INTRODUCTION A.

Tax Formula - Gross Income ( 61) Exclusions ( 101-150 gifts/inheritance/annuities) Above the line deductions (162 business deductions, 62 specified deductions) = AGI o AGI person exemptions, 151-152 minus A) 63 standard deduction or B) itemized deduction ( 63, 2% floor imposed by 67 misc. itemized) o Then personal/dependency exemptions ( 151, 152) = Taxable Income Taxable income Tax Credits ( 25A) = Tax Liability o Tax liability x Applicable Tax Rate = Tax Due or Your Refund B. Limitations to tax - Federal Tax must have uniformity across all 50 states, same tax is subject to everyone o Uniformity: Whenever some mode of taxation is used somewhere in the US, the same mode of taxation must be used everywhere throughout the US Ex: federal income tax - State income tax varies across each state - Direct tax: tax demanded from the very person who is intended to pay it (income tax, property tax) o must have apportionment (Ar. 1 9): direct tax unavoidable, must be apportioned among the states on the basis of population (head tax) - Indirect tax: tax paid primarily by a person who can shift the burden of the tax to someone else or who at least is under no legal compulsion to pay the tax, it is avoidable o Ex: sales tax, buyer pays the sales tax but it is applied to the merchants Pollock: taxes on income from property is a direct tax. SC says tax on income is on property and it is a direct tax on property, when theres direct tax there has to be apportionment; apportionment is usually based on income 16th amendment: can tax income from whatever source derived without apportionment, but still must be uniformed

C. Courts - Tax Court: o TP does not have to pay deficiency, a taxpayer can petition the Tax Court for a redetermination of the deficiency. Suits are between taxpayer and commissioner. o Tried without a jury. o Ct based in DC but travels around the country o If lose can appeal to Circuit Ct. of where TP resides - District Court: o TP must pay all the deficiency and then if win case can get money back o There is a jury. If law is unfavorable to TP they can come here. o If lose can appeal to circuit courts, but can only appeal in circuit of where TP resides - Court of Federal Claims: o Must pay deficiency. Then can get $ back if win. o No jury trial o If lose here, can go to US Court of Appeals Federal Circuit Ct. 1

Court of Appeals for the Federal Circuit: decisions by district courts and of Tax Courts are appealable here. o If lose here can go to SC Supreme Court: appealable here by petition for cert.

D. Procedure of Audit TPs choices: - Paying disputed items - Dispute it o Auditor sends a 30-day letter (disagreeing) TP can pay or TP has 30 days to file written protest giving TPs reasons If written protect is filed by TP within 30 days, case is sent to the appeals office of IRS if not settled or TP does nothing then o TP receives a 90 day letter called Statutory notice of deficiency (6212-13) TP has 90 days from date of mailing to file petition w/ US Tax Ct or pay No extension of 90 days If TP does nothing no recourse but to pay the deficiency If TP files petition within 90 days then IRS cant assess or collect deficiency until case is settled or Tax Ct. decides case. (if TP wants to be heard in Ct. must file) Petition must be postmarked on or before 90 days from the date on 90-day letter, if not then TP is screwed and must pay Interest: interest accrues on the amount during the pendency of any tax case from the time the tax return was due to be filed and continued until tax was paid Burden of Proof: burden initially on TP, can shift burden if TP has done certain things SOL: IRS has 3 yrs from day you filed (typically 4/15), unless filed early then it will be considered as filed on such last day o 3 year period is extended to 6 years if TP omitted gross income in excess of 25% ( 6501(e)(1)(A)) o IRS must mail the 90 day letter certified mail and must be post marked before SOL expired Exceptions to 3 yr SOL No return filed by TP: No SOL, open indefinitely Fraud: requires specific and knowing intent, burden of proof on IRS to show TP knew something was taxable and didnt include it Waiver/Agreement to Extend: IRS and TP can agree to extend. TP must sign waiver Penalty - Failure to file: if there is a deficiency 5% of the tax per month - Filed late: 1% per month until filed - Failure to pay the tax due on the return is one half of 1% of the tax per month -

GROSS INCOME

61 Gross Income
(a) General Rule: GI is broadly defined and includes all income from whatever source derived. Includes everything unless something is specifically excluded, intentionally set forth so Congress doesnt have to keep amending it Definition of Income: o Accession to Wealth and o Realization event: there must be some sale or other disposition of an item of property before the appreciation is realized and becomes gain included in GI o Receipt of economic benefit: when TP receives an economic benefit List is illustrative not inclusive Cash flow is not income (ex. Loans) Can reduce income w/ adjustments for AGI (Adjusted Gross Income) under 62 Gross income reduced by adjustments = AGI above the line and below the line deductions above the line generate a bigger tax benefit- gets deductions and reduces gross income can further reduce by personal and dependency exemptions each person gets a exemption for themselves unless they are claimed by someone else (151) exemptions for all individuals that qualify as your dependent (152) 63 Taxable Income- reduce AGI with personal/dependency exemptions and deductions o can reduce AGI by greater of standard deductions or itemized deductions standard deductions are automatic itemized deductions are a number of deductions Congress has set (ex. Buying a home) o aged or blind gets additional standard deductions From taxable income you compute your tax liability (1) o Filing status effects your tax rate schedule After computing tax liability then you may reduce w/ tax credit o Tax credit decreases tax liability dollar for dollar while deductions only reduces by marginal rate Non-refundable and Refundable- refundable can get a refund if tax liability is 0 (ex. HOPE, making work pay, Earned Income Tax Credit) Current system of tax is progressive not flat rate 1.61-14(a): treasure trove includable in GI in the year which is reduced to undisputed possession o Jewelry: not taxed until possessor turns it into cash (no realization event) 1.61-8. If received cash for providing rent or rental space you will have income TR. 1.61-14(a) makes punitive damages included in GI

TR -

Cesarini v. US - Discovered a treasure trove of old currency. 61 interpreted very broadly, gross income is broadly defined and includes treasure trove. Treasure trove: when you discover something that you didnt own before and somehow affirm title to it, once gain title then includable in income - Treasury regs under 61 : income in any form and does not have to be cash - Realization capturing the value; must be reported Old Colony Trust v. Commissioner - The discharge by a third party of an obligation owed by the taxpayer is an economic benefit to the TP, and is includable as gross income. Accession to wealth Commissioner v. Glenshaw Glass - Awarding of punitive damages and treble damages are gross income. Gross income means all income from whatever source derived. Gross income when you have undeniable accession to wealth, clearly realized, and over which the taxpayer has complete dominion. Charley v. Commissioner - Travel credits converted into cash in a personal travel account established by an employer constitute gross income to the employee. (air miles)

Helvering v Independent Life Ins. Co. - The rental value of the building used by the owner does not constitute income within the meaning of the 16th A Revenue Ruling 79-24 - The FMV of the services or property received as payment must be included as gross income Dean v Commissioner - The fair rental value of the residence property is to be included in the taxpayers gross income when the property was held in the name of the corporation and he lived there for free

EXCLUSIONS FROM GROSS INCOME

102 Gifts p. 96
(a) General Rule: GI does not include the value of property acquired by gift, bequest, devise, or inheritance. Under Duberstein a gift proceeds from a detached and disinterested generosity out of affection, respect admiration, charity, or like impulses. Whether it is a gift is determined by the facts and circumstances o (b)(1) Exclusion does not include the income from the property received; or o (b)(2) Where gift, bequest, devise, or inheritance is of income from property o (c)(1) Exclusion does not apply for any amount transferred by or for an employer to or for the benefit of an employee 4

Gifts from employer to an employee Gifts generally out of the business relationship are deemed compensation To an employee during ongoing employment To employee upon or after retirement To survivors upon death of an employee Excluded if employee can show that transfer was not made in recognition of the employees employment. Shall not apply to amounts transferred between related parties (father/son) if the purpose of the transfer can be shown transfer was for the familial relationship and not to the circumstances of employment. Policy: IRS doesnt want gift to be disguised as compensation Look to the relationship, no quid pro quo

TR 1.102-1(f) o

102 does not apply to prizes and awards under 74 and de minimis fringe benefits under 132 Exceptions to TR 132(e) if traditional retirement gifts are treated as de minimis fringe benefits then excluded from GI 74(c) employee achievement awards are freed from tax Gift from spouse: o 1041(b): When property transferred to a spouse, there is no need to determine transferors motive. Property is treated as received by the transferee as a gift and excluded from GI. Wolder v. Commissioner - Agreement between client and atty to continue to provide services if agreed to devise, bequest, inherit - Court held that it is compensation. Cant just call something that is a devise, bequest, inheritance to turn the compensation for services as a devise, bequest, inheritance - Test is whether in actuality the gift is a bonafide gift or simply a method for paying compensation o Must look to the intent of the parties, the reason for the transfer, and the parties performance in accordance with their intentions - We look to substance of the transaction and not the form o Form here was devise, bequest, inheritance and substance was compensation for services that were provided to his client Lyeth v. Hoey - Received money from grandmas estate - Intent of statute 102 if truly an inheritance or bequest then can be excluded from gross income, here it is truly inheritance but the state labeled it something else so to form it was not inheritance, but the Ct. looked at the substance and it is truly an inheritance - Money received from the compromise of a will contest is received through inheritance and is exempt from income tax - Damage received in settlement of a will contest are not taxed bc bequest are not taxed 5

 132 Certain Fringe Benefits

Non-discrimination rule; must be provided on substantially equal terms to other employers (a) Not included as gross income any fringe benefit which qualifies as a: 1. No-additional cost, 2. Qualified employment, 3. Working condition fringe, 4. De minis fringe, 5. Qualified Transportation, 6. Qualified moving expense, 7. Qualified retirement planning services Cannot give discount below cost o (b) no additional cost benefit means any service provided by an employer to an employee for their use (b)(1): such services is offered for sale to customers in the ordinary course of the line of business of the employer in which employee is performing services, and (b)(2): employer incurs no substantial additional cost in providing service to employee.

(c) Qualified Employee Discount (1) Any employee discount with respect to qualified property or services to the extent discount does not exceed: (A) In the case of property discount, exclusion cant be greater than gross profit percentage (GPP) (B) In the case of services, 20 % of the price offered to customers

(2) GPP = (aggregate sale price cost of goods)/aggregate sale price = % that may be excluded from GI (4): Qualified property or services means any property or service (other than personal or real property) which are offered for sale to customers in the ordinary course of the line of business of the employer in which employee is performing services.

(d) Working Condition Fringe- this means any property or service provided to an employee to the extent that if the employee paid for property or services such payment is deductible under 162 (trade/business deductions) and 167 (depreciation deduction) Ex: use of company car, airplane, on job training, magazine subscription. (e) de minimis fringe (1) Means property or service the value of which is so small as to make accounting for it unreasonable or administratively impractical. Ex: photocopy, pens, coffee, eating facility (2): Any eating facility for employees is treated as a de minimis fringe if (A): facility is located on or near the business premises of the employer, and (B): revenue derived from facility normally equals or exceeds the direct operation costs of the facility

TR 1.132-7(b)(1): operating costs include costs of food and beverages and cost of cooks, servers and others employed at the restuarant Will apply to highly compensated employee only if access to the facility is available on substantially the same terms to all other employees

(f) Qualified transportation fringe (1) means the following provided by an employer to an employee: (A) Transportation in a commuter hwy vehicle if transportation is in connection with travel between employees residence and place of employment o (f)(5)(B) Commuter vehicle means any highway vehicle which sits 6 adults and at least 80% of the mileage used can reasonably be expected to be for purposes of transporting employees between residence and place of employment, and trips during which employees are transported is at least of the adult seating capacity (at least 3 people) (B) Transit pass o (f)(5)(A) Transit pass means any pass, token, farecard, voucher, or similar item entitling a person to transportation if such transportation is (f)(5)(A)(i) on mass transit (f)(5)(A)(ii) provided by any person in the business of transporting persons for compensation (C) Qualified parking o (f)(5)(C) means parking provided to an employee on or near business premises of the employer or on or near a location from which employee commutes to work (2) fringe benefits which are provided to employee which may be excluded from GI shall not exceed (A) $100 per month in the case of the aggregate of the benefits (B) $175 per month in the case of qualified parking (3) Cash Reimbursements- fringe benefit includes a cash reimbursement provided by employer. Apply to reimbursement for transit pass only if a voucher or similar item is not readily available for direct distribution by EP to EE (f)(4) No constructive receipt- no amt. shall be included as GI of an employee b/c EE may choose b/w any qualified transportation fringe and compensation which would otherwise be includible in GI of EE (g) qualified moving expense - means amount received directly or indirectly by an individual from an employer as a payment for expenses which would be deductible as moving expenses under 217. If not deductible than must be included in GI (h) Certain Individuals treated as EEs for purposes of no additional cost and qualified EE discount (1) Retired and disabled EEs and surviving spouse of EE treated as EE includes 7

o o

(A) any individual formerly employed in the line of business by reason of retirement or disability (B) any widow or widower of any individual who died while employed in the line of business or w/in meaning of (A) (2) Spouse and dependent children Any spouse or dependent child of the EE treated as EE (3) Parent shall be treated as EE in cases of air transportation (i) Reciprocal Agreements any service provided by an EP to EE of another EP shall be treated as provided by the EP of EE if: (1) pursuant to written agreement (2) neither EP incurs additional cost (j) Only applies to highly compensated officers if not discriminatory (m) qualified retirement planning services - means any retirement planning advice or info provided to an employee and his spouse by employer Does not include retirement planning that includes tax prep, accounting, legal or brokerage servic

119 Meals or lodging furnished for the convenience of the employer

(a) Gen Rule: Employee may exclude from GI the value of meals and lodging furnished to employee, his spouse, and his dependents for the convenience of the employer only if: o (1): Meals are furnished on the business premises of the employer and if they are furnished for the convenience of the employer or, o (2) In the case of lodging, the employee is required to accept such lodging on the business premise of the employer as a condition of his employment. TR Elements Lodging is furnished on business premises of the employer Furnished for convenience of employer and Employee is required to accept lodging as condition of his employment (b) Special Rules o (1) In determining whether meals or lodging are furnished for the convenience of the employer, the provisions of an employment contract or of a State statute fixing terms of employment shall not be determinative of whether the meals or lodging are intended as compensation. o (2) In determining whether meals are furnished for the convenience of the employer, the fact that a charge is made for such meals, and the fact that the employee may accept or decline such meals, shall not be taken into account. o (3) If an employee is required to pay on a periodic basis a fixed charge for his meals, and such meals are furnished by the employer for the convenience of the employer, there shall be excluded from the employee's gross income an amount equal to such fixed charge. o (4) All meals furnished on the business premises of an employer to such employer's employees shall be treated as furnished for the convenience of the employer if, without regard to this paragraph, more than half of the employees to whom such meals are furnished on such premises are furnished such meals for the convenience of the employer. -

(d)(1) Qualified campus lodging furnished by educational institutions to employees is excluded from GI (faculty housing, Professor getting free rent) o (2)(A)Amount of exclusion is limited to either 5% of the appraised value of the qualified campus lodging or average neighborhood rent. Excluded amount = the difference between how much TP pays and the lesser of the two (5% of appraised value or avg. neighborhood rent) o (3)(A)qualified campus lodging means lodging located on or near proximity of campus (B)Has to be furnished and for TP, spouse, and dependent, no one other than TP and must be used as a residence o (4)(A)Employer must be academic college or academic health center (B) Health center defined as providing of medical or hospital care, medical education or research TR 1.119-1 - Meals furnished to EE by EP shall be excluded as GI if: 1. Meals furnished on business premises, 2. For the convenience of the EP - Meals furnished on nonworking days do not qualify for exclusion - If employer would have furnished meals to employee during work hours, but was furnished immediately after work hours because so busy employee couldnt eat then it was furnished for non compensatory business reason - If furnishing lodging then must meet 3 requirements: 1. On business premises, 2. Convenience of EP, 3. Condition of employment -

Herbert G. Hatt v. Commissioner Rule: The fact that a taxpayer is a shareholder in a closely held corporation does not alone disqualify him from excluding lodging benefits furnished for the convenience of the corporation

74 Prizes and Awards

(a)Gen Rule: GI includes amounts received as to the FMV of prizes and awards. 3 exceptions where TP/client can exclude: o (b): TP may exclude from GI amounts made primarily in recognition of religious, charitable, scientific, education, artistic, literary, or civic achievement, but only if: (must satisfy all 3) (1) Recipient selected without any action on his part to enter contest or proceeding (passive recipient); (2) Recipient is not required to render substantial future services as a condition to receiving the price; and Rev. Ruling 1.74-1(b): Pulitzer Prize or Nobel prize is excluded from GI if donated to charitable org, even though the recipient is expected to make a speech at the award ceremonies. (3) The award/prize is transferred by the payor to a governmental unit or organization described in paragraph (1) or (2) of 170 pursuant to a designation made by the recipient (there was immediate transfer to charity w/o any use or enjoyment of it by the taxpayer). o (c) Exceptions for certain employee achievement awards 9

(1): If cost to the employer of the award does not exceed the amount allowable as a deduction to the employer for the cost of the award than it is excluded from GI. (employee achievement awards are excluded only to the amount that employer can deduct) The value of the award is its cost and not the FMV of the award that affects how much employer can deduct. An award may qualify if it relates to length of service or to safety and must be in the form of tangible personal property, be awarded as part of a meaningful ceremony, and not be mere disguised compensation Limits under 274 Disallowance of Certain Entertainment Expenses - (j)(2): Deduction for the cost of an employee achievement award (not FMV) made by an employer to an employee: o (A)Deduction cant be greater than $400, and o (B) is a qualified award when added to the cost to the employer for all other awards made to employee shall not exceed $1600 - (j)(3)(A)Employee achievement award is tangible property which o (i) Must be related to length of stay or safety o (ii) Needs to be awarded during a meaningful presentation, and o (iii) Cant be disguised as compensation - (j)(4)(B): Length must be at least 5yrs or more and has not received a length of service award for the current or any 4 yrs prior. o (C): Safety achievement award qualifies if (i) employee achievement awards for safety achievement have not been previously awarded by the employer to more than 10% of the employees of the employer (ii) award made to employee other than manager, administrator, clerical employee or other profession employee - Not indexed for inflation Allen J. McDonell - Ct held that under the facts and circumstances, the expenses of the trip are not includable in the gross income of petitioners. Petitioner had a duty to go and was a work obligation - Might also be able to exclude as fringe benefit under 132

117 Qualified Scholarship

(a) TP may exclude from GI money received from qualified scholarship who is a candidate for a degree at a qualifying educational institution (b)(1)Qualified scholarship means amount received by an individual as a scholarship or fellowship grant so long used for qualified tuition and related expenses o (2)(A) Qualified tuition and related expenses means tuition and fees required for enrollment or attendance of a student at an education organization, and (B) fees, books, supplies, and equipment required for course of instruction at the educational organization

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(c) Limitations: o (c)(1) May not exclude any amount earned doing research, teaching, or other services by the student required as a condition for receiving the scholarship Dont want this scholarship to be disguised as compensation) Any amount used for room and board and non-scholastic will be included in GI o (2) May exclude amount received under Natl Health Service Corps or Armed forces health Profession Scholarship (d)(1) Qualified tuition reduction is excluded o (2) Qualified tuition reduction means amount of any reduction in tuition provided to an employee of an educational organization described in 170(b)(1)(A)(ii) (an educational org that maintains a regular faculty and curriculum and regularly enrolled body of students in attendance) for the education (A) of such employee (applies to only below grad level), or (B) Any person treated as an employee under 132(h) (broad definition) o (3) Reduction must not discriminate in favor of highly compensated

TR 1.117-6(d)(3): If TP gets scholarship and required to do some teaching or researching and facts show how much other non-students get paid to do similar teaching or researching then TP can exclude from GI amount of scholarship of how much he got more than what other non-students get paid for doing similar teaching.

127 Educational Assistance Programs

(a)(1) Gen Rule: Employees can exclude from GI amounts paid or expenses incurred by the employer for educational assistance to the employee o (2) Max exclusion up to $5,250 (b) Educational Assistance Program o (1) Is a sep written plan of an employer for the exclusive benefit of his employees to provide such employees with educational assistance o (2) Must be available to broad class of employee and not discriminate in favor of highly compensated employees o (3) no more than 5% of amounts paid will benefit principal shareholders or owners o (4) program cant provide choice of education assistance and other remuneration o (6) must have reasonable notification to employees that program exists (c)(1) Educational assistance means (A) The payment by an employer, of expenses incurred by employee for education of the employee including but not limited to tuition, fees, and similar payments, books supplies, and equipment relating to the education of the employee (B). Does not include meals, lodging or tools or supplies which may be retained by employee after completion of a course. Does not include payment for transportation, sports, games, or hobbies. 11

(2) Employee includes individual who is an employee under 401(c)(1) (self employed individual treated as employee) Reg 1.127-2(c)(4)- Education is instruction which improves or develops the capabilities of the employee; it is not limited to job related courses and the employee is not required to be a candidate for a degree If it exceeds limit of $5,250 or does not fulfill other requirements under 127 then: - Can still be excluded from employees GI if it constitutes a working condition fringe benefit under 132(a)(3)

101 Life Insurance/Death Benefits

(a)(1)Gen. Rule: TP may exclude from GI amounts received under a life insurance contract if such amounts are paid by reason of the death of the insured. o (2) If transfer for a valuable consideration by assignment or in other manner than exclusion is only limited to principle amount of the policy. Must include amount if beneficiary receives more. (c) if any amount excluded from GI is held under an agreement to pay interest, the interest payments are included. (d) When payment made at a date later than death: amounts held by insurer with respect to a beneficiary are prorated over period in which payments are to be made. Excluded from GI of such beneficiary in taxable years received any amount determined by proration. If beneficiary/TP does not elect to take lump sum when policy holder dies TP can receive money in installments and excluded amounts are prorated for each paid installment. Exclude capital investment (g): Amounts paid to insurer who is (g)(1)(A) terminally or (g)(1)(B) chronically ill under life insurance K is deemed to be paid by death of an insured and is excluded from GI. If borrow from own life insurance policy is not gross income because you dont have accession to wealth since you have a debt. (g)(2)(B)(ii) Terminally ill defined as someone who is expected to die within 24 months after being certified by a physician as having an illness or physical condition which will lead to her death ( 101(g)(2)(B)) (g)(2)(B)(ii) Chronically ill defined as someone other than a terminally ill person, who has been certified by a licensed health care practitioner as being unable to perform without assistance certain activities of daily living, such as eating or bathing, or requiring supervision because of cognitive impairment ( 101(g)(4)(B)). (g)(3) Payments made to chronically ill individuals are excludable only to extent that the payments are for qualified long term care services of the insured or are amts received on a per diem or other basis that do not exceed $175/day

72 Annuity
- (a)Gen. Rule: Any amount received as annuity is included in GI (inclusionary provision) Exclusion Provision: When annuity is excluded from GI: - (b)(1) Exclusion ratio is the amount of TPs initial investment divided by their expected return. Return of capital is excluded 12

o o -

Exclusion Ratio = amount of TPs initial investment/expected return If not above formula then expected return = life expectancy (years) of TP x $ payout per year (2): Exclusion from GI is limited to amount invested. Portion received that is under amount invested is excluded from GI o Ex: When TP has recovered 150,000 then any payments received after that is all GI and must be included. (3)(A)(i) If after the annuity starting date, payments as an annuity under the contract cease by reason of the death of an annuitant, and (ii) as of the date of cessation, there is unrecovered investment in the contract, the unrecovered amount shall be allowed as a deduction to the annuitant for his last taxable year. (will be itemized deduction and not misc. itemized) o If TP doesnt have sufficient GI in her final year to absorb a deduction of whats left over of the annuity that TP didnt receive (deduction greater than GI) then it will be a net operating loss than it can be carried back to offset income in the TPs preceding years or can be carried forward for 20 years to offset income in those years

108 Discharge of indebtedness

61 (a)(12) Discharge of indebtedness - 61 (a)(12): General Rule: GI includes any increases of wealth due to discharge of indebtedness o US v. Kirby: if bond is sold at a price less than the issuing price or face value, the excess of the price or face value over the purchase price is a gain and included in GI. If price sold is less than issuing price it is included in GI. Exception to 61(a)(12) - 108(a)(1): General Rule: can exclude from GI income from discharge of indebtedness if discharge occurs: o (A) in a title 11 case. If bankrupt then debt relief is excluded from GI. o (B) when the taxpayer is insolvent (TP owes more than owns/liabilities more than assets). (a)(3): insolvency exclusion shall not exceed the amount by which TP is insolvent o (C) The indebtedness discharged is qualified farm indebtedness. o (D) Debt incurred when acquisition/improvement of real property used in TPs trade or business is cancelled. Amount excluded is limited to extent that the outstanding principal amount of such indebtedness exceeds the FMV of the real property. Any amount so excluded results in a reduction of the basis of TPs depreciable real property. Reduction of Tax attributes - (b)(1) If discharge of indebtedness is excluded from GI under (A) or (B) above then tax attributes of TP must be reduced by that amount excluded. Takes away tax benefits to where you might enjoy them later. Prevents double benefit. - (b)(2) Reduction made in following order 13

o o o o o

(A) Net operating losses (B) General Business Credit (C) Min. Tax Credit (D) Capital loss carryovers (E) Basis Reduction If excluded from GI under (a) and (b)(2)(E) then such portion shall be applied in the reduction of the basis of any property held under 1017.

IRC 1017 - 1017(b)(2): (limitation in title 11 case or insolvency) TP required to reduce his basis only to the extent of the excess of the total adjusted basis of TPs property immediately after the discharge over the total liabilities immediately after the discharge. This does not apply if TP elects to reduce the basis of depreciable property and real property inventory in lieu of reducing net operating losses and other tax attributes. o (b)(2)(F) Passive activity loss and credit carryovers Purchase Price Adjustment - (e)(5): If indebtedness arising out of the purchase of property is reduced or discharged by the seller of the property, the reduction is treated as a reduction in the purchase price of the property rather than as income from the discharge of indebtedness, so it is excluded from GI. If the purchase price of an item of property is reduced here, the cost basis of the property must also be reduced. Reduction must not occur in a title 11 case or when purchaser is insolvent Zarin V. Commisioner The term indebtedness of the taxpayer, means any indebtedness a) for which the taxpayer is liable or b)subject to which the taxpayer holds property. in order to come under the scope of discharge of indebtedness rules, the TP must satisfy one of the two prongs. 1. Debt subject to which he held property and 2. legal obligation to repay debt. Contested Liability- if a TP, in good faith, disputed the amt. of a debt, a subsequent settlement of the dispute would be treated as the amt. of debt cognizable for tax purposes. If a TP pays off a debt for less than the amt owed, the difference constitutes income to him, bc he realizes an economic benefit by way of an increase in his net worth much as if he had sold property as a profit

Damages - Damages received to be made whole for injury are excludable; punitive damages generally have to be included as gross income - Taxability of a recovery of damages can be determined by identifying the nature of the injury - Punitive or exemplary damages recovered arising in a business context are taxable, Glenshaw Glass Raytheon v. Commissioner - Recovery of damages of lost profit is gross income and taxable 14

Court applies in-lieu-of test. o Must ask in lieu of what were the damages awarded? If damages awarded in lieu of salary than it is included in GI. Where the suit is no to recover lost profits but is for injury to good will, the recovery represents a return of capital and with certain limitations is not taxable The determining factor is the nature of the basic claim from which the compromised amount was realized Compensation for the loss of Raytheons good will in excess of its cost is gross income

104 Compensation for Injuries or Sickness

(a) General Rule: TP may exclude from GI (except amounts attributable to deduction allowed under 213 made in a prior taxable year relating to the accident, then that amount deducted in the prior year is included in GI) o (1) amounts received under workmens comp. acts as compensation for personal injuries or sickness; (so must occur while in course of employment) o (2) amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness; Emotional distress shall not be treated as physical injury or physical sickness. Emotional distress can be treated as physical injury to the extent amounts are paid for under medical care in (A) (diagnosis, treat, cure, mitigate, treatment or prevention of disease) or (B) (transportation for care under (A))of 213(d)(1) attributable the emotional distress Rev Rul 85-97: Lost wages can be excluded under (a)(2) if award is for damages on account for physical injury (c)(1) Other than punitive damages shall not apply to punitive damages awarded in a wrongful death action Loss of consortium is a physical injury so can be excluded o (3) amounts received through accident or health insurance (or through arrangements having effect of a health plan) for personal injuries or sickness (other than amounts received by an employee, to extent amounts (A) are attributable to contributions by the employer which were not included in GI by the employee, or are (B) paid by employer) 105: Exclusion does not apply if the payments are made to an employee either: (1) Under an accident or health plan to which employer made contributions which were excluded from employees GI under 106, or (2) paid by the employer. If employer paid it and you didnt include it in GI that they paid it, then you cant not use (3) o (4) amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the armed forces of any country -

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(5) amounts received by an individual as disability income attributable to injuries as a direct result of a terroristic or military action TR. 1.61-14(a) makes punitive damages included in GI

106 Contributions by Employer to Accident and Health Plans

(a) General Rule: Employee may exclude from GI employer-provided coverage under an accident or health plan. (Employer paying into plan) o Employees include dependents ( 152) and spouses ( 132(h)(2)) (c)(1) TP must include in GI employer provided coverage for qualified long-term care services to the extent coverage is provided thru flexible spending or similar arrangement o (2) Flexible spending arrangement is a benefit program which provides EE with coverage under which (A) specified incurred expenses may be reimbursed and (B) the maximum amt. of reimbursement which is reasonably available to a participant is less than 500% of the value of such coverage TP may exclude money employer is paying into a plan for the later benefit of employee. Tax free fringe benefit. Exclusion relates to amounts paid by employers for insurance premiums or into funded plans to set up benefits for employees in case of future sickness or injury Employer can deduct it; Excludes employer fringe benefits

105 Amounts Received under Accident and Health plans (employer/employee relationship)
(a) Must include in GI amounts received by an employee through accident or health insurance of personal injuries or sickness to the extent such amounts o (1) from contributions by the employer which were not includible in GI of the employee ( 106), or o (2) paid by the employer Can exclude when: - (b) (Except amounts attributable to 213 deduction from a prior taxable year) TP may exclude from GI amounts received under accident and health plans if amounts are paid directly or indirectly, to the TP to reimburse the TP for expenses incurred by him for the medical care (defined under 213(d) as diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body) of TP, his spouse, and his dependents ( 152) - (c) May exclude from GI to the extent such amounts constitute payment for the permanent loss or loss of use of a member or function of the body, or permanent disfigurement, of TP, his spouse, or a dependent and are computed with reference to the nature of the injury w/o regard to the period EE is absent from work. 16

(g) Self employed not considered an employee (h) Exclusion not available if payments are made under a plan which discriminates in favor of highly compensated employees

911 Citizens or Resident of US Living Abroad

(a) Qualified individual may exclude from GI for any taxable year the foreign earned income and the housing cost amount of TP (b)(1)(A): Foreign income means amount received from sources within a foreign country which constitute earned income attributable to services performed by TP o (B): foreign income does not include pension or annuity paid by US o (b)(2)(D): Exclusion amount limited to $80,000 and indexed for inflation in 2006 (now at 91K) (d)(1): Qualified individual means an person whose tax home is in a foreign country and a US citizen that demonstrates he is bona fide resident of a foreign country for an uninterrupted period which includes a taxable year, or who during any period of 12 consecutive months is present in a foreign country or countries at during at least 330 full days in such period (so must be there for 331 days to be a qualified individual) Provides an exclusion for amounts paid as reimbursement of foreign housing expenses in excess of a statutorily provided base housing requirement, if the housing expenses are paid for by the TPs employer Qualified TPs whose housing cost are not paid for by employers may elect to deduct a limited amt. of housing costs in computing AGI Income and housing cost exclusions are elective and once made remain in effect in future yrs unless revoked

25A Hope and Lifetime Learning Credits

Credits come from taxable income. Not AGI. Dollar for dollar savings for TP. Greater benefit here. Give advice to TP to take one with greatest benefits. - (a) Gen Rule: An individual is allowed a credit against the tax imposed. - (b) Hope Scholarship Credit (more narrow) o (b)(1): This credit allows TP to elect a maximum per student credit of $2,500 of the qualified tuition and related expenses. 100% of qualified and related expenses not exceeding 2K and 25 % of such expenses exceed 2000 but not more than 2000. Limitations o (b)(2)(A): Credit is only allowed for 4 taxable years. o (b)(2)(B): Credit only allowed only if individual is at least time student for portion of year o (b)(2)(C): Credit allowed only for first 2 years of post-secondary education o (b)(2)(D): Credit is denied if Student is convicted of a felony drug offense Eligible Student 17

(b)(3)Means a student who is carrying at least the normal full-time work load for the course of study the student is pursuing (c) Lifetime Learning Credit (more broad) o (c)(1): Is the amount equal to 20% of the qualified tuition and related expenses paid by the TP (for education furnished during any academic period beginning in such taxable year) as does not exceed $10k o (c)(2)(B): Shall include qualified tuition and related expenses with respect to any course of instruction at an educational institution to acquire or improve job skills of the individual Limitations for BOTH o (f)(1)(A) Qualified tuition and related expenses means tuition and fees required for the enrollment or attendance of the TP, TPs spouse, or any dependant of the TP whom the TP is allowed a deduction under 151, at an educational institution for courses of instruction at the institution. o (f)(B): Qualified tuition and related expense does not include expenses for education involving sports, games, or hobbies, unless course or other education is part of the individuals degree program o (f)(C): Qualified tuition and related expense does not include nonacademic fees like student activity fees, athletic fees, insurance expenses, or expenses unrelated to academic course of instruction o (d)(2)(A & B) Maximum credit for both is phased out for TPs with modified AGI between 80K and 90K (160K and 180K for joint returns) (g) No double benefit with any other provisions in this chapter

221 Interest on Education Loans (Above the line deduction, 62 (a)(17)

(a) There shall be allowed as a deduction for the taxable year an amount equal to the interest paid by TP during the taxable year on a qualified education loan (b)(1) Max dollar amount is $2,500 o (2) limited based on AGI over 50 K (100K MFJ) bears over 15K (30K MFJ) (c) Dependents not eligible for deduction (d)(1) Qualified education means any indebtedness incurred by TP to pay qualified higher education expenses (A) which are incurred on behalf of the TP, TPs spouse, or any dependent of TP as of the time of indebtedness incurred, (B) which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and (C) which are attributable to education furnished during a period during which the recipient was an eligible student o (2) The term "qualified higher education expenses" means the cost of attendance 221(e)(2) trap for people filing separately. If TP is married deduction shall be allowed only if TP and TPs spouse file a joint return. Can take $2500 total for those who marry. If single then each can take $2500.

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 222 Qualified Tuition and Related Expenses ABOVE THE LINE ( 62(a)(18))
(a) Shall be allowed as a deduction an amount equal to the qualified tuition and related expenses paid by TP during taxable year (b) TP subject to dollar limitations o (b)(1) Amount allowed as a deduction can not exceed applicable dollar limit (b)(2)(B) After 2003: Applicable dollar limit: (i) for TP whose AGI is not over $65,000 ($130,000 joint return) is $4000 (ii) if TP not under (i) whose AGI is not over $80,000 ($160,000 joint return) is $2000

135 Income from US savings bonds used to pay higher education tuition and fees
(a) Gen. Rule- no redemption of any qualified US savings bonds will be included as gross income if the taxpayer uses it to pay for qualified higher education expenses during the taxable year - (b) Limitations- not included as gross income is redemption amount of US savings bonds that exceed qualified higher education cost Not available to a parent if the bonds purchased by the parent but put in the name of a child or are purchased by a child Phased out if TPs gross income exceeds 40K (60K joint return)- Fully phased out at 55K (90K) adjusted for inflation starting in 1990 -

529 Qualified tuition programs

(a) A qualified tuition program shall be exempt from taxation (b) qualified tuition means a program established and maintained by a State or agency or instrumentality or by 1 or more eligible educational institutions Excess distribution of funds not used for higher education purposes are taxable using 72 principles There is a tax penalty for distribution that is taxed of 10% Taxation of distribution may be avoided by a rollover within 60 days to other plans or other family members No phase out -

530 Coverdell Educational Savings Accounts

(a) Gen Rule- A Coverdell education savings account is exempt from taxation (b) Coverdell means a trust created or organized in the US exclusively for the purpose of paying the qualified educational cost of an individual who is the beneficiary of the trust o (b)A- contributions must be in cash and individual contributions cannot be more than 2K, before beneficiary turns 18, or maybe made by rollover contributions, if such contributions result in aggregate contributions for the taxable year exceeding 2K 2K per yr contribution ceiling is phased out for higher income families w modified AGI between 95 K and 110K (190K and 220K joint) 19

Distribution that is exceeds education costs are taxable like in 529 - Rollover must be to someone under 30 as additional requirement

103 Interest on state and local bonds

(a) gross income does not include interest on any State or local bond (b) exceptions: (1) private activity bond which is not a qualified bond (2) arbitrage bond (3) bond not in registered form

115 Income of states and municipalities

Federal govt cannot tax state govt

Gain from dealings in property

Philadelphia Park v. US - Basis = FMV (fair market value) of property received on day of transaction --- arms length deal - Once property is received property should not have any built in gain or loss - If basis = FMV and sell it immediately then wont have any gain or loss - All gain realized on bridge must be recognized under 1001(c), so paying for 10 yr extension on the franchise - Basis of property received must be equal to FMV or property received or FMV of property given up

1001 Amount and Recognition of Gain or Loss

(a) Gain derived from sale of property is the excess of the AR over the propertys AB o Gain or Loss from sale of property determined by AR AB = GR/LR (positive number = Gain, negative number = Loss). o Must compute gain and loss on any transaction, if you have a realization event then trigger to compute gain or loss under (a). (b) Amount realized includes the sum of any money plus the FMV of any property (other than money) received in the transaction, and debt relief. Everything received in exchange for the property and is not limited to cash. (c) the entire amt. of gain or loss on the sale or exchange of property shall be recognized unless specifically excluded

1011 Adjusted Basis for Determining Gain or loss,

(a) shall be the basis of the property and as adjusted under 1016 20

 1012 Basis of Property Cost,

Basis of property is the cost of the property. What TP paid for. o TR 1.263(a)-2(e): brokerage fee offsets the sell price so if sold stock for $70 it is really $65 o If settling a claim and receive stock your cost basis would be the value of the stock

1016 Adjustments to Basis,

(a): is the basis plus or minus certain adjustments in respect to the property, o (a)(1): Basis of property is increased by the amount of capital expenditures, such as cost of capital improvements made to property o (a)(2): Amount of reduction in basis on account of deductions for depreciation, amortization or depletion Under 1001(c), TP must recognize every gain/loss realized, unless a nonrecognition provision applies. o Included in GI under 61(a)(3)

Amount realized - Recourse debt: lender has recourse on you and whatever you have, if debt is taken over by the buyer you will have relieve of debt equal to face value amount of that debt - Nonrecourse debt: loan where borrower is not personally liable

1014 Basis of Property Acquired from a Decedent,

(a) General Rule: Basis of property acquired from a decedent is the FMV of the property at the date of decedents death. (b) Property acquired from decedent include o (1) Property by bequest, devise, or inheritance, or by the decedents estate from the decedent o (2) Property transferred by decedent during the lifetime in trust to pay the income for life to or on the order or direction of the decedent with the right reserved to the decedent at all times before his death o (6) In a community property state, surviving spouses one-half share and gets a step up in basis to the FMV when spouse dies. (e) Appreciated property will not receive a stepped-up basis if it is acquired by gift by a decedent within one year of his death and if it passes back to the initial donor or the donors spouse. The property will take a transferred basis, equal to the donors original basis in the property prior to the gift to the decedent. (prevent fraud) Built in gain or loss disappears

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 1015 Basis of Property Acquired by Gifts and Transfers in Trust,

(a) Property acquired by gift after 1920, the basis shall be the same as it would be in the hands of the donor. Step into the shoes of the donor. (inter vivos gift) o Exception. (a) does not apply if basis is greater than the FMV of the property at the time of the gift; and donee sells the property in a transaction that would result in a loss. If basis unknown then basis would be FMV at time gift was acquired by donor.

(d)(1)(A) If donor paid gift tax, donees basis goes up by that amount, but not above the FMV of the property at time of gift.

Taft v Bowers - Rule: Constitution does not prevent congress from treating as taxable income to the recipient of a gift the increase in the value of the gift while it is owned by the donor. - LR: 1015 provides that if property was acquired by gift,the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift. 16th amend gives congress to tax all gains derived even from a gift. - to the extent that property has a built in loss and sold, the done cannot take the tax benefit from the built in loss exception to the general rule

1041 Transfers of Property Between Spouses or Incident to Divorce

(a) Nonrecognition provision. No gain or loss shall be recognized on a transfer of property from an individual to o (a)(1) a spouse, or o (a)(2) a former spouse, but only if the transfer is incident to the divorce. (c) Transfer of property is incident to divorce if such transfer (c)(1) occurs within 1 year after the date on which the marriage ceases, or (c)(2) is related to the cessation of the marriage (b) Transfer of property between spouses then o (b)(1) the property shall be treated as acquired by the transferee by gift, and o (b)(2) the basis of the transferee in the property shall be the adjusted basis of the transferor Trumps 1015 Basis Acquired by Gift

Intl Freighting Corp. v. Commissioner - Rule: When TP disposes of property in exchange for services, there is an amount realized equal to the fair market value of the services. - When P gave stock with a fair market value greater than its basis to its employees, P realized a gain in the amount of the difference between the basis of the stock and its fair market value

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when transferred. Delivery of shares was not a gift and constituted a disposition of property for a valid consideration. Crane v. Commissioner: - Amount of a nonrecourse liability incurred on the acquisition of property is included in the basis. So, if one takes property that is subject to a nonrecourse mortgage either by sale, devise or gfit, that person has a basis in the property equal to the balance on the mortgage plus any other money or property that he gave in order to obtain the property. - Establishes the proposition that nonrecourse mortgages should be treated as true loans for tax purposes. - Under 1012, when you buy property with nonrecourse debt you get the nonrecourse debt as your basis. - So when you buy property with nonrecourse debt it becomes part of your basis and when you sell property you can offset AR as well as depreciate it if you dont sell it and instead hold on to it. Thus, court concluded that amount realized should nonrecourse debt Commissioner v. Tufts - Rule: When a party transfers property encumbered by a nonrecourse mortgage with an unpaid balance that exceeds the fair market value of the property, the transferor has realized an amount equal to the unpaid mortgage balance. - Issue: if the value of the house is below amount of debt and it is nonrecourse debt should we have to include in the amount realized the entire debt or just the FMV of the property? - Answer: if you include it in basis and depreciate it and off set it then Court argues we should include the full face amount of the debt in the amount realized. After Crane/Tufts - amount realized includes all of the nonrecourse debt thats been discharged even if FMV is well below that debt

CAPITAL GAINS AND LOSSES

1221 Capital Asset Defined,
(a) capital asset means property held by a TP, but does not include: o (1) Stock in trade of the TP or other property of a kind which would be included in inventory (things you would sell) of the TP if on hand at the close of tax year, or property held by the TP primarily for sale to customers in the ordinary course of TPs trade or business; o (2) Property not sold, but property used in trade or business (ex: tables chairs, utensils, real property) 23

o o o

(3) TPs self produced or prepared items such as copyright, literary, musical, or artistic composition. If sold will give rise to ordinary income or loss (4) Accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property (5) A publication of the US gov. which is received from the US gov. or any other agency, other than by purchase at the price at which it is offered for sale to the public and is held by TP who received the publication, or TP (a)(5)(B) (8) Supplies of a type regularly used or consumed by TP in the ordinary course of a trade or business of TP. If sold while using in course of ordinary business then gain is ordinary income

1222 Terms Relating to Capital Gains and Losses ,

(1) STCG: gain from sale or x/c of an asset held less than a year, extent such gain is taken into account in computing GI (2) STCL: loss from sale or x/c of an asset held less than a year, extent such loss is taken into account in computing GI (3) LTCG: gain held more than a year, extent such gain is taken into account in computing GI (4) LTCL: loss held more than a year, extent such loss is taken into account in computing GI (5) NSTCG: Excess of STCG for the taxable year over the STCL for such year (STCG STCL) (6) NSTCL: Excess of STCL for the taxable year over the STCG for such year (STCL STCG) (7) NLTCG: Excess of LTCG over the LTCL (LTCG LTCL) (8) NLTCL: Excess of LTCL over the LTCG (LTCL LTCG) (9) Capital gain net income: Excess of the gains from sales or x/cs of capital assets over the losses from such sales or exchanges (G L) (10) Net Capital loss: excess of the losses from sale or x/c of capital assets over the sum allowed under 1211. (11) Net Capital gain: excess of TPs NLTCG over the NSTCL (NLTCG NSTCL) Rev. Rul. 66-7: for property, the date on which it is acquired is excluded and the date on which it is sold is included. Property goes long term on the date 1 year and 1 day after it is acquired. If capital asset is acquired on the last day of a calendar month, it must not be sold or exchanged until on or after the first day of the thirteenth succeeding calendar month in order to hold it for more than a year. Rev. Rul. 66-97: Trade date is the date securities are considered acquired and sold. Thus, holding period for securities is determined by excluding the trade date on which they were acquired and by including the trade date on which they were sold. Settlement date (when security is delivered and payment tender) does not affect holding period of the security o If received as gift: count date you receive it, holding period would be donor or transferor. o If you inherit property holding period will ALWAYS be long term regardless of transferors holding period. 24

When TP buys stock at different times go to TR1223-1, first shares in is first shares out when TP sells stock (FIFO)

1223 Holding Period of Property

(1) TP is holding the property during period property is held and has the same basis in whole or in part - (9) If acquired property by 1041 (through spouse) and basis in property is based under 1041 and property is sold within 1 year after decedents death then property is considered to have held property for more than 1 year. - Must hold property for more than 1 year to get preferential tax treatment. If held for less than 1 year than would be subject to tax at ordinary tax rate. If it is a Net Capital Gain then: o For TPs who are in the 25 % or higher bracket (rich ppl) and it is NCG (not short term capital gain) than under 1(h)(1)(C) max rate is 15%, unless it is a collectible then under 1(h)(5)(A) it will be 28% o For TPs who are the 25% or below bracket (poor ppl) and it is NCG under 1(h)(1)(B) max rate is 5% and in 2008 it is 0%, unless it is a collectible then it will be 28% under 1(h)(5)(A) If it is a short term capital gain o Then taxed at regular rate of 35% If it Net Capital Loss: o 1211 for limitations on loss. TP can deduct the amount of loss of either the lesser of $3000 or excess of losses over gains o 1212 for carryover TP has lifetime carryforward to offset ordinary income. Can carry a min. of $3000 each year under 1211(b)(1) or excess of losses over gains under 1211(b)(2) If not Net Capital Loss o 62(a)(3) can use capital loss deduction to offset GI. The loss allowable is to extent of the capital loss plus the excess of the capital losses over gains. 1. 1001 (a) determines if there is gain or loss (AR AB) = Gain or loss realized and must be recognized unless other provision states you dont have to pursuant to 1001(c) a. if gain or loss is part of a capital asset as defined as 1221 we then have to go to 1222 (defines STCG, STCL, LTCG, LTCL) 2. Net [STCG and STCL] and [LTCG and LTCL] a. And you will end up with Net short term capital gain (net is positive number) or a net short term capital loss (net is a negative number, losses exceed gain, you lose money), net them by subtracting (p. 680 STCG STCL = NSTCG/NSTCL) 25

b. You can end up with a net long term capital gain or net long term capital loss. Net them by subtracting them from each other (p. 680 LTCG LTCL = NLTCG/NLTCL) c. Once we net each individual Short or Long and then we add them together. i. Can have NSTCG (taxed as ordinary income) and NLTCG ( 1(h) tax rate of 15% on collectible). And offset each value ii. Can have NSTCG or NLTCL. NSTCG it will be taxed as ordinary income. If you end up with NLTCL then it is subject to limits 1211(b) limit to $3000. Under 1212(b) excess of $3000 can carry it forward indefinitely iii. Can have Net Capital Gain under 1222 so you have NLTCG and taxed at 28% iv. Can end up with a NSTCL and a NLTCL. Use NSTCL first to carryover under 1212(b), when carry forward it retains character. (25% rate in book do not need to know, just know 15% and 28% on collectible) Mauldin v. Commissioner - important how P advertised land and in originally what you are in as a business - if buy house with intention to doing this on a routine basis then it can be inventory - when you buy land and hold it as an investment then the asset in your hands is a capital asset, just like stock

1(h) Maximum Capital Gains Rate

(1) If TP has net capital gain TP gets preferential tax treatment. Can have capital asset hold more than a year and sell it at a gain and get max tax rate of 15% unless it is a collectible, for those who are above 25% tax bracket (B) Pay only 5% rate if you have adjusted net capital gain, and 0% rate for taxable years after 2007. Applies only for TP who are below 25% bracket and applies only to net capital gains. Does not apply to net short term capital gain can liquidate your gains and then have a 0% tax rate (h)(5)(A) Collectibles: capital gain or loss means gain or loss of a collectible held for more than 1 year. Has max tax rate of 28%, no preferential rate, just get regular rate o 408(m) Defines collectibles as (A) work of art, (B) rug or antique, (C) metal or gem, (D) any stamp or coin, (E) alcohol beverage, (F) or any tangible personal property specified by the Secretary. If you sell collectibles and incur a gain or loss will be subject to 28% rate. TP will never pay higher rate then your ordinary rate, ex: so if you pay 15% rate you dont pay 28% collectible rate since youre ordinary rate is 15%. (11) Dividends taxed as net capital gain. Qualified dividends included as net capital gain, and subject to tax rate of max tax rate of 15% o To get dividends you must be a corporate shareholder, earnings are paid out through dividends. Publicly traded companys pay dividends out quarterly. Dividends tax favored source of income. If you hold stock for more than 1 year and sell it as a gain, it will be LTCG. Dividends and Interest income is different. Interest income paid for the use of 26

your money. Interest income is not subject to tax preferred rates as dividends are. Added to salary on rest of income and subject to tax at ordinary rates

1202 50% Exclusion for Gain from Small Business Stock

(a)(1) allows noncorporate TP an exclusion of 50% of the gain on qualified small business stock held for more than 5 yrs

1211 Limitation on Capital Losses

(b) for regular TP, losses from sales or exchanges of capital assets shall be deductible to extent losses exceed gains from such sales or exchanges, plus up to the smallest of o (b)(1) $3,000 ($1500 for married individual filing sep. return), or o (b)(2) the excess of such capital losses over such capital gains Which ever value is chosen then that value is constructive STCG and added to the given STCG and that deduction must be deducted from NSTCL then NLTCL for 1212 carryforward

1212 Capital Loss Carryforward

(b) If noncorporate TP has net capital loss ( 1222 (10)) o (1)(A) the excess of the net short term capital loss over the net long term capital gain for such year shall be a short term capital loss in the succeeding taxable year and o (2)(B) the excess of the net long term capital loss over the net short term capital gain for such year shall be carried over as a long-term capital loss in the succeeding year Provides that the carryforward of losses retain their character as short-term or long-term to the next tax year (b)(2): For determining the excess referred to under (b)(1)(A) and (B) there shall be treated as a short term capital gain an amount equal to the lesser of o (i) the amount allowed under (1) ($3,000) or (2) (excess of such losses over such gains) of 1211(b) (must add one of these values to STCG before determining carry forward amount) o Forces TP to use their short-term capital losses before any long-term capital losses for offset allowed against ordinary income

Mauldin v. Commissioner Rule: Property held by TP for sale to customers in the ordinary course of a trade or business is not a capital asset entitled to capital gain or loss treatment, regardless of TPs stated purpose. Malat v. Riddell

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Rule: When determining whether property is held primarily for sale to customers in the course of a trade or business, and thus exempt from capital gain or loss treatment, primarily means of first importance or principally Kenan v. Commissioner Rule: Using stock to satisfy a specific monetary gift to a beneficiary results in a capital gain to the estate equal to the amount the stock had appreciated from the time of the decedents death to the time of transfer. Hudson v. Commissioner Rule: Collecting money to settle a judgment even if the judgment was purchased from the original creditor, is not a sale or exchange.

Assignment of Income
ASSIGNMENT OF INCOME Idea is to shift income to lower tax brackets to get lower tax rates o State general rule of assignment: Income is taxed to TP who earns it or owns property that produces the income. Person who is earning income will be subject to tax on that income. TP must include compensation in GI, and TP cant generally shift earnings to another person. Under Lucas v. Early TP cant separate income stream from person who is earning it, cant cut out earnings and shift it to someone else. Cant take something earned from sweat and labor and give it to somebody for tax purposes TPs would like to shift income to another person because of the progressive tax rates. TPs want to try to escape and avoid taxation thats why hard to service scrutinizes assignment of income. o Then look to facts and see where income is coming from: If coming from personal earnings or services: income in form of compensation is generally included in person of who performed the services (Lucas v. Earl) Sub issues: Giananini: when qualified TP early on disclaims salary before it ripens and never earned any $$ and refuses to receive any compensation and tells his employer where to donate it without having any control of where it will go then TP does not have to include in GI, since it is forgone compensation. This is an exception to the rule in Lucas. If TP retains interest in where compensation will go then it is still considered to belong to TP. If giving away dominion or control of money then not included in GI. (fruit and tree analogy) 28

If income coming from property (rental, lease, stocks/dividends) then property owner may not avoid income merely by directing income to another person (Helvering v. Horst). Income derived is normally included in owners GI If TP wants to not include in GI then must transfer not only the $ but also the property (fruit and tree analogy) Improper assignment when a conveyance is unsupported by consideration. Children were merely a conduit through which to pass title form was proper, but substance was an anticipatory assignment (Susie Salvatore) One who receives income as the owner of the beneficial trust pays the tax. (Blair) It is proper assignment of property when Under Estate of Stranahan, transaction showed substance and form and was an assignment of future income for valid consideration. Just because it was a transfer within family does not make it invalid. Here father was not trying to avoid or escape recognition of income, but wanted to take advantage of reduced taxation. The assignment was an assignment of the asset and not just redirecting a stream of income.

Stocks: if you want to shift dividend income to someone else, you have to shift the entire stock. (the tree) Cant just tell company to write dividend check to son. Not good enough because you will get taxed. Rental income: can forward check to child but you as the landlord will be taxed because you are the property owner. Put child on title (give tree), cant just divert income stream. No substance for tax purposes.

Rev. Ruling 66-167 - Husband disclaimed fees never took possession, similar to Giannini. Substance of transaction showed that husband did not take a fee and worked based on a gratuitous basis. Rev. Ruling 74-581 - in substance the school was getting the money, so school must include it in GI - TP received check, but gave check to school

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DEDUCTIONS for Individuals

Deductions are used to offset GI and prevent that amount of GI from being taxed.

62 AGI
Above the line deductions are generally more advantageous for a taxpayer than below the line deductions. Above the line deductions are not subject to income-sensitive phaseouts or limitations. Certain below the line deductions, by contrast, are phased out for wealthy taxpayers. Additionally, certain below the line deductions may be taken only if they exceed a certain percentage of adjusted gross income. Policy why above the line deductions are better: Adjustments for AGI (above the line deductions) reduces gross income and more powerful deductions because it generates tax benefit higher than marginal tax rate. (a) Gen Rule: AGI = GI Above the line deductions All are above the line deductions o (1) Trade and business deductions where TP is not an employee o (2) Trade and business deductions for employees (A): Reimbursed expenses of employees (allowed under 161 and following). Expenses paid or incurred by TP in connection with the performance by TP of services as an employee under a reimbursement or expense allowance arrangement with TPs employer (B) Expenses for Performing artists (allowed under 162). Expenses paid or incurred by a qualified performing artist in connection with the performances by him of services in the performing arts as an employee. (C) Expenses of officials (allowed under 162). Consist of expenses paid or incurred with respect to services performed as an official as an employee of a State or a political subdivision (D) Expenses of elementary and secondary teachers (allowed under 162). Not in excess of $250, paid or incurred by an eligible educator in connection with books, supplies (other than nonathletic supplies for health or physical education, CPU equipment (including related software and services) and other equipment, and supplementary materials used by the educator in class. (d)(1)(A) Eligible educator means an individual who is a K-12 teacher, instructor, counselor, principal, or aide in a school for at least 900hours during a school year. (d)(1)(B) School means any school that has grades K-12 o (3) Losses from sale or exchange of property (should think about 165) o (4) Deductions attributable to rents and royalties (allowed by 161 and following, 212(relating to expenses for production of income), and 611 (relating to depletion) which are attributable to property held for the production of rents or royalties. o (5) Certain deductions of life tenants and income beneficiaries of property. (allowed by 167 and 611) o (6) Pension, profit-sharing, and annuity plans of self-employed individuals. If TP who is an employee within the meaning 401 (c)(1), the deduction is allowed by 404. o (7) Retirement savings. (allowed by 219) 30

o o o o o o

(10) Alimony. (allowed by 215) (15) Moving Expenses (allowed by 217) (17) Interest on education loans ( 221) (18) Higher education expenses ( 222) (19) Health savings accounts ( 223) (20) Costs involving discrimination suit

63 Taxable Income
(a) Gen Rule: TI = GI Deductions allowed by this chapter (other than standard deduction) o If they dont fall under 62 fall here, and all are itemized deductions Standard Deduction o (b) If TP doesnt choose itemized then TI = AGI standard deduction and deduction for personal exemptions under 151 o (c)(1) Standard deduction means sum of basic standard deduction and the additional standard deduction (c)(2) (A)Basic standard deduction is 200% of the dollar amount of $3000 for the taxable year in the case of: ($11,400) (i) Joint return, or (ii) A surviving spouse (defined by 2(a)) (c)(2)(B) $8,100 in the case of a head of household (under 2(b)), or (c)(2)(C) $5,700 in any other case (c)(3) Additional standard deduction is sum of aged and blind amounts (f)(1)(A) TP shall take an additional $600 if he has attained age of 65 before the close of his taxable year, and (f)(1)(B) for the spouse if spouse has attained 65 before close of tax year and additional exemption is allowed to TP for the spouse under 151(b) (f)(2)(A) TP shall take additional $600 if himself is blind at close of taxable year, and (f)(2)(B) for the spouse of TP if spouse is blind at close of tax year and additional exemption is allowed to TP for such spouse under 151(b). If spouse dies during tax year than whether she is blind is determined at time of death (f)(3) if not married TP can take $750 instead of $600 (f)(4) Blindness is does not exceed 20/200 in the better eye with correcting lenses, or if his visual acuity is greater than 20/200 but has limitation in field of vision where widest diameter of visual field subtends an angle no greater than 20 degrees (c)(5) If individual to whom a deduction under 151 is allowable to another TP for a taxable year, the basic standard deduction applicable to such individual shall not exceed greater of (c)(5)(A) $500 ,or (c)(5)(B) the sum of $250 and such individuals earned income (c)(6): Not eligible for standard deduction if: (A) married individual filing sep. return where either spouse itemizes deductions; (B) a nonresident alien individual 31

 o o

(D) an estate or trust, common trust fund, or partnership

Itemized Deductions (d) Itemized deductions means deductions allowable under this chapter other than deductions allowable under 62 and the deduction for personal exceptions under 151 itemized are usually personal deductions TI = GI AGI Itemized personal/dependency exemptions

67 Misc. Itemized deductions,

For individuals the misc. itemized deduction allowed only to extent that the aggregate of such deductions exceed 2% of AGI o (b) Misc. Itemized deductions are NOT listed below (1) 163 deductions Interest (2) 164 deductions Taxes (3) 165 deductions Losses (4) 170 deductions Charitable Contributions (5) 213 deductions Medical Expenses (6) Deductions allowable for impairment related work (7) 691 deductions (8) Deductions allowable in connection with personal property used in a short sale (9) 1341 deduction (10) 74(b)(3) deduction Prizes and Awards (11) 171 (12) 216 Policy: misc. itemized not that powerful since most people take the standard deduction over itemized

151 Deductions for Personal Exemptions (deduction taken after taking 62/63 deductions)
(a) All individuals allowed exemption deduction in computing taxable income (b) TP allowed exemption and additional exemption allowed for spouse of TP if joint return is not made by TP and spouse, has no GI, and is not dependent of another TP (c) TP allowed exemption for each dependant (defined under 152). o (d)(1): Exemption amount is $3,650 o (d)(2): TP may not claim a personal exemption for himself, if he is able to be claimed as a dependent by another TP (such as a parent). (d)(3) phase out TPs whose AGI exceeds the threshold then the exemption amt is reduced by the applicable percentages in (d)(B)& (C).

152 Dependent Defined

- TP may take an additional deduction for the exemption amount for each of TPs dependents - (a) Gen Rule: Dependent means a qualifying child or a qualifying relative Exceptions - (b)(1): If individual is dependent of a TP that individual will be treated as having no dependents

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(b)(2): Individual not treated as a dependent of a TP if individual has made a joint return with spouse - (b)(3)(A): Dependent does not include individual who is not a citizen of US unless is resident of US or a country contiguous with US - (b)(3)(B): Child shall be excluded under (A) as a dependent if child has same principal place of abode as TP and is a member of TPs household and the TP is a citizen or national of US Qualifying child means: - (c)(1)(A): an individual who bears a relationship to the TP, o (c)(1)(B) who has same principal place of abode as TP for more than one half of taxable year, o (c)(1)(C) who is under the age of 19 or a student under the age of 24, and (f)(2): Student defined as a full time student at an educational organization described under 170(b)(1)(A)(ii) (an educational org that maintains a reg faculty and curriculum and regularly enrolled body of students in attendance) or pursuing a fulltime course of institutional on-farm training under supervision of an accredited agent of an educational organization under 170(b)(1)(A)(ii) o (c)(1)(D) who has not provided over one-half of such individuals own support for the taxable year. - (c)(2) Individual is related to TP if person is a child of the TP or a descendant of such a child, a brother, sister, stepbrother, or stepsister of the TP or a descendant of any such relative (c)(2), o (f)(1): Definition of a child includes stepchildren, eligible foster children, and adopted children - (c)(3)(B): Person who is permanently disabled at any time during calendar year the age requirement is met. - (c)(4)(A): If qualifying child is claimed by 2 or more TP as a dependent then individual treated as qualifying child of TP who is a parent of the individual or if not a parent then TP with highest AGI - (c)(4)(B): if parents claiming any qualifying child do not file a joint return, the child shall be treated qualifying child of the parent with whom child has resided for the longest period of time, or if the child resides with both parents for the same amount of time during taxable year, then the parent with the highest AGI Qualifying Relative means: - (d)(1) o (d)(1)(A) One who bears a relationship to TP, o (d)(1)(B) whose GI for calendar year is less than exemption amount ($3,650, defined under 151(d)), o (d)(1)(C) for whom the TP provides over one-half of the individuals support for the calendar year, and o (d)(1)(D) who is not a qualifying child of such TP or any other TP for any taxable year - (d)(2) Relationship to TP means o (A) a child or a descendent of a child o (B) a brother, sister, stepbrother, or stepsister, o (C) the father or mother, or an ancestor of either o (D) a stepfather or stepmother o (E) a son or daughter of a brother or sister of the TP o (F) a brother or a sister of the father or mother of the TP o (G) a son in law, daughter in law, father in law, mother in law, brother in law, sister in law -

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(H) an individual other than the spouse, who for the taxable year of TP has the same principal place of abode as the TP and is member of TPs household - (d)(3): If individual satisfies requirements of qualifying relative of a TP, but TP does not provide over one-half of individuals support, TP may still claim individual as a dependent if TP satisfies multiple support agreement. To qualify, no one person may contribute over one-half of the individuals support, but over one-half of the support must be provided by qualified relatives. TP must contribute over 10% of the individuals support, and each person related to the individual who furnished over 10% of the dependents support must file a written declaration that they will not claim an exemption for that individual for the taxable year. Children of Divorced Parents - (e)(1) Child who received more than one-half of his support from his parents, but whose parents are divorced, sep, or living apart during the last 6 months of a calendar year, and who is in custody of one or both parents for more than one-half of the year is treated as being the qualifying child or qualifying relative of the custodial parent. - (e)(2) If custodial parent signs written declaration stating that he will not claim the child as either a qualifying child or relative and the non custodial parent attaches that declaration to her return then the non custodial parent may claim the child as a dependent - (e)(3) Rule does not apply if TP is treated as providing more than one-half of a childs support because of multiple support agreement.

213 Medical, Dental Expenses (not listed in 62(a) so Itemized Deduction, 67(b)(5)), not misc.
(a) TP may deduct expenses paid which are not compensated for by insurance for medical care of the TP, his spouse, or dependent (under 152) to the extent that such expenses exceed 7.5% percent of AGI. (d)(1) Medical care means o (d)(1)(A) amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body, o (d)(1)(B) the transportation primarily for and essential to medical care, o (d)(1)(C) for qualified long term services, or o (d)(1)(D) for insurance covering medical care referred in (A) or (B) (d)(2) Expenses for lodging (not lavish or extravagant) while away from home primarily for medical care shall be treated as amounts paid for medical care if: o (d)(2)(A) the medical care referred to in (d)(1)(A) is provided by a physician in a licensed hospital or in a medical facility related to or an equivalent to a licensed hospital o (d)(2)(B) and there is not element of personal pleasure or vacation in the travel away from home. (d)(5): Any child to whom 152(e) (child of divorced parents applies shall be treated a dependent of both parents for purposes of this section (d)(9) Medical care does not include cosmetic surgery unless the surgery or procedure is necessary to ameliorate a deformity arising from or directly related to a congenial abnormality, a personal injury resulting from an accident or trauma or disfiguring disease.

TR - 1.213-1(e)(1)(iii): eye glasses and contacts are deductible - Rev. Rul. 79-151: weight loss program to promote general health and not to cure a specific ailment or disease is not deductible. 34

Rev. Rul. 55-261: medical care includes the cost of special food is (1) the food alleviates or treats an illness, (2) it is not part of the normal nutritional needs of the TP, (3) the need for the food is substantiated by a physician Rev. Rul. 2002-19: uncompensated amts. paid by individual for participation in a weight-loss program as treatment for a specific disease or diseases (including obesity) diagnosed by a physician are expenses for medical care that are deductible under 213.

Gerard v. Commissioner (air conditioner was built for daughters health and it raised value of house. TP was allowed to deduct 500 as medical expenses). Where the TP is able to show that the expenditure was more than the increase in value the difference is allowed as a medical deduction. ($1300 for AC, raised value of house by $800= 500 deduction for medical) - If you see this cite TR 1.213(1)(e)(1). It says portions of capital improvements made primarily for medical care are deductible under 213 (ex: air conditioning, wheel chair ramp) - If installed something in house like railings to assist handicap person then have to argue it is or is not a capital expenditure under 263. Maybe able to exclude cite Ferris v. Commissioner where they excluded a pool for health reasons and that was a capital expenditures - lodging and 50% of meals en route to place of care are included (Montgomery v Commissioner) - 213 (d)(2) deduction is limited to $50 per night for each eligible person.

215 Alimony (above the line deduction 62(a)(10))

(a) Gen Rule: In the case of an individual, there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual's taxable year. (b) Included in GI under 71

217 Moving Expenses ABOVE THE LINE DEDUCTION ( 62(a)(15))

(a) Gen Rule: Deduction allowed for moving expenses paid with the commencement of work by the TP as an employee or self employed at a new principal place of work (b)(1): Moving expenses means the reasonable expenses of moving household goods and personal effects from the old residence to the new residence and of traveling (including lodging) from the old place to the new residence o (2): For individual other than TP expenses, under (1) shall be taken into account only if individual has both the old and new residence as his principal place of abode and is a member of TPs household (c) No deduction shall be allowed unless o (1) TPs new principal place of work (A) is at least 50 miles from his old residence than was his old principal place of work or, (B) if he had no former principal place of work, is at least 50 miles form his former residence, and o (2) either (A) TP is a full-time employee at least 39 weeks during the 12 month period following his arrival, or (B) if self employed TP is full-time employee for at least 78 weeks of the 24 month period following his arrival, which not less than 39 weeks are during the 12 month period under (A)

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Interest Expense, Taxes, and Exclusion of Gain from Sale of Principal Residence
163 Interest (not listed in 62(a) so Itemized deductions 67(b)(1)), not misc
(a) Gen Rule: Deduction allowed on all interest paid or accrued within the taxable year on indebtedness. Investment Interest - (d)(1) if TP other than a corporation, the amount allowed as a deduction shall not exceed the net investment income of TP - (d)(2) Interest not deductible under (d)(1) is allowed a carryforward Personal Interest not allowed - (h)(1): Gen Rule: no deduction is allowed for personal interest paid or accrued for regular TP - (h)(2): Personal interest means any interest allowable as a deduction under this chapter other than (below is not personal interest so deductible) o (h)(2)(A) deduction may be taken on interest paid or accrued on indebtedness incurred in connection to a trade or business, other than the trade or business of performing services as an employee (above the line deduction) o (h)(2)(B) Deduction may be taken for interest paid or accrued on indebtedness incurred to purchase or carry property (ie: stocks) held for investment, itemized below the line deduction 265(a)(2): cant deduct interest if it is on an investment where income is excluded from GI (d)(1) Interest which may be deducted is limited to the amount of net investment income; any investment interest paid or accrued in excess of that limitation is carried over to succeeding tax years (d)(2) Limitation on investment interest, allows carryforward o (h)(2)(C) interest from engaging in passive activity o (h)(2)(D) interest from indebtedness by a qualified residence of TP may be deducted (h)(3)(A) Qualified residence interest means any interest paid on acquisition indebtedness with respect to any qualified residence of the TP, or home equity indebtedness with respect to any qualified residence of the TP. (h)(3)(B) Acquisition indebtedness means indebtedness which is incurred in acquiring, constructing, or substantially improving any qualified residence of the TP, and is secured by such residence. The aggregate amount treated for acquisition indebtedness shall not exceed $1 mil (500K MFS) (h)(3)(C) Home equity indebtedness means any indebtedness secured by a qualified residence where aggregate amount does not exceed the FMV of the qualified residence reduced by the amount of acquisition indebtedness. Limit is to 100k (50K MFS) and can deduct interest on that. -

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No restriction on TPs use of funds borrowed as home equity indebtedness, the money can be used to purchase anything. (h)(4)(A) Qualified residence need not be the principal or primary residence of the TP, but qualifying indebtedness is limited to a max of 2 residencies, if theres 2, one must be TPs principal residence. (home then can use add on a boat, RV, etc.) (h)(2)(F) any interest allowable as a deduction under 221(a) (interest on educational loans), max deduction allowed is $2,500. Qualified education loan is one which incurred to pay the higher education expenses of a TP, TPs spouse, or any dependent. (above the line deduction because of 62(a)(17)). Amount is phased out when TPs modified AGI is between 50-65k (100k and 130k if joint filed). 221(e)(2) trap for people filing separately. If TP is married deduction shall be allowed only if TP and TPs spouse file a joint return. Can take $2500 total for those who marry. If single then each can take $2500.

Rev. Rul. 69-188: interests is defined as the amt. one has contracted to pay for the use of borrowed money, and as the compensation paid for the use or forbearance of money. To qualify as interest for tax purposes, the payment must be compensation for the use or forbearance of money per se and not a payment for specific services which the lender performs in connection w the borrowers account.

164 Taxes (not listed in 62(a) so Itemized deduction, 67(b)(2)) not misc.
(a) Gen Rule: Except as otherwise provided the following taxes are allowed as a deduction o (a)(1) State and local, and foreign, real property taxes o (a)(2) State and local personal property taxes (ex: cars, below the line deduction) o (a)(3) State and local, and foreign, income, war profits, and excess profits taxes (deducted as itemized below the line) o (a)(4) GST tax o (a)(5) Environmental tax If not deductible under AGI under 62 go to 63 and deducted as itemized (b)(5): applies to people with no income tax. Came into being during election for political reasons

121 Exclusion of Gain from Sale of Principal Residence NONRECOGNITION PROVISION

(a) May exclude from GI the sale or exchange of property if TP owned and used the property as his principal residence for 2 out of the last 5 years. Must be an aggregate of 2 years. (b) Limitations o (1) Amount excluded form GI shall not exceed $250,000 o (2)(A) If husband and wife who make joint return and married as of last day of the tax year the amount excluded from GI shall not exceed $500,000 if (i) either spouse meets ownership requirement under (a); (ii) both spouses must meet use requirement under (a); 37

(iii) and neither spouse made a sale in the previous 2 years (b)(3). (3) Can only exclude sale or exchange once every 2 years (4) allows surviving spouse the luxury of deciding what to do w/o worrying about the tax consequences : in a non community property state basis gets step up (one half gets step up), in a community property state surviving spouse basis goes to FMV o 121(b)(5) 5 yr look back period, homeowner must have lived at the residence for 2 out of the last 5 years in the aggregate, gain do to non qualified use cannot be excluded (prorated) Non qualified use is defined as any period where residence is not being used as principal residence (c) If TP does not satisfy the use and ownership test, but TP is selling principal residence because of unforeseen circumstance (change jobs, divorce) the max amount that may be excluded is prorated. o TR: 1.121-2(c)(2): Distance safe harbor: selling by reason of employment happens during TPs ownership and use of the home AND new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment. Not dispositive if you cant meet 50 miles. As long as show there were unforeseen circumstances that required you to move then can still fall under the exclusion o TR: 1.121-3(e): physicians recommendation for safe harbor. Sale or x/c by reason of health o Determined by the exclusion amount (either 250 or 500) multiplied by a fraction, which is determined by numerator is the shorter of either the time period since (a) was applied to a pervious sale, or the time period the house was owned and used as a principal residence, and the denominator is 2 years. (d)(1): Joint Returns: if H and W make joint return for the taxable year of the sale of property, (a) and (c) still apply if either spouse meets the ownership and use requirements (d)(2) Property of deceased spouse: If TP is unmarried and spouse dies on day of the sale, the period such unmarried TP owned and used such property shall include the period such deceased spouse owned and used the property before death (d)(3)(A): If TP holding property transferred under 1041(a) the period individual owns property shall include period the transferor has owned it (d)(3)(B): Individual shall be treated as using property as such individuals principal residence during any period of ownership while individuals spouse or former spouse is granted use of the property under a divorce or separation instrument (f) TP chooses to have this apply or not. Can amend a tax return and not have it apply to a previous home if can exclude more from a later sell o o TR 1.121(b)(2)(i): factors to look at to determine principle place of residence o Property used for the majority of the time o TPs place of employment o Principal place of abode of TPs family members o Address listed on TPs federal and state tax returns, drivers license, car registration, and voter registration o TPs mailing address for bills and correspondence o Location of TPs banks o Location of religious organizations and recreational clubs which TP is affiliate 38

Business Deductions
262 Personal, living, and family expenses NOT deductible,FIRST!!!
(a) Gen Rule: No deduction shall be allowed for personal, living, or family expenses, unless otherwise stated. (b) 1st telephone line is personal expense

162 Trade or Business deduction (above the line if it is an employer 62 (a)(1), otherwise itemized deduction under 63 and misc. itemized since not listed under 67(b) )
(a) TP allowed as a deduction all the ordinary and necessary and reasonable expenses paid or incurred during the taxable year in carrying on any trade or business, including: Ordinary: Customary and common within the business community, not limited to something that everyone does, this person can do it and no one else does it can still deduct it so long as appropriate and helpful (more for necc, the just overlap), cant be irrational; can also be once in a lifetime Necessary: appropriate and helpful; does not have to mean required; can be w/in the discretion of the owner (dont want to micro manage) o (a)(1): a reasonable allowance for salaries or other compensation for personal services actually rendered; o (a)(2) traveling expenses (including amounts used for meals and lodging other than lavish or extravagant) while away from home in the pursuit of a trade or business; and (look to the facts and circumstances of trip to see if it is deductible) TR 1.162-2(c): Wives and spouses accompanying TP on business trip, expenses from her travel are deductible if it can be shown that presence of wife had a bona fide business purpose. Commute is not deductible, seen as personal expense. If going to client as an atty, from office to client then can deduct. If TP has 2 homes the tax home is the location of the PPOB and if TP has more than 1 PPOB then it is a question of fact and determined by looking at amount of income earned in each location, nature and extent of the business. If deduct meals must go to 274 where meals can only be deducted up to 50% o (a)(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the TP has not taken or is not taken title Necessary if it is appropriate and helpful to the trade or business. Not necessary if TP could be compensate or reimbursed for the expense or amount is unreasonable. Repairs vs. Capitalize ( 263)? TR 1.162-4: cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition. (Mt. Morris Drive ) TR 1.162-4 - any repairs made that do not add value to the property but only to keep it in an ordinarily efficient operating condition is deducted as an expense so long as other property is not increased 39

TR 1.162-5 - Individual allowed to deduct educational expenses as a 67 misc itemized deduction, if maintain or improve skills in a trade or business or meets express requirements of employer or legal requirement imposed by law. - (2) Cost incurred from minimum degree required for job cant deduct. JD is minimum education to practice law, so cant deduct cost of a JD. Cant deduct a bachelors because it is generally minimum - (3) New trade or business cant deduct cost. (a-d) favors elementary to secondary school classroom teacher. Refer to examples (1-4) on p. 968

263 Capital Expenditures,

(a)(1) No deduction allowed for amounts paid out for new buildings or for permanent improvements to increase the value of any property or estate beyond the taxable year If it is capitalized cant deduct it immediate, have to depreciate or amortize it over time.

Midland Empire Packing - improvement here did prolonged useful life and enhanced property, but - Decided that it was a necessary repair and can deduct it immediately, just keeping TP at status quo to operate their business of selling meat, it didnt enhance or prolong useful life. Just allowed TP to continue doing their business. - Ordinary and necessary can be a unique fact and circumstances INDOPCO v Commissioner - Ct held that while creation of a separate asset may be sufficient to require capitalization of an expenditure, it is not necessarily a condition - Whether the transaction produces a significant future benefit is a important factor when considering whether it is a business expense or a capital expenditure Morton Frank v. Commissioner - Must be an existing business - Can expense start up expenses under 195, immediately expense only $5k, and other balance must be amortized for 180 months (15 yrs). Excess over 50K reduced dollar for dollar - Any start-up expensed not amortized or depreciated due to closure may be deducted to the extent provided in 165. Exacto Spring Corp. v Commissioner - CT abandons multi factor test and adopts the independent investor test to determine if salary is reasonable o Independent investor test: the higher rate of return that a manager can generate, the greater the salary he can command o Multi factor test: 1. Type and extent of services rendered, 2. Scarcity of qualified employees, 3. Qualifications and prior earning capacity of the employee, 4. Contributions of the employee to the venture, 5. Net earnings of the employee, 6. The prevailing compensation paid to employees w comparable jobs, and 7. Peculiar characteristics of the employers business

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Congress has imposed a 1 mil ceiling on the amt of compensation that a publicly held corp. may deduct in any year. Not taken into account are: compensation on commission basis, compensation paid solely on account of attainment of performance goals and amts that are excluded from recipients gross income (payments to qualified retirement plans) Golden Parachute Payments are any payment in the nature of compensation made to a disqualified individual contingent on a change in the ownership or effective control of a corp. and the aggregate present value must equal or exceed three times the disqualified individuals base amt. Section 280G prohibits a 162 deduction to the payor corp and imposes a 20% excise tax to the recipient Rosenspan v. US - Expenses (travel, lodging, gas, food) may be deducted if away from home and in the pursuit of business and ordinary, reasonable, and necessaryTP had no home thus could not deduct - Home in the traditional sense - Congress allows deductions bc they do not want TP to pay double expenses while away doing businesshere there was no home thus he was not incurring double expenses --- CT seen them as personal expenses thus not deductable Andrews - had 2 tax homes and was duplicating expenses - going out incurring additional expenses, so it turns on where your tax home is - can only have 1 tax home so remanded to have lower ct. determine which home is the tax home Rev. Rul. 99-7: travel expenses of driving is not deductible when it is your commute (home to job) - If at job and go to see client then it is deductible - If you have two jobs then travel from job 1 to job 2 is deductible - If job makes you drive somewhere else then deductible as long as its temporary - Travel expenses must be ordinary, reasonable, and necessary TR 1.162-2 Traveling expenses(e): commuters fares are not considered as business expense and thus not deductible Hill v. Commissioner - goes to Columbia to renew her teaching certificate - incurs expenses - Since Hill paid for it, it will be itemized business deduction - Ct said it may be deducted bc it was necessary, ordinary, and reasonable; needed the license to be certified to teach Coughlin v Commssioner - TP incurred expenses when he went to TAX courses - CT says it was deductible bc the expenses incurred were needed to perform his work and overshadowed the personal aspect

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TR 1.162-5 Expenses for education: Min requirement to get a job is not deductible; education expenses for maintaining or improving skills or meeting the requirements of an employer are deductible as well as the travel expenses if away from home to receive education

195 Start Up Expenditures (not listed under 62(a) so below the line deduction under 63, and misc. itemized deduction since not listed under 67(b)
(a) No deduction allowed for start up expenditures (b)(1)(A) TP is allowed to deduct $5,000 and the remainder of such start up expenditures shall be allowed as a deduction ratably over 180-month period beginning with the month in which the trade or business begins

165 Losses (ABOVE THE LINE DEDUCTION for class purposes of using it in trade or business 62(3), should be itemized deduction 63(b)(3))
(a) Gen Rule: Deduction allowed for any loss sustained during the taxable year and not compensated for by insurance or otherwise - (b) The basis for determining the amount of deduction for any loss shall be the adjusted basis provided in 1011 for determining the loss from the sale or disposition of property Limitations - (c) Deductions shall be limited to o (c)(1) losses incurred in a trade or business (ABOVE THE LINE 62(a)(1)) o (c)(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (itemized since not listed under 62(a)) -

274 Disallowance of Certain Entertainment Expenses (if employer than above the line 62(a)(1), if employee than itemized under 63 and since not listed under 67(b) it is misc. itemized deduction
(a) No deduction allowed for things considered entertainment, amusement, recreation, unless TP shows it was related to or directly preceding or following a substantial and bona fide business discussion (including business meetings), that such item was associated with Substantiation requirement - (d) No deduction allowed for things considered entertainment, amusement, recreation, unless TP substantiates by adequate records or by sufficient evidence o (d)(4)(A) the amount of expense, o (d)(4)(B) time and place of the travel, entertainment, amusement, o (d)(4)(C) the business purpose of the item, and o (d)(4)(D) the business relationship to the TP of persons entertained Business Meals - (k) No deduction allowed unless such expense is not lavish or extravagant, and the TP is present at the furnishing of such food or beverage Only 50% of meal and entertainment expenses allowed as deduction - (n) Only 50% is allowable deduction for food or beverages, and any item linked to an activity which is considered to be entertainment, amusement, or recreation. -

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Depreciation and Amortization

Business expenses that are not allowed an immediate deduction must be depreciated or amortized

167 Depreciation (not listed in 62(a) so itemized under 63, it is misc. itemized deduction since not listed under 67(b))
(a) Gen Rule: TP allowed a depreciation deduction for the reasonable allowance exhaustion, wear and tear (including reasonable allowance for obsolescence), cant depreciate land because it is a wasting asset. o (1) of property used in trade or business, or o (2) of property held for the production of income Real property can not be depreciated because real property appreciates Cant deduct personal use property. Things fixed to ground is not personal use property so likely can deduct Cant deduct: inventory, fine art/antiques, land, real property because not depreciable assets, they are appreciable assets. (c) Depreciation deduction for an item of property is generally computed with reference to its adjusted basis under 1011. (start depreciating from its adjusted basis) Useful life: is the length of time the property may reasonably be expected to be used in TPs income seeking activity

Simon v Commissioner - Generally Fine Art and Antics are not subject to wear and tear thus not depreciable, however, the bows used by the violinist were used in their business and trade and thus were subject to wear and tear and depreciable - Generally all assets are depreciable if used in trade or business and suffer from wear and tear

168 Accelerated Cost Recovery System,

Accelerated Cost Recovery System (ACRS): takes deduction at a faster rate and is front loaded o Personal property (used with trade or business): depreciated using ACRS (a) Gen Rule: Depreciation deduction under 167(a) for any tangible property shall be determined by o (a)(1) applicable depreciation method o (a)(2) the applicable recovery period, and Real property not land: uses straight line method (c) Recovery Period: Residential: 27 years, apt building, condo, single family residence renting to someone else (c) Recovery Period: Nonresidential property: 39 years, office building, shopping mall o (a)(3) the applicable convention (d)(1) Applicable convention is the half year convention. So it means that for personal property, regardless of when place property in service you get a half year depreciation. Ex: Personal property thats depreciable in 5 years, 1st year you depreciate half and year 6 you have another half.

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(d)(2) In the case of nonresidential real property, residential rental property, and any railroad grading or tunnel bore, the applicable convention is the mid-month convention (b) Applicable depreciation method o (1) 200 % declining balance method (used in most personal property ) o (2) 150 % declining balance method (used in any 15 or 20 yr property, any property used in farming, and any property other than stated in (3) TP elects to apply, irrevocable o (3) straight line method (applies to non residential real property, residential rea property, any railroad grading or tunnel bore, property TP elects, etc o (4) salvage value is treated as zero (c) Applicable recovery period o most personal property is 5 or 7 yrs (d) Applicable Convention o (1) Except otherwise stated the applicable convention is the half year convention o (2) Real Property (nonresidential, residential rental, any railroad grading or tunnel bore) is the mid month convention o (3) special rule where substantial property placed in service during last 3 yrs of taxable yr gets the mid-quarter convention (k) allows for 50% deduction of cost along w/ regular deduction if personal property

179 Election to Expense certain depreciable business assets, itemized deduction since not listed under 62(a)
Here dont have to go through depreciation expenses for every year, rather than depreciating it can expense it immediately, balances of any thats depreciated, if you immediately expense than basis goes down, cant immediately expense and depreciate at the same time, either do 179 or depreciate over time. This is an election so can elect to use this. - (b)(1) allows small business to expense $100,000 immediately (must do it before the year 2010) - (b)(2) limitation under (b)(1) shall be reduced by which 179 property placed in service exceeds $200,000 - (b)(5) Adjusted for inflation so can potentially expense more than $100,000 - (d) 179 property is tangible property defined here as personal property and cant be land (ex: furniture, equipment) Allows TP to immediately deduct thus no depreciation o If there is a balance then depreciate o Limit is set at 500K o Must be tangible personal property

197 Amortization of goodwill and certain other intangibles (below the line deductions since not listed under 62(a)),
Intangibles are not depreciated but amortized (a) TP shall be entitled to amortization deduction with respect to any 197 intangible. Amount of such deduction shall be determined by amortizing the adjusted bases of such intangible ratably over the 15 year period beginning with the month in which such intangible was acquired. o Ex: amortize goodwill, patents, trademarks, covenants not to compete - Generally the straight line method is used Reduces the Basis -

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Table of Contents GROSS INCOME ..................................................................................................... 3 61 Gross Income ................................................................................................. 3 EXCLUSIONS FROM GROSS INCOME ...................................................................... 4
102 Gifts ................................................................................................................................................... 4 132 Certain Fringe Benefits ....................................................................................................................... 6 119 Meals or lodging furnished for the convenience of the employer .................................................... 8 74 Prizes and Awards ................................................................................................................................ 9 117 Qualified Scholarship ........................................................................................................................ 10 127 Educational Assistance Programs ..................................................................................................... 11 101 Life Insurance/Death Benefits........................................................................................................... 12 72 Annuity ................................................................................................................................................ 12 108 Discharge of indebtedness ................................................................................................................ 13 104 Compensation for Injuries or Sickness .............................................................................................. 15 106 Contributions by Employer to Accident and Health Plans ................................................................ 16 105 Amounts Received under Accident and Health plans (employer/employee relationship) .............. 16 911 Citizens or Resident of US Living Abroad .......................................................................................... 17 25A Hope and Lifetime Learning Credits ................................................................................................. 17 221 Interest on Education Loans (Above the line deduction, 62 (a)(17) ............................................. 18 222 Qualified Tuition and Related Expenses ABOVE THE LINE ( 62(a)(18)) ........................................... 19 135 Income from US savings bonds used to pay higher education tuition and fees ............................... 19 529 Qualified tuition programs................................................................................................................. 19 530 Coverdell Educational Savings Accounts ........................................................................................... 19 103 Interest on state and local bonds ...................................................................................................... 20 115 Income of states and municipalities .................................................................................................. 20

Gain from dealings in property ............................................................................ 20

1001 Amount and Recognition of Gain or Loss........................................................................................ 20 1011 Adjusted Basis for Determining Gain or loss, .................................................................................. 20 1012 Basis of Property Cost, ................................................................................................................. 21 1016 Adjustments to Basis, ...................................................................................................................... 21 1014 Basis of Property Acquired from a Decedent,................................................................................. 21 45

 1015 Basis of Property Acquired by Gifts and Transfers in Trust, ........................................................... 22 1041 Transfers of Property Between Spouses or Incident to Divorce ..................................................... 22

CAPITAL GAINS AND LOSSES ................................................................................ 23

1221 Capital Asset Defined, ..................................................................................................................... 23 1222 Terms Relating to Capital Gains and Losses , .................................................................................. 24 1223 Holding Period of Property ............................................................................................................. 25 1(h) Maximum Capital Gains Rate ........................................................................................................... 26 1202 50% Exclusion for Gain from Small Business Stock ......................................................................... 27 1211 Limitation on Capital Losses ............................................................................................................ 27 1212 Capital Loss Carryforward ............................................................................................................... 27

Assignment of Income ......................................................................................... 28 DEDUCTIONS for Individuals ................................................................................ 30

62 AGI ................................................................................................................................................... 30 63 Taxable Income ............................................................................................................................... 31 67 Misc. Itemized deductions, ............................................................................................................. 32 151 Deductions for Personal Exemptions (deduction taken after taking 62/63 deductions) ............. 32 152 Dependent Defined ....................................................................................................................... 32 213 Medical, Dental Expenses (not listed in 62(a) so Itemized Deduction, 67(b)(5)), not misc. ... 34 215 Alimony (above the line deduction 62(a)(10)) ........................................................................... 35 217 Moving Expenses ABOVE THE LINE DEDUCTION ( 62(a)(15)) ..................................................... 35

Interest Expense, Taxes, and Exclusion of Gain from Sale of Principal Residence 36
163 Interest (not listed in 62(a) so Itemized deductions 67(b)(1)), not misc ................................ 36 164 Taxes (not listed in 62(a) so Itemized deduction, 67(b)(2)) not misc. ..................................... 37 121 Exclusion of Gain from Sale of Principal Residence NONRECOGNITION PROVISION ................... 37

Business Deductions ............................................................................................ 39

262 Personal, living, and family expenses NOT deductible,FIRST!!!.................................................... 39 162 Trade or Business deduction (above the line if it is an employer 62 (a)(1), otherwise itemized deduction under 63 and misc. itemized since not listed under 67(b) ) ............................................ 39 263 Capital Expenditures, .................................................................................................................... 40 195 Start Up Expenditures (not listed under 62(a) so below the line deduction under 63, and misc. itemized deduction since not listed under 67(b) ................................................................................. 42 46

 165 Losses (ABOVE THE LINE DEDUCTION for class purposes of using it in trade or business 62(3), should be itemized deduction 63(b)(3)) .............................................................................................. 42 274 Disallowance of Certain Entertainment Expenses (if employer than above the line 62(a)(1), if employee than itemized under 63 and since not listed under 67(b) it is misc. itemized deduction 42

Depreciation and Amortization ............................................................................ 43

167 Depreciation (not listed in 62(a) so itemized under 63, it is misc. itemized deduction since not listed under 67(b)) ......................................................................................................................... 43 168 Accelerated Cost Recovery System, .............................................................................................. 43 179 Election to Expense certain depreciable business assets, itemized deduction since not listed under 62(a)........................................................................................................................................... 44 197 Amortization of goodwill and certain other intangibles (below the line deductions since not listed under 62(a)), ............................................................................................................................... 44

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