Income Tax Davis

8/4/2019 Income Tax Davis

1/22

Individual Income Tax Outline

16th Amendment: Allowed income tax. Previously, it had been considered a Direct tax andtherefore unconstitutional. (Tried it during civil war . . . uncon).

Must consider: 1) economics, 2) administration (recording), and 3) non-tax policy when trying todetermine what should be taxable income (in the basket) and deductions (out of the basket).

Defn: 1) Income: Gain on property subject to tax (Sell price buy price = income).2) Amount Realized: Dollar amount you get for selling property.3) Basis: Investment in the property.4) Gain: Same as Taxable income. (amt realized basis = gain).

General Rule: Disposition of appreciated property is taxable, unless there is an exception.

Practice Problem:

Client wants to sell house. Bought with husband, but theyre getting divorced. She got MS housein settlement; he got FL house (which he lived in while working). She wants to sell, buy horses.

LAW: 1041property settlement/disposition b/t spouses are not taxed as an incomegain. The basis remains the same.

121If meet all the requirements, the sale of a residence will be tax-free.

121: Exclusion available for gains realized on sale or exchange of principal residenceA. Exclude up to $250 (single) or $500 (if file joint return, either owns, both use house,

and neither has used 121 within past 2 years).a. If file jointly and one doesnt meet use reqt, cant get $500. Can still get

$250.

B. Must OWN and USE as principle residence for 2 yrs in past 5 yrsa. Doesnt have to be continuous 2 yrs (750 days in 5 yrs)b. Temporary absence is OK (even if rent house)

C. Ownership : In case of divorce or death of spouse, ownership includes period of timethe residence was owned by the other spouse.

D. Principle Residence : Main test is: Where do you spend the majority of your time?State law defn of principle residence is not applicable.

a. FACTORS :(1) Location of residence v. taxpayers principal business location(2) Amount of time taxpayer and family spend at residence **most important(3) Involvement in community

(4) Voting and licensing registrationE. Uncontrollable Circumstances/Employment Change : You can still get the exclusionif you dont satisfy the 2 yr own/use reqt b/c of changed employment. Fraction, there1 yr, you get exclusion. (Time/2 * 250K or 500K)

F. Only can use once every 2 yrs .G. Depreciation (like if you used part of house for business) is subtracted from the

excludable amt.H. Acreage around the house may be considered part of the residence.

1


2/22

1041: Marriage ExceptionA. No gain is recognized if transferred to 1) spouse (if separated, still married), or 2)

incident to divorce (property settlement)B. It is considered as a gift.

Punishment for Bad Advice: 1) Tax Preparer PenaltySignificant bad advice, you can be fined.2) Malpractice, 3) You can be barred from dealing with the IRS.

Order of Authority: Starting w/ revenue rulings, they arent binding.1) Const, 2) Statute (IRS code by Congress), 3) Regulations (Treasury Department), 4) RevenueRulings (By IRS), 5) Revenue Procedure (IRS), 6) Private Letter Rulings, 7) Legislative History(used to explain statutes, prior law, reasons for change, etc.) 8) Case law.

Revenue Rulings: Like cases, but decided by the IRS only binding on govt., not tax payers.Revenue Procedures: Like a how-to guide for doing something.

Private Letter Ruling: Ask IRSs opinion about tax treatment of something. It is only binding forthe particular taxpayer who asks for the opinion. You can use the letters to show that the IRS hasbeen either consistent or inconsistent in their treatment of something. No real authority, though.Case Law: Often to define terms, Interpret statute/reg.

Independent Judicial Doctrine: Tax Common Law (applies to whole Code)EX: Assignment of income doctrine: tax must be paid by person who earns.

I. Introductory Stuff

A. Audit - There are 3 levels of audits. **You have a right to have counsel/acc when meetIRS

a) Correspondence audit - IRS just sends letter saying you owe us money. You either

send money or explain why you dont owe.b) Office audit - bring your documentation and go to IRS.(i) Never give IRS an original document.

c) Field audit - The come to you. Most inclusive.(i) Try to control flow of information. Get copies for yourself of what IRS wants

What if you Do owe more $ after the audit? *First, you try to negotiate a settlement price. Theearlier you settle, the better price you will get.1. If you cant reach an agreement, you get 30-day letter saying you owe IRS money.OPTIONS:

a. Concede liability and pay the money,

b. Request an Administrative appeal (cheaper than trial),c. Do nothing then you get the 90-day letter. 90-day letter is ticket to court.*During 30 or 90 day, IRS cant seize any assets UNLESS you are a flight risk.

2. Once you receive your 90-day letter:a. File petition (same as complaint) in tax ct (file petition, IRS cant seize prop)b. Do nothing - Then IRS can seize assets. Lose right to argue if dont file suit

w/in 90 days.

2


3/22

B. TAX CT: Hears only deficiency Cases (taxpayer owes IRS).- No jury trial (But you do get a specialist judge)- Appeal to Circuit where taxpayer lives. Golsen: That Circuits law binds the Tax Ct.

C. DISTRICT CT: Hears only refund claims (you overpay, ask IRS to refund, they refuse).

- Jury trial- Can convert a deficiency action into a refund action (pay the amt asked for by the IRS,ask for a refund and then sue when they wont refund you.)

D. SOL: Generally, there is a 3 yr SOL to bring suit/- SOL begins to run at the time you file (if you file early, it starts on 4/15).- 6 yr SOL: If you understate your taxes by 25% or more, the SOL is 6 yr- Never Runs: If you commit fraud or never file sufficient form, the SOL never runs.- Often, the audit starts w/in 3 yrs, but it cant be completed w/in 3 yrs. In that case, IRSwill ask you to extend. If you dont, theyll just say you owe.

- Dont extend if they may find more problems

- Always set an end date and try to limit the scope.E. Ethics:- What to report is ultimately up to the client.- Always put your advice in a letter or memo.- There is no client/acc privilege, so Atty. Should hire the Acc.

Chapter 2: Gross Income: 61 (GI (sec. 61) deductions = taxable income (X tax rates of rateschedules) = tentative tax liability credits = tax liability)

Tax Rates: 1) ProgressiveAs income increases, tax rate increases.

2) ProportionalEveryone pays same %

3) RegressiveIncome decreased, rate increases. Sales tax works this way.

Marginal Tax Rate: The highest rate you pay (note: all your income isnt taxed at MTR).Effective Tax Rate: (Tax liability)/(Total Income)=ETR

- This shows a persons actual tax burden. Amt paying in taxes as % of income.

Progressive structure1st 10K, 0%; 2d 10K, 3%; 3d 20K, 4%; all other, 5%15K income, 10K taxed at 0%, 5K taxed at 3%. $150/15K = 1% ETR.

61 Gross income: All income from whatever source derived, unless excluded by law. There isa list, but it is not exhaustive. Concerned with the substance received, not the form of income.

Glenshaw Glass Test for Income (more exhaustive than Eisner made by labor):

1) Accession to Wealth (economically better off)2) Clearly Realized (changing)

a. If you get direct deposit, it doesnt come to you, but you still realize.b. Old Colony : Corp had in K to pay officers taxes. Officer died, Corp

paid for previous yrs tax. Even though dead, still realized benefit. Thiswas consideration for services rendered. Path of $ is irrelevant.

3) Complete Dominion over property (hold in trust, no dominion)a. Ability to use property/$ as you wish

3


4/22

**Therefore, punitive damages and Qui Tam damages (Roco) are taxable.

Roco: When you get a Qui Tam award, you get a 1099 from govt. and they also give one to theIRS. When you file w/out listing the award, IRSs matching computer flags your return.Penalty: IF you understate by a certain %, you will be punished by forcing you to pay 20% of

your tax liability as a penalty + any accrued interest.*How to avoid penalties: 1) If your trmt was based on substantial authority, no penalty.2) If you state what you did and why, no penalty (like stamping audit me)3) Reasonable cause + Good faith (records burned, forgot, etc) not in jail.

**The path/form of benefit is irrelevant, Congress had intent to reach as much as possible.Chapter 2 Problems:

1(A): woman has $75K salary, take home 50K (15K fed tax, 5.5 SS, 4.5 state tax). GI75*Old Colony: Report everything, then deduct.

(B): Bonus of 5K; GIadd 5K(C): Gets desk & chair worth $500 (FMV) for 50.

*Bargain Purchase: Generally, dont recognize gain until you sell the bargain. This isthe situation if she and firm didnt know the value of the desk.*Exception: If E/er knew value and sold it for less b/c she was an employee, itscompensation and therefore the 450 should be GI.

*Suppose builder built house and sold for cheap to someone b/c he was friendswith that persons dad. NOT GI, b/c favor wasnt to buyer, it was to dad.

(D): She took a mandatory trip for business worth $2500.

*Rule: If the trip is compensation (not reqd, get it b/c you did well, etc) report as GI*Here, though, trip was required, she conducted business (E/er also benefited).*The FMV of trip should be taxed (not subjective value).

2. Buy stk for 1K, EOY1 1.5K, EOY2 2K, EOY3 3K (pledged stk as security on loan),EOY5 3500 (stk got burned in a fire, received a new certificate from corp.), Then, gave the stkto a creditor to satisfy a debt.

*GI on (amt worth basis) when you gave it to creditor. Realized when gave to creditor.*NOT realized when pledged as security.*NOT realized when received a new certificate.

*Report found money as GI when you find it. Not Realized until found.*Why might IRS go to ct over small $? 1) Set precedence, 2) lot of people doing it, binds all.*Rev R: If you barter for services, you should report the FMV of any services you receive as GI.

*Prob 1(f): She did service for free, to thank her, cousin built her a greenhouse.

Distinguishable b/c not bartered for up front. Must anticipate getting something in return for GI.

Old Colonys Pyramiding: They didnt pyramid, should have.*E/ee has $1000 salary. 40% TR. E/er pays $400, E/ee gets $600.*Suppose E/ee wants $600 and E/er pay all taxes. E/er pays 240, but this is also GI for

the E/ee (benefit). 240*0.4, etc . . . COMES out the same. Formula: AT/(1-TR) = BT

4


5/22

Chapter 3: Effects of an Obligation to Repay.*A loan is not a taxable b/c along with receiving money, you get debt. Pay off, no ded.

N.A. Oil: 1916 profit paid to receiver b/c of dispute over ownership.1917 NA OIL won at TC, receivership paid $ to NA oil (High tax rates in 1917).1922 The Govt.s appeal rights are exhausted.

**NA Oil argues that 1916 (Pay on $ dont have) or 1922 should be when the GI is due.*Holding: Govt. received $ under a claim of right w/out restriction as to the $sdisposition in 1917 (escrow until them). Pay taxes then. If forced to repay, get a deduction.

Indianapolis P&L: Deposits may or may not be taxable. Can be an obligation to repay.

*If in general fund, no obligation to repay, unfettered control/disposition taxable.*Here, IPL did have an obligation to repay or would apply to last mo, BUT the customer

controlled the disposition of the property. Customer pays, wont lose deposit.

Illegal Acts: Illegally obtained funds are taxable.*For tax fraud, must have mens rea. Therefore, if S Ct changes law on you, not punished.

Problems w/ Taxing Illegal Acts:Thief has an obligation to repay, but he also had to pay taxes on the $. Tax liability is 1st in line.

*What if spouses file Joint Return (jointly liable) and hubby runs off?(a) Innocent spouse rule (keeps innocent from having to pay taxes)

(i) Need a substantial misstatement of tax liability(ii) Understatement generated by one spouse(iii) The other spouse must have no reason to know about

understatement(iv)Equities are in favor of some relieve (hard to get if married)

1. Equities not in favor if spouse benefited from lavish unexplained

lifestyle. Innocent used $ - must pay taxes.2. Court will look at level of education and sophisticationCurrent Events:*Cubs pitcher and delivery guy have same name. For three checks, delivery guy gets P salary.Assume D Guy got $ in one yr and gave it back in the next yr. A lot like the illegal acts area.

1) Hes taxed in the yr he received the $ even though he had no Claim of Right.-That yr, he made his 50K salary + 300K; therefore, he had a higher tax rate.-The yr he got his deduction, he only had the 50K salary; therefore, he couldnt use wholededuction. He losses $ b/c he paid tax on $ he couldnt keep, and he couldnt recoup tax.

1341: If forced to pay $ back, you can either take a tax credit for amt paid, OR the deduction.

Reqts: 1) It appeared that TP had an unrestricted right the yr the taxes were paid.2) Deduction allowable b/c after close of yr, TP didnt have an unrestricted right.*This is the Equivalent of allowing an Amended return. **Must be over $3K.

EX: NA OIL, but assume pd taxes in 1917 and had to reimburse G in 22*1917 (60%), 22 (35%). Therefore, it would be unfair to only allow a deduction.10K @ 60% is 6K paid in tax; in 22, if you deduct the 10K @ 35%, only get back 3500.

*W/ 1341NA OIL could have just taken a tax credit for amt paid ($6K).

5


6/22

*A deduction is a function of the TR . . . Worth what it saves TP (Ded * Rate).*A Credit is a flat reduction of tax liability ($ for $).

Chapter 4: Gains Derived From Dealings in Property

Problem 1: Pd - $100K, Sold - $175K. 61Gain from property = $75 (Amt realized - Basis).

1001: (a) Gain = Amt realized - Basis;(b) Amt realized Any $ or FMV of property received in sale of prop.

1011: Adjusted basis for determining gainTP un-recovered investment. 1012: Basis of property is cost of property.1016: Adjustments.

Methods of Analyzing: 1) Acquisition of Property and 2) Disposition of Property.I. Acquisition:

1) Does the receipt of property trigger INCOME? 61: Arms length purchase, NO. If you

buy at discount b/c you are an E/eecompensation, Income.2) Whats my BASIS in the Property? Basis = investment in the property. Stk for

bonusrequires an inclusion. The price of the stk @ time received is your BASIS.

2) Disposition :1) Is there a disposition? Sale or equivalent (trade). Borrowing on prop isnt disposition.

2) Amt Realized: 1001(b)Any $ received + FMV of any property received for prop.3) Adjusted Basis: 1011 = 1012 (cost of prop) + 1016 (adjustments)

a. Upward adjMost important is improvements to prop. Downwarddepn.4) Gain/Loss

a. Loss: Can I take a deduction for that loss? ( 165 - later)b. Gain: is there an exclusion? I.e., 121.

5) Tax Rate for gain that isnt excludable. Ordinary income1; Long term CG20%.

Problem 2: Buy house for $200K (50 down, 150 loan) Buying property, not taxable.

2A) Basis1012 Cost = $200K (it doesnt matter where the $ comes from, just what pd).2B) What if she borrows from the seller and not the bank? No change (doesnt matter where $).

*What if she repays $25K of the loannot a taxable event. Repmt, has no tax consequences2C) Refinanced, got $50K extra. $40K went to improve house, $10K went to piano.

*1016 adjustment$40K, new basis in house is $240K; Basis in piano is $10K. Use of loanis what counts, not getting loan.

2D) Sale of property for $300K. Maggie gets $140K in pocket and $160 to pay off loan.

*Amt realized is 1001(b)-$300K. Gain = Amt Realized - Adj basis$60K.

*If buyer assumes Maggies debt, same result.

Problem 3: Clare owes Liz 10K debt. She is a painter and has a $5,500 painting ($100 material)

Liz: acquisition1) receiving painting income? YES, for compensation.2) Basis? $5,500 (1012 - cost to get the painting). RULE: If you have to include receiptin your taxes, the amt included on taxes is your basis (prevents losing if sell for $5500.**buy stk at $25 b/c E/ee; value at $100. Pay taxes on excess of FMV - pd. 100Basis

6


7/22

Clare: Disposition: Amt Realized1011(b) $5500, Basis$100; TIME DOESNT gointo basis. Gain: 5500 - 100 = $5400.

Philadelphia Park: Basis in property received is the FMV of the property received.*Note, this will only matter when the value of prop changes b/t K and closing.

IF for some reason property received cant be valued, assume that the property given up

and the property received have the same value.**AMT real and basis is FMV of prop. received.

Problem 4: M- pting worth $100 (bought for $75); P- lot worth 100 (bought for 40). Exchange**Exchange of property can trigger Tax . . . AMT realized is FMV of prop Received. 1001.

A) M receives something worth 100K for an investment of 75G=25; P gain is 60 (100-40).**Both have a basis of $100 (received prop worth 100). M sells lot for 140, 40 gain on it.

B) At closing, Ps lot is worth only 80.**M now receives something worth 80 for 75 (5 gain); P still receives 100 for 40.**Ms basis in lot is now 80 (value of property received). W/out this, M gets under-taxed.

C) Debt on property youre receiving: Assume that Ps lot is worth 120. M gives ptg (100) in $,and assumes $20 of Ps debt (same as giving P $20K).

**P is now receiving a 120 benefit (amt realized). Basis-still $40. 80 Gain.**M: Look at this either 1 of 2 ways: 1st, either M has two basisptg(75) and assumingdebt(20) for a total basis of 95. OR, Amt realized (120) should be reduced by the amt of$/debt assumed pd for the lot. Both gives the same result. $120 basis in the lot; 25 G on ptg.

1. Basis in lot is still the FMV of the property received.2. Assuming Debt is the same as paying Cash

Chapter 5: Gifts, Bequests, and Inheritance:Even though gifts/B/I satisfy Glenshaw Glass (acc to wealth, clearly realized, dominion), therehas always been an exception to including it receipt of a gift as Gross Income. (102)

**Also, giving a gift is NOT a realization event by the giftor.

Problems w/ basis: 1) It doesnt adjust for inflation, 2) BOP is on the Tper to discover basis.

Whats the recipients Basis from a GIFT:1015: The recipient of a Gift takes the Donors basis.

*EX: B bought lot worth 50K for 20K; gives it to RRs basis is 20K.- 1015 is really an exception to the assignment of income doctrine. B/c the recipient ispaying tax that was incurred during the donor, but the recipient pays it when he sells property.Loss property/Basis in excess of FMV, under 1015, at the day of gift,

(1) for gain purposesyou take the donors basis;

(2) for loss purposesyou take the FMV of date given.

ReasonDont want to allow people to shift losses (even if can shift gain).**Therefore, if the property value has gone down, dont gift it, sell it and gift the $. (That

way at least you can take the deduction . . . the recipient cant).

Whats the recipients Basis from a Bequest:1014: Basis of a recipient, from a decedent, is the FMV of the property on the date of the

decedents death, or an alternate amt (basisamt of estate tax). **The gain incurred by decedentis NEVER taxed as income (AMNESTY)

7


8/22

Estate TaxesAmt of persons value Must be taxed (not an income tax). You either evaluatethe amt to be taxed at the Date of Death or 6 mo after death (you pay the lower amt).

Problem 5: B-20 basis, worth 50; At the date ofGIFT, it was worth 15K. R then sells it for

$10K. B/c DofG Donors Basis (even if sell for less)Recipient takes Ds B.FMV @ DofG < Donors Basis; Three options:

1. Dispose of property at a gainUse Donors basis

2. Dispose of property at a lossTake DofG as basis.

3. B/t FMV and BasisNO GAIN/LOSS, period.

Problem 6: B-20K Basis in lot, Worth 50K. Transfers to son for $25K. This is a bargain sale.

Essentially, is a sale, is a gift. Bs tax trmt? SHE can use all of her basis. (25-20).BUT, if she had made the gift to a charity instead of her son, Must divide the two.

EXAR-25, Basis on the of that was sold ($10K). Also, Gift has 10K basis.RULES: Not to charity, giftor gets the full basis;

To charity, split up basis b/t sale and gift.

Rs Tax Trmt: No GI on receipt. His basis. Prop.pd 25K.OR: Pd 25 for half, received 25 as gift. Therefore, 25K basis.

**NOTE, this is fair, b/c here if he pd FMV for whole lot, the property would beunder-taxed. Take the full donors basis, property would be over-taxed.

Problem 8: Receive prop as bequest, basis is date of death OR alt (6 mos after).

*Practicalmake sure loss prop is sold b/f death; keep gain prop until death.

Problem 9:

A. Abuse of the Bequest RuleWhen someone gifts property to a dying person so it will bebequested back. This provides a tax amnesty. Virtually risk free step up in basis.

1. The Solution : 1014(e): Person who receives prop as a gift must hold the prop forat least 1 YEAR for the giftor to receive the step up basis from a bequest.

i. Only applies if the giftor is the recipient of the bequest. I.e. - If bequestedto someone else, even w/in 1 yr of receiving, recipient gets step up basis.

102: Definition of Gift: Different than gift in property . . . this is a statutory gift.1. Must be given in detached and disinterested Generosity. (Duberstein)2. Intent of the parties in a transfer is the dominant factor in determining whether a transfer

is a gift or income. Wolder(attorney received stocks in bequeath, held to be income b/cpurpose was to compensate); Goodwin (annual gifts to pastor considered taxable income)

a. Sizeable, comes at set intervals, given by someone who has been benefited, etc.

3. 102(c)There can be no gifts b/t E/er and E/ee.

8


9/22

4. No double DippingIf one party deducts the gift, the other cant claim as a gift (thisonly points to amounts over $25).

Problem 1: C works for L (owner of firm-has two associates). C receives a Christmas gift from L

and both associates. Gift? NO E/er-E/ee. For associatesLook at intent of donor, did she work?

Problem 2: C was personal rep for Gpa. By law, she could receive up to $10K for this. She wasbequested 10K. Effect?

*RuleIf intent is to compensate for work in bequest to avoid taxes, it is taxable.*Look at how much other Gkids received. If all 25K, likely bequest. Look at how much

work she did. Could always argue that 10K should definitely be the lowest amt of possible tax.

Problem 3: Mom/son, also E/er/E/ee. She gives him prop worth 50k (her basis was 20K). This isa dual relationship, so you must look at which hat she was wearing . . . mom or E/er.

Chapter 10: Personal Injury Suits and Sickness:

1. 104Excludes any damages received on account of personal physical injury.*Borderline stupid b/c liability is based on physical bruising.*BUT, physical manifestation of emotional damages isnt Physical injury.

2. Split in the Circuits : $1 Million award, Contingent fee of 40%. Should this 40% first betaxed to the C, he then receive a deduction; OR should 40% go directly to Atty.

a. Davis : Best way is to have the 40% go directly to the Atty. (Tax liab$193K)b. Other Cirs : C must report the entire 1M. The Atty. gets to deduct the 40%.

EXAMPLE: 1M verdict for malicious prosecution. LOOK AT P 26 IN NOTES

- Old 104didnt look at Physical, just tort like. $0 Tax liability- New 104 (2 options)

1) 5th Cir : Contingent fee attys. have an interest in the litigation/lien. Therefore, 600 goes to Cand is taxed. TL of 193K. Looks at state law. The 400K contingent fee goes to Atty.2) Others: Report 1M and take a $400K deduction. (treats contingent fee as a regular fee).

3 problems1) 67 applies, 2) 68 applies, 3) Alternative Minimum Tax applies.

*67/68These are hidden ways to get more $ instead of raising tax rates.

*Alternative Min TaxOriginally was a way to combat people taking too many govt.offered subsidies. Over the yrs, it hasnt been adjusted enough for inflation and reaches thingsother than subsidies. Takes away deductions. Therefore, it is a problem. Taxes too many.

**The 400 deduction is a 212 ded subject to 67/68.**62: The 212 deduction is a below the line deduction. (not in 62).

* 67: Miscellaneous itemized deductions (as this one is) reduce AGI by 2%. (20k).

* 68: If AGI > applicable amt, Deduction is reduced by (AGI - applicable amt)*3%(25,719) . . .

67/68 creates $354,281 total deduction. TL of $206,909.20.*55: Unfortunately, Alt min tax also applies.

(Reg. Taxable Income + Adjustments (56, 57, 58))- Exemptions _______

Tentative Minimum Tax

56 adj: No Misc. itemized Ded (67(b))Reg TI + adj = $1M

9


10/22

55(d): Exemption AmtNone b/c phased out.

55(b): Tentative Tax Rate: 28%. Tentative Min Tax$276,500

Tentative Min Tax **Must separate b/c it will matter for some.- Reg. Tax Liability **Only pay alternative Min. Tax if (Alt Min) > Reg TL.

Alt. Tax Min. Liability.

Effective Tax Rate: (Tax liability/taxable income)*Atty. lien state: 190/600 = 31.8%*Other Cir: 276/600 = 46.1%. (if w/out Reg. Tax Liability = 34.5%).

There is a trend w/ 56/57/58: Adjusts away from Tper for depn, medical exp, interest, stk,housing, etc. . . . our suit doesnt fit.

MORE 104: 104 was a deliberate policy decision w/ unintended results. B/c of the split b/t thecircuits on how to handle the Atty. fees, it resulted in inefficiency.

Inefficiency was created b/c of similar situated taxpayers being treated differently dependingon which Circuit they were from. This caused forum shopping, which in turn caused transactioncosts of litigation to increase. If the playing field was level, these inefficiencies would go away.Also, the people who messed up on their taxes have to pay an underpmt penalty.

Veneble Case: Suit won in 1996 for malicious prosecution. B/c of appeals, Veneble didntreceive $ until 1998.

*Tried to get under old 104 by saying it was a retroactive law (reliance on old law-wouldveput in jury instruction that the jmt would be taxed if knew law would change).

*Also, stipulated to facts, but never had any stipulations about what they would have donedifferently or how he relied. Kept saying, we would have alleged physical injury. Judge kept

saying, is that in the tax ct record? Typically, changes arent retroactive.*Finally, N.A. Oil seems to apply. It said that you paid taxes in the year where you had aclaim of right to use the funds with unfettered discretion. Therefore, pay when you get $,

1998and clearly the new 104 should apply.

Problem 2: Tom hurt by drunk driver. P/S-500K, Med Ex-100 (he pd 10K, took a 6K deduction;Insurance paid the rest), Future Med Exp-50K, Lost income-80K, Pun-150K, Property Dam-20K.

1) Truck trmt :

a. If TotaledTreat it just as if it was a disposition of property. Amt realized-$20K;Basis-15 (5 gain); basis-25K (5K deduction if business).

b. Not TotaledNo G.I., but treat it as an adjustment to your basis. Reduces basis by20K. If his basis was 15K, record it as a 5K gain.

2) Punitive : Taxable3) Once w/in 104, all other damages that flow from the physical injury are excluded,

UNLESS he deducted it pursuant to 213. (i.e.-he cant exclude the 6K of med exp heclaimed as a deduction-he gets $94 of med exp). Lost wages wont be taxable here.

*Note, if he was just scared (not hit), ONLY the medical expenses are excludable.

10


11/22

(b): Assume he settled for $400K at once and then $100K per yr for 5 yrs. ALSO, he wants itall allocated to P/S.

*P want it b/c punitive is taxable. *D wants it b/c if punitive awarded, ins wont cover it.*Govt. wont allow the settlement to stand for tax purposes.

(c): What are tax consequences for $100K loss of consortium?

*Leg history, excludable if physical injury in original claim.

Problem 3: Sexual harassment, fired. Emotional distress.*Physical manifestation of emotional distress WONT get you into 104.*Medical expenses can be excluded.

Problem 1: If not a physical personal physical injury (i.e.-K, bus cl). Larry Loaned Bert 100K, Bbreached the K. Also lost 75K in lost wages. Larry Got jmt for $175, took property for it (Bertsbasis was $125).

*K or business case, you look at what each element of damages replaces to determine if youpay taxes. I.e.-lost wages-taxable. Getting $ you loaned back-nontaxable (return of capital).

*Larrys Basis: $175-same place*Bert: Giving the property to satisfy a debt; it is a disposition of property. 1001-amt realized(175) - basis (125) is a gain of 50K.

Problem 4: Skiing accident, blind. She had $30K medical expenses.- Her policy: 15K med exp; $10K lost wages; 25K loss of sight.- E/er policy: $20K med exp; $12K lost wages; $20K loss of sight.

*Include the 12K in lost wages.Med. Exp-20/35*35=17,143. 20K-17,143=2,857 is includable.

1. Insurance Policies:

a. 104- Persons own policy

She cant deduct the costs of it. All pmt to the taxpayeris excludable

b. 105- E/er policyE/er can deduct the cost of the policy.

c. 106- Self Insurance by E/erPmts to E/ee are excludable. Cant discriminate.2. Treatment of pmt made to hospital:

a. E/ees- excluded (any amt)b. E/ers- excluded up to the actual costs of the medical expenses.c. Both pay- break up b/t % paid by each policy. Must include in GI the amt paid by the

E/er minus the % of total medical expenses paid.3. Lost Wages:

a. E/ees- EVEN though it replaces lost wages, it is still excludable.

b. E/ers- NOT excludable. (med exp and permanent disabilities are excludable).

Chapter 7: Scholarships and Prizes:

74: Generally, GI includes prizes and awards.(b): Exception: Prizes/awards in recognition of religious, charitable, scientific, educational,

artistic, literary, or civic achievement AND you give the prize away to charity.*NOTE, If not in recognition to religious, prize gets taxed. BUT, can take charitable ded.

11


12/22

(c): Exception for E/ee achievement awards: Wont be taxed except for amt above which theE/er can deduct.

*If there is a formal plan (i.e.-every 20 yrs, watch) Amt of award can be up to $1600.*W/out a formal plan, Amt of award can only be $400. (highest amt they can deduct).

Defn 274Tangible personal property which is

i. transferred from E/er to E/ee for lengthy service or safety.ii. Part of a meaningful presentation.iii. Not disguised compensation.

117: Scholarships: Qualified educational costs are not included in GI UP TO the amt ofqualified expenses incurred. (dont have to trace amt). 10K scholarship, 8K QE, 2K taxed.

*QualifiedBooks, tuition, etc. *Not qualifiedRoom and board.

Problem 1: Joan won a computer through a competition. He teacher also got one. Computersusually sell for 2000 (1600 when on sale). The corp. paid 900. Kid kept it; T sold it for 1200.

*Tax Consequences: Receipt is taxable. Basis for T is ann issue for finder of fact.

Problem 2: Teacher received a computer worth 1200 for 25 yrs of teaching.*Tax Consequences: Not a gift b/c it is given b/c of past services. Look at factors/$ limits.

Problem 3: Tuition is 15K for nonresident; 5K for resident. Nancy is an out of state student whogot her out of state tuition waived for doing certain work. The work was 200 hrs; she gets 3credits; all students are required to do the course; and they usually get $10/hr.

*Tax Consequences: If no services-it wouldve been a qualified education exp and tax free.BUT, universities cant use scholarships as a hidden way to compensate E/ees. Tper will arguethat she should only be taxed on 2000 and that the other was a scholarship. Probably the way itshould be since she did get credit.

Problem 4: Athletic ScholarshipsTreated as a typical scholarship for QE. Room and board amtwill be taxable though.

Problem 5: Law firm gives 5K tuition scholarships. Simultaneously offers her a job.*Tax Consequences: If she ONLY gets scholarship for going to work there, taxable. BUT, if

she could get the scholarships and work anywhere, Excluded up to the amt qualified.

Chapter 8: Life Insurance and Annuities:

1) Term Insurance : Pure insurance. You build up no value.

a. During K -no tax trmt. Cant deduct premiums.b. Death -Excluded. (also can get it early if terminally ill and allowed by K).c. Cancel -ONLY get back unearned premiums.

2) Whole LI : You always pay a level price.a. During K -Interest earned on the savings component isnt taxed in the period

earned. Earnings get to build tax free.b. Paid by Reason of Death -Excluded

12


13/22

c. Cancel -You pay taxes on amt of Cash Surrender Value > the TOTAL amt of ALLpremiums paid. This is a step up in basis (typical investment would have the beenthe amt put in the investment.)-Bankers dont like this.

Components of a Whole Policy

d. Savings component : In the beginning, you pay more for the whole policy than you

would pay for the term. This difference is the Savings Component.e. Cash Surrender Value : If you cancel the policy, you get this amt back. It consistsof the savings component and the interest earned by the savings component.

3) Not Really Insurance : There is a certain % where the savings is too high for it to still beconsidered life insurance.

a. In analyzing : you separate out the two different components. Treat insurance likeinsurance. Treat the investment like an investment.

b. Investment : You have to pay taxes each yr on interest. No deferring.

*Deduction: When you purchase policy and pay premiums, it isnt deductible for either.

1. What if you die? : 101: Life insurance proceeds paid by reason of the death of the insuredare excluded from gross income. 101(a)(1). Same effect as a bequest.2. What if you cancel policy?:

a. Term : Get unused portion of premiumNO GI (just repayment of unused $).b. Whole : Get Cash Surrender Value. Note, not paid by reason of death, so taxable.

Whole has better tax consequences than a typical investment. The amt of the cashsurrender value minus the TOTAL premium paid is a taxable gain.

i. NOTE, this may sound good BUT, you have to pay for the insurance also.This would make your costs go up.

Problem 1: P buys home, Term LI-$85K. Mortgage-$100K, After $5K in insurance, P died.

*No GI under 101. Even if it directly went to bank, no GI.(b): What if seller financed and the insurance policy goes directly to the seller?*Still no GI to hubby. BUT, for the seller two different possibilities:

1): Viewed as a transaction up front and THEN financed by seller-NO GI. (paying loan).2): Viewed as sold when all pmts due, then complete at the end-TAXABLE.

Problem 2: 30 Yr old Rick has a whole policy for $40K. Pays 1200/yr; totaling 18K. At the timeof death, 14K Cash Surrender Value. Term would have cost $6K.

*Tax Consequences for wife: Face Value of Insurance policy is excludable.(b): What if cancelled?*Only need Amt of CSV and Premiums paid. 14-18=4 loss (no gain/taxes). This is really like

being able to deduct your premium.

Problem 3: Same policy, but didnt pay after death until 18 Mos. and then pd $47,500.*These extra earnings are taxed. Other isnt. GI=$7,500.

Problem 4: Closely held/small businesses often insure key personnel. Cant go out and buypolicy on just anybody. Must have an insurable interest. But, the small business can also sellthe policy after they no longer need it.

13


14/22

*This is a transfer for value. Dont get a 101 exclusion here. But, the amt paid for thepolicy is the basis.

*Exception: If you sell the policy to insured, partnership, corporation, it is excludable(trend is to allow exception to people who already had an insurable interest. BUT, it must beexclusively listed in 101.) NOTE, if a child bought a pre-existing policy, TAXABLE.

*If you have insurable interest and take out policy-101 exclusion applies.

Annuities: K where person pays a certain amount of $ for which that person will receive adefined amount of $ over time. (Especially for retirement).

1) Two Periodsa. Time when the person is paying;

i. While you are waiting to receive pmt, the $ builds tax free.b. Time when person is receiving pmt.

2) When you receive $

a. 72 -GI on $ received EXCEPT as provided.b. (b) : Exclusion Ratio- (Investment / expected return)*payment (yearly).i. This ratio shows the amt of your investment you recoup every pmt you

receive. (you exclude your investment from gain).ii. 453 is similar except it is an inclusion ratio.

1. It applies when you seller finance property and receive pmts.

3) What if you cancel annuity? 72(q)a. 10% prepayment penalty to disgorge you of the tax deferred benefit.b. You can avoid the penalty by falling in the:

i. Sympathy provisionii. Older than 59

Problem 1: George pays 5K at age 55. Ins. Co pays him $1K/yr for 10 yrs.*(5K / 10K) * 1K = $500. Exclude $500 from each pmt. *Pd 6K, exclude $600.

Problem 2: G pays 10K. Gets 1K for the rest of his life. Must look at his life expectancy.*1.72-9 (p.911)-look for the multiple. (Multiple * yearly payment) = expected return.*Here, multiple for 55 yr old is 28.6. (28.6 * 1K) = 28,600.

- (10,000 / 28,600) * 1,000 = $350 excluded per pmt.(a): What if you die later than 28.6 yrs?

* 72(v)(2): All pmts after you recoup your investment are FULLY taxable.(b): What if you die early?

*Decedent gets a deduction on his final tax return of his unused investment.

Problem 6: Survivor annuity for 60 yr old man and 53 yr old wife. 44.6% excluded. Same math.

Chapter 9: Discharge of Indebtedness: The general rule is that the discharge of debt is GI.BUT, there are exemptions. 108-usually only when insolvent . . . certain other exclusions whenthere is a work out when property value decreases.

14


15/22

Traditional View: If someone pays off your debt, you are receiving a benefitTaxable.i.e.- If a Corp. issued bonds and then bought them back at a lower amt, taxable.

Accounting Fix: Only tax discharge of debt if it was money you had expected to have to repay.

i.e.- If you gave a gift to your brother legally, but b/f you actual gave it to him, you hit hardtimes and he said, Dont worry about it.

Contingent Debt: It is only considered your liability if it is More likely than not that you willhave to pay.

*By E/er: Relief of debt by an E/er can likely be considered compensation and therefore GI.*Gift: If the debt relief can properly be considered a GIFT under 102/Duberstien, it will notgenerate GI. (i.e.-borrow $ from mom, she says, dont pay it back, sugar.)

1. Two Questions :

a. Do we have Debt Relief?i. Contested DebtThere is no debt relief b/c the amt of debt was never certain.

ii. Disputed Price DoctrineFMV was disputed b/c there were defects in theproperty not discovered until after the sale. The new price relates back tothe date of purchase. The seller lowers your debt to conform to this new lowerprice. (No debt relief).

1. Must reduce your basis.iii. 108(e)(4): Acquisition of debt by relative : If a qualifying family member pays

off your debt, it is treated as if debtor paid it off.1. I.e.-someone allows family member to pay off a debt at a discount,

unless you have an exclusion, relief of the debt is GI.

2. BUT, by the family member to you will likely be a gift. (assumed).b. Is there an Exclusion Exemption?

i. Insolvency Exemption108(a): GI doesnt include any amt which would beincludible in GI by reason of discharge of indebtedness if it occurs b/c of Title11 bankruptcy or Insolvency. (NOTE, this isnt a permanent exclusion-deferral). ONLY applies to discharge. Give/Sell prop to pay debt-GI.

1. Insolvency = Liabilities > Assets2. You can only exclude to the amt liabilities > assets.

a. Price of using 108(a)108(b): The amt excluded from GIshall be applied to reduce your tax attributes. LISTED.

i. Result : At some later point, you must reduce a tax

attribute by the amt you excluded under 108(a).ii. Basis : You always have the option of reducing your

basis in property. Defers paying the tax. BEST.

ii. Pmt would have generated Deduction108(e)(2): No GI if pmt of thedischarged debt would have given rise to a deduction. (Implicit inclusion anddeduction).

iii. Purchase Price Adjustment108(e)(5): Regardless of how the valuechanged, this could potentially apply. Treated as a reduction of purchase price.

15


16/22

1. Must reduce your basis (other tax attribute).2. Must be the same buyer and seller. If Buyer got a loan, or seller sold

the note, the exclusion wouldnt have applied.iv. Purchase Price Adjustment when debt was acquired for a business purpose

108(a)(1)(D): If debt on property was relieved by the person holding the

note, it may be excluded. Must be a debt on real property acquired by anindividual in connection w/ a business or trade.1. This is used when the PPA wouldnt apply b/c the same B/S arent still

in the deal.2. Again, you must reduce a tax attribute after you use this.3. This promotes work outs.

Problem 2: Kevin got 10K bill for landscaping. Landscaper did a horrible job and Kevin refusedto pay. He then got a default jmt for 10K. Kevin threatened to appeal. Landscaper reduced $5K.

Disputed Debt:

*When there is a disputed or contested debtno GI. Reason-Debt wasnt certain, so couldnt

be relieved.

(b): Kevin borrowed 20K, L agreed to accept 10K for the remaining 19K on the loan.*Expected to have to repay 20K, only pd 11K. GI of 9K. NO EXEMPTION.

Pmt wouldve generated a Deduction:(d):Owed 10K for 10K worth of services. Reduced to 4K.

*If pmt of debt would have generated a deduction, no GI.

(e): Kevin contracted w/ Ashley for building. $150K note, FMV at that time was $150K. Later,Kevin has paid the debt down to $130K, but the FMV is worth $115K.

(i): FMV lower b/c there is a hazard on the property. Seller knew. Lowers debt to FMV.*There is no discharge GI b/c the purchase price was disputed.*BUT, Kevins basis will decrease by the amt of the discharge ($135K).

(ii): Now assume the value decreased b/c of the economy. Reduced FMV to 115K. Buyer andSeller enter into a workout agreement.

*There is GI b/c there is no disputed debt/price.*BUT, same buyer and seller. Can reduce debt w/out there being GI, BUT reduce basis.

Purchase Price Adjustment NOT b/t the same Buyer and Seller

Problem 2(e)-changed: K borrowed $150K from bank to buy property from Ashley.*Kevin gives bank a note for $150K. Bank gives K $. K gives $ to Ashley for property.(a): When K has 130 left on note. Property is now valued at $115K.

- Recourse Debt : Bank can claim other assets of the lender until the note is satisfied.o If K is solvent; 1st-bank takes property (cheapest for bank), Then-bank will go

after $15K of Kevins assets. Kevin bears risk if property loses value.

Bank wont relieve that $15K of debt if Kevin is solvento If K is insolvent; likely will take the property, forgive the rest. (108(a) exc).

16


17/22

- Non-recourse Debt : Debt where lender can only take the security for the debt.o Here, the bank bears the risk if the property loses value. If property loses

value, Kevin may go ahead and deed it to the bank. No choice but to relieve.

Whole debt is satisfied when bank gets the property. B gets ded.o Kevin has had a disposition of property, but no debt relief income b/c the

contract said the property would satisfy the entire debt. Nothing to relieve. Amt realized of $130, basis $150. NO RELIEF OF DEBT.

(b): NOW assume that bank doesnt want property back. Dont want to have to resell it.*Bank says, Well drop loan to FMV of the property. K wont have to buy other land.- Tax perspective : K has $15K debt relief. Debt workout. Not purchase price

adjustment exclusion b/c not same buyer/seller.o Exclusion: 108(a)(1)(D) : For individual, indebtedness discharged is qualified

real property business indebtedness. 108(c)(3)Debt incurred in connectionw/ real property used in a trade/business.

Limit : Only can exclude amt up to what will bring you down to FMV.

AgainMust reduce a tax attribute (like PPA). If reduced to 110K, the extra 5K would be relieved income.

Acquisition by FamilyProblem 2(c): K borrowed 20K. pd 1K, lender relieved 9K. Not insolvent, so that is 9K of GI.

(a) Now, assume K cant pay the 10K so his parents come in and give K the $. K pays off.a. This is clearly a gift. No facts to contrary. NO GI from receipt of 10K.

(b) What if parents dont give it to K, but they go straight to lender and pay debt.a. Doesnt change the outcome. 108(e)(4): Acquisition of debt by relative. Says that

K will still have debt relief of 9K. TREAT just as if $ given to Kevin.b. W/out 108(e)(4) the parents have bought a right to receive 19K for 10K. THIS

ISNT IMPORTANT REALLY . . . JUST FYI.i. No debt relief b/c no debt has been relieved. K just owes it to parents. OK

to then gift it. That would keep the 9k from being taxedNOT DONE.

**Assumed that if relative buys it, the debt will be forgiven by the relatives. IF not9K ded.

InsolvencyProblem 3: Bill borrows $75K from Judy. Bill gave Judy land worth 60K (he paid $20K for it).Bill also had $50K of other personal debt. Bill was also the guarantor of his sons loan for $25K,but there is only a 50/50 chance that Bill will have to pay it. Bill had an additional $50K inassets.

*NOTE, if he paid $60K in cash, the debt relief analysis will be the same.*Assets: 55K + 60K (land) = $115K; Liabilities: $75K + 50K = $125.

**Amt of Insolvency: $125 - $115 = $10K. (liabilities-assets).*You received $15K in discharge ($75K-$60K), BUT you can only claim an exclusion on

the $10K (amt where liabilities > assets).****If you sell the $55K, it will reduce your basis to $45K.

*Also NOTE, you had a disposition of property. You must pay taxes on that. Even if you areinsolvent, you must still pay taxes on disposition of property. 108 only applies to discharge ofindebtedness.

17


18/22

**Lender still has some issues: She had a contractual right to be paid. It cost her $75K. Thatis her basis, BUT she got back $60. Essentially, it is a $15K loss. She should get a deduction.

- Bad Debt Deduction : If lender doesnt get your basis backGet deduction.Also, she has new property. Whats the basis? $60K. FMV of property received.

Problem 4: Lloyd is an actor. Insolvent. Received 10K for services. Still insolvent.- He still has to pay taxes on the 10K.

*Does it matter if he owes the debt to the producer and producer relieves debt?- No. Same as if getting paid. Paid by relieving debt. GI.

Gift and E/er relievedProblem 1: D borrowed 5K to help daughter. He gives $ to her, but he cant repay it. Had toresign his job b/c of health. He isnt technically insolvent. Cant pay debt. $2K relieved.

*Since he isnt insolvent, no 108(a) exclusion.(a) What D if borrowed $ from his E/er? The relief of debt would probably be considered

compensation b/c E/ee. ARGUE BOTH WAYS.

(b) What if borrowed from brother? Looks kind of like a GIFT (102). NOT excluded under108, but it may be excluded under 102.

Deductions: What do we take out of the basket?*There is no general deduction statute. Must find a specific statute to give you a deduction.

Person has 3 hats:

Trade or business : Atty., Dr. Being an E/ee is a trade or business. (A spouse who stays athome but brings in no money have no trade or business.) almost always deductible.

o 162 : Deduction used to generate income from your trade or business.

Production of Income : Doesnt rise to the level of a trade or business, but it is still designed

to generate income. (i.e.-investing). Almost always deductible (more limits).o Higgins : Man spent a lot of time and effort investing $. S Ct: Investing on your own

behalf doesnt rise to the level of a trade or business. NOTE, he was taxed onearnings and dividends. This is why we have 212.

o 212 : Expenses of producing income are deductible.

Personal : $ spent in leisure, family life, etc . . . generally not deductible. Many limitsEXCEPTIONSo Interest on home loan/some home equities.

o Property taxes on principal residence.

o Med Exp if they exceed > 75% above your AGI.

o Charitable Deductions

o Casualty Losses (in the event of a calamity, some things may become deductible)

I.e.-house is destroyed by storm, fire, etc . . . may can keep deduction.

Loss of property wont be a casualty loss. (dog runs off); But if dog was stolen

or hit by a carcan get a deduction.

Distinguishing 212 v. 162:

18


19/22

Groetzinger: Betting on dog races. Spent a ton of time. It wasnt a trade/business. Tper spends

substantially full time, intends to create moneytrade or business

61

- 62 (above line deductions)Trade/business (except reimbursed E/ee expenses).

AGI- 63 (below the line)Most production of income deductions are here.

TI*Above the line deductions are subject to less limitations.*Below the line subject to 67/68.

162: Trade or Business Deductions:There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred

during the taxable year in carrying on any trade or business.

Expressly allowed: Reasonable allowance for salaries. Traveling expenses. Rent for trade/bus.Limits: Illegal pmts to officials.

Illegal Income is still income. (James). Are you entitled to any deductions? YES.

Deductions on Illegal Income : In absence of a specific disallowance, you can deduct it.

Gambling business: Need bookies, knee breakers, paper, bribes. Rent for gambling.o Can deduct salaries, computers, rent, flash paper, etc.

o Cant deduct: 1) bribes to govt. 2) E/ee. If it is a pmt illegal under state law, non-

deductible (Generally, illegal to pay someone to assault someone).

If illegal undertaking is the sale of drugs, you can take no deduction in the sale of drugs.

162 Specifics: This is our Work Horse Most generic deduction. Broadest.To get into the statute:

Ordinary and Necessaryo Necessary : Must be appropriate and helpful in you business.

This is a deferential standard. They wont second-guess your decisions.o Ordinary : Normal in the life of this type of business.

Some : Must not be a capital expenditure (used up in the same yr).

Others : Doesnt have to happen to every business or often, but it must besomething that ordinarily happens (i.e.-retail store-slip and fall suit).

Must be really unusual not to be ordinary. (i.e.-hire a minister to preach toyour bank tellers). OR, while traveling, an artist has nervous breakdown

and hurts someonenot ordinary.

Traveling salesman having wrecksordinary.

Expenses

Paid or incurred in the taxable yr (this is a Q of timing)o Cash Method : Report in the yr you actually receive the money, not the yr incurred

Same for deductions. Take deduction when you pay the expense.o Accrual : Report in the yr you incurred/obligation to pay the $.

Used in carrying on (looking for another job may be carrying on)

19


20/22

o Travel exp : Look to see what the PRIMARY PURPOSE of the trip was. If the

purpose was ToB, you can deduct if Domestic trip. (Foreign, divide up).

o RetailWhen the doors open for a start up.

o ServiceWhenever you are available for services for a start up.

A trade or businesso We accept the fact that to be engaged in a trade or business, the taxpayer must be

involved in the activity w/ continuity and regularity and the taxpayers primarypurpose for engaging in the activity must be for income or profit. Groetzinger

o Must be something you engage in Full time.

o Higgins: Personal Investing is not a Trade or Business.

Meals: only up to 50%

Travel: Only if primary purpose was ToB.

Clothes: Obj StdAre they fit for normal wear? (i.e.-military uniform).o To deduct: 1) not suitable for normal wear & 2) not worn off duty.

Starting a Business: 2 types of Expenses:1) Personal Investigatory : Looking for the type of business you want.

a. Generally, cant deduct. Treated as a personal expense. Wouldnt have beendeductible if it was a pre-existing business.

2) Start up costs : Buying building/equip, staff (ads, training, interviews, salary).a. 195: Staff/ads/etc : If the exp wouldve been deductible if you were a pre-existing

business, you can take a 195 deduction. Must amortize over 5 yr period.b. Equip/Building : Would not have generated a deduction in yr incurred if existing.

i. 167-68 : Treated as a capital expenditure. Depn.ii. The transaction costs of acquiring the capital would be added into basis.

Problem 1: Karen owns 5 pharmacies. Daughter, Laurie is a pharmacist. She gets $150K (75salary, 75K bonus). All other pharmacists get a 2500 bonus. Can business deduct?

1. 162: allows deductions for reasonable salaries.a. Reasonable : Look at why the daughter gets more $. If it is b/f she does more,

maybe OK. B/c of being daughter, it is really a gift. If GIFTCant deduct.Can 2500.

b. Tax effect on Daughter : If given in detached and disinterested generosity, gift.May have a problem since business tried to deduct.

2. Karens office is in a big plush building. 100K per yr. Son in law owns.a. Look at FMV of this one compared to other to determine if it is a gift to son. Itis OK that it is plush as long as not overly extravagant.

3. 50K salary for son whos janitor. When there, bad work.a. Unreasonable. Cant deduct over reasonable. What would you pay other.

Problem 2: Sally is a law clerk. Hubby student. Both go to NY looking for job. Also site seeing.Each Incurred: $500 travel; $600 hotel; $100 for writing sample. She got a job.

20


21/22

*Hubby: Since hes not currently in a ToB, cant deduct (summer job wont count).NOTE, if firm paid all his expenses, it isnt GI to him (it was for the firms benefit).

*Wife: Being an E/ee is her ToB. (Govt would argue different b/c Govt v. private.).*Travel-deduct b/c looking for another job was carrying on - primary purpose.*Hotel-the days where she was doing job stuff can be deducted.

*Meals-Only if overnight trip. Only up to 50%.*If the firm pays, it is an exclusion to GI (never report). Firm can deduct (only 50% for meal)

Problem 3: Newcaster has to buy clothes. Wouldnt buy otherwise.

*Doesnt matter. Fit for normal wearcant deduct.

Problem 4: Quit job, buy franchise for 100K, advertise for building to buy (1K), pay 5K for rent,training 3K, salary 2K.

*Franchise isnt a start up cost. Must amortize over life of franchise.*Rent, training, salary will be w/ in 195. Deduct over 5 yrs from start of ToB.

Problem 5: Vic has bond portfolio worth 300K. bought book on how to buy tax free bonds for25, tax return cost 400, tax L cost 200, WSJ costs 250. Safety deposit box 200.Higgins: Personal Investing is not a Trade or Business.212: $ spent in producing income

*$ spent on getting tax advice is always deductible (even for personal).*265: $ spent on producing tax free income cant be deducted (book on munis).*For all your other expenses, you must pro rate your expenses b/t regular bonds and tax

free bonds. But, all of these expenses would be deductible after this pro rata math is done.

Entertainment and Meals: You can ONLY RECOUP 50%. Travel meals are difft form E.

Reqt to deduct.I. Moss: Must be a meal sufficiently related to ToB.II. 274: You can deduct E/M if either:

1) Directly related to T or B (cant be yachting, fishing, hunting trip). 1.274-2(c)a. Expect to derive income from E/M (more than good will).b. During E/M, engage in business discussion.c. Principle character T or B (dont have to spend majority of time on it).

2) Directly before or after meal, have a bona fide business discussion. 1.274-2(d)(2)a. Must have a Clear business purpose, not deriving income (broader). Ok

to be maintaining old C or trying to get new C.b. Directly before-satisfied if the next day if had to sleep b/c of C.

III. You can only deduct 50%. 274(k).IV. You must substantiate the amt.

Losses: 165: Produced in either ToB or Producing Income.

General Rule: Extent to which your basis is not used, you may deduct it as a loss. You maydeduct the loss against all of your income. YOU GET TO USE ALL OF YOUR BASIS ONTOB OR PROPERTY TO PRODUCE INCOME.

21


22/22

*i.e.-Buy stock for 100, sell for 70 . . . deduct 30 from GI.

Personal expenditure (i.e.-house), that you lose $ on, you can only deduct if casualty.

Capital Expenditures: For qualifying expenses where the benefit extends past the yr, you cant

deduct the entire amt in one yr. You must depreciate it out. Land/stk-never depreciates.

263: Must capitalize the costs of acquisition of property that will not be used up in one yr.

167/68: Depreciation: Depreciable property is that which will undergo wear and tear(equipment), become obsolete (computer programs), or time renders useless (copyright).

1016: As you record depreciation, you must adjust your basis downward to reflect it.

EX: Buy a Dozer (100K), assume it has a 10 yr life and will be depreciated at 10K/yr.*Make 70K with it. 10K for fuel. What is your income? 50K (70-depn-162 ded).

*Use dozer for 3 yrs, you depreciate it each yr. Also, you must reduce your basis each yr.- Assume you sell dozer for 50K after 3d yr.o You have a loss on the property of 20K. (amt realized - adj basis) 1001.

165 says you can deduct that loss in yr realized. (Under 172, it can carryover or backwards if you dont have enough GI to deduct it all).

- Sell it for 80, 10K gain.

Accelerated depreciation allows you to deduct more $ in earlier yrs. Supposedly helps economy.

Documents

Income Tax Davis