is COD, and 8 gross income for compensation for services.

(f) Same as (a), above, except that Poor’s Employer makes the $7,000 payment to Rich, renouncing any claim to repayment by Poor.

There is COD in the amount of 3, and there is also the added element that the employer providing the 7 is another form of compensation for services.

2. Mortgagor purchases a parcel of land held for investment from Seller for $100,000 with $20,000 of cash paid directly by Mortgagor and $80,000 paid from the proceeds of a recourse mortgage incurred from Bank. Mortgagor is personally liable for the loan and the land is security for the loan. When the land increases in value to $300,000, Mortgagor borrows another $100,000 from Bank again incurring personal liability and again with the land as security. Mortgagor uses the $100,000 of loan proceeds to purchase stocks and bonds. Several years later when the principal amount of the mortgages is still $180,000, the land declines in value to $170,000, Mortgagor transfers the land to the Bank, and the Bank discharges all of the Mortgagor’s indebtedness.

(a) What are the tax consequences to Mortgagor? See Reg. §§ 1.1001-2(a) and 2(c) Example 8.

COD of $10,000. Mortgagor has income of $10,000.

(b) What are the tax consequences to Mortgagor if the liabilities had been nonrecourse liabilities? See problem 1(i) at page 151 of the text.

If the liabilities had been non-recourse liabilities then there would be no COD income, because the bank is getting what it bargained for, the property.

WEEK 3

Problems p. 155

Internal Revenue Code: Sections 101(a), (c), (d), and (g)

Regulations: Sections 1.101(a)(1), (b)(1), -4(a)(1)(i), (b)(1), (c).

1. Insured died in the current year owning a policy of insurance that would pay Beneficiary $100,000 but under which several alternatives were available to Beneficiary.

(a) What result if Beneficiary simply accepts the $100,000 in cash?

Under that §101(a) Beneficiary does not have any GI.

(b) What result in (a) above, if Beneficiary instead leaves all the proceeds with the company and they pay her $10,000 interest in the current year?

Under §101(c) Beneficiary will have gross income in the amount of $10,000.

(c) What result if Insured’s Daughter is Beneficiary of the policy and, in accordance with an option that she elects, the company pays her $12,000 in the current year? Assume that such payments will be made annually for her life and that she has a 25-year life expectancy.

$100,000 over 25 years is $4,000 a year. The rest of her $12,000 payment is GI. Therefore Daughter will get $12,000 a year and be able to exclude $4,000 of this. She will thus have GI of $8,000 a year.

(d) What result in (c), above, if Insured’s Daughter lives beyond her 25-year life expectancy and receives $12,000 in the twenty-sixth year?

She will continue to exclude $4,000 of the $12,000 payments.

2. Jock agreed to play football for Pro Corporation. Pro, fearful that Jock might not survive, acquired a $1 million insurance policy on Jock’s life. If Jock dies during the term of the policy and the proceeds of the policy are paid to Pro, what different consequences will Pro incur under the following alternatives?

(a) With Jock’s consent Pro took out and paid $20,000 for a two year term policy on Jock’s life.

(b) Jock owned a paid-up two year term $1 million policy on his life which he sold to Pro for $20,000, Pro being named beneficiary of the policy.

Pro will only be able to exclude $20,000 of the money.

3. Insured purchases a single premium $100,000 life insurance policy on her life for a cost of $40,000. Consider the income tax consequences to Insured and the purchaser of the policy in each of the following alternative situations:

(a) Insured sells the policy to her Child for its $60,000 fair market value and, on insured death, the $100,000 of proceeds are paid to Child.

This is an example of a transfer for valuable consideration. Under § 101(a)(2) the exclusion is limited to the buyer’s purchase price in the contract; amounts in excess of the purchase price must be included in gross income. Therefore when Insured dies and Child collects $100,000, Child will only be able to deduct $60,000 from his/her GI.

(b) Insured sells the policy to her Spouse for its $60,000 fair market value and, on Insured’s death, the $100,000 of proceeds are paid to Spouse.

The 101a2a exception applies and so the spouse gets to exclude the whole proceeds from the policy even though the spouse acquired the policy in a transaction.

(c) Insured is certified by her physician as terminally ill and she sells the policy for its $80,000 fair market value to Viatical Settlement Provider who collects the $100,000 of proceeds on Insured’s death.

Insured does not have gross income. Viatical Settlement Provider

Problems p. 160

Internal Revenue Code: Sections 72(a), (b), (c)

Regulations: Section 1.72-4(a), -9(Table V)

1. In the current year, T purchases a single life annuity with no refund feature for $48,000. Under the contract T is to receive $3,000 per year for life. T has a 24-year life expectancy.

(a) To what extent, if at all, is T taxable on the $3,000 received in the first year?

2/3 of the $3,000 is taxable.

(b) If the law remains the same and T is still alive, how will T be taxed on the $3,000 received in the thirtieth year of the annuity payments?

Unlike life insurance, the exclusion is limited to the investment. §72. Therefore anything after 24 years will be taxed fully, none will be excluded from GI. Thus they have $3,000 GI from this event.

Yes, a deduction will be allowed under §72 (b)(3). T or T’s estate is allowed to deduct the unrecovered amount, in this case it will be $30,000. There have been 9 years of payments at $2,000.

(d) To what extent are T and T’s spouse taxable on the $3,000 received in the current year if at a cost of $76,500 they purchase a joint and survivorship annuity to pay $3,000 per year as long as either lives and they have a joint life expectancy of 34 years?

They will be taxed on %25 percent of the $3,000 they receive. They must report $750 as gross income. 2 life annuity, complicated, you need a different table to calculate it, table is on page 928, you need to correlate the two ages. Find the place in the table where they hit. That will be your multiple.

Problems p. 182

1. Plaintiff brought suit and unless otherwise indicated successfully recovered. Discuss the tax consequences in the following alternative situations:

(a) Plaintiff’s suit was based on a recovery of an $8,000 loan made to Debtor. Plaintiff recovered $8,500 cash, $8,000 for the loan plus $500 of interest.

Plaintiff will have gross income of $500.

(b) What result to Debtor under the facts of (a), above, if instead Debtor transferred some land worth $8,500 with a basis of $2,000 to Plaintiff to satisfy the obligation? What is Plaintiff’s basis in the land?

The basis in the land is $8,500 or the FMV. Plaintiff would have a GI of $500. Debtor has a $6,500 gain on the disposition of the land. Nothing to do with the repaying of the debt and repaying the interest, this has to do with disposing of the land. Using the land at its full value, (International Freighting), this taxpayer took the asset and used it as full value and therefore has a gain on it.

(c) Plaintiff’s suit was based on a breach of a business contract and Plaintiff recovered $8,000 for lost profits and also recovered $16,000 for punitive damages.

Plaintiff will have a GI of $24,000. Both lost profits (in lieu test Raytheon case) and punitive damages (Glenshaw Glass) are taxable.

(d) Plaintiff’s suit was based on a claim of injury to the goodwill of Plaintiff’s business arising from a breach of a business contract. Plaintiff had a $4,000 basis for the goodwill. The goodwill was worth $10,000 at the time of the breach of contract.

(1) What result to Plaintiff if the suit is settled for $10,000 in a situation where the goodwill was totally destroyed?

Goodwill is treated as if it is property—any damages received in excess of cost is GI. Here, the plaintiff had a basis of $4,000 anything above $4,000 in the recovery is considered gross income. In this case Plaintiff would have a GI of $6,000.

(2) What result if Plaintiff recovers $4,000 because the goodwill was partially destroyed and worth only $6,000 after the breach of contract?

Plaintiff would have no GI.

(3) What result if Plaintiff recovers only $3,000 because the goodwill was worth $7,000 after the breach of contract?

Then Plaintiff would have no GI.

Problems p. 190

Internal Revenue Code: Sections 104(a); 105(a)-(c) and (e); 106(a)

Regulations: Sections 1.104-1(a), (c), (d); 1.105-1(a); 1.106-1

1. Plaintiff brought suit and successfully recovered in the following situations. Discuss the tax consequences to Plaintiff.

(a) Plaintiff, a professional gymnast, lost the use of her leg after a psychotic fan assaulted her with a tire iron. Plaintiff was awarded damages of $100,000.

Plaintiff would have no GI under §104(a)(1). Under § 104(a)(1) money for personal injuries or sickness is not included in GI.

(b) $50,000 of the recovery in (a), above, is specifically allocated as compensation for scheduled performances Plaintiff failed to make as a result of the injured leg.

$50,000 would fall under GI because this would have been a profit to the Plaintiff.

All $200,000 would be GI (Glenshaw Glass).

(d) The jury also awards Plaintiff damages of $200,000 to compensate for Plaintiff’s suicidal tendencies resulting from the loss of the use of her leg.

Under §104(a)(2)(ii) this would not be considered GI as it is emotional distress associated or attached with the injury.

(e) Plaintiff in a separate suit recovered $100,000 of damages from a fan who mercilessly taunted plaintiff about her unnaturally high, squeaky voice, causing Plaintiff extreme anxiety and stress.

This $100,000 would be considered GI. It is emotional distress, but it does not relate or is not associated with the physical injury suffered.

(f) Plaintiff recovered $200,000 in a suit of sexual harassment against the former coach.

This would be considered GI.

(g) Plaintiff dies as a result of the leg injury, and Plaintiff’s parents recover $1,000,000 of punitive damages awarded in a wrongful death action under long-standing State statute?

This would not be GI under § 104(c), since the damages are punitive and stem from a wrongful death action. Exception to punitive damage inclusion rule, but only where the state law gives you a punitive damages cause of action for the wrongful death. Back to problem…what if cause of action? 104a2-should she be able to claim an exclusion for the 70k she received? Is taxable income, cannot be excluded.

2. Injured and Spouse were inured in an automobile accident. Their total medical expenses incurred were $2,500.

(a) In the year of the accident they property deducted $1,500 of the expenses on their joint income tax return and filed suit against Wrongdoer. In the succeeding year they settled their claim against Wrongdoer for $2,500. What income tax consequences on receipt of the $2,500 settlement?

There is a properly deducted amount of 1500 and then the year is over. 1500 is correct and definitely legitimate. What about 2007? It’s an amount received from litigation damages for personal injury. Since you have already gotten an adjustment for 1500, we are going to offset the prior deduction, and bring the 1500 back. So of the 2500, 1500 would be GI, and the remaining 1000 out of 2500 would not be. The 1500 is attributable to previous deducted medical expenses and must be included in gross income.

(b) In the succeeding year Spouse was ill but, fortunately, they carried medical insurance and additionally Spouse had insurance benefits under a policy provided by Employer. Spouse’s medical expenses totaled $4,000 and they received $3,000 of benefits under their policy and $2,000 of benefits under Employer’s policy. To what extent are the benefits included in their gross income? (See footnote 29 on page 188, supra.)

Med expenses totaled 4k. Recoveries came in 2 parts, 3k in benefits under their personal policy, and 2k from the employer policy. All tests of 104a3 are satisfied for the 3k. But 2k, is employer plan, must cross reference to 105b. How much of 2k was spend on section 213d medical care? Deem that 2400 or 60% (3/5) of 4000 was paid from private plan, and therefore (2/5) 40% or 1600 was paid from the employer plan. This leaves me as such…gross income of 400, since employer has given injured an amount in excess. Footnote 29, p 188.

No injured and spouse may not deduct expenses. They have no unrecovered amount left to deduct.

3. Injured, who has a 20-year life expectancy, recovers $1 million in a personal injury suit arising out of a boating accident.

(a) What are the tax consequences to Injured if the $1 million is deposited in a money market account paying 5% interest?

The interest will be taxed as GI.

(b) What are the tax consequences to Injured if the $1 million is used by injured to purchase and annuity to pay Injured $100,000 a year for Injured’s life?

Go to section 72, normal annuity problem. Exclusion ratio would be 50% applied to100k as it is received each year.

(c) What are the tax consequences to Injured if the case was settled, and in the settlement, Injured received payments from Defendant of $100,000 a year for life?

100% is excludable if these receipts are coming from the settlement.

Problem p. 200 (problem 1)

Internal Revenue Code: Section 71 (omit (c)(2) and (3), (f))); 215(a) and (b); 7701(a)(17)

Regulations: Section 1.71-1T(a) and (b) (omit Q 6, 7, 11, and 12)

1. Determine whether the following payments are accorded “alimony or separate maintenance” status and therefore are includable in the recipient’s gross income under § 71(a) and deductible by the payor under §215(a). Unless otherwise stated, Andy and Fergie are divorced and payments are called for by the divorce decree.

(a) The divorce decree directs Andy to make payments of $10,000 per year to Fergie for her life or until she remarries. Andy makes a $10,000 cash payment to Fergie in the current year.

Yes, this amount is includable in the recipient’s gross income and deductible by the payor.

(b) Same as (a), above, except that Andy, finding himself short on cash during the year, transfers his $10,000 promissory note to Fergie.

Payments must be made in cash, this is not cash so it cannot be included as GI for the recipient and thus cannot be deducted by the payor.

(c) Same as (b), above, except that instead of transferring his promissory note to Fergie, Andy transfers a piece of art work, having a fair market value of $10,000.

Payments must be made in cash, this is not cash so it cannot be included as GI for the recipient and thus cannot be deducted by the payor.

(d) Same as (a), above, except in addition the decree provides that the payments are nondeductible by Andy and are excludable from Fergie’s gross income.

Congress will allow them to do that and they will not get 71, and 215, no deduction for him, and no income for her. What if there instrument only addressed 6k of it, and said the obligation is to pay 10k, but the parties agree that 6k of that the parties agree will not be shifted under section 71 and 215. They can do this. There is no reason why they can’t.

(e) Would it make any difference in (d), above, if you learned that Andy anticipated that he would have little or no taxable income in the immediate future, making the § 215 deduction practically worthless to him, and as a consequence of this agreed to the “nondeductibility” provision in order to enable Fergie to avoid the imposition of federal income taxes on the payments?

No. Congress wrote statue under assumption that you will engage in tax planning.

(f) What result in (a) above, if the divorce decree directs Andy to pay $10,000 cash each year to Fergie for a period of 10 years?

This would not fall under GI for purposes of §72 and it would not be deductible for §215 because the payments are not contingent on the death of the spouse.

(g) Same as (f), above, except that under local law Andy is not required to make any post-death payments.

The contingency doesn’t have to be in the instrument if it is required by state law. If state law requires that element they don’t have to state it.

(h) Same as (a), above, except the divorce decree directs Andy to pay $10,000 cash each year to Fergie for a period of 10 years or her life, whichever ends sooner. Additionally, the decree requires Andy to pay $15,000 cash each year to Fergie or her estate for a period of 10 years. Andy makes a $25,000 cash payment to Fergie in the year.

Second part does not qualify. Not a payment that will end at her death. The payment will continue after her death. The point of the question is to illustrate bifurcation. Can you provide in a series of provisions for part of it to qualify and part of it to not. Yes, you can.

(i) Same as (a), above, except that at the time of the payment, Andy and Fergie are living in the same house.

This amount would not be considered GI. It would not be deductible by the payor.

(j) Same as (i), above, except that Andy and Fergie are not divorced or legally separated and the payments are made pursuant to a written separation agreement instead of a divorce decree.

There is simply a written separation agreement. That does not trip the requirement. The requirement is that there is a decree. These payments can be shifted probably.

Problem p. 204

Internal Revenue Code: Section 71(b)(1)(a)

Regulations: Section 1.71-1T(b)(Q6 and 7)

1. Tom and Nicole are divorced. Pursuant to their written separation agreement incorporated in the divorce decree, Tom is required to make the following alternative payments which satisfy the §71(b) requirements. Discuss the tax consequences to both Tom and Nicole.

(a) Rental payments of $1,000 per month to Nicole’s landlord.

There can be a shift because Tom does not own the property in question. Thus Tom is eligible for the deduction and Nicole must declare income as GI.

(b) Mortgage payments of $1,000 per month on their family home which is transferred outright to Nicole in the divorce proceedings.

This is an example of the ownership test. Since she owns the asset then there can be a shift and Tom may deduct the payments from his income. Also Nicole has GI.

(c) Mortgage payments of $1,000 per month as well as real estate taxes and upkeep expenses on the house where Nicole is living which is owned by Tom.

Tom is not eligible to deduct the payments from his income because he owns the property. This income is also excluded from Nicole’s GI.

2. Brad agrees to pay Jen $15,000 a year in alimony until the death of either or the remarriage of Jen. The alimony satisfies the §71(b) requirements. After 3 years, Jen is concerned about Brad’s life expectancy and they agree to reduce the alimony amount to $10,000 a year if Brad provides Jen $100,000 of life insurance on his life.

(a) What are the tax consequences to Jen ad Brad if Brad purchases a single premium $100,000 policy on his life for $60,000 and he transfers it to Jen?

This is not cash, so there is no § 71, or § 215 application. Life insurance policy is not cash, even if it is being used to substitute, it itself is not cash.

(b) What result in (a), above, if Brad instead pays Jen $60,000 cash and she purchases the policy for $60,000?

The cash would fall under §71 and §215. This is fine. What is being transferred to her? 10k plus the 60k in cash. This has nothing to do directly with maintaining her in her lifestyle, it is fund to provide her with guarantee, but it doesn’t matter, 71, and 215 do not actually require spousal support.

(c) What result if Brad buys an ordinary policy on his life for $5,000, transfers it to Jen, and agrees to transfer $5,000 cash to her each year so she can pay the annual premiums on the policy?

This is a transfer of cash to Jen, so it would fall under §71 and §215. This qualifies just as the mortgage payment qualifies. If it is her policy, it qualifies.

(d) Same as (c), above, except that Brad pays the $5,000 annual premiums directly to the insurance company.

This would also qualify, see I.T. 4001. “It is held that premiums paid by the husband on the life insurance policy absolutely assigned to his former wife and with respect to which she is the irrevocable beneficiary are includible in the gross income of the wife under section 22(k) of the IRC and deductible b the husband under section 23(u) of the IRC.”

(e) Same as (d), above, except that instead of transferring the policy to Jen, Brad retains ownership of the policy but irrevocably names Jen as its beneficiary.

Brad would not be allowed a §215 deduction and Jen would not have GI since he owns the policy. This doesn’t qualify, he didn’t transfer the policy, he still owns it, and the annual premiums he is paying are in respect to his policy.

Problem p. 209

Internal Revenue Code: Section 1041; See Section 1015(e)

Regulations: Section 1.1041-1T(b)

1. Michael and Lisa Marie’s divorce decree becomes final on January 1 of year one. Discuss the tax consequences of the following transactions to both Michael and Lisa Marie.

(a) Pursuant to their divorce decree, Michael transfers to Lisa Marie in March of year one a parcel of unimproved land he purchased 10 years ago. The land has a basis of $100,000 and a fair market value of $500,000. Lisa Marie sells the land in April of year one for $600,000.

Subject to §1041 there is no GI and the basis transfers from one spouse to another. Lisa Marie will have GI of $500,000. Lisa is his former spouse. Transfer is incident if it occurs within one year of the date the marriage ceases. Consequences, he has no gain recognized, she gets his basis, if she sells it one month later or 20 years later, she will have the gain of 500k on that property. If you are negotiating one of these arrangements, recognize that property transfer carries tax consequences to the new owner.

(b) Same as (a), above, except that the land is transferred to satisfy a debt that Michael owes Lisa Marie. The land has a basis of $500,000 and a fair market value of $400,000 at the time of the transfer. Lisa Marie sells the land for $350,000.

Land as a basis of 5 and value of 4. Sells 3.5. Does statute 1041 care why property is transferred? No, covered by 1041. What would happen if it was not incident to the divorce? To a non-spouse or to a former spouse? Recognize you have the diagram of a Tufts/Crane situation. Basis of 500 and lower FMV at time and subsequent sale of even less. If not covered by 1041 you would be back analyzing this at arms length transaction. When she sells for 350, she would be able to get 150 of loss, 1041 does not have split basis, has transferred basis. She will get loss because of direct operation of 1041.

(c) What result if pursuant to the divorce decree, Michael transfers the land in (a) above, to Lisa Marie in March of year four.

Year 4, outside of automatic 1 year. In relation to cessation of marriage. After 1^st year, but before 7^th. What about the regs? What do they say? How are we to determine if a transfer in this one to six year period will be considered incident to the divorce. LOOK AT REGS. Delayed transfer but within 6 years and the decree calls for it. Divorce or separation instrument, a broader category, REg refers you back to instrument for section 71, includes all three categories. Includes a modification or amendment.

(d) Same as (c), above, except that the transfer is required by a written instrument incident to the divorce decree.

Same answer, reg picks up broader category of instrument, rather than decree.

(e) Same as (c), above, except that the transfer is made in March of year seven.

Outside of one year, outside of six years, where are we then. Any transfer not pursuant to that instrument and more than 6 years after the cessation is presumed not related. May be rebutted….More than 6 years out, presumption it is not related. All we need to say about 1041.

Problem p. 211

Internal Revenue Code: Section 71(b)(1)(D), (c)

Regulations: See Section 1.71-1T(c)

1. Sean and Madonna enter into a written support agreement which is incorporated into their divorce decree at the time of their divorce. They have one child who is in Madonna’s custody. Discuss the tax consequences in the following alternative situations:

(a) The agreement requires Sean to pay Madonna $10,000 per year and it provides that $4,000 of the $10,000 is for the support of their child.

Madonna will have $6000 of her income excluded from GI, and $4,000 is not deductible by the payor spouse or includable in the income of the payee spouse.

(b) The agreement requires Sean to pay Madonna $10,000 per year, but when their child reaches age twenty-one, dies, or marries prior to reaching twenty-one, the amount is to be reduced to $6,000 per year.

This type of agreement is taken to read that $4,000 is child support. Thus the payor spouse will not get a deduction for the $4,000 and the payee spouse does not include the $4,000 as her GI. The remaining $6,000 may be deducted from the payor spouse’s income and is GI under §71. Reduction that is going to occur upon an event relating to a child, 71c2 extends the term fixed to include arrangement. 6k qualifies and 4k falls out as child support which cannot be deducted or shifted.

(c) The agreement requires Sean to pay Madonna $10,000 per year but that the payments will be reduced to $8,000 per year on January 1, 2008, and to $6,000 per year on January 1, 2012. Sean and Madonna have two children: Daughter (born June 17, 1990), and Son (born March 5, 1993).

(d) What result in (a), above, if Sean pays Madonna only $5,000 of the $10,000 obligation in the current year?

Here we have an under payment. 10k owed, if the 10 had been paid 6 would have been spousal and 4 would have been child. Prorate situation, how are we going to charge that 5k? 71(c) all child support in full at first. 4k will be non deductable, non shiftable, and only 1k will be spousal support. Congress addresses this one directly, favoring the child support obligation.

WEEK 4

Problems p. 223

Internal Revenue Code: Sections 121 (omit (d)(4) and (5), (e))

Regulations: Section 1.121-1(a), (b)(1), (2) and (4) Example 1, (c)(1), (d), -2(a)(1)-(4) Example 2, -3(b), (c)(1)-(4) Example 1, (d)(1)-(3) Example 1, (e)(1) and (2), (f), (g)(1)-(2) Example 1.

1. Determine the amount of gain that Taxpayers (a married couple filing a joint return) must include in gross income in the following situations:

(a) Taxpayers sold their principal residence for $600,000. They had purchased the residence several years ago for $200,000 and lived in it over those years.

Taxpayer would not have GI in this instance. Since they are filing a joint return, they may exclude up to $500,000. Here there is only a gain of $400,000.

(b) Taxpayers in (a), above, purchased another principal residence for $600,000 and they sold it 2.5 years later for $1,000,000.

Again, this would not create any GI, since they have stayed in the house for over two years and since it has been longer than two years since they have used the exception.

No, exclusion if no exigent circumstances. Sale within two years prevents exclusion. Sale here does not qualify for exclusion. What about 121(c)? Only where you have exigent circumstances to use 121(c).

(d) What result in (b), above, if Taxpayers had sold their first residence and were granted nonrecognition under former Section 1034 (the rollover provision) and, as a result, their basis in the second residence was $200,000?

If their basis was $200,000 then they would have a gain of $800,000 and if $500,000 of this was offset under §121 then they would have a gain of $300,000.

(e) What result in (a), above, if the residence was Taxpayers’ summer home which they used 3 months out of the year?

Does this qualify since it is a summer home? Must be principle residence to qualify. Term of art as used in these sections. Taxpayer must prove that he now lives most of the time in the other home.

(f) What result if Taxpayer who met the ownership and use requirements is a single taxpayer who sold the principal residence for $400,000 and it had an adjusted basis of $190,000 after Taxpayer validly took $10,000 of post 1997 depreciation deductions on the residence which served as an office in Taxpayer’s home?

Depreciation reduces basis. Time of sale basis of 190k. Sell at 400 basis of 190, gain of 210. Entitled to exclude 250, do qualify for exclusion. Are we supposed to take into account that depreciation deduction was taken? Yes. There is a depreciation recapture. There is no exclusion. There will be 10 of Gross Income, the 200 will not be taxed. 121d6.

2. Single Taxpayer purchased a principal residence for $500,000 and after using it for one year, Single sold the residence for $600,000 because Single’s employers transferred Single to a new job location.

(a) How much gain must Single include in gross income?

Taxpayer has a gain of $100,000 however he is eligible to claim a reduced maximum. His reduced maximum is (1/2)*$250,000 which equals $125,000. Therefore Taxpayer has no gain from the sale.

(b) What result in (a), above, if Single sold the residence for $700,000?

Taxpayer has a gain of $200,000 however he is eligible to claim a reduced maximum. His reduced maximum is (1/2)*$250,000 which equals $125,000. Therefore Taxpayer has a gain of $75,000.

3. Taxpayer has owned and lived in Taxpayer’s principal residence for 10 years, the last year with Taxpayer’s Spouse after they married. Spouses decided to sell the residence which has a $100,000 basis for $500,000.

(a) If the Spouses file a joint return do they have any gross income?

failed 500k, but look at each separately for 250k. Taxpayer owned and used for 2 years so he is entitled to 250 exclusions. Spouse, by reason of saving provision. Since T owned for 10 years S satisfies ownership. Spouse continues to fail the use. Total exclusions each qualify for is 250 and 150 of gain is recognized, but 250 of gain is excluded under statutes.

(b) What result if the Spouses had lived together for two years in Taxpayer’s residence prior to their marriage and sold the residence after one year of marriage for $500,000?

Does their marital status matter? Yes, it does. When is marital status determined for purposes for tax returns? On the last day of the tax year. Someone married on the 31^st of December is viewed as being married since the beginning of the year. T qualifies under ownership and use, but S does not qualify for ownership ( but “either” in statute doesn’t require ownership by both) but S does qualify under the use provision since she has used it for two years.

(c) What result in (a), above, if after one year of marriage Taxpayer pursuant to their divorce decree deeded one-half of the residence to Spouse and Spouse lived in the residence while Taxpayer moved out and, one year later, they sold the residence for $500,000?

Taxpayer selling ½ of it, but has owned and used it for 10 years. The gain would be 200, and the eligibility would be 250. Underlying assumption that this was a 1041 transfer. Spouse has ownership for only 1 year. At the time of sale the spouse owns a half which has been owned for a year, the use is for 2 years. One the face the spouse would not get an exclusion under 121a because she has not owned it for 2 years. 121 d3a. Spouse qualifies for ownership. D3a, neither one of them will have any recognized gain from this transaction.

(d) What result in (a), above, if after one year of marriage Taxpayer pursuant to their divorce decree deeded one-half of the residence to Spouse and Taxpayer continued to occupy the residence while Spouse moved out, and, one year later, they sold the residence for $500,000?

Neither one has gross income recognized, each gets 250 exclusion. Just apply d3(B) relaxation provision.

4. Estate Planner sold a remainder interest in Planner’s principal residence for $300,000 (its FMV) to Planner’s Son. Planner’s basis in the remainder interest was $125,000. Does Planner have any gross income?

Yes, because the sale is between the related parties. Sale of a remainder interest. Not the same kind of planning you would be doing if you were giving coownership interest.

Problem p. 252 (does not correspond to Section 911)

1. Executive has a salaried position with Hi Rolling Corporation under which she earns $80,000 each calendar year.

(a) Who is taxed if Executive, at the beginning of the year, directs that $20,000 be paid to her parents?

The rule is that Income is taxed to the person who earns it, regardless of arrangements made to channel it to another person. Therefore, Executive will be taxed on the $20,000.

(b) Who is taxed if Executive at the beginning of the year directs that $20,000 of her salary be paid to any charity the Board of Directors of Hi Rolling selects? (Executive is not a member of the Board.)

The rule is that Income is taxed to the person who earns it, regardless of arrangements made to channel it to another person. Therefore, Executive will be taxed on the $20,000.

(c) Same as (b), above, except that Executive makes the same request with respect to a $10,000 year end bonus which Corporation has announced toward the end of the year, based on the services rendered during the year?

The rule is that Income is taxed to the person who earns it, regardless of arrangements made to channel it to another person. Therefore, Executive will be taxed on the $20,000.

(d) Who is taxed if Executive, in her corporate role, gives a series of lectures on corporate finance at a local business school and, pursuant to her contract with Hi Rolling, turns her $1,000 honorarium over to Corporation?

Problem p. 272 (problems 1 and 2)

Internal Revenue Code: See Section 911

Internal Revenue Code: Sections 1(a) through (e), (h); 6013(a). See Sections 1(g); 63; 66; 73.

1. Father owns a registered corporate coupon bond which he purchased several years ago for $8,000. It has a $10,000 face amount and is to be paid off in 2010. The current fair market value of the bond is $9,000. The bond pays 8% interest, semi annually April 1^st and October 1^st (i.e. $400 each payment). What tax consequences to Father and Daughter in the following alternative situations?

(a) On April 2 of the current year, Father assigns Daughter all the interest coupons.

Since Father owns he income producing asset, the income cannot be assigned for purposes of tax distribution. Therefore Father will have GI in the amount of the interest and the money will be given to daughter as a gift.

(b) On April 2, Father gives Daughter the bond with the right to all the interest coupons.

Now we have transferred the source of the future income. Having done that the taxability of the future income follows the source to the new owner. Now the daughter will receive interest and pay tax on it.

Father owns ½ of the bond and daughter owns ½ of the bond. ½ of the income thereafter will properly be taxed to the daughter.

(d) Father owns an income interest in a trust which owns the bonds and on April 2, Father vies his income interest (the right to the succeeding interest coupons) to Daughter.

Because it is a trust and analytical features (didn’t ask to read cases on) even though all father has is a right to income, father has given away everything he has, so the income will shift. If all you have is s a pure right to income, when you assign that right, it is deemed a transfer of property. He will no longer be taxable on the income of that trust. Longstanding treatment in our tax system.

(e) On December 31, Father gives Daughter the bond with the right to all the interest coupons.

State on 31^st of December. Of the 400 dollar coupon, father will pay tax on 200 of that because it has already accrued prior to the transfer of the bond. It is different from the principle of dividends.

(f) On April 2, Father sells Daughter the right to the two succeeding interest coupons for $600, their fair market value at the time of sale.

Not an income incidence issue, it is a timing issue. Are we going to tax father on his 600 dolalrs in hand today? Yes. He has accelerated the income in those coupons by selling them at full value today. Will have income today of 600. Daughter will have a 600 dollar basis. When the pay her 800, she will have 200 dollar income.

(g) On April 2, Father sells the bond and directs that the $9,000 sale price be paid to Daughter.

Now we are not redirecting the interest, we are redirecting the proceeds of the sale, this is still income related to his ownership of the bond. He has a basis of 8 he is stuck with 1k gain, daughter gets a gift.

(h) Prior to April 2, Father negotiates the above sale and on April 2 he transfers the bond to Daughter who transfers the bond to Buyer who pays Daughter the $9,000.

[e-h not asked to read these cases] Can you shift gain by shifting the property? Yes. But if you start negotiating the sale, entering into an agreement, etc., you can’t sluff the property off on somebody else and have them complete the sale. If you have a binding contract to sell and you shift property in order to try to shift proceeds, this will not work. If you shift the property before you start thinking about the sale, you don’t get the gain. Must draw a line where you have gone too far in completing the sale. That is just a line that cases we did not have to read get drawn out. See the scenario in your mind.

2. In the financial page of the San Francisco CHRONICLE it was reported:

Playboy Enterprises Inc. declared a semiannual dividend of six cents a share Tuesday, but the company said its president, Hugh Hefner, decided to give his back.

A spokesman said Hefner’s dividend would have totaled more than $380,000. He holds more than six million of the total shares in the company, or 72 percent of the stock.

“It was a gesture of his faith in the company,” the spokesman said. “It will go back to the company for its use.”

How will Mr. Hefner’s gesture be treated by the Commissioner? What additional facts do you want to know?

When does this income accrue and who accrues is? Dividends don’t exist until they are declared. Typically whoever owns stock, i.e. the record owner. No right until dividend is declared. Which date will govern? Public companies it is record date, closely held companies it may be declaration date. Dividends no entitlement prior to declaration. Owner transfers property prior to the record date. On the record date our former owner doesn’t own stock. Record date usually controls so there won’t be assignment of income.

Problems p. 317

Internal Revenue Code: See Sections 1; 63

Internal Revenue Code: Section 162(a)

Regulations Section 1.162-1(a)

1. Taxpayer is a businessman, local politician who is also an officer-director of a savings and loan association of which he was a founder. When, partially due to his mismanagement, the savings and loan began to go under, he voluntarily donated nearly one half a million dollars to help bail it out. Is the payment deductible under § 162? See Elmer W. Conti, 31 T.C.M. 348 (1972).

Is this similar enough to Welch and Helvering to get a similar result? Yes, we will allow the deduction on these facts using the same standards as articulated in the Supreme Court. There are case by case determinations of whether the relevant standards have been met.

2. Employee incurred ordinary and necessary expenses on a business trip for which she was entitled to reimbursement upon filing a voucher. However, Employee did not file a voucher and was not reimbursed but, instead, deducted her costs on her income tax return. Is Employee entitled to a §162 deduction? See Heidt v. Commissioner, 274 F. 2d 25 (7^th Cir. 1959).

The deduction is only worth the marginal tax rate that would ordinarily apply to that amount. She would be much better off taking a 100% reimbursement, rather than taking a marginal reduction on the savings. You cannot chose, if you are entitled to a reimbursement, it is no longer ordinary and necessary for you to claim the reimbursement as a deduction. An employee who chooses not to get a reimbursement to which she is entitled will not get a deduction.

Problems p. 334

Internal Revenue Code: Sections 162(a); 263(a)

Regulations: Sections 1.162-4; 1.263(a)-2 through (c)(1), (d)(1), (e)(1)(i), (2), (3), (4)(i), -5(a), (b)(1).

1. Landlord incurs the following expenses during the current year on a ten-unit apartment complex. Is each expenditure a currently deductible repair or a capital expenditure?

(a) $350 for painting three rooms of one of the apartments.

Painting is generally seen to be a repair. If you rehab the entire building and paint the structure (Idaho Power) it’s a capital expenditure. Painting with construction is a capital expenditure. Just painting is an expense.

(b) $1,500 for replacing the roof over an apartment. The roof had suffered termite damage.

Replace a few tiles or shingles, you are repairing. If you re roof entire building it is a capital expenditure. 1 unit re roofed out of 10…

This would probably be an expense because it is being done in order maintain an operating condition.

(d) $750 for adding a carport to an apartment.

This would probably be a capital expenditure since it is being spent on improving the property.

(e) $100 for advertising for a tenant to occupy an empty apartment.

This is a normal expense.

2. Are the regulations on capitalization of amounts paid to acquire, create, or enhance intangible assets consistent with the Supreme Court’s decision in INDOPCO?

3. Suppose that taxpayer in INDOPCO has performed some of the services in connection with the takeover transaction itself “in house.” Would the regulations require those expenses to be capitalized? See Reg. § 1.263(a)-5(d)(1) and (2). Compare that situation with the taxpayer who pays an employee in connection with the construction of a new building. Is the difference in the results justified?

Problems p. 342

Internal Revenue Code: Sections 161(a); 195; 262

Regulations: Section 1.195-1(a)

1. Determine the deductibility under §§ 162 and 195 of expenses incurred in the following situations.

(a) Tycoon, a doctor, unexpectedly inherited a sizeable amount of money from an eccentric millionaire. Tycoon decided to invest a part of her fortune in the development of industrial properties and she incurred expenses in making a preliminary investigation.

Under the Morton Frank decision, the process of investigating an industry, but not narrowed in on a particular transaction are not considered carrying on trade or business.

(b) The facts are the same as in (a), above, except that Tycoon, rather than having been a doctor, was a successful developer of residential and shopping center properties.

Looking at it one way it is an extension of business. Looking at it another way, there may be factors that distinguish residential development from industrial. This raises the possibility that it is juts an extension, in which case you get 162 deductions.

(c) The facts are the same as in (b), above, except that Tycoon, desiring to diversify her investments, incurs expenses in investigating the possibility of purchasing a professional sports team.

Same as problem 1a. This is not an existing business. When an individual does it it is clearly a vanity purchase. However what about Disney or something along those lines? This could be an extension.

(d) The facts are the same as in (c), above, and Tycoon purchases a sports team. However, after two years Tycoon’s fortunes turn sour and she sells the team at a loss. What happens to the deferred investigation expenses?

Assuming it is a 195 to begin with, 24 months into period, still has 13 years worth of amortization to go. If you totally cease business before amortization has run, then you can claim loss (and by loss it is remainder of amortization) for current year

2. Law student’s Spouse completed secretarial school just prior to student entering law school. Consider whether Spouse’s employment agency fees are deductible in the following circumstances:

(a) Agency in unsuccessful in finding Spouse a job.

No, you have to have a job in order to deduct.

(b) Agency is successful in finding Spouse a job.

No. Revenue Ruling 75-120 will not allow deductions under Section 162 for expenses incurred by individuals who have been unemployed for such a period of time…however Success is not an element in the deductibility of employment-seeking expenses.

(c) Same as (b), above, except that Agency’s fee was contingent upon its securing employment for Spouse and the payments will not become due until Spouse has begun working.

?? Success is not an element in the deductibility of employment-seeking expenses.

(d) same as (a) and (b), above, except that Spouse previously worked as a secretary in Old Town and seeks employment in New Town where student attends law school.

This would be deductible.

(e) Same as (d), above, except that Agency is successful in finding Spouse a job in New Town as a bank teller.

This would not be deductible because it is not along the same line of business or trade.

Problem p. 356

Internal Revenue Code: Section 162(a)(1). See Sections 162(m); 280G.

Regulations: Section 1.162-7, -8, -9

1. Employee is the majority shareholder (248 of 250 outstanding shares) and president of Corporation. Shortly after Corporation was incorporated, its Directors adopted a resolution establishing a contingent compensation contract for Employee. The plan provided for Corporation to pay Employee a nominal salary plus an annual bonus based on a percentage of Corporation’s net income. In the early years of the plan, payments to Employee averaged $50,000 annually. In recent years, Corporation’s profits have increased substantially and, as a consequence, Employee has received payments averaging more than $200,000 per year.

(a) What are Corporation’s possible alternative tax treatments for the payments?

(b) What factors should be considered in determining the proper tax treatment for the payments?

(c) The problem assumes Employee always owned 248 of the Corporation’s 250 shares. Might it be important to learn that the compensation contract was made at a time when Employee held only 10 out of 250 shares?

WEEK 5/6

Problems p. 374

Internal Revenue Code: Section 162(a)(2), 162(a) second to last sentence; 274(n)(1). See Sections 162(h); 274(c), (h) and (m)(1) and (3)

Regulations: Section 1.162-2 (omit-2(c))

1. Commuter owns a home in Suburb of City and drives to work in City each day. He eats lunch in various restaurants in City.

(a) May Commuter deduct his costs of transportation and/or his meals? See Reg. § 1.162-2(e).

No. Commuters’ fares are not considered as business expenses and are not deductible.

(b) Same as (a), above, but Commuter is an attorney and often must travel between his office and the City Court House to file papers, try cases, etc. May Commuter deduct all or any of his costs of transportation and meals?

Yes, he can deduct commute from office to courthouse, but cannot deduct the meals

(c) Commuter resides and works in City, but occasionally must fly to Other City on business for his employer. He eats lunch in Other City and returns home in the late afternoon or early evening. May he deduct all or a part of his costs?

Meals are deductible only if you are on the road long enough to need sleep or rest. Daily flight there and back, not long enough to stay over night, means that meals are not deductible. If the lunches were business meal then it is deductible.

2. Taxpayer lives with her husband and children in City and works there.

(a) If her employer sends her to Metro on business for two days and one night each week and if Taxpayer is not reimbursed for her expenses, what may she deduct? See § 274(n)(1).

Transportation should be deductible to metro, lodging should be deductible, meals should qualify under 162. Introducing further refinements to this. 274(n)(1)—50%. Overlay on 162, already determined that amount is deductible. 274 comes along where it applies, takes that and adds 274 overlay. Overlay is that there is a 50% limit on amount otherwise allowable on 162. I.e. 150 dollars qualify under 162, only 75 dollars is actually deductible.

(b) Same as (a), above, except that she works three days and spends two nights each week in Metro and maintains and apartment there.

where is her tax home? Getting closer to an Andrews issue. Whether or not she has two residences with business locations attached to them. Which one will be tax home. How do we determine in an Andrews situation what the real tax home his? Consider, time spent, relative income.

(c) Taxpayer and Husband own a home in City and Husband works there. Taxpayer works in Metro, maintaining an apartment there, and travels to City each weekend to visit her husband and family. What may she deduct?

She may deduct nothing. Each has their own separate tax home. Each has their own business. Traveling to visit her husband is a personal expense, it is not related to business.

3. Burly is a professional football player for the City Stompers. He and his wife own a home in Metro where they reside during the 7-month “off-season.”

(a) If Burly’s only source of income is his salary from the Stompers, may Burly deduct any of his City living expenses which he incurs during the football season?

No. His choice to live in the other location, in metro is a personal choice a Flowers choice and this will not allow him to claim that working for the Stompers is being away on business.

(b) Would there be any difference in result in (a), above, if during the 7-month “off-season” Burly worked as an insurance salesman in Metro?

Yes, there would be a difference. Andrews issue again (go through factors, time spent, relative income), can’t answer definitively. Which one of those places, in each of which he is conducting a business.

4. Temporary works for Employer in City where Temporary and his family live.

(a) Employer has trouble in Branch City office in another state. She asks Temporary to supervise the Branch City office for nine months. Temporary’s family stays in City and he rents an apartment in Branch City. Are Temporary’s expenses in Branch City deductible?

Yes, they are. 9 month posting, expecting to last 9 months, or less than a year, and it lasted for less than a year. This satisfies the services ‘temporary’ standard and so it would be deductible.

(b) What result in (a), above, if the time period is expected to be nine months, but after eight months it is extended to fifteen months?

No longer temporary under IRS standards. It is indefinite and it would eliminate ability to deduct expenses. From month 8 on, it is non-deductible. You can deduct the first 8 months so long as it remained in the temporary category. When it shifted to indefinite you can no longer rule the expenses as deductible. First 8 months you will get deduction even though it turns out to be non deductible from that part on.

(c) What result in (a), above, if Temporary and his family had lived in a furnished apartment in City and he and family gave the apartment up and moved to Branch City where they lived in a furnished apartment for nine months?

Lack of duplication which isn’t a definitive test. No answer to this. Moving the whole family may or may not enter into tax analysis. Depends on how you analyze this in terms of doctrine and whether there should be an away from home circumstance.

5. Traveler flies from her personal and tax home in New York to a business meeting in Florida on Monday. The meeting ends late Wednesday and she flies home on Friday afternoon after two days in the sunshine.

(a) To what extent are Traveler’s transportation, meals, and lodging deductible? See Reg. § 1.162-2(a) and (b).

1 trip with a 5 day duration. M-F. Business on M-W, non business Thurs, return trip Friday. As far as the meals and lodging go, no issue. Meals and lodging associated with business will be deductible as usual. What is the issue here? The plane fare. We have one trip with one plane fare, is it deductible because it is business travel or is it non deductible? Look at regs, we will characterized the transportation as one or the other 100%. It is either business travel with a little personal on the side or it is personal travel with a little business on the side. If it is personal none of the plane fare is deductible. If it is business then it is all deductible. Primary factor is time spent on business v. pleasure. Since more than 50% was spent on business, the plane fare should be deductible. Time is most important factor but not determinative one.

(b) May Traveler deduct any of her spouse’s expenses if he joins her on the trip? See § 274(m)(3).

Only if she is an employee and she is essential and she would be subject to the deduction if she went alone. That means in general it is real tough to get the spouse written off.

7 day trip 4 days non-business and consequently 100% of the plane would be non deductible.

(d) What result in (a), above, if Traveler takes a cruise ship leaving Florida on Wednesday night and arriving in New York on Friday? See § 274(m)(1).

Another element. In theory water transportation is too much fun. No deduction allowed for water transportation. This is a dollar limitation amount

(e) What result in (a), above, if Traveler’s trip is to Mexico City rather than Florida? See § 274(c).

Foreign travel. 274c Travel that would normally be deductible under 162. Only element in question is the transportation costs. Amount that has passed 162 which means it is deductible travel. If it is to a foreign destination outside the US we cut it back to an allocation of the business portion of the trip. Will bifurcate and divide it in two pieces one remaining deductible attributable to the business portion, and the other non deductible. In this problem, a few exceptions…travel less than one week, 274 does not limit and whole transportation will be allowed.

Less than 25% you get whole deduction. It is de minimis.

(f) What result in (e), above, if Traveler went to Mexico City on Thursday and conducted business on Thursday, Friday, Monday, and Tuesday, and returned to New York on the succeeding Friday night? See Reg. § 1.274-4(d)(2)(v).

6 out of 9 business, 3 out of 9 non. More than 25%, you can deduct 2/3 or airfare may deducted and 1/3 will be disallowed for deduction.

(g) what result in (e), above, if Traveler’s trip to Mexico City is to attend a business convention? See § 274 (h).

Another penalty provision. Limits attendance of conventions. Again motivated by a different abuse Congress perceived.

Problem p. 396

Internal Revenue Code: Sections 162(a); 274(a), (d), (e), (k), (l) and (n).

Regulations: See Sections 1.162-20(a)(2); 1.274-2(a)(1), (c), (d).

1. Employee spends $100 taking 3 business clients to lunch at a local restaurant to discuss a particular business matter. The $100 cost includes $5 in tax and $15 in tip. They each have two martinis before lunch.

(a) To what extent are Employee’s expenses deductible?

162 they are discussing business, looks like it qualifies, pass this screen. That takes us to 274. What about the additional standard of 274 (a)—pass this. 274(k) for meals, no deduction is allowed if the expense is lavish or extravagant under the circumstances. Lavish or extravagant adds another opportunity for the service to challenge the deduction. If you are not at the lunch, you don’t get the deduction, even if it is not lavish and they are talking about business. $100 totally reasonable amount, 50% is deductible.

(b) To what extent are the meals deductible if the lunch is merely to touch base with clients?

None. Zero, fails 274a, networking and building good will does not constitute active business deduction.

Fails 274k, employee is not present. Might conceivably argue that this is a business gift. 274b limits amount of gift.

(e) What result in (a), above if Employer reimburses Employee for the $100 tab?

This is business transportation, deductible in full nothing in 274 limits this.

2. Businessperson who is in New York on business meets with two clients and afterward takes them to the Broadway production of The Producers. To what extent is the $600 cost of their tickets deductible if the marked price on the tickets is $100 each, but the Businessperson buys then from the hotel concierge for $200 each?

This is entertainment. Satisfies 274a, must watch out for 274(l) additional limitations on entertainment tickets. In general, no matter how much you pay, you can only deduct face. This is an anti scalping provision. Can only take into account 300 dollars, but keep going, but then do (n) which does include entertainment, so you have to cut back the otherwise allowable 300 dollars by 50%, so the deduction is only 150 dollars for the 600 tickets. Face value is 300 dollars and then you get 50% of that.

3. Airline Pilot incurs the following expenses in the current year:

(1) $250 for the cost of a new uniform.

A new uniform, yes this is a job requirement and it would be deductible. What is the test for uniforms? What about a suit? No, this is a personal item.

(2) $30 for dry cleaning the uniform.

Maintaining the uniform in its useful condition would also qualify for a deduction.

(3) $100 in newspaper ads to acquire a new job as a property manager.

Employment expenses are non-deductible. Expenses of entering into a new business are not deductible. These are preparatory.

(4) $200 in union dues.

Yes, union dues are deductible.

(5) $50 in political contributions to his local legislator who he hopes will push legislation beneficial to airline pilots.

No under 162 e.

(6) $500 in fees to a local gym to keep in physical shape for flying.

Has been held to be too far away. This is for general health rather than a Pilot’s job.

What is the total of Pilot’s deductible § 162 expenses?

$480

Problem p. 399

Internal Revenue Code: Sections 165(c)(1); 280B

1. Taxpayer has an automobile used exclusively in Taxpayer’s business which was purchased for $40,000 and, as a result of depreciation deductions, has an adjusted basis of $22,000. When the automobile was worth $30,000, it was totally destroyed in an accident and Taxpayer received $15,000 insurance proceeds.

(a) What is Taxpayer’s deductible loss under Section 165?

Nominal economic loss before insurance of 30000. Receipt of insurance in the amount of 15000. What is going to be the deduction here? Economic loss greater than the basis. Our deduction would be limited by the basis. We have recovered 15 of insurance. What we have left for deduction is 7000. The insurance reduces the amount of the allowable loss deduction because we are not out that much. Our deduction will be 7000 for this casualty. What is the basis effect of this? 22000 reduces by 15000, reduced by 7000 leaving us with 0. 15000 does not show up on tax return because it is a recovery of basis but it is not in excess. It still needs to be tracked in to basis of property.

(b) What result in (a), above, if the automobile had not been totally destroyed but was worth $10,000 after the accident? See Reg. § 1.165-7(b)(1).

Start out again with basic set of facts except value afterward of 10000, which means economic loss is 20000. Not total destruction, only partial. 20000-15000 deduction of 5000. What about the basis? 22000-15000-5000 = 2000 left over. Go out and sell it for 10 and I now have a basis of 2 in it, I have a gain of 8.

(c) What is Taxpayer’s adjusted basis in the automobile in (b), above, if Taxpayer incurs $17,000 repairing the automobile?

This is a capital investment to restore the automobile. Restoring the auto as a new investment. This is not repair v. capital expenditure. 17k goes back into basis which is 2000 and you have a final basis of 19,000.

Problem p. 435

1. On January 2 of the current year for $300,000 Depreciator purchases new equipment for use in her business. The purchase is made from an unrelated person. The equipment has a 6-year class life and is 5-year property under § 168(c). Depreciator plans to use the equipment for seven years, and expects it to have a salvage value of $30,000 at the end of that time. Depreciator is a single, calendar year taxpayer, and she uses the equipment only in her business.

In the following problems, compute the depreciation deductions with respect to the equipment in each year of its use and Depreciator’s adjusted basis for the property each year.

(a) Depreciator elects under § 168(b)(5) to use the straight-line method for the equipment and all other property in its class placed in service during the year.

Straight line method: Amount available for depreciation is 300,000 with no deduction for salvage. Time period is 5 year recovery period. The method is the straight line method.

If we took straight line, we would think that we would be getting 60,000 per 12 month period. What do you get for the first year. In a half year convention, you get 30,000, in the last year you get 30,000 because you only have 30,000 left. So your five year recovery touches 6 tax years because of the half year convention.

(b) Depreciator uses the accelerated ACRS method provided by § 168 (a).

(c) Same as (b), above, except that Depreciator also elects to use § 179? Assume there is no post-2002 inflation. What additional facts do you need to know?

We haven’t run out yet. Year of sale, we still have a basis in this property, we have not fully depreciated 300,000. This is held for almost the full year, 11 months and the sale occurs on December 1^st with only one month left to go. Can we get any depreciation in the year of sale? Yes. Still own the property still get depreciation. Artificially end with half year convention in year of sale. Answer here is that she gets a half year of depreciation in year 5. Year 5 we would get 17,280 and that would be the crossover year. That would be the straight line calculation and the basis at the time of sale would be 34,560. Get 11.52 as full year percentage, for year 5 we would get half of that and that is the crossover year.

(d) What differences from (b), above, if Depreciator also elects to use the § 168(g) alternative depreciation system for the equipment and all other property in its class placed in service during the year.

Here again this just reminds us that Congress occasionally will want to juice economy or produce a faster write off. Difference between depreciation and amortization, for income tax purposes there is no difference. In most cases amortization is just another variety of a write-off. Amortization is usually an even deduction over a period of time which may not be tied to useful life. Effect on return is the same.

179 which is bonus depreciation for certain property. 179 is business property only. The function of 179 is similar to 195, it is an extra first year deduction calculated differently outside of the depreciation scheme to allow you to reduce your taxes in the year you place the property into service. Congress wants people to invest. It encourages small business people to buy equipment. If your aggregate cost is above a certain level then you can start phasing out a certain allowance, it is a dollar by dollar phase out.

Still total write off of 300,000, we are just getting an extra bump in the first year. It still affects basis, it still affects what you can depreciate. Methodology doesn’t change, the number just does.

(e) The equipment has a 6-year class life and Depreciator elects to use the §168(g) alternative depreciation system for the equipment and all other property in its class placed in service during the year.

Alternative depreciation system is the slowest methodology in §168. This is a straight line method applied not over 168 recovery period of 5 years, but rather over 6 year class life, which means that we have deductions over 7 years. Just apply straight line method applied to the class life. Special examples, municipal waste use a 24 year, etc. There are special rules, but if you don’t have special rules applying then you just use class life for this. Essentially 4 methods, 2 are straight line, double declining of 150 percent declining if allowed. 168 tells what property can use what method. For example, real estate uses straight line.

Problems p. 511

1. Discuss the extent to which § 465 limits Taxpayer’s loss deductions, generates recapture income out of a previously allowed loss deductions, or allows the use of a loss carryover in the following situations:

(a) Taxpayer purchased a farm for $50,000 cash and his personal note for $400,000 secured by a mortgage. In the first two years of operation he put in an additional $50,000 each year, by way of cash and personal loans, for feed, fertilizer and other supplies; but things did not go well. In the first year of operations his loss was $80,000 and he had another $80,000 loss in the second year of operations. No principal was paid on the liability in either year.

(b) The facts are the same as in (a), above, except that the farm was acquired for $50,000 cash and $400,000 of nonrecourse financing.

(c) The facts are the same as in (a), above, except that in the third year of operations when the farm broke even, Taxpayer converted his personal liability of $400,000 to a nonrecourse loan.

(d) The facts rae the same as in (b), above, except that the farm breaks even in year three and Taxpayer pays off $10,000 of the nonrecourse loan in year two.

(e) The facts are the same as in (b), above, except that the farm breaks even in year three and Taxpayer pays off $10,000 of the nonrecourse loan in year three.

Thursday, 19 July Ch 17 pages 520 – 534

Monday, 23 July Ch 21 pages 674 – 691

Tuesday, 24 July Ch 21 pages 733 - 741 for reference

Ch 23 page 767

Ch 25 pages 864

Ch 25 pages 871 - 873

Thursday, 26 July Ch 27 pages 925 - 932 for reference

Ch 27 pages 932 - 944