First lay out facts in chronological order! G.I. – Deductions (§62) = AGIAGI – More deductions = Taxable Income
“ABOVE the line deductions” are essentially BUSINESS deductions.
Above the line deductions tend to include business, alimony, moving expenses…
POWER TO TAX – constitution enumerates the powers (Art I §8) Amendment XVI Power to lay INCOME tax
Congress passes statutes establishing tax system – IRS Duly Promulgated T.R. has force of Law
IRC §1 TAX IMPOSED 1(a) Joint1bHoH1cSingle1d Marr. sep1hcap gains
GROSS INCOME- IRC §61(a)(1-15) Except…as in this subtitle… G.I. means all income Including but not limited to….
§61 is Starting point of income Not excluded from taxation from whatever source derived broadly construed
Treas Reg §1.61-14(a) Treasure Trove (found money) IS income (SEEK an EXCEPTION)
G.I. is NOT limited to Cash, Need not be from product of labor or capital, and can include Punitive Damages
CIR v Glenshaw Glass. (caselaw Definition of Income includes all gains except those specifically exempted)
Estate of Stranahan a TP’s tax avoidance motives will not nullify an otherwise bona fide transaction.
Barnett Banks-accrual advance payment of services were OK to prorate income over 12 months because discretion
vs Signet Bank – who charged nonrefundable fee and therefore could not prorate accrual income.
Ford Motor Co 1995 propted TR§1-446-1Economic performance test –must have paid expense to deduct it
Here Ford had tort liability and bought annuity to pay its structured settlement and deducted all even though not paid.
Accrual method can only be used by TP IF it clearly reflects income.
Hort – a lump sum payment held to be a substitute for rent (not Present Value of future consideration) is Ordinary Income1241
Specific Inclusions IRC §71-90,
EXCLUSIONS- IRC §101-139 = benefits Congress has excluded from taxation, b) Income that is not considered
FROM G.I. taxable, and the recipient is generally a gratuitous transferee of money or other economic benefit
IRC §101(a), §§102(a & c); §6053 (Duberstein the cadilac “gift” looked too much like compensation &therefore was.
Duberstein, donor needs motive of “detached and disinterested generosity”
See 1001§102(a)Gifts (TR 1f2family)GENERALLY excluded from Income §102(c)EE gifts are not excluded from income
However EE gifts (deMinimus Fringe §132(e) and EE achievement Awards §74(c) are treated differently)
Life INSURANCE (§101(a) and 102 do not exclude all Life Ins. proceeds from tax –personal,not commercial flavor)
But DOES Include ACCELERATED payments under §101(g)
ANNUITIES – §72(a) Inclusion into G.I.§72(b) Exclusion ratio (back out of G.I.)
§72(b)(1) [(amt to be excluded) / (amt to be received,payments) = (total investment) / (total expected return) ]
§72(b)(2) excluded amt. limited to INVESTMENT--amt excl. from G.I. can’t exceed “unrecovered investment”
SEE CODE BOOK !@!!@! SOME of the payment every year is RECOVERED and some is NOT
§72(b)(3) can deduct “unrecovered investment” can not Under-recover OR Over-recover
§101(d) Pymts of Life Insurance proceeds at a date later than Death. Prorata EXCLUDED from beneficiary’s G.I.
TR§1.101-4 Can OVER/under RECOVER ie $100,000/25 years = $4,000 excluded EVERY year
§132FRINGE BENEFITS132(a)(1-7) details 7 exclusions from Gross Income for EE’s a2EE discount, a3working
condition F, a4 de minimum F, §132(a)(6) Qualified moving as defined in §132(g) etc…EE Discount see TR
132(i)recip agreements OK and 132(h) spouse and dependent children §132(j) 132&125
§125“Cafeteria” Plans–non discriminatory in favor OF HCEE’s ALL % TAXABLE unless separate plans
§119(a) Excludes from EE’s G.I. Meals and lodging that ER provides to EE for convenience or ER if 2 part TEST
In this case it would be a normal business expense to ER (deductible as such) & not EE income
§74 & 117TR 1.74-1, TR §1.117-1,2,3,4 TR§ 1.114-6 §74prizes/awards ARE income §117Scholarships NOT
§104 (a)(2) G.I. does not include INJURY/sick damagesExcept Punitive damages take structured settlements!!!
§103(a)Except as in (b), G.I. does NOT include interest on “state or local bond”
A.G.I. IRC §62 (a) GI = Taxable Income minus following deductions (a)(1) Trade or business (a)(2) Certain (a)(1)
deductions of EE’s (a)(2)(A) Reimbursed Expenses of EE’s(a)(2)(B) Performing Artists (a)(2)(C) officials
§62(a)(1-18) Including PROPERTY losses per §161(3), Pension and retirement(4,5), Alimony per §215 (10),
Moving expenses per §217 (15), Education loan interest per §221 (17), Higher Ed. expenses per §222 (18)
Also include any §1001 losses in subtracting from Basis to get AGI
NOTE §62(a)(2)A) Reimbursed expenses in relation to §67 2% floor on deductions (must have more than 2% of GI
in Unreimbursed expenses to deduct)
AGI also can be a CEILING ie 50% of AGI for §170(b)(1)(F) CHARITY deduction
DEDUCTIONS for current or prior expenditures of money DIRECTLY REDUCING income.
Allowable EXPENSES
IRC §§ 161-198PART 6 ALL TAXPayers ITEMIZED DEDUCTIONSLOOK AT ALL IN SEQUENCE
IRC §§ 211-222PART 7 INDIVIDUALS
§212 allows T.P.to deduct all ordinary and necessary expenses…(1,2)for production of income, (3)tax prep
IRC § 63(a and b) Standard or Itemizes
Specifically NOT deductible provided in §§261-280(H)
§263Capital Expenditures- ADD HORMANN v CIR
§280ABusiness use of home(a) generally no deduction … but (c)(1) certain EXCLUSIVE business use..
Int’l Artists (Liberace) allowed him to deduct some of corporate home.
PpoB is not now essential for home office IF EE has no other fixed location to perform admin or mgmt tasks.
LOSSSES sustained during Year §§165-166 (Including Capital losses using 165(c))
§165(a), (c)(2), (f) ; 1211(b) was the process used by FORMAN to do the “Loss Problem”
Personal Exemptions §§151 and §152PART 5
Each T.P. entitled to ONE exemption, deduction for TP, spouse, dependents BUT phases our for AGI at high $$
DEPRECIATION §167 and 168 see below under §263 for more info
“for wear and tear, obsolescence of property. Depreciation refers to a series of deductions generated by the asset’s
basis. Formula deduction of basis during useful life.
PART6§161 in computing T.I. under §63, there SHALL be allowed Part 6 deductions except as prohibited in Part 9
►§162(a)*Ordinary and *Necessary *Expenses *Paid or incurred… *in carrying on any trade or business Including…
“ordinary” = according to the ways of conduct and the forms of speech prevailing in the business world…”
“Ordinary & Necessary” expenses must have a causal relationshipto that business
Coughlin – “expenses…deductible under §162a if they were ‘directly connected with’ or “proximately
resulted from’ the practice of his profession.”
“Ordinary” if ‘usual… in similar [trade] to incur such expenses
“Necessary” if appropriate and helpful
DILEMMA == Are they ordinary …expensesorCapital Expenditures? As in Welch v Helvering pmts for goodwill
Relationship b/t business & pmts IRS disallowed Welch with no legal obligation to pay the company’s debts. VSJenkins (Twitty’s goodwill)
DILEMMA == Trade or businessorInherently personal(§262) i.e. Amend’s Christian Science spiritual advisor
If some of both, must allocate between as per Trebilocock BEWARE of De Minimus possibility!!!
Origin & character§212 rewards individual seekers of profit so long as NO §262 seeking to satisfy own needsUS v Don Gilmore
§212 enacted in response to HIGGINS (paris stock NYSE trader)—Doesn’t have to be business !
► TRAVEL162(a)(2) 274(m3) travel expensesCommuting not=on *trade or B is Personal 1.162-2(e), 1.262-1(b)(5) Flowers – 1) reasonable and necessary, incurred (2) “while away from home” and (3) in pursuit of business
NOTE: home can be “tax home” (IRS position) or P.P.o.B. [ only 1 Tax home (ANDREWS) ]
CORRELL – Sup Ct upheld the “overnight Rule” for Flowers’ away from home requirement
Green – (blood) travel can be deducted as Ordinary and Necessary business expense instead.
Rev. Rul. 93-86 1-yr limit on temporary travel. INTENT controls. 1 If intend to be Less than, then deductible.
If intent is to be “away” for 2 more than one year, then NOT deductible3 changes when intent changes
Hantzis – “Tax Home” – if reason is personal, home will be place of Employment & deduction denied.
--if reason is business exigencies, home will be residence & deduction allowed
--Must Have Business Connection with New location to Qualify For “away from home”
MEALS*274(n) 50% only & only If allowable under Ch1B 274(k) business meals – generally NO deduction
Moss – law firm meeting for lunches deduction disallowed b/c inherently personal–
-solution give §119 Fringe to be able to deduct
§274(e) REQUIRED to give effect to 274n – ER(274e3) OR ER 274e2
OU us Tax ExemptEr deducts $50 (½) ER deducts $100
EE excludes $100 EE 100 as comp and deduct $50
ENTERTAINMENT 274(a) entertainment, amusement, or recreation – No deduction ,c certain foreign travel,d
substantiation Required also see 1.162-17,e exception to (a),g,h attendance at conventions,l entertainment tickets)
MOVING§217(a)Deduction ALLOWED “in connection with commencement of work” §217(c) Requirements
Easy plan 1.162-17b1 §82 Reimbursement for moving expenses included in G.I. - - - Except for §132 ER Fringe
EDUCATION: 1.162-5(a) 1-Maintains or improves skills required by trade OR 2-ER requires education
NON-Deductible -5(b)(2)Minimum Ed. Reqs. 5(b)(3)Qualification for new trade or business
§274(m)(2) NO deduction fortravelas a form of education (no greek teachers touring greece)
Coughlin – tax institute attendance was deductible b/c had responsibility for tax subjects.
Hudgens – LLM for lawyer CAN (not automatically) be deductible if it related to his trade or business
“hiatus” principle can work IF TP can show that TP always intended to return to same trade…
Sharon – held Sharon must AMORITIZE capital expenditures incurred in obtaining his license to practice…
►§263Capital expenditures §167Depreciation §168 Accelerated recovery period (c) Matching
It is possible that an expense will be neither ordinary and necessary NOR capital (must have LIFE)
<1year usually a repair (= No benefit beyond the taxable year! Wells Fargo Flow chart step #1)
>1 year or a major part (that increases useful life) usually capitalRev. Ruling 2001-4 8year plane repair
§263(a)(2) Restoration would require mort than replacing worn components- it requires more LIFE
NOTE: Fall River Gas Co made expenditure in anticipation of continuing eco. Benefit over years = Cap.
Norwest – “code does not envision the fragmentation of an overall project for deduction or cap...
Indopco, Held that Professional fees CAN be #1 capital or #2 deductible(LTBenefit)or neither
Harrah’s Club good example, restored cars indefinite useful life & no business relation to gambling
§167 Depreciation §167(b) refers reader to §168 if not specifically listed in §167 . OF an Asset’s “USEFUL” life
RECAPTURE §1016 If you sell then A.R – A.B. §1011 (orig basis – depreciation) = gain or loss §1001
§1245 Recapture Recapture Depreciation FIRST as O.I., then you get Cap Gain treatment. Esp for 1231
i.e. B=100, AB=40 AR=110 70Gain 60 recaptured depreciation as O.I. 10 as Cap Gain
TR§1.167(a)(1)(a) “reasonably consistent plan, … depreciation cannot exceed cost or other basis ….”
TR§1.167(b)-1 “straight line method” == (total allowable deduction / useful life) yields (yearly deduction)
NOW-MACRS method of depreciation which eliminated “salvage value”.Useful Life no longer necessary
§168applies to TANGIBLE property only. §167 still applies to Intangible property !!
§197 applies to INTangible 15 year deduction but prohibits any other type of depreciation or amorit. Deduction
Example: if sell Dr.’s office, must do asset by asset Gain recognition between tangibles and intangibles.
§172 Net Operating Loss Deduction -- Classified a “business” loss (alternatively claim §1341 claim of right …)
TAXABLE INCOME – IRC §63(a) T.I. = §61 G.I. minus deductions allowed by this chapter (§62 and §151) Not std deduct
§63(b) THOSE who do NOT itemize -> (b)(1 and 2) ‘Standard deduction’ PLUS §151 personal exemptions
§63(c) “Standard Deduction” defined = c1A“basic std deduction” PLUS c1B addt’l std deduction
§63(c)(2) Basic Std deduction = $5000 CPI for joint….
§63(e) Those who DO itemize §62’s AGI deductions PLUS §151 personal exemptions
§63(a) computation / §63(b) computationGross Income / Gross Income
- above line deductions / -above line deductions §62 bus exp…..
= Adjusted Gross Income / = Adjusted Gross Income
- deductions for pers. Exemptions / - deductions for personal exemptions
- itemized deductions / - standard decuctions
= Taxable Income / = Taxable Income
CREDITS against Tax imposed IRC §§21-53 (directly off of tax liability, does not offset Taxable Income as deductions do)
§21 Child Care Credit Credit = (applicable %) x (employment related expenses) of a “qualifying individual”
§21(e)(7) “student” a FT student is deemed “gainfully employed”
§23 Adoption Tax Credit
§24 Child Tax Credit (Partly REFUNDABLE)
EDUCATION - Hope§25A(b)(1)Up to $1,500 with AGI Limits
- Lifetime Learning credit §25A(c)(1)Up to 20%of up to $5,000 with AGI limits
§32 Earned Income Credit (fully refundable)
§32(c)(3) qualifying child with 1 relationship, 2 same…abode 3 meets age requirements
§32(c)(1)(A) “eligible individual” = (i) with Q child or (ii) 3 part test (I,II,III)
use§32(b)(1)(A) Percentages 6000= g.i. 7.65% x 4,220 = 322.83
and §32(b)(1)(B) Amounts
and §32(b)(2) phaseout amounts7.65% x (6000 - 5280 ) = 55.08 322.83 - 55.08 = 267.75
1F Exempt Organizations Pt8 §530 Education IRA’s §529 Qualified Tuition Programs
BASIS – G.I. contemplates Accretions to wealth after deducting costs of goods sold and basis of property BUT Before
any reduction of expenses excluded by a Code section
INCOME FROM SERVICES - attributed to party performing services (Lucas v Earl)
“VALUE” is ONLY what the services provider would have charged in an arms-length transaction
Keep in mind Barter IMPUTED INCOME ( to self is no taxable event) VS MARKET SERVICES (taxable)
Fringe Benefits are Taxed unless exclusion section applies
‘Qualified Scholarship’ prize is excluded from income
REALIZATION (BASISand Debt) Q. = Was something sold or disposed of ? if Yes A.R. (1001b)–A.B. (1011,1012)=1001
Crane v CIR (debt is included in (added to) basis and DISCHARGE of debt should be included in Amount Realized)
See alsoTR§1.1001-2(a)(1) include liabilities from which transferor is discharged as result of sale
Non-Recourse(§7701(g) debt w/o personal liability---against collateral only) Crane and Tufts
Recourse(debt W personal liability—collateral and personal assets) Rev. Rul 90-16
IRC §1001(a) Gain is excess……, Loss is excess of ‘adjusted basis’ over ‘Amount realized’
IRC §1001(b) “Amount Realized” A.R. from sale or other disposition = money Rcvd PLUS F.M.V. (see §7701g Non)
§1011 “Adjusted Basis’ = basis under §1012or other applicable sections adjusted as §1016 provides….
►§1012 Basis of Property = COST
§1013 Basis of Inventory = last inventory value
►§1014 Basis of Property Acquired from a decedent (STEP UP basis = FMV at death) CAN INCLUDE vivos trust
►§1015 “ of Prop. Acquired by GIFTS & transfers in TRUST §1015, 101(a)(2) TR 1.1001-1e, 1015-1a & 1015-4
§1015(a) Gifts – New Basis SAME as PreGift Basis EXCEPT if basis is greater than FMV, then FMV
see §102 gifts determines the loss if any. TAFT v BOWERS Congress even has power to tax donee’s gains
PART GIFT/ PART SALE Divvy up the gain by same % as by gift/sale % (ie gift = ¾, then ¾ gain NO tax)
“Transfer for Valuable consideration” of INSURANCE §102(a)(2)(A) Leads to TAXABLE gains – err for family.
§1016ADJUSTMENTS to Basis (a) Adjustments shall be made (a)(1) for expenditures, receipts, losses, or other
items, Properly Chargeable to a capital account but NOT for (a)(1)(A) …Taxes… or (a)(1)(B) §173
Expenditures (make sure it isn’t too personal like a 10ft sign!!!!!)
(a)(2) …for exhaustion, wear and tear, obsolescence, amortization and depletion to the extent the amount
(a)(2)(A) allowed as .. under this title, AND (a)(2)(B) resulting in reduction for any taxable year…..
§1016(a)…Where no §167 method has been adopted, Straight line method Shall be used.
CAPITAL GAINS(Tax rate MAX = 20% IRC § 1(h)(1)(E) )§1211 §1212(b) §1221 §1222 &1011 and 1012
DILEMMA = are they Capital Assets (investment) orinventory? re HOLLIS Look to purpose of holding property…
Hollis – a single venture can still be a business not just an investment
The level of activity of a TP in the “property” (promote, develop) can be indicative of Asset v Inv.
BYRAM reluctantly agreed that b/c trial court found property investment, then it was investment purpose
Merchants’ Loan & Trust (1921) makes it clear that capital gains are taxable
§1221Capital Asset = property held by TP (business or not) but does not include (1) stock in trade…(2) Prop used
in business, or (3) copyright, …artistic…
Corn Products DoctrineCapital asset treatment Discourage Hedging. [ Futures v spot pricing ]
-“congress intended that profits and losses arising from the everyday operation of a business be
considered as ordinary income or loss rather than capital gain or loss….”
-Arkansas Best “motivation in purchasing an asses is irrelevant to question whether asses is
“property held by a TP” and is thus within §1221’s general definition of “capital asset”
Banking fallout where TP sold bank shares for loss and claimed Cap Loss. Stock is Capital
§1222 Definitions (1) STCG (2) STCL (3) LTCG (4) LTCL
(5-8) Excesses of (5)NSTCG =stcg-stcl (6) NSTCL = stcl – stcg (7) NLTCG=ltcg-ltcl (8) NLTCL=ltcl-ltcg
(9) CGNetIncome = excess of gains over losses (10) NetCapLoss = excess of losses over sum allowed
under §1211. (11)NetCapGain = excess of NLTCG over NSTCL
§1211(b) Limit on Cap losses limited only to the extent of gains PLUS lower of b(1) $3,000 or b(2) losses to gains
§1212(b)USES NSTCL >Must apply §1212(b)(2) before applying §1212(b)(1)NCL carried forward to next tax
year. CarryBacks & CarryOvers IF TP has a NCL (per §1222(10)), then usually carryover SEE CODE BK
CarryOver requires “deeming” as a STCG ***The lesser of (b)(2)(A)(i) amount allowed by §1211(b)Max 3k
Don’t forget §165 losses OR (b)(2)(A)(ii) the adjusted taxable income as defined in §1212b2B
NOTE: Annual Accounting Per Arrowsmith requiring current treatment of assets to be essentially same as in past.
Arrowsmith business liquidated & took an ordinary business loss. Later recouped loss, MUST take ordinary gain
§1231Involuntary conversions of business property QUAISI CAPITAL ASSETS – best of both worlds
For real property and depreciable Personal Property held for more than 1 year and used in business
McGowan Sale of hardware business – Asset by asset sale- [land, building, goodwill]=LTCG Inventory=ordin. Incom.
§1245 Recapture Recapture Depreciation FIRST as O.I., then you get Cap Gain treatment.
§1231 – if net gain, then all CAPITAL, if net loss, then all ORDINARY.
§108 Income from discharge of indebtedness (see also Old Colony Trust [ER can not pay EE’s taxes]
‘discharge’ has a tax meaning = getting out of debt for less than it would otherwise cost see 108(d)
business meaning = to retire a debt (satisfied (paid or forgiven))
§109 Lessor’s G.I. doesn’t improve lessee’s improvements AND§1019 Lessor’s property basis will NOT change
§166 BAD DEBTS 166(b) Deduction IS allowed and basis shall be adjusted basis §1011
§6053 Presumed 8% Tip rate in “large food or beverage establishment”
Under §1015 property acquired by gift, see §1041 indicating NO Gain or Loss on transfer of property incident to divorce
Inventories §446 methods of accounting and TR 1.446-1(a)
TR 1.446-1(c)(1)(i) Definition of CASH method
TR 1.446-1(c)(1)(ii) Definition of ACCRUAL method – MUST CLEARLY reflect income
Used for§471General rule for inventories = when necessary to use inventories to clearly REFLECT income, then
calculatinginventories shall conform to best accounting practice
Gain orLIFOFIFO
LossCAN’T write out inventories and keep to sell, and if don’t keep possession, you can’t keep DOMINION
Claim of right vs tax benefit doctrine flip sides of each other
Claim of right You have rights now (cash or accrual) to use the property, even though you may later lose it. (N.American)