Federal Income Tax Outline – Page 1 Gross Income

Chapter 1 Power to Tax Article 1, Section 8, Clause 1 Very extensive power with two constitutional limitations: Direct taxes must be imposed by the rule of apportionment among the several states in accordance with their respective populations Indirect taxes by the rule of uniformity – geographic 16th Amendment –        “from whatever source derived” Courts Tax Court – no jury District Court of Appeals – jury or non-jury; must pay a fee –        You can start in either court. Consider precedent/jury/fee   Statute of Limitations 3 years is normal 6 years if you omit 25% of your gross income Infinity if fraud or no file   Gross Income Section 61 Gross income includes the receipt of any financial benefit which is: Not a mere return of capital, and Not accompanied by a contemporaneously acknowledged obligation to repay, and Not excluded by a specific statutory provision Income is realized whenever there are “instances of: undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”   Cases: Cesarini v. United States Money found in an used piano; section 61 is broad, all-inclusive; treasure trove is included in GI to the extent of its value in US currency* Old Colony Trust Co. v. Commissioner Corporation agreed to pay income tax of directors; the taxes were paid based on the employees services to the employer Commissioner v. Glenshaw Glass Co. Exemplary/punitive damages are included in GI; compensatory damages are not GI because they return the individual to his original place Charley v. Commissioner Travel credits converted to cash; the taxpayer was wealthier from the sale of the travel credits = GI *Fair market value: willing buyer, willing seller, neither of whom is under unusual compulsion   Gross Income (GI) – (Deductions Toward AGI) = Adjusted Gross Income (AGI) – (Deductions From AGI) = Taxable Income (Credits) __________________________ Amount Realized – (Adjusted Basis) = Gain Realized Gain Recognized* *Gain recognized is the full amount of Gain Realized unless some other Code section states that it is not recognized.   Income is taxable from both legal and illegal sources – “The wages of sin are not exempt from taxation.” In order to have an Amount Realized: Must have a sale or an exchange   Federal Tax Outline – Page 2   This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press....

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Federal Income Tax Outline – Page 2 – Gifts and Inheritances

Exclusions of Gifts and Inheritances – 102 102(a) – Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance Employee Gifts – 102(c), 274(b) Generally all “gifts” from employer to employee must be counted as gross income Exceptions: “Extraordinary transfers to the natural objects of an employer’s bounty…if the employee can show that the transfer was not made in recognition of the employee’s employment.” Certain traditional retirement gifts (Section 132(e)) Certain employee achievement awards (Section 74(c)) Cases: Commissioner v. Duberstein (1960) Duberstein was given a Cadillac by the president of another company after Duberstein provided him with names of potential customers; this qualified as a gift Lyeth v. Hoey (1938) The beneficiary challenged the will and received money after a settlement; this money is not gross income because he received it based on his status as a beneficiary Wolder v. Commissioner (1974) Wolder’s client bequeathed stock to him in return for providing legal services; “A transfer in the form of a bequest was the method that the parties chose to compensate Mr. Wolder for his legal services, and that transfer is therefore subject to taxation”   Employee Benefits – 132, 119 132(a)(1)&(2) – Certain Fringe Benefits Nondiscrimination rule 132(j)(1) – may be made available tax-free to officers, owners, or highly compensated employees only if the benefits are also provided on substantially equal terms to other employees If a classification of fringes is discriminatory, highly compensated employees have gross income, but the exclusion still applies to those employees who receive the benefit and are not highly compensated   132(c) – Qualified employee discount Property: Gross Profit Percentage: Aggregate sales price/Aggregate cost Services: An employee discount is not taxed as long as it is less than 20% or Review beginning of Chapter 4 for summary of 132(a) fringe benefits   119 – Meals or lodging furnished for the convenience of the employer Section 119 grants an exclusion from gross income of lodging furnished to an employee if three conditions are met: The lodging is on the business premises of the employer The employee is “required to accept such lodging as a condition of his employment The lodging is furnished for the convenience of the employer 119 does not recognize sole proprietorship 119 does recognize a partnership   Cases: Herbert G. Hatt President of a funeral home and lived there; the funeral business requires someone to...

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Federal Income Tax Outline – Page 3 Property Gains, Life Insurance

Gain from Dealings in Property – Chapter 6   1001 – Amount Realized 1012 – Basis = cost (most basic) 1014 – Estate tax basis (decedent) 1015 – Gift tax basis 1041 – Transfers of property between spouses Cases: Philadelphia Park Amusement Co. v. United States Cost basis is the fair market value of the property received; if we cannot determine with reasonable certainty the value for the property, it is fair to   assume the properties are equal in an arms-length transaction Taft v. Bowers Donee assumes the donor’s basis in property acquired by gift (1015) Crane v. Commissioner 1041; husband and wife same entity Commissioner v. Tufts Nonrecourse mortgage treated the same as a true loan   Life Insurance Proceeds and Annuities – Chapter 7   Life Insurance Proceeds – Section 101 101(d): Instead of taking proceeds, you leave it with the insurance company who makes payments to you with interest. Must understand the difference between insurance proceeds and annuities in how these are taxed 101(g): Terminally or chronically ill do not pay tax on proceeds from insurance policies However, there are limitations for chronically ill; there are none for terminally   Annuities – 72 72(b): Exclusion Ratio = Investment Contract/Total Expected Return –        The exclusion rate is EXCLUDED from gross income –        The remaining is INCLUDED in gross income Page 159 for example   Discharge of Indebtedness – Chapter 8   61(a)(12) – Discharge of Indebtedness (Included in Gross Income) 108 – Can exclude or defer 108(b) – not a total freebie, just a deferral Debt discharge amount: The amount of discharged debt which is excluded from gross income by virtue of the bill’s provision is to be applied to reduce certain tax attributes. The debt discharge amount is applied to reduce the taxpayer’s tax attributes in the following order: Net operating losses and carryovers; Carryovers of the [general business credit] The Section 53 alternative minimum tax credit Capital losses and carryovers; The basis of the taxpayer’s assets (both depreciable and nondepreciable); Carryovers of passive activity losses or credits; Carryovers of the foreign tax credit A business loss can be put back 2 years or forward 20 years Debt discharge outside of bankruptcy The amount of debt discharge is excluded from gross income up to the amount by which the taxpayer is insolvent   Damages and Related Receipts – Chapter 9 Sections 104 – 106 Punitive...

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Federal Income Tax Outline – Page 4 Divorce & Other Exclusions

Settlement and Divorce – Chapter 10 71 (income rule); 215 (deduction rule) You cannot take a 215 deduction unless the other spouse counts it as income under 71   Alimony Payments that qualify as alimony or separate maintenance are gross income to the payee spouse under Section 71(a) and deductible by the payor spouse under Section 215(a). Must meet five requirements: Four listed in 71(b)(1) and the payment is not for child support. Transfers of property, incident to divorce, will be treated as a gift and the transferee will receive the property at the transferor’s basis   Alimony Recapture Purpose: To prevent property settlements from being categorized as alimony If the alimony is front-end loaded, it looks like a property division (settlement) 3 years is the most that you will have to worry about. The alimony will be recaptured in Year 3. Steps for Recapture 71(f)(4) – Year 2 71(f)(3) – Year 1 Exception to Recapture – 71(f)(5) – death in 3 years Alimony Trusts Income of alimony trusts is excluded from the payor’s gross income (no deduction) and is taxable to the payee. The payee is treated as the beneficiary Example of why you would use an alimony trust: Payor husband is a gambler and may lose all of his money.   Cases: Young v. Commissioner The code uses the language “incident to divorce” if it (1) occurs within 1 year after the date on which the marriage ceases (the regulations extend a safe harbor to transfers made within six years of divorce), or (2) is related to the cessation of the marriage   Other Exclusions – Chapter 11   Gain from the Sale of a Principal Residence – 121 A taxpayer can exclude up to $250,000 ($500k if married filing jointly) of gain realized on the sale or exchange of a principal residence. Cannot take this exclusion more frequently than once every two years and the taxpayer must have owned the residence and occupied it as a principal residence for at least two of the five years prior to the sale or exchange. Also, cannot include a loss from sale of personal residence: Example: Amount Realized = 200 Adjusted Basis = 500 Loss Realized = <300> Loss Recognized = 0 121(d)(3) – Property owned by spouse or former spouse; (see drawing in Evernote) 121(d)(11) – Decedent; If the decedent used it for 20 months, the beneficiary is...

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Federal Income Tax Outline – Page 5 Individual Deductions

Deductions for Individuals Only   Adjusted Gross Income – Section 62 Allowable “above the line” – described in section 62 Deductible “below the line” – outside section 62 Section 67 – 2% floor on miscellaneous itemized deductions 85% is the maximum amount of Social Security benefits that can be taxed   Moving Expenses – 62(a)(15), 217 Two requirements to qualify for a deduction: 1. Distance – 217(c)(1) 2. Time – 217(c)(2) (Meals are not deductible) Extraordinary Medical Expenses – 213 213(a) allows a deduction for uncompensated expenses for medical care of an individual, the individual’s spouse or a dependent, to the extent the expenses exceed 7.5 percent of AGI (floor) 213(d)(1)(A) – medical care means 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” They do not include costs to improve the taxpayer’s general health and appearance. 213 – travel to medical facility – 50% of meals, 100% of hotels – reasonable estimate Deductible medical expenses Don mentioned: Birth control pills, vasectomy Excludes: cosmetic surgery Cases: Raymond Gerard v. Commissioner Daughter had cystic fibrosis. Doctor recommended a central A/C unit and they installed one. The $1300 was an expenditure for medical care within the scope of 213. However, 263 states, “No deduction shall be allowed for permanent improvements made to increase the value of any property.”  If a taxpayer can show that the increase in value is less than the expenditure, the difference is deductible. Here, the unit increased the value of the home by $800. $1300 – $800 = $500 medical deduction Revenue Ruling 2002-19 Expenses for weight-loss program for a specific disease or ailment diagnosed by a physician – cost of participation in the weight-loss program is paid for medical care and is deductible under 213 (fees to join the program and attend periodic meetings); diet food items are not deductible You would rather have a 162 deduction instead of 213 Where it is questionable whether an expense is a business or medical expense, the Service indicates the expenses may be deduction under Section 163 if the following three elements are present: 1. The nature of the taxpayer’s work clearly requires that he incur a particular expense to satisfactorily perform such work, 2. the goods or services purchased by such expense are clearly not required or used, other than incidentally, in the...

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Federal Income Tax Outline – Page 6 Capital Gains and Losses

Capital Gains and Losses – Chapter 21 “Capital” is usually dependent upon: 1. Whether it arises in a transaction involving a “capital asset” 2. Whether the capital asset has been the subject of a “sale or exchange” 3. How long the taxpayer has “held” the asset *There are some statutes that may artificially accord capital gain or loss treatment to some transactions which do not actually involve the sale or exchange of a capital asset. Section 1222 (1) Short-term capital gain – gain from the sale or exchange of a capital asset held for not more than 1 year (2) Short-term capital loss – loss from the sale or exchange of a capital asset held for not more than 1 year (3) Long-term capital gain – held for more than 1 year (4) Long-term capital loss – held for more than 1 year (5)-(8) Netting of short-term losses against short-term gains and long-term losses against long-term gains STCG – STCL = Net short-term capital gain or loss (1222(5) and (6)) LTCG – LTCL = Net long-term capital gain or loss (1222(7) and (8)) Review numbers on page 691 Net gains can arise in three situations: 1. A net short-term gain in excess of a net long-term loss (taxed at ordinary income) 2. A net long-term gain in excess of a net short-term loss (net capital gain Section 1222(11)) 3. A combination of a net short-term gain and a net long-term gain Collectible LTCG rate = 28% If there is a “net capital gain,” Section 1(h) comes into play.   Corporation v. Individual – Treatment of Capital Gains Corporations compute and net their capital gains like noncorporate taxpayers but no preferential tax treatment is provided to corporations. Gains – noncorporate taxpayer has the advantage because of the preferential rate Losses – noncorporate taxpayer can offset ordinary income up to $3,000; corporations can only deduct losses from the extent of their gains However, Corporations – for carryover it is ALWAYS a short-term capital loss regardless of its origin (back three years, forward five years) Individuals can only carry forward losses   The Mechanics of Capital Losses Section 165 – primary code section that determines whether a loss is deductible Capital losses are generally deductible only from or against capital gains. Any capital loss balance remaining is carried forward into succeeding taxable years (retaining either LT or ST capital loss)   Restrictions on capital losses...

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