income tax reading notes

7/30/2019 Income Tax Reading Notes

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Income Tax Reading Notes 5/5/13 10:43 AM

Table of Contents

HISTORY, STRUCTURE, AND THE TAXING FORMULA ................................................................................................ 5DEVELOPMENT OF THE INCOME TAX .................................................................................................................................................... 5

Alternatives to Income Tax ........................................................................................................................................................... 5

Constitutionality Of The Income Tax ........................................................................................................................................ 5STRUCTURE OF TAX LAW......................................................................................................................................................................... 6Metrics To Evaluate Tax Policy: (Goals of Equity and Efficiency) .............................................................................. 6Progressive Rate Structure: .......................................................................................................................................................... 6Policy: Macroeconomic Growth And Income Taxation (P. 17) .................................................................................... 6

ILLEGALITY AND ETHICAL CONSIDERATIONS:

TAXING FORMULA...................................................................................................................................................................................... 7Gross Income = accessions to wealth on which an invididual is taxed................................................................. 74 Classes of permissible deductions: ......................................................................................................................................... 7

WHAT IS GROSS INCOME? .................................................................................................................................................... 9INTRODUCTION:61(A):ALL INCOME FROM WHATEVER SOURCE DERIVED. ............................................................................. 9

FORMS OF GROSS INCOME (P.39) .......................................................................................................................................................... 9Compensation for Services & Sale of Appreciated Property 61(a), 1001(ac) ................................................ 9Income without Receipt of Cash [61, 83(a)(1)] .............................................................................................................. 9Barter Transactions [61, 1001] .......................................................................................................................................... 10Unanticipated Gains (Windfalls) [61(a); R: 1.61-14] .................................................................................................. 10Prizes and Awards [74] ............................................................................................................................................................. 10

ROLE OF DEBT IN GROSS INCOME ........................................................................................................................................................ 11What is Debt? ................................................................................................................................................................................... 11Receipts Subject To Claims ........................................................................................................................................................ 11Discharge of Indebtedness [61(a)(12); R:1.61-12(a)] ................................................................................................ 12

LIMITATIONS ON GROSS INCOME.......................................................................................................................................................... 12Recovery of Capital [1001, 1012] ....................................................................................................................................... 12

Realization [1001; R: 1.61-6(a); 1.1001-1(a)] ............................................................................................................... 13Imputed Income, p.85 ................................................................................................................................................................... 13

Administrative Exceptions To Gross Income ..................................................................................................................... 14DISPOSITION OF PROPERTY ................................................................................................................................................................... 14

Gains on the Disposition of Property, p.91 .......................................................................................................................... 14Determining Adjusted Basis ...................................................................................................................................................... 14

Amount Realized from Debt Relief ......................................................................................................................................... 15Discharge Of Indebtedness Redux ........................................................................................................................................... 16

ITEMS EXCLUDED FROM GROSS INCOME (CH.3) ....................................................................................................... 19GIFTS AND BEQUESTS (102,1014(A),1015(A);1.102-1(F)(2)) ................................................................................... 19

Introduction ...................................................................................................................................................................................... 19

1015 Basis for Property Received as Gift ...................................................................................................................... 19Part Sale/Part Gift Transactions ........................................................................................................................................... 20

1014 Basis of property acquired by Inheritance or Devise ................................................................................... 20LIFE INSURANCE PROCEEDS 101 .................................................................................................................................................... 21EMPLOYEE BENEFITS .............................................................................................................................................................................. 21

Meals and Lodging ......................................................................................................................................................................... 21Costs for Employee Life and Health Insurance ................................................................................................................. 22Other Employee Fringe Benefits, p.152 ................................................................................................................................ 22

COMPENSATION FOR PERSONAL INJURIES AND SICKNESS ............................................................................................................... 24DISCHARGE OF INDEBTEDNESS.............................................................................................................................................................. 24

Bankruptcy Tax Act of 1980 ...................................................................................................................................................... 24


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Rev. Rul. 92-53 ................................................................................................................................................................................. 24OTHER MISCHELLANEOUS EXCLUSIONS .............................................................................................................................................. 24

Tax-Exempt Interest ..................................................................................................................................................................... 24Social Security .................................................................................................................................................................................. 24Sale of Principal Residence ........................................................................................................................................................ 24

CHOOSING THE PROPER TAXPAYER (CH4) ................................................................................................................. 25ASSIGNMENT OF INCOMESERVICES [61,73] ........................................................................................................................... 25

The Concept of Income Splitting ............................................................................................................................................. 25Shifting Income within the Family by Gratuitous Transfer ........................................................................................ 25Shifting Income within the Family by Compensatory Arrangement ...................................................................... 25Shifting Income to a Related Corporation .......................................................................................................................... 25

ASSIGNMENT OF INCOMEPROPERTY 102,1015(A) ................................................................................................................. 26Appreciated Property Transferred by Gift .......................................................................................................................... 26Transfers of Income from Property ....................................................................................................................................... 26Property and Income Transfers Compared ........................................................................................................................ 26Substance versus Form Analysis .............................................................................................................................................. 26Dividends on Stock ......................................................................................................................................................................... 27

Assignments of Income for Consideration .......................................................................................................................... 27Statutory Response: The Kiddie Tax 1(g) ..................................................................................................................... 28

DIVORCE AND ALIMONY.......................................................................................................................................................................... 28Alimony versus Property Settlements ................................................................................................................................... 28Statutory Requirements: 71(b) ............................................................................................................................................. 28Property Transfers between Spouses 1041 .................................................................................................................. 29

TIMING OF GROSS INCOME (CH.5) .................................................................................................................................. 31GENERAL PRINICPALS ............................................................................................................................................................................. 31

Intro: when should an item be included in gross income? .......................................................................................... 31Annual Accounting Period (Pillar #1) .................................................................................................................................. 31Tax Accounting Method (Pillar #2) ....................................................................................................................................... 31Relief Provisions .............................................................................................................................................................................. 31

CASH METHOD OF ACCOUNTING ........................................................................................................................................................... 31Cash Equivalency [RE-READ].................................................................................................................................................... 31

Actual versus Constructive Receipt ........................................................................................................................................ 3283 Property Received for Services Performed ............................................................................................................. 33Employee Stock Options .............................................................................................................................................................. 34

ACCRUAL METHOD OF ACCOUNTING ................................................................................................................................................... 34All Events Test .................................................................................................................................................................................. 34Fixed Rights to Receipt ................................................................................................................................................................ 34Timing of Inclusion of Various Forms of Income ............................................................................................................. 35

JUDICIAL EXCEPTIONS POSTPONING INCLUSION ................................................................................................................................ 35Security Deposits ............................................................................................................................................................................ 35Option to Purchase Real Property .......................................................................................................................................... 36

DEFERRED PAYMENT SALES OF PROPERTY ........................................................................................................................................ 36Closed Transaction Reporting .................................................................................................................................................. 36Open Transaction Reporting ..................................................................................................................................................... 36Installment Reporting .................................................................................................................................................................. 37

NONRECOGNITION OF GROSS INCOME.................................................................................................................................................. 381031Like-Kind Exchanges. ................................................................................................................................................. 38Involuntary Conversions ............................................................................................................................................................. 39


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DEDUCTIONS FOR TRADE OR BUSINESS EXPENSES (CH.6) ................................................................................... 41DEDUCTIONSIN GENERAL.................................................................................................................................................................. 41ADJUSTED GROSS INCOME -62 ........................................................................................................................................................... 41STATUTORY REQUIREMENTS FOR BUSINESS DEDUCTIONS [162(A);262(A)] ......................................................................... 41

Ordinary and Necessary.......................................................................................................................................................... 41Incurred in a Trade or Business........................................................................................................................................... 42Current Expense vs. Capital Expenditure ............................................................................................................................ 43

SPECIFIC CATEGORIES OF BUSINESS EXPENSES.................................................................................................................................. 44Business-related Travel (p.381) .............................................................................................................................................. 44Entertainment Expenses (3/21: p.404-413; 416-420) .................................................................................................. 47Business Meals ................................................................................................................................................................................. 49

DEPRECIATION AND COST RECOVERY (3/22: P.432-451) ............................................................................................................ 50The Concept of Depreciation ..................................................................................................................................................... 50The Accelerated Cost Recovery System ................................................................................................................................ 50Mixed-Use Assets280F........................................................................................................................................................... 53

Amortization of Intangible Assets .......................................................................................................................................... 53LIMITATIONS ON BUSINESS EXPENSES (4/2: P.451-58) ................................................................................................................ 54

Business Use of Personal ResidenceHome Offices....................................................................................................... 54Illegality and Public Policy......................................................................................................................................................... 54


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5

Introduction: History, Structure, and the Taxing FormulaI. Development Of The Income Tax

A. Alternatives to Income Tax1. Consumption Tax = rather than taxing income that is saved, defer taxation until such savings

are consumed; arguments for: incentives people to save; tax laws should not unduly burdensocially preferred behavior by influencing decision btwn consuming and saving

2. Value-Added Taxes (VAT) = tax on all the elements of gross national product (another formof consumption tax); Ex. Co pays a tax on value it added on to materials that passed throughits hands (e.g., dif btwn value of peanuts bought and peanut butter sold)

a. Cos that suffer a net loss over a tax period may still pay a tax3. Transaction Taxes = Retail sales tax (like a consumption tax but at point of sale); Excise tax

(tax on the privilege of the manufacture, sale or consuption of a good, e.g., alcohol and tabaccotax); Wealth transfer tax (e.g., gift and estate tax)

4. Wealth Tax = tax on the aggregate of an individuals wealth (e.g. property tax)B. Constitutionality Of The Income Tax

1. Congress shall have the power to lay and collect taxes (Art I, Sec.8)a. Limitation #1: Uniformity: taxes have to be uniform throughout the country (Art.I, 8)b. Limitation #2: Apportionment: direct taxes in proportion to the population(Art.I, 9)c. Pollock v. Farmers (1895): tax on rents from real estate was a direct tax on the real

estate itself and thus unconstil violation of apportionment cl2. Sixteenth Amendment (1913) = The Congress shall have power to lay and collect taxes on

incomes, from whatever source derived, without apportionment among the several States,and without regard to any census or enumeration.

a. Authorizes taxes on income without regard to apportionmentb. Upheld in Brushaber v. Uni on Pacifi c Rail road, 240 U.S. 1 (1916) (p. 3) which said

that income tax does not violate due process clause3. Challenges to constitionality of taxes usually fail (p.4)

a. Taft v. Bowers, (U.S. 1929): Ct rejected the taxpayers arg that Congress could not taxthe gain that accrued on a piece of property before it was given as a gift. In effect, the

Ct deferred to Congress as to the meaning of income for the purposes of the

16

th

, as long as Congress did not act unreasonably or arbitrarily.b. Autenr ieth v. Cul len, (9th Cir. 1969): Ps said that they were entitled to a refund of

their income taxes because they did not support the Vietnam War. Their argumentswere based on equal protection and freedom of religion. The Ct held that nothing inthe Constitution prohibits the Congress from levying a tax upon all persons for thesupport of the general govt and that the Code was religion-neutral. Ct also expressedconcern about the Govts ability to function if the taxpayers position was permitted.

c. Hellerman v. Commissioner, 77 T.C. 1361 (1981):court held that gain solely due toinflation income IS within meaning of the 16 th Am for two reasons: (1) Congress hasthe power to establish the dollar as a unit of legal value with respect to thedetermination of taxable income independent of its actual worth. [Legal Tender Cases];(2) the meaning of income is to be gathered from the implicit assumptions of its use in

common speech, i.e., as a layperson would interpret it and not as an economist would.Thus, given that the taxpayer had more dollars now, that could be treated as gain.

d. Perry v. Commissioner, (p.6): Taxpayers contended that Congress was taxing incomethat did not exist b/c Congress limited the deductions due to losses to $3K. Ct foundthat the taxpayers did have income and that net income (gains losses) is not the samething as taxable income because deductions are a matter of legislative grace.

e. Most courts consider tax laws to be an issue of property rightsrather than one offundamental personal rights or liberties


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Introduction 6

II. STRUCTURE OF TAX LAWA. Metrics To Evaluate Tax Policy:(Goals of Equity and Efficiency)

1. Equity: Basic idea is that tax allowances will not change taxpayer behavior, and if they do, itwill not change pre-tax income significantly.

a. Horizontal: Does the Code treat taxpayers with the equally income similarly?b. Vertical: Does the Code treat taxpayers with the different income differently?

2. Efficiency: Do tax allowances allocate resources efficiently? Tax-favored behavior willincrease with a corresponding decrease in tax-unfavored behaviors.

3. Simplicity: How costly is it for taxpayers to determine their liability and file their taxes?4. Administration: How easy is it for govt to induce compliance; how costly is it to enforce?

a. Administrative costs: direct costs incurred by govt to administer tax system ($10B)b. Compliance costs: taxpayers cost to interact w/ income tax syst ($100B to $200B)c. Efficiency costs: (TP may make inefficient choices to take advantage of tax-favored

behaviors): Economic theory suggests if you 2x tax rate, you 4x the excess burden.B. Progressive Rate Structure:

1. Premises of progressivity: 1) Ability to pay, 2) Marginal utility2. Definitions:

a. Progressive: Rate increases as the value of the tax base increases.b. Proportional: Tax rate is constant for all values of the tax base.c. Regressive: Tax rate decreases as the value of the tax base increases.

3. Rates:a. Marginal: Rate for the next range of income (i.e., marginal income)b. Effective: Tax liability/income

4. Utilitya. Marginal: The more money you have, the less valuable it isb. Linear: All money is equally valuable

5. Good statistics to potentially use on the final (p. 14)C. Policy: Macroeconomic Growth And Income Taxation (P. 17)

1. High marginal rates may discourage additional work and savings while encourage taxavoidance schemes that tie up capital in unproductive uses.

2. Tax cuts could help in the modernization of plant and equipments in heavy industry.3. Tax incentives could help for research and development.4. Tax cuts could boost savings.

D. Procedure: Primary Sources of Fed Tax Law1. Statute.

a. U.S. Constitution: Art I, 9, cl. 4; 16th Amendment (permitting taxation of income).b. Internal Revenue Code.c. Legislative history.d. Joint committee on taxation.

2. Treasurys statutory interpretation:a. Regulations.b. IRS rulings.c. Public (revenue) rulings. Offer general guidance and are precedential.d. Revenue procedures. IRS explaining required steps to practitioners.

3. Case authority (tax court and other courts).4. Tax treaties (international).

III. ILLEGALITY AND ETHICAL CONSIDERATIONS: U.S. v. Greenberg, 735 F.2d 29 (2d Cir. 1984) (p. 19): Taxpayerfiled jointly with his wife and reported his income as split between the two of them, so his wife could obtaincredit. The difference in taxes between the correct and false returns was only $48. He was convicted of filingmaterially false returns and failure to file a return. The court held that the issue is not the effect of a falsestatement, but rather does the false statement have an obstructive or inhibitive effect.


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Introduction 7

Comparison of Trial Forums for Tax Disputes

Question U.S. Tax Court U.S. District Court U.S. Court of Federal Claims

Pay tax first? No Yes Yes

Jury Trial? No Available No

IV. TAXING FORMULAGross income

- 62 deductionsAdjusted gross income (AGI)- Standard deduction oritemized deductions- Personal exemptions

Taxable income

* Tax rateTax liability (TI)

- Credits+ Additional taxes

Final liability

A. Gross Income = accessions to wealth on which an indiv is taxed; 4 Classes of permissible deductions:1) Those associated with the conduct of the taxpayers business/trade,2) Associated w/ an activity gearted to the production of income (but not business/trade-related),

3) Congressionally specifically authorized deductions, [not in (1) or (2)]4) Artificial deductions: allowed on policy grounds, but no funds expended, e.g., personal exemption


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What Is Gross Income? (ch.2)I. INTRODUCTION: All encompassing definition of gross income has proved to be elusive

A. 61(a):All income from whatever source derived. (up to the limits of the 16th amend.)1. Ei sner v. Macomber, (1920) [Labor-Capital Formula]: narrowly defined income as the gain

derived from labor, from capital, or from both combined. Def incomplete & inadequate b/cexcluded: Prizes, awards, punitive damage awards, and discovered wealth.

2. Commissioner v. Glenshaw Glass, (1955) (p.37): Taxpayers argued punitive damages were notincome. The Court disagreed and stated that income includes [1] undeniable accessions towealth, [2] clearly realized, and [3] over which the taxpayers have complete dominion.

B. Haig-Simons (economists) [BROAD]: Personal income may be defined as the algebraic sum of (1) themarket value of rights exercised in consumption and (2) the change in the value of the store of propertyrights between the beginning and the end of the period. In other words, how much could have been

spent on consumption during the year without a change in net wealth

1. INCOME = consumption + change in net worth (over tax yr)2. Would include increases in value of an individuals store or property rights (ex. if house

increases in value during a yr., owners net worth increases practical problems).

C. Accountants approach [NARROW]: Income encompasses only realized amountsthat is, assetsthat have been converted into money or other property by economic transactionsneed an

economic benefi t:1. Mere increase in value of a house Income unless appreciation in value has been realizedD. Tax law [btwn economists and accountants]: Goes beyond accountants def to incorporate policy

considerations in determining whether to tax an accession to wealth apportionment

. Critical questions:A. Whatitems are includedin gross income?:

1. focus on taxpayer receiving stuff of value= incl Cash, Property, Services, Discharge of debt2. What is NOT income:

a. Loan proceeds (b/c of offsetting obligation to repay)b. Capital recoveryc. Imputed Income (use of TPs own property or value of TPs own services),

B. What is the amountof such inclusions?C. To whomare these accessions gross income? (Who is the TP?)D. Whenmust an accession to wealth be included in gross income?(Note if combines a nontaxable receipt

and a later development that may change the result, e.g., discharge of debt)

III. FORMS OF GROSS INCOME (p.39)A. Compensation for Services & Sale of Appreciated Property [61(a), 1001(ac)]

1. 61(a)(1):Gross income includes compensation for services, including fees, commissions,fringe benefits, similaritems. Arise from a compensatory relationship and are attributable tothe rendition of labor (Thus, IRS will closely scrutinize a transaction between employer andemployee to ensure that a transaction is not really disguised compensation.)

2. 61(a)(3): Gross income incl gains derived from dealings in property (gains receipts);3. 1001(a):Gain from aProperty Transaction = Amount realizedAdjusted basis

a. Adjusted Basis: Cost to acquire the property.b. 1001(b): Amount Realized: Total economic benefit received in exchange for the

property; Amt Realized = Money received + FMV of any property/other economicbenefit received in transaction.

B. Income Without Receipt of Cash [61, 83(a)(1)]1. 2-Step Analysis: (1) Is It Gross INCOME?; (2) How Should It Be VALUED?2. 61 explicitly includes noncash benefits in gross income. Reg 1.61-1(a): gross income

includes income realized in any form, whether in money, propery, or services; (receiving landas compensation for services = cash payment)

a. Important questions to considerwhen determining which in-kind receipts are includedin gross income: (1) type of relationship between the parties (familialless likely


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What is Gross I ncome (ch2) 10receipt is compensatory in nature)?; and (2) What effect does inclusion of noncashreceipts have on ability to pay the resulting tax liablity?

3. Valuation: Tax law generally adopts the purely objective standard of fair market value,(price that would be reached btwn a willing buyer seller); Reg 1.61-2(d)(1): If services are paidfor in property, the FMV of property must be included in income as compensation

4. Rooney v. Commissioner, (1987) (p. 41): TP agreed to accept goods and services as paymentfor previously rendered services. Valuation amt = Retail price; but Ct suggested that if it was aforced purchase, a subjective valuation may be appropriate

5. McCann v. Uni ted States, (Fed. Cir. 1983) (p. 41): Court held that (1) it IS income when anemployer pays an employees expenses on a trip that is arewardforservices renderedby theemployee, the value of the reward = income. (2) When services paid for in a form other thanmoney, it is necessary to determine the FMV of the thing received. FMV=Cost of trip to ER.

6. United States v. Gotcher, 401 F.2d 118 (5th Cir. 1968)(p. 43): Taxpayers all-expenses-paidtrip to Germany to tour a VW factory is NOT income because the trip was predominantbusiness related and the taxpayer did not personally benefit from it. Here, trip waspredominantly business-related, no personal benefit; When this indirect economic gain issubordinate to an overall business purpose, recipient not taxed

a. Rule: 2 Prerequisites for gross income: (1) there must be an economic gain and (2)this gain must primarily benefit the taxpayerpersonally.

b. Key differences fromMcCann: 1) Trip was for personal benefit of McCanns v. benefitof VW, 2) McCann was an employee while Gotcher was not a VW employee, 3)McCanns were not required to go to seminars while Gotcher had no choice but to go toGermany, 4) McCanns schedule had plenty of time for personal diversions whileGotchers schedule did not and had been planned by VW.

C. Barter Transactions [61, 1001]1. Reg. 1.61-1(a): Income may be realized in the form of services, meals, accommodations,

stock, or other property, as well as in cash.2. Rev. Rul. 79-24 (1979-1) (p. 45): 1.61-2(d)(1) of the regs provide that if taxpayers exchange

services, each has income equal to the FMV of the services received; If the services wererendered at a stipulated price, such price will be presumed to be the FMV of the compensationreceived in the absence of evidence to the contrary.

D.

Unanticipated Gains (Windfalls) [61(a); R: 1.61-14]1. Underthe Glenshaw Glassdefinition, income includes receipts without a compensatory nexus;in other words, it is irrelevant if taxpayer earned the income, instead what matters is ifreceipt of the item increased the taxpayers wealth

2. Cesari ni v. Uni ted States, 428 F.2d 812 (6th Cir. 1970) (p. 47): Taxpayers found $5,000 cashinside an old piano they had purchased. Held: cash was income in year in which they found it;Citing Reg 1.61-14 which states value of treasure trove is included in income in the year itwhich it is discovered and reduced to undisputed possession. (note: not the same as when a TPdiscovers that something he had bought was worth more than he originally paid for it; incomewould be when item sold, i.e. when gain was realized)

3. Problem 2-8: Lucinda finds brooch in backyard. Appraised at $16K, but sold for $14Ka. She has gross income of $14K as soon as it is reduced to her possession

4.

Problem 2-9(a): H bought rare book for $850, was appraised at $2k, but sold for $1800.a. a) Gross income of $950 ($1800 - $850)b. d) If had found book in trash, treasure trove and gross income would be FMV

E. Prizes and Awards [74]1. 74(a): Prizes and awards are generally included in gross income;2. Reg 1.74-1(a): Prizes and awards includes (but not limited to) amts received in contests,

door prizes, radio and TV promotions and games and employee prizes.

3. Limited Exceptions: In 1986, Congress expanded the scope of 74 and revoked the previousgood works exception (where Pultzier prize excluded from gross income); Now, 74(b) saysprizes and awards transferred to charities may be excluded IF:

a. Recipient was chosen without action on his part to enter contest,


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What is Gross I ncome (ch2) 11b. Recipient not required to render substantial future services as a condition of receipt,c. and must immediately transfer the prize to charity.

4. Turner v. Commissioner, T.C. Memo 1954-38 (p. 51): Taxpayers received 2 round-trip firstclass cruise tickets which they exchanged for 4 coach class tickets. They reported $520 on theirreturn while the IRS stipulated that it should have been $2200, the retail price of the tickets.

a. Holding: Value to the taxpayers was not equal to their retail cost because it 1) Was aluxury that they could not afford and 2) Probably would not have been resold for$2200. The court, based on meager evidence, assigned a value of $1400.

IV. ROLE OF DEBT IN GROSS INCOMEA. What is Debt?

1. Interest: commonly defined as compensation for the use or forbearance of money (DuPont);From a legal perspective, interest is stated as a single rate on the principal amount of the loan.

2. Interest consists of 3 components: 1) Inflation, 2) Time-value of money, 3) Credit risk.3. Interest Calcualted by 2 methods (1) simple; (2) compound

B. Receipts Subject To Claims1. LOAN: United States v Rochell e, (1967) (p. 54): Not income because the economic benefit is

temporary and there is an obligation to repay: whatever temporary economic benefit hederives from the use of the funds is offset by the corresponding obligation to pay

2.

CLAIM OF RIGHT: North American Oil Consolidated v. Burnet, 286 U.S. 417 (1932) (p.54): When a creditor takes payment from a debtor regarding a disputed debt, which may needto be refunded if the dispute is settled in favor of the debtor it IS income; If the funds arereturned, taxpayer is entitled to a deduction the year the funds were returned.

a. Claim of Right Doctrine: when a taxpayer received funds with (1) a contingentobligation to repay, because the sum is either disputed or mistakenly paid, and (2) nolimitation on the use of the funds exists, those funds are included in the taxpayersincome in the year they were received.

3. Summary: Borrowed funds are not included in income, but funds subject to a claim ofright are. (No income if a binding obligation to repay, but if mightneed to repay, may haveincome.) Difficulty occurs if borrower does not acknowledge an obligation to repay.

4. Erickson Post Acquisition v. Commissioner, T.C. Memo 2003-218 (p. 55): Background:Amoco provided Erickson with certain equipment and a $175,000 loan. Erickson had to repay10% per year (6% interest), but if supply agreement was full force, then no need to repay forthat year. During the 5-year term, Erickson did not make any payments.

a. RULE: (definition of a loan): For a payment to constitute a loan, at the time thepayment is received, (1) the recipient must intend to repaythe amount and (2) thetransferor must in tend to enforcerepayment. (3) Further, the obligationto repay mustbe unconditionaland not contingent on a future event.

b. Holding: $175K was a loan b/c (1) There was a promissory note, (2) Amoco took stepsto collect the outstanding balance of the loan, (3) Debt was secured by a mortgage onEricksons property and (4) There was an unconditional obligation to repay.

c. Factors: court could use to determine if there was a loan, p.57:i. Is there a note or other evidence of indebtedness?; Written loan agreement?

ii. Interest charged?; A fixed maturity date or schedule for repayments?iii. Security or collateral requested?;iv. Has demand for repayment been made? Have any repayments been made?v. Do parties records reflect transaction as a loan?

vi. Was borrower solvent at time of the loan?5. Kriemer v. CommissionerT.C. 1983-672 (p. 58): Kriemer et al. borrowed money, but

concealed their true identities as borrowers. The court held that the money was a loan, andtherefore not income, because there was an actual intent to repay. RULE: gains fromfraudulent or illegal activities are income even though there is no rightful claim to that gainand/or that money may need to be repaid. However, fraudulent intent does not in itself

establish a lack of intent to repay


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What is Gross I ncome (ch2) 12a. TEST: Loans are only loans if there is a mutual recognition of the obligation to repay.

Both parties must haveactual intentto repay the loan.b. Held: In this case, although Kriemer concealed their identities, they treated the

obligation as a bona fide debt. They had sufficient net worth and cash flow to repay thedebt, witnesses established that they always intended to repay the debt, and they didrepay the debt. (factors for actual intent to repay listed on p.62)

C. Discharge of Indebtedness [61(a)(12); R:1.61-12(a)]1. 61(a)(12): Removal of a liability is as much income as the receipt of cash because thetaxpayer has more cash or assets over which to exercise dominion and control; gross income

includes discharge of indebtedeness, (in particular the payment or purchase of taxpayersobligation at < face amount)

2. US v. Ki rby Lumber Co, (1931) (p. 64):TPs are required to include as income the differencebetween the face amount of the debt and what was actually repaid. (in yr cancellation occurs)

3. Zar in v. Commissioner(3rd 1990), p.64: [contested liability]: if a TP, in good faith, disputedthe amt of the debt, a subsequent settlement of the dispute is treated as the amount of the debt,(No assets are freed, and so, no income b/c the amount of assets that were offset by the debt isnot clear.); Here, b/c the debt was unenforceable, the amount of the debt, wasin dispute.

a. Facts: Zarin ran up $3.4M in gambling debt to a casino. When casino sued, Z claimeddebt was unenforceable because Casino had illegally increased his credit limit. They

settled and Z paid $500k.b. Holding: The $500 settlement fixed the amount of debt. In other words, the parties

agreed that based on the circumstances the chips he acquired might not have beenworth $3.4M, but were worth something. Such a debt cannot be called liquidated,since its exact amount was not fixed until settlement.

4. Rood v. Commissioner, T.C. Memo 1996-248, p.67: A settl ement aloneis notsufficient toestablish the disputed nature of a debt; Debtor may actually owe the debt but Creditor maybe willing to settle to save the time and expense of litigation or other policy reasons. (eg ifproblems of proof or collectibility)

a. Facts: :Lawyer ran up a Casino debt of $355K that he couldnt pay. To induce him tomake a payment, Casino agreed to write of $225K, if he paid $100K.

b. Holding: cancellation of debt was income because the circumstances of the settlementwere not conclusive of whether the debt was disputed in good faith

5. Indicia used to determine if debt is real: 1) Legally enforceable K, 2) Reasonable intent to pay?6. Problem 2-15: Bank offers a 10% discount to each borrower who prepays the balance on their

mortgage note. J paid the financial institution $180k cash in full payment of his $200k note.a. a) Have gross income of $20K. (debt forgiven)b. b) Have gross income of $10K ($10K debt still outstanding)c. c) Yes, $10K relief of debt (61(a)(12)), $15K of ordinary compensation incomed. d) Has gross income of $17K ($10K debt forgiven + $7K gain).

V. LIMITATIONS ON GROSS INCOMEA. Recovery of Capital [1001, 1012]

1.

Recovery of original capital investment is NOT an accession to wealth;a. Stanton v. Baltic M ini ng(1916): SCt implies by legislated perogative, not constl rightb. Thus, receipt of a loan payment is recovery of ones original capital investment and a

rebate is a reduction in purchase price (return of capital)c. Reason why compensatory damages are excluded from gross income while damages

representing lost profit are included in income (see ch.3)2. Rev. Rul. 81-277 (1981-1), p.71: Payment by a contractor in exchange for a release of the

buyers claims against contractor for failure to fulfill a contract is a return of capital. The buyerdid not receive any economic gain b/c the payment was only to make the buyer whole.

a. If payment for damages oflost profi t, IS taxed as ordinary income


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What is Gross I ncome (ch2) 13b. If payment made to restore TP to position he was in before loss incurred (i.e., to make

wholeas if the contract had been fulfilled), a return of capital and NOT taxed3. Cts have avoided issue where paymt for body products (blood, breast milk) are taxable.4. Problem 2-16: Jane pays $100K for her house and discovered that the roof was defective . She

sued the builder and recovered $20K.a) No gross income (return of capital); Basis of house is $80kb) No gross income; basis of house $95k

5. Problem 2-18: T purchased a car for $8k with a $1,000 cash rebate to follow from the factory.a) No gross income (return of capital)b) $7K

6. Problem 2-19: K flies on Uniteds frequent flyer program for personal trips during a 2-yrperiod. amasses enough mileage to earn RT ticket to Australia that is normally sold for $1700.

a) Does not have gross income because of return of capital doctrine states that eachtime she bought tickets over the years she purchased a little more of the Australia ticket.The ticket can also be characterized as a rebate.b) Would have $1100 in gross incomec) Tickets are valued objectively, so he may have $600 of gross incomed) $400 of gross incomee) Announcement 2002-18

B. Realization [1001; R: 1.61-6(a); 1.1001-1(a)]1. Realization is a fundament concept that generally ensures that gains/losses are not taxed until

they are severed from the capital that created it. (Severance = sale, exchange, etc.)a. Policy of administrative convenience: Glenshaw Glass characterized realization as an

administrative rule rather than a constl requirement as held inEisner v. Macomber

2. Realization Event: a transaction in which the taxpayer receives something materially differentfrom that which he had before the exchange; TEST: to be materially different, propertyreceived must confer different legal interests or entitlements on the taxpayer (Cottage Savings)

3. Cottage Savings v. Commissioner, 499 US 554 (1991), p.76: (Dif Legal EntitlementsTest): holding: [1] A realization event under 1001(a) occurs only if the properties exchangedare materially different. [2] A property is materially different if the legal entitlementsassociated with the property are different in kind or extent (test from case law). Here, the swap

of mortgage loans that were made to different obligors and secured by different homes resultedin a realization event because there were legally distinct entitlements . (TP had differentlegal interests than it had before the exchange, thus the loss that was realized.)

a. Comparison (stock): Separate groups of stock are NOT different if they confer thesame proportional interest of the same character in the same corporation; while itwould be different if issued by different corporations or confer different rights andpowers (Phellis and Marr: stock in company that reincorporated in different stateWAS different because different rights; but Weiss: company that reincorporated insame state, was not really different)

b. Dicta: Material difference Economic substitute (IRSs arg): 1) Case law does notsupport this approach, 2) Overly complex, 3) Incompatible with the structure of theCode (gain/loss realized under 1001(a) shall be recognized unless a nonrecognition

provision applies; one such provision withholds recognition for the exchange ofproperties that are economic substitutes.)c. Reg. 1.1001-3(e) (in response to Cottage Savings): Modifications to debt instruments

must be significant for there to be a realization event.i. If debt instrmt is not within one of the specific bright line tests, then under the

general signif rule, modifications to propertys legal rights and obligationsmust be economically significant under all the facts and circumstnaces

C. Imputed Income,p.851. Generated in 2 situations: When taxpayer derives an economic benefit from (1) ownership/use

of their own property (e.g., renting out house), and (2) performing services for themselves.


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What is Gross I ncome (ch2) 142. Policy: Not included in income tax base b/c of valuation difficulties, potential burden on the

poor/industrious/creative, and early misgivings if taxing imputed income was constitutional.3. A barter transaction does NOT generate imputed income; drawing line btwn imputed income &

barteringis difficult, eg catching ball result of my skill4. Commissioner v. Daehler, 281 F.2d 823 (5th Cir. 1960) (p. 87): Taxpayer (who was a real

estate broker) bought property and received 70% of the brokerage fee from that sale from hisemployer (a broker); the Tax Court held that the fee was a reduction in the purchase price(because the taxpayer had been acting as his own broker) and not income. The Court held that

the taxpayer acted as an employee and that the fee he received was compensation for services.5. Problem 2-21: Phillip Granville, a lawyer, normally charges $1400 for drafting a will.

a. a) $1400 is not counted gross income because net there is no gross income because itcost him $1400 to do the service

b. b) Yes, have gross income, because barterD. Administrative Exceptions To Gross Income

1. Policy: Transaction costs would exceed costs of collection.2. Examples: Frequent flier miles, relocation payment made by a local jurisdiction to a taxpayer

to move from his flood-damaged to another residence, ball from a home run (assuming that thetaxpayer does not sell it). [Announcement 2002-18]

3. Problem 2-19: [see above]VI. DISPOSITION OF PROPERTY

(ch 2E) (1001(a)-(c), 1012, 1016(a)(1)-(2); 1.1001-2(a)(1)-(2), (b), (c) Example 1 and 2; 1016-2(a)-(b))

A. Gains on the Disposition of Property,p.911. Gains from property (netgains realizedon the sale or exchange) are gross income 61(a)(3)

a. Gain is not gross income until the gain has been realized;b. A gain is realized if the amount realized> adjusted basisc. Gain from property does NOT include amounts received as a return of the initial

capital investmentin the property

2. Gain = Amount RealizedAdjusted Basisa. Amt realized: total economic benefit received in exchange for the property transferred.

i. 1001(b): Amount realized = Sum of $ received (includes debt forgiveness)+ FMV of property/services given in return.

b. Adjusted basis:i. Only relevant to computing net gain from property (irrelevant for services)

ii. 1012: Basis equals cost to acquire property1. includes certain acquisition expenses, e.g., brokers and attorneys fees2. If acquire 2 or more properties in single transaction, total cost basis

allocated among individual properties. If not arms length, use FMV.iii. Basis determined depending on how property was acquired (purchase, gift,

inheritance, or exchange) and adjusted thereafter as required by 1016 (e.g.,depreciation, or capital improvements)

B. Determining Adjusted Basis1. Taxable Exchanges Of Propertya. Basis (of received property) = FMV of property received

i. Phil adelphia Park(maj view): cost basis of the property received is the FMVof the property received; Based on theory that the term cost is a tax conceptand is related to other areas of the tax code

1. But where the value of property received cannot be ascertained, theFMV of property transferred is used. Based on reasoning that FMV ofexchanged properties should be equal

ii. Minority View: basis is the FMV of property given; FMV of the propertytransferred in the exchange (prop A) was the amount paid and thus was thecost basis of the property received (Budd International, 1944)


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What is Gross I ncome (ch2) 151. Based on theory that the cost to the taxpayer is the economic value of

prop relinquished, but when properties exchanged are of unequalvalue, resulted in taxpayer realizing an incorrect amt of gain or loss ona subsequent disposition of the acquired property

b. Problem 2-24: On 1/1, S got 100 stock at $60/share. On 12/1, market value of stockappreciated to $100, S exchanged for a parcel of undeveloped land appraised at $10k.

i. a) Gain = $4000ii. b) Basis on land = $10K

c. Problem 2-25: W exchanged stock with adjusted basis of $10K and FMV of $15K inreturn forJs GM stock, having an adjusted basis of $20K and a FMV of $16K. Thereis a realization event because change of legal entitlement to each specific stock.

i. a) Wyatt: Amount realized = $16K, adjusted basis = $10K, gain = $6K; Jones:Amount realized = $15K, adjusted basis = $20K, loss = $5K

ii. b)Wyatt: $16K; Jones: $15K2. Debt Incurred in the Acquisitionof Property

a. Loan and debt basics:i. Higher credit = lower interest rate

ii. Secured loan = A loan that has collateral;iii. Unsecured loan = A loan that does not have specific property as collateraliv. Recourse Debt = Borrower is personally liable for full amount of debt. If

borrower doesnt repay, his other assets are at risk.v. Nonrecourse Debt = Lenders only recourse is against the property. Thus, if

value of the property is insufficient to repay debt in ful, lender cannot proceedagainst debtors other assets for repayment (the lender bears the risk theproperty will decline in value)

b. Basis (of property acquired by purchase) = Purchase price (cash + liabilitiesincurred in acquiring the property) (Crane)

c. Crane v. Commissioner, 331 U.S. 1 (1947) (p.96): Entire amount ofany debt incurredin the acquisition of property is included in the purchasers cost basis at the time theproperty is acquired (not at a later date when the debt is paid). Example: $100Kpurchase price: $20K cash, $80K note Basis = $100K (not $20K).

i. Originally limited to cases where debt < value of propertyii. If didnt include debt, depreciation deductions could produce negative basis

iii. Including debt allows basis to be fixed at the time of purchase (else basiswould change with principal payments)

d. Problem 2-26: a-e) $100K3. Debt Incurred AfterProperty Acquisition (p.100)

a. Woodsam Assoc v. Commi ssioner(2nd Cir. 1952): When property is mortgaged assecurity for a loan for a purpose other than the propertys acquisition, there are no taxconsequences because there has not been a realization event

b. Same result if a nonrecourse debt in excess of the basis of the encumbered property,but also debt does not represent the cost of the property, so not included in basis

C. Amount Realized from Debt Relief1. Nonrecourse Indebtednessa. Reg. 1.1001-2 provides the general rule that the amount realized on the disposition of

encumbered property includes the full amount of any debt relief.

b. Double deduction theory: (Mil lar v. Commissioner, 577 F.2d 212 (3d Cir. 1978) (p.104): Taxpayer should include the full amount of a nonrecourse loan in the amountrealized because to exclude the amount of liability from the amount realized would betantamount to giving the taxpayer a double deduction (Once for depreciationdeductions against that basis and for debt forgiveness).


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What is Gross I ncome (ch2) 16c. Commissioner v. Tufts, 461 U.S. 300 (1983) (p. 104): When the nonrecourse

obligation exceeds the FMV of property sold, amount realized includes theoutstanding amount of the obligation.FMV is irrelevant.

i. Example: $100K purchase price for a $100K note. Basis = $100K. Takedepreciation deduction of $20K (for a basis of $80K) but dont pay principal.FMV drops to $50K. Gain/loss = $100K - $80K = $20K.

2. Recourse Indebtednessa. Rev. Rul. 90-16 (1990-1) (p. 111): X defaulted on recourse debt. FMV = $10K, basis

$8K, debt = $12K. Recourse debt of $12K > FMV of $10K. Regular gain = $10K -$8K. Discharge of indebtedness gain = $12K - $10K.

b. Problem 2-29: On 1/1, Year 1, Rose purchased a parcel of undeveloped land fromMorgan in exchange for $100,000 cash and Roses $900,000 promissory note. Rosewas unconditionally liable for repayment of the note, which was secured by the land.On 1/15, Year 3, Rose made a total of $25,000 payments on the note and informedMorgan that because the FMV of the property had declined to $850,000, Rose wouldnot make additional payments on the note. What result to Rose if:

i. a) 1001(a): $850 (90025 payments25 deficiency jdmt)$1M = -$150 lossii. b) 1001(a): $850 (amt realized from discharge of debt) - $1M = -$150 loss

iii. c) 1001(a): $850K (amount realized from the discharge of indebtedness) -$1M = -$150K +$25K discharge of indebtedness = -$125K loss.

D. Discharge Of Indebtedness Redux1. Preslar v. Commissioner, 167 F.3d 1323 (10th Cir. 1999) (p. 115): Preslars paid down

$1000K recourse debt to $799K. Preslars settled with the FDIC for $350K after bank wentunder. Contested liability doctrine does not apply because the original amount of the debt mustbe liquidated (not subject to debateif it is, settlement determines original debt amount (SeeZarin)). Therefore, extinguished debt obligation is gross income.

2. Problem 2-27: [not doing in class anymore]a. a) A/B $30K (10K cash + 20K note), Amt Real. = $42K (22K cash + 20K obligation)b. b) Basis still $30, A/R = $42 (Cancellation of $22 obligation + discharge of $20 debt)c. c) Basis is still $30K, Amt realized = $42K (Get $22K truck + discharge of $20K debt)

3. Summarya.

Example #1: Adjusted basis: $1,000K real debt, FMV = $800Ki. Non-Recourse: If Gain = 0 (walk away), Tufts tells us amount realized =

$1,000K, even if FMV is lowerii. Recourse: -$200K = $800K - $1M.

1. Why the difference? They can come after you for the remaining$200K.

2. What if the bank just says dont worry about the remaining $200K?3. $200K capital loss AND4. $200K of cancellation of indebtedness (i.e., $200K income)

b. Example #2


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What is Gross I ncome (ch2) 17Debt example

Cuban borrows $100M from bank to buy TX capital building; owes $100M plus interest to bank Under first part ofCrane, Cuban owns capital with $100M adjusted basis, regardless if recourse or nonrecourse, even

though none of the money came from his pocket If repays, adjusted basis does not change. Basis can change under 1016, but not for debt reasons. Property appreciates to $200M, so Cuban borrows an additional $50M from the bank (post acquisition loan)

o $50M is still not income because there is an offsetting obligationo Basis remains $100M (does not change to $150M)o Using property as collateral is not a realization event. If you give up control, etc., that would be realization

event. Property drops to $80M (Adjusted basis $100M, $100M of debt). Perot gets building and assumes debt obligation.

Cuban is out the property, but no debt. Perot doesnt pay anything.o This is the issue in the second part ofCrane and forTufts.o Crane: FMV > AB. taxpayer got something valuable, relief from debt. Amount realized = debt.o Tufts: FMV < AB, Cubans amount realized = $100M (amount of non-recourse debt), $0 gaino Perots basis: $100M. If walks away, amount realized is $100M.

Foreclosureo $100M obligation, $100M AB, $80M FMVo Changes Cubans legal rights Realization evento Amount realized = $100M


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19

Items Excluded from Gross Income (Ch.3)I. GIFTS AND BEQUESTS (102, 1014(a), 1015(a); 1.102-1(f)(2))

A. Introduction1. 102(a) excludes gifts, bequests, devises, and inheritances (assume latter 3 are the same thing

because someone has to die) from gross incomea. But subsequent income earned from gifts is gross income - 102(b)b. Policy: administrative burden to track gifts (whereas treasure trove is relatively rare)

2. Definition: A gift is a payment or transfer (Duberstein v. Commissioner, (1960),p. 122):a. made out of a detached and disinterested generosity;b. made out of affection, respect, admiration, charity, or like impulses;c. not made primarily from the constraining force of any moral or legal duty;d. not made from the incentive of anticipated benefit of an economic nature; ande. not made in return for services rendered.

3. Whether a payment/transfer is a gift depends on the donors intent or motive4. Olk v. U.S., 536 F.2d 876 (9th Cir. 1976) (p. 124): Even though players motive for giving

Tokes (tips) was impulsive generosity or superstition: are not acts of detached generosity, butare gross income because: 1) Regularity of flow, 2) Equal division between dealers, 3) Dailyamt received indicate that the person would come to see them as a form of compensation.

5. Note on Gift versus Compensationa. Al tman v. Commissioner, (2d Cir. 1973): Mothers checks for $122k to son were not

a gift, but was gross income because they were given in response to the sons threats(i.e., not detached generosity).

b. Wolder v. Commissioner, (2d Cir. 1974): Bequest of cash/stock to lawyer for lifetimeservices was compensation for tax services.

c. Greisen v. U.S., (9th Cir. 1987): Oil royalty payments given to Alaska residents werenot a gift because they were given out by the State due to a legal (or moral) obligation

6. Problem 3-2: Js employer had 2 bikes delivered to her, with a note: To J, with many thanks.a. 102(c); Would need to rebut presumption that the gift is includable by virtue of the

employer-employee relationship by applying theDubersteinfactors to the employerssubjective intent. This statement modifies 102(a), so if 102(a) does not apply, then102(c) does not apply. But, need to analyze type of relationship in 102(a) first.

7. Problem 3-4: T approaches his two sons, R and D, and offered to pay $500 to the one whoearned the highest GPA by the end of the academic year. As a result of the offer, both spentextra time and effort studying; however, D finished the year with a 3.75GPA while R couldonly muster a 3.6 GPA. What result to Donald on the receipt of the $500?

a. Why gift: Familial relationship is hard presumption to overcomeb. Why not gift: Quid pro quo. No legal obligation

B. 1015Basis for Property Received as Gift 1015(a), (d)(1), (2), (4), (6); R: 1.1015-1(a),(c),(d)1. 1012: Basis of property = cost $0 basis for gifts, but under 1015 gift recipient acquires a

transferred or carryover basis; that is, the donees basis is the donors basis at time of transfer

2. 1015: Calculating donees basis:a. If property has appreciated(FMV is donors adjusted basis) Carryover Basis

i. Donees basis = Donors adjusted basis + gift tax paidb. If property has depreciated(FMV < donors adjusted basis), donee has two basesi. Gain basis = Donors adjusted basis (same as above)

ii. Loss basis = FMV of the property at time of the giftc. Using gain/loss bases:

i. If (donees amount realized > gain basis) then // Donee has gain1. Realized gain = Donees amount realized gain basis

ii. Else if (donees amount realized < loss basis) then // Donee has loss1. Realized loss = Donees amount realizedloss basis

iii. // else No gain or loss (thus, if sold a depreciated property at FMV, doneewould realize neither gan nor loss)


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I tems Excluded fr om Gross I ncome 20

d. Gift Tax: increase basis (but not above propertys FMV) for gift tax paid, which isattributable to the net appreciation in the property (pro-rated) - 1015(d)

i. Ex. AB: (As adjusted basis = $30k) (FMV = $40k) (total gift tax = $1K)1. $1k x $10k (net appreciation) $40k (total amount of the gift) = $250

(the gift tax attributable to the net apreciation)3. Gifts of appreciated property to children (low tax bracket) can result in significant tax savings,

but Code does not allow using gift to transfer tax losses to another person.

4. Problem 3-6 (Assume no gift tax): W purchased the following in Year 1: Property A, $10k andProperty B, $14k. In Year 5, the properties were valued at $15,000 and $9,000, respectively.

a. a) [Gives A to M, who sells in Yr 6 for $17,000] Amount realized = $17K (1001(b))i. FMV in year 5 > donors basis ($15K > $10K) donees basis = $10K

ii. Gain = $17K - $10K = $7Kb. b) [Gives B to Pearl, who sells 1 month later for $8K] Amount realized = $8K

i. FMV in year 5 < donors basis ($9K < $14K)1. Gain basis = $14K; Loss basis = $9K

ii. Donees amount realized < loss basis: Realized loss = $8K- $9K = $1Kc. c) [Pearl sells B for $12K] Amount realized = $12K

i. FMV in year 5 < donors basis ($9K < $14K)1. Gain basis = $14K; Loss basis = $9K

ii. Gain basis > amount realized > loss basis No gain or lossd. c.2) [Sold B at $17K] Amount realized = $17K

i. FMV in year 5 , donors basis ($9K < $14K)1. Gain basis = $14K; Loss basis = $9K

ii. Donees amount realized > gain basis: Realized gain = $17K- $14K = $3KC. Part Sale/Part Gift Transactions -1015(a); 1011(b); R: 1.1015-4; 1.1001(e); 1.1001-2(a)(1), 4(iii)

1. when property is transferred in return for consideration totaling less than propertys FMV2. Reg 1.1015-4: basis is a hybrid of cost basis and gift basis rules

a. Basis: transferees basis=greaterof (1) amount paid OR (2) transferors adjusted basisi. No loss deduction permitted to the transferor on part sale/part gift. 1.001-1(e)

b. Determining a Realized loss:i. Loss basis: lesserof (1) transferees basis (greater of: amt paid ortransferors

adjusted basis) OR (2) the FMV of the property at the time of the transfer3. Diedri ch v. Commissioner, 475 U.S. 191 (1982), p.133:4. Problem 3-7: S transferred prop with A/B of $30K and FMV of $90k to son M for $60K;

M sold property for $100ka. A) Gain of $40K = amt realized $100kMs basis: $60kb. B) if sold for $25K? Loss of $35K (basis of $60kamt realized $25k)c. C) Gain of $40k = amt realized $100kbasis of $60kd. D) Loss of $35k = basis of $60kamt realized $25ke. E) Gain of $10k = amt realized $100k90k basisf. F) Loss of $35k = basis of 60kamt realized of $25k

D. Basis of property acquired by Inheritance or Devise - 1014(a)1. 1014(a):basis is the FMV of the property on date of death

a. If (FMV > decedents basis) theni. Donees basis = FMV // FMV - decedents basis escapes income taxb. else // FMV < decedents basis

i. Donees basis = FMV // Decedent and donee cannot realize the inherent lossii. Rule of thumb: Hold your winners ; harvest your losers

c. If get by inheritance, basis stepped-up to FMV. Donee must pay for gain btwnamt realized & FMV@time of inheritance. BASIS AT DEATH ALWAYS FMV.

i. Reasons to step-up basis: 1) Donor is dead (cant ask) 2) Spotty record keeping2. Consequences:

a. Devise property that has appreciated To get the stepped-up basisb. Sell property that has depreciated just before death To be able to get the loss


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3. CLASS NOTE: look at categories under1014(b)!!4. Exception: 1014(e): Stepped-up basis rules in 1014 do not apply w.r.t. appreciated property

acquired by the decedent through gift within 1 year of death where such property passes fromthe decedent to the original donor(basically, the heir cant transfer appreciated propertyimmediately before grandmas death in hopes of receiving it back at stepped up basis)

5. Problem 3-8: A) no income on $40k sale;II. LIFE INSURANCE PROCEEDS101(a),(c),(d); Reg: 1.101-1(a)(1), (b)(1-2); 1.101-3; 1.101-4(a)

A. 101(a) excludes from gross income life insurance proceeds, payable by reason of death1. If however the policyholder lives to see the endowment policy mature, or if he cashes in a

whole life policy, may be governed by 72 (designed to exclude policies that functionprimarily as investments rather than insurance)

2. 3 Types of Insurance Policies:a. Term policies: only provide insurance coverage for state period; insured acquires no

cash value while policy in forceb. Endowment policies: provide two types of coverage: 1) if insured lives for a specified

number of years, he will receive a predetermined sum at end of the period, 2) but ifinsured dies before, a beneficiary will receive a predetermined death benefit

c. Whole Life policies: like endowments, acquire a cash value; but more of the premiumgoes toward purchasing a death benefit

3. Special Rules and exceptions: Accelerated death benefits-101(g): under certain contracts, aterminally ill or chronically ill individual may exclude proceeds of a life insurance contract,even though they are not paid by reason of death as required by 101

4. Problem 3-9:Rs uncle died and R got $20k from a whole life insurance policyIII. EMPLOYEE BENEFITS

A. Introduction: List of employee fringe benefits can be found in 132B. Meals and Lodging(119(a)(b)(d), 107; Reg: 1.119-1(a)-(c),(f))

1. 119. Requirements: can exclude the value of ER provided meals and lodging IF provided for:a. (1) Convenience of the employer: there must be a substantial noncompensatory

business reason of the employerfor supplying the meals/lodging (ex. on call meals);satisfied when there is a direct nexusbetween housing furnished and business interests

of the employer served thereby (The McDonald Rule)b. (2) on Business premises: generally where the employee performs his duties; but is a

functional definition not a physical one (Adams v. U.S.)

c. (3) LodgingCondition of employment: TP required to accept lodging in order toenable him properly to perform the duties of his employment (Reg 1.119-1(b))

2. Policy: meals and lodging, when provided for the convenience of the ER rather than the benefitof the EE are not compensation and thus not gross income

3. 107 (For clergy only): Excludes value of cash housing allowances as well as the rental valueof housing furnished in-kind

4. employer-provided groceries (circuit split): in Tougher, (9th Cir.) Groceries are not excluded,but inJacob, (3d Cir.): Groceries cooked and eaten on premises are excluded

5. Commissioner v. Kowalski, 434 U.S. 77 (1977), p.142: Meal allowances for state troopers whopatrolled highways and ate at restraurants are NOT excluded form gross income under 119.Here, meal allowances were not necessary for employee to properly perform his duties.

a. RULE: cash for meals allowances is not the same as meals. Cannot infer thenoncompensatory character of a benefit merely from employers characterization, needevidence that benefit was granted because the employers business could not functionproperly unless an employee was furnished that benefit on the employers permises.

b. Reasoning: no limitations on how they spent meal allowances (not required to spendon mid-shift meals, nor required to account for how money was speant) and could eatin anywhere within patrol area (including home) .


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6. Adams v. United States, 585 F.2d 1060 (Ct. Cl. 1978) (p. 145): Japanese residence providedby Exxon Mobil for the president of their Tokyo subsidiary is not gross income.

a. 1) Convenience of ER requirement: His living at residence was in business bestinterests because they built and owned it, it had been the home of the subsidiaryspresident for about 20 years, and it needed to be (and was) sufficiently lavish. Also,due to Tokyo real estate prices, needed subsidy to attract a qualified candidate.

b. 2) Premises requirement: Employers premises is a functional definition, not aphysical one. Thus, its not limited to business compound or HQ, but rather anywhere

where an employees duties are performed. Here, it directly served a business functionand influenced his effectiveness in business computinty

c. 3) Condition of Employment requirement: Living at residence was condition ofemployment because his home needed to be sufficiently dignified to him to beeffective in the Tokyo business community and he needed to have meetings, entertainclients, conference calls, etc.

7. Problem 3-10: EE, a law firm associate, was required to attend luncheons of her ER everyMon and Thur. The ER wanted to encourage social interaction among the firm employees andarranged for lunch to take place at a restaurant across the street. Lunches were $20/plate.

a. Need to be for 1) Convenience of the employer and 2) Business premisesb. Hard to say that meals are for convenience of the employerc. Business premises is property where business is conducted. In this case, no specific

work being done, so hard to say that employer is renting space. Most likely grossincome because hard to meet convenience of the employer test.

8. Problem 3-11: R is a waiter and is on duty from 10a-6p every day. His employment K statesthat he is to eat lunch at 2p and dinner at 7p and may select any item from menu at no charge.

a. Need to be for 1) Convenience of the employer and 2) Business premisesb. Definitely on business premises for both lunch and dinnerc. 2pm lunch is for convenience of employer because need him on-site, may want him

on-call, want him to try food, be competitive with other restaurants, etc.d. Dinner is harder to say because regulations say it needs to be immediately before/after.

7pm may not be immediate.

C. Costs for Employee Life and Health Insurance (79, 106)1.

79(a): Excludes up to $50K ofgroup term life insurance (cost for coverage above $50K aregross income). Premiums for endowment/ whole-life polices not excluded (are gross income).

a. 79(d): Life insurance plans must be nondiscriminatory (if provide more substantialbenefits for key employees, cost of coverage included in key employees gross income)

2. 106: Employer contributions to health/accident insurance plans are generally excludable.Not subject to nondiscriminatory policy.

D. Other Employee Fringe Benefits,p.1521. General Rule: Gross income does not include any fringe benefit that qualifies as an employe

benefit at no additional cost to the employer, an employee discount, a working conditionfringe, a de minimis fringe, a transportation fringe, or a moving expense reimbursement

2. Policy Reasons: Employers have valid business reasons, other than simply providingcompensation, for offering employee discounts on items they sell. (ex.store EEs wearing

clothes they sell); and want to Set clear boundaries for what counts as a tax-free benefits3. 132(a)Statutory Criteria for Excludable Fringe Benefits: if a fringe benefit does notfall

under one of the following categories, it mustbe included in gross income:

(1) No-addit ional-cost service:i. any service provided for EEs use, at no additional cost to the ER (including

forgone revenue); (includes benefits provided directly at no charge, at areduced price, or through a cash rebate)

ii. Requirements:1. Nondiscrimination requirement: service must be available to all

employees, else favored employees will be taxed


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2. Line of business limitation: Service must be the same type of servicesold to the public in the ordinary course of the employers line ofbusiness, in which the employee works. (If employee works in one ofthe X lines the company has, employee can only get discounts in theline he works in.)

a. If an EE provides services that directly benefit more than oneline of business (e.g. payroll), then the employee is treated asperforming services for all of the employers lines of business

b. Reciprocal arrangements provided by an unrelated ER okay if:1) Both Ers in same line of business, 2) Written reciprocityagreement, 3) No substantial additional cost for either

(2) Quali fi ed Employee Discounts:

iii. EE discounts are excludable only if it is with respect to a qualified property orservice and falls within a specified percentage requirement; (also subject tothe nondiscriminatory requirement and the line of business limitiation)

1. Limitations: 1) Not available on highly liquid property; 2) Discountfor services cannot exceed 20%; 3) Discount on goods cannot exceedERs profit % (retailcost); (EEs excess discount is gross income)

(3) Working Conditi on F ri nge Benefi ts:iv. Property or services provided by the employers that, had the EE purchased it

directly, the EE would be allowed to deduct it under 162 or 167 (at leasthypothetically deductible) (At times, an exclusion can be much more valuablethan a deduction)

v. Examples: law firm pays Bar dues, Company car (But must be used forbusiness purposes)

(4) De minimis Fringe Benefi ts:

vi. Any property/service value is so small its unreasonable/impractical to track1. Some may be offered discriminatorily (but not eating facility benefit)2. Benefit is NOT de minimis if granted to a particular EE so regularly

that in effect it serves as a means of disguised compensation3. No statutory/regulatory limit on how much benefit a particular EE can

receive as long as overall fringe benefit program is de minimis to ER

vii. Ex: Below-cost meals in EE cafeteria, typing of personal letters by secretary,occasional personal use of copier, monthly transit passes < $21/mo., etc.(5) Qualified Transportation fringe: includes ER-provided commuter transportation,

transit pass, or qualified parking (Ceilings are imposed, but are inflation-adjusted)

(6) Quali fi ed Moving Expense reimbursement: Includes moving expenses and lodgingpaid by employer (direct or reimbursed) as long as costs are reasonable. Does notinclude meals while traveling.

(7) Qualified retirement planning services: Includes any retirement planning adviceprovided to employee or spouse by an employer who has a qualified plan, contract,pension, etc. Must be non-discriminatory

b. On-premises athletic facilities: Includes FMV of on-premises facilities if most of theuse of the facility is by employees, spouses, and children. Facility needs to be ownedand operated by employer. Nondiscrimination requirement does NOT apply.

c. Family members: Most benefits are explicitly for the employee only, but 132(h)(2)enjoyment of a no-additional-cost or employee discount fringe benefit by spouses anddependent children as if had been enjoyed by the EE.

4. Problem 3-17: E is an attorney working full-time in the legal department at United. During thecurrent year, she received and used the following benefits at no charge pursuant to hernegotiated employment agreement w/ United. What tax consequences attend the following?

a. (a): [Round trip, first-class standby ticket for United flight between NY and Paris forher and spouse] No gross income under 132(a)(1) because there is no additional cost


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(132(b)(2): Minimal w.r.t. employers fixed costs), meets nondiscrimination, andmeets line of business requirement. Spouses ticket not GI either due to 132(h)(2)(A).

b. (b): [Reserved ticket] Gross income because reserved ticket means forgone revenue,which is an additional cost.

c. (c): [if on Air France]: not gross income as long as there is a written reciprocity agrmtd. (d): [Daughter and brother used tickets instead] Daughter qualifies under 132(h)(2) if

a dependent. Brother does not qualify.e. (e): [30% discount on in-flight sales brochure]: income because discriminatoryf. (f): 5% discount above profit would be taxedg. (h): [50% discount for 10 nights lodging at Inter-Continental Hotel which is

owned/operated by United] Almost certainly no. No similar concept of standby rooms,line of business limitation, questions about whether hotel room is a service or a good.Even if excluded, discount limited to 20%.

h. (m):[Making 1000 personal copies per year] Does not qualify under no-additional-costservice because of line-of-work. May be de minimis.

5. Problem 3-18: J worked for M and purchased a new car. The typical price for the car was$30k but J only paid $24k b/c of the customary 20% EE discount. Dealer profit ratio is 30%.

a. Excludable under 132(c) b/c (1) Car offered for sale to customers in normal course ofbusiness; (2) profit percentage of 30% > 20% discount; (3) discount is on somethingthat is not highly liquid and generally held for investment; (4) nondiscriminatory.

IV. COMPENSATION FORPERSONAL INJURIES AND SICKNESS -104(a)(1)-(3); 105(a)-(b), (e), (h)(1-2), (7); 106(a)A. 104: Generally excludes amount received due to personal injury or illness (regardless if received through

workers comp, accident or health insurance, or civil suit).1. Exclusion does NOT apply if taxpayer has taken itemized deduction for corresponding

expenses. (Along with 105(a), gross income if employer pays.)2. Includes compensation for tortious conduct (include personal, but not nonphysical injuries,

e.g., gender discrimination

B. 104(a)(2):1. Punitive damages are includable, unless state law mandates that only punitive damages can be

awarded for wrongful death and injuries were account of a personal injury/sickness.a. Rationale: Compensatory damages could be considered to be a return of capital.

2. Exclusion only applies to physical injuries/sickness, includes non-physical injuries/sicknessthat has a physical origin, e.g., emotional distress, loss of consortium

3. Doesnt matter if paid in lump sum or in periodic payments (even if end up getting more thatway) because of time value of money

V. DISCHARGE OF INDEBTEDNESS:108(a), (b)(1)-(2), (d)(1)-(3), (e)(5); 1017(a)A. Bankruptcy Tax Act of 1980

1. lkjB. Rev. Rul. 92-53

1. lkjVI. OTHERMISCHELLANEOUS EXCLUSIONS

A. Tax-Exempt Interest1. lkjl

B. Social Security1. Goldin v. Baker, p.178

C. Sale of Principal Residence1. Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997


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Choosing the Proper Taxpayer (Ch4)I. ASSIGNMENT OF INCOMESERVICES [61,73]

A. The Concept of Income Splitting1. Motivation for income splitting is to avoid high marginal tax rates by assigning income to

another taxpayer with lower taxable income while still effectively controlling the use andenjoyment of the income

2. Lucas v. Earl, 281 U.S. 111 (1930) (p.198): Income is taxed to the one who earns itKbetween husband and wife gave half of husbands income to wife so they each had half histotal income. Using the tree and fruit analogy, Court held: cannot escape income tax byanticipatory arrangements and Ks however skillfully devisedby which the fruits areattributed to a different tree from that on which they grew

3. Vnuk v. Commissioner, 621 F.2d 1318 (8th Cir 1980) (p.199): whoever controlsthe income,rather than who receives it, is the one who should be taxed . (TP transferred all theirproperty to an inter vivos trust and claimed that as a leased employee of the trust, it is thetrust that pays tax on income from the services; Ct rejected because trust had no right tosupervise TPs employment and the TP had no legal duty to earn money for the Trust)

a. Ultimate direction and control: Who has authority to dictate 1) Nature and extentof the individuals services, and 2) to Whom those services should be rendered.

B. Shifting Income within the Family by Gratuitous Transfer1. Teschner v. Commissioner, 38 T.C. 1003 (1962) (p. 200): where an individual neither

receives nor has the right to receive income, he is not the taxable individual. (Parents wonessay contest for which the prize was an annuity for a person


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Choosing the Proper Taxpayer(ch.4) 26

E. Rule: Each individual is a separate taxpayer and who has the power (Factors: Arms lengthcontract, employment contract, etc.) to generate it is a significant factor in whos income it is.

However, it is not the only or dominant factor. No bright line.

F. Problem 4-1: Gordon entered into an employment contract with Greensleeves that required him to work40 hours/week for $1000/week.

1. a) [G and GS agree to give $800 to him and $200 to 15-yr old son J] All $1000 to G (Lucas)2. b) [Same as a), but there is a K btwn G and J] All $1000 to Gordon. Joseph has legal right, but

Gordon has the power to generate. Contract is not dispositive as was the case for wife in Lucas.

3. c) [Same as b), but K is a GS requirement] Same result even though G could not get $1000because employer paid $1000 for $1000 of services. But there is an arg that Teschner applies.

4. d) [Joseph does some work in exchange for $100 of Gordons $1000] Joseph provided servicesfor his $100, so the answer is different. Gordon gets $900, Joseph gets $100. 73.

5. e) [Same as d), but Joseph signs employment contract] Result would not change. Contract onlylets him be legally entitled, but doesnt change who generated the income.

G. Problem 4-2: 8-year old Tracey wins a free trip to Disneyland for her and 4 other kids.1. a) Tracey has gross income.2. b) [goes alone and does not designate any other kids] Ability to control is important, but so is

accession to wealth.3. c) [Tracey designates a kid in return for $250] Tracey has gross income.

II. ASSIGNMENT OF INCOMEPROPERTY [102, 1015(a); Reg: 1.102-1, 1.61-9(c)]A. Appreciated Property Transferred by Gift

1. Gifts 102 and 1015: combination of these statutory rules allows a donor to transfer to thedonee the unrealized appreciation in property, if the gift is of thefullproperty

2. Key Q: Has there been an assignment of income from the property or a transfer of property?a. Assignment of income from the property: Gross income to donorb. Assignment of property:No gross income to donor, donee gets stepped up basis (FMV)

B. Transfers of Income from Property1. Generally income from property is taxable to the owner of the property. In these situations, an

owner of income-producing property (eg, stocks, bonds, realestate) gifts income or property.2. Rule: Attempts to transfer income of property independently of property itself are allowed only

if the income interest is transferred for its entire duration. Otherwise, donor will be taxed on theincome, and will be deemed to have made a (nontaxable) gift to donee

3. Blair v. Commissioner: If property is assigned to a person, income from the property is taxedto the assignee (assigned life estate to children).

4. Helvering v. Horst, 311 U.S. 112 (1940) (p. 212): Income that a taxpayerrealizes is taxable tohim even if he never directly receives it. The Dads gift of the coupons constituted enjoymentof the income, and hence the realization, thus income should be taxed to the person whoobtains enjoyment of it. (Taxpayer transferred interest coupons on bond as a gift. Donor hadincome even before maturity date bc no doubt interest would be paid to owner of bond.)

C. Property and Income Transfers Compared1. Moore v. Commissioner, T.C. Memo 1968-110 (p 215): Assigning a mere right to receive

future royalties (future income) of book falls under assignment of income. (Moore did not

transferproperty to his children because he had previously granted all property rights in themanuscript to to publisher by K)

2. Heim v. F itzpatr ick, 262 F.2d 887 (2d Cir. 1959) (p. 216): Coupling a right to income withadditional significant rights elevates a mere bare right to future income to the statuts ofincome-producingproperty. (Along with a right to future royalties in patent, P also assigned abargaining power over ce

income tax reading notes

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