Fed Tax - Final Outline
Fed Tax - Final Outline
Fed Tax - Final Outline
Chevron Standard
For Interpretive Regulations (7805)
(1) Is the statute ambiguous?
If not, the analysis is over and the regulation fails.
(2) Did the agency reach a reasonable resolution of the ambiguity?
(Did the agency stay within the scope of the ambiguity)
Administrative Convenience can play towards a reasonable
resolution.
Whether the regulation comports with statutory construction
precedent. In Mayo, the court said the IRS followed a canon of
construction that exceptions from taxability are to be
narrowly construed; therefore reasonable.
For Legislative Regulations
(1) [Same] Is the statute ambiguous?
(2) [Different] Was the agency arbitrary or capricious in resolving
the ambiguity?
Retroactive Regulations
General Rule: The IRS does NOT have authority to issue retroactive regulations
UNLESS a statute says they can. People rely on the law.
Even if the agency has the power to write a retroactive regulation, they still
can be sued for abuse of discretion.
Held: Chevron standard. Mayo now brought Chevron into the tax world.
In 1996, congress amended 7805 to say that regulations can only be prospective.
ONLY Applies to code sections enacted AFTER 1996.
Most sections were enacted before 1996. IRS can issue retroactive
regulations for these but they can still be sued for abuse of
discretion.
Exceptions:
7805(b)(3) for taxpayer abuse: IRS has the power to issue
retroactive regulations, even for section after 96, to close down
taxpayer abuse. This exception is not well tested in the courts yet.
7805(b)(2) for promptly issued regulations: If the regulation is
issued within 18 months of enactment of the statute, IRS can make it
retroactive to the date of enactment.
RR Deference
RR used to resolve ambiguity in regulation: = Auer Standard (higher than Chevron)
RR used to resolve ambiguity in the code: = Skidmore Deference (lower than
Chevron)
Skidmore also applies to any other form of IRS interpretation of the code
(except regulation, thats Chevron deference). Ex: briefs, etc...
Skidmore Deference:
Courts ultimate question: Whether or not this interpretation is persuasive.
Subsidiary factors:
(1) Was the interpretation (the RR) issued contemporaneous with
the enactment of the underlying statute?
Versus if the interpretation his issued in the heat of litigation.
(2) Consistency: Has the agency been consistent?
This is the big difference between Skidmore and Chevron.
Chevron doesnt care about inconsistency.
Ex. In Mayo, the IRS issued a regulation to change the law
that was very inconsistent, but it didnt matter because
Chevron deference is used there.
Overview of Deference
Interpreting Document
Ambiguous Regulation
Ambiguous CODE
Interpretive Regulation
Chevron 1
(reasonable resolution)
Legislative Regulation
Chevron 2
(arbitrary & capricious)
RR
Auer
Skidmore
Auer
Skidmore
A Private Letter Ruling (PLR) is a ruling that is issued privately to an individual taxpayer
at their request.
Hypo: Client wants to do a transaction but is worried about the consequences and
there is no clear answer. Lawyer drafts a letter to the IRS detailing the facts, relevant
authority, and proposed outcome and asks them to rule on it
IRS charges a user fee (can be expensive, Gans case charged $14,000)
2-3 weeks letter Gans got a phone call (after submitting request with check)-- IRS
says they are litigating in this area and does not want to say anything to prejudice
the litigation.
If they refuse to rule, you get your money back, HOWEVER, hiring a lawyer to do this
is expensive as well-- and we gots to get paid nigga.
Privacy: Often times they contain confidential information. Since they are published rulings,
the confidential information is redacted.
Court Reviewed Decision: Tax court judge files opinion with Chief Judge who
decides its controversial and it will be reviewed en banc (all 19 judges will
look at it and can concur or dissent)
Opinion is published by official tax court reports
Has a lot of precedential effect
Official Opinion: Tax court judge files with Chief Judge who thinks its an
important issue, but not controversial and therefore no need for court
reviewed opinion.
Also published by official tax court reports
Memorandum Opinion: Chief Judge looks at the opinion and theres nothing
novel about the issue.
Not published in official reports but private publishers will come and
publish these opinions. (TC Memo 2011-5)
Forum Shopping
Jury/Sympathy:
Go to district court if you want sympathy from a jury
Expertise:
Tax court is full of tax experts so if the law is against you choose district or
claims court.
If its a complex law in your favor, you may want tax court.
Payment:
Dont want to pay up front = tax court
Pay and sue for refund = district or claims court
Appeal:
Tax Ct. appeal = Federal Circuit (bound by this authority)
District and Claims ct. appeal = taxpayers home circuit (bound by authority)
Go where the law is in your favor
present law is, what the problem is, why change needed, this is the change (proposal) and
how it would work
provides those not on the committee a way to read in plain english what is going on
Once voted on by house floor goes to Senate
2) Senate
Senate Finance Committee:
tax backgrounds
vote on the proposed legislation
Senate Finance Committee Report: what House proposed and how they feel about it, if they
would modify it
Send to the Senate Floor
Senate Floor
votes on the proposed legislation
3) Conference Committee: If the final bill which passed the House and Senate don't agree entirely and are not
entirely the same
Both House and Senate members
Take the bill from House and bill from Senate and find compromise
Once agreed by vote goes back to the House and Senate for final approval vote
Write Conference Committee Report prior to sending it for final approval vote
4) Once approved by both houses Sent to President
5) President
Can (but most likely wont) write memo before approving it
Base Taxation on Benefits: Divide the cost of government based on how much benefit each
person takes from the government [not easily calculated]
a Opposition to Benefits Theory: will end up with regressive tax system
b Regressive Taxation: higher you go on income scale, the less rate of tax you pay (the
lower your percentage would be)
i Ex. $10$100; $1 benefit = originally 10% of income now 1% of income
ii As income goes up, your tax rate would go down ,while benefits remain the same
c Progressive Taxation: higher you go on income scale, the higher the rate of tax you pay
[Our System]
d Flat Taxation: as you earn more, pay the same %
Base Taxation on Ability to Pay: How much ability to contribute to the cost of government
does each person have this year
a what factors should be considered: medical bills, mortgage interest on house?
[Single]
Taxable
Income
Tax Rate
(%)
400k
[Calculated
Tax $ for
bracket]
[Married]
Taxable
Income
Tax Rate
(%)
[Calculated
Tax $ for
bracket]
39.6
450k
39.6
1650
35
51,650
35
215,100
33
70,983
175,300
33
95,400
28
26,782
86,650
28
51,600
25
12,900
73,900
25
18,475.00
27,325
15
4,098.75
54,650
15
8,197.50
8,925
10
892.50
17,850
10
1,785.00
Ex. ($4,991.25 Tax Owed / $36,325.00 Taxable Income ) * 100 = 13.741% Average Tax Rate
Ex. Income 8,920 + 1$. Was all at 10%, even with additional 1%, still in 10%.
Purchasing a home could result in a lower marginal bracket, bc of the new deduction to
taxable income
Arguments Against:
Flat Tax: Simpler
Libertarian view: my money which i earned reflects my worth, and inappropriate intrusion
to take what i am entitled to
Progressive reply: not just your attributes which contributed to your wealth and
success
Progressive Rate could stifle incentives
As marginal bracket goes up - will cause people to not want to work - not worth my
time to work if large % is getting taken by gov
progressive reply: is 35% versus 20-22% really such a large amount to dissuade
someone from working?
Feminist Argument:
w/ joint filing: spouse 1 working and income at top of bracket; if spouse 2 starts to
work, marginal bracket of spouse 2 starts at the next bracket [could file separately
though - very rare]
spouse 2 also incurs additional cost to enter the workforce reducing the income
earned
Flat tax: would eliminate this issue
Leads to Marriage Non-Neutrality: tax law in some way causing people to get married or
avoid getting married
Marriage Neutrality: Penalty / Bonus
Width of taxable income brackets different for married
10% + 15% brackets doubled [no penalty]
higher brackets not doubled
Causes penalty (pay more tax) / bonus (pay less tax) when deciding if you will get married
or not = non-marriage neutral
Argument for marriage penalty:
Economics of Scale: when two people put income together, certain savings, one
house, cost of living goes down, and increases ability to contribute to government
Argument against marriage penalty:
people can choose to live together verse getting married
discourages marriage
To avoid a potential marriage penalty: can continue to file separately
Couple Neutrality
Mathematically impossible to have a progressive tax-rate schedule and marriage neutrality and
couple neutrality
Couple Neutrality: any couple with an income of X should pay the same tax as any other
couple with an income of X regardless of how the income is distributed between the two
Can avoid marriage non-neutrality by file separate returns
NO way to avoid couple non-neutrality in progressive:
Ex. #1 earns and #2 doesnt
married: joint file and gets benefit of a bigger width for tax rate
Couple: have to file separately and keep a higher bracket, even though similar
earning distribution compared to married couple
Chapter 2
Gross Income
Intro
Section 61: Defines gross income
Gross income essentially means economic benefit
(Glenshaw Glass) Punitive damages was gross income. Abandoned old rule that it
was income from capital or labor.
Now, income where there has been an undeniable accession to wealth,
clearly realized, and over which the taxpayer has complete dominion.
A court will find that section 61 is an all-encompassing section (congress intended this)
In doubtful cases, air on the side of gross income
Treasure Trove:
First Question: Is it Gross Income?? [Economic Benefit]
Rev. Rule: Someone who finds treasure trove has income
Treasury Regulation: 1.61-14: Miscellaneous items of gross income: treasure trove
constitutes gross income for taxable year in which it is reduced to undisputed
possession
10
(General Rule) Allow taxpayer to take a deduction on his return when he makes the
repayment
Deduction: dont have to pay tax on that dollar
Problem when marginal tax changes from year reported and year disgorged
Ex. 50% bracket when you paid $6000 income = $3000 tax owed; Repaid dude his
$6000 but now in 10% bracket = get $6000 deduction this year but you are only in
10% bracket = ($6000 x 10%) $6000 deduction worth only $600 tax savings now.
1341 (Special Treatment): Taxpayer who reports income in previous year and disgorges it
in later year, will give you a refund based upon the higher bracket in the earlier year
Narrow exception to general rule
Requires more than $3000
Does Not apply to thief's only innocent people
Taxpayers choice: use 1341 to get the benefit of previous tax bracket or use
deduction in current tax bracket
11
FORM OVER SUBSTANCE!! [No Code Section but available IRS Argument]
Creates Inequity and Distortion.
Inequity: Two people doing the same thing but one is taxed & one isnt
Distortion: As a result of the tax law itself someones behavior/choice is influenced
Barter Transactions
Rev Rul 79-24: Barter transactions constitute gross income
In reality, no mechanism for catching this and hard for IRS to deal with
Form Over Substance
Ex. Two Situations with two people
1 One needs his house painted and painter needs legal advice. Agree to exchange and that value of legal
work and paint job $5k each.
a Constitutes economic benefit even though it is not cash (non-cash benefit has economic
benefit nonetheless)
b BOTH lawyer and painter have $5000 of benefit = gross income.
2 Painter comes to my house and paid $5k. Painter comes after payment and asked legal question
which costs $5k and pays.
a Painter and Lawyer exchanged checks for $5k.
b Constitutes Gross Income for both of them.
12
Two people have difference in form not substance = should be taxed the same
Problems:
Employer buys the tickets, employee gets the miles:
Still Purchase price reduction but EMPLOYER is enjoying it not employee
(miles are not income to employer)
Employee gets miles from employer, as fringe benefit
Benefit to employee = income to employee
HOWEVER, hard to value frequent flyer miles given to employees
Administrative Convenience: difficulty in determining benefit
2002 Service Announcement (ANN 2012-18): Service says we are studying
employer provided frequent flyer mile issue and will get back to you - but
for now dont have to report it
13
Realization Requirement (1001): Dont have to pay tax on increases in value until you
realize them (i.e. sell)
Two Reasons why you dont immediately tax a bargain purchase even though you have
economic benefit:
1 Valuation Difficulty: administratively difficult and onerous to require someone to get a
valuation on every purchase
Much easier to get solid number once the item is sold [need solid number for
return]
2
Liquidity: Person might not have liquidity to pay tax on the purchase, might force them
to sell it
61-2(d) Compensatory Bargain Purchase: economic benefit is income and taxed now
(not when its sold)
1998 Service Announcement (IR 98-56): If you turn down the baseball - NO income
Rev. Rul 66-167: If you turn down economic benefit no income
If you return the baseball in exchange for gifts from the team/owner = NOW Income!!
Determined as if he sold the baseball for things of value and income on the sale - not
a gift from the team/owners
Taxpayer wants to argue they are two separate transactions: (1) returned the
baseball so no income, (2) got gifts from team/owner
Step Transaction Doctrine: If two separate transactions are sufficiently related, IRS
can look at is as if they are an integrated unit
NOT two separate transactions, but returned baseball and immediately got gifts!
15
Assignment of Income Doctrine: Income is taxed to the person who earns it and
cannot shift it to anyone by assignment
Attempting to game the system and tax the income in daughters 10%
bracket not your 35% bracket
Bedrock Proposition: Do not tax imputed income from home ownership (benefit of not
having to pay rent) (Independent Life Insurance Case)
Ex: Why Renting Sucks: Two guys both make 80k a year. One has 100k in the bank and
collects 10k a year interest and uses it to rent (taxed on $80k/yr + $10k interest = 90k). The
other guy used the 100k to buy a home. (only taxed on $80k/yr NO interest).
Horizontal Inequity: If one wants to own and one wants to rent its unfair to tax them
differently.
Vertical Inequity: The more expensive the home, the advantage to the homeowner
increases and the disadvantage to the renter increases.
Distortion: The tax law is sending out a message: DONT RENT, OWN !
Ownership is good. Valuable to the economy and improves neighborhoods.
16
Owning a Car
Indep. Life Ins. applies to ownership of all assets. No imputed income from
ownership.
Might be better to buy the car than using interest from money in the bank because
the interest will be income.
Dean v. Commr: Case where guy owned stock in a corporation which owned a home that
he lived in.
Corporations are separate from their shareholders
The taxpayer has income (not an imputed benefit like in Indep. Life Ins.)
Substance over Form is a One Way Doctrine:
It can only be invoked by the IRS, not the taxpayer.
If the taxpayer chooses a bad form, tough life bro.
Gross income?
No, not yet. This is self created property. (not taxed)
What if she sells them?
Yes, gross income. (taxed)
What if she consumes them?
Not gross income. This is imputed income from services. (not taxed)
Administrative nightmare to tax imputed income.
What if she traded her veggies for fish worth $100?
Barter transaction, both have income. (Taxed)
Chapter 3
Gifts
Consumption Model:
Multi-layer taxation / repetitive taxation
Every time you pay for something, you dont get a deduction and its income for someone
else also
consuming income doesnt reduce taxable income
Spending for personal reasons is not deductible, business reasons is...
17
18
Its a Murky Test: The transferee has to ask himself at the end of the year, what the
predominant motive was of the transferor. Transferee wants it to be a gift so it
doesnt count as income. So if colorably looks like a gift, he probably will treat it as
one.
Donor Intent = Factual Question for the Jury
The courts decision will be reviewed deferentially, not de novo, so they have
to affirm this fact finding issue; requires the finding to be clearly erroneous
to overturn.
This murkiness is bad for the self reporting system because it gives incentive
for people to not to the right thing.
274 Disallowance
To be entitled to a deduction, must be able to show a section which authorizes the
deduction
Disallowance Rule: If the item is a gift to the donee under 102, then the donor CANNOT
take a business deduction.
274 (b): De Minimus Exception:
Although transferee is not reporting it as income by calling it a gift, transferor can take a $25
deduction for each small business-like gift instead of the entire cost as a business
deduction.
Once you get through 162 Business Deduction [Business Expenses on one side
(employer) - Gift on the other side (employee)] $25 Cap for employer deduction
BUT, General Rule: If its a gift in the hands of the payee, the payor cannot take a deduction.
Gans Idea: Rules are not very effective because the donee and donor are each making their own
judgment call about whether its a gift or not. IDEA: make donor send notice to the donee that they
are taking a deduction (it was not a gift - uncomfortable position)
102(c)
If an employer gives an employee something, it is automatically not a gift.
No need to worry about 274 disallowance rule
1986 Amendment to IRC adds a per se rule!
19
Goodwin 8th Cir; Rev. Rul 55-422: gifts made by congregants to the minister are not subject
to 102(c) because the congregants are not technically employers
May not deduct contributions to a person; charitable deductions are permitted
when given to an organization
Analysis
Hypo: Clients invited his lawyer to his daughters wedding. Lawyer gave a generous gift (more generous than
normal because of business relationship); does the couple have income? Can the lawyer deduct it?
Dual Relationships
Employee is also the daughter to the employer
102(c): A gift to an employee is not a gift under 102, and counts as income to the
employee
Duberstein: One of the factors to determine the predominant motivation of the donor is the
nature of the relationship
Familiar relationship and employer relationship !!!!
Williams TC Memo 2003-97: case law indicates, 102(c) should not apply if it can be shown
that the gift was given NOT because of the employer/employee relationship, but because of
the familial relationship or some other aspect, than can get out of 102(c)
Gans: Dont want to have to fire my daughter because I want to give her a gift to help
her with a mortgage payment!
Ex. Mother-employer gives all employees a $120 case of wine at christmas. Son-employee gets a
case of wine worth $700.
20
$120 of the $700 is income because of the sons services as an employee -- every
employee got that
2 Remaining $580 ($700-$120) could be argued as a gift
It was the familial relationship (love, affection, etc.) which was the
predominant motivation for that portion
Mother-Employer-Donor Analysis: Business Deduction?
Two Transfers going on:
1 $120 to every employee
a Business Deduction - Business Expense
2 Remaining $580 to son
a Predominant Motivation for the extra $580 was love, affection, etc - Gift
$120 Deductible - $580 non-deductible
NO $25 Dollar deduction for the $580 because it was determined to be a 102 gift for
the son once it is found a gift cant now deduct by calling it a business expense
Inheritance
102: Inheritance / Bequests / Devises: EXCLUDED from gross income
Intestate: someone dies without a Will
Bequest: giving personal property
Devise: giving real property
21
Nuisance Value:
Someone with no case (a nuisance) is contesting a will. The estate decides to settle
for $10k instead of paying $100k for Trial.
Underlying claim nature is inheritance Excluded as income, even nuisance value
settlement (too complicated to create a nuisance exception)
Per Se Rule: If taxpayer was an intestate taker, any recovery he gets is inheritance
Contract claim: promise to add someone to a Will and they fail to do so before dieing
Underlying claim is relating to inheritance and any verdict/settlement will be seen
as a gift
When both Contract claim and Quantum Meruit claim are alleged, and none have been
dismissed, Contract claim is more important, and any verdict/settlement will be based on it
for income determination
Ex. Attorney renders services for chicks divorce in exchange for bequest of certain stock in Will when she
dies. Income to Attorney? [Post-Duberstein]
Predominant Motivation in giving attorney the stock?? [ 102 - Duberstein]
Found: Compensation for services = Income, NOT gift
SCPA 2307: Executor entitled to commission for services rendered as executor and it is a
percentage of the estate
Merriam Case: In Will, I bequeath the sum of $20,000 to my friend John in lieu of all compensation
for the services he renders as my executor.
Compensation and Income - or - Bequest and NOT income?
Predominant Motive: Services
Language: Bequest
Treated as Bequest because of the language
Settlement Agreements
Settlement Agreement is taxed the same as you would a recovery on the underlying claim,
no different if a court verdict
Hypos on P.66-68
Chapter 4
Adjusted Gross Income (AGI)
22
62: Adjusted Gross Income: List of what deductions you can take Above
the Line. (Gross Income) - (Some Deductions) = Adjusted Gross Income
Includes: Business Expenses of a Non-Employee
Ex: Sole Practitioner / anyone without a boss
Itemized Deductions
If your expenses are above the standard deduction amount,
prefer itemized
Required to prove you are above the standard deduction
amount and list each expense
[Income Tax return 1040 Schedule: lists itemized
deductions]
Analysis:
1 Calculate Gross Income (accounting for any proper Exclusions)
2 Subtract 62 and other appropriate Deductions
3 Calculate Adjusted Gross Income
4 Decide if you want Standard Deduction or Itemized Deduction
5 Calculate Taxable Income
Ex. Sole Practitioner makes $100k, pays secretary $50k. Taxable Income for Lawyer? [Assume SD = $11,600]
a Gross Income $100k
b Any Deductions?
i
162 Business Deduction permitted
ii Applied Above the Line or Below the Line?
1 62: non-employee expenses (sole practitioner = has no boss; if he was an
associate it would be employee expense and below the line)
iii Salary of secretary is applied Above the line
c Adjusted Gross Income = $50k ($100k - $50k)
d Below the line deductions?
i
No other deductions in hypo
ii Choose to take Standard Deduction $11,600
e Taxable Income = $38,400 ($50k - $11,600)
Medical Expenses
213: The first 7.5% of your Adjusted Gross Income is essentially a haircut on your
medical deduction
Ex. $100k AGI; Medical Expenses $10k. 7.5% of $100k = $7,500. First $7,500 is
income, anything remaining is deductible = $2,500.
Reason for Haircut: Involuntary medical expenses affect the ability for the taxpayer to
contribute to the cost of government
A lot of medical expenses viewed merely as consumption
Used for unfortunate, serious and extraordinary medical expenses
Medical Expense Deduction applied Below the Line
Below the line deduction is not necessarily going to pan out into tax savings. May not have
value if you choose to take the standard deduction.
Ex. Law School says they wont pay for JIBL or AZTECH so Professor pays it himself for $1,000.
a Deduction?
i
162: Business Expenses
b Above the Line or Below the Line? 62
i
Since Professor is an employee goes Below the Line
ii If he was non-employee Above the Line
c Standard Deduction v. Itemized?
i
Applied Below the Line: Will use Standard Deduction! No tax savings.
d MORE likely to ask the Law School to pay him $99,000 and $1000 for the stupid shitty
Journal!!!
i
Journal $1000 could then be excluded from professors income as Working
Condition Fringe (Infra) [Straight $1k off Gross Income]
24
Employee Expense goes Below the Line, and must be itemized if you want to claim a
deduction greater than the Standard Deduction
Ex. Professor again; AGI $100,000; All of the employees business expenses: $1,000 JIBL & $500 ACTEH, $500
Conference = $2,000.
a AGI: $100,000
b Deduction? 162 Business Expenses
c Above or Below the Line? 62 Employee Expenses Below the Line
d 67 Employee Business Expenses: Miscellaneous Itemized Deduction
i
2% of $100,000 = $2,000
ii Can take deduction on anything over $2,000
iii Professors total expenses were only $2,000
e NO deductions!!! Only paid $2,000 and no Expenses over that to get deduction!
f
Paying tax on $100k AGI and also had to pay $2,000 for expenses!
g Like Above: Better to work with law school to get less salary and have them pay for expenses
so they are fall into Work Condition Fringe, and get excluded from Professors Gross Income
Fringe Benefits
Fringe Benefits:
Something you get from employment relationship over and above salary
Ex: Frequent flyer miles
Not a gift because of 102(c) [employer to employee] but can still exclude from employees
GI
25
26
Anti-Conglomerate Rule: Only get exclusion for the no additional cost service fringe
or qualified employee discount if item you are purchasing is in the same line of
business that you sell for the company
If employer sells to the employee such that the price is less than their cost
INCOME to employee is difference between employee price and employers cost
Look at profit markup for the entire year.
Ex: Company bought $1 million in goods and had $2 million in profit. 50%
profit and 50% cost, so they can give their employees a 50% discount
without them having any income.
Company has 50% cost. Item normally sold for $100 but they sell to
employee with a 70% discount. Employee has $70 economic benefit
but only $20 will be income. [employee paid = $30; employer cost
$50]
De Minimus Fringe
Things that are low in value and not worth keeping track of.
Requirements: Low value, traditional, holiday/birthday, and NOT cash
Ex: Employer provides coffee. Employer is going to deduct this and the
employees are going to exclude it as a de minimus fringe. We tolerate this
violation of the business income model.
27
Lodging Requirements: (1) the convenience of the employer; (2) required to use it as
condition of employment; (3) it must be on the business premises of the employer
Employer can only give the employee the right to use the property, NOT title
Meal Requirements: (1) convenience of the employer; (2) business premises requirement
Gans doesnt think theres really a difference.
Ex: Maid/Butler/Chef who lives on the premises and gets free lodging and meals.
Note: Just because the employment contract has a clause saying that lodging is a
condition of employment doesnt mean it qualifies under 119. Provisions will not be
determinative (substance over form)
Dobbe: TC Memo 2000-330: Groceries do not qualify for excluded meals under 119. If
employee gets whatever groceries he wants, that is income. No coercive effect from
employer since employee is making the decision. If employer buys the groceries and
employee has no choice, then probably 119 exclusion.
Hypos on P.80-82
28
Herbert Hatt Case: Dude had a funeral home, he lived there and worked there. He
incorporated it and claimed lodging and meal exclusions under 119. It was allowed,
although it violates substance over form because if he didnt incorporate he wouldnt have
been an employee and would not qualify for 119. (form over substance!?)
Tax laws buy into the corporate fiction that a corporation is a separate and distinct
entity. The IRC will respect the fact that if you work for your own corporation youre
an employee.
Hatt could now pay the residence portion of utility bills and for his personal meals
with the corporation. The corp would take a business expense deduction and he
would exclude his personal benefit from his gross income. This is a violation of the
business income model.
Commr v. Kowalski: State troopers were provided a cash reimbursement for their meals.
They tried to get this excluded under 119.
Supreme court held that there is a difference between the use of the word meals
and cash reimbursement and construes the term meals narrowly.
meal: meal provided in kind, not a cash reimbursement for a meal
Rule: 119 does not apply when employer provides reimbursement for meals you
had over time.
66-94: Imposes civil penalties on preparer of return (advisor) for taking a position without
sufficient foundation.
Circular 230 (10-34): same as 66-94, civil penalties and violations, can result in disbarment.
Chapter 5
Prizes and Awards
74 Prizes and Awards:
Prizes and Awards constitute gross income. (Economic Benefit)
Prior to 74 taxpayers have argued it was a gift under 102 and therefore excludable from
gross income.
Ex: Prize on a game show, the predominant motivation is business reasons,
therefore seems like a gift under 102. However, now 74 is a per se rule that does not
allow the gift argument for prizes and awards.
29
170: Charitable Contribution Deduction: A below the line deduction with a limit
on how much you can deduct. A person cannot deduct more than 50% of their AGI
under this provision in any given year, the excess is carried over to the following
year for up to 5 years.
Rule: Code says that the 50% rule from 170 does NOT apply if giving an award
directly to charity. (Avoids the above problem)
Must go directly from organization giving the prize to the charity, cannot
accept the award then give it to charity yourself.
Remember: Only the government can make a substance over form
argument. Taxpayer must be careful here.
274(m)(3): Employer cannot take a business deduction for the cost of sending his
employees wife on the business trip with him.
Education
Scholarships
30
117: A student who is a degree candidate can exclude a Scholarships from income (per se
exclusion)
1986 Amendment: Removed the Room and Board exclusion ONLY exclusion for
Tuition (1986 - widening the base to lower taxes and removed some exclusions)
117(c): If you are getting a scholarship in exchange for past, present, or future
services rendered that portion is NOT excludable and constitutes income
Ex: School gives $10,000 of scholarship, but $5,000 is room and board and $5,000 is for
tuition.
Only the tuition portion is excludable.
Ex: School gives $10,000 of scholarship but requires $1,000 of services (work in library)
The services portion is not excludable under 117. ($9,000 excludable)
Athletic Scholarships
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Rev. Rul 77-263: Athletic Scholarships are NOT income and are excludable
Seems like compensation for services, but not income
Reciprocal Plan: Employers can set up reciprocal plans with other employers, so that the
employee of 1 school can send his daughter to a reciprocating school for free and still
exclude the cost of the tuition.
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Solo practitioner paying for a $2,000 course in tax law = Deductible business expense.
Carrying on his business and incurred the expenses to hone his skill
Deductible Above the Line because he is a non-employee.
Gans paying for a $2,000 course in tax law and Employed of Hofstra. Deductible business
expenses for Gans.
Carrying on his business and Gans incurred the expenses to hone his skills.
Deductible Below the Line because Gans is an employee
Requires itemized deduction
Subject to 2% haircut rule
Hofstra pays for a $2,000 course in tax law for Gans. Deductible business expenses for
Hofstra, Working Condition Fringe for Gans. (Money disappears from tax system)
Hofstra: gets a business deduction because they are carrying on their business by
honing their professors skills.
Gans: gets to exclude this as a working condition fringe because he would have been
able to take a business deduction had he paid for the class himself.
Employer pays for bar prep course to all new associates (nondiscriminatory).
Employee: CANNOT qualify for 117 Scholarship - Required to be in pursuit of a
degree - License is NOT the same as a degree (ALSO if required to work would be
seen as compensatory and not scholarship)
Employee: NO working condition fringe - Employee could not get 162 Business
Deduction if they had paid it himself
127: Can exclude $5250 [INFRA]
Chapter 6
Gains from Dealing in Property
Basis
61(a)(3): Gross Income includes Gains derived from dealings in property
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Realized Gain/Loss
Loss:
When 1001 computation shows a loss, you dont automatically get a deduction.
1001 only gives a computation and doesnt authorize a deduction.
Note on Casualty Loss: Can only deduct the casualty to the extent it
exceeds 10% of AGI
Ex: AGI is $ 100,000. Your $40,000 car fuckin explodes. You
can only take a loss of $30,000. (10% of AGI is $10k, $40k $10k = $30k)
The code relates the loss to your income to assess your
ability to contribute to the cost of government.
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Concept of Deferral
Taxpayers love deferral because it has economic value by giving the taxpayer the
opportunity to earn money/interest on money that would have gone to the IRS.
Taxable Exchange
Giving up one asset for another. Taxpayer wants to enjoy the continuation of the deferral.
The code doesnt allow this and it is taxable on the spot.
Generally exchanges are taxable. (The realized gain will be recognized.) (Barter)
Ex: Trade $500,000 worth of stock for $500,000 shopping center. (Bought stock a long time ago for
$1000 so basis is $1000). The taxpayer was enjoying the deferral on the stock all these years, and
wants to continue to defer the tax until he sells the shopping center. The code says no! This is a
taxable exchange and his realized gain ($499,000/ value of shopping center) will be recognized
(taxable).
When you do a taxable exchange [i.e. you can calculate realized gain and therefore pay tax
on that amount] your basis in the newly acquired asset is equal to the fair market value
Peel Rule:
Calculating your Basis in the received asset when you do an exchange and have a Deferral
No Recognized Gains (Ex. Dont know value of either asset - Philly #3; 1031 Exchange INFRA!!)
When you acquire land for $100, lets say you put a note on it indicating the basis of
100
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When you do Philly Rule #3 Deferral you peel the note off the asset you
originally had and attach it to the new asset which you received [Same applied for
1031 Exchange]
Philadelphia:
Exchanges are generally taxable, but on occasion there might be a nontaxable exchange
1012: when you purchase an asset its basis is equal to cost
1001(c): all realized gain is to be recognized gain except as otherwise provided
Recognized Gain: realized gain which gets added to gross income; some code
sections provide exceptions which will prevent realized gain from being recognized
gain
When you qualify for a 121 exclusion - it is permanent - NOT a deferral
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[KNOW VALUE OF BOTH] Basis in newly acquired asset is equal to the fair market value of
asset received
a Dont want to double tax on same gain
b Accounted for any gain recognized already stemming from the transaction and paid
tax on that, so now your basis in the new asset accounts for that
c Function 1 and Function 2
[DONT KNOW VALUE OF ASSET BEING RECEIVED] If you dont know the value of the
asset received, the value of asset received is equal to the fair market value of the asset given
a Need to think about the amount realized of received asset; if receiving a painting
and dont know value, infer the value is equal to the value of real estate which is
being given
b Use this assumed amount realized to calculate your realized gain from the
transaction
[DONT KNOW VALUE OF EITHER ASSETS] If you cannot determine the value of either
asset, cannot determine amount realized, will not tax the exchange!! Allow you to defer the
gain!!! [PEEL Rule Applied]
a Taxed when you sell the asset you received -- accounted for when you can
determine an amount realized from a sale to someone else [occurring after the
original exchange]
With Real Estate: requires a Qualified Intermediary if the owner of the property you want
doesnt want to exchange for your property but wants cash!!
For a fee: a third party buys the property you want from the original owner who
wants cash not trade, and then exchanges with you under 1031, than third party
sells your original party
Example 1:
Farmer 1 wants to exchange land with his neighbor, Farmer 2; Exchange Taxable?
Farmer 1 paid $100 for his land = Basis in his original land
Farmer 2s land value being exchanged = $500 = Amount Realized
Amount Realized - Farmer 1 Basis = Farmer 1s Realized Gain
$500 - $100 = $400 Realized Gain to Farmer 1
1001(c): All Realized Gain = Recognized Gain unless exception applies
NO Philly Exception: Know Value of Each Asset
1031: LIKE-KIND exchange !!!
1031 permits tax to be deferred
Farmer 1s Basis in his new asset??
PEEL Rule: Because of 1031 Deferral, No Recognized Gain during Exchange
Peel his $100 Basis and put it into New Asset
Example 2: Real Estate Investment
Own a shopping center in NY and want to buy one in FL
NY shopping center cost $100k = Basis in NY shopping center
FMV = $1,000,000
If straight up sale: $900k Realized Gain
Find Florida shopping center with FMV = $1,000,000
Setup 1031 exchange!
Like Kind exchange of asset used for investment
No Recognized Gains = Tax Deferred
Peel Rule: Carry over $100k basis from original NY shopping center to florida shopping
center
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Boot
You can do a 1031 exchange to get a piece of property that CVS wants to escape
paying tax while also getting rent payments!
NOTE: still paying tax on the income from rent payments!
In reality: you have a piece of paper - promise from CVS to pay rent - not property
Exchanging property and one person is getting extra cash on the side because the fair
market values are different [real world situations]
Receiving cash does not qualify as a like kind property under 1031
Separate and tax the cash portion while the land exchange gains a 1031 deferral
Dealing with boot - In non-recognition model:
The amount of gain recognized is equal to the lesser of: (1) the realized gain;
OR (2) the amount of boot received
$105
+ $0
- $10
$95
$5
$5
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+ $5
$100
109: Even when the lease terminates, its still not income. Will be taxed when its sold.
Supreme Court Intent Question: Was the improvement intended as additional rent or was it
more in the nature of something the tenant wanted. (now adopted in reg. 61-8(c))
Dont want to let Blatt rule exploit barter situations
Ex: Build a movie theatre on my property, use it for 5 years and I wont charge you
rent = INCOME! Taxed now, no deferral.
Note: Draft a good lease! Language should say any structures built are to facilitate
tenant business and is not intended as rent.
Gans: Intent allows taxpayers to play with issue and avoid the income
outcome.
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If Painting is an Investment: 132 doesnt apply and need to recognize 1,000 of income.
Function 1 = 9,000
Function 2= 1,000
Basis = 10,000
Basis in Gifts
1015: Basis of Property Acquired by Gift
The gain that accrued on the donors watch shifts to the donee.
The donee recognizes the gain when its sold. (Not when received! - 102)
Donees basis = Donors basis.
Basis remains permanently fixed to the asset when gifted. (sticky note).
Hypo: Gans has an asset he bought for $ 1k (basis) and now its worth $ 2k. He shifts it to his
daughter-- not income to daughter ( 102). What happened to the $ 1,000 of gain? Does it
disappear? Tax to Gans when he makes the gift (like a sale)? Tax to daughter when she
sells?
1015: Donee basis = donor basis
Tax to daughter when she sells. (Her basis = $ 1,000)
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We dont care about Gain shifting because most gain that one has from selling an
asset is Capital Gain which has a max tax rate of 20%. People cannot shift capital
assets to lower their marginal bracket. (As seen with income shifting).
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HYPO:
Examples
1041 Today: Husband and Wife Getting Divorce
Husband and Wife are getting a Divorce. Asset A: FMV $1,000,000 - Basis $0. Asset B: $1,000,000 - Basis:
$1,000,000. Husband has title to both. Husband wants to give an asset to wife in exchange for a waiver of her
rights.
Representing Husband: Husband owns both assets and wants to make the transfer
Husband gives Asset A (FMV: $1,000,000 with $0 basis) to his Wife
1041 NO gain recognized
Representing Wife: Gets Asset A in exchange for waiver of rights
Asset A carries over the Basis of $0 to the wife!
When she sells, she will have huge gain ($1,000,000)
She thought she was getting a 50-50 split of the assets and both were walking away with
$1,000,000! WHEN SHE SELLS SHE WILL GET BENT OVER!
Whoever gets the asset with basis of $0 needs to get compensated for taken on that liability
For Divorce Lawyer: Two Columns for each asset - (1) FMV (2) Basis!!
Two Consequences of Gift Model
1 Transferor recognized no gain
Wife: Asset with Basis of $1,000. Husband buys it from the wife for $7,000 in Cash.
Husbands Basis?
Under 1041: Subject to Gift Model
Wifes basis is carried over with property = $1,000
How Much Gain Does Wife Recognize?
1041: NO GAIN recognized
ALL DAY:
Two Assets both worth $1,000,000. Husbands Basis - $0. Wifes Basis - $500,000. Agree to exchange.
Husbands Recognized Gain?
Acquired an asset with $1,000,000 with a Basis of $500,00 in exchange for an asset with
$1,000,000 and a Basis of $0.
Has Realized Gain But does it become recognized gain?
Taxable or does any rule permit tax free exchange.
Feels like spouse could apply ( 1041) NO gain recognition = gift model
ordinarily this would be taxable exchange (1,000,000 - 0 = 1,000,000) but 1041
prevents it from becoming recognized gains
Husbands Basis in new asset?
1041: Basis is attached to the asset when exchanged
Husband got Wifes asset which had a basis of $500,000.
Husbands Basis in the new asset = $500,000
Wifes Gain?
Realized Gain ($1,000,000 - $500,000 = $500,000) but 1041 cuts it off
NO Recognized Gain
Wifes Basis in asset received?
1041: basis is attached to the asset during exchange
Wife gets basis of the asset which she received = $0 (The Basis which Husbands asset had)
Wife is pissed off: lost her $500,000 Basis and received an asset worth the same as what she gave
up!!
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All capital losses can only be deducted to the extent that you recognize capital gain that
year. (Usually will be stocks).
Capital Losses are deductible ABOVE THE LINE
Two Exceptions:
De-minimus Rule: Can deduct up to $3,000 even if no capital gains. (Can go
against ordinary gains)
Can carry over loss into future years indefinitely: Until there is capital gain
to deduct from, and deduction is used up.
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If there is a Loss
To Compute Loss, the Donee must use as basis, the lesser of the donors basis OR the
fair market value of the asset at the time of the gift.
Ex: Donors basis in a gift is $ 100. FMV at the time of gift is $ 50.
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Donee sells for $ 30 [Represents a loss when selling under the FMV when gifted]
B/c there is a loss, can use different basis calculation.
Basis = lesser of donors basis or FMV at the time of gift [Basis = $ 50]
Donee can report a $20 loss. (assuming 165) ($30 - $50 = - $20)
IRS Reg:
Gans Basis?
Realized Gain = $40
Sold for $50 with Basis of $10.
Daughter Basis?
Basis in Asset = $50
Donee investment = $50
Gans original basis of $10 + $40 = $50 (also equal to what she
invested)
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FMV = $100 & Price = $50 price represents of asset - Basis is split evenly
1/2 of the total $10 basis for each transaction = $5
Selling Half: Price = $50, Basis = $5
Gifting Half: Basis $5 carried over because it is attached to asset
Donor Gains:
Sale: AR ($50) - Basis ($5) = Realized Gain ($45)
DIFFERENCE FROM LAW: LAW puts full basis into sale aspect, and
nothing apportioned into gift aspect
Gift: No Gains from a gift
The basis of an asset acquired by testamentary gift is the fair market value of the asset at
the Donors death.
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The Old Loophole: Gift asset to dying friend and have them give it back in their will.
This can increase your basis to the FMV!
Rule: 1014(e): If the gift is made to the decedent within 1 year of death and then the
asset is bequeathed back to you or your spouse, you do not yet the 1014 basis
adjustment.
Note: Only to you or your spouse. The loophole doesnt count your children
or anyone else. However, service may argue step transaction doctrine and
substance over form. Taxpayer then argues that death was not a prearranged step.
Ex: Employer has an asset worth 100 with a basis of 10. Employer decides to give the
asset to employee as a gift
First Tier of Analysis (Amount Realized)
Employee will have income (102[c] not a gift). The income is equal to FMV
so income = 100.
Employer can take a business deduction.
Need to get appraisal to know the value of the deduction (which triggers the gain). Still no
sympathy because the gain will never be higher than the deduction. (Gain will never be
higher than the value of the asset by definition).
Ex: Husband is the employer and Wife is the Employee. Husband gives
wife/employee an asset. 1041 applies, not International Trading.
Recap: 1041 = spousal transfers are treated as a gift (gift model 1015)
Depreciation Deductions
167 and 168: Depreciation Deduction
In order to take a depreciation deduction, the asset must be used in trade or business, or to
produce income.
Some things are never subject to depreciation deductions
Land is not subject to depreciation deduction. (Doesnt get used up).
However, the cost of improvements can (Ex. build factory on land).
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Ex: $5,000 machine with a life of 5 years. It produces 1,200 of income per year.
In effect: Investing 5000 to make 6000. (1,200 x 5 years - 6k)
Assume it will depreciate on a straight line basis (1k per year for 5 years)
In year 1: 1,200 of income, 1,000 depreciation deduction. (200 income).
200 per year for 5 years = 1000 (same in effect).
Borrowing:
If I lend someone $100, that person doesnt have income because there is no real economic
benefit.
Have $100 cash but $100 liability to repay
Buying an asset without the cash:
Seller Financed: Buy an asset from seller and pay the seller an amount in
installments over a number of years
Borrow Cash: Buy an asset from the seller and he gets a lump sum, I repay the
lender
lender might want mortgage on the asset, so he can get the asset if you dont
pay
Someone Buys Asset with Mortgage on it
Selling an asset with a mortgage on it - TRIGGERS DEBT - Buyer cannot take over mortgage
When someone takes over your mortgage:
You see Economic Benefit!!
Buyer is taking over your liability!
If your debt is assumed by purchaser, it enters into Amount Realized, as if you
received valuable consideration [Crane]
Disposing Debt - included in Amount Realized
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Now that you have a basis you can take depreciation deductions against that basis!!
Ex. Buying an asset with borrowed money for $100. Note says you will promise to repay $100.
Asset has 5 year life, and you want to take depreciation deduction in year 1.
Even though you didnt invest capital yet - treated as if you did because of promise to repay
the $100 loan
Because of high likelihood of repayment - Can now include the loaned money into
basis calculation
Basis = $100
Now that you have a Basis, can take depreciation deduction which in turn lowers that basis!
$100 FMV and 5 year life = $20 / year depreciation deduction over the 5 years
Basis will be reduced by $20 - giving you $20 depreciation deduction / yr
Example: Calculating Gain [Basis = loan b/c high likelihood of repayment]
Someone agrees to buy my building for $120. I got $100 note from bank when I bought it
originally. Building is encumbered by a mortgage!
$120 (AR) - $100 (b) = $20 (Gain)
Pay Back $100 to bank and see $20 Gain!
Made $20 Gain without ever actually investing any money!! [Concept of Leverage]
NOW: I took depreciation deduction in 1st year. SOLD building in 2nd year.
B: $100 - $20 (depreciation deduction) = $80
$120 (AR) - $80 (B) = $40 (Gain)
$20 of Gain is from sale
$20 of Gain is from depreciation recapture (took false depreciation since
asset didnt lose value - need to pay this back!)
NOW: Took depreciation still, SOLD for $80.
$80 (AR) - $80 (B) = $0 (Gain)
Asset DID lose value - depreciation!
I saw $20 loss of investment.
Recourse v. Non-Recourse Note
Recourse Debt: (Personal Liability) - If you dont pay back the loan, lender can sue you
personally
Non-Recourse Debt: (Involves a mortgage) - If you dont pay back the loan, only recourse is
against the asset, not against the person
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Non-Recourse Note:
3 Ways Non-Recourse Debt can originate:
1 Purchase asset and provide in note it will be without recourse against me
a Bank will likely charge extra interest in exchange for the higher risk
2 Own an asset encumbered by a mortgage; Purchaser comes and agrees to take over
the mortgage; and purchaser agrees to assume the mortgage.
a Assume: purchaser agrees to pay and will be personally liable for failure to pay
b Subject to the mortgage: purchaser taking on mortgage that is non-recourse,
purchaser is not personally liable to repay
i So if dont pay: purchaser will lose the property but the bank can still
come to original person, not the purchaser
3 Original Person had Recourse Debt but died. Person who inherits an asset through a
will is not personally liable on the mortgage, the debt becomes non-recourse.
Crane
Basis for income tax purposes with Non-Recourse Debt: [Crane]
Non-Recourse Debt treated the same as Recourse Debt and included in basis!!
Assumed you will repay the mortgage - so treated as if you paid in cash from your
pocket = capital investment
Ex. Calculating Basis on Inherited Asset with Mortgage. FMV = $10; Mortgage = $10K
1014: basis when you inherit an asset is the FMV
Property Subject to Mortgage = $10k
FMV = $10k with Mortgage = $10k NO Equity
Assumed she will repay the mortgage
Treat Recourse and Non-Recourse the same
Basis = FMV!! [$10k]
If basis started at $0, each repayment of mortgage would provide an upward basis
adjustment (investment of capital), creating a very messy situation
Abuse of Crane:
Negative Equity: Value of the asset is way less than the amount of the debt
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Can only include non-recourse debt into basis if there is a likelihood of repayment
Likelihood of Repayment: Where the value of the asset is at least equal to the debt
[like Crane] or greater than the debt
If the value of the asset was less than the debt (negative equity), NO likelihood of
repayment, CANNOT include non-recourse debt into basis
Tufts
Any Debt You get Rid of is Included In Amount Realized (even non-recourse debt) [Tufts]
Tufts Rule: Any debt you get rid of, even non-recourse, is included in
amount realized. (IRS wins, he had a gain of 400,000).
Dont care about the Crane likelihood of repayment test at the time of the sale.
Only at the time of purchase to determine basis (for false depreciation deductions).
Capital Gains
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Ex. Bought asset for $10k. Took depreciation deduction of $10k, and basis is now $0. If you sell for
$10k, NO loss in value. [$10k(AR) - $0(Basis) = $10k(Real. Gain)]
Took depreciation deductions on false premise! The asset did not lose value!
When you sell: need to make amends gain
Taxpayer took the depreciation deductions at 35% Rate.
Does taxpayer make amends gain use gain capital rate (@ 20%) or ordinary gain marginal
bracket rate?
$10k deduction at marginal bracket of 35% worth $3,500 savings.
$10k deduction at capital gains rate of 20% worth $2,000 savings.
Using 20% Capital Gains rate wouldnt fully make amends
Deduction was used at Ordinary Gain rate - Recaptures Deduction should be at the same
rate!!
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