I.

A.

The Court Process for Tax Cases

Three courts:
a.
Tax court claims of Non-payment tax
i.
ii.
b.

Claims court claims of Payment under protest

i.
ii.

c.

b.

E.

A.

*Timing issue generally like to put off payment as long as possible, but may argue that you were supposed
to pay earlier if it would mean that the SOL had run, and no longer had to pay taxes.

Gross Income The Scope of 61 - Equivocal Receipt of Financial Benefit

Income tax is imposed on taxable income
a.
Taxable income = gross income authorized deductions
b.
c.

B.

Commissioner always does so in tax court cases, but does so on a more limited basis in district courts. The
decision is published yearly in cumulative bulletin.
Reliance on a case that the commission non-acquiesced wont get you very far.

Letter rulings
a.
Private letter ruling: individuals questions; cant use as precedent.
b.
Rev. Ruling: the service is bound by its determination, but the courts arent bound
i.
Can rely on as precedent
IRS has 3 years to go after underpaid amount of taxes, as of the day the tax return was done.
Exceptions:
a.
Fraud
b.
Failure to file.
c.

II.

Appeals: district court of appeals in the circuit where the taxpayer resides.
Where you go if you have a more sympathetic case. More likely to rely on legislative history;
decide against service less often.

Service can refuse to follow any case up until it reaches US Supreme Court.
When there is a decision, commissioner must acquiesce or non-acquiesce.
a.

D.

Court of limited j (tax, patent, admiralty)

Appeals: Federal Court of Appeals only hears tax, patent, maritime

Federal district court claims of Payment under protest

i.
ii.

B.
C.

Appeals: District court of appeals in the circuit where the taxpayer resides.
More willing to go against the service; where to go if you have the law on your side

101-137 Exclusions from income

71-90 Inclusions in income

61(a) Defines gross income: Except as otherwise provided, gross income means all income
from whatever source derived, including but not limited to:
a.
Compensation for services (commissions, fringe benefits, and similar items)
i.
Employer gifts given to employee, for good service, whether $/property.
1.

Ex: employer paid taxes for ee; that payment was GI for ee.

Exception: moving expenses.

b.
Gross income derived from business
c.
Gains from sale of property
d.
Interest, Royalties, Dividends
e.
Rents
i.
Improvements made that are in the nature of rent include the FMV
f.
Alimony, maintenance payments
g.
Income from life insurance
h.
Income from discharge of indebtedness (wipes out obligation to repay)
i.
Exception: discharge is a gift (i.e. your mom forgives your debt)
Gross income includes income realized in any form, whether in money, property, or services.
[Reg 1.61-1(a)]
Other items generally considered gross income:
a.
Lottery winnings
ii.

C.
D.

b.
c.
d.
e.
f.
g.
h.

Wages (including property given for services)

i.
Value of property- determined as of the time you get it
Kickbacks
i.
Ex: kickbacks for referrals
Punitive/treble damages [Glenshaw Glass Co., Reg 1.61-14 covers punitive]
Damages from Non-physical injury (slander, libel, discrimination)
Bribes, Illegal gains [Reg 1.61-14]
Treasure trove - It must be recorded as gross income in the year it is reduced to undisputed
possession.
Payment of a legal obligation by one person for another. [Old Colony Trust]
i.
ii.
iii.

E.

F.

Exception: The payment may be considered a gift if intended as such

Gross income probably does NOT include:
a.
Monetary damages for accidents resulting in physical injury
b.
Student loan check
c.
Property settlement at divorce
d.
Child support
e.
Frequent flyer miles
Defining Gross income: Accessions to wealth, meaning increase in net worth, over which
taxpayer has complete dominion. [Glenshaw Glass Co.]
a.

G.

H.

*Complete dominion aspect Money is not income when there is no control over the money.
i.
Ex: Security deposits arent income until the company decides to keep them, because there is an
obligation to return the money unless the customer fails to make payments.

Determining the Amount of Income Tax:

Gross income (61)
Above the line deductions (62)
=
Adjusted gross income (AGI) (62)
Below the line deductions (161-222) (aka itemized deductions)
Or - Standardized deductions (63)
Personal exemption (151)
=
Taxable income
Taxable income (63)
X
Applicable Tax Rates (1)
Tentative Tax Liability
Tax Credits
Tax Liability
Realization: an occasion/transaction that changes the taxpayers relationship with the property.
a.
Examples: Sale, Exchange, Condemnation, Theft, Gift, Destruction
i.
Gain in exchange: value of what you got investment in what you gave up
b.
c.
d.

I.

Legal obligations: income or property taxes, interest on mortgage

Ex: payment of taxpayers income tax [Reg 1.61-14]

Ex: Finding money in the piano: before they found it they didnt own it

Appreciation in property value is not taxed until there is a realization event

Examples of events that arent realization: harvesting crops, eating crops

Recognition including the amount in income or taking it as a deduction on your tax return.
a.
Generally realized gains must be recognized unless there is a non-recognition exception.
[1001(c)]
i.

Ex. of an exception: insurance money used to rebuild.

J.

Assignment of income is not allowed - Income is taxed to he who earned it.

a.
b.

III.
A.
B.
C.
D.

Gross Income The Scope of 61 - Income w/o receipt of cash or property

Receipt of services is income to the recipient.; you are taxed on the value of the services you
receive. [Rev. Ruling 79-24]
You are taxed on the value of the services in the year they are received (even if you are in a barter club,
and dont perform your own services until the next year). [RR 83-163]
A homeowner doesnt have to include the rental value of property owned and occupied by the
taxpayer as income. [Helvering v. Independent Life Insurance Co.]
An individual is taxed for the fair rental value of property if allowed to live there rent-free rent is
imputed. [Dean v. Commissioner]
a.

E.

c.

A.
B.

Ex: if X loans 10k at no interest, X may still be taxed for imputed interest.

Two types of imputed income not taxed:

i.
Imputed Rental value of your own home
ii.
Self-help income (ex: L writing his own will; mechanic fixing her own engine, growing food)
1.
Performing services for family members isnt taxed
Another type that has gone untaxed informal reciprocal back-scratching

Gifts & Inheritences

Defining Gift: transfer given out of detached and disinterested generosity, or out of affection,
respect, admiration, charity, or like impulses. [Duberstein]
General rule: Gifts and inheritances are not GI. [102]
a.
But, could be part gift, part non-gift.
b.

C.

ex: Corp. owners live in house owned by corporation. If ee-eer, it would be compensation. If mother-son, it
could be a gift.

Congress has a right to tax some imputed income.

a.
b.

IV.

Assignment of salary to another individual in order to be taxed at a lower rate.

Ex: eer gives ees spouse a car. It is included in ees income b/c it is viewed as two transactions to ee as
compensation, then a gift from ee to wife.

Gift taxes: Any gift in excess of 11k to any one person during a taxable year is taxable to the donor for gift
tax purposes.

Exceptions: The following are included in GI:

a.
Income from gifts [102b]
b.
Gift of income from property [102b]
i.
c.

ex: right to receive rent on a piece of property.

Gifts to, or for the benefit of, an employee. [102c]

i.
*Must determine if there is truly an ee/eer relationship before applying exception.
Look at the level of control over ees activities.
1.
ii.

Misters courts are split:

Exceptions (which arent GI):

1.
Certain fringe benefits (132)
2.
Employee achievement award (74c)
3.
Transfers between related parties, if it is shown that the transfer wasnt made in
recognition of the ees employment. [Proposed Reg (1.102-1(f)(2)]
(a)
Factors to consider:
(i)
What sort of transfers were made to other ees
(a)
Could be part gift and part compensation if family member
receives more valuable present than other employees
(ii)
Where did eer give present to ee? At office? Or at home?
(iii)
Was the entire value deducted as a business expense?
4.

[This has also been applied to transfers from eer to former ees.]
3

V.
A.

VI.
A.

B.

VII.
A.

Fringe Benefits Eer gives economic benefit other than cash wages given to, or for the benefit of,
ee as compensation for services.
General rule fringe benefits are gross income, unless specifically excluded. [61]
a.
The amount included as GI = FMV any money paid for it. [1.61-21(b)]
Provision applicable to certain fringe benefits:
Expanded definition of employee (132 h) The following receive certain ee benefits (No
additional cost services; Qualified employee discount):
a.
Spouses and dependent children
b.
Retired ees and ees with a disability
c.
Surviving spouses
d.
Parents (for airlines only- under no additional cost services)
Non-discrimination rules. (132(j)(1))
a.
Employer cant discriminate in favor of Highly compensated ees those who
i.
Make over 80k/year, or
ii.
At any time during the previous year owned at least 5% of company stock.
b.
If a benefit is provided for highly compensated employees, it must be provided on
substantially the same terms to other employees.
c.
If the benefit discriminates:
i.
Highly compensated must include the entire value of the benefit in income
ii.
Other ees can still exclude.
Fringe benefits excluded from income
No Additional cost services (132(b))
a.
Services can be provided at partial or no cost, or under a cash rebate program.
i.
b.

c.

Ex of cash rebate: ee pays for hotel, and get reimbursed by employer.

3 requirements:
i.
Service must be offered to customers by employer in the ordinary course of
business
ii.
EE must be in same line of business as the service that is being offered
1.
Exception: if you have a job that requires you to perform substantial
services in many lines of business, you are in all of the lines of business.
iii.
Employer cant incur substantial additional costs or forgo revenue in providing the
service.
Reciprocity agreements are allowed between employers. Requirements:
i.
Must be written.
ii.
Both employers must be in the same line of business.
iii.
Neither employer can incur substantial additional cost or forego revenue.
iv.

Ex: United Airlines stewardess can fly on American, and vice versa.

Rules that Apply- Expanded definition of employee, Non-discrimination rules

Qualified employee discount (132(c)(4)) - Discount that reduces the employees cost of a good/ service
d.

B.

otherwise sold to customers.

a.
Requirements:
i.
Goods/services must be offered to customers in the ordinary course of business.
ii.
Employer must be in the same line of business as the good/service offered.
iii.
Only the qualified discount can be excluded from income; any amount over that
b.

must be included. [1.132-3(e)]

Determining the qualified amount that can be excluded:
i.
Services: may discount 20% off the amount charged to customers.
1.
Includes insurance, hotel rooms
4

2.

ex: ER normally charge $100. 20% is $20, so a $20 discount is not taxable. If there is a
discount for $50, $30 of it is not qualified and must be included as income from a fringe
benefit.

The amount charged to customers is the rate determined by the price at

which goods/services are offered to regular customers at the time the
discount is given.
(a)
But, if more than 35% of the time there is a discount, ee can use that
as the price charged to customers.
Property: the amount excluded may not exceed the gross profit percentage of the
price at which the property is sold to customers:
1.
Discount = gross profit % x cost of item
2.
Gross profit %= aggregate sales price cost of goods sold
aggregate sales price
(a)
These figures are based on yearly sales and costs.
3.

ii.

3.

ex: 100k - 60k = 40%. Entitled to a 40% discount as an exclusion.

100k
If employee gets a 50% discount, she must include 10% of the discount.

Rules that Apply: Non-discrimination, expanded definition of employee

Working condition fringe benefit (132(d))
a.
Definition: property or services given to an ee by an eer that would be deductible by the ee
as a business expense had the ee paid for the property or service himself.
c.

C.

b.

Examples of business expense deductions:

i.
Cost of flight, lodging, business entertainment, etc. paid on a business trip.
ii.
Cost of tools for a carpenter.
iii.
Subscriptions to journals that are business related.
iv.
Membership dues, bar dues.
v.
Car used for business.

c.

Special category: Demo car used by full-time car salesperson is a working condition, if
there are substantial restrictions on use.
Rules dont apply: Non-discrimination rules, Expanded definition of employee.

d.

i.
D.

Ex: if spouse flies with you while you work, includable in income.

De minimus fringe (132(e)(1))

a.
A fringe so small that accounting for it would be unreasonable/ impracticable.
i.
b.
c.
d.

Ex: use of copy machine, occasional cocktail party, traditional holiday gifts w/ low FMV, small
retirement gift

Take into consideration how often the benefit is given to employees.

That an employer accounts for it is not determinative of whether it is a de minimus fringe.
Special category (132(e)(1)): eating facility on or near business premises is de minimus
fringe benefit as long as the amount charged for the meals ordinarily covers the employers
costs.
i.

If food is free of charge, it is taxable.

Rules dont apply: Non-discrimination rules, Expanded definition of ee

i.
Exception: non-discrimination applies for on premises eating facility.
On premises athletic facility (132(j)(4))
a.
GI doesnt include the value of on-premises athletic facility provided by eer to ee
b.
3 requirements to be excludable:
i.
Must be located on eers premises (whether they rent or own)
ii.
Facility must be operated by the employer (or hire managing company)
iii.
Substantially all of the use is by ees, their spouses and dependents.
c.
Non-discrimination rule - DN apply [1.132-1(e)(5)]
i.
Limitation: an employer cant deduct the athletic facility as a business expense if it
discriminates. [274(j)]
e.

E.

d.
F.

Doesnt include a gym provided in building for all tenants and employees in the building.

Qualified transportation fringe (132(f))

a.
3 types of qualified transportation fringe benefits:
i.
-Employer provided parking up to $175/month.
1.
On or near premises.
2.
Doesnt have to be owned by employer.
ii.
Up to $100/month for the following combined:
1.
-Employer provided vanpools.
2.
-Employer provided mass transit passes.
iii.

These amounts are per month, not per year.

Rules DN apply: Non-discrimination, expanded definition

Qualified moving expenses reimbursement (132(f))
Qualified retirement planning services (132(m))
a.
Covers retirement planning services provided by someone hired by employer.
b.

G.
H.

i.
b.

DN include financial planning.

Non-discrimination rule apply but only to those who would qualify for retirement
benefits.
i.

Ex: dn apply to ees who only get retirement benefits after working for 5 years.

Expanded definition of employee - does NOT apply.

Life insurance (79)
a.
Employer can provide up to 50k of life insurance for employee.
c.

I.

i.

The cost of any additional life insurance is included in ees income.

Nondiscrimination rules apply.

Dependent care assistance (day care) (129)
a.
Employer may give up to 5k of dependent care assistance
b.
Non-discrimination rules apply.
Military Benefits
a.
Can exclude many military benefits from GI [ 112, 113 and 134]
b.

J.

K.

i.

Ex: Combat pay.

L.

Cafeteria Plan 125 offers a menu of choices of benefits

a.
Ex: $500/month could be used for the following: eye care, healthcare, dental insurance,
pension plan
b.
The amount received under cafeteria plans are excluded from GI.
i.
Exception: if you choose cash instead of the benefits (sometimes allowed)

VIII.

Prizes and Awards Generally included in income. [74]

Three exceptions:
a.
Qualified scholarships and fellowships (117)
b.
Meritorious Achievement Awards (74(b))
c.
Employee achievement awards. (74(c))
Meritorious Achievement Awards (74(b)) 4 requirements:
a.
Offered in recognition for religious, charitable, civic, scientific, education, artistic, or
literary achievements

A.

B.

i.
ii.
iii.
b.

c.

Ex: Nobel prize

Professional sports award dn qualify; could possibly argue that amateur are civic achievement.
Civic achievements: advantageous to the community

Recipient must be selected w/o any action on her part.

i.
Cant apply for it, but if chosen as a possible candidate for the award, may go
through interview/application process if required.
Cant be required to perform substantial additional services to receive the award.
i.

Acceptance speech is probably allowed

d.

Award must be paid directly to charitable organization or governmental unit.

i.
ii.

Recipient may receive and pay to organization, but cant use it.
Benefits: 74(b) excludes income (it is not a deduction). Excluding is better than a deduction,
because the government never sees the money as income.
1.
Problems with deductions: You have to itemize, There is a cap on the amount of charitable
donations you can give away each year (limit is 50% of GI).

[May choose to give a portion to a charity/governmental entity, and keep the other
portion for you.]
Employee achievement awards. (74(c))
a.
3 requirements:
i.
Award given either for:
1.
Length of service, or
(a)
May only be given after 5 years of employment, and can only be
given every 5 years.
2.
Safety achievement. Limitations:
(a)
Only certain ees qualify [274(j)] managers, clerical employees,
administrators DN apply
(b)
10% or less of eers qualified ees may receive the award
ii.
Awarded as part of meaningful presentation.
iii.
Has to be given under circumstances that make it unlikely that it is disguised
compensation.- court basically ignores this requirement.
b.
Caps on amount of award excludable (Excludable up to the amount of cost of award to the employer
that is deductible):
1.
If a qualified plan award, $1600/employee per year.
iii.

C.

(a)
2.
3.
c.

IX.
A.

Qualified plan award: one that is written, and non-discriminatory.

If not, $400/employee per year.

[This cap is for the total of safety and length of services awards combined.]

Must be tangible property no cash (or gift certificate) awards.

Scholarships and Fellowships.

Qualified Scholarships (117(a))
a.
Requirements to exclude from GI:
i.
Candidate for a degree.
1.
Undergrad or grad
2.
ii.

iii.
iv.

Jr colleges qualify if planning on attending a different school to get a degree

Must be attending an educational institution.

1.
Defined to require: regular faculty and curriculum, a body of students
enrolled, educational activities regularly carried on.
Qualified expenses: tuition, books, fees, supplies and equipment.
1.
This doesnt include room and board, travel expenses, etc.
Payment cant be compensation for past, present or future services.
1.

If employer gives scholarship, it wont qualify. Nondiscrimination rule DN apply.

No cap on the amount excluded

Athletic Scholarships: Requirements to be excludable: [RR77-263]
i.
University expects, but doesnt require, the student to participate in sports.
ii.
Student doesnt have to do any activity in lieu of sport.
iii.
Scholarship wont be cancelled if the student doesnt participate.
Qualified Tuition Reduction (117(d)) - Can be free or reduced rate of tuition
a.
Requirements
i.
Given to employee of educational institution
ii.
Undergraduate education
b.
c.

B.

Exception: Grad students working as research or teaching assistant

Cant represent compensation for past, present or future services.
b.
Rules that Apply: Expanded definition of ee; Nondiscrimination rule.
c.
Tuition reduction at a different educational institution also applies. [172(d)(2)]
i.
DN have to be a reciprocal program.
d.
No cap on amount.
Employer Educational Assistance Programs (127)
a.
Employee can exclude up to $5250 of educational assistance from employer that goes to
books, fees, tuition, supplies, equipment.
b.
Requirements:
i.
Plan must be written.
ii.
Nondiscrimination rule applies.
iii.
Applies to Undergrad or graduate courses, trade schools, etc.
1.
DN include courses for hobbies, sports, etc.
c.
Expanded definition of employee DN apply.
d.
No requirement that:
i.
It is educational institution
ii.
It not be in the form of compensation.
1.
But employees cant have the choice to choose money or education.
2.
What qualifies as Employer Educational Assistance probably doesnt also
qualify as Qualified Scholarship because Q.S. requires that it cant be
compensation for services.
iii.
You are a candidate for a degree.
1.

iii.

C.

I.
A.

Gains from Dealings in Property.

Basics
a.
1001(a): upon a sale or other disposition of property, a taxpayer realizes gain or loss
equal to amount realized on the sale/disposition, less adjusted basis a realization event is
required to trigger gain/loss.
i.
Once there is a realization event, must recognize unless non-recognition provision
applies. Recognize in the year of the realization event.
1.
ex: transfers between spouses dn have to recognize
ii.
Property may be tangible or intangible (i.e. an option)
iii.
Amount realized (AR): what you get. The amount of money received and the
FMV of property (other than money) received. [1001(b)]
iv.
Adjusted basis (AB): what you put into the property, what you get back tax-free.
1.

B.

C.

Ex: selling veggies. Basis may include seeds + reasonable cost of gardener.

v.
Realized Gain = AR AB
Determining Adjusted Basis
a.
Start with Unadjusted basis and add/subtract from that.
b.
Improvements made by lessee:
i.
If in the nature of rent, included in income, and added to basis.
1.
Rent alone dn affect basis.
ii.
If not in the nature of rent, lessor dn have to include in income, so you cant add to
basis.
c.
Loan amount of a loan used for improvements is added to basis.
Unadjusted basis 5 types - **There is a treatise on reserve under cecils name for these.
a.
Cost basis

Tax basis
Gift basis
Basis in decedents property
Basis in property transferred between spouses or ex-spouses pursuant to divorce
Cost basis (1012) what you paid for it.
a.
Costs of purchasing property are added to the cost, and added to basis. (ex: brokers,
attorney or appraisal fees, title insurance, option to purchase, taxes paid to purchase
property) [1016]
b.
Employee discounts: the basis in property = amount paid + amount of discount excludable
from income
c.
**The cost basis of property received in a property for property (barter) transaction is the
FMV of the property received (not the property you gave up). [Philadelphia Park Amusement]
i.
If you cant determine the value of what you received, there is a presumption that
what you received is worth the same as the FMV of what you gave up.
d.
If taxpayer has a gain: include it in income unless there is a non-recognition provision.
e.
If taxpayer has a loss, may only take a deduction in three situations: (1659c):
i.
-Trade or business losses
ii.
-Investment losses (if you sell stock at a loss)
b.
c.
d.
e.

D.

1.
2.

This DN include losses on the sale of personal property

House usually is not considered an investment.

-Casualty losses (fire, storm, shipwreck)

Improvements are included as part of basis.
i.
Exception: Lessor can t include the value of improvements, if lessee makes
improvements which arent in the nature of rent, and arent included in lessors GI.
ii.
If lessee made improvements that were in the nature of rent, lessor would have to
include those amounts in GI at the time of the improvements, and could also
increase basis by those amounts.
Tax cost basis [Reg 1.61-2d2i, not in code] for receipt of property in exchange for
services, basis = the amount claimed for income tax purposes + money was paid for the
property.
iii.

f.

g.

i.

E.

Ex: paid 5k for a car, but didnt have to pay the other 30k of the value. The 30k is claimed as
income. Add these together, for 35k basis.

Gift Basis (1015)

a.
When given a gift, donee takes donors transferred basis when:
i.
There is a built in gain (AB<FMV)
ii.
AB = FMV
iii.
There is a built in loss (AB>FMV), if donee sold at or above AB.
b.
Exceptions when there is a built in loss (AB > FMV) at the time of the gift:
i.
If donee sells the gift for < FMV, donees AB = FMV.
ii.
If donee sells for an amount between FMV and donors basis, there is no gain/loss.
c.
Part sale/ part gift:
i.
Requirements
1.
Property is sold for less than FMV;
2.
The reason it is sold for below FMV is because of detached and
disinterested generosity.
ii.
*1.1001-1e: Donors gain = AR AB.
1.
But there is no recognized loss if the AR < AB.
iii.
Donees basis is the greater of: [Reg 1.1015-4]
1.
Amount paid by donee, or
2.
Donors AB at the time of the gift.
9

iv.

Charities: View transaction as a partial sale of land for full consideration, and the
rest as an outright gift.
1.
Donors gain = AR (AB x (amount paid/FMV)).
2.
Donees basis = cost basis for purchased part + transferred basis for the gift
portion.
(a) AB of the sold portion = AB x amount paid/FMV
3.

Example: AB = 120k; FMV = 180k. AR = 120k.

(a) Donors gain:
(i) AB = 120 x (120/180) = 120 x 2/3 = 80k
(ii) AR- AB = 120 80 = 40k gain for donor
(b) Donee:
(i) AB = value of 2/3 of property + basis of gift of 1/3 property
(ii) 120 + 40 = 160 k basis

Spouses: there is no part-sale/part-gift.

1.
DN recognize gain/loss
2.
Spouse gets the other spouses transferred basis
Basis of property acquired from decedent.
a.
Stepped up Basis - Current through 2010 - [1014]
i.
General rule: heir receives a basis equal to the FMV at death.
b.
Exception: appreciated property given to decedent w/in 1 year before death, and
transferred back to donor/ donors spouse at death. [1014(e)]
v.

F.

i.
ii.
iii.
c.

Recipient gets transferred basis.

Could transfer stepped up basis to anyone else (including donors children)
Potential problem: if strings are attached (i.e. have to give the gift back to donors children at death),
it is probably not a gift.

Law during 2010: [1022]

i.
Modified Carry-over basis: Property received from decedent receives lesser of:
1.
Transferred basis
2.
FMV at death.
3.
ii.

This preserves built in gain, but eliminates built in loss.

Heirs are entitled to increase basis up to 1.3 million, but not greater than FMV.
1.

iii.
iv.
v.

G.

ex: Stock: AB=100k; FMV=350k. Increase 100k basis to 350k, so you dont have to pay
taxes on built in gain.
2.
allows heirs to eliminate first 1.3 million gain.
Spouse is entitled to an additional 3 million (for a total of a 4.3 million increase in basis)

Executor determines who gets the extra basis. [1022d]

Exception: property transferred to decedent within 3 years of death is ineligible for
increase in basis unless it is a gift from a spouse
Basis of Property Acquired between Spouses. [1041]
a.
Property transferred from one spouse to the other, or to a former spouse pursuant to
divorce, receives transferred basis.
b.
Spouses can transfer gains and losses between one another.
i.

Reasoning: spouses are an economic unit it is as if the transaction never occurred.

Transfer DN have to be without consideration.

No part-sale/part-gift to spouse it is always transferred basis.
Sale of a part of a piece of property: when a part of a larger property is sold, the basis of the entire
property shall be equitably apportioned among the several parts. Gain or loss is determined at the
time of the sale.
a.
FMV of portion sold
x total basis = basis of the parcel
FMV of entire property
c.
d.

H.

10

II.
A.
B.

Gains from dealings in property Amount realized.

Amount realized = amount of money + FMV of other property received in the transfer.
a.
If we dont know fmv, assume that it is equal to fmv of property given up.
b.
Selling expenses: costs of sale reduce amount realized (under case law)
FMV of services are included in amount realized - *International Freighting
a.
b.

ex: eer gives ees stock, they get services in exchange.

Paying off a liability with appreciated property is a realization event giving rise to gain/loss.
i.
Ex: stock had cost basis, but had appreciated. Court said FMV of services was the appreciated value
of the stocks, so it was a gain.

If the FMV of services is not known, it will be considered to be the value of property
transferred
When a purchaser of property takes a loan/mortgage as part of the purchase, that amount goes
into the basis (whether recourse-assumed or non-recourse-subject to). [Crane]
a.
When the property is sold, the liability that the seller is relieved of goes into the AR.
i.
Interest is not included it doesnt affect basis.
ii.
The entire amount of liability relieved goes in AR even if liability is greater than
FMV of the property.
b.
Depreciation. Depreciable property: property subject to wear/tear, used in trade/business,
investment
i.
Depreciation means that you can deduct the cost of the property over time
ii.
Amount you can depreciate is based on the amount in basis.
iii.
By adding liabilities into basis, you can depreciate (deduct) more.
Gift tax paid by donee included in amount realized to donor. [Diedrich]
a.
This makes the transaction part sale/ part gift.
i.
Ex: FMV = 100; AB=40; Gift tax paid by donee= 25k.
c.

C.

D.

1.
b.

Adjusted basis on gift taxes paid by donor/donee:

i.
Increase basis for gift tax paid by donor/donee by amount proportionate to the net
appreciation in value of the gift to the amount of the gift.
1.
Net appreciation of gift x gift tax paid = increase in basis
FMV of gift
2.

B.

AR AB = gain/loss. 25 40 = 15k loss. But in part sale/part gift, you dont take a loss.
Realized loss, but not recognized.

ex: Basis = 20k. FMV = 30k. Gift tax = 6k. Resold for 32k.
(a) 10k x 6k = 2k
30k
(b) Basis = 20k + 2k = 22k.
(c) 32k 22k = 10k gain.

i.
Damages
Excluded from income:
a.
Tort damages - Personal injury awards
b.
Work Comp payments
c.
Payments from accident/health insurance plans
d.
Recovery of after tax investments
i.

e.

Ex: sue to get 8k loan repaid. 8k recovery is not taxed.

Wrongful death recovery excluded if:

i.
Action was brought under statute
ii.
Statute has been interpreted only to allow for punitive damages
11

C.

Included in income:
a.
Lost profit damages
b.
Loss of property compensation that exceeds value of property
c.
Interest awarded
d.
Punitive damages (even if you have a physical injury)
i.

D.
E.
F.

Exception: wrongful death.

e.
Non-physical damages (defamation, slander and libel, etc.)
Attorney fees: If a non-physical injury, the circuits are split as to when attorney gets fees:
a.
Some courts: give L her share, and client only pays taxes on his own share.
b.
Other courts: client pays taxes on the entire amount received.
Paying off a liability with appreciated property triggers a built in gain. Transferees basis is FMV.
Work comp benefits
a.
May exclude from income almost all work comp benefits, including
i.
ii.
iii.
iv.

Medical expenses,
Compensation for loss of use.
Payments made based on wages.
$ Payments to family if killed.

b.
G.

Exception: If retirement benefits are paid they are included in income, even if employee
retired as a result of injury.
Personal injury. Only applies to physical injuries.
a.

Ex: damages from lost wages are excluded from GI if they arose from physical injury.

b.

H.

Emotional distress damages - considered physical in nature, and excluded from income, if
they arise out of physical injury.
c.
An express allocation of settlement (i.e. whether punitive or not) is not always
determinative if other facts indicate that the payment was intended by the parties to be for a
different purpose.
Payments from accident/health insurance plans.
a.
Who paid the premiums?
i.
Employee- payments are excluded. [104a3]
1.
Entire amount is excluded even if it exceeds expenses.
ii.
Employer - payments are not excluded. Exceptions: [105]
1.
If payments are reimbursement for actual medical expenses
2.
Payments for permanent bodily injury.
3.
[Premiums paid by the eer are excluded from employees income].
b.
If employee pays some, and employer pays some, it is treated as two plans.
c.
The amount of medical expenses considered paid by each policy is proportionate to
benefits received from each:
1.
Eer payment
x expenses = amount of medical expenses paid
Total insurance payment
by eers plan
2.

Ex: 3k from own policy; 2k from eers policy; expenses = 4k.

(a)
2/5 x 4k = 1600 (the amount from eers policy that is excluded)

3.

d.
e.

[Note: only need to prorate when ee receives an amount greater than the
cost of medical expenses.]
Payments cant be based on the amount of time you are out of work.
i.
Should be calculated based on charts that provide amount of reimbursement
depending on injury.
Not excluded if recipient took a medical expense deduction for that amount in a previous
year.
i.
Medical expenses - deductible up to the extent they exceed 7.5% of AGI.

12

A.

Payments made pursuant to separation agreement or divorce:

a.
Alimony or separate maintenance (referred to only as alimony)
b.
Property settlements
i.
Payments not deductible by payor and not included in recipients income.
c.
Child support
i.
Payments not deductible by payor and not included in recipients income.

II.

Alimony and Separate Maintenance payment.

Deductible an exception to the general rule that personal expenses arent deductible.
a.
Above the line
Payments are included in recipients income (71a) and deductible by payor (215a).

A.
B.

a.
C.

These are interdependent: no deduction for payor unless recipient has included in income.

7 Requirements for payment to qualify as alimony or maintenance:

a.
Cash or cash equivalent (check, money order)
b.
Payments received by or on behalf of a spouse, under a divorce or separation instrument.
i.
Divorce decree, separate maintenance decree, or temporary support decree.
ii.
On behalf of: Payments can go to a third party so long as payor is relieving
recipient of a legal obligation.
1.
c.

Payment cant be designated as non-alimony

i.

d.
e.
f.
g.

III.
A.
B.
C.

IV.
A.
B.
C.

ex: pay rent, tuition, mortgage, utilities.

If designated as alimony, not necessarily alimony (if it is a payment for something else disguised as
alimony). If designated as non-alimony, it is not alimony.

The spouses cant be members of the same household

i.
Exception: if not permanently separated or divorced
Payors obligation must end at payees death
Payment cant be for child support.
Cant file a joint tax return.

Property settlements.
Recipient DN have to include in income, payor cant exclude.
Transfer from one spouse to another, or former spouses, incident to a divorce- DN recognize gain.
a.
Transferred basis.
When is transfer incident to a divorce - Two situations: [1041(c)]
a.
Transfer w/in one year after marriage ends is presumed to be incident to divorce
b.
Transfer related to the cessation of the marriage there is a presumption that a transfer
within 6 years of the marriage ending, which was required under divorce/separation
agreement, relates to cessation of marriage.
i.
After 6 years, parties have the burden of proving that the transfer is related to the
cessation of the marriage.
Child support. Child support if:
-Called child support
-Payment decreases upon the happening of a contingency related to child (reaches 18, marries,)
-Reduction of payment can be clearly associated with a contingency relating to the child. [71c2]
a.
Ex: payment decreases on 1/1/10 (which happens to be the date that child turns 18)
b.
Regs: 2 instances to which this will apply
i.
If date of reduction of the payment is w/in 6 months on either side of the childs
18th or 21st birthday, or age of majority if different.
13

ii.
iii.

I.
A.

If payments are to be reduced on two or more dates, w/in a year on either side on
two or more minor childrens same birthday, between the ages of 18 and 24.
[These are rebuttable presumptions - ex: this date is w/in 2 months of childs
birthday, but also happens to be the date ex-spouses graduation.]

Gain from sale of principal residence.

121: apply to transactions after May 27, 1997
a.
Can exclude from income a gain on sale of principal house. 2 requirements:
i.
Owns the house for two of five years before sale.
1.
When property is partly transferred to spouse2 pursuant to divorce, spouse2
gets to count the time taxpayer owned the property towards spouse2s
ownership requirement.
ii.
Uses property as a principal residence for two of five years before sale.
1.
In transfer of property pursuant to divorce, use period includes time
includes time during divorce.
iii.
[The two years DN have to be consecutive, and the same two years DN have to be
used for ownership and use requirements]
b.
Principal residence: primary residence, based on number of days.
i.
Includes condos, houseboats, co-ops, etc.
ii.
Includes land around the house if not used commercially.
c.
Three limitations on exclusion:
i.
Maximum gain that can be excluded is 250k. [121b1]
1.
Increased to 500k if taxpayers:
(a) Are married,
(b) Filing joint return,
(c) Both spouses meet use requirement, and
(i) DN have to be married to meet use requirement
(d) At least one spouse meets ownership requirement.
2.
Statute DN specify what happens if one spouse has to move for job reasons,
but other spouse doesnt (and hasnt met use requirements).
(a) Cecil thinks exclusion would be based on 500.
ii.
Exclusion can be used only once every 2 years.
1.
Exception: if TP has to move for job or health related purposes, or other
unforeseen circumstances.
(a) This exception also applies to use and ownership requirements
(b) Allowable exclusion = (250 or 500) x Y
2 years
Y= shorter of
- The time period since 121 was applied to the previous sale; or
- The time period that the house was used as a principal residence.
iii.
Gain cant be excluded from income to the extent that it was attributable to
depreciation deductions taken after 5/6/97. [121d6]
1.

How that situation arises:

(a) C owns home, and rents basement to tenants. If a portion of residence is
business property, can depreciate (or take deductions) the cost of that property.
(b) Can take depreciation deduction for cost for of house cost if is used for
business purposes. Deductions must be taken over time:
(c) To the extent that you take a depreciation deduction, that is a decrease in
basis.

14

I.
A.

Federal Educational tax benefits.

Credits v. deductions: Credit more beneficial to taxpayer b/c it saves taxes dollar for dollar,
whereas tax deduction only saves taxes = amount of deduction x tax rate.
a.
b.

B.

C.
D.
E.

Ex: 10k income. 50% tax rate. Income (10k) deductions (2k) = taxable income of 8k. Multiply that by
tax rate, and pay 4k in taxes.
i.
Deduction saved 1k in taxes.
Credit: GI x Tax rate=tax liability (5k). Subtract tax credits (2k), reducing taxes owed to 3k.
i.
In this situation, tax saved 2000k.

Hope Scholarship Credit

a.
Costs paid by dependent are deemed to be paid by taxpayer, but dependents cant claim the
credit themselves.
b.
Private letter ruling: If you can be claimed as a dependent on parents tax return, but they
didnt claim dependency exemption, you can claim the Hope credit.
c.
Phase out: 1500 x (modified AGI (40 or 80)) = amount of credit phased out
(10 or 20)
Lifetime Learning Credit
Educational Savings bond
Educational IRA

These two cant be used in the same year

Hope Scholarship Credit

Lifetime Learning Credit

After

12/31/97

6/30/98

Cap

$1,500 per year per student, equal to

100% of first $1K of qualified tuition
and related expenses paid, and 50% of
the next $1K.
- After 2001, adjusted for inflation in
$100 multiples.

$1K / year per T/P (no matter how many

students), consisting of 20% of first $10K
of qualified tuition and related expenses
paid.

Phases out: begins when T/Ps

modified AGI (AGI + excluded foreign
earned income) is greater than $40K
for single T/Ps and $80K for married
T/Ps filing jointly, and is completely
phased out at $50K and $100K,
resepectively. Phase out amounts are
indexed for inflation after 2001.

Qualified Tuition
& Related Exps.

Pmt of exps. by taxfree gift or

inheritance

Max credit available increases to $2K per

year for tax years after 2002, which is
comprised of 20% of the first $10K of
qualified tuition and related expenses
paid.
Phases out: begins when T/Ps modified
AGI ( = AGI + excluded foreign earned
income) is greater than $40K for single
T/Ps and $80K for married T/Ps filing
jointly, and is completely phased out at
$50K and $100K, respectively. Phase out
amounts are indexed for inflation after
2001.

Tuition, academic fees, NOT room and board, books, and non-academic fees (student
activity, athletic, insurance). NOT expenses for courses involving sports, games, or
hobbies UNLESS the course is part of the degree program.

Qualify

15

Whos expenses
qualify?

T/P, spouse, or dependent (see 152). Costs paid by dependent are deemed to be
paid by the T/P (but dependents cannot claim the credit themselves). Under PLR
200236001, if you can be claimed as a dependent on parents tax return, but they do
not claim the HOPE credit, the dependent can. Note PLR cannot be used or cited as
precedent.

Course Load?

Student must carry at least one-half of the

normal academic load of a F/T student at an
eligible institution of higher education
(25A(f)(2)), including certain vocational
schools (it is an educational institution
eligible to participate in US Dept. of
Education student aid programs).

NO Course Load Requirement,

BUT the student must attend an
eligible institution of higher
education, which is defined in
25A(f)(2) to include certain
vocational schools.

Elective Credit

Elective credit which may be elected for the

first 2 years of students post-secondary
education.

Elective credit which may be

elected for any year of the students
post-secondary education. No limit
as to number of years.

Refundable?
Not available if:

No
- Amounts paid are deductible as trade or
business expenses (162).

- Amounts paid are deductible as

trade or business expenses (162).

- Married T/Ps file separate returns.

- Married T/Ps file separate returns.

- In year in which distributions are made

from an educational IRA excluded from GI.
- Same student takes Lifetime Learning
Credit during the same year.

- In year in which distributions are

made from an educational IRA
excluded from GI. This is changed now
through 2010.

- The student has been convicted of a federal

or state drug felony in the year in which the
credit is being taken.

- Same student takes HOPE

Scholarship Credit during the same
year.

- In year in which distributions are made

from an educational IRA excluded from GI.

- Non-qualifying payments include:

tax-free scholarships and
fellowships
payments from E/rs
educational assistance plan
other tax-free educational
benefits

- Non-qualifying payments include:

*tax-free scholarships and fellowships
*payments from E/rs educational
assistance plan
*other tax-free educational benefits

II.

Prepaid expenses: does LLC apply?

a.
25Ag4: any expenses incurred for first three months are deemed to have been incurred in previous year.

F.

Educational Savings Bonds (135)

a.
General rule: Interest is included in income the year that you cash in the bond.
b.
Exception: Educational Savings Bonds
i.
Series EE savings bonds, purchased after 1989, at a discount, by someone who was
24 years old, in the name of TP claiming the exclusion
ii.
May never have to include interest, depending on what you use it for.
16

c.

Qualified educational expenses

x gain otherwise includable
Proceeds from bond -Principal and interest
in income
i.
This is used if expenses are less than proceeds from the redemption of the bonds to
determine the amount that does not have to be included in income.
ii.

Ex: expenses=24k; Bond value = 30k (10k was gain).

24k
x
10k = 8k.
30k
1.
Can exclude 8k from income. Must include 2k of gain.

d.

G.

H.

II.

Exclusion only applies to the extent TP pays qualified higher education expenses during
the year.
i.
Expenses: tuition, fees at eligible educational institution
1.
Expenses reduced by tax-free scholarships, etc. excluded from income
ii.
Expenses can be paid on behalf of TP, spouse, dependents
e.
Can use the Bond in the same year that you use the Hope or Lifetime Credit, if for different
expenses.
f.
Phase out: if modified AGI > 40k, 60k
i.
No exclusion for married, filing jointly
Educational IRAs (530) [Individual retirement account]
a.
Taxpayer who takes out the IRA must designate a beneficiary at the time they take out the
money.
b.
Available beginning in 1998.
c.
No deduction is allowed for the amount contributed to the IRA in the year of the
contribution
d.
Applies to After tax-IRAs (you pay taxes on the money you are putting into the IRA).
e.
Can deduct up to $2000 / year / individual.
f.
The total amount that can be put in an IRA for a specific beneficiary is $2k.
i.
Ex: if mom puts 2k in the IRA, grandma cant put any in.
g.
Dont pay tax on principal or earnings if used for qualified expenses.
h.
Can use IRA for elementary and secondary education.
i.
IRA contribution must:
i.
Be made in cash.
ii.
Be made before intended beneficiary reaches 18.
j.
Phase out until a higher income, as compared to other benefits [Hope, Lifetime, etc].
i.
Modified AGI > 95k, 190k
k.
Cant use the IRA in the same year as Lifetime or Hope credits, but may be done in same
year as Bond, if for different expenses.
l.
If distribution exceeds qualified higher education expenses for the year, a portion of the
earnings from the IRA will be taxable, and subject to 10% penalty tax.
m.
Applies to expanded educational expenses: expenses include tuition, books, fees, supplies,
equipment, and room and board.
n.
Naming beneficiary:
i.
If created for one beneficiary doesnt go to school, can roll over the IRA into an
IRA for any beneficiary who is a relative of the intended beneficiary, or is an inlaw.
1.
The new beneficiary cant have reached 30 years old.
Refundable v. Nonrefundable:
a.
Tax credits are nonrefundable, so take them first, and then take refundable.

Capital gain. [ 1201-1288]

17

A.
B.

Characterization of income:
a.
Ordinary income, or
b.
Capital gain.
Advantages of capital gain:
a.
LTCG is taxed at lower rate than ordinary income.
i.
Current Income Tax rates: 10, 15, 27, 30, 35 and 38.6%. [1]
1.
2.

C.
D.
E.
F.

These rates are different than what is listed in the code. Tax brackets for individuals are
reduced over a period of time. [p. 21 of code]
Ex: Amount over 37000 is taxed at 27%. But, the first 37k is taxed at 15%.

ii.
Capital gains are taxed at 20, 25 and 28%.
b.
Both long-term capital gains and short term capital gains can offset long term capital loss.
Otherwise capital loss generally cant be deducted.
2 Requirements to have a capital gain/loss:
a.
There must be a sale or exchange
b.
Of a capital asset.
LTCG/L - held for more than one year.
a.
STCG/L - held for one year or less.
Prefer ST losses to LT losses (wipes out ST gains, which are taxed at higher rate.)
a.
Prefer LT gains over ST gains (LT gains are taxed at preferential rate.)
Netting Process: Net capital gain= Net LTCG net STCL. [1222(11).
a.
Net long term capital gains with net short term capital losses the remaining gain is taxed
at preferential rates.
b.
-DN net if long term and short term gains.
i.
ii.
iii.

c.
d.

Ex: N LTCG: 60k. 20 STCG; 10STCL.

20k 10k = 10k N STCG.
There are Gains on both sides, so you dont net them. How are those taxed?
1.
LTCG: No STCL, so N CG is 60k.
2.
STCG is taxed the same as ordinary income.
3.
LTCG are taxed at preferential rates.

No special treatment for capital losses

Tax reform act: Created three categories of CG:
i.
28% rate: consists of LTCG from collectibles.
1.
Coins, stamps, artwork, antiques, gems, and liquor.
2.
15% tax bracket: 28% CGs taxed at 15% rate.
ii.
25% gains: apply to unrecaptured 1250 gain (the gain on sale of real property
that was subject to depreciation but only the amount of gain = to depreciation).
1.
15% tax bracket 25% CGs taxed at 15%.
2.
There is never a loss in this category.
iii.
20% gains: any capital gain that doesnt fall into the other two categories.
1.

Ex: stock, summer home, etc.

2.
3.

15% tax bracket - 20% CGs are taxed at 10%.

20% rate decreased to 18% if:
(a) Asset is held for more than 5 years
(b) Asset was purchased after 12/31/00.
10% rate decreased to 8% for:
(a) Assets held for more than 5 years,
(b) Assets sold after 12/31/00.
[Use Constructive repurchase of property after that date to qualify. Problem
is that constructive sale is real sale for tax purpose.]
[There will never be a loss in 18% or 8% categories]

4.
5.
6.

18

A.

Netting capital gains in long term and short term, and netting together.
i.
Net STCG with STCL
ii.
Then Net 20% gains LTCG and LTCL
iii.
In 25% bracket, only have LTCG
iv.
In 28% bracket, net LTCG and LTCL
v.
In 18%, LTCG. But there are no 18% LTCL they are 20%.
vi.
Losses in one LT category first offset gains in the highest tax category.

II.
A.
B.

Capital losses.
To net, the loss must be a deductible loss.
Capital losses can only be deducted against (offset) capital gains + $3k of ordinary income.
a.
It doesnt matter if short or long term capital gains.
Can carry excess losses forward and use them later but losses die with the taxpayer.
a.
All LTCL carryovers are treated as 28% losses.
After netting, if there are losses in excess of gains, use the loss to offset ordinary income:
b.
Constructive STCG is added back into the netting process- on short term side. The STCG
is the lowest of the following:
1.
3k
2.
Ordinary Taxable income
3.
Net stcl + Net ltcl

C.
D.

c.
E.

F.

G.

This wipes out short-term losses first, and then long term losses.

28%
25
20
ST
10k ltcg
8
5k
2k stcg
22k ltcl
0
4k
4k stcl
12k n ltcl
8k net ltcg
1k ltcg
2k n stcl
d.
Income: 50k
e.
Loss offsets highest tax bracket first: 12k loss sets off 8k gain, so there is a net loss of 4k.
f.
Then net that 4k loss with 1k gain. This gives a net 3k ltcl
g.
In this case, add in 3k. (it is the lowest number between income (50k), total loss (5k), and the 3k limit. Add
to 2k stcl, so we have 1k STCG. Net STCG with 3k LTCL, and end up with 2k LtCL carryover.
h.
If income were only 2k, the lowest number to add when figuring constructive gains, so can only add that
amount. This leaves 3k ltcl carryover.
Income=20k.
28%
25
20
ST
10k ltcg
8
5k
2k stcg
19k ltcl
0
4k
4k stcl
9k n ltcl
8k net ltcl
1k ltcg
2k n stcl
a.
Net within long term category:
i.
9k ltcl offsets 8k 25% gain = 1k loss
ii.
Net with the 1k gain; end up with 0.
iii.
Can add the least of: 3k, 20k income, or 2k stcl.
iv.
Add 2k constructive stcg, and net with 2k stcl - there is no carryover.
28%
25
20
ST
10k ltcg
8
5k
2k stcg
22k ltcl
0
7k
4k stcl
12k n ltcl
8k net ltcg
2k ltcl
2k n stcl
a.
Net within long term category:
i.
Use loss to offset highest taxed gain first:
1.
12k-8k = 4k loss (28%)
2.
Add 2k 20% loss (even though they have different rates); there is a total of 6k loss.
b.
Add constructive gain
i.
Add 3k constructive STCG gain to STCL, giving us 1k n STCG.
ii.
Then net gain with ltcl, giving us 5k ltcl carryover.
iii.
All LTCG carryovers offset income in 28% bracket first

19

H.

I.

2k ltcg; 6k ltcl; 2600 stcg; 1k stcl; ordinary income= 10k.

Net ltcg and loss = 4k N Ltcl.
Net Shorts: 1600 net stcg
Net long and short together: 2400 n ltcl
How much ordinary income we can offset:
o The lowest of the three was 2400 (the net ltcl and net stcl)
o There is no carryover.
o Total taxable income is 10k constructive stcg = 7600
2k ltcg; 10k ltcl; 2k stcg; 4k stcl; income = 10k
Net: 8k ltcl; 2k stcl. Cant net LT and ST b/c there isnt a gain and a loss.
Choose the lowest of the three numbers: 3k, 10k (income), 10k (losses)
3k becomes constructive short term capital gain
7k long term capital loss carryover, 28% category

J.

Flowchart.
a.
Realization event? Was it a sale or exchange?
i.
If no, not a capital event.
b.
Capital asset?
i.
If no, not a capital event.
c.
Was it held for more than a year (LT)? Or held a year or less (ST)?
d.
Is any loss deductible?
-Netting process: Determine N Ltcg and N stcg
e.
N LTCG and N STCG
i.
LT taxed at preferential rates; ST taxed as ordinary income
f.
If N LTCG, and N STCL:
i.
Net LT gain with ST loss: If Result is 1.
Net gain: capital gains taxed at preferential rates.
2.
Net loss: use the 3k constructive STCG (or the amount of taxable income, if
less) to determine the carryover, if any, as follows:
(a) Recalculate the STCG/L by adding an additional 3k constructive
STCG to the equation.
(i) Use lesser of: 3k, income, N STCL + N LTCL
(b) Remaining loss is carried over as STCL.
g.
If N LTCL, N STCG:
i.
Net ltcl with n stcg. If result is:
1.
Net gain: STCG taxed at ordinary rates.
2.
Net loss: use 3k of constructive STCG (or amount of taxable income, if
less) to determine the carryover, if any, as follows:
(a) Recalculate the STCG/L by adding an additional 3k constructive
STCG to the equation.
(i) Use lesser of: 3k, income, N STCL + N LTCL
(b) Remaining loss is carried over as LTCL.
h.
If N LTCL, N STCL:
i.
Use 3k constructive STCG to determine carryovers
1.
Or amount of income, or Net losses, if less
ii.
Recalculate N STCG/L by adding constructive STCG to the equation. If result is:
1.
N STCL that loss will carryover as STCL, and LTCL will carry over as
LTCL
2.
N STCG net that gain with N LTCL, and carry over the rest of the loss
3.
If 3k or less of loss, there wont be a carryover.

III.

How to determine whether something is a capital asset (1221)

20

A.
B.
C.

D.

E.
F.

Everything is a capital asset unless it falls into one of the exceptions.

Categories of non-capital assets: (sale therefore results in ordinary gain/loss)
-Trade or business property that is: real property, or depreciable personal property.
a.
Quasi capital assets (1231) trade or business property (depreciable personal property or
real property), if held for more than one year.
i.
If sold at a:
1.
Gain: LTCG (so taxed at preferential rates)
2.
Loss: ordinary loss (and deductible as trade/b loss).
-Copyrights, Literary, Musical and Artistic Compositions, Letters and Memorandum
a.
Applies to:
i.
Creator
ii.
Person who received the item from the creator, with a transferred basis.
b.
For letters and memorandum, it also applies to
i.
The person for whom they were created.
-Accounts receivable - the right to receive a payment that is due for services performed/goods
provided.
-Publications of the US Government given to people free of charge
a.

G.

Policy: if C makes charitable contribution, C can take deduction of the FMV of that property. If contribution
would have been ordinary income if sold, cant take fmv deduction; can only take deduction equal to basis.

-Inventory, Sock and Trade, and Property held for sale to customers in the ordinary course of the
taxpayers trade or business.
a.
Inventory: property used to make stock and trade; stock and trade
i.
Stock and trade: Goods or merchandise held for sale.
b.
Property held for sale to customers in the ordinary course of trade or business:
i.

Difficult b/c people often hold property for more than one reason.

ii.

Consider
1.
Why you bought the property
2.
*** your intent when you sold the property.
Safe-Harbor: tracts of unimproved land are a capital asset if the following
requirements are met:
1.
The taxpayer must not have held the land previously for sale to customers.
2.
Taxpayer cant hold any other real property for sale to customers.
3.
No substantial improvements can be made to the property, by the taxpayer,
or related persons.
4.
Taxpayer must hold property 5 years before selling it (unless inherited).
Exception to safe-harbor rule:
1.
If more than 5 parcels are sold on the same tract of land, any sale occurring
in the year in which the 6th parcel is sold, and thereafter, will be treated in
part as ordinary income - 5% of the selling price is treated as ordinary.
(a) Selling expenses - deductible from the gain taxed as ordinary
income
Special rule with respect to capital gains: Uniform Basis rule (1001e)
1.
Basis in Term interest = 0, if TPs basis is:
(a) Gift basis
(b) Inheritance basis
(c) Spouse transfer

iii.

iv.

v.

(d) [Term interest: life interest, term of years, income interest in a trust]
2.
3.

The remaindermen still gets to use his basis.

Exception: if term interest holder and remaindermen sell together, the term
interest holder can use her basis.
21

(a) Not clear if they have to sell to the same person or not

I.
A.
B.

C.

D.

Sale or Exchange Requirement for capital assets

Otherwise it is ordinary gain/loss
2 situations that possibly are not an exchange (ok if ordinary income, they are non-rec. events):
a.
-Gifts
b.
-Transfer between spouses
c.
Also, Property destroyed by fire, which was not insured, is NOT an exchange.
When a disposition is an exchange: [case law]
a.
Foreclosure sale (even if involuntary)
b.
Condemnation/eminent domain
c.
Abandonment (i.e. leave property to bank instead of foreclosure)
d.
Voluntary conveyance
Statutory provisions giving exchange treatment:
a.
Creditors receipt of payment in exchange for cancelled note. [1261]
i.
New law: Debtor gives property to Creditor, and Creditor gives D a cancelled note.
Debtor has an exchange; creditor is deemed to have a sale or exchange when he
receives payment.
b.
Cancellation of a lease or distributorship agreement. [1241]
i.
Ex: X gives Y money in exchange for Y canceling his lease.
1.
Lesee has sale/exchange treatment it is probably a capital asset, and
therefore capital gain.
c.
Worthless stock [165g]
i.
There is a deemed sale/exchange of the stock on the last day of the taxable year in
which the stock becomes worthless.
1.
2.

Reasoning for this section: The sale of almost worthless stock results in a capital loss, so
the if the owner of the stock waits until it is completely worthless, it will be taken in
bankruptcy and will be an ordinary loss, and offset ordinary income.
B/c it is deemed a sale, it meets definition of capital gain/loss, and loss is deductible as
capital loss, or can offset capital gains. It basically converts an ordinary loss to a capital
loss. (anti-taxpayer)

ii.
d.

II.
A.

Holding Requirement. To Determine LT or ST capital gain/loss.

RR66-7: Do not count day of purchase, but count the day of sale.
a.
Trade date: day taxpayer says to buy or sell the stocki.
These dates are used for stock transactions
1.
Exception: Thinly traded stock it might take time to buy the stock because
it is not sold/bought as often. The actual date of purchase is the trade date.
b.

B.

This provision can convert short-term capital loss to long-term capital loss (which
is bad for the taxpayer!)
Bad debts [166d]
i.
If a non-business debt becomes worthless (i.e. not collectible), it is deemed to be a
sale or exchange of the debt, and gives rise to short-term capital loss (regardless of
how long you held it).

Settlement date the day buyer pays the seller

Special rules (1223)

a.
If you receive an inheritance with stepped up basis, it is deemed to be held LT. [1223(11)]
i.

Only applies if basis is under 1014, so in 2010, there wont be long term holding period granted.

22

b.

c.

First in, first out: If you sell a portion of your stock, deemed to have sold the stock
bought first. [1.1223-1(i)]
i.
Exception: seller identifies what stock is sold,
Tacked holding period [1223(2)]
i.
Recipient of property can tack on holding period of transferor, if received a
transferred basis.
1.
Transferred basis: gift, transfer between spouses
(a) Transferred basis= transferors basis. But if built in loss, and sold below
FMV, use FMV.

2.
3.

Generally good because there may be a gain that is LTCG.

Unlimited tacking

III.
A.

Deductions from gross income:

GI
- Above the line deductions
= AGI
- Personal exemption
- Standard deduction or itemized deductions (below the line deductions)
Taxable income (defined as all income less all allowable losses and deductions)
x Tax rates
Tentative Tax Liability
- Tax Credits (education, earned income, etc.)
Ultimate taxable liability

IV.
A.
B.

Trade or business deduction (162)

Above the line deduction.
Allows taxpayer to deduct all ordinary and necessary expenses paid or incurred in carrying on
trade or business.
a.
Ordinary Expenses are ordinary if common in taxpayers business community, even if
not ongoing or recurrent expense.
i.
Paying debts that you DN owe is probably not ordinary, unless done to protect your
reputation (as compared to when its done when starting a business)
b.
Necessary appropriate and helpful in taxpayers trade/business.
1.
Cant be lavish expenses.
2.
If unreasonable in light of the circumstances, probably not necessary.
c.
Expenses: amount spent for maintaining or repairing property.
1.
Doesnt materially add to the value, doesnt prolong useful life beyond
when it was new.
(a) Ex: add new roof, prolongs life, but is no different then when new.
(b) Ex: add drainage system in flood plain prolongs its useful life.

2.
ii.

C.

If not expense, it is a capital expenditure (not deductible) - adds materially

to value or prolongs useful life, or adapts property to new and different use.
(a) Capital expenditure is added to basis.

Expense is better b/c of the tax savings on that amount. Deductible currently, and the rate is better.
1.
If you have a deduction, it is worth the amount of the tax bracket you are in. if in 27%
bracket, deduction is worth 27%.
2.
If expenditure, lower gain, and are only saving 20% of the cost.
3.
Another benefit is the time value of money.

Expenses must be incurred in carrying on a trade or business.

a.
If already in the business, you are carrying it on, and as long as ordinary/necessary, they
are deductible.
23

b.

c.

d.

Starting a business: expenses are not deductible.

i.
195 Start-up expenses: if expenses are incurred in starting a trade or business, the
expenses are amortizable over not less than 60 months, beginning when trade or
business commences.
4.
DN apply to ee seeking employment.
5.
Applies to those going into business for themselves.
ii.
May deduct start-up expenses (w/o amortization) when:
1.
Start business and it goes bankrupt
2.
Sell business
An employee seeking employment:
i.
Carrying on trade/B if:
1.
Have a job, but looking for another in same trade/b
(a) Case law is all over: Accountant and CPA are different; Lawyer
in MO and L in IL are different t/b; Math teacher and principal are
the same; dentist and orthodontist are the same.
(b) Whether you need a different license, although not
determinative, seems to be a relative constant.
2.
Unemployed but continually looking for a new job in same trade/b
ii.
Hundley exception: If expenses are paid by a third person, and you dont have to
pay it back until you have started in the business, the expenses are deductible.
Deductibility of employment agency fees
i.
Not deductible as start-up expenses b/c an employee
ii.
Not carrying on trade/b, so not trade/business expense unless you DN have to pay
until you have a job.
iii.
Deductible as trade/b expense if you already have one job, but are looking for
another in same trade/b

V.
A.

When are higher education expenses deductible above the line deduction
222: Requirements for Expenses for higher education to be deductible:
a.
Can only be used for tuition or fees
b.
You cant use deduction if you took a higher education tax credit
c.
3k limit this year (next year it goes to 4k)
d.
Can take the deduction until you make 65k/year (if single), 130k/year (if married and filing
jointly)
e.
Cant claim the deduction if a dependant of another taxpayer
f.
Although you cant use same expenses for both this deduction and IRA/savings bond, you
can use them in the same year.

I.
A.
B.

Travel Deductions: Travel away from home, temporarily away from home
Travel away from home - an ordinary and necessary business expense.
May deduct:
a.
Airfare
b.
Cab fare, mileage, parking
c.
Lodging
d.
Meals, entertainment (50%)
e.
Baggage handling fees/tips
f.
Reasonable telephone charges
24

C.

D.

G.

H.

I.

J.

K.

Requirements for travel away from home:

a.
Expenses are Reasoanble and Necessary
b.
Expenses incurred while TP is away from home for a period requiring rest/sleep
c.
Expenses incurred in pursuit of trade/b
Tax home 2 approaches
a.
Principle place of business (service approach)
i.
If an ee in 2+ places, tax home is where you make the most money
ii.
If you work in 2+ places, but arent an ee in both, home is where you spend the
most time.
b.
Personal residence where you spend the most time
i.
If it is somewhere besides where TP works b/c of personal choice, expenses when
he goes to place where he works may not be deductible.
Travel away from home example: If you consider principal place of business as tax home a.
If family is in City, and TP works there 2 days, and works other three days in Metro:
i.
Can deduct expenses in City but service might try to limit it to business days.
1.
could deduct travel to/from.
ii.
Would probably be allowed reasonable living expenses but not sure about lodging
expenses in City (where she stays with her family)
Temporarily away from home:
a.
If you plan to be gone for less than a year, and actually are, expenses are deductible.
i.
If gone more than one year, expenses not deductible.
ii.
If you plan on being gone more than a year, not deductible even if gone less than a
year.
iii.
If you plan on being gone less than a year, but later learn you will be gone longer,
expenses are no longer deductible at the point you learn you will be gone more than
a year.
b.
Travel Expenses:
i.
Travel expenses to go home for the weekend are deductible
ii.
Cant deduct expense of family coming to visit you
c.
When temporarily away from home, not required to maintain residence in both places.
i.
Minority: duplicative expenses are required to deduct. If you move your family,
you have moved your home
Commuting expenses:
a.
Commuting to/from job is not deductible. Exceptions:
i.
While away from home (if reasonable/necessary)
ii.
Commuting to temporary worksite out of metropolitan area
b.
Driving between worksites is deductible.
Travel expenses: (airfare, parking, travel to/from airport, etc)
a.
ALL expenses deductible if primarily business (based on # of days)
i.
If primarily personal, cant deduct any.
ii.
The number of days is the determining factor unless there is some sort of
fraud/deception.
Part business/Part pleasure.
a.
Travel expenses deducted if primarily business
b.
Other expenses deductible on days that are business days
1.
If more than half of the business hours are worked, it is a business day.
c.
The original intent of the trip is not important If you go to Disneyland on vacation, and
end up working with client, it is business.
25

d.
L.

M.

Lodging Expenses: after business ends, and as pleasure begins, whether lodging is
deductible depends on whether TP could have gotten home easily

Meals:
a.
For each trip choose Per diem allowance or actual expenses
i.
may only deduct 50% of either
b.
Per diem: Allowed $35 or $45 (low- or high-cost locale).
Foreign travel.
a.
Travel outside of US: travel expenses are pro-rated depending on business/pleasure
i.
Can only deduct the portion based on number of business day.
1.

ex: 6 business days, 3 pleasure days. Deduct 6/9 of travel expenses.

ii.

N.

O.

P.

I.
A.
B.
C.
D.

Exceptions dn pro-rate if
1.
Travel for < one week
2.
Business travel is of the time
iii.
Weekend days are treated as business days for travel purposes if you work on both
sides of the weekend.
1.
Can also deduct food/lodging for weekend
Expenses for spouse: to deduct, must meet three requirements:
a.
Spouse is bona fide ee of person paying the expenses
b.
Travel is for bona fide purpose
c.
Expenses are otherwise deductible
Taking a cruise as means of travel:
a.
Can deduct the costs up to the amount of twice the daily per diem amount, for the # of days
on the cruise
i.
Per diem amount: amount allowed to government ees in travel
Conventions:
a.
In North America: deductible if other requirements are met
b.
Outside North America: must show that it was at least as reasonable to have convention
outside N. America as to have it in N. America. Look at
i.
Who is attending, their residences
ii.
Speakers
iii.
Purpose of the meeting
c.
Not allowed on cruise ships, or for investment purposes.

Deductibility of interest.
Situations which may occur.
a.
Business interest deductible as ordinary trade business expenses.
b.
Interest on investments. Deduct under 212.
General rule: personal expenses are not deductible.
a.
Exception: interest deductions (in limited instances)
Interest is deductible in two instances:
-Qualified educational loans [221] (An above the line deduction)
a.
Can deduct interest on Qualified educational loans (which are loans to pay for qualified
higher education expenses tuition, fees, books, room and board)
i.
Used by you or dependents
ii.
Must have been least a half-time student.
b.
Qualified expenses are reduced by non-taxable amounts received, but not by gifts.
c.
Limited to $2500/year.
d.
Phased out for singles between 50k-65k; for married between 100-130k.
26

E.

F.

e.
[Deduction is for interest paid not for interest incurred.]
f.
Both spouses can probably take statute says individual, not taxpayer
-Qualified Residence Interest [163h3]
a.
Must meet two tests:
i.
Debt must be secured by qualified residence (QR).
ii.
Debt must be acquisition indebtedness or home equity indebtedness.
b.
Qualified residence
i.
Principal residence (where you live the majority of the year), and
ii.
One other residence that meets use test (if residence is used)
1.
Must use the property as a residence for more than 14 days or 10% of the
rental use, whichever is greater.
(a) Includes a vacation home.
(b) Ex: Condo in Columbia. Graduate in 2002. In 2003, stay for
Jan and Feb, and then move, and rent condo for the rest of the year.
(i) 10% of the use: rented for about 300 days; 10% is 30.
Must use as a residence for more than 31 days during the
year to qualify.
(c) If property isnt rented at all, dont have to meet use
requirement.
2.
If you rent your own principal residence, but own two homes:
(a) You cant use the two homes; this applies only for principal
residence plus one other house.
c.
Acquisition indebtedness: Debt incurred to purchase, construct or substantially improve a
qualified residence. []
i.
Ex: loan to build a house.
ii.
Substantially improve: usually involves an addition.
1.
Ex: adding a patio is probably not substantial improvement.
iii.
Total amount: can only deduct interest on first million dollars of borrowing. Any
amount over that amount, is not acquisition indebtedness.
iv.
Ex: purchase 2 mil home. Only half of the interest is deductible.
v.
Before 1987: there wasnt a million dollar cap.
1.
The amount is grandfathered in. If debt greater than one million, all interest
is deductible.
vi.
Refinance the mortgage: [make a new loan, borrow the same amount of money, and
pay off old loan]
1.
If you refinance, you technically dont meet acquisition indebtedness
requirements. But, to the extent you refinance, the refinanced loan is
acquisition indebtedness.
d.
Home equity indebtedness:
i.
Debt secured by a qualified residence up to the equity value in your home.
ii.
Capped at 100k.
iii.
Ex: 200k acquisition indebtedness; 700k FMV; 500k refinance.
1.
200k is acquisition.
2.
100k is home equity indebtedness.
iv.
Equity: defined as FMV acquisition indebtedness.
1.
Ex: worth 1.1 million. Loan is 1.1 million.
(a) Equity for purposes of this: 1.1 1mil (b/c capped at one
million), so there is 100k of home equity indebtedness.
Home mortgage interest
a.
A Point = 1% of loan amount.
27

b.
c.
d.

e.

f.

A point a fee in getting a mortgage.

i.
Points arent a cost in purchasing your house, and therefore arent included in basis.
[see exception below]
Are points deductible?
Argue in favor of deductibility: A point is a cost of borrowing money.
i.
Interest is also a cost of borrowing money.
ii.
But in some jurisdictions points are designated as the cost of preparing the loan:
processing documents, renting a room, etc.
1.
In those jurisdictions where points are costs associated with the loan, it is
not interest. In these places, the points may be added to basis.
Points dont fall w/in acquisition or home equity indebtedness how are they deductible?
i.
Do they have to amortized over the life of the loan, or can they be deducted
currently?
ii.
Can be deductible currently if three requirements are met: [461g3]
1.
The indebtedness is for purchasing or improving a principal residence.
2.
Payment of points is an established practice in the area
3.
Points are reasonable in amount for the area.
4.
[If these requirements are not met, must amorization deductions over the
life of the loan.]
iii.
Refinancing: You cant currently deduct the points; you must amortize them
because they dont meet the above requirements.
1.
Exceptions in 8th circuit: points on a refinance loan are deductible in the
year paid if you otherwise meet these requirements (must be for principal
residence, points must be an established practice, points must be reasonable)
[Huntsman v. Commr]
(a) This is wrong!
(b) This was a case where they couldnt afford the interest rate, so
they got a balloon loan. This occurred during the purchasing phase,
and commentators say this is why the court did what they did.
[If seller pays the points, it is considered a cost of selling the property, and reduces the
sellers amount realized.]

I.

Below or Above the line deductions AGI

GI
- above the line
AGI
- below the line
- personal exemptions
Taxable income
a.
Why we need to know AGI
i.
Can only take medical expenses as a deduction to the extent they exceed 7.5 % of
AGi
ii.
2% floor on certain itemized deductions.
iii.
Charitable contributions: deductible up to 50% of AGI
b.
Deductions listed in section 62 of the code are above the line deductions; all other
deductions are itemized, below the line deductions.
i.
62 doesnt give deductions; it just categorizes them.
ii.
63 governs below the line.
28

c.

Examples:
i.
A.Trade/business expenses are generally above the line for employers/selfemployed
1.
Below the line if an employee.
ii.
B. employee expenses deductible below the line.
1.
only 50% are deductible if entertainment.
iii.
c. Reg cited: if there is an exact reimbursement of an expense that is deductible,
employee doesnt have to include that amount on the return.
1.
62a2a: reimbursed expenses are above the line.
2.
sometimes ee include reimbursement in income if they do, this 62 rule
applies, resulting in a wash.
iv.
If amount reimbursement exceeds expenses?
1.
excess is income.
2.
If expenses exceed reimbursement: deduction of excess by employee. That
deduction is below the line.
v.
d.
vi.
e. deductible b/c in that line of business, but b/c an employee, below the line
deductions.
1.
expenses are above the line under 62a18 if they qualify for more strict
rules of qualified educational expenses of 222
vii.
f. none of these are in 62. all allowable deductions (real estate tax, med expenses,
charitable) they are all below the line.
viii. G. related to income producing property. 62a4. Producing rents and royalties are
above the line.
ix.
H. below the line 62a3.
1.
assumes loss is deductible , but it is under 165, because it is investment loss.
x.
I. Above the line - 62a17.
xi.
J. is that trade/business, or personal expense (below the line)? Taxes are not
directly attributable to tax/business.
1.
therefore they are persona, not trade/business, and are below the line.
2.
reg 162-1d

get Friday notes

A.

[$3050 is the dependency exemption this year.]

Office hours: Thursday before final 1-5. Room 320.

cecilm@missouri.edu
882-7765
Final: 36 mc (1/2 of the grade); 3 essays (45, 15 and 30 min). 3.5 hours.

29