Intro to Federal Income Taxation - Law School Exam Outline

8/13/2019 Intro to Federal Income Taxation - Law School Exam Outline

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ABBREVIATION!

F"V!fair market valueNO#!net operating loss$%E!Highly compensated employeeRAF"V!readily ascertainable fair market valueEIT%! Earned Income Tax CreditPA!Passive ActivityA"T!Alternative Minimum Tax%&! capital gains%#! capital losses

I INTRO!"#$%A' $istorical Bac()round of IR%

" &irst the '( started using excise taxes on li)uor* carriages* slaves* and real property+ ,efferson repealed taxes- tariffs became the federal revenue source$ Income tax re#administered as flat tax in "./0

!a Constitutional challengebased on mandate that direct taxes on states must beapportioned to states based on population

!i 1o one kno2s exactly 2hat a 3direct tax4 is!ii It is agreed that a head tax5flat amount on everyone5is a direct tax!iii Problem is that if you apportion income tax on the basis of population*

people in different states 2ould pay different rates- people in poorer states2ould pay a higher tax rate

B' Taxa*le Income

" 6%$!a7 for individuals 2ho don8t itemi9e their deductions* it is ad:usted incomeminus deductions

+ 6%$!b7 for individuals 2ho do itemi9e* it is gross income minus deductions allo2ed;$ 6%+!a7 ad:usted gross income is gross income minus deductions0 The rule that applies to the total amount of income of the top rate in your bracket

along 2ith all of the lo2er rates;%' Tax+a,ers! %ate)ories

" Married individuals filing :ointly+ Heads of Household$ (ingle Individuals0 Married individuals filing separately

AC? T= THI(


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!b It is impossible for the federal tax code to be neutral on marriage encouragement2ith the progressive rates structure and commitment to treating all marriedcouples the same regardless of each spouse8s contribution

F' Pa,in) Taxes

-' Procedure

!a TP files a return 2ith I@( service center!b Potential audit!c Potential appeal to I@( appeals office!d If TP fails* can litigate in

!i '( Tax Court7 appealable to '( Court of Appeals

If you sue here* don8t have to pay first and then sue for a refund5you

can refuse to pay until it rules

1o right to a :ury trial here

Article I :udge

Dill follo2 the la2 of the Circuit 2here TP lives

!ii '( &ederal ut there isonly a +G chance you 2ill have to pay that* so expected cost of not payingyour taxes is only $;F;

II' IN%O"E

A' Definitions

-' Income

!a Haig-Simons definition of income! 2hat you spend plus 2hat you save in a giventime period

!i Dould also include imputed income !parent raising child instead of payingfor childcare;

!ii De don8t use this definition for tax purposes!b Economic!Consumption plus savings !see consumption tax section!c There is no crisp definition of income for tax purposes!d (C=T'( initial definition !later abandoned7 gain derived from labor* capital* or

both;!e %ommissioner &lens3a1 &lass !

!i &ACT(7 t2o cases involving receipt of punitive damages- both TPsexcluded the punitive damages they received since they 2eren8t derived


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from income or capital* and that 2as the going definition of income at thetime;

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!c N A@(7 The consideration 2as paid for the easement granted to the city and theconse)uent damage to N8s property rights- that it 2as an easement means it is notpractical to attempt to apportion a basis to the damaged property;

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!i 4=2.a'7 TP not taxed during time the money is accumulating* unlike asavings account* bonds* or stocks 2here interest and dividends are taxed asearned 2hether 2ithdra2n or reinvested;

6+!u says that if you are a corporation and hold a deferred annuity*

you DIJJ be taxed on inside build#up* unlike an individual!ii 4=2.*'!2hen money is 2ithdra2n* some is taxable and some is return on

basis5investment in the contract is the basis and that is divided byexpected return !actuary comes up 2ith expected return;

Exam+le!TP invests 6F? and actuaries say expected return is

";FM; @atio is "$* so " of every $ that is 2ithdra2n is a return ofbasis; If the annuity is 0F?yr* only $? of that is taxable;

Oou don8t ACT'AJJO get basis back at a steady rate5you get more

earnings in the early years* but the tax code treats you as though you aregetting a pro#rata amount each time* 2hich is a tax advantage;

!d Polic, Rationales!Encourages savings so people can pay for their o2nretirement;

!e Borro1in) A)ainst an Annuit,7 tax treatment much less favorable than it used

to be; p; /$ EE$' Annual Accountin)" &eneral!2e calculate income on the basis of each year* annually52hat happens to

TP in each year*!a Pretty arbitrary as a convention!b enerally the calendar year for individuals* may vary for businesses

+ T3e %lar( anford Broo(sPro*lem!a %lar( %ommissioner !"+"

!i &ACT(7 TP8s tax preparer gave him bad advice* telling him to fileseparately from his 2ife; If he had filed :ointly he 2ould have saved"/*/0" in income tax; Tax preparer paid him that amount a fe2 years

later;!ii H=J


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Clark* did not and could not have deducted the loss 2hen it happened*

so maybe court is trying to line up economics 2ith tax; It 2as notdeducted 2hen it 2as lost* so it 2as off the tax radar* and 2hen hereceived it a couple years later it 2as off the radar

(anford >rook 7 did take the deduction on the losses for three years;

(o if it had gotten the money back tax free* it 2ould not have netted out

to 9ero; Ho2ever* their income 2as 9ero in those years* so them takingthe deduction didn8t change the taxes they 2ere paying- this means thatthe situations really 2eren8t e)uali9ed after all;

!ii Dhat C='J< the court have done to solve the unfairnessB

ive individuals 2negative income a payment from the government in

amount you 2ould have paid in taxes if you have made the amount thatyou lost;

>AAC?( if you 2ant to !not carry

for2ards!vi >asically* you can take unused loss and move it back and for2ard in time to

eat up income;!vii'nder the 6"+ regime* the TP in (anford >rooks could have carried

for2ard the "%? loss for + years* 2iping out the entire "%? settlement

they received a fe2 years later;>' %laim of Ri)3t

!a Nort3 American Oil %onsolidated Burnet !"$"!i &ACT(7 TP and '( overnment are fighting over land* 2hich is generating

income; In "/"%* that income held by a receiver pending dispute resolution;In "/" TP 2ins* and "/"% income is paid to TP; I@( says that money 2astaxable to "/" 2hen received- TP says it is taxable to "/"% 2hen earned*or "/++ 2hen the last appeal 2as decided in its favor; !Tax 2as higher in"/" bc of 2ar than it 2as in "/"% or "/++

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'ntil that :udgment* he had claimed and used the ++? entirely as his o2nunder the good faith 3mistake4 belief that he 2as entitled to it;

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@ecovery =utcome under 6"""

Case I F? Include F? in O

Case II F? F? excluded in year O

Case III F? $? included in year O

Case IK "? "? included in year O

!c 4---is chiseling a2ay at the idea of an annual accounting period

!i TP8s perspective7 can be helpful* but if rule of inclusion comes into play asin Case there is no relief from change in tax rates;

!d Income Aera)in)!1=T done no2- idea is that TP could average for a certainnumber of years to protect against s2ings in income; Made more sense 2hen topmarginal rates 2ere very high;

I' $ealt3 Insurance

" 4-06.a'7 EE8s gross income doesn8t include E@#provided coverage of accident orhealth insurance; (ection also covers retired former EEs* and spouses and dependantsof EEs* but not unmarried couples 2ho aren8t dependants; E@#provided domesticpartnersame sex couple coverage creates extra federal taxable income to EE;!a E@ provided doesn8t mean E@ has to pay the 2hole bill* but E@#provided portion

2ill be excluded from EEs income!b Policy originated from 2age controls during DD nII* 2hen E@s had to competefor EEs using fringe benefits- by "/F0 it 2as common not to consider healthbenefits income* so Congress 2ent along 2ith it;

+ 4-09.*'!benefits out of an E@#provided health or accident plan also not includable inEEbeneficiary8s taxable income; (eems like a huge incentive to consume medicalservices* bc of the tax subsidy at both ends;

$ (ome think repealing these rules 2ould increase the number of insured people !2ithother reforms* presumably

, Personal In7ur, Reim*ursement!"0"" 4-0C.a'.2'!any damages received on account of personal in:urysickness are

excludable* from 2orkers compensation or settlement of a suit* 2hether a lump sumor periodic* except punitive damages or lost profits;!a 3Jump sum or periodic4 language means that NTP can choose an annuity- if

NTP chooses an annuity* not only are the damages untaxed* the interest is as 2ell!i ood deal for N5creates an incentive to structure settlements to provide

deferred periodic payments!ii >ad for U 2ho 2ill be taxed on interest earned on money put aside for the

periodic payments to N* and 2ill have to invest a larger sum in order tostretch the payments out;

!b enerally U funds such payments through an insurance product!i 1either N nor U thus pays taxes

!ii N gets more money in the long run bc not taxed on interest !i;e; if N took alump sum and invested it* the interest 2ould be taxable income* butpayments coming out of life insurance at 2hatever rate N 2ants are nottaxable to N; (ee p; """ EE Problem +;

!c A2ards for lost DAE( are excludable* :ust not lost profits;!d TP excluding the income can be someone other than the person 2ho suffered the

in:ury or sickness !e;g; spouse* dependent;!e The only case in 2hich punitive damages are excludable are 2hen a state =1JO

allo2s recovery of punitive damages;


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!f Rationale!Exclusion serves as a proxy for a system of depreciating humancapital; =ther args for and against taxation of certain a2ards;

!i "edical Ex+enses!Places the in:ured person in the same financial positionthey 2ould be in 2ithout the in:ury- fairness dictates she should not paymore than others in taxes

!ii #ost @a)es!replaces funds that 2ould have been taxed other2ise- fairnessdictates that she should be taxed on income she 2ould have been taxed onbut for the accident; >ut they are excluded;

!iii Punitie Dama)es!These are complete 2indfall to the recipient so shouldbe taxed !the only argument against taxation is that not taxing these gainsmight encourage more people 2ho are actually 2ronged to sue to recover

+ "ur+3, IR!a &ACT(7 TP 2as a 2histleblo2er 2ho eventually got ? in damages from E@

for emotional distress 2physical symptoms- 0F? for emotional distress and+F? for in:ury to reputation- nothing a2arded specifically for physical in:uries;TP paid tax on the a2ard then sued for a refund;

!b TP THE=@IE(7 !" should be excluded under 6"0!a!+; !+ 6"0!a!+ isunconstitutional;

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amount of the gift tax* and kids discharged the debt* so it 2as income forthe discharge of indebtedness;

!c Insolenc, and BR 4-0H.a'!there is no income from discharge of indebtednessif the indebtedness happens 2hen you are in bankruptcy under Title "" orinsolvent; Ho2ever* for insolvency 2o >@* the income from discharge ofindebtedness can only be excluded to the extent of the insolvency immediatelybefore the debt discharge;

!d Affect on Basis!>asis in property includes the amount borro2ed to buy property*and amount reali9ed on sale of that property includes relief of indebtedness;Assumption of indebtedness is also included in basis of property boughtreceived; p; +0 EE* example .0;

!e %ontested8Dis+uted #ia*ilit,!If the amount of debt is disputed and then settledfor an amount less than one 2hat party said it should have been* it is notnecessary for the debtor to include in his taxable income any income fromdischarge of indebtedness;

!f &ifts!if a gift is forgiven out of detached and disinterested generosity* the debtforgiveness is a 6"+ gift and therefore not taxable;

!g arin %ommissioner !"F

!i &ACT(7 TP* Compulsive gambler accumulated $;0M gambling debt at acasino; 1, la2 says it 2as unenforceable* illegal gambling debt; Casinoand TP settle for F?; I@( said he had +;/M income from the dischargeof indebtedness;

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)*+ of the !ro!erty %ill be included in basis ,along %ith any cash

!ayments by &';!d %ommissioner Tufts !"F !2ith rounded numbers by !exempts interest on state* municipal* and other such bonds for TP 2ho holdsthemgets the interest from them;

+ It is the locality that benefits5the interest rates are lo2er on tax#exempt bonds* andthe difference in interest is a subsidy to the locality from the federal government;

$ This starts to break do2n because not everyone is taxed at the same rate7Tax Rate %or+orate

Bond Rate

@3at t3e, 1ill ta(e to

*u, tate8#ocal

%ost to Feds Benefit to

tates

Benefit to

Tax+a,ers

FG "G FG FG FG 1one+FG "G ;FG =n FG taxpayers7

FG=n +FG taxpayers 7+;FG

+;FG on alltaxpayers

&or FGtaxpayers7+;FG&or +FGtaxpayers7G

"G "G /G Taps out at FG still!less for lo2erbrackets

"G &or FG7 0G&or +FG7";FG&or "G7 G


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!a Jocalities have to increase interest rates to attract TPs at a lo2er rate- can8t issuedifferent bonds for different tax brackets

!b Above doesn8t change cost to government* but does reduce subsidydifferencegoes to TP in highest tax brackets;

III' TI"IN&

A' Reali5ation of &ains

-' Policies *e3ind not taxin) until Jreali5ationK

!a Ji)uidity issues!b ain could evaporate !although this couldbe solved be a deduction for loss if it

does evaporate!c Kaluation problems!d Also* in terms of economic#only income gives some TPs control of 2hen they are

going to pay tax that other TPs don8t have+ Eisner "acom*er !$* +"

!a &ACT(7 TP had shares of Co;* and Co; issued FG stock dividend !for every t2oshares* TP got one free;

!b 1=TE7 There can also be cash dividends* but this 2as a stock dividend;!c I@( A@'ME1T( that she should be taxed on the dividend

!i TPs 2ealth increased by virtue of the dividends!ii Even if she8s not richer* the fact of the distribution is a reali9ation of 2ealth

that accumulated in corporate form!iii They don8t need reali9ation even at all5an increase of 2ealth at corporate

level taxable to TP as shareholder!d H=J


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!a &ACT(7 Dood bought property for +/%*0* incurring a recourse loan; ThenDood refinanced 2ith a 0? nonrecourse mortgage; Dood then donatedproperty to TP* her company; In "/$$ Dood defaulted on the loan;

!b TPDood A@'ME1T(7 Dhen she got another loan from recourse tononrecourse* it 2as a reali9ation event;

!c H=J-!i 4-0>-.a'.-'!if there is a like#kind exchange* no gain or loss recogni9ed;

T2o farmers 2ho trade their farms* e;g;

Improved real property and unimproved real property are considered

like kind if they are both held for productive use in a trade or businessor for investment; Treasury @eg; 6";"$"!a#"!b;

!ii Exce+tions 4-0>-.a'.2'!makes exceptions to 6"$"!a!"; &or example7

4-0>-.a'.2'.A'!-.a'.2'.%'!-.c'!if there is boot received along 2ith like#kind property* a loss

2ill not be recogni9ed


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1et relief of indebtedness is treated as boot under 6"$"* and it is

additional to cash boot;.i' Basis 4-0>-.d'

No Boot!the basis of the property IKE1 is the basis in the property

received in the exchange !i;e; each party keeps their old basis;

Boot

TP 13o )ets *oot! the basis of non#cash property TP gets 2ill bethebasis of the property TP gave in exchange minus cash TP receives*plus the amount of gain or minus the amount of lost that is reali9edand recogni9ed;a; That basis is allocated among like#kind property and non#cash boot

received by TP- the non#cash boot8s basis is its &MK;

TP 13o )ies *oot!the basis of the ne2 property TP ET( inexchange 2ill be the basis of the property TP gave plus any cash TPpaid for the exchange;

!b Inoluntar, %onersion 4-0>>!ain not recogni9ed on involuntary conversionof property; Dhen conversion is to dissimilar property* gain 2ill be recogni9ed

but TP gets a period of time to buy like property so it 2on8t be; TP can al2ays*ho2ever* recogni9e J=(( on involuntary conversions !generally in the amount ofbasis in the property;

!c 4-0>9!ainloss from exchange of life insurance policies or other annuities nonrecogni9ed;

!d 4-0>6!ainloss from exchange of stock in same corporate not recogni9ed;!e 4-0>=!ainloss from exchange of '( Treasury obligations for others!f 4-0C>!ainloss not recogni9ed 2hen any officer or EE of executive branch of

federal government has to sell property to comply 2conflict of interest la2sC Boot and Basis !+$"

" Exam+le!C has Property A 2ith a basis of F and &MK of /- < has Property >;

They exchange;!a If > has a &MK of /* it 2ill :ust be a property exchange; C 2ill reali9e a gain

of 0 but it 2on8t be recogni9ed bc there 2as no boot and it 2as an exchange oflike#kind property; >asis in > 2ill be F;

!b If > has a &MK of % and comes 2ith a $ boot* C8s reali9ed gain 2ill still be0* his recogni9ed gain 2ill be $; >asis in > 2ill be F;

!c If > has a &MK of $F and a cash boot of FF* C8s reali9ed gain is still 0-recogni9ed gain 2ill be 0 because it is the lesser of the boot or reali9ed gain;>asis in > 2ill be $F;

!d This is basis doing 2hat it should7 keep track of 2hat TP has been taxed on and2hat TP still o2es in tax;

+ Lordan "ars3 %ommissioner !++!a &ACT(7 TP o2ned property on 2hich he operated a department store 2ith a basisof 0;.M; He sold the property for cash !+;$M* the &MK of the property at aloss then leased it back from buyer long#term for fair rent so as to keep runningthe store; TP 2anted to deduct the loss but I@( said it 2as an exchange of likeproperty5a fee interest for a long term lease !@egs 6";"$"!a#"!c says a longterm lease is e)uivalent to a fee;

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the TP made an unconditional conveyance to a stranger- this 2as more than achange in form of o2nership* it 2as a change in amount of o2nership in 2hich heclosed out on a losing venture; enerally* exchange means the giving of onepiece of property in return for another* not the return of a less interest in aproperty received from another !2hich is 2hat basically 2ent on here;

$ Reenue Rulin) HC:-C9!+$.!a &ACT(7 TP 2as an airline* held operating certificates to service certain routes;


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+ %as3 "et3od!TP generally 2ill include an item in gross income 2hen actuallyreceived or made available for receipt and 2ill deduct an item 2hen actually lost;Individuals almost al2ays on this method;

$ Accrual "et3od!Jarge business normally on this; Jooks to 2hen the right toreceive is accrued and the obligation to pay is accrued- that determines timing ofincome and deduction; "/ EE;

E' %onstructie Recei+t and Related Doctrines

" Em+lo,ee Deferred %om+ensation Arran)ement!!a Contract b2 E@ and EE that E@ 2ill pay some or all of EE8s compensation after

it is earned;!b


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current economic benefit toEE

Minor !+%. ;

If you kno2 this* and do it any2ay* nothing to stop the company frompicking up your tax liability; (o Enron could have happened even ifthis statute 2as in place; It8s not good;

F' ?ualified Pension8Profit 3arin) Plans +2=0

" Personnel ob:ectives7 Enable employee loyalty and employee incentives !includinginvesting in the employer8s stock- cf;* Enron Corp;;

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!d 1on#tax benefit X funds are protected from employer8s financial risks !althoughpossible actuarial underfunding for plans;

9' #imitations on ualified +lan structurin)!

!a 1on#discrimination rules X cannot favor highly#paid employees !but socialsecurity integration;

!b Kesting X benefit becomes nonforfeitable- cf;* effect of termination beforeretirement;

!c &unding X infusion of contributions into a separate trust enables security of funds;!d Jimits on contributions made by employer;

&' +ecial Retirement Plan tructures +2=>:C

" (elf#employed persons X use a ?eogh plan 2hen only one !or several employees;+ >ut* other mechanisms for corporate plansB$ I@As X individual retirement accounts X e;g;* 2hen employer not providing benefits;

60.;0 @oth I@A Xnondeductible contributions* but non#inclusion for accruals and

distributions;!a Penalties for early 2ithdra2als* !b @e)uired minimum distributions ! Y;

$' Pro+ert, Exc3an)ed for erices

" 4H>.a'! if there is a transfer of property in exchange for performance of services* theperson getting the property must include the &MK of the property minus the amountthey paid for the property in their gross income at the time 2hen the property istransferable or not sub:ect to a substantial risk of forfeiture;!a Pro+ert, not ested!2hen property is not vested * the above has not yet been

triggered* put EE can elect to include it at the time of receipt and o2n it free andclear for tax purposes at that time; 6.$!b;

!b Deduction!E@ can deduct the payment in property 2hen EE includes theproperty in their gross income; 6.$!h;

2' toc( O+tions

!a O+tion @IT$ NO RAF"V 4H>.e'.>'!6.$!a does not apply to the transfer ofan option if the option has no readily ascertainable market value !@A&MK;

.i' Treasur, Re) 4 -H>:=

EE is taxed on value of the option !that is 2hat they saved by using it

either 2hen

=ption is exercised

=ption is sold

Example

=ption for " shares at Fshare

(pot price 2hen exercised5"share

Taxable compensation income L +F !E@ cannot claim a deductionon this 2o a D+ but it is also not capital gains

!b O+tion @IT$ RAF"V 4H>.e'.C'!6.$!a doesn8t apply to the transfer ofproperty pursuant to the exercise of an option 2ith a @A&MK at the time of thegrant;

!i (o if you 2ere taxed on the @A&MK of an option 2hen you got it* youexercise the option 2ithout further taxation;

!ii Oou can still be taxed !most likely capital gains tax 2hen you sell the(HA@E( you buy 2ith that option* ho2ever* and your basis in those shares


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2ill be the @A&MK at the time of inclusion in your income plus 2hateveryou actually pay for the shares;

=PTI=1( Z Z @A&MK [ grant 1= @A&MK [ grant Z Z 6.$!a applies to option 6.$!a applies to stock 2hen exercised

!c %all O+tions!right to buy5almost all EE stock options are call options;enerally exercise price is the same price as the &MK on the day the option isgranted;

!i enerally no @A&MK to a call option!ii Exam+le7 in "/// option to buy " shares at Fshare* in ++ 2hen TP

vests they are selling at "share* gain 2ill be +F; That income to himis :ust compensation income to TP under 6.$ and 6%"!a!"- no taxableevent in "///* bc the option had no @A&MK;

>' IR Notice 200>:C= And Tax 3elters

!a overnment challenged stock option shelters on t2o grounds

!i (ale to a limited partnership only made up of family members is not anarm8s length transaction- the original o2ner of the stock shares retainso2nership 2hether he 3sells4 to the partnership or not

!ii Installment sale does not )ualify as such 2hen paid for 2a promissory note.*' Exam+le

!i (chmidt gets the options from oogle and sells them to (chmidt &amilyJimited Partnership

!ii (chmidt &amily JP gives (chmidt a $#year installment note 2ith a balloonpayment at the end

!iii Dhen vested* the (chmidt &amily JP gives oogle $M for the optionsand gets %M 2orth of stock

.i' "ain Ideas!

The note is not a payment* there is nothing to include in the return that

year

The partnership is not an EE of oogle* so 6.$ does not cover this

transaction!c 1=TE7 most options are not transferable to others except through divorce or

be)uest;!i Tax shelters re)uired companies to make internal changes in their stock

optsions!ii This is not really a probably anymore after this ruling

0 %ramer %ommissioner !+/0!a &ACT(7 TP founded a privately held company in "/+- b2 "/. and "/." it 2as

neither publicly traded nor registered 2the (EC and it 2as held by "F#+shareholders; In "/. it issued TP an option to buy F? shares at Fshare* aslong as it 2as exercised only in +G increments and only as long as he 2as stillemployed there- there 2ere also some transfer restrictions; In "// the co; issuedTP another option to purchase 0$/ shares at .share* and some options to someother execs; The co; issued all of these options in recognition of services theyprovided to the co* and the delayed vesting 2as intended to induce their continuedemployment; 1one of them ever exercised the options; Then TP got bad tax


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advice from an accountant* 2ho told him to file 6.$!b elections 2ith the I@( forthe options; The TP declared value on the options even though he thought they2ere 2orth something* because the tax attorney had advised him that 6.$!bmight not apply 2out a readily determinable &MK and he 2anted them to have areadily available &MK;

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!c Dhere the parties are not longer living together; 6"!b!"!C;

Dhere payments don8t continue after the death of the payee spouse

!other2ise they are more like property settlements; 6"!b!"!


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made in the third year !c plus "F?; 6"!f!0; (econd Gear Excess.G' * .c Q S-9;'

S R O !The excess amounts for the first t2o years must be includedin the payor8s income in Oear $ !and may be deducted from thepayee8s;

Rationale!


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Al1a,s consum+tion tax

rate 90U

Al1a,s income tax rate

90U

%3an)e from income

to consum+tion *81

Time - Time 2

Time - earn S-00 inest

after:tax amount in land

" from labor #" forinvestment in land L taxable

" from labor x ;FLF paid in tax* F toinvest in land

" from labor* o2eF tax* invest F inland

Time 2 sell land 13en

F"V -90U of +urc3ase

"F sale proceeds; If youreinvest* taxable

If you consume there is aF tax !"F x ;F 1etafter#tax amount of F

F sale proceeds # Fbasis L +F gain taxable at

FG L "+;F1et after#tax amount of%$;F

F sale proceeds; Ifyou reinvest*

taxable; If youconsume* you have nobasis; F of proceedsso all F is taxable;(o you pay $;F intaxes and have only netafter#tax amount of$;F

F "a7or reason 1e dont!businesses and old people don8t 2ant their basis 2iped out;IV'DED/%TION AND PREFEREN%E

A' Personal Deductions

" &eneral rule!personal expenses generally are not deductible; 6+%+; Many

exceptions;2' Personal De+endenc, Exem+tions

$ Non:Itemi5ers! @oadmap to taxable income for non#itemi9er!a ross income!b Minus deductions allo2ed under 6%+ L ad:usted gross income

!i These are 3above the line4 deductions!c ross income minus standard deduction

!i This is a flat amount indexed for inflation!ii Intentionally set higher than most 2ould have if they itemi9ed to encourage

administrative ease!d Minus personal exemptions

!i This is a deduction for the TP and each of her dependents Personal Exem+tion 4-9-

@ationales7a; >asic living expenses should be taken into account in determining

ability to pay !i;e; they should be removed from the picture beforesuch determination

b; Expenses increase as the si9e of the household increasesc; Administratively it is easier to give a standard number than try to

determine in each given circumstance 2hat a family8s cost ofliving is

Effects

a; Increases threshold at 2hich lo2er income people don8t pay taxesb; Contributes to overall progressivity by creating a larger 9ero#

bracket

Phaseout7 TPs lose +G of the personal exemption for every +F ofincome over the threshold !currently +"0*F for marrieds

De+endents .c3ildren )randc3ildren ot3er ualif,in) relaties or

si*lin)s 13o are under -


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a; Jive 2TP for at least FG of the year if the TP8s child !thoughtemporary absences to attend school do not count to2ard beinga2ay from home

b; Have at least FG of support paid for by TPc;


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allo2ed e)ual to the ad:usted basis of the property* even if it is greaterthan the &MK;

!ii D,er %ommissioner !$0$

&ACT(7 family cat started having fits- in first fit it broke a " vase;

TPs claimed " casualty loss deduction;

H=Jro2n#(impson

murders happened 2hen the house 2as still in escro2; TPs 2entthrough 2ith the sale; @ealtors and brokers told them it 2as verydevalued and TPs claimed a deduction for loss of property value;

H=J


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(upport of native Alaskans engaged in subsistence 2haling isdeductible under 6""!n !


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The charitable nature of the donation 2as here extinguished and nodeduction 2ill be allo2ed;

'gives the basis for being a tax exempt organi9ation5very

similar to list in 6" of groups of to 2hom TP can donate and deductthose donations; There are eight* ESCJ'(IKE categories7


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@eligious

Charitable

(cientific

Public safety testing

Jiterary

=r educational purposes

=r amateur sports=r prevention cruelty to children or animals

.d' Deductions for Interest

!i &eneral rule!there are no deductions for personal interest paid or accruedduring the taxable year; 6"%$!h!";

!ii Exce+tions!found in 6"%$!h!+;

Interest allocable to a trade or business7 cost of producing income from

the trade or business and therefore a business expense* unless it is anexpense allocable to the business of being an EE;

6"%$!h!+!d7 TP can deduct interest 2hen borro2ing to buy or

improve a home* or borro2ing against TP8s home !like a mortgage;

This is a subsidy to home o2nership lobbied for by national associationof realtors;

!iii 4269.a'.2'!there can be no deduction for interest 2here income is exemptfrom taxes bc that 2ould be double tax avoidance; A little 2eird bc ittreats tax exempt bonds as though the subsidy goes to the TP* 2here in factit goes to the municipality;

!iv 4-6>.d'!2hen investment interest debt is in excess of income* TP can carrythe interest deduction allo2ance for2ard to future years;


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!a ale of Personal Residence6"+"7 allo2s )ualifying TP to permanently excludefrom income up to +F? from sale or exchange of principle resident

!i TP must have o2ned and occupied the property as a principal residence forat least t2o of the five years prior to the sale or exchange; 6"+"!a;

!ii TP can )ualify for the exclusion only once every t2o years; 6"+"!b!$;!iii TP 2ho does not meet both above re)uirements may )ualify for a reduced

exclusion under 6"+"!c if TP had to move bc of a change in place ofemployment* health* or other unforeseen circumstances;

If TP can8t satisfy occupancy re)uirement* may exclude +F? times

!the period of time in the five years before the sale during 2hich the TPdid o2n and use the residence as a principal residence divided by t2oyears;Q

If TP has already excluded gain under the section 2in the past t2o

years* the TP can exclude +F? times the period of time b2 the saleand exchange of the previous principle residence for 2hich theexclusion 2as recently used divided by t2o years;

B' Tax %redits

" Definition!A tax credit is a subtraction from the net tax due !as opposed to adeduction* 2hich is a subtraction from the income to be taxed!a &ormulas7

.i' &ross income minus deductions taxa*le income

.ii' .Taxa*le income times tax rate' minus tax credit total tax due

!b Almost al2ays a true tax preference5based on policy* not :ust definitions ofincome !like exclusion for amounts borro2ed* deduction for business expense areabout definition of income* charitable contributions and interest on state and localbonds is purely about policy;

2' @ort3 more t3an exclusions or deductions

!a At FG tax rate* " exclusion or deduction 2orth F!b At FG tax rate* " credit 2orth "* because credits come after application

of the tax rate;!c Can be refunda*leto those in the G tax bracket* so they actually ET !d


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!v Must be earning income to get the EITC!vi A single person 2ith t2o children therefore has no federal tax liability 2hen

they earn less than "0;%?- F? deduction and /;%? credit;!f "arried 18t1o (idsdon8t pay taxes if combined income less than ++;.?

0 %3ild Tax %redit!!a " for each )ualifying child under 6+0!c !under "* dependent* name and

((1!b Phases out at higher levels of income under 6+0!d!c Incenties!better characteri9ed as relief to those 2ith children than an incentive

to have children; >ut if you are on the margins of having earned income for not*then you are incentived to push to get more earned income

!d Jargest federal child relief program* more than +;F times 2hat 2e provide throughTA1&;

!e ood for the middle class7Income Ran)e U Eli)i*le for %3ild Tax %red 3are of %3ild Tax %redit

\"? ;+ ;"

"#+? "0;0 0;F

+#$? +%;+ "0;0

$#0? +; "0;%0#F? +;0 "";

F#F? $";. +0;%

F#"? $F "F;.

"#+? +/;/ "0;+

%' "ixed Personal and Business Deductions

" Remem*er &eneral Rules $" EE!a The general rule under 6+%+ is that personal deductions usually are not allo2ed

!i >ut 6+"$ and 6"%F!e!$ and anything that carve out personal exemptionstrumps this;

!b The general rule under 6"%+ is that the expenses of carrying on a trade or business

are deductible!i 6%7 +G floor on itemi9ed deductions7 this means that the deductions must

exceed +G of ad:usted gross income to be deductible !and are onlydeductible to the extent they exceed +G of AI;

!ii 6%.7 The threshold is currently "? I for an unmarried person; People2incomes above "? must reduce their other2ise allo2able deductionby either7

$G of the excess of AI over "? =@

.G of other2ise allo2able itemi9ed deduction

!iii This general 6"%+ is not an itemi9ed deduction- it8s included in 6%+*ho2ever the 3if you are an EE4 exception !2hich allo2s deductions for

different stuff is an itemi9ed deduction!c Actiities not for +rofit 4-H>!allo2s a deduction for activities not done for

profit* up to the gross income of the activity that is engaged in not for profit!i This is an itemi9ed deduction- TP sub:ect to 66"%+ or +"+ are not sub:ect to

this deduction;!ii


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!" Tradebusiness expenseof non#EE

Oes* bc of 6"%+ 1o* bc of 6%+ 1one ]] !not really

!+ Tradebusiness expenseof EE

Oes under 6"%+ 1o under 6%+ +G floor under 6%-ad:usted gross incomephaseout under 6%.

!$ Production of incomenot tradebusiness

Oes under 6+"+ Oes under 6%+ +G floor under 6%-ad:usted gross incomephaseout under 6%.

!0 Activity not engaged infor profit

Oes under 6".$ Oes under 6%+


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!ii 6+.A!c!Flimitation on deductions; (o7

$ome office ex+ense! Income from trade or business use of home

minus personal expenses other2ise deductible !like mortgage and realestate tax plus business expenses not attributable to the business use ofthe homeQ; The result is 2hat TP may deduct for home office expenses;

Dhat you get to deduct under 6+.A is basically 2hat you haven8t been

able to deduct yet;!b Po+o %ommissionerp; 0"0!i &ACT(7 TP shares a " bedroom apartment 2ith her husband and child; (he

is a chamber orchestra and symphony musician; (he practices herinstrument in the living room; TP claims her living room is her principleplace of business;

!ii H=J


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6' Deductions for Trael Entertainment Food

.a' &eneral Rules

!i Entertainment expenses associated 2business and directly precede orfollo2 a substantial and bona fide business discussion deductible under6+0!a!"!A;


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!a (pecial rule in 6"%+!a!+ says travel expenses a2ay from home and meals aredeductible;

!i 3Home4 may not mean real home* but location of business;!ii Exam+les!

TP lives in reen2ich but 2orks in 1OC* traveling from 1OC to

reen2ich each day; 1ot deductible* :ust commutingpersonal under6+%+; e;g; Flo1ers;

TP above goes on a day trip for a photoshoot for her maga9ine- tofrom

the photoshoot is covered by the general rule of 6"%+!a; The mealsthere may or may not be under the "ossprimary purpose test;

TP above goes to JA for t2o days for some consulting- travel and meals

are both deductible under 6"%+!a!+8s special rule;!b %ommissioner Flo1ers !0F/

!i &ACT(7 TP lives in ,ackson* hired by a la2 firm client in Mobile to go inhouse* but made arrangements to keep living in ,ackson;

!ii H=Joston firm* she and her H lived in >oston; Instead she a got a :ob in 1O;(he tried to deduct cost of travel as 2ell as the apartment she rented in1OC;

!ii H=J


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gross income; "?yr total contributions* can be used any level of ed;Phaseout of eligibility to use this at /#""?; Can claim either credit inthe same year you get a distribution from Coverdell as long as don8t countsame ed; expenditures t2ice;

!iii Vualified Tuition Program under 6F+/7 must be sponsored by state or ed;institution; 1o income limits on 2ho can contribute- can8t exceed amountot be used for ed; expenses; ro2thdist; for ed; expenses not taxed; Canclaim either credit in same year as getting distribution from this* and gettingdistribution from Coverdell* as long as no ed; expense claimed more thanonce;

Proision T,+e of +reference Income limits %ost to /

$o+e 1@ credit "Fyr F+?#"F? F;$ billionyr 2ithbelo2

#ifetime learnin) 34 +yr 34 F;$ billionyr 2ithabove

# In Ded


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proceedings

The nature of each of these legal claims gre2 out of the TP8s professional capacityD' Deductions for t3e cost of earnin) income

-' %a+ital Ex+enditures

!a Definition of a ca+ital ex+enditure!any expenditure made to ac)uire an assetthat has a useful life of more than one year In other 2ords7

!i If a business asset is spentconsumed in one year* 2e allo2 a deduction for

it!ii I& a business asset lasts and produces income for longer than a year* it is a

capital expenditure!iii 1ot a precise definition

!b Cannot be deducted currently!c Included in and made part of the basis of the asset* recovered 2hen TP starts to

make subtractions in basis !depreciation* sale of property.d' @3at must *e ca+itali5ed

!i 426>.a'.-' .2'!any amount paid for ne2 buildings or improvements toincrease the value of any property* or restorations to property or makinggood exhaustion of property* can8t be deducted; Must be capitali9ed;

.ii' Exam+les of *u,in) a ine,ard to ma(e 1ine! Must be capitali9ed7

Jand

>uilding

E)uipment

rapes

Dine

ood2ill of former o2ners

May be deducted

'tilities

EE (alaries=ffice supplies

!e Enc,clo+edia Britannica %ommissioner !0/"!i &ACT(7 TP* a publisher* paid another publisher to make a book* but

contracted to hold the copyright and publish it themselves; Danted todeduct the entire price of the contract;

!ii H=J


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Capitali9ation


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!i &ACT(7 TP incurred investment banking fees in connection 2a merger2another firm; 1o separate or identifiable asset had been created to 2hichthe outlays could be allocated* so the TP deducted the banking fees as acurrent expense;

!ii H=J


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conceding the rest of the renovation 2as improvement and should becapitali9ed;

!ii H=Jaseline M for 2holepro:ect renovation R

asbestoscapitali9e

+$$?yr ""?yr ";.M M # ";.ML F;+M

@enovation alone

FMcapitali9e

"%?yr .$?yr ";$M FM # ";$ML $;M

!iii


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Education that meets the re)uirements of the individual8s employer or

re)uirements of applicable regulations as a condition of retention of theEE

C' Rent Pa,ment Installment Purc3ase

!a tarrs Estate !F+"!i &ACT(7 sprinkler co; leased a sprinkler system to TP- lease payment 2as

the same for five years* and then rene2able after that for nominal amount;TP treats the payments as deductible rent but I@( says it is an installmentsale; If it is a sale* then the sprinkler co; should be able to include thedifference b2 basis and amount they received- if it is a lease* the fullamount of the lease payment is income to them;

!ii H=J


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a; Oear +7 beginning inventory L "? !left over from year "; 1e2purchases L "0?; 'nder this accounting method* the " leftover at the end of Oear + are considered to be out of the onesbought in Oear +- so the value of ending inventory is "0; (ocost of goods sold is"? plus "0? minus "0 L "$;%?;

#IFO "et3od!Jast in* first out

Exam+le from a*oea; Oear +7 beginning inventory L "? !left over from year "; 'nder

this accounting method* all of the mugs sold in Oear + areconsidered to be sold first so the value of ending inventory is "?!2hat 2as left over from year one; (o cost of goods soldis "?plus "0? minus "? L "0?;

!ii


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6"%+!c !+ disallo2s deduction of any bribe or kickback that 2ould

sub:ect TP to criminal prosecution

6"%+!c !$ special rules for bribes* rebates for MedicareMedicaid

6"%+!f7 no deduction of any fine or penalty paid to federal or state

government for violation of any la2;

6"%+!g7 no deduction for +$ of the amount paid for treble damages for

violation of antitrust la2s Kery narro2

=' Reasona*le %om+ensation

!a 4-62.a'.-'provides a deduction of 3reasonable allo2ance for salaries or othercompensation for personal services actually rendered4

!i =riginally intended to permit TP to deduct reasonable amounts for salarieseven if not paid

!ii 1=D relied on by I@( for denying deductions for unreasonable salaries*usually 2hen it is a sham salary and is really a nondeductible dividend

Diidends %om+ensation

Compensation is for services rendered-


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2asting asset that has a life beyond the current year that is used for the productionof revenue;

!i 6"%!a deals 2depreciation of property that is used in a trade or businessor for the production of income;

The idea is if the TP invests in property for income production* TP can

deduct the yearly decrease in value due to 2ear and tear* etc;

T= essentially recovers basis over the useful like!b Exam+le! TP pays "? for machine;


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!i Congressional scheme to let companies that couldn8t get the benefit of thene2 depreciation schedule to get (=ME benefit

Essentially a Congressionally#sponsored tax shelter

!ii Basic sc3eme! A company 2no taxable income could sell an asset toanother company 2ith taxable income

Jeaseback 2ould give company A use of the asset

Company > 2ould get the depreciation deductionsD' Passie Actiit, #osses and %redits

" 4C6


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" Congress unable to I< the common denominator about abusive transactionsthemselves

+ 1e2 rules go after accounting firms selling tax shelters!a Tax 3elter Promoter Penalt, 6%7 penalty for anyone making a false or

fraudulent statement!i @aised from "G to FG of gross income derived from producing a shelter

!b 6%""" a material advisor of a reportable transaction must file an info returndescribing the transaction and its benefits and 6 %""+ compile a list of clientsadvised on the transaction

!i material advisor L la2yer or accountant!ii @eportable transaction L high tax avoidance or evasion potential!iii Penalty for not filing F#+? on a corporation* "?#"? on an

individual!iv "?day penalty 2ith no cap for not providing client list!v Ja2 firms tried to litigate this as a confidentiality issue and failed!vi 1o statute of limitations

$ Accurac, and Fraud Penalties! aimed at substance of TP8s legal arguments

Reason for Penalt, %ode Penalt, Defense

1egligencedisregard forrules and regs

6%%%+ +G of underpayment @easonable cause andgood faith !unsophisticatedTP 2ho 2as confused2hen advised

(ubstantial understatementof tax

6%%%+ +G of underpayment @easonable cause andgood faith- substantialauthority- reasonable basisand disclosure to I@(

'nderstatement fromreportable transaction

6%%%+!a +G of underpayment*$G if no disclosure onreturn

@easonable case anddisclosure and substantialauthority and reasonablebelief that more likely than

not !all four factorsnecessary for defense

'nderpayment from fraud 6%%%$ FG @easonable cause andgood faith

!a u*stantial Aut3orit,!someone has to tell you that you 2ill have at least 0Gchance of success on the merits before the Tax Court

!b Reasona*le Basis!


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!ii tax layer can8t advise client to take a position unless there8s a realisticpossibility of success on the merits !" in $ chance of 2inning in litigation

0 Circular +$ !pp; F0#F0+7.a'

VI'IN%O"E ATTRIB/TION

A' Alternatie "inimum Tax

-' @3ere did it come from

!a Didespread perception that tax system unfair!b =riginal idea 2as that higher income TP 2ould calculate their interests both 2ays

and pay at least some tax!c 1o2 applies to millions of Americans though it 2as not supposed to- reaches the

middle class!d It is basically an attack on preferences; Individual preferences include7

!i Tax#exempt interest!ii Percentage depletion!iii Intangible drilling costs!iv Itemi9ed deductions !see belo2!v Credits

2' $o1 does it 1or(

!a 6FF!a tentative minimum tax minus the regular tax L AMT!i Tentatie minimum taxL taxable income 2ith ad:ustments re)uired by

66F%* F* F. !this is the alternative minimum taxable income* minusexemption amount allo2ed to everyone times !this is the taxable excesstimes +%#+.G

Taxable excess _ "F?* multiply by +.G

Taxable excess \ "F?* multiply by +%G

Taxa*le ExcessL Alternative minimum taxable income minusexemption amount

.*' Deductions NOT allo1ed!i Miscellaneous itemi9ed!ii (tate and local property taxes!iii Medical expenses above ;F#"G!iv Certain home mortgage interest!v (tandard deduction!vi Personal exemptions !kids* etc

!c (lo2er depreciation schedule for some property!d Jose some net operating losses* some tax exempt interest added back

>' @3at is t3e +ro*lem

!a The exemption amounts not indexed for inflationcost of living!b 1ature of items considered tax preferences* e;g; children!c ush tax cuts7 made a bad situation 2orse re7 AMT

!i Most cuts that 2ent to the middle class 2ere taken back 2ith the expandedapplicability of the AMT;

!ii Affect concentrated in the middle class because at very high incomes you32ealth out4 of the AMT

!iii This 2as very deliberateallo2ed an across the board tax cut 2out losingmuch revenue


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0 ;laasen %ommissioner !F/"!a &ACT(7 TPs have " dependent children* and they 2ere sub:ect to the AMT

because of the number of exemptions for their children; A family 2ith the sameincome but only . children 2ould not pay the AMT; They paid regular taxesinstead* and the I@( assessed a deficiency; The TP said the AMT 2as contrary toCongressional intent as applied* and as applied violated the free exercise* e)ualprotection* andor due process clauses of the '( Constitution;

!b H=J


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The decision is based on a 3battle of paradigms4; In Taft there 2as no )uestionthat the recipient 2ould be taxed on the income from a gift* but Jucas said of2hat you are transferring is not property the transferor 2ill be taxed on theincome; (o the court is dra2n to that model and asks 2hether there is a transferof income or property;

!e %urrent ?uestion!though Horst and >lair are still both good la2* the )uestion isno2 %hether %hat has been transferred is the right to all or !art of the incomefrom the !ro!erty %ith no reversion to the transferor# or a right to all or !art of

the income from the !ro!erty %ith a reversion to the transferor/

9' Assi)nment of income attri*uta*le to +ro+ert, created t3rou)3 serices

!a $elerin) Eu*an( !%+%!i &ACT(7 an insurance agent assigned back several rene2al commissions to

his insurance company at retirement so he could get the income over severalyears instead of one; He assigned it to a trust that 2ould pay to his children;

!ii H=J


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!iii ains held on real estate preferential for those at or above +.G incomebracket

!iv ains on collectibles preferential for those at or above $$G income bracket!b Dis+reference for %a+ital #osses!can be netted out against capital gains* but

can only offset $? of ordinary income in a year; Corporations can8t deductA1O capital loss;

!i Ordinar, losses and ca+ital )ain!ordinary losses can offset any kind ofgain* including capital gain; (ee notes p; ""$ for examples;

B' @3at is u+ 1it3 t3e ca+ital )ain and loss re)ime

" There are strong feelings on both sides of the issue+ Congress is al2ays changing the 2ay they are taxed

!a b2 "/.% and +. Congress has been at both extremes!b Preference eliminated in "/.%!c In +. some people 2ill get a G taxation bracket on long term C

>' Ar)uments FOR %& +references

!a Jock#in effect!i TP 2ho hold appreciated assets reluctant to sell them bc of the tax on gains

>ad for flo2 of capital* reduces li)uidity

overnment benefits by raising some tax instead of none if people never

sold anything!ii %ounter ar)! The step#up in basis at death is a bigger lock#in issue- TP

likely to be responsive to the fact that if they hold an asset until death* noone 2ill pay tax on it;

!iii Jock#in does distinguish b2 assets people hold for investment and thosethey hold for sale in the ordinary course of business;

It 2ould make sense to have no capital gain treatment for people in the

business of selling things bc they 2ill sell them any2ay!b Corporate double tax at corporate and then shareholder level;

!i Counter#arg7 capital gains rate applies to all capital assets* not :ust shares ofstock- other2ise this argument 2ould be more compelling for encouragingmovement of the stock market;

0 Ar)uments A&AINT %& +references7!a a dollar of capital gains is the same dollar as one coming from a trade or business;!b C taxation too complex!c >enefits tend to go to those at higher end of the distribution level

9' Polic, of %# Dis+reference

!a Prevents TPs from cherrypicking losses!i @eali9ation is in TPs control- they 2ould :ust reali9e losses and not gain if

they could

!ii Example7 TP makes "M investment 2it FF chance of +F? gain or loss*then enters into a transaction that perfectly hedges the first; Dno losslimitation* TP is unchanged financially but 2ould li)uidate the loss andhold the gain investment* reali9ing a big loss and no gain

%' Net %a+ital &ains and #osses

" Net %a+ital &ainis net long term capital gain minus net short term capital loss !seechart for more detail; 6"+++!"";!a Net #on) Term %a+ital &ain or #oss!Excess of long term capital gain minus

long term capital loss; 6"+++!


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!i Jong term capital gain L gain from selling or exchanging a capital assetheld for more than a year if and to the extent the gain taken into account incomputing gross income !that is* it must be recogni9ed and reali9ed;6"+++!$

!ii Jong term capital loss L loss from selling or exchanging a capital asset heldfor more than a year if and to the extent the loss taken into account incomputing gross income 6"+++!B;

!b Net 3ort Term %a+ital &ain or #oss!amount of short term capital gains minusshort term capital losses if negative; 6"+++!%

+ @3at is a ca+ital asset 6 "++" omet3in) t3at is +ro+ert, *ut NOT7!a stock in trade of TP*!b inventory of the TP !things TP is selling in ordinary course of business!c property sub:ect to deprecation under 6"% !that used in a trade or business

.i' Exce+tion t3at s1allo1s t3is rule

A 6"+$" gain is a gain from sale or exchange of depreciable or real

property held for more than a year used in trade or business but not forsale to customers in ordinary course of business 6"+$"!b

If 6"+$" gains exceed 6"+$" losses* they are treated as long#term capital

gains and losses; If these losses exceed gains* treated as ordinary;6"+$"!a!";

Al2ays good for the TP

!d self#created IP!e accounts receivable!f notes receivable

>' T3is is t3e seuence

!a Jong Term Capital ains and Josses7 2here capital assets has been held for morethan one year

!i 6"++$ has special rules for determining holding period of property

Includes time during 2hich TP holds asset (ometimes includes time other than 2hen property held* or time 2hen

another person held it

6"++$!/7 holding period of property from a dead person includes thetime they held it5step up holding period

if there is appreciation after death* beneficiary automatically deemedto hold asset for more than one year !is this different from aboveB

!b (hort Term Capital ains and Josses7 2here capital asset has been held for lessthan a year;

!c 1et Jong Term Capital ains against Jong Term Capital Josses!d 1et (hort Term Capital ains against (hort Term Capital Josses !6"+++

separates long and short term and nets them separatelyTP 3as Net 3ort Term %a+ital #oss TP 3as Net 3ort Term %a+ital &ain

TP 3as Net

#on) Term

%a+ital &ain

!" if the long term gain is greater*the excess of the net long termcapital gain minus short termloss 2ill be taxed at preferentialrate long term capital gain rate

!+ If short term loss is greater* theloss 2ill eat up the gain and ifthere is still loss after the $?of ordinary income* you can

Jong term gain gets preferential rates and shortterm gain gets the non#preferential rates;


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Take delivery* make a profit of "7 this 2ould be all ordinary income*

from sale of inventory

>uy on spot market and sell futures contract* make " profit7 this

2ould be half ordinary income from sale* half capital income bc sale ofthe contract 2hich is a capital asset !courts says no to this

$ H=J


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ordinary income; (elling all the rents at one time by selling the building is capital-getting rent or selling the right to collect rent is ordinary; The different treatmentseems 2eird; Arguably the :ustification is that there is an arbitrary distinctionany2ay* and in a middle case like this it must go one 2ay or another; Classifying thisas capital 2ould effectively collapse the distinction;

0 >=TT=M JI1E7 2here a TP is taking a stream of income that 2ould be ordinary ifreceived in the stream but converted it to a lump sum that 2as :ust a substitute for thestream* it retains its character as ordinary income;

, "c%allisterp; +" &ACT(7 TP had a life interest in a trust 2remainder to another and converted the life

interest;+ H=Jlair controls; &ransfer of income

!roducing !ro!erty generally results in 34 treatment unless transferor retains

reversion interest in the !ro!erty; (ame as assignment of income;? %ommissioner Bro1n !/

" &ACT7 1on#profit Cancer @esearch !C@ bought stock from TP8s lumber co; for";$M; They dissolved the co; and leased the bi9 to ne2 company o2ned by TP8sla2yers* 2hich operates the bi9; The purchase price 2ill come from profits of ne2

co; and 2hen ";$M is paid* C@ 2ill o2n the lumber co; outright !bootstrap sale;1ote also secured by assets of the lumber business so TP 2ould recover it on default;

+ H=JankTP 2as holding notes and sold to a $rdparty* reported the gain as C;+ H=JECA'(E the TP had already claimed an

ordinary loss on the notes in an earlier year;$


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= Arro1smit3 %ommissioner !0%" &ACT(7 TP li)uidated a co; over 0 years* properly claiming C treatments on the

distributions; Jater there 2as a :udgment against the no#longer#existing co; and TPhad to pay the :udgment; TP claimed an ordinary deduction on the payment;

+ H=J

Intro to Federal Income Taxation - Law School Exam Outline

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Transcript of Intro to Federal Income Taxation - Law School Exam Outline