Income Tax Outline
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Apr 3, 2024
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Income Tax: Colin Brown
Contents
Chapter 1: Introduction:
...............................................................................................................................
2
Chapter 2: Gross Income
.............................................................................................................................
2
A.
Introduction
....................................................................................................................................
2
B.
Equivocal Receipt of Financial Benefit
..........................................................................................
3
Cesarini v. US- Treasure Trove as Income
...........................................................................................
3
Old Colony Trust Co. v. Commissioner- Company Paying Income Tax
..............................................
4
Glenshaw Glass- Payments of Settlement as Income
...........................................................................
5
C.
Income without Receipt of Cash or Property
..................................................................................
6
1.
Revenue Ruling 79-24
................................................................................................................
6
2.
Dean v. Commissioner
................................................................................................................
6
D.
Economists’ Definition of Income
..................................................................................................
6
Chapter 3: Exclusion of Gifts and Inheritances
...........................................................................................
7
A.
Rules of Inclusion and Exclusion
...................................................................................................
7
B.
Gifts
................................................................................................................................................
8
1.
Income Tax Meaning of “Gift”
...................................................................................................
8
Duberstein: “Gift”- Gift in Business
....................................................................................................
9
2.
Employee Gifts- 102(c)
..............................................................................................................
9
C.
Bequest, Devises, and Inheritances
...............................................................................................
10
Lyeth v. Hoey – Inheritance?
.............................................................................................................
10
Wolder v. Commissioner- Lifetime Services
......................................................................................
10
Chapter 4: Employee Benefits
...................................................................................................................
11
A.
Exclusions for Fringe Benefits
......................................................................................................
11
B.
Exclusions for Meals and Lodging
...............................................................................................
14
Problems
............................................................................................................................................
14
Chapter 5: Awards
.....................................................................................................................................
14
A.
Prizes
............................................................................................................................................
14
B.
Scholarships and Fellowships
.......................................................................................................
17
Chapter 9: Damaged and Related Receipts
................................................................................................
18
A.
Introduction
..................................................................................................................................
18
B.
Damages and Other Recoveries for Personal Injuries
...................................................................
18
Chapter 6: Gains From Dealings in Property
.............................................................................................
22
Chapter 1: Introduction: Income Tax Calculation:
1.
Calculate gross income (§61)
2.
Subtract “above-the line” deductions (§62)
3.
Resulting figure is adjusted gross income (§62)
4.
Subtract “below-the-line” deductions = the sum of personal exemptions (§§151 and 152) and either a standard deduction (§63) or itemized deductions (start with IRC §67).
5.
Resulting figure is taxable income (§63).
6.
Apply the tax rate schedules (found in §1) to taxable income to determine tentative tax liability (may also need to apply special computational provisions when applicable (§1(g), (h),) and add alternative minimum tax when applicable (§55).
7.
Subtract from tentative tax liability any available tax credits
8.
Remaining amount is final tax liability (tax due or refund owed to taxpayer)
Income Tax Brackets (single)
1.
100,000- taxable income:
1.
$100,000-95,376= $4,625 x 24% = 1,110
2.
$100,000 (progressive calculations) = 16,290 + 1,110 = $17,400
3.
$17,400 (tax) /100,000 (taxable income) = 17.4%
2.
Deductions = applied to initial tax liability
3.
Tax credit= subtract from tax calculated.
Chapter 2: Gross Income Code
: §61; 1001(a)
Treasury Regulations
: 1.61-1(a); 1.61-2(a), (d)(1); 1.61-14(a)
A. Introduction IRC Section §
61(a): except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
1.
Compensation for services, including fees, commissions, fringe benefits, and similar items:
2.
Gross income derived from business
3.
Gains derived from dealings in property;
4.
Interest;
5.
Rents;
6.
Royalties;
7.
Dividends;
8.
Alimony and separate maintenance payments;
9.
Annuities;
10.
Income from life insurance and endowment contracts;
11.
Pensions
12.
Income from discharge of indebtedness;
13.
Distributive share of partnership gross income;
14.
Income in respect of decedent; and
15.
Income from an interest in a trust or estate. IRC 1001- Determination of Amount of and Recognition of Gain or Loss (a)
Computation of gain or loss:
a.
the gain or sale
or other disposition of property shall bethe excess of the amount realized
therefrom over the adjusted basis provided in Section 1011 for determining gain, and b.
the loss shall
be the excess of the adjusted basis provided in such section for determining
loss over the amount realized. Question 3: Joe purchases stock in Apple Corp in Year 1 for $1,000. At the end of Year 1, the stock is worth $1,500. In Year 2 when the stock is worth $2,000, Mary offers to buy the stock for $2,000 but Joe declines. In Year 3, when the stock is worth $3,000, Joe gives it to a creditor to satisfy a $3,000 debt he owes the creditor. Does Joe have gross income? When? He has gross income when the stock value increases but not when he gives it to the creditor
He will have gross income in YR 3 when he gives the cash to the creditor. He paid $1,000 to acquire the stock and he was already taxed on that therefore we give him credit for that.
His basis is $1,000, so we are only going to tax him on the amount realized (appreciation) would be $2,000.
B. Equivocal Receipt of Financial Benefit Cesarini v. US- Treasure Trove as Income
1957: taxpayer purchased piano at auction.
1964: taxpayer found $4,467 in the piano.
Is the found money gross income and therefore, taxable?
Treas. Reg. 1.61-14(a): Miscellaneous Items of Gross Income:
(a) in general: in addition, the items enumerated in section 61(a), there are many other kinds of gross income. For example:
Punitive damages such as treble damages under antitrust laws and exemplary damages for fraud are GI.
Another person's payment of taxpayer's income is GI to the taxpayer
Illegal gains
Treasure Trove,
to the extent of its value in US currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession.
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Question 1
Would the results to the taxpayers in the Cesarini case be different if instead of discovering $4,467 in old currency in the piano, they discovered a diamond ring worth $5,000 in the piano?
-
No. It would be the fair market value of the ring. Income encompasses services, property, etc. not
just cash. Teas. Reg 1.61-14(a). Question 2
Would the results to the taxpayers in the Cesarini case be different if instead of discovering $4,467 in old currency in the piano, they discovered that the piano, a Steinway, was the first Steinway piano ever built and it is worth $500,000.
-
No objective, identifiable event has taken place. No sale. The only thing that has changed is the knowledge of the value of the piano. The realization doctrine conditions have not been met so this is not gross income. Question 5: TP works at the cash register at Home Depot. And while he is working there he manages to embezzle or steal $5,000 in cash. Is this $5,000 GI? Does TP have to report $5,000 on this tax return?
-
Yes. If you obtain income illegally, you still need to report it. Rationale is that you can’t benefit from a tax perspective by obtaining illegally. Quiz 2: Question 2: As an associate at a law firm, you bill 3,000 hours in your first year. The law firm wants to award you for the amazing work that you have done and gives you a $50,000 bonus in year 1.
-
Yes, $50,000 bonus is gross income. It satisfies the definition of income and it is not excluded from Sec 61. -
Treasury regulations 1.61-2(a) even specifically tells us that bonus is compensation income (which is specifically included in gross income under 61(a)(1).)
Old Colony Trust Co. v. Commissioner- Company Paying Income Tax
Does this payment constitute gross income to the employee?
Yes.
The payment of tax by the employers was in consideration of the services rendered by the employee and was a gain derived by the employee from his labor. The form of payment is expressly declared to make no difference. o
Immaterial taxes were directly paid over to the government. o
Not a gift: compensation for services no matter what way you put it, it would be additional income. Treas. Reg. 1.61-2(d)(1): Compensation paid other than in Cash: (1) In general:
if services are paid for in property,
the FMV of the property taken in payment must be included in income as compensation.
If services are paid for in exchange for other services
, the fair market value of such other services taken in payment must be included in income as compensation.
If the services rendered at a stipulated price
, such price will be presumed to be the FMV of the compensation received in the absence of evidence to the contrary. Question 4:
Employee has worked for Employer’s incorporated business for several years at a salary of $80,000 per year. Another company is attempting to hire Employee but Employer persuades Employee to agree to stay for at least two more years by giving Employee 2% of the company’s stock, which is worth $100,000 000 (i.e., 2% of the company’s stock is worth $100,000), and by buying Employee’s spouse a new car worth $30,000. How much income does Employee realize from these transactions? [Based on Textbook (p.56), Problem #3]
Compensation for services is gross income. It doesn’t matter in what form the income comes in. if you are paid in property use the FMV of the property and if services use the FMV of services. Car will also be gross income.
$210,000 is gross income.
Quiz 2: Question 1:
You graduate from SMU and obtain a job at a law firm where you earn a $160,000 salary per year. However, your take home pay is approximately only $100,000, because the law firm withheld money as federal income taxes and Social Security taxes. How much gross income, if any, do you have?
$160,000 this year. First, you have gross income for tax purpose, because you have income (undeniable accession to wealth clearly realized, and complete dominion over it) AND its not otherwise excluded from gross income. o
In fact, because this is compensation for services, this income is specifically
included in gross income under 61(a)(1).
Second, the amount of gross income is $160,000. It does not matter that the firm withheld $60,000 in taxes. You still have $160,000 in gross income. The taxes were just paid by the law firm on your behalf. This is the holding of Old Colony Trust case. Glenshaw Glass- Payments of Settlement as Income What is income? (1) undeniable accession to wealth, (2) clearly realized, (3) over which taxpayer has complete dominion.
Issue: Is money received as exemplary damages for fraud or as the punitive 2/3 portion of treble damage antitrust recovery must be reported by a taxpayer as gross income under 22(a) of the IRC of 1939? Yes. o
Sec 22(a): Gross Income: includes any gains, profits, and income derived from salaries, wages, or compensation for personal services of whatever kind… or gains or profits and income derived from any source whatever. o
Courts use this language that was used by Congress to exert the full measure of its taxing power. o
Congress did not apply any limitations to the source of taxable receipts, nor restrictive labels o
The fact that payments were extracted from wrongdoers as punishment for unlawful conduct cannot detract from their character as taxable income to the recipients. o
It would be an anomaly that could not be understood to say that a recovery for actual damages is taxable but not the additional amount extracted as punishment for the same conduct of the injury. No evidence of intent to exempt the payments. o
Punitive damages cannot be classified as gifts, nor do they come under any other exemption provision in the code.
Quiz 2- Question 4: While at Northpark Mall, Sydney finds a bag in which there is $7,000 in cash and an Apple iPhone worth approximately $1,000. Under state law, Sydney became owner of the property after no one claimed the items while they were held by mall management.
How much gross income must Sydney report in the year she finds and takes ownership of the property?
Sydney must report $8,000 gross income this year. o
The amount of cash and FMV of any property found and taken into the taxpayer’s possession constitutes gross income. [See Treas. Reg. § 1.61-14; Comm'r v. Glenshaw Glass Co.]. o
This is an example of treasure trove and the case of Cesarini v. United States made clear that this is gross income.
C. Income without Receipt of Cash or Property 1.
Revenue Ruling 79-24
Exchange of labor: housepainter and lawyer exchange labor without a fee
Hold: FMV of services received by lawyer and housepainter are includible in their gross incomes
under Section 61 of the Code.
Individual who owned an apartment building received a work of art created by artist in return for rent-free
use of apartment by artist
Hold: FMV of work of art and 6-month rental of apartment are includible in the gross incomes of
the apartment-owner and the artist under Section 61. Question 7: Doctor needs to have his income tax return prepared. Lawyer would like a general physical check up. Doctor would normally charge $200 for the physical and Lawyer would normally charge $200 for the income tax return. [Based on Textbook (p.59), Problem #2]
What tax consequences to each if they simply swap services without any money changing hands?
They will each need to report $200 in income
Does Lawyer realize any income when she fills out her own tax return?
$200 for filling out the doctor’s income tax return, but not for filling out her own tax return. 2.
Dean v. Commissioner
The taxpayer and wife are sole shareholder of Nemours. Wife owns 80% of the stock. Property in question was owned by wife prior to her marriage. 1931 Nemours was in debt to the bank and Bank suggests the property be transferred to the corporation. Parties occupied the place as a home following the
transfer. Taxpayer was in military during war and received $$ from corporation the difference between military pay and salary before war. He also lived in home when available. o
Issue: Was fair rental value of property to be included in taxpayer's gross income? Yes.
Taxpayer's legal obligation to provide a home and if he did it by occupancy of a property which was held in name of corporation in which he was president, the FV of that occupancy was income to him.
This theory is based upon taxpayer's valuable occupation of corporation real estate as a dwelling. D. Economists’ Definition of Income Imputed Income: non-cash benefit derived from performing services for one’s own benefit or from using
household goods. o
Goods and services produced for own consumption Question 6: Vegy grows vegetables in her garden. Does Vegy have gross income when:
Vegy harvests her corp? No, this is imputed income
Vegy and her family consume $100 worth of vegetables? No, this is imputed income. They are consuming their own goods
Vegy sells vegetables for $100? Yes
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Vegy exchanges $100 worth of vegetables with Charlie for $100 worth of tuna which Charlie caught? [Based on Textbook (p.59), Problem #1] Yes! $100 worth of gross income. Fair market value of what they received
Quiz 2- Question 3: After taking this class and becoming an expert in tax law, you sue the IRS in court for a refund of taxes. You represent yourself in this lawsuit. Had you hired an attorney to represent yourself, you would have paid $10,000 in legal fees.
True/False: You have to report the $10,000 in legal fees (the value of the services that you provided to yourself) as gross income.
False. You do not need to report the $10,000 worth of services that you provided to yourself as gross income. o
You do not have gross income because this is imputed income and imputed income is not
gross income (not taxable). o
Here, you are using your own time and talent to do things for yourself rather than hiring someone else to do the job. Recall we do not impute income to the individual for the value of self-help. Realization Requirement – objective, identifiable event has taken place. Chapter 3: Exclusion of Gifts and Inheritances
A. Rules of Inclusion and Exclusion IRC 102. Gifts and Inheritances: (a) General Rule. - Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance. (b) Income.- Subsection (a) shall not exclude from gross income-- (1) the income from any property referred to in subsection (a); or (2) where the gift, bequest, devise, or inheritance is of income from property the amount of such income. Where, under the terms of the gift, bequest, devise, or inheritance, the payment, crediting, or distribution thereof is to be made at intervals, then, to the extent that it is paid or credited or to be distributed out of income from property, it shall be treated for purposes of paragraph (2)
as a gift, bequest, or inheritance of income from property. Any amount included in gross income of a beneficiary under Subchapter J shall be treated for purposes of paragraph (2) as a
gift, bequest, devise, or inheritance of income from property.
Quiz #6: Generous Gina is a big stock investor. This year, as a wedding gift to her Daughter Dottie, Gina transfers the following items to Dottie: (1) all of her shares of Apple stock which are
currently worth $100,000 and (2) the right to receive all future dividend payments on Gina's PepsiCo stock (as a result of which, Dottie receives $20,000 this year). How much gross income does Dottie have to report this year on account of these transfers?
o
Dottie must report $20,000 of GI this year. o
Gina’s gift to Dottie of the $100,000 worth of Apple Stock is excluded from GI under 102(a).
However, the $20,000 dividend payment is included in gross income. Even though Gina’s transfer of the income satisfies the definition of “gift” for tax purposes, it cannot be excluded from GI under 102(a).
It falls under 102(b)(2) which says that 102(a) will NOT excluded from GI the gift of income from property. Here, the dividend payments represent a gift of income from property (from the underlying PepsiCo stock). Treasury Regulations: 1.102-1 Gifts and Inheritances (a) General Rule. - Property received as a gift, or received under a will or under statutes of descent and distribution, is not includible in gross income although the income from such property is includible in gross income
. An amount of principal paid under a marriage settlement is a gift. However, see Section 71 and the regulations thereunder for rules relating to alimony or allowances paid upon divorce or separation. Section 102 does not apply to prizes and award (see 74 and 1.74-1) nor to scholarships and fellowship grants (see Section 117 and the regulations thereunder) (
b) income from gifts and inheritance. The income from any property received as a gift, or under a will or statute of descent and distribution shall not be excluded from gross income under paragraph (a) of this section. B. Gifts Code
: § 102; 274(b); 274(j); 74(c)
Treasury Regulations
: § 1.102-1(a), (b); Prop. Reg. 1.102-1(f)
1.
Income Tax Meaning of “Gift” Exception #1: IRC Section 102(b)(1):
(a) general rule: gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.
(b) Income: subsection (a) shall not exclude from gross income (1) the income from any property referred to in subsection (a); or Question 1: Rachel receives a gift of land. She then rents out the land and receives rental income.
A.
Is the fair market value of the land gross income to Rachel?
No.
102(a) gross income does not include the value of property acquired by gift, bequest, devise, or inheritance. B.
Is the rental income that Rachel receives gross income to Rachel? Yes. 102(b)(1): shall NOT exclude gross income from (1) income from any property referred to in subsection (a). Here, it is the gift of land. Exception #2: IRC Section 102(b)(2):
(a) general rule: gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.
((b) Income: subsection (a) shall not exclude from gross income (2) where the gift, bequest, devise, or inheritance is of income from property, the amount of such income. Duberstein: “Gift”- Gift in Business
"proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses” a.
A common law gift is not necessarily a "gift" within the meaning of the statue. The court has shown that absence of legal or moral obligation to make such a payment does not establish that it is a gift (Old Colony)
b.
And, if the payment proceeds primarily from "the constraining force of any moral or legal duty" or from "the incentive or anticipated benefit" of an economic nature it is not a gift. c.
Conversely, "where the payment is in return for services rendered, it is irrelevant that the donor derives no economic benefit from it." Robertson
d.
Bogardus***- what controls is the intention with which payment, however voluntary has been made."
i.
Donor's characterization of his action is not determinative, there must be an inquiry into whether what is called a gift amounts to it in reality. ii.
One that inquires what the basic reason for his conduct was in fact- the dominant reason that explains his action in making the transfer. Question 2: A poor individual asks for change in a public park and receives $10 from someone passing by. Does taxable income result from this transfer?
No. Duberstein standard. This would be a gift out of “detached and disinterested generosity, out of … charity.”
2.
Employee Gifts- 102(c)
Exception #3: IRC Section 102(c):
(c): employee gifts. o
(1) In general: subsection (a) shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of, an employee. o
(2) Cross References: for provisions excluding certain employee achievement awards from gross income, see section 74(c).
for provisions excluding certain de minimis fringes from gross income see section 132(e).
Scenarios of Employer-Employee Gifts: o
To an employee during an ongoing employment relationship. o
To an employee upon or after retirement.
o
To survivors upon death of employee.
Legislative History
o
Statute seems to indicate broad congressional intent to deny gift classification to all transfers by employers to employees.
The regulations recognize that to tax all transfers from employer to an employee would be unfair, and they carve out an exception for "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.
Two limited exceptions to 102(c)
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o
Section 132(e):
certain traditional retirement gifts are treated as de minimis fringe benefits; and
o
74(c):
certain employee achievement awards are freed from tax.
Section 274(b)(1):
limits the deductible amount of business gifts to $25 per donee per year, but defines gift with minor exceptions, as items excludable from the recipient's gross income under 102. o
As employee "gifts" now are includible in GI under 102(c) they are NOT subject to the section 274(b)(1) ceiling. That ceiling is applicable only to non-employee business gifts. Question3& Question 4: A Legal Assistant at a law firm receives three cash gifts at the firm’s holiday party: (1)
$500 from the law firm, (2) $200 from the lawyer he directly works for, and (3) $50 from one of the firm’s clients. Are these cash presents includible in the Legal Assistant’s gross income?
C. Bequest, Devises, and Inheritances Lyeth v. Hoey – Inheritance?
Facts:
During the probate of the will of Petitioner's grandmother in MA, the heirs objected, citing
lack of testamentary capacity and undue influence. A compromise agreement was entered into. Heirs formed a corporation, to which they assigned their interests in the estate in exchange for common stock. Petitioner received his share of the estate and respondent taxed petitioner's share as income.
DC granted summary judgment in favor of petitioner. It was reversed. Petitioner appealed.
Issue:
Whether property received by petitioner from the estate of a decedent in compromise of his claim as an heir is taxable as income under the Revenue Act of 1932? NO. Not taxable.
Rule:
When a will is admitted to probate under a compromise agreement, the state succession tax is applied to the property that passes by the terms of the will as written and not as changed by any agreement for compromise. Although under MA statute relating to compromise, it is practice to insert a clause in the court's decree that the estate is to be administered in accordance with the agreement, yet the rights of the parties so far as they rest upon the agreement are contractual and not testamentary.
Analysis:
Court reversed the decision of the intermediate appellate court, holding that the property petitioner inherited from his grandmother was exempt from taxation under the Revenue Act of 1932.
The court erred in applying the MA rule, which depended upon the law of the jurisdiction under which petitioner received the property. What an heir acquired by inheritance withing the meaning of federal statute was a federal, not state question.
Wolder v. Commissioner- Lifetime Services
Facts:
Pursuant to a written agreement, appellant taxpayer, who was an attorney, provided legal services at no charge to his client, who bequeathed her stock to appellant upon her death. Appellant received the stock and cash one year after death, when its value had increased.
Tax court held that the stock and cash were taxable income under IRC 61, and were not exempt as a bequest, under IRC 102 and that appellant constructively received the stock and cash in the year of the client's death rather than the year in which he actually received it. Appellant and appellee Commissioner of IR both sought review.
Issue:
Whether an attorney contracting to and performing lifetime legal services for a client receives income when the client, pursuant to the contract, bequeaths a substantial sum to the attorney in lieu of the payment of fees during the client's lifetime?
NO.
Analysis:
The test of whether income is exempt from taxation under 102 is whether the in actuality the gift is a bona fide gift or simply a method of paying compensation.
This question is resolved by an examination of the intent of the parties, the reasons for the transfer, and the
parties performance in accordance with their intentions-- what the basic reason for the donor's conduct in fact- the dominant reason that explains his action in making the transfer.
Conclusion:
The US COA held that the bequest of stock and cash by appellant taxpayer's client to him was not exempt from taxation, as the bequest was not a gift but a postponed payment for uncharged legal services. Chapter 4: Employee Benefits A. Exclusions for Fringe Benefits -
IRC: Section 132 (omit (j)(2) and (5), (m, and (n)). See Section 61(a)(1); 79; 83; 112; 125.
-
Regulations: Sections 1.61-1(a), -21(a)(1) and (2), (b)(1) and (2)
o
If an employee benefit is not specifically excluded from gross income, its value must be included withing gross income under Section 61. o
IRC: Section 132(a)(1)/b(1-2): No Additional-Cost Services: o
(a)
exclusions from gross income.- gross income shall not include any fringe benefits which qualifies as a-
(1) no-additional cost service o
(b) no-additional-cost service defined.- for purposes of this section, the term no-
additional cost service means any service provided by an employer to an employee for use by such employee if –
(1) such service is offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is performing services, and
(2) the employer incurs no substantial additional cost (including forgone revenue)
in providing such service to employee (determined without regard to any amount paid by the employee for such service) o
132(a)(1): No-additional Cost Services:
o
The amount of revenue an employer loses because of providing the service to the employee rather than paying customer and the amount of time spent by the other employees in providing a service for employer are factors taken into consideration to determine whether there is substantial additional.
Ex.) airline, railroad, or subway seats furnished to employees, if they are working
in those respective businesses, in a way that does not displace non-employee customers.
Allowed whether provided free of charge, at cost or some partial charge.
Could have reciprocal agreements with other companies (i.e. other airlines), but cannot support conglomerates, (i.e. company owns planes and cruises, EE of airlines cannot get cruises) Problem Set 3B.
Kyle works for American Airlines as a flight attendant. American Airlines permits its employees and families to fly free on any scheduled flight on a standby basis (i.e., space available basis).
a. Kyle and his wife fly free to Switzerland for vacation. If they were to have bought a ticket, it would have cost them a total of $2,000. Does Kyle have gross income?
o
No. this should fall under 132(a)(1) No-additional Cost services of the IRC. (1) The service is offered to customers in the course of business of the airlines (standby). (2) And there is no additional cost incurred by the airline because it is standby, they are not losing the $2,000. o
IRC: Section 132(a)(2)/c(1)(A-B): Qualified Employee Discounts
a)
exclusions from gross income. - gross income shall not include any fringe benefits which qualifies as a-
(2) qualified employee discount
(c) qualified employee discount defined. – for the purpose of this section-
(1) qualified employee discount- the term “qualified employee discount” means any employee discount with respect to qualified property or services to the extent such discount does not exceed- o
(A) in the case of property,
the gross profit percentage of the price at which the property is being offered by the employer to customers, or o
(B) in the case of services, 20 % of the price at which the services are being offered by the employer to customers.
o
Section 132(a)(2): Qualified Employee Discounts
o
Both nondiscrimination and same-line-of business inclusions apply to employee discounts as well. o
Exclusion applies to purchase of both property (other than real and personal property held
for investment) and purchases of services which includes:
Insurance policies, but
Not applicable to loans to employees of financial institutions. o
Can be rebate or reduction. o
Maximum discount: the employer’s profit on the goods in employee’s line of business. “
gross profit percentage”
Aggregate sales price reduced by cost/
aggregate sales price = “Gross Profit Percentage”
o
Ex.) employee works for home appliance store and employer has total sales for year of $800,000 and paid $600,000 for goods sold, gross profit is 25%.
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$800,000-$600,000
/$800,000 = $200,000/$800,000= 25%
o
Thus if employer allows employee to buy appliance regularly selling for $1,000 for $750 or more, the discount is subject to exclusion.
If price is below $750, exclusion is limited to $250, and employee must report some income from the transaction (the excess over permitted exclusion) Reg. 1.132-3(e)
o
b. American Airlines also has a policy that employees can purchase reserved airline tickets at a 10% discount. Instead of flying standby or for free, Kyle buys discount tickets to Switzerland for himself and his wife for vacation. He pays $1,800 for the ticket, instead of $2,000. Does Kyle have gross income?
o
- No. Exempt under 132(a)(2) & 132(c)(1)(B)-> the plane ticket here is a service and the discount
is 10%. The rule allows up to 20% of the price at which the services are being offered by the employer to customers. c. The airline’s policy permits top executives to fly first-class on a standby basis, while rank and file employees (e.g., flight attendants) may only claim standby coach seats. Connie, the firm’s CEO, flies first-class to London also for vacation. Does Connie have gross income?
- Yes. A large policy implication of these exemptions is the non-discriminatory way they are applied here. It is for this exact reason; the rules do not want executives to be getting better benefits than the lower employees. There is case law on this. Substantially different. Quiz #2: Asa is an employee of Pelican, Inc. Pelican sells clothing to customers in the ordinary course of the line of business, and Asa's job is to provide marketing and publicity with respect to clothing. As part of his compensation, Asa is permitted to buy clothing at a discount. In Year 1, Asa buys $350 of clothing for $200. The gross profit percentage of the clothing that Asa purchased, as defined in Section 132(c)(2), is 10 percent. How much must Asa include in his gross income due to these purchases?
$115
Consider the limitation in Section 132(c)(1), other limitation. Absent any exception. Asa would include $350-200= $150. Under Section 132(c), Asa can exclude that value to the extent that it does NOT exceed the gross profit %, which equals 10% of the price at which the
clothing is offered to customers. 10% of $350 is $35. The amount that would be included in GI is in excess of this statutory limit, so the amount excluded is limited to $35. The amount included is therefore $150-$35 = $115
o
IRC: Section 132(a)(3)/ (d): Working Conditions Fringe
o
(a) exclusions from gross income- gross income shall not include any fringe benefits which qualifies as a-
(3) working conditions fringe o
(d) – Working Condition fringe defined- for purposes of this section, the term “working
condition fringe” means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services such payment would be allowable as a deduction under Section 162 or 167. o
Section 132(a)(3): Working Conditions Fringe. o
Examples:
Use of company car or airplane for business purposes;
Employer’s subscription to a business periodical for the employee;
Bodyguard provided to an employee for security reasons; and
On-job training provided by an employer. o
Section 132(j)(3) adds a working condition fringe to a full time auto salesperson’s use value of an employer-provided demonstration car if the car is used to facilitate the salesperson’s performance of services for the employer and there are substantial restrictions on the person use of the car by the salesperson. o
IRC: Section 132(a)(4)/(): De Minimis Fringes
o
Any property or service whose value is so small as to make required accounting for it unreasonable or administratively impracticable is excluded as a de minimis fringe benefit.
Frequency in which similar fringes are provided by an employer to employees must be taken into account to determine whether an item is within de minimis. o
Examples:
Typing of personal letters by company secretary
Personal use of copying machine
Occasional cocktail parties
Supper money or taxi fare because of overtime work
Traditional retirement gifts presented to an employee on his retirement after lengthy service.
*** Cash will not be de minimis because it will be easy to track***
o
Bargains at employer-operated eating facilities will be treated as well if they are located on or near premises and the revenue generated from operation normally equals or exceeds
their operating costs.
o
IRC: Section 132(a)(5): Qualified Transportation Fringe. o
Includes the value of benefits provided to an employee by an employer in the form of transportation in a “commuter highway vehicle” between an employee’s residence and place of employment; a transit pass, fare card, voucher, etc.. o
Fringe Benefits: o
Section 119- meals and lodging o
Section 105- health and health insurance o
Section 79- group term life insurance o
Section 129- dependent care assistance o
Section 137- qualified adoption expenses.
B. Exclusions for Meals and Lodging i.
Hatt v. Commissioner Problems Chapter 5: Awards A. Prizes IRC: Sec 74, see 102(c); 132(a)(4), (e); 274(j)
i.
McDonell v. Commissioner
Facts: Petitioner taxpayers filed a joint annual tax return and reported miscellaneous commissions of their tax return as the estimated costs attributable to the wife’s presence on a business trip. The respondent
Commissioner of Internal Revenue determined a deficiency in their income tax return. Petitioners challenged respondent’s decision. Issue: Whether all or any portion of expenses of a trip taken by petitioners and paid for by petitioners Allen’s employer are includable in petitioners’ income or, if so, are deductible in arriving at adjusted gross income? NO. Rule: Taxpayers’ participation made the trip no different from any other business trip requiring their services- whose duties were substantial and could not have been performed by stag men. The expenses of the trip are not includable in the GI of taxpayers. Conclusion: On appeal, the court held that the taxpayers were expected to have gone on the trip as an essential part of the husband’s employment and that the trip was not a vacation for the taxpayers because it was realistically commanded work. The court held that the expenses of the trip were not includable in the gross income of the taxpayers.
Free Hawaii Trip does not equal Gross Income
o
The reason they went on the trip was for business reasons; company reputation is intact and you must go on this business trip and wife is essential to the trip. o
This fell under 74. Question 1: Fletcher goes to a local bar to watch a Cowboys game on the local cable television. Each person is given a number as he or she walks into the bar and the owner says that if the Cowboys win, he’ll
draw one number and give the winner an all‐expenses‐paid trip to the Super Bowl Game in Miami. The Cowboys win and Fletcher’s number is drawn. Does Fletcher have gross income and, if so, in what amount?
This would be gross income. Under the Section 74 exemption for prizes this would not fit the definition because he received the gift.
Gross income = to the value of the trip. wealthier, clearly realized, complete control of it.
The Government Hates Gifts:
Two congressional goals in enacting the revenue-neutral Tax Reform Act of 1986 were to (1) broaden the tax base (increase the amount of taxable income subject to income tax) and to (2) lower the income tax rates.
How to do so: o
increase items included in gross income.
o
Decrease items allowed as deductions.
Prizes and Awards: o
Section 74 relates to company’s sales or other contests, Nobel Peace Prize, Pulitzer prize etc.
Statute now excludes prizes and awards but not really: o
Section 74(b) prizes and awards that satisfy the requirements of old Section 74(b) are excluded from GI only if, in addition to prior requirements, the taxpayer winner designates a governmental unit or a charity to receive the award and if the award is transferred directly to the designee without any use of enjoyment of it by the taxpayer.
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o
Section 74(c) creates exclusion for “employee achievement awards.”
Amount of exclusion is geared to the extent to which employer qualifies for a deduction for the awards under Section 274(j) which is a shit show.
Exceptions: -
Section 74(b)- Transferred to Charities o
Recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement.
o
Recipient selected without any action on his/her part to enter the contest o
Recipient is not required to render substantial future services as a condition to receiving the prize.
o
Prize/award MUST be transferred by the payor to an eligible charity
-
Question 2: Each year national sportswriters get together and select the single most outstanding amateur athlete in the country and award that person a check for $5,000. Michael, a talented swimmer has been selected for this year’s award. The award is given with the stipulation that the winner deliver a 15 minute “acceptance speech” at the award’s banquet. Michael, essentially delivering an acceptable rejection “acceptance speech,” designates the Paralympics Games, a charity under § 170 to receive the $5,000 award. The sportswriters send the check to the Paralympic
Games. [Textbook, problem #2]
o
Will Michael be able to exclude the $5,000 from his gross income?
This is a prize or award, will be gross income unless excluded under Section 74(b). Award has to be in recognition of charitable, scientific, educational, artistic, literary, or civic achievement. Will automatically
be considered a taxable award.
-
Section 74(c)-Employee Achievement Awards o
Satisfies definition of “Employee Achievement Award” (see Section 274(j) (deduction limitations)
o
Award cannot exceed amount allowable as a deduction to the employer for the cost of the employee achievement award.
-
Question 3: Gusher Oil desires to make its employees feel more appreciated. To implement this desire, Gusher creates an awards program whereby employees are given awards for achieving certain lengths of service. In each case, determine the extent to which employee, Cliff Hanger, is able to exclude the award from gross income.
o
Cliff has been working for Gusher for 12 years. Announcing Cliff’s retirement at the Oil Baron’s Ball, Gusher Oil gives him a $300 gift certificate.
274(j)- gift card is not tangible property because it was a cash equivalent. Has to be for length of service, meaningful presentation, and under disguise as compensation.
o
Cliff (who is continuing to work for Gusher) receives a gold watch worth $300 for his twelve years of service, presented at the Oil Baron’s Ball.
Meets all the criteria. (1) 74(c), could excluded from gross income. o
Same as (b), above, except that Cliff has worked for Gusher for only four years.
Must work 5 years or more.
-
Section 74(d)- Olympics
o
(1) in general: gross income shall not include the value of any medal awarded in, or any prize money received from the US Olympic Committee on account of competition in the Olympic Games or Paralympic Games o
(2) Limitation based on ADJ GI
(A) In general: paragraph (1) shall not apply to any taxpayer for any taxable year if the adjusted gross income (determined without regard to this subsection) of such taxpayer for
such taxable year exceeds $1,000,000 (half of such amount in case of a married individual filing a separate return)
o
What result if Michael receives the $5,000 check from the United States Olympic Committee for his performance at the Olympics and deposits the check in his personal account?
Section 74(d)- prize money for Olympics as long as gross income is under $1,000,000. B. Scholarships and Fellowships
Section 117 Exception: o
Qualified scholarship or qualified tuition reduction o
Degree candidate o
At educational organization.
IRC Section 127(a):
o
Exclusions from gross income (1) in general: gross income of an employee does not include amount paid or expenses incurred by the employer for educational assistance to the employee if the assistance is furnished pursuant to a program which is described in subsection (b) o
(2) $5,250 maximum exclusion: if, but for this paragraph, this section would exclude from GI more than $5,250 of educational assistance furnished to an individual during a calendar year, this section shall apply only to the first $5,250 of such assistance so furnished.
Quiz #3: Elizabeth, a law student at SMU, receives the following awards from the DBA this year: (1) $10,000 as a merit-based scholarship credited against her tuition bill; and (2) $4000 as a scholarship credited against her tuition bill, only if she works 200 hours as a TA for a member of the law faculty. How much, if any, of these amount must Elizabeth include in her GI? $4000
o
Elizabeth must include $4000 in her GI this year. o
Under 117(c), the imposition of an employment condition prevents the $4000 from qualifying for the scholarship exclusion under 117(a). o
However the $10,000 she receives as scholarship and which is used for tuition (a qualified expense) is excluded from gross income under 117(a).
Question 4: Secretary, in a large tax law firm, receives a $10,000 stipend from her firm to
assist her while on a leave of absence to obtain a college degree. The stipend is part of a firm plan under
which all recipients are required to return to the firm following their educational leave. What are the tax consequences to Secretary? [Based on Textbook, problem #2(a)].
o
This would not fall withing 117 because compensation, but 127(a). this would apply to the secretary here 5,250 would be excluded and the remainder would be applied. Would have to know if the money was spent on books if it was spent on room and board.
Question 5: Student working toward and A.B. degree is awarded a scholarship of $15,000 for full tuition and for room and board during the academic year. The tuition, including the cost of required books, is $10,000, and the room and board costs $5,000. As a scholarship recipient, Student is required to do about 300 hours of research for the professor to whom he is assigned.
Non-scholarship students, if hired, receive $10.00 per hour for such work. What tax consequences
to Student? [Based on Textbook, problem #1(a)].
o
Tax consequences?
117(a): exclude $10,000 of the tuition, but not the room and board. 117(a).
$5000 -> not excluded under 117(a) -> Include in GI
3,000 included in GI because compensation -117(c)
Up to $5,000 included in GI because 74 tax prize/award
Required to perform $3000 worth of service, 117(c).
What was she required to work for?
IRS: if scholarship does not specific otherwise, will treat work you did for the room and board. $3000 is gross income and the remaining $2,000 is still taxable.
$5,000 in gross income, and $10,000 excluded. -
More examples: o
15,000 in scholarships at qualified educational organization in exchange you have to do $3,000 worth of work of school for free.
Include 3,000 in GI (12000 withheld)
117(c): performing services in exchange for scholarship. The portion you work for is
not excluded from GI. o
5,000 for R&B and 3,000 for work you do for the school.
Cannot exclude room and board. Room and board would be a prize or award. Should include the 3,000 dollars of work in compensation. You would throw the 3,000 dollars into the $5000 you receive. o
Student receives a $15,000 scholarship for tuition & room & board: $10,000 of Scholarship is for tuition & $5,000 is for room & board. Scholarship specifically states that in exchange for receiving $10,000 for tuition, student has to do $3,000 of work
10,000 is a qualified scholarship while the 5,000 is not.
Receive a 10,000 scholarship.
And 5,000 is not a qualified scholarship, all included in gross income.
117(c) is an overriding exclusion. In exchange for 3,000 dollars of work for the 10,000 scholarships.
Chapter 9: Damaged and Related Receipts
A. Introduction
To determine what is and what is not gross income is that same in tax law as in other parts of the law. There will be:
-
A common law tax rule: is there an element of gain in a receipt? If not, the receipt falls outside the income concept, as in the case of the payment of principal on a loan. -
Or there may be a controlling statutory rule: receive a gift, bequest, devise, or inheritance, the essence of gain. o
And yet by statutory proscription, Section 102, property received by gift, bequest, devise, or inheritance is excluded from gross income. -
The amount received as damages or reimbursement for damages are governed by in part statute. Section 104-106 contain most of the tax rules on compensation for injuries or sickness.
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B. Damages and Other Recoveries for Personal Injuries
-
IRC: Section 104(a); 105(a)-(c) and (e); 106(a).
-
Regulations: Sections 1.104-1(a), (c), (d); 1.105-1(a); 1.106-1. -
Section 104-106: one who has incurred some types of personal injury should not additionally suffer injury to one’s purse in the form of tax liability on the receipt of some financial recompense. -
After years of deliberation SCOTUS finally gave some guidance to Section 104(a)(2) excluding “any amounts recovered for personal injuries or sickness” a phrase that generated substantial litigation. o
First decision, SCOTUS refused to exclude an award for backpay arising from a sex discrimination claim by limiting the Section 104(a)(2) exclusion to “damages received on account of a claim that redresses a tort like personal injury.” o
Secondly, court denied a plaintiff recovery in an age discrimination case by formulating a two prong test.
(1). Underlying action must be based upon tort or tort-type rights and
(2) damages must be incurred on account of personal injuries or sickness. -
Section 104(a)(2) o
Physical Injuries o
Section 104(a)(2) now excludes damages incurred on account of personal physical injuries or physical sickness from gross income
Damages received for nonphysical injuries, (
defamation), 1
st
amendment rights and sex and age discrimination are no long excludable o
Damages for emotional distress incurred on account of physical injury are excludable, but to the extent that damages are received for the amount paid for in medical care which is attributable to emotional distress.
-
IRC Section 104(a):
o
If you go into personal injury litigation, correctly argue what you want in payment for personal
injuries/punitive damages for taxable reasons
o
104(a)(2): 101-139 are all exclusion provisions.
Gross Income does not include: (2): amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or periodic payments) on account of personal physical injuries or physical
sickness” o
Quiz #4: Last Fourth of July, Joelle sustained physical injuries from a fireworks injury at a fireworks show held by Kaboom, Inc. Joelle sued the company for damages, but the case settled-out-of-court. In the settlement, Joelle received $75,000 for her injuries.
True/False: Joelle must include the $75,000 of damages in her gross income
False. Joelle can exclude the $75,000 of damages from gross income.
Under 104(a)(2), damages received for physical injuries as a result of a legal action are excludible from gross income. It does not make a difference if the damages for the physical injury are “received by suit or agreement.”
-
Punitive Damages- 104(a)(2)
Punitive damages recovered even in a physical personal injury suit are now specifically included within gross income.
Exception: damages awarded in a wrongful death action under state law in effect if punitive damages are the only wrongful death recovery option. o
This has led to difficult decision on what to tax and what not to when injuries are indistinguishable.
o
One revenue ruling gave this decision though:
That the taxpayer’s complaint was the best evidence for determining a proper allocation of a settlement.
i.e.) request 15x dollars compensatory and 45x dollars punitive = 25 % compensatory and
75% punitive. 1.
Plaintiff brought suit and unless otherwise indicated successfully recovered. Discuss the tax consequences in the following alternative situations [Textbook, problem #1(a), (c)]:
o
Plaintiff’s suit was based on a recovery of an $8,000 loan made to Debtor. Plaintiff recovered $8,500 cash, $8,000 for the loan plus $500 of interest. The only thing taxable here would be the $500 interest. The original $8,000 loaned would have already been taxed however the interest has not been. Section 61(a) gross income means all income from whatever source derived including (but not limited to the following items: (4) interest. -
In lieu of what was this payment made? o
You are not wealthier than you once were, getting back already taxed income. Doesn’t fit definition of gross income. o
Interest: “wealthier, clearly realized, in complete control,” and 61(a)(4).
What if Plaintiff’s suit was based on a breach of a business contract and Plaintiff recovered $8,000 for lost profits and also recovered $16,000 of punitive damages.
-
All 24,000 should be included. $8,000 is just profits due, these are finally realized at the time of payment. And punitive damages are also Gross Income, no exception here. o
Glenshaw Glass: punitive damages are Gross Income, because wealthier, clearly realized, and control. -
2.
Plaintiff settled her physical injury tort claim against Defendant by agreeing to accept Microsoft stock, worth $100,000 at the time of the transfer. If Plaintiff sells the stock several years later for $120,000, what is the amount of her taxable gain?
100,000 at the time are not taxable as Gross Income under 104(a)(2). It is payment on the account
of physical injuries. The $20,00 several years later will be gross income gained through appreciation/interest. 61(a)
(4). Wealthier, clearly realized, and complete control. Amount realized- adjusted basis= gain/loss 120,000-100,000 (tax cost basis)= 20,000 (gain) Taxable Gross Income
3.
Plaintiff receives $100,000 damages for Defendant’s intentional infliction of emotional distress (for which Plaintiff exhibits physical symptoms such as nausea and severe rash). Of the $100,000 damages, $10,000 was for past medical expenses (which Plaintiff had not deducted), and the other $90,000 was not allocated between lost wages and non-pecuniary damages. How much, if anything, may Plaintiff exclude from gross income?
Only the $10,000 for medical expenses. IIED damages are taxable, the only non-taxable part not included in gross income are the medical expenses. -
First, this deals with PERSONAL damages, not business damages. Doesn’t matter if its for lost wages etc..
o
Was this for a physical injury? NO. o
Physical symptoms? Doesn’t matter because Congress wants to limit 104(a)(2).
Murphy Case: whistleblower case where reputation was harmed. Awarded $70,000. Wanted to exclude the entire award but had plenty of physical symptoms. Murphy Case only held that a PHYSICAL INJURY causes IIED this would fall under 104(a)(2). o
104(a): IIED “shall not apply to an amount of damages not in excess of amount paid for medical care attributable to emotional distress.”
Physical Injury -> Emotional Distress -> 104(a)(2)
Emotional Distress -> Physical Injury -> Not a physical Injury (only actual medical expenses) 4.
Plaintiff brought suit and successfully recovered in the following situations. Discuss the tax consequences to Plaintiff. [Textbook, problem #1(a) – (d)]
Plaintiff, a professional gymnast, lost the use of her leg after a psychotic fan assaulted her
with a tire iron. Plaintiff was awarded damages of $100,000.
Physical injury in lieu of physical injuries would be covered under 104(a)(2).’
-
Physical Injury = 104(a)(2), $100,000 excluded from Gross Income.
$50,000 of the recovery in (a) above, is specifically allocated as compensation for scheduled performances Plaintiff failed to make as a result of the injured leg.
This is an opportunity cost missed out on not ever realized gains, but this also would not be for the actual physical injury as the statute intended. Depends on how the court looks at this. -
Physical Injury= when in personal damages. o
What caused the injury? Can be for anything except for punitive damages. Excluded even though never realized. Compensatory.
The jury also awards Plaintiff $200,000 in punitive damages.
Punitive damages are expressly included in gross income.
The jury also awards Plaintiff damages of $200,000 to compensate for Plaintiff’s suicidal tendencies resulting form the loss of the use of her leg.
. -
This would be as a result of personal injury damages from IIED. With IIED from physical injury this would be excluded under 104(a)(2). -
Damages: o
Non-physical injury cases let client know that this is taxable and vice versa for physical injury cases.
o
When damages are awarded, you want settlement award amount to be going to the non-taxable
award amount. -
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-
-
Life Insurance Proceeds: IRC 101(a):
If you are the recipient of life insurance proceeds it is excluded from amounts received. o
Quiz 5: Peter Gibbons who owned a $75,000 whole life insurance policy died last year. This year the insurance company paid his wife Joanna the $75,000 face value of the policy. True/False: Joanna must include the $75,000 proceeds in her GI.
False: the entire proceeds are excludable from GI under 101(a)(1)
Chapter 6: Gains From Dealings in Property A.Factors in the Determination of Gain IRC: Sections 1001(a), (b) first sentence, c; 1011(a); 1012(a).
Regulations: Section 1.1001-1(a)
1. Introduction
Return of Capital: no gross income upon repayment of capital, there is no element of gain in such a transaction.
Basis: “how much have I got in it?”
o
Thus if T buys property for $10,000, T has that amount in it, and T’s basis is $10,000.
o
Basis and value must be carefully differentiated.
What is a Gain? o
Gains derived from dealings in property = GI (61(a)(3))
o
IRC 1001(a): Computation of Gain or Loss – G/L = AR- AB
Realized v. Recognized: o
Recognized G/L: Taxable/Deductible Gain/Loss
o
IRC Section 1001(c): General Rule: Realized G/L = Recognized G/L
Section 1001. Determination of amount of and Recognition of gain or loss.
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a.
Computation of gain or loss. The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in Section 1011
for determining gain, and the loss shall be excess of the adjusted basis provided in such
section for determining loss over the amount realized.
b.
Amount realized. The amount realized from the sale or other disposition of property shall be the sum of any money received + FMV of the property (other than money) received. In determining the amount realized-
1.
There shall not be taken into account any amount received as reimbursement for real property taxes which are treated under 164(d) as imposed on the purchaser and
2.
There shall be taken into account amounts representing real property taxes which are treated under 164(d) as imposed on the taxpayer if such taxes are to be paid by the purchaser.
c.) recognition of gain or loss.- expect as otherwise provided in this subtitle, the entire amount of gain or loss, determined under this section, on the sale or exchange of property shall be recognized.
a.) identifies gain
on the disposition of property as the excess of the “amount realized” over the “adjusted bias”.
“Sale or other disposition”= realization event.
b.) “Amount realized” is defined in 1001(b) as: the amount of money received and the fair market value of
property (other than property) received on disposition.
ex.) property increases in value to $15,000 from $10,000.
Basis: $10,000
Value: $15,000.
Amount realized: $15,000 and if basis was $10,000, realized gain is $5,000.
(Value-Basis)= Gain/Loss.
c) requires gain realized to be recognized unless otherwise provided
by another code section.
Problem 1(a) Owner purchases some land for $10,000 and later sells it for $16,000. What is the amount of Owner’s gain or the sale? o
$16,000 (AR)- $10,000 (AB) = $6,000 (G/L).
Adjusted Basis IRC 1001(a)-> IRC 1011 o
Adjusted Basis = 1012 or other basis + 1016 adjustments o
General Basis Rule: IRC 1012
cost basis
Upward Basis Adjustments: o
Expenditures
o
Receipts o
Losses
o
Other items properly chargeable to a capital account
Treatment Of Payments
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o
Deduction o
Capitalization o
Non-deductible and non-capitalized
Downward Basis Adjustments o
Exhaustion o
Wear and Tear
o
Obsolescence o
Amortization o
depletion
2.
Realization Requirement
Realization Event: a sale or other disposition of property that gives rise to the gain or loss. (1001(a)).
Types of Realization Events:
o
Cash sales
o
Exchanges of property for other property that is materially different in kind or in extent (Reg 1.1001-1(a)).
o
The use of property as currency (to pay compensation);
o
Transfer of property subject to liability
Absent a realization event there is generally no gain or loss for Federal Income tax purposes.
Appreciation of property and increase in net wealth are not taxed until there is a realization event.
o
Can even take out a secured loan with appreciated assets without a taxable event resulting.
Realization requirements are frequently criticized. Reasons:
o
Allows a taxpayer to defer tax on appreciation in property until there is a disposition of the property.
Deferral confers a TVM benefit (can have more money to spend or use to generate further income instead of paying taxes)
Taxpayers can choose when to sell assets too, choosing the most advantageous time.
B.Determination of Basis
IRC: Sections 109; 1011(a), 1012(a); 1016(a)(1); 1019.
Regulations: Section 1.61-2(d)(2)(i); 1.1012-1(a).
Cost of Basis
Philadelphia Park Amusement Co. v. United States
Facts:
PP in 1889, had a 50-year franchise to operate a passenger railway in Fairmount Park, Philadelphia. PP constructed the Strawberry Bridge over the River for use by its streetcars.
In 1934 PP sold the bridge to the city in exchange for a 10-year extension of its franchise.
Then in 1946, PP abandoned the 10-year extension of the railway franchise and instead employed
bus transportation for its passengers.
PP attempted to take depreciation deduction with respect to the 10-year extension of the franchise
as well as a loss deduction on its abandonment.
Issue:
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What is the cost basis of the 10-year extension of the taxpayer's franchise? (deductions for depreciation and loss with respect to property cannot exceed the taxpayer’s basis in the property)
o
FMV of the bridge was much less than FMV of the 10 year extension at the time the taxpayer exchanged the bridge for the extension. Thus creating the problem in figuring out what the basis in the extension was.
Analysis:
Two theories of cost:
o
(1) that the basis of property acquired in an exchange is the FMV of the property given in
exchange.
o
(2) the basis of property acquired in an exchange is the FMV of the property received
in the exchange. Winner.
“When property is exchanged for property in a taxable exchange the taxpayer is taxed on the difference between the adjusted basis of the property given in exchange and the FMV of the property received in exchange.”
Ordinarily the values of two properties exchanged in an arm’s-length transaction are equal or presumed to be equal.
Thus, the court said that the FMV of the 10-year extension should be ascertained and that will be its basis in PP’s hands for further transactions.
o
If the coursaid said the value could not be ascertained on the extension, you would look at the value of the bridge.
o
Once the value of the bridge is established it can be assumed that it was the same as that of the extension.
Since the case was not prosecuted on this theory, the court remanded the case.
By Exchange:
o
(1) FMV property received or
o
(2) FMV property Given up or
o
(3) Basis of Property Given up (
Philadelphia Park)
.
Problem 1(b): What difference in result in (a), above, if Owner purchased the land by paying $1,000 for an option to purchase the land for an additional $9,000 and subsequently exercised the option? What is the amount of owner’s gain on the sale? o
1/Year 1: Purchase Option for $1000
o
6/Year 1: Exercise option -> purchases land for $9000
o
Year 5: Sells land for $16,000 o
Options are rights to property. When he exercised the option to purchase the land his basis was still $10,000. 16k-10k = $6000 gained, AB = $10,000. Includes the $9000 paid for the land and the $1000 for the option.
Problem 1(c): What result to Owner in (b), above, if rather than ever actually acquiring the land Owner sold the option to Investor for $1,500?
o
Selling the option is the property: AR (1500)- AB (1000)= 500 Gain
Problem 1(d):
What difference in result in (a), above, if Owner purchased the land by making a $2,000 cash payment from Owner’s funds and an $8,000 payment by borrowing $8,000 from the bank in a recourse mortgage (on which Owner is personally liable)? Would it make any difference if the mortgage was a nonrecourse liability (on which only the land was security for the obligation)? Owner still would have $6,000 gained in the recourse mortgage
o
Owner purchased land with $2000 payment o
Borrowing $8000 from the bank.
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o
Later sold for $16,000
AB = $10,000 (borrowed $ + payment)
AR= $16,000 sold land.
G/L: 6,000 = 16,000 -10,000 o
RECOURSE: Borrower is personally liable on the debt. o
NON-RECOURSE: borrower is NOT personally liable on the debt beyond the pledged collateral on the loan.
Problem 1(e): What would result in (a), above, if Owner purchased the land for $10,000, spent $2,000 in clearing the land prior to its sale, and sold it for $18,000?
o
$10,000 (AB) + $2,000 Upward improvements = $12,000 (AB)
18,000 (AR)- 12,000 (AB) = $6,000
The 2,000 is a capitalization so you add to your AB
If deductible, do not touch AB, apply the deduction only to GI.
Problem 1(f): What difference in result in (e), above, if Owner had previously rented the land to Lessee for five years for $1,000 per year cash rental and permitted Lessee to expend $2,000 clearing the property? Assume that, although Owner properly reported the cash rental payments as gross income, the $2,000 expenditures were properly excluded under § 109. [See §1019]
o
owner buys for $10,000 (AB), rented to Lessee for 5-years for $1,000 (GI). o
Lessee spends $2,000 clearing the property o
Owner sells land for $18,000 (AR)
$1,000 per year for rent is ordinary income reported by the owner.
1019: $2,000 Lessee spends clearing is NOT added to the AB of the owner??
109: Owner can exclude from income as long as it was not in lieu of not charging
rent. o
$18,000 (AR)- 1000 (AB) = $8000 Gain
Hypo 1: Owner owns a huge plot of land that he leases to Jerry Jones. While renting Jerry Jones builds Cowboys stadium for 1 billion dollars.
o
Exclude this from GI. You would bunch your income and you may not have the liquidity to pay these taxes based on someone else’s improvements.
109+ 1019 o
1019: you do not get to adjust your basis based on leasehold improvements
Hypo 2: Owner rents lake house for $4,000. Tenant pays $1,000 and makes $3,000 worth of improvements to the house.
o
109 N/A to leasehold improvement
$3000 rental income from leasehold improvements
Owner’s basis in property: Increases by $3,000 (1019 N/A)
o
Exchanging the rent for improvements. Would be classified as compensation for rent.
Problem 1(h): what difference if Owner is a salesperson in an art gallery and Owner purchases a $10,000 painting from the art gallery, but is required to pay only $9,000 for it (instead of $10,000
because Owner is allowed a 10% employee discount which is excluded from gross income under §132(a)(2)), and Owner later sells the painting for $16,000?
o
$16,000 (AR)- $9,000 (AB) = $7,000 G/L discount taken o
$16,000 (AR)- $10,000 (AB) = $6,000 Gain discount not taken
Problem 2(a):
In an arm's-length exchange, Sharp exchanges some land with a cost basis of $6,000 and a value of $9,000 with Dull for some non-publicly traded stock which Dull owns and in which Dull has a basis of $8,000 and is worth $10,000 at the time of the exchange. [Based on
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Textbook, Problem #2] Consider Sharp and Dull's gains on the exchange and their respective
cost bases in the assets they receive.
o
Sharp:
G/L: $10,000 A/R- $6,00 A/B Land = $4,000 gain
Basis: $10,000 Basis in Stock o
Dull:
G/L: $9,000 (AR) - $8,000 (AB) Stock = $1,000 Gain
Basis: $9,00 basis in land
o
Philly Park- AR (Amount received) – AB (Adjusted basis, previous basis) = G/L o
What results in (A), above, if the value of Dull's stock cannot be determined with any reasonable certainty.
Receives Dull’s stock, but doesn’t know the price of stocks. Use FMV of land you gave away.
Sharp:
G/L: 9,000 AR - 6,000 A/B = 3,000 gain
Basis: 9,000 basis in stock
Dull:
o
G/L: 9,000 AR- 8,000 A/B= 1,000 gain
o
Basis: 9,000 AR : FMV of property received. 2. Property Acquired By Gift:
Code
: 1015(a), (e)
Treasury Regulations
: § 1.1001-1(e); 1.1015-1; 1.1015-4(a)
General Basis Rule: 1012 Cost Basis
Exception: 1015
Taft v. Bowers:
A taxpayer who gives appreciated property to a donee usually is not deemed to have realized the gain; instead the donee takes the donor’s basis and the donee, not the donor, eventually realizes the income. Taft, IRC 1015.
ex.) A owns Blackacre which he paid $10,000 and gives it to B when it is worth $15,000 and B sells it for $17,000.
o
B will have a taxable gain of $7000.
If BA had been worth $8,000 when A gave it to B, B would also have $7,000 gain when he sold it
for $17,000 later.
IRC 1015: Basis of property acquired by gifts and transfers in trust.
If the property was acquired by gift after December 31, 1920, 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,
except that if such basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value.
o
General rule= transferred basis
o
Exception: if (1) A/B > FMV and
(2) sold at a loss ->
use FMV basis
gain = transferred basis.
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Problem 1: Donor gave Donee property under circumstances that required no payment of gift tax. What gain or loss to Donee on the subsequent sale of the property if [Based on Textbook, Problem #1]:
o
The property had cost Donor $20,000, had a $30,000 fair market value at the time of the gift, and Donee sold it for:
$35,000?
Donee’s Basis is the Donor’s basis. Transferred Basis. At the time of transfer there was $10,000 of appreciation by giving the donee the appreciation donor shifts the gain to the gift recipient.
Initial Basis= $20,000.
1015
Recipient Basis= $20,000
G/L= $15,000 = $35K-20K
$15,000?
Donee’s Basis is the Donor’s basis. Transferred Basis.
Initial Basis= $20,000.
Recipient Basis= $30,000
15,000 (AR)- $20,000 (A/B)= (5,000)
o
$25,000?
Donee’s Basis is the Donor’s basis. Transferred Basis.
Initial Basis= $20,000.
Recipient Basis= $20,000
25,000 (AR) - 20,000(AB)= $5,000
o
The property had cost Donor $30,000, had a $20,000 fair market value at the time of the gift, and Donee sold it for:
$35,000?
Initial Basis= $30,000.
Recipient Basis= $30,000
35,000 (AR) - 30,000(AB)= $5,000
$15,000?
Initial Basis= $30,000.
Recipient Basis= $20,000
15,000 (AR) - 30,000(AB)= $(15,000)
BUT, BOTH PRONGS MET: (1) selling at a loss & (2) AB > FMV
15,000 (AR) - 20,000 (FMV) = ($5,000)
$24,000?
Initial Basis= $30,000.
Recipient Basis= $20,000
24,000 (AR) - 30,000(AB)= $(6,000) but 2 prongs
24,000 (AR) - 20,000(FMV)= $4,000
1.1015-1(a)(2): sell price in between FMV and Transferred Basis, you will have no gain or loss on the sale. *** 0 G/L****
Part Gift- Part Sale
Father had some land that he had purchased for $100,000, but which had increased in value to $200,000. He transferred it to Daughter for $100,000 in cash in a transaction properly identified as in part a gift and in part a sale. Assume no gift tax was paid on the transfer. [Based on
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Textbook, Problem #2]
What gain to Father and what basis to Daughter under Reg. §§1.1001-1(e) and 1.1015-4(a)(1)?
Greater of :
$100,000 cost basis
$100,000 Gift Basis (transferred basis
Here, Father= 100,000 (AR) - 100,000 (AB) Recognize gains, but not losses=
3. Property Acquired Between Spouses or Incident to Divorce
Code
: 1041(a), (b)
Treasury Regulations
: 1.1041-1T(a), (d)
In contrast to gifts, when property is transferred between spouses or between former spouses incident to divorce, neither gain nor loss will be recognized and the basis to the transferee will be the same as it was in the hands of the transferor, for gain or loss purposes. (1041(a)(b))
o
The basis of the property in the hands of the transferee will be the adjusted basis of the transferor.
o
Must be within 1 year of divorce or is related to cessation of marriage.
General Rule: no gain or loss shall be recognized.
Basis: transferred basis
Problem 3: Andre purchased some land ten years ago for $40,000 The property appreciated to $70,000 at which time Andre sold it to his wife Steffi for $70,000 cash, its fair market value. [Based Textbook, Problem #1]What are the income tax consequences to Andre?
30,000 realized gain. $0 recognized gain because of 1041.
B.
What is Steffi’s basis in the property?
Transferred basis, $40,000.
C.
What gain to Steffi if she immediately resells the property?
She would have a $30,000 gain
D.
What results in (a)-(c) above, if the property had declined in value to $30,000 and Andre sold it to Steffi for $30,000?
Andre still has no recognized loss. But $10,000 realized loss.
Steffi still has a $40,000 transferred basis.
o
Steffi will have a $10,000 realized loss
o
30,000 (AR)- 40,000 (AB) = (10,000).
E.
What results (gains, losses and bases) to Andre and Steffi if Steffi transfers other property with a basis of $50,000 and value of $70,000 (rather than cash) to Andre in return for his property?
FMV of property received. Andre receives $70,000 (A/R) - $40,000 (AB)= 30,000
o
Realized gain= 0
o
Transferred basis = $50,000
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4. Property Acquired from a Decedent
Section 1014:
(a)
I
N
GENERAL
Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be—
(1)the fair market value of the property at the date of the decedent’s death.
General Rule: basis= FMV on date of death.
All appreciation just disappears.
Hypo #1: D purchases for $10k. Appreciates to $100k. Transferred to Riley at the time of death.
Recognizes 0. Basis = $100,000
IRC 1044- Basis of Property Aquired from a Decedent
(a)In general
Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be—
(1)the fair market value of the property at the date of the decedent’s death,
(2)in the case of an election under section 2032, its value at the applicable valuation date prescribed by such section,
(3)in the case of an election under section 2032A, its value determined under such section, or
(4)to the extent of the applicability of the exclusion described in section 2031(c), the basis in the hands of the decedent.
Problem Set
4.
In the current year, Giver holds two blocks of identical stock, both worth $1M. Giver purchased the first block years ago for $50,000 and the second block more recently for $950,000. Giver plans to make an inter vivos/lifetime gift of one block and retain the second until death. Which block of stock should Giver transfer inter vivos and why? [Based on Textbook, Problem #1]
Block 2 Gift -> $950,000 basis -> $50,000 inherent gain
Block 1 Gift-> $50,000 basis -> $950,000 inherent gain C. Amount Realized:
IRC: Section 1001(b): Determination of amount of and Recognition of gain or loss.
(b) amount realized: the amount realized from the sale or other disposition of property shall be the sum of any money received + FMV of the property (other than money) received. In determine
the amount realized–
o
(1) there shall not be taken into account any amount received as reimbursement for real property taxes which are treated under Section 164(d) as imposed on the purchaser, and
o
(2) there shall be taken into account amounts representing real property taxes which are treated under Section 164(d) as imposed on the taxpayer if such taxes are to be paid by the purchaser.
Treasury Regulations:
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1.001–1(a): Computation of gain or loss:
(a) General rule: gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or as loss sustained. The amount realized from a sale or other disposition of property is
the sum of any money received + FMV any property received.
International Freighting Corporation, Inc. v. Commissioner
Facts:
Taxpayer’s company adopted a bonus plan which would grant 150 shares of common stock to employees.
The cost of stock to the taxpayer at the date of delivery was $16,153.36 and the market value was then $24,858.75.
The employees receiving those shares in 1936 paid tax on them, computing the market value at the time of delivery as taxable income.
The Taxpayer took a deduction of $24,858.75 for the 150 shares of stock.
Commissioner noticed a deficiency and reduced deduction from $24k to $16k, a difference of $8k, determining that as the bonus was paid in property:
o
“The basis for calculation of the amount thereof is the cost of such property and not is market value as claimed on the return.”
Even if entitled to full $24k deduction, then they would have a realized profit of $8,705 on the disposition of the shares.
Issue:
Did the delivery of the shares to its employees result in a taxable gain to the taxpayer?
Analysis:
Tax court correctly held that the MV at the time of delivery was properly deducted by the taxpayer as an ordinary expense of the business under 162(a) because the delivery was an additional reasonable compensation for past services actually rendered.
Did the transaction result in a taxable gain to taxpayer? Yes.
o
Delivery of shares were not a gift, (1) would have been wrongful as against taxpayer’s stockholders, (2) value of the shares could not have been deducted as an expenses under 162(a), and (3) employees as donees would not be obliged to pay as they must, an income
tax on what they received. It was compensation.
o
This was a disposition for a valid consideration, it resulted in a closed transaction with a consequent realized gain.
o
Since there was no gift, but a disposition of shares for consideration equal to market value of shares when delivered, there was a taxable gain = to the difference between the cost of the shares and that market value.
o
1001(a): gain = sale or disposition of property is the excess of Amount realized therefrom
over the adjusted basis.
Basis: cost of property (1012)
Amount realized: sum of any money received + FMV of the property received.
No property or money received by the person who disposes of the stock.
AR( 24K) - Basis (16) = 8k gain
Class Notes:
o
Employer gives stock of another company to employees as a bonus:
AB= $16,000
FMV= $25,000
o
What are the tax consequences to the employer?
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Employer is giving something to the employee. Any time you dispose of property
you have an amount realized.
AR= $25000, deducted it as a business expense. For compensation as a bonus.
FMV of Stock = Services received
o
AR- AB =G/L
Amount realized:
includes FMV of Services received.
25,000 A/R-16,000= 9,000
FMV of property should be the FMV of the services provided by the employer.
Recognize this gain as well for taxable income.
o
Tax
consequences to employees?
Each got $5,000 worth of stock.
AB= 16K
FMV= 25K.
employees= $5000 in gross income.
Basis would be $5,000.
Tax Cost Basis= Because you are already taxed on the $5,000 you would
increase the basis = amount paid + anything you were taxed on it.
I.R.S. Notice 2014-21 - VC
Section 1: Purpose: how existing general tax principles apply to transactions using VC.
Section 2: Background:
IRS is aware that VC may be used to pay for goods or services or held for investment.
VC that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as convertible virtual currency.
Section 4: FAQs:
(1) how is VC treated for tax purposes?
o
VC is treated as property and general tax principles apply to property transactions apply to VC transactions.
(3)must taxpayers receiving VC as payment for goods or services included in computing GI the FMV of the VC? o
Yes. FMV of VC at the date VC was received.
(4) Basis?
o
Basis of VC that a taxpayer receives as payment is the FMV of the VC at the date of receipt.
(5)How is FMV determined?
o
Reported in US dollars at date of payment or receipt. If listed on exchange apply that.
(6) gain or loss?
o
Yes. FMV of property received in exchange for VC exceeds the adjusted basis the taxpayer has a gain.
Has a loss if the FMV received is less than AB of the VC.
(8) mining?
o
Included in gross income at date of receipt.
Basis = Cost Basis = FMV of the Date Purchased.
o
If you take bitcoin and convert it into dollars it increases in value.
1500 (AR/FMV) - 1000 (Basis) = 500 gain. SOLD
-1000 (Basis); 1500(FMV)
AR-AB = G/L
1500(AR) -1000(AB)= 500 Gain. Buying Purse with appreciated value. Exchange scenario.
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Effect of Debt on Amount Realized
o
Recourse Debt (“assumed”)- have personal liability. If collateral doesn’t satisfy debt you
have to come up with other assets.
o
Non-Recourse Debt (“taken subject to”)- only recourse the creditor has is taking the collateral.
o
Mortgagor= Debtor
o
Mortgagee = Creditor
Crane v. Commissioner
1.
How do liabilities incurred in connection with the purchase of property affect adjusted basis?
2.
How does the relief of liabilities affect amount realized?
RULE:
I.R.C. § 111 (b) (1938) defines the "amount realized" from "the sale of property" as "the sum of any money received plus the fair market value of the property (other than money) received. " Section 111 (a) defines the gain on "the sale of property" as the excess of the amount realized over the basis.
FACTS:
Petitioner was the sole beneficiary and the executrix of the will of her husband, who died in 1932.
He then owned an apartment building and a lot subject to a mortgage, which secured a principal debt of $ 255,000 and interest in default of $ 7,042. As of that date, the property was appraised for federal estate tax purposes at a value exactly equal to the total amount of this encumbrance.
Shortly after her husband's death, petitioner entered into an agreement with the mortgagee whereby she was to continue to operate the property -- collecting the rents, paying for necessary repairs, labor, and other operating expenses, and reserving $ 200 monthly for taxes -- and was to remit the net rentals to the mortgagee. Nevertheless, the arrearage of interest increased to $ 15,857. In November 1938, with the mortgagee threatening foreclosure, petitioner sold to a third party for $ 3,000 cash, subject to the mortgage, and paid $ 500 expenses of sale.
Petitioner reported a taxable gain of $ 1,250. Her theory was that the "property" which she had acquired in 1932 and sold in 1938 was only the equity, or the excess in the value of the apartment
building and lot over the amount of the mortgage. Respondent Commissioner of the Internal Revenue Service, however, determined that petitioner realized a net taxable gain of $ 23,767. His theory was that the "property" acquired and sold was not the equity, as petitioner claimed, but rather the physical property itself, or the owner's rights to possess, use, and dispose of it, undiminished by the mortgage. The Commissioner agreed that the land was a "capital asset," but thought that the building was not.
Thus, he determined that petitioner sustained a capital loss of $ 528 on the land, of which 50 percent or $ 264 was taken into account, and an ordinary gain of $ 24,031 on the building, or a net taxable gain as indicated. The Tax Court agreed with the Commissioner that the building was not a "capital asset." In all other respects it adopted petitioner's contentions, and expunged the deficiency. On the Commissioner's appeal, the Circuit Court of Appeals reversed. Petitioner sought certiorari.
ISSUE:
Did the Circuit Court of Appeals err in its reversal?
ANSWER:
No
CONCLUSION:
On certiorari, the Supreme Court of the United States sought to determine the gain or loss applying proper interpretation and construction. Explaining that the first step was to determine the basis of the property, the Court found the basis to be the value of the property undiminished by mortgages under I.R.C. § 113 (a) (5) (1938).
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Second, the Court examined whether depreciation adjustments were proper under § 113 (b) (1) (B) (1938).
Third, the Court looked at the amount realized on the sale of the bequeathed property. Section 111 (b) defined "amount realized" from "the sale of property" as "the sum of any money received plus the fair market value of the property," not its equity. The Court concluded that the Commissioner was right in determining that the petitioner realized $ 257,500 on the sale of this property. The Court affirmed the judgment by which the appellate court found that the tax court's use of equity as a basis was improper.
Crane:
Acquires apartment by inheritance
o
FMV = 262,000
o
Debt= 262,000
Depreciation Deductions: $28,000
Sell Property for $2,5000
o
Debt = 255,000
What is Crane’s G/L from the sale?
Initial Basis= Value at Death = $262,000
o
equity= FMV-debt on the property.
o
Property= the entire apartment building received.
Court is going to use $262,000 as basis.
AR-A/B= Gain/Loss
262K - $28,000 of depreciation= $235,000 (AB)
AR= 2500 cash + 255,000 of debt relief = 257,500
o
Doesn’t matter if recourse or non-recourse.
Takeaways:
1.
Liabilities assumed taken subject to or otherwise incurred in acquisition of property
are included in basis.
2.
Liabilities of a seller assumed or taken subject to by the purchaser are included in the seller’s amount realized.
Hypo:
Seller is selling property for $100,000. Buyer agrees with a 40,000 down payment and 60,000 promise to pay in one year.
o
Mortgagee= Seller (Lender); Mortgagor = Buyer (Debtor)
o
Buyer’s Basis= 40,000 cash + 60,000 Debt = 100,000
Crane leaves open the question when: FMV of property is less than the debt.
AR= entire debt relief when FMV < Debt? Answered by Tufts.
Commissioner v. Tufts
Initial Purchase Price: 40,000 cash + 1.85 M nonrecourse debt = 1.890 Initial Basis
Adjusted Basis = 1.89M - 440,000 depreciation deductions = 1.45M
FMV at time of Sale: 1.4M
Non-Recourse Debt= 1.85 Million dollars. Would want to pay on for property worth less than the debt.
HOLD: still held to the whole amount. You got the basis deductions and now are paying for it.
RULE:
26 U.S.C.S. § 752(d) specifically provides that liabilities involved in the sale or exchange of a partnership interest are to be treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. 26 U.S.C.S.
§ 1001 governs the determination of gains and losses on the disposition of property. Under § 1001(a), the gain or loss from a sale or other disposition of property is defined as the difference between the amount realized on the disposition and the property's adjusted basis.
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Subsection (b) of § 1001 defines amount realized as the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property, other than money received.
FACTS:
A general partnership obtained a nonrecourse mortgage loan of $ 1,851,500 in order to construct an apartment complex.
The partnership was not unable to make the payments due on the mortgage, and each partner sold his partnership interest to an unrelated third party who assumed the nonrecourse mortgage.
On the date of transfer, the fair market value of the property did not exceed $ 1,400,000 and the partnership's adjusted basis in the property was $ 1,455,740.
Each partner reported the sale on his federal income tax return and indicated that a partnership loss of $ 55,740 had been sustained.
The Commissioner of Internal Revenue determined that the sale resulted in a partnership capital gain of approximately $ 400,000 on the theory that the partnership had realized the full amount of
the non recourse obligation.
The United States Tax Court upheld the asserted deficiencies (70 TC 756). The United States Court of Appeals for the Fifth Circuit reversed (651 F2d 1058).
ISSUE:
Should a taxpayer who sells property encumbered by nonrecourse mortgage exceeding fair market value of property sold be required to include unpaid balance of mortgage in computation of amount that the taxpayer realized on sale?
ANSWER:
Yes
.
CONCLUSION:
The court determined that it was irrelevant that there was no economic benefit, since under the Internal Revenue Code, the value of the mortgage was relieved, and thus was a taxable benefit to respondents.
In an opinion by Blackmun, J., expressing the unanimous view of the court, it was held that a taxpayer who sells property encumbered by a nonrecourse mortgage exceeding the fair market value of the property sold must include the unpaid balance of the mortgage in the computation of the amount the taxpayer realized on the sale.
Bayles (Buyer here) wanted a tax shelter:
200k Salary- no deductions = 200k taxable income x 40%= 80,000 taxes paid.
Buys $2,000,000 property. Borrow 2M to buy property. 10 years.
200,000 deductions every year.
o
Now she has 200,000 salary - 200,000 deduction= 0 taxes paid.
Saves 80,000 for 10 years. Saved $800,000 in taxes.
Basis = 2,000,000
Deductions = 2,000,000
o
Adjusted Basis= 0.
o
Bank comes and forecloses the property and thus it is disposed of.
o
AR-AB= Gain/Loss
o
2,000,000 - 0 = 2,000,000 million x 40% = 800,000 in taxes paid.
o
TMV invest the 80,000 every year
1. Mortgagor purchases a parcel of land from Seller for $100,000. Mortgagor borrows $80,000 from Bank and pays that amount and an additional $20,000 of cash to Seller giving Bank a nonrecourse mortgage on the land. The land is the security for the mortgage which bears an adequate interest rate.
(a) What is the Mortgagor’s cost basis in the land?
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The basis would be $100,000. The borrowing of the money does not affect this and does not create any income for M. §1012.
(b) Two years later when the land has appreciated in value to $300,000 and Mortgagor has paid only interest on the $80,000 mortgage, Mortgagor takes out a second nonrecourse mortgage of $100,000 with adequate rates of interest from Bank again using the land as security. Does Mortgagor have income when
she borrows the $100,000? See Woodsam Associates, Inc. v. Commissioner, 198 F.2d 357 (2d Cir.1952).
Mortgagor paid only interest on the $80,000 mortgage. Payments on the debt or interest does not affect the basis.
Recourse debt v. non recourse does not matter.
o
The 100,000 in debt taken out the second time does not affect the basis.
(c) What is Mortgagor’s basis in the land if the $100,000 of mortgage proceeds are used to improve the land? This would be a §1016 adjustment. The basis is increased by $100,000. $200,000.
No income, but adjusted basis increases.
(d)What is Mortgagor’s basis in the land if the $100,000 of mortgage proceeds are used to purchase stocks and bonds worth $100,000?
There is no change in the basis of the property, but the stocks and bonds get a §1012 basis treatment. The
contrast. Not required to invest it in the property. Monetized real estate investment in stocks and bonds, no effect on basis of the land.
(e) What result under the facts of (d), above, if when the principal amount of the two mortgages is still $180,000 and the land is still worth $300,000, Mortgagor sells the property subject to both mortgages to Purchaser for $120,000 of cash? What is Purchaser’s cost basis in the land?
Purchaser’s cost basis in the land is what he paid, or $120,000.
The property is subject to the mortgages. What is gain or loss from this? A
R, Crane amount of money received and amount received.
AR of 300, AB is 100, gain of 200 will be realized and recognized.
Any cancellation of indebtedness income? No. Buyer will take over debt. Disposition of land is 200,000. Purchaser has a cost basis of 300.
Sold for $120,000 cash.
o
Transferring mortgage subject to the property.
o
Amount realized: 120k Cash + 180 debt relief = 300,000.
o
200,000 gain = 300 AR - 100 AB
Purchaser cost basis= 3000
o
120 cash + 180 debt = 300 cost basis.
(f) What result under the facts of (d), above, if instead Mortgager gives the land subject to the mortgages and still worth $300,000 to her Son? What is Son’s basis in the land?
Amount Realized = 180; a gain of 80.
The son has a basis of 180.
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Part sale, part gift. What is the AR here?
Mortgagor, aka seller is being relieved of 180 of liability.
Crane says this is the amount realized. Basis of 100, so mortgagor would have gain realized recognized.
Son’s cost = $180,000 of the debt taken on. The gift portion is the $120,000 of value without paying anything for it.
Seller will recognize gains but not losses= 180,000 (AR)- 100,000 (AB)= 80,000 gain.
Son= greater of cost/transferred basis. He paid 180,000 and transfer would be 100,000 so he takes
the 180,000 as his basis.
Part gift part sale= look at the gift basis; what is the cost basis?
(g) What result under the facts of (f), above, if Mortgagor gives the land to her Spouse rather than to her Son? What is Spouse’s basis in the land? What is Spouse’s basis in the land after Spouse pays off the $180,000 of mortgages?
§1041-gives to spouse. No gain or loss, change of basis to the spouse, spouses basis is 100 in land, same as mortgagor. Basis is still 100 after paying off mortgage. Paying off debt has no effect on basis at all.
Taking on the debt relief= 180,000 amount realized
No gain recognized for mortgagor= 180-100= 80
Spouse Basis= 100,000
(h) What results to Mortgagor under the facts of (d), above, if the land declines in value from $300,000 to
$180,000 and Mortgagor transfers the land by means of a quitclaim deed to Bank? See Parker v. Delaney
, 186 F.2d 455 (1
st
Cir.1950).
The FMV has declined to 180. The total value of the property is the outstanding debt. The AR includes 180 relief of liability achieved by transfer of property. Realize and recognize a gain of 80, even though M doesn’t get any cash out of it.
(i) What results to Mortgagor under the facts of (h), above, if the land declines in value from $300,000 to
$170,000 at the time of the quitclaim deed?
$180,000. Tufts
case: Even though the FMV is less than the debt, the AR is the debt. Tufts case.
Still have gain of 80 all of it attributed to land, no cancellation. Contrast this with problem 2 on p. 177.
o
180,000 NRD > 170,000 FMV.
2. Investor purchased three acres of land, each acre worth $100,000 for $300,000. Investor sold one of the acres in year one for $140,000 and a second in year two for $160,000. The total amount realized by Investor was $300,000 which is not in excess of her total purchase price. Does Investor have any gain or loss on the sales? See Reg. § 1.61-6(a)
Yes, the investor takes gain in the sales. According to § 1.61-6(a) the total cost of the property is apportioned among the divided lots. Thus, the AB of the lots is $100,000. From this the gain realized from the sale of the acre in year one is $40,000 and the gain from the sale in year two is $60,000.
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Arce 1: AR= 140,000; Basis = 100,000 for 1 ACRE. = 40,000 gain.
Arce 2: AR= 160,000; Basis = 100,000 for 1 ACRE = 60,000 gain.
Arce 3= Not sold; AB = 100,000.
Class Notes: 2/6/24
Basis:
o
Default rule: Cost Basis: 1012
o
Exchange Basis
o
Spouse Basis
Problem 4: two blocks of identical stock
o
Block 1: FMV $1m; AB 50,000
o
Block 2: FMV $1M; AB, 950,000
Sold during your lifetime: you would get your AB 50,000
If you sold at death you would get FMV $1,000,000.
So sell block 2 during your lifetime.
Hypo: FMV 100,000; Cost 5,000
o
95,000 Gain
o
Transfer stock to Aunt Sue (100 years old)
o
Upon death you will receive the stock back.
No gain or loss for the gift to aunt sue.
AR- AB=
o
Aunt Sue= Gift= Transferred Basis = $5k
o
Upon Death= 100k = Death triggers FMV of the property at the date of death.
o
104(e): appreciated property acquired by decedent by gift within 1 year of death
(1) in general. (a) appreciated property was acquired by the decedent by gift during the 1-year period ending on the date of the decedent’s death, and
(b) such property is acquired from the decedent by (or passes form the decedent to) the donor of such property (or spouse of such donor).
The basis of such property in the hands of such donor shall be the adjusted basis
of such property in the hands of the decedent immediately before the death of the decedent.
Review Problem #4: Pursuant to the terms of divorce, W transferred to her former husband, H, some securities with a value of $100,000 and an adjusted basis in her hands of $120,00
o
1041: transfers between spouses you no not recognize a gain or loss on transfer of property.
o
100k (FMV)- 120k (AB) = -20K but no loss recognized
Part 2: H sells the securities to a 3rd party for $150,000
o
150,000 (sale price)- 120,000 (AB) = 30,000 Gain
o
You use a transferred basis. W’s basis becomes H’s basis.
Review Problem:
o
$40 of stock when purchased: Cost Basis
o
$50 of stock when death:
o
$80 of FMV at end of Y1
o
$90 when sold at end of Y1
Amount Realized 1001(b):
o
Amount realized= Money + FMV Property
o
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Quiz 4:
Question 1: Gus owns a parcel of land, Blackacre, with an adjusted basis of $100,000 and a fair market value of $160,000. Divya owns a parcel of land, Whiteacre, with an adjusted basis of $140,000 and a fair market value of $190,000. If Gus exchanged Blackacre for Divya’s property,
Whiteacre, in a respected exchange, how much gain would Gus realize on the exchange?
Gus realizes a $90,000 gain from the exchange.
The amount realized from the sale or other disposition of property is:
o
Sum of any money received + FMV of property (other than money) received: (1001(b)).
o
This means that the amount realized is $190,000, the FMV of the Whiteacre property that Gus receives.
Gus’s Adjusted Basis in BA (property he gives up) is $100,000.
Therefore, the gain Gus realizes form the exchange is $190,00 (AR) - $100,000 (AB)= $90,000 realized gain.
Question 2: Matthew owns a share of Snapchat stock that he purchased several years ago for $500. The stock declines in value to $200, at which time Matthew decides to gift the stock to his daughter, Violet. A year after receiving the stock, Violet sells the stock for $300. How much gain
or loss will Violet recognize from this sales transaction?
Violent will not recognize a gain or a loss on the sale, Violet received the stock as a gift. Therefore, her basis in the stock is determined under IRC 1015 gift basis rules.
o
At the time she acquired the gift, it had an inherent loss ($200 FMV at the time of gift > $500 donor’s basis.)
o
Therefore, if she were to sell the gift at a loss she would use the $200 FMV on the
date of gift as her basis.
o
If she were to sell the gift at a gain, then she would use the $500 donor’s transferred basis as her basis.
In this case though, she sells the gift for an amount that is BETWEEN the $200 FMV on the date of gift and the $500 donor’s basis. Treas. Reg. 1.1015-1(a)
tells us that in this situation, the donee will recognize neither a gain nor a loss on the sale.
Question 3: Austin owns a parcel of land in California that he purchased for investment many years ago for $4,000,000. The property is subject to a non-recourse mortgage of $3,500,000. Today, the land is worth only $2,500,000. Since it no longer makes sense to own the property, Austin stops making payments on the mortgage and the creditor forecloses on the property. What
are the tax consequences to Austin when the creditor acquires the property?
Austin recognizes a $500,000 loss on this transaction.
When the creditor forecloses on the property and acquires it from austin, this is a realization event. Therefore, Austin will have realized gain or loss equal to the amount realized - adjusted basis.
Crane and Tufts tell us that AR includes the amount of debt relief, even in cases when the
FMV of the property is less than the debt amount. Thus, Austin’s amount realized on this transaction is $3.5 M- amount of the debt.
Austin’s AB is $4M - original purchase price.
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Therefore, Austin’s gain or loss from the transaction equals: $3.5 M (AR) - $4M (AB) = (500,000) loss that is realized and likely recognized.
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Related Questions
question 7. Paid required annual contribution to pension plan, $250,000.
Expenditures—Operating—Pension Contribution...................................
Cash................................................................................
To record annual pension contribution.
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2. Sohar Company had a 40 percent tax rate. Given the following pre-tax amounts, what would be the income tax expense reported on the face of the income statement ?............................................................................
Sales $ 100,000
Depreciation expense11,000
Cost of goods sold60,000
Dividend revenue9,000
Salary expense8,000
Utilities expense1,000
Extraordinary loss10,000
Interest expense2,000
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Use the table below for the next few questions
Table for Single Taxpayers
Over
But not over
$51
$195......................10% of excess over $51
$195
$645......................$14.40 plus 15% of excess over $195
$645
$1,482...................$81.90 plus 25% of excess over $645
$1,482
$3,131...................$291.15 plus 28% of excess over $1,482
$3,131
$6,763...................$752.87 plus 33% of excess over $3,131
$6,763...........................................$1,951.43 plus 35% of excess over $6,763
Herb Becker had gross earnings of $465 last week. He is single and claims a withholding allowance for himself only. The amount of each weekly withholding allowance is $65.38. Using the Table for Single Taxpayers above, compute the amount that will be withheld from his paycheck for federal income tax. (Figure withholding to the nearest cent.)
40.59
54.09
45.09
35.09
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3
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EXERC
13 Calculating Deferred Income Taxes.
The Harmon Corporation prepared the following income statements TA 2
and income tax returns for Year 1 through Year 4.
Income Statement
Sales...
Operating expenses
..
Pretax net income.
Provisions for income taxes.
Net income..
Income Tax Return
Sales....
Operating expenses...
Taxable income
Income tax payable ...
After-tax net income....
I
..
..
Year 1
$1,000
650
350
140
$ 210
Year 1
$1,000
900
SA
$
100
80
20
Year 2
$1,000
650
350
140
$ 210
Year 2
$1,000
900
100
Hoy 80
$20
Year 3
$1,000
650
350
140
$ 210
Year 3
$1,000
400
$1,000
650
$
350
140
|
210
Year 4
$1,000
400
600
600
200
200
$ 400 $ 400
von Wand Insol a
Calculate the balance in the company's deferred income tax liability account at the end of each year. Explain
what a growing balance in the deferred income tax liability is likely to indicate about a company's net income
relative to its taxable income. Why might investment professionals view this situation positively? Negatively?
uses…
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Answer part C only
The following information was obtained from the financial statements of X Inc.
Defined Benefit Plan Obligations
Pension Benefits
2020……………………..2019
Defined Benefit Obligation(DBO):
Balance, beginning of year…………………………………………$40,032…………………..42,370
Current Service Cost…………………………………………………… 864…………………. 1,126
Interest Cost…………………………………………………………… 2,344…………………... 2,255
Benefits Paid……………………………………………………………(3,198)………………….. (2,881)
Actuarial Gains………………………………………………………... (3,339)………………….. (2,838)
Balance, end of year………………………………………………….$36,703……………….….$40,032
Defined Benefit Plan Assets
Pension Benefits
2020…………..…………2019
Balance, beginning of year…………………………………………$75,891………………….$90,828
Expected return on Plan Assets……………………………………. 5,599………………….. 6,723
Employee…
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B1.
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The tax rate of $.6943 in decimal form can be expressed per $100 as
A. $69.43.
B. $6.943.
C. $69.43 mills.
D. $690.3.
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23
Net income may be based on estimates.
true or False
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Astercor, Inc. reported the following during the year.
• P 400,000 proceeds of life insurance of an officer where Antercor is the beneficiary
(P600,000 still uncollected.)
• P800,000 interest income, exclusive of P200,000 uncollected and accrued interest
• P300,000 increase in value of investment in stocks
8. Compute the gross income under cash basis.
а. Р 800,000
b. P
ОБ.Р1,000,000
c. P 1,200,000
O d. P1,400,000
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Simple Accounting - Property Tax.
Market Value
Tax Policy
Rate
Property Tax
$1,370,980.00
50.75%
4.39571
a. $3,058,413.48
O b. $29,680.17
O c. $30,584.13
d. $60,264.30
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that are sold on the installment basis.
Rona Company started to manufacture in 2020 copy machines
payments are received for tax purposes.
Rona Company recognizes revenue when equipment is sold
for financial reporting purposes, and when installment
financial reporting purposes and P1,500,000 for tax purposes.
Koanancial reporting purposes, and when installment
. 2020, the entity recognized gross profit of P6,000,000 for
Enancial reporting purposes and P1,500,000 for tax purposes.
The amounts of gross profit expected to be recognized for
tax purposes in 2021 and 2022 are P2,500,000 and P2,000,000,
respectively.
The entity guaranteed the copy machines for two years.
Warranty costs are recognized on the accrual basis for
financial reporting purposes and when paid for tax purposes.
Warranty cost accrued in 2020 is P2,500,000 but only P500,000
of warranty cost is paid in 2020.
It is expected that in 2021 and 2022, P1,000,000 and
P1,000,000 respectively, of warranty cost will be paid.
In…
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Question 14: The original Social Security tax rate was
of taxable earnings.
Answer:
A.
10%
O 1%
С.
5%
D.
7%
B.
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