Table of Contents Back to eTextbook Cover Page, 1 Title Page, 2 Copyright Page , 3 Preface, 4 Table of Contents , 6 PART I: OVERVIEW

W OF TAXES AND THE FEDERAL INCOME TAX SYSTEM, 18 Chapter 1: Introduction to Taxation, 19 Introduction, 19 Why Governments Must Tax, 20 Allocating the Tax Burden, 20 Deciding on a Tax Structure, 21 Major Types of Taxes, 23 Property Taxes, 23 Sales and Use Taxes, 25 Excise Taxes, 26 User Fees, 27 Wealth Transfer Taxes, 27 Employment Taxes, 29 Federal Income Taxes, 31 State and Local Income Taxes, 37 The Makings of a ?Good" Tax , 37 Make It Fair, 37 Make It Efficient, 38 Factors Taken Into Consideration When Creating a Tax, 39 Equity Concerns, 39 Social and Economic Considerations, 40

Redistribution of Wealth, 46 Administrative Convenience, 46 Political Considerations, 47 The Importance of Studying Federal Income Tax Laws, 47 Summary, 48 Chapter 2: Understanding the Federal Tax Laws, 56 Introduction, 56 History of the U.S. Federal Income Tax, 57 The Legislative Process, 57 Internal Revenue Code, 59 Amendment of the Code, 59 Primary vs. Secondary Sources of Tax Law, 59 LEGISLATIVE AUTHORITY, 60 The Internal Revenue Code, 60 Committee Reports, 63 Blue Books, 64 Treaties, 65 ADMINISTRATIVE AUTHORITY, 65 Treasury Regulations, 65 Stages of Regulations, 66 Types of Regulations, 67 Authoritative Weight Accorded to Regulations, 68 IRS Pronouncements, 70 Revenue Rulings, 71 Revenue Procedures, 72 Written Determinations, 73 Other Pronouncements and Publications, 76 JUDICIAL AUTHORITY, 77

Trial Courts, 78 Tax Court, 78 District Court, 80 Court of Federal Claims, 81 Appellate Courts, 82 Courts of Appeals, 82 The Supreme Court, 85 RESEARCHING THE TAX LAW, 86 Tax Planning vs. Compliance Research, 86 Tax Evasion vs. Tax Avoidance, 86 Tax Planning Strategies, 87 Ethical and Professional Standards, 87 Professional Standards for Tax Research, 88 Federal Standards for Tax Research, 89 Secondary Sources of Tax Authority , 91 Tax Services, 92 Citators, 92 Periodicals and Other Publications, 93 The Tax Research Process, 93 Gathering Facts, 93 Identifying Issues, 94 Locating Relevant Sources of Authority, 94 Analyzing and Evaluating Relevant Authorities, 95 Developing Conclusions and Recommendations, 95 Communicating Research Findings, 96 Summary, 96 Chapter 3: Tax Accounting, 102 Introduction, 102

Tax Accounting Distinguished from Financial Accounting, 102 ACCOUNTING PERIODS, 104 Permitted Tax Years, 105 Required Tax Years, 105 Section 444 Election, 107 Adopting a Tax Year, 108 Changing a Tax Year, 108 Business Purpose Tax Year, 108 Requesting a Change in Tax Year, 110 ACCOUNTING METHODS, 111 Permissible Methods of Accounting, 112 Limitations on the Use of the Cash Method, 112 Special Methods of Accounting, 115 Cash Receipts and Disbursements Method, 115 Accounting for Income, 115 Accounting for Expenses, 117 Other Special Rules for Cash Method Taxpayers, 120 Accrual Method of Accounting, 120 Accounting for Income, 120 Accounting for Expenses, 122 Hybrid Method of Accounting, 126 Special Accounting Methods, 126 Installment Method of Accounting, 127 Long-Term Contracts, 127 Research and Experimental Expenditures, 130 Crop Method of Accounting, 131 Soil and Water Conservation or Endangered Species RecoveryExpenditures, 131 Adopting an Accounting Method, 131

Changing an Accounting Method, 132 Automatic Changes, 132 Claim of Right Doctrine, 132 Tax Benefit Rule, 133 Summary, 134 PART II: FEDERAL TAXATION OF BUSINESS INCOME AND DEDUCTIONS, 140 Chapter 4: Federal Income Taxes and Gross Income, 141 Introduction, 141 CALCULATING TAXABLE INCOME, 142 Taxable Income Formula, 142 Overview of Gross Income, 144 Gains from Sales or Exchanges of Property, 144 Items of Gross Income Unique to Individual Taxpayers, 145 Exclusions, 146 Overview of Deductions, 146 Capital Expenditures, 147 Losses from Disposing of Business or Investment Property, 147 Expanded Taxable Income Formula for Individual Taxpayers , 149 CALCULATING TAXES OWED, 151 Regular Income Tax Liability, 152 Tax Rates for Corporations, 152 Tax Rates for Individuals, 155 Tax Rate for Personal Service Corporations, 156 Alternative Minimum Tax, 157 Corporate AMT, 158 Individual AMT, 158 Self-Employment Tax, 159 Tax Credits, 159

General Business Credit, 160 Foreign Tax Credit, 161 Minimum Tax Credit, 161 Prepayments of Federal Income Taxes, 161 Estimated Tax Payments, 162 Avoiding the Underpayment PenaltyCorporate Taxpayers, 163 Avoiding the Underpayment PenaltyIndividual Taxpayers, 164 GROSS INCOME, 164 Identifying Income, 165 Gross Profit, 167 Gains from Sales of Property, 168 Rental Income, 169 Dividend Income, 170 Interest Income, 171 Distributive Shares from Flow-Through Entities, 175 Other Items of Income, 175 Exclusions, 176 Municipal Interest, 176 Dividends Received Deduction, 177 Improvements Made by a Tenant, 179 Cancellation of Indebtedness, 179 Life Insurance Proceeds, 180 Summary, 180 Chapter 5: Business Deductions: Ordinary and Necessary Business Expenses , 186 Introduction, 186 General Requirements for Deductibility, 186 Ordinary and Necessary, 187 Reasonable in Amount, 187

Not Capital in Nature, 187 Not Otherwise Disallowed, 190 Timing of the Deduction, 192 Organizational Expenditures, 193 Beginning of Business Operations, 194 Election to Amortize, 195 Start-Up Costs, 195 Start-up Costs Distinguished from Other Types of Expenses, 196 Start-up and Acquisition Costs for Abortive Business Ventures, 196 Election to Amortize, 198 Interest Expense, 198 Deficiency Interest, 198 Investment Interest Expense, 198 Required Capitalization of Interest, 199 Taxes, 200 Research and Experimentation Expenditures, 202 Activities That Constitute Research and Experimentation, 203 Research Credit in Lieu of a Deduction, 204 Special Rule for Patents, 204 Dividends Received Deduction, 205 Domestic Production Activities Deduction, 205 Domestic Production Activities, 206 Calculating the Amount of the Deduction, 206 Bad Debts, 209 Computing the Amount of the Deduction, 210 Proof of Worthlessness, 211 Charitable Contributions, 212 Qualified Charitable Organizations, 212

Calculating the Amount of the Contributions, 212 Timing of the Contributions, 215 Limitations, 216 Sequencing of Deductions, 217 Substantiation, 219 Business Gifts , 220 Summary, 221 Chapter 6: Business Deductions: Employment-Related Expenses, 230 Introduction, 230 Compensation Paid to Workers, 231 Employee vs. Independent Contractor, 231 Employee Compensation, 234 Reimbursements from Nonaccountable Plans, 237 Employee Benefits, 238 Contributions to Accident and Health Plans, 239 Flexible Spending Accounts (FSAs), 240 Cafeteria Plans, 242 Other Employee Fringe Benefits, 243 Contributions Made to Employees' Retirement Plans, 246 Qualified Retirement Plans, 246 Employer Contributions, 247 Simplified Employee Pension (SEP) Plans, 248 401(k) and 403(b) Plans, 249 Roth 401(k) Plans, 250 SIMPLE Plans, 250 Employment Taxes, 253 Federal Insurance Contributions Act (FICA, 253 Federal Unemployment Tax Act (FUTA) Taxes, 254

Meals and Entertainment Expenses, 257 Meals, 257 Entertainment, 257 Travel Expenses, 260 Away from Home, 260 Combined Business and Personal Travel, 261 Attendance at Conventions, 262 Substantiation, 263 Transportation Expenses, 264 Automobile Expenses, 264 Education, 266 Summary, 267 Chapter 7: Depreciation, Depletion, and Amortization, 274 Introduction, 274 DEPRECIATION, 275 The Concept of Depreciation, 275 Financial Accounting Depreciation Rules, 276 Tax Depreciation Rules, 279 Personal Property Depreciation Rules, 284 General and Alternative MACRS, 284 Additional First-Year Depreciation (Bonus Depreciation), 292 Section 179 Immediate Expensing, 293 Special Rules for Passenger Automobiles, 296 Real Property Depreciation Rules, 299 Tax Depreciation of Improvements, 301 DEPLETION, 301 Cost Depletion, 302 Percentage Depletion, 302

Percentage Depletion for Oil and Gas, 303 Small Independent Producers and Royalty Owners, 304 Intangible Drilling and Development Costs, 305 AMORTIZATION, 305 Amortization of Section 197 Intangibles, 306 Amortization of Non-Section 197 Intangibles, 307 Leaseholds, 307 Computer Software, 307 Summary, 308 APPENDIX, 308 MACRS and ADS Depreciation Tables, 308 Passenger Automobile Limits, 312 Inclusion Amounts for Leased Automobiles Placed in Service During 2010 , 313 PART III: TRANSACTIONS INVOLVING BUSINESS PROPERTY, 323 Chapter 8: Property Transactions: Realized and Recognized Gains andLosses, 324 Introduction, 324 Realized vs. Recognized Gains and Losses, 325 Realized Gains and Losses, 326 Amount Realized, 326 Adjusted Basis, 331 Recognized Gains and Losses, 333 Losses between Related Parties, 334 Constructive Ownership, 336 Subsequent Use of Disallowed Loss by Purchaser, 338 Wash Sales, 338 Substantially Identical, 339 Eventual Recognition of the Loss from the Wash Sale, 340 Qualified Small Business Stock, 341

Rollover of Gain on the Sale of Publicly Traded Stock, 342 Calculating the Postponed Gain, 342 Reduction of Basis, 343 Making the Election , 344 Like-Kind Exchanges, 345 Like-Kind Exchange Requirements, 345 Time Frame for Taking Possession of Like-Kind Property, 347 Tax Consequences of a Like-Kind Exchange, 348 Special Rules for Like-Kind Exchanges between Related Parties, 353 Involuntary Conversions, 354 Postponing the Realized Gain, 355 Qualified Replacement Property, 356 Time Frame for Making the Purchase, 357 Installment Sales, 358 Operating Rules , 359 Sale of an Installment Note, 360 Installment Sales between Related Parties, 361 Electing Out of the Installment Method, 361 Summary, 361 Chapter 9: Property Transactions: Character of Gain or Loss, 369 Introduction, 369 The Significance of Capital Gains and Losses, 370 Limitations on Capital Losses, 370 Special Tax Rates on Net Capital Gains, 375 Holding Periods, 378 Generating Capital Gains and Losses, 381 Sale or Exchange of Capital Assets, 381 Capital Assets Defined, 382

Capital Assets Sold to a Related Party, 383 Patents , 384 Subdivided Realty, 386 Section 1244 Stock, 388 Section 1231 Gains and Losses, 390 Significance of Net Section 1231 Gains, 390 Depreciation Recapture, 391 Nonrecaptured Section 1231 Losses, 395 Business Casualty and Theft Gains and Losses, 398 Review of the Netting Process, 399 Netting Process for Flow-Through Entities, 402 Long-Term Capital Gains for Individual Taxpayers, 402 Summary, 403 PART IV: CALCULATING TAX LIABILITY AND TAXES OWED, 411 Chapter 10: NOLs, AMT, and Other Business Taxes, 412 Introduction, 412 NET OPERATING LOSSES, 413 Tax Treatment of NOLs, 413 Carryover Provisions, 414 Calculating a Corporation's NOL, 414 The DRD and the NOL, 414 Calculating an Individual Taxpayer's NOL, 416 Utilizing a NOL, 417 Modified Taxable Income, 417 Carryback and Carryover Periods, 419 Deriving Tax Benefits from a NOL, 420 ALTERNATIVE MINIMUM TAX, 421 Taxpayers Subject to AMT, 421

Corporate Taxpayers Subject to AMT, 422 Individual Taxpayers Subject to AMT, 422 The Corporate AMT Formula, 422 Tax Preferences, 425 Percentage Depletion, 425 Intangible Drilling Costs, 425 Tax-Exempt Interest from Private Activity Bonds, 426 AMT Adjustments, 427 AMT Adjustment for Depreciation, 428 Adjusted Gain or Loss, 431 Amortization of Circulation Expenditures, Certified Pollution ControlFacilities, and Mining Exploration and Development Costs, 432 Long-Term Contracts, 432 Recomputed Deductions Using the AMT System, 432 ACE Adjustment, 433 Concept of E&P, 434 Calculating ACE, 435 Minimum Tax Credit, 438 Individual AMT, 439 AMT Preferences and Adjustments for Individual Taxpayers, 439 AMT Exemption for Individual Taxpayers, 441 AMT Tax Rates for Individual Taxpayers, 441 Tax Planning for AMT, 441 ACCUMULATED EARNINGS TAX, 442 Corporations Subject to the Accumulated Earnings Tax, 442 Calculating the Accumulated Earnings Tax, 443 Adjustments to Taxable Income, 444 Accumulated Earnings Credit , 445 PERSONAL HOLDING COMPANY TAX, 447

Personal Holding Company Defined, 447 Stock Ownership Requirement, 448 Income Requirement, 448 Undistributed Personal Holding Company Income, 448 Summary, 449 Chapter 11: Tax Credits, 457 Introduction, 457 Tax Savings Generated from a Tax Credit vs. a Tax Deduction, 458 Types of Tax Credits, 459 Business vs. Personal Tax Credits, 459 The Motivation Behind Offering Tax Credits, 460 General Business Credit, 461 Calculating the General Business Credit, 461 Overall Limitations on the Amount of General Business Credit, 463 Claiming the General Business Credit, 464 BUSINESS TAX CREDITS AIMED AT ENCOURAGING EMPLOYERS TO HIRE CERTAINWORKERS, 466 Empowerment Zone and Renewal Community Employment Credit, 466 Calculating the Amount of the Credit, 466 Qualified Zone Wages, 467 Claiming the Credit, 468 Work Opportunity Credit, 468 Qualifying for the Credit, 468 Calculating the Amount of the Credit, 469 Coordination with the Empowerment Zone and Renewal CommunityEmployment Credit, 471 Claiming the Credit, 472 TAX CREDITS AIMED AT ENCOURAGING CONSERVATION OF ENERGY, 472 Energy Credits, 472 TAX CREDITS AIMED AT REWARDING RESEARCH IN CERTAIN AREAS, 473

Tax Credit for Increasing Research Activities, 473 Calculating the Amount of the Credit, 474 Qualified Research, 475 Qualified Research Expenses, 476 Base Amount, 477 Claiming the Credit, 477 Orphan Drug Credit, 477 TAX CREDITS AIMED AT ENCOURAGING ECONOMIC DEVELOPMENT, 478 New Markets Credit, 478 Calculating the Amount of the Credit, 479 Claiming the Credit, 479 Recapture of the Credit, 479 TAX CREDITS USED TO SUBSIDIZE BUSINESSES FOR CERTAIN EXPENDITURESMADE DURING THE YEAR, 480 Employer Social Security Credit, 480 Rehabilitation Credit, 480 Calculating the Amount of the Credit, 480 Expenditures Qualifying for the Rehabilitation Credit, 481 When Expenditures May Be Taken into Account , 482 Claiming the Credit, 482 Recapture of the Credit, 482 Low-Income Housing Credit, 483 Calculating the Amount of the Credit, 483 Claiming the Credit, 485 Recapture of the Credit, 485 Disabled Access Credit, 485 Eligible Small Business Defined, 486 Computing the Amount of the Credit, 486 Eligible Access Expenditures, 486

Claiming the Credit, 487 Employer-Provided Child Care Credit, 487 Calculating the Amount of the Credit, 487 Claiming the Credit, 488 Recapture of the Credit, 489 Small Employer Health Insurance Credit, 489 Eligible Small Employer, 490 Amount of the Credit, 490 Phaseout of the Credit, 490 Claiming the Credit, 490 TAX CREDIT FOR FOREIGN INCOME TAXES PAID, 491 Foreign Tax Credit, 491 Election To Take a Deduction Instead of a Credit for Foreign IncomeTaxes Paid, 491 Taxpayers Eligible for the Credit, 492 Taxes Eligible for the Foreign Tax Credit, 492 Limitations on the Amount of the Credit, 493 Foreign Tax Credit Carryback and Carryover, 494 Claiming the Credit, 494 Summary, 495 PART V: BUSINESS ENTITY ISSUES, 501 Chapter 12: Corporate Formation, Distributions, and OtherCorporation-Related Tax Issues, 502 Introduction, 502 FORMATION OF A CORPORATION, 503 Transfer of Property to a Controlled Corporation, 503 ?Control" Defined , 503 Excepted Transactions, 504 ?Boot" , 504 Basis in Property Received, 505

CORPORATE DISTRIBUTIONS, 505 Calculating the Amount of a Distribution, 506 Reduction for Liabilities, 507 Tax Consequences of Dividend Distributions to Shareholders, 507 Corporate Shareholders, 507 Individual Shareholders, 508 Distributions Treated as Dividends vs. Return of Capital, 509 Distributions That Do Not Exceed Current Year E&P, 511 Distributions When Current Year E&P Has a Negative Balance, 512 Distributions in Excess of Current Year E&P, 512 Constructive Dividends, 515 The Need for the Constructive Dividend Rules, 515 Identifying a Constructive Dividend, 516 Stock Dividends, 517 Distributions in Lieu of Money or Other Property, 518 Disproportionate Distributions, 518 Shareholders' Basis Adjustments and Holding Period, 519 Keeping Track of E&P, 520 Adjustments Due to Permanent Differences, 520 Adjustments Due to Timing Differences, 522 Items Requiring No Adjustment to E&P, 525 Effects of Distributions on E&P, 526 RECONCILIATION OF NET INCOME AND TAXABLE INCOME, 527 Differences between Book Income and Taxable Income, 527 Permanent Differences, 527 Timing Differences, 529 Schedules M-1 and M-3, 533 Schedule M-1 , 534

Schedule M-3, 536 Schedule M-2, 537 Summary, 539 Chapter 13: The Sole Proprietorship and Individual Tax Return, 546 Introduction, 546 Taxable Income Formula for Individual Taxpayers, 547 Above the Line Deductions vs. Deductions from AGI, 548 Method of Accounting, 549 Gross Income, 550 Investment Income, 551 Gains on the Sale of Business and Investment Property, 552 Above the Line Deductions, 552 Certain Business-Related Expenses Not Deductible as Business Expenses , 552 Expenses Paid or Incurred in Carrying on a Trade or Business, 555 Other Business Expenses Deductible as Above the Line Deductions, 560 Passive Activity Losses, 565 Deductions from AGI, 568 Personal and Dependency Exemptions, 568 Standard Deduction, 569 Itemized Deductions, 571 Net Operating Loss, 580 Calculating the Amount of NOL, 580 Carryover Provisions, 581 Calculation of Taxes Owed or Refund Due, 582 Regular Income Tax Liability, 584 Alternative Minimum Tax, 588 AMT Itemized Deductions, 591 Summary, 592

Chapter 14: Flow-Through Entities: Partnerships, LLPs, and LLCs, 604 Introduction, 604 Tax and Nontax Aspects of Partnerships, 605 Responsibility for Partnership Liabilities, 605 Single Level of Taxation, 606 Responsibility for Making Accounting Elections, 607 Why Study Partnership Taxation?, 609 Forming a Partnership, 610 Partnership Agreement, 610 Contributions of Property, 611 Partnership's Basis and Holding Period in Contributed Property, 613 Partner's Tax Basis and Holding Period in the Partnership Interest, 614 Reporting Partnership Operations, 621 Required Tax Year, 621 Permissible Accounting Methods, 626 Calculating Partnership Income, 626 Allocating Partnership Items, 633 Keeping Track of a Partner's Interest in the Partnership ., 636 Increases to Basis, 637 Decreases to Basis, 638 Ordering Rules, 640 Impact of Distributions to Partners, 643 Limited Liability Companies (LLCs) and Limited Liability Partnerships(LLPs), 643 Entity Classification, 645 Summary, 646 Chapter 15: Flow-Through Entities: S Corporations, 655 Introduction, 655 The History Behind the S Corporation, 656

Advantages and Disadvantages of Operating a Business as an SCorporation, 657 Corporations That Can Elect S Status, 658 Permitted Shareholders, 659 100 Shareholder Limit, 662 Single Class of Stock, 665 Electing S Corporation Status, 666 Termination of S Status, 667 Voluntary Revocation of an S Election, 667 Involuntary Revocation of an S Election , 668 Treatment of S Termination Year, 670 Allocating S Corporation Items, 671 Separately vs. Nonseparately-Stated Items, 672 Treatment of Organizational Expenditures, 673 Corporate Preference Items, 674 Tax Consequences to Shareholders, 675 Pro Rata Share, 675 When Income Must Be Reported, 676 Character of Items Constituting a Shareholder's Pro Rata Share, 676 Limits on the Deductibility of Losses, 677 Adjustment of Shareholder's Basis in Stock, 678 Adjustment to Basis of Indebtedness to Shareholder, 680 Distributions to Shareholders, 681 Accumulated Adjustments Account, 681 S Corporations with No Accumulated E&P, 682 S Corporations with Accumulated E&P, 682 Distributions of Property Other Than Cash, 684 Distributions During the Post-Termination Transition Period, 684 Fringe Benefits for Shareholders, 685

Corporate Tax on Excess Passive Investment Income, 685 Amounts Subject to Passive Investment Income Tax, 686 Deduction for the Tax, 687 Corporate Tax on Built-In Gains, 687 Calculating the Built-In Gains Tax, 688 Corporate Tax on LIFO Recapture Amount, 689 Summary, 690 Appendix, 696 Tax Terms, 696 2011 Tax Rate Tables, 715 Finding Devices, 716 Case Table, 716 Finding List, 718 Topical Index, 729 A , 729 B , 730 C , 730 D , 732 E , 733 F , 734 G , 736 H , 736 I , 736 J , 738 K , 738 L , 738 M , 738 N , 739

O , 739 P , 739 Q , 741 R , 741 S , 742 T , 744 U , 746 W , 746 Y , 747 Z , 747 Back Cover, 748