Term
| What are the two restrictions on Congress’ power to tax under the Article 1, Section 8 of the Constitution? How does the federal government have the power to tax income? |
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Definition
| (1) For indirect taxes, the tax must be uniform (which does not include split circuit decisions). (2) For direct taxes, there must be apportionment, meaning that the tax burden for each state has to be determined by the population. This means that the only tax that the federal government could collect directly would be a per capita tax, or a tax directly on the state based on census numbers. The 16th Amendment provides an explicit exception for income tax. |
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Term
| What is the difference between a “direct” tax and an “indirect” tax? |
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Definition
| A direct tax is a tax demanded from the very person who is intended to pay it (e.g., the income tax). An indirect tax is a tax paid primarily by a person who can shift the burden of the tax to someone else or who at least is under no legal obligation to pay the tax (e.g., sales tax). |
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Term
| What is the force of law associated with tax regulations and revenue rulings, including private letter rulings? |
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Definition
| Interpretive regulations do not have the force of law. Legislative regulations (“prescribed by the Secretary”) do have the force of law. Private letter rulings are only binding as to the parties. Revenue rulings are binding against the agency, but not against individuals. The internal revenue manual and revenue procedures are the internal rules of the IRS. |
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Term
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Definition
| A 30-day letter, in contrast to a “no change” letter, indicates an excess or a deficiency after an audit. The taxpayer has 30 days to pursue administrative appeals. The Appeals Office of the Service hears the taxpayer’s appeal. |
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Term
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Definition
| If a taxpayer does not resolve a tax controversy in the appeals process or fails to respond to the 30-day letter, the Service will issue the taxpayer a statutory notice of deficiency (also known as a 90-day letter). The Service must issue the 90-day letter before it can begin collection of the asserted deficiency. |
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Term
| What are the two types of jurisdiction for tax disputes? |
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Definition
| Refund Jurisdiction and Deficiency Jurisdiction. For refund jurisdiction, the taxpayer files a Form 870 to pay the deficiency after receiving a 90-day letter, but then makes a claim against the government in either a U.S. District Court (only court that provides for a jury), or the Federal Court of Claims. For deficiency jurisdiction, the taxpayer does not pay the deficiency after receiving a 90-day letter, and appeals the decision of the Service in Tax Court, which is an Article I court. |
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Term
| What is the statute of limitations? |
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Definition
| 3 years from filing is the basic statute of limitations. 6 years from filing for substantial understatements. Forever if you don’t file. There’s also a 10-year statute for collection after there has been litigation. |
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Term
| What are the steps for creating a tax base? |
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Definition
| (1) Under the 16th Amendment and § 61, gather “all income from whatever source derived.” (2) Apply the narrow and explicit exclusions of §§ 101-150 to arrive at gross income. (3) Take “Above the Line Deductions” under § 62 to arrive at adjusted gross income. (4) For individuals, take away personal exemptions and then calculate the standard deduction and the itemized, below the line deduction under § 63, taking the greater of the two. (5) Apply the progressive and marginal rates to the taxable income, considering rates for long-term capital gains. (6) Apply any credits to the final amount. |
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Term
| What is the definition of gross income under § 61? |
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Definition
| Gross income means all income from whatever source derived, including (but not limited to) compensation for services (including fees, benefits, and commission), gross income derives from businesses, gains from dealings in property, interest, rents, royalties, dividends, and alimony and separate maintenance payments. |
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Term
| How do you determine the value of compensation paid other than in cash? |
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Definition
| If services are paid for in property, the fair market value 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 are rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary. |
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Term
| Must there be an express exception to § 61 to exclude an item from gross income? |
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Definition
| YES. Under Cesarini v. U.S., the definition of income under § 61 is broad, and that income will be taxed unless there is an express exception. In Cesarini, the taxpayers found $5,000 in a piano that they had purchased. The Court held that they should include it in income in the year that it was found and “reduced to undisputed possession.” |
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Term
| Is it income if an employer pays his employee’s taxes? |
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Definition
| YES. Under Old Colony Trust, payment by an employer of an employee’s taxes is income to the employee. If it is between an employer and an employee, it is clearly consideration for services. If someone pays an obligation that you owe, it’s income to you. |
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Term
| What is the definition of income under Glenshaw Glass and Eisner v. Macomber? |
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Definition
| Under Glenshaw Glass, something is income when it is an accession to wealth clearly realized over which the taxpayer exercises complete dominion and control. Under Eisner v. Macomber, the realization requirement serves as a limitation. There must be a taxable event, sparking a change in your economic situation, in order to be taxed. Realization is considered to be a matter of administrative convenience, and is not a constitutional requirement. |
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Term
| Are profits from illegal activities considered in gross income? |
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Definition
| YES. The legality of the source of income does not matter. The definition of gross income is ALL income from WHATEVER source derived. |
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Term
| How much income does Owner realize if she agrees to charge Tenant only $1,000 if he makes $3,000 worth of improvements to the property? |
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Definition
| $4,000. Under § 61, rents are included in gross income. Under Reg. § 61-8, improvements to the property are considered as a substitute for rent where the parties intended it to be as such. However, unwanted improvements would not be considered income to the landlord and are explicitly excluded from income under § 109. |
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Term
| What are the tax consequences for an employee who receives property from his employer in exchange for services? |
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Definition
| Under §§ 61 and 83, the employee must include the fair market value of the property as part of his gross income. But if the property is nontransferable and subject to substantial risk of forfeiture, then the employee does not have to include it as income until one of the two restrictions lapses. |
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Term
| How do you compute a gain or a loss? |
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Definition
| Under § 1001(a), the gain or loss from dealings in property is the amount realized, less the adjusted basis. |
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Term
| What is the definition of amount realized under § 1001(b)? |
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Definition
| The amount realized from the sale or other disposition of property is the sum of any money received plus the fair market value of the property (other than money) received. |
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Term
| If T lends B money and later B pays it back, is the repayment income for T? |
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Definition
| No. The repayment constitutes a mere return of capital. There is no element of gain in the transaction, and it is therefore not recognized as gross income. |
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Term
| In general, how do you calculate the basis of property? |
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Definition
| Under § 1112, the basis of property is the cost of the property to the taxpayer (that is, the amount that the taxpayer originally paid, without regard for taxes on the property). Under Philadelphia Park, “cost” is “tax cost.” Tax cost means how much you can report as a result of the transaction. |
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Term
| How is cost basis determined under Philadelphia Park? |
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Definition
| Cost basis is determined by the value of what is received. If the fair market value is unascertainable, then the fair market value of the property given may be used to determine the basis. These values are presumed to be equal in an arms-length transaction. |
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Term
| A purchased property in 1941 for $10,000. He subsequently expended $6,000 for improvements. If A sells the property in 1954 for $20,000, what will be the amount of his gain? |
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Definition
| $4,000. Under § 1001(a), gain is the amount realized less the adjusted basis. Under § 1001(b), the amount realized is the amount of cash received in addition to the fair market value of any property, which, in this case, is $20,000. Under § 1012, basis is the cost of the property to the taxpayer, which in this case is $10,000. Under § 1016(a), basis may be adjusted for any expenditure properly chargeable to the capital account, including the cost of improvements to the property. Thus, gain is $20,000 less $16,000, which is $4,000. |
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Term
| A purchased property in 1941 for $10,000. He rented the property to B for five years, collecting $1,000 each year in rent and allowing B to spend $2,000 clearing the property. A sells the property in 1951 for $18,000. What is A’s gain? |
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Definition
| $8,000, assuming that B’s improvements are properly excluded from A’s gross income under § 109. § 1019 provides that improvements by tenants that are excludable under § 109 are not included in basis. Thus, the basis is $10,000 and the amount realized is $18,000, making the gain $8,000. The value of those improvements may be included in the taxable gain. |
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Term
| A is a salesperson in an art gallery who purchases a $10,000 painting from the art gallery, but is required to pay only $9,000 because of a 10% employee discount (which is excluded from gross income under § 132(a)(2)), and A later sells the painting for $16,000. What is A’s gain? |
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Definition
| $6,000. Under § 1012 and Philadelphia Park, basis is cost and cost is tax cost. However, by excluding employee discounts from gross income, Congress made clear that it did not want to tax the $1,000. Thus, to give A her full exclusion, the basis must be $10,000. With an amount realized of $16,000, A’s gain is $ 6,000. |
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Term
| How do you calculate the basis for property acquired by gift? |
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Definition
| Under § 1015(a), if the property was acquired by gift, the donee has a transferred basis, meaning that the basis is the same as it would be in the hands of the donor. However, if this basis 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 is the fair market value. |
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Term
| A father purchases property for $10,000. After some years pass, the value of the property goes up to $25,000. That year, the father gives the property to his daughter. The daughter sells the property for $37,000. What is her taxable gain? |
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Definition
| $27,000. These similar to the facts of Taft v. Bowers. Under Taft and § 1015(a), the donee voluntarily assumes the role of the donor. Thus, even though § 102 excludes gifts from taxable income, the daughter’s basis in the land is $10,000, creating a deferral and not a true exclusion. The amount realized, $37,000, less $10,000 is $27,000. |
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Term
| In contemplation of his future marriage to B, A gives B 100 shares of stock worth $5 a share in exchange for her release of dower and other marital rights. When A bought the shares, the stock was worth $1 a share. B later sells the stock for $8 a share. What is B’s taxable gain? |
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Definition
| $300. These are similar to the facts of Farid-Es-Sultaneh. Because there was consideration for the shares, and the donor did not have “detached and disinterested generosity,” the gift statute does not apply. Thus, the basis is the fair market value at the time of transfer ($500) and not A’s transferred basis ($100). The amount realized ($800) less the adjusted basis ($500) is $300. (Note that this is a strange tax loophole because the gift tax excludes “marital rights” as consideration). |
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Term
| A gives B a gift of property. The property had cost A $30,000, and it had a fair market value of $20,000 at the time of the gift. What is B’s gain if he later sells it for $35,000? |
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Definition
| $5,000. Under § 1015, the basis is the fair market value only for the purpose of determining loss. Thus, B still has a transferred basis of $30,000, even though A transferred the property at a loss. |
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Term
| A gives B a gift of property. The property had cost A $30,000, and it had a fair market value of $20,000 at the time of the gift. What is B’s gain if he later sells it for $24,000? |
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Definition
| Nothing. B’s basis is nothing since he would be selling it at a loss if he used A’s transferred basis, but would receive a gain if he used the fair market value at the time of transfer. Under § 1015(a), this means that the gain is nothing. |
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Term
| How do you determine the basis in the hands of a transferee when the transfer is in part a gift and in part a sale? |
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Definition
| In general, under Reg. § 1.1015-4, where a transfer of property is in part a sale and in part a gift, the unadjusted basis of the property in the hands of the transferee is the greater of the amount paid by the transferee for the property or the transferor’s adjusted basis for the property at the time of the transfer. |
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Term
| A transfers property to his son for $60,000. Such property in the hands of A has an adjusted basis of $30,000 (and a fair market value of $90,000). What is A’s gain and what is his son’s basis? |
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Definition
| A’s gain is $30,000, the excess of $60,000, the amount realized, over the adjusted basis, $30,000. Under § 1001-1(e), the transferor has a gain to the extent that the amount realized by him exceeds his adjusted basis. Under § 1015-4, the son’s basis is $60,000, the greater of the amount that he paid and his father’s adjusted basis. |
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Term
| A transfers property to his son for $30,000. Such property in the hands of A has an adjusted basis of $60,000 (and a fair market value of $90,000). What is A’s gain and what is his son’s basis? |
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Definition
| A has no gain or loss. Under § 1001-1(e), although the transferor has a gain to the extent that the amount realized by him exceeds his adjusted basis, there is no loss if the amount realized is less than the adjusted basis. Under § 1015-4, the son’s basis is $60,000, the greater of the amount that he paid and his father’s adjusted basis. |
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Term
| A buys property for $50,000 in year 1. In year 15, the property is worth $200,000. He sells it to a charitable organization for $100,000. What is the charity’s basis in the property? |
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Definition
| $125,000. Under §§ 1.1011-2 and 170(e)(2) this is a “bargain sale to charity,” so basis is determined in two steps. First, it’s treated as though A outright sold half of the land at its full value to the charity. Thus, the charity’s basis is $100,000, which is the value of the half that’s sold. As to the gift half, they get a § 1015(a) transferred basis of $25,000. Thus, the entire basis is $125,000. |
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Term
| Under § 1041(a), when is a gain or a loss not recognized? |
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Definition
| § 1041(a) provides that no gain or loss shall be recognized on transfers of property between: (1) spouses; and (2) former spouses (but only if the transfer is incident to the divorce). Under § 1041(c), a transfer of property is incident to the divorce if the transfer either occurs within one year after the date on which the marriage ceases or is “related to” the cessation of the marriage. |
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Term
| What are the tax consequences of a transfer between spouses or former spouses, when the transfer is incident to a divorce? |
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Definition
| In general, such transfers will not be recognized under § 1041(a), so the property given from Spouse A to Spouse B is not income to Spouse B. Under § 1041(b), the transfer is treated as a gift and the transferee takes the adjusted basis of the transferor. This is done so that the transfer between the “unit” remains tax neutral. |
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Term
| Does gross income include amounts received as alimony or separate maintenance payments? |
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Definition
| Yes, § 71(a) explicitly provides that it does. |
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Term
| When is a transfer of property “incident to a divorce”? |
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Definition
| Under § 1041(c), a transfer of property is incident to the divorce if the transfer either occurs within one year after the date on which the marriage ceases or is “related to” the cessation of the marriage. Treasury regulations provide a safe harbor to transfers within six years of divorce if “pursuant to a divorce or separation instrument.” A property transfer not made pursuant to a divorce decree is “presumed not to be related to the cessation of the marriage.” However, this presumption can be rebutted by showing that the transfer was made to effect the division of property at the time of the cessation of the marriage. |
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Term
| W and H get divorced in 1988. As part of the divorce decree, H delivers to W a $1.5 million promissory note. H defaults on the note, and W is awarded a judgment in state court in 1991. In satisfaction of the judgment, H transfers land to W, retaining the option to repurchase the land for $ 2.2 million. Will this transaction be recognized as a taxable event? |
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Definition
| NO. These are the facts of Young v. Commissioner. Whether or not the transaction is “recognized” depends on whether it falls into the § 1041(a) nonrecognition provision for property transfers within marriage or “incident to divorce.” Because the transfer took place more than a year after the divorce, the question is whether it was “related to the cessation of the marriage”? In Young, the court held that it was, even absent a provision in the divorce decree. The transaction would not have happened but for the divorce decree, and it “effects the division of property” provided for in the decree. |
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Term
| Under § 71(b), what is the definition of alimony or separate maintenance payments? |
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Definition
| Any payment in cash received by or on behalf of a spouse pursuant to a divorce or separate maintenance decree where there is no contrary provision in the decree, the two are not living together, and there is no liability to continue the payments after the death of the payee spouse. |
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Term
| Aside from transactions that do not meet the definition of § 71(b), what are three types of payments that can never be alimony? |
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Definition
| (1) § 71(c): Payments for child support. Any payments that end when a child dies or reaches a certain age will be characterized as child support payments. (2) § 71(e): Payments where the spouses have filed a joint return. (3) § 71(f): Payments that are front-loaded. That is, payments that are not substantially equal in the first three years that they are made. |
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Term
| What are the three major exceptions to the § 71(f) front-loading rules? |
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Definition
| First, if the amount of payment in the second or third year is reduced because one of the spouses dies or remarries. Second, if the support is pursuant to a mere decree for support or for temporary maintenance, then Congress does not suspect a property settlement. Third, contingent payments are not subject to the recapture rules, because these payments are subject to fluctuations beyond the control of the taxpayer. |
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Term
| What are the tax consequences of a transaction that is in the nature of alimony or support? |
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Definition
| Under § 71, the payee-spouse includes the payments in his gross income. Under § 215, the payor-spouse receives an above-the-line deduction. |
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Term
| A assigns a life insurance policy to his former wife and with respect to which she is the irrevocable beneficiary. Does he qualify for a § 215 deduction? |
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Definition
| Yes, assuming that the payment was made pursuant to a divorce decree with no contrary provision and the two are not living together. Although indirect, the payments are “on behalf of” A’s spouse because it is absolutely assigned to her and she is the irrevocable beneficiary. |
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Term
| A includes, in the divorce decree, a life insurance policy that he retains possession of. The children are the beneficiaries and the wife is a contingent beneficiary. Does he qualify for a § 215 deduction? |
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Definition
| No. Because the husband retains control and the wife is only a contingent beneficiary, the payments are not “on behalf of” a spouse, and can therefore not qualify as alimony or separate maintenance payments under § 71(b). |
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Term
| What sorts of payments can qualify as indirect alimony payments under § 71(b)(1)(A)? |
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Definition
| Where the payor spouse satisfies a legal obligation that belongs exclusively to the payee spouse and the payor spouse has no legal interest in the property. For example, if the payor spouse owns the home, it’s not alimony, but if the payor spouse is making rental payments for the payee spouse or mortgage payments on a home that the payee owns, then that is “on behalf of.” |
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Term
| Under § 71(c), how do you determine if a payment made pursuant to a divorce decree or separation instrument is in the nature of child support? |
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Definition
| There are two ways of determining if a payment is “child support.” First, if it is designated as such on the instrument. Second if any reduction is related to or seems to be related to a significant date for that child, then the amount of the reduction is child support. The regulations narrow this rule, making the “significant date” within six months of the local age of majority. |
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Term
| What are the tax consequences of determining that a payment is child support? |
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Definition
| Because “child support” is an exception to the exception for alimony, designation as such throws you back into the general rule for support payments. Thus, the payments are not considered income for the payee, and there is no above-the-line deduction for the payor. |
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Term
| What happens if the payor does not pay the full amount pursuant to a divorce decree or separation instrument? |
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Definition
| The payments are allocated first to child support. Any excess should be allocated to alimony or spousal support. |
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Term
| What are the consequences of a lump sum transfer by a spouse that does not go directly to the payee spouse but generates periodic income received by the payee? |
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Definition
| In these circumstances, there is no payment by the payor, even indirectly to the payee, which would qualify as alimony or separate maintenance (so, no deduction under § 215). Rather, the annuity rules of § 72 apply. Although the payments must be included in the payee’s gross income, the payor has no income and is not entitled to any deduction. |
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Term
| Pursuant to a divorce decree between H and W, H transfers a specified amount of property to a trust under the terms of which the income is to be paid to W until W dies or remarries, and when W dies or remarries, the remainder is to be paid to the children. What are the tax consequences? |
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Definition
| This is an alimony trust, therefore § 682 governs, not § 71. The payee has gross income and the trust is entitled to a deduction. |
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Term
| What are the tax consequences if, under state law, a divorce is found to be invalid? |
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Definition
| State law governs marital status. If a divorce is invalid, subsequent payments are no longer considered alimony. |
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Term
| How do you determine the basis of property acquired by a decedent—that is, by bequest, devise, or inheritance? |
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Definition
| Under § 1014(a), the general rule is that you use the fair market value of the property at the date of the decedent’s death. |
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Term
| Employer purchases 100 shares of stock at $5 a share in 1980. In 2010, Employer gives all of the stock, now worth $15 a share, to several high-performing employees in addition to their salary. What are the tax consequences for Employer? |
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Definition
| These are similar to the facts of International Freight, which held that the fair market value of services can be included the amount realized under § 1001(b). Even in the event of a bonus, we consider this to be an arms-length transaction where the value paid is equal to the amount received. Thus, the employer has a basis of $500, an amount realized of $1500, and a taxable gain of $1,000. The payment of employee bonuses will also be deductible as an “ordinary and necessary business expense” under § 162(a). |
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Term
| In 1976, A purchases an asset for $10,000. A pays the seller $1,000 in cash and signs a note payable to the seller for $9,000. During the years 1976 and 1977, A takes depreciation deductions on the asset in the amount of $3,100. During this same time period A reduces the outstanding principal on the note to $7,600. At the beginning of 1978, A sells the asset. The buyer pays A $1,600 in cash and assumes the $7,600 outstanding liability on the note. What tax consequences result? |
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Definition
| Under Crane v. Commissioner, A’s amount realized is $9,200, which is the sum of the $1,600 in cash and the $7,600 in debt from which he is relieved. A’s adjusted basis in the asset is $6,900, which is the $10,000 value of the note and the cash less the $3,100 in depreciation deductions. Under § 1001(a), A realized a taxable gain of $2,300 ($9,200 - $6,900). Note that it does not matter whether A is personally liable for repayment, or whether the seller’s only recourse is in the asset itself. The sale of property that secures a non-recourse liability discharges a person from liability. |
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Term
| A takes out a non-recourse mortgage in the amount of $1,000,000 to buy property in 1950. Between 1951 and 1999, A takes $100,000 in depreciation deductions. A also pays $100,000 of the debt. A sells the property, now with a fair market value of $700,000 to B in 2000. What is A’s taxable gain from the sale? |
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Definition
| ZERO. The sale of property that secures a non-recourse liability discharges a person from liability. Under Crane v. Commissioner and Commissioner v. Tufts, this discharge of indebtedness must be reflected in the amount realized, even if it is greater than the property’s fair market value. A’s basis in the property is $900,000 (the amount of debt that he incurred to purchase the property less his depreciation deductions), and his amount realized is also $900,000, which is the amount of debt from which he is relieved. He therefore has no taxable gain. |
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Term
| M purchases a parcel of land from S for $100,000, borrowing $80,000 from the bank and paying $20,000 in cash. Two years later, the land has appreciated in value to $300,000 and M has paid only interest on the $80,000. M takes out an additional $100,000 non-recourse loan on the property. Does M have income? |
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Definition
| No. The additional mortgage is not considered disposition of the property, requisite to receiving taxable gain and increasing basis in the property. M retains her original basis of $100,000. |
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Term
| M purchases a parcel of land from S for $100,000, borrowing $80,000 from the bank and paying $20,000 in cash. Two years later, the land has appreciated in value to $300,000 and M has paid only interest on the $80,000. M takes out an additional $100,000 non-recourse loan on the property. M uses the $100,000 to make improvements on the land. What is M’s basis? |
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Definition
| $200,000. Under § 1012, basis is the cost of the property to the taxpayer, including debt that the taxpayer incurs to acquire the property, which in this case is $100,000. Under § 1016(a), basis may be adjusted for any expenditure properly chargeable to the capital account, including the cost of improvements to the property. Thus, basis is increased to $200,000. |
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Term
| A, a dealer in real estate, acquired a 10-acre tract for $10,000 in 2000, which he divides into 10 lots. He sells 5 of the lots for $8,000 in 2005. He sells 2 lots in 2008 for $2,000. What are the tax consequences? |
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Definition
| Under Reg. § 1.61-6, the $10,000 cost must me equally apportioned among the lots so that on the sale of each A can determine his taxable gain or deductible loss. Thus, in 2005, A has a gain of $3,000 ($8,000 - $5,000). In 2008, A has no gain ($2,000 - $2,000). A still owns three lots with a basis of $1,000 each. |
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Term
| B receives property as a gift from A in 2000. A paid a $60,000 gift tax on the transfer. In 1990, A had paid $200,000 for the property. In 2010, when the property is worth $300,000, B sells the property to C for $320,000. What is B’s gain? |
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Definition
| $100,000. To determine B’s basis, start with a § 1015(a) transfer basis of $200,000. Then go to § 1015(d) for adjusting the basis to reflect the donor’s tax. § 1015(d) provides that the increase in basis is the net appreciation over the fair market value of the gift. Under § 1015(d)(6)(B), net appreciation is the mount by which the fair market value of he gift ($300,000) exceeds the donor’s adjusted basis ($200,000), which is $100,000. $100,000 (net appreciation) over $300,000 (fair market value) is 1/3. Multiplying the amount of the gift tax ($60,000) by 1/3 gets you a $20,000 increase. Thus, B’s gain is $320,000 (amount realized) less $220,000 (adjusted basis), which is $100,000. |
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Term
| What types of expenses are deductible as “trade or business expenses” under § 162(a)? |
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Definition
| All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. |
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Term
| What does “ordinary and necessary” mean under § 162? |
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Definition
| In Welch v. Helvering, the Supreme Court held that “ordinary” means “common,” or something that someone usually, or ordinarily does in the course of general and accepted business practice. This is a facts and circumstances test, looking to what people in the industry would consider ordinary. The Court also held that “necessary” means “appropriate and helpful.” This is a highly deferential standard, on par with the business judgment rule. |
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Term
| W had been an executive with a bankrupt company. When he became a commission agent in the same line of business as his former company, he voluntarily paid some of the company’s unpaid debts in order to establish good relations with his customers. Can W deduct these payments under § 162? |
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Definition
| No. These are the facts of Welch v. Helvering. These payments are not deductable because they are not ordinary expenses. An ordinary expense is one that is common and accepted in the industry, even if it is uncommon for a particular taxpayer. It is extremely rare in business for an individual to undertake the payment of an unenforceable debt. |
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Term
| What is the test for determining whether something is a capital expenditure or an expense, which is deductible under § 162(a)? |
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Definition
| To determine whether something is a capital expense, first ask whether the transaction created a separate asset. If yes, then it is a capital expenditure. If not, then ask whether the payment creates a more than insignificant future benefit to the taxpayer. If yes, then it is a capital expenditure. If not, then it is an expense. Note that there is a presumption in favor of finding that something is a capital expenditure. Expenditures will be things such as repairs that are temporary in nature and aren’t meant for anything more than preservation. |
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Term
| M-Corp’s neighbors were producing oil that was leaking into M-Corp’s basement. In response, M-Corp spent $10,000 to reinforce the lining of the basement. Is the $10,000 deductible as an “expense” under § 162(a)? |
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Definition
| Yes. These are the facts of Midland Packing. Generally, a repair fits under the definition of an expense because it’s meant to protect or maintain an asset that already exists. Replacements, however, are capital expenditures—not expenses—because they create a new asset. Here, the new lining was put in to protect an asset that already existed—the basement. Thus, M-Corp’s new lining is an expense. |
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Term
| B-Corp had water that was leaking onto its neighbor’s property. Under threat of lawsuit, B-Corp spent $10,000 to put in a drainage system, which stopped the leaking. Is the $10,000 deductible as an “expense” under § 162(a)? |
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Definition
| No. These are the facts of Mt. Morris Drive-In. Generally, a repair fits under the definition of an expense because it’s meant to protect or maintain an asset that already exists. Replacements, however, are capital expenditures—not expenses—because they create a new asset. Here, there was no drainage system before B-Corp. spent the $10,000—the drainage system was a new asset that they built, making it a capital expenditure. |
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Term
| U-Corp sought to acquire N-Corp in a friendly takeover. N-Corp incurred a variety of expenses, including $2.2 million in banker’s fees and about $500,000 in legal fees. Were the costs associated with the acquisition capital expenditures or deductible expenses? |
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Definition
| Capital expenditures. These are the facts of INDOPCO, Inc. v. Commissioner. Here, the Supreme Court held that even though no “separate and distinct” asset was created, that is a sufficient, but not necessary for finding that something is a capital expenditure. Merging creates value-added that extends into the future, making it a non-deductible capital expenditure. The banking and outside legal services “facilitated” this enhancement. Note, however, that under current treasury regulations, compensation paid to employees, overhead, and de minimis costs do not have to be capitalized as amounts that facilitate a transaction. |
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Term
| Are advertising expenses, incidental building repairs, and employer-incurred training costs deductible expenses under § 162(a)? |
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Definition
| Yes. Despite the “future benefits” test of INDOPCO, the Service has issued rulings specifically providing that these are expenses. |
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Term
| H and W are searching for a radio station to buy. Neither currently owns a radio station or is currently in the ration station or newspaper development business, but they’re hoping to break into it. Can H and W deduct the travel expenses associated with their search under § 162(a)? |
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Definition
| No. These are the facts of Morton Frank v. Commissioner. In that case, the Tax Court held that “in pursuit of a trade or business” does not mean “in search of.” Rather, it means that you’re already in the business and you’re carrying on the business. H and W will have to capitalize these expenses. |
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Term
| What is the definition of a start-up cost under § 195? |
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Definition
| § 195 softens the blow of the Morton Frank rule by allowing certain start-up costs to be amortized over a period of 60 months. “Start-up costs” are amounts incurred with respect to investigating the creation of or acquisition of an active business, creating an active business, or activities engaged for profit before the active business begins, but in anticipation of it beginning. For example, market studies, evaluation of labor supplies, advertising before the business begins, training employees, and lining up distributors are all considered “start-up costs.” |
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Term
| T, a doctor, inherited a substantial sum of money. T decided to invest a part of her fortune in the development of industrial properties and she incurred expenses in making a preliminary investigation. Are these expenses deductible under §§ 162 and 195? |
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Definition
| No. T is a doctor, so she is not already in the business of developing industrial properties. Under § 195(b)(1)(A), you can only elect § 195 once you’ve already started the business, so the expenses are not deductible. |
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Term
| T, a developer of residential and shopping center properties, inherited a substantial sum of money. T decided to invest a part of her fortune in the development of industrial properties and she incurred expenses in making a preliminary investigation. Are these expenses deductible under §§ 162 and 195? |
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Definition
| Yes. Most courts would find that T is already in the “real estate business,” even though she will be developing a new type of property. |
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Term
| When is seeking new employment deductible under §§ 162 and 195? |
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Definition
| Generally, costs associated with seeking new employment are only deductible under §§ 162 and 195 when the individual is: (1) already in the business and seeking employment elsewhere; or (2) where payment for services was contingent upon becoming employed. Costs associated with seeking new employment are not deductible if the individual is a first time job seeker, is seeking to break into a new business, or has had a lengthy period of unemployment. Law school, for example, is not a deductible expense. |
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Term
| When are business meals and entertainment deductible under §§ 162 and 274? |
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Definition
| First, the expense can’t be “lavish or extravagant” (§ 274(k)). Second, the expense must be “directly related to” or “associated with” the taxpayer’s trade or business (§ 274(a)). Essentially, “directly related to” means that business is going on during the entertainment, and “associated with” requires that the entertainment have a business purpose and directly precede or follow a bona fide business discussion. Third, the deducting taxpayer or an employee of the taxpayer must be present (§ 274(k)). Fourth, the taxpayer must have receipts (§ 274(d)). Finally, if all of those requirements are met, the taxpayer is only able to deduct 50% of the amount (§ 274(n)). |
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Term
| Does § 274 allow deductions for club dues? |
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Definition
| No. § 274(a)(3) explicitly provides that no deduction shall be allowed for amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or other social purpose. Note that this does NOT include club-dues for non-entertainment purposes. |
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Term
| When are deductions for uniforms allowed under § 162? |
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Definition
| Deductions for uniforms are allowed only if “(1) the uniforms are specifically required as a condition of employment and (2) are not of a type adaptable to general or continues usage to the extent that they take the place of ordinary clothing.” For example, a police officer’s uniform would be deductible, but a lawyer’s suit would not be. |
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Term
| When are deductions for advertising allowed under § 162? |
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Definition
| Generally advertising expenses of a business are deductible in the year that they are paid or incurred even though the benefits may extend over several years. This includes advertising in magazines or on television. On the other hand, an expenditure related to advertising can be capital in nature, like buying property to put up a billboard. Also, advertising that spills into being a political contribution is not deductible, as contributions directly or indirectly to political candidates are never deductible (§§ 162(e) and 271). |
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Term
| When are dues deductible under § 162? |
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Definition
| In general, dues paid to organizations directly related to one’s business are deductible (e.g., bar association dues). This also includes union dues, except that you cannot deduct the percentage that goes to political campaigns. |
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Term
| What are the three requirements that losses must satisfy in order to be properly deducted? |
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Definition
| Losses must be realized, recognized, and allowed. § 165 of the tax code provides when losses are allowed. |
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Term
| What are the three types of losses that individuals can deduct under § 165(c)? |
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Definition
| Losses associated with a trade or business (§ 165(c)(1)), losses associated with the production of income (§ 165(c)(2)), and casualty losses, or “acts of god” (§ 165(c)(3)). |
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Term
| D has a $6,000 adjusted basis for his uninsured boat, which was worth $10,000 before the storm. After the storm, the boat is damaged and is only worth $7,000. What are the tax consequences for D? |
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Definition
| D has a $3,000 casualty loss, which is deductible under § 165(c)(3). |
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Term
| D has a $6,000 adjusted basis for his uninsured boat, which was worth $10,000 before the storm. After the storm, the boat is totally destroyed. What are the tax consequences for D? |
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Definition
| D has a $6,000 casualty loss, which is deductible under § 165(c)(3). His loss cannot exceed his adjusted basis. |
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Term
| D has a $6,000 adjusted basis for his boat, which was worth $10,000 before the storm. After the storm, the boat is totally destroyed, but insurance paid him $4,000. What are the tax consequences for D? |
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Definition
| D has a $2,000 casualty loss, which is deductible under § 165(c)(3). To the extent that any loss is compensated by insurance, the loss must be reduced. |
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Term
| D has a $6,000 adjusted basis for his boat, which was worth $10,000 before the storm. After the storm, the boat is totally destroyed, but his insurance covered the full value of the boat. What are the tax consequences for D? |
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Definition
| D has a taxable casualty gain of $4,000. To the extent that insurance recovery exceeds the adjusted basis, a taxpayer has a taxable gain. |
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Term
| C buys property with a vacant barn worth $1,000 and spends $5,000 demolishing the barn. What are the tax consequences for C? |
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Definition
| Under § 280B, C cannot deduct the cost of demolition ($5,000) or the associated loss ($1,000). Rather, these costs are capitalized and will be included in the basis of the land on which the demolished structure was located. |
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Term
| What three factors help determine whether a cost is an “improvement” that must be capitalized? |
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Definition
| If the amounts paid: (1) result in a “betterment” of the property; (2) “restore” the property; or (3) adapt the property for a new use. To determine whether the property has been “bettered,” look to whether the cost fixes a defect at the time of acquisition or production or whether it makes the property more efficient. Also, look to the property’s total increase in value from just before wear and tear or when regular maintenance was required. |
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Term
| What are the three major pieces of information that you need in order to determine a taxpayer’s depreciation deductions? |
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Definition
| In order to determine a taxpayer’s depreciation deductions for an asset, you must determine (1) the useful life of the asset, (2) the salvage value of the asset, and (3) the method of allocating the cost of the asset (less its salvage value) over the useful life. |
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Term
| How do you use the straight-line method for depreciation deductions? |
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Definition
| Straight-line spreads the depreciation deduction evenly over the life of the property. Thus, you take the taxpayer’s basis in the item and subtract the salvage value. Then, divide that total by the useful life. The taxpayer will be able to deduct that much each year, and their basis will be reduced accordingly. |
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Term
| How do you use the declining balance method for depreciation deductions? |
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Definition
| The declining balance method makes it such that most of the deduction will be taken up-front. A uniform rate is applied each year to the basis of the property. As the basis gets smaller, the depreciation amount will be smaller as well. |
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Term
| What are the prerequisites under §§ 167(a) and 167(b) for taking a depreciation deduction? |
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Definition
| Depreciation deductions are allowed, provided that the property has a limited useful life (that is, it is subject to exhaustion and wear and tear), and it is either used in the trade or business or held for the production of income. |
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Term
| What is the relationship of depreciation to basis? |
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Definition
| Under § 1016, the periodic amount of depreciation (under the chosen method and convention) reduces the basis accordingly. Basis is reduced even if the taxpayer does not claim the deduction. |
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Term
| What is the relationship between the ACRS rules and the pre-ACRS rules? |
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Definition
| The ACRS was enacted in 1981. It is mandatory, and applies to most tangible depreciable property. The pre-ACRS rules, under § 167, apply only when the ACRS does not apply. Note that in 1986, significant changes were made to the ACRS, such that the post-1986 rules are referred to as “current ACRS.” |
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Term
| What are the major differences between the ACRS and pre-ACRS rules? |
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Definition
| ACRS accelerates the taxpayer’s deductions in three ways: (1) it uses recovery periods (predetermined useful lives) that are substantially shorter than the actual useful lives of the property; (2) it allows the use of accelerated depreciation methods; and (3) it assumes that the salvage value of property is zero. All of these measures streamline the depreciation process, and also make it less individualized, providing bright-line rules that reduce fights between the taxpayer and the government. |
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Term
| What is the salvage value when depreciating under the ACRS (§ 168)? |
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Definition
| Under § 168(b)(4), the salvage value is always treated as zero. |
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Term
| Under § 168, what three things determine the taxpayer’s annual depreciation deductions? |
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Definition
| (1) The applicable depreciation method; (2) the applicable recovery period; and (3) the applicable contention. |
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Term
| How is the applicable recovery period for tangible property determined? |
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Definition
| The applicable recovery period is determined under §§ 168 (c) and (e). The recovery periods are generally based upon the class life for the property determined by the secretary of the Treasury. Section 168 (e)(3) gives the classification for certain types of property. |
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Term
| What is an “applicable convention”? |
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Definition
| Under § 168(d), the applicable convention is the date on which the depreciable property is deemed to have been placed in service by the taxpayer. |
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Term
| What is the half-year convention and when is it used? |
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Definition
| Under the half-year convention, property is deemed to have been placed into service on the date that is halfway through the year. This convention is used for all property that is not real property, except, under § 168(d)(3), in the case of suspected abuse—when a disproportionate amount of depreciable property is placed in the last three months of the year. |
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Term
| What is the mid-quarter convention and when is it used? |
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Definition
| The mid-quarter convention assumes that property has been placed into use midway through the applicable quarter. It is used for non-real property instead of the half-year convention when abuse is suspected under § 168(d)(3)—when a disproportionate amount of depreciable property is placed in the last three months of the year. |
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Term
| What is the mid-month convention and when is it used? |
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Definition
| The mid-month convention assumes that property has been placed into use midway through the applicable month. It is used for all depreciable real property. |
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Term
| When must a taxpayer use the straight-line method of depreciation under § 168(b)? |
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Definition
| A taxpayer must use the straight-line method to depreciate real property and may elect to use the straight-line method to depreciate other types of property. |
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Term
| What is the 150 percent declining balance method and when is it used? |
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Definition
| The percentage deduction that would be allowed for the property under the straight-line method is calculated and multiplied by 150%. Each year, that percentage is taken from the reduced basis. This method applies if the property is 15-year property or 20-year property. However, a taxpayer may elect to use it for any non-real property. |
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Term
| What is the 200 percent declining balance method and when is it used? |
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Definition
| The percentage deduction that would be allowed for the property under the straight-line method is calculated and multiplied by 200%. Each year, that percentage is taken from the reduced basis. This method applies to all non-real property that is not 15-year property or 20-year property. |
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Term
| When do the anti-churning rules of the ACRS apply? |
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Definition
| Anti-churning rules are designed to prevent taxpayers from bringing within the current ACRS rules property they or “related persons” used before the current ACRS rules applied (before 1987). They apply if and only if the current ACRS rules allow a more rapid write-off in the first year that property is placed in service than depreciation for that year under the rules that the “related person” had been using. Related persons include family members and entities such as partnerships and corporations in which the taxpayer has an interest. These rules do not apply to real property. |
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Term
| S had a $30,000 adjusted basis in property that he used 1/3 for business and 2/3 for pleasure. Over ten years, he took $5,000 in depreciation deductions. He then sold the property to X when it was worth only $15,000. What are the tax consequences for S? |
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Definition
| Under Sharp v. United States, S must divide the property according to its business use and its pleasure use. Thus, the basis for the property’s business use is $10,000 less the full $5,000 in depreciation deductions (which you can only take on income-producing property). His amount realized is $5,000, giving him no deductible loss and no taxable gain. He has a $10,000 loss on the part of the property used for pleasure, which is not deductible under § 165. |
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Term
| A is a professional musician who uses specialized, antique bows to perform his music. The bows are expensive and have a short life. B is an art collector who hangs antique bows in his gallery. What tax consequences for A and B? |
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Definition
| Under Simon v. Commissioner, A will be able to take depreciation deductions and B will not. In general, you cannot determine the useful life of an antique. Thus, for the average person, these antique bows will not be depreciable. A, however, uses them in such a way that they undergo wear and tear and have a determinable useful life. |
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Term
| Can a taxpayer who elects to use the straight-line method for depreciation deductions on his automobile (which is five year property), still use the 200 percent declining balancing method for computers and other qualifying technology (which is also five year property) that he put into service the same year? |
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Definition
| No. Under §§ 168(b)(5) and (g)(7), if any of the alternatives are elected, the election is applied to all ACRS property within the same class which is placed in service the year of election. However, this rule DOES NOT APPLY in the case of real property. |
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Term
| When can a taxpayer take advantage of the § 168(k) additional depreciation? |
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Definition
| When the taxpayer purchases personal property qualifying under the ACRS or off-the-shelf computer software in 2009, 2010, 2011, and any year thereafter, the taxpayer may be able to deduct a portion of the cost as a regular business expense and depreciate the remainder. In 2009, the applicable amount was $250,000. In 2010, it was $125,000. In 2011 and the years following, it is $25,000. |
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Term
| What are the effects of § 168(g)? |
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Definition
| § 168(g) provides an alternative depreciation system for the types of property specifies in § 168(g)(1). Property subject to this alternative system has a longer recovery period and is depreciated using the straight-line method. |
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Term
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Definition
| § 280F is triggered for “luxury” cars (those costing more than $12,800, depending on the year), and “listed property” that has a business use of 50% or less. It imposes limitations on the amount of depreciation that a taxpayer can deduct. If the property is used for less than 50% business in the year that it is put into service, but that changes in subsequent years, then the taxpayer can recapture that reduced depreciation as income. |
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Term
| What is the recovery period, method, and convention for residential rental property? |
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Definition
| 27.5 years under the mid-month convention using the straight-line method. |
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Term
| What is the recovery period, method, and convention for nonresidential real property? |
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Definition
| 39 years under the mid-month convention using the straight-line method. |
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Term
| When is rental property classified as “residential”? |
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Definition
| Under § 168(e), only when 80 percent or more of the gross rental income is from “dwelling units”—this does not include hotel rooms and units rented on a “transient basis. |
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Term
| A policeman purchases a new uniform at his own expense. Is this deductible under § 62 or § 63? |
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Definition
| An employee is not involved in a trade or business, so this is deductable below the line under § 63. |
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Term
| A salesperson takes a client out to dinner and is not reimbursed by the employer. Is this deductible under § 62 or § 63? |
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Definition
| Assuming that the dinner meets all of the requirements under § 274, she will be able to deduct half under § 274(n). This deduction will be below the line under § 63 because she is an employee. |
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Term
| An employee spends $300 taking a client out to dinner. The employer reimburses her $500. What are the tax consequences? |
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Definition
| Because the meal has been reimbursed by the employer, the employer will be able to deduct the full amount of the expense ($300) above the line under § 62. The employee has $500 in income, but can deduct $300 below the line. § 274(n) does not apply. Also, the employee will have to report the deduction and the reimbursement because the expense and reimbursement do not match up. |
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Term
| An employee deducts $1,000 for interest on student loans. Is this allowed? If so, is the deduction above the line or below the line? |
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Definition
| Yes. The deduction is allowed under § 221 and it is above the line. |
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Term
| An employee is an elementary school teacher who buys $350 worth of classroom materials in the current year. Can she deduct this expense? If so, is the deduction above or below the line? |
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Definition
| Yes. Under § 62(a)(2)(D), she can deduct up to $250 above the line. The remainder must be below the line. |
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Term
| What are the requirements for deducting moving expenses under § 217? |
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Definition
| There are two major requirements of § 217: distance and timing. First, the distance to your new place of work must either be 50 miles from your former place of work or (if you are unemployed) 50 miles from your former residence. Second, you must be employed at your new job for 39 weeks out of the first twelve months from your move. If you’re self-employed, you must meet the additional requirement of working 78 weeks in a 24-month period. The time requirement is waived if the taxpayer dies, becomes disabled, gets fired (other than for willful misconduct), or gets transferred. |
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Term
| What is the scope of deductible expenses under § 217 and when does the deduction apply? |
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Definition
| The scope includes reasonable expenses for moving and traveling (e.g., lodging), but not meals. Members of the taxpayer’s household who lived in the former residence and are also taking on the new residence as their principle place of residence (e.g., spouse) are also included. If the taxpayer is moving outside of the United States, he can also deduct reasonable costs of storage. The deduction applies either in the year paid or accrued. |
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Term
| What are the requirements for a deduction for medical expenses under § 213? |
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Definition
| Under § 213(a), the expenses must be paid in the taxable year, not compensated by insurance or otherwise, for the medical care of the taxpayer, his spouse, or a dependent, and they can only be deducted to the extent that they exceed 7.5% of gross income. Under § 213(b), only insulin and prescribed drugs qualify for a deduction. |
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Term
| T’s condition made it dangerous for her to be exposed to dry, dusty air. On the recommendation of a physician, she installed a central air unit for $1,200. Installing the unit increased the value of her home by $500. What are the tax consequences for T? |
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Definition
| T can deduct only $700 under § 213. The remainder is a capital expenditure to be added to the basis of her home. As a general rule, a medical care expenditure for what is a capital expenditure in the nature of a permanent improvement to the taxpayer’s home is not deductible as a medical expense. However, where the taxpayer is able to show that such increase in value is less than the expenditure, the excess is deductible as a medical care expense. |
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Term
| A physician has diagnosed X with hypertension and recommended that he participate in a weight loss program. X spends $300 in program fees and $500 for reduced calorie foods as part of the program. Is this deductible under § 213? |
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Definition
| The $300 in fees is deductible, but the $500 in food costs is not. The test is whether the expense is incurred primarily for the prevention, treatment, cure, or diagnosis of a medical condition, or whether it is “merely beneficial” to the taxpayer’s health. Here, because the program is a treatment for X’s hypertension, the program fees are a medical expense. The food costs are a mere substitute for normal food costs, however, and are not deductible. |
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Term
| X spends $4,000 on a hair transplant and $5,000 on plastic surgery to repair an injury he sustained in a car accident. What is deductible under § 213? |
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Definition
| The cost of the hair transplant is not deductible, but the cost of the plastic surgery is. § 213(d)(9) excludes cosmetic surgery or similar procedures from the definition of “medical care,” unless the procedure is in response to a deformity arising from a congenital abnormality, trauma, or a disfiguring disease. |
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Term
| Are state and local property taxes deductible? |
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Definition
| Yes, under § 164(a), they are generally allowed as an above the line deduction. |
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Term
| Is interest on a loan tax deductible? |
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Definition
| Yes, under § 163(a), interest on indebtedness is generally allowed as a deduction, and this is an above-the-line deduction. |
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Term
| What is the adjusted gross income limit for charitable contribution deductions under § 170? |
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Definition
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Term
| When is someone allowed to take a personal exemption for himself under § 151? |
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Definition
| When his income is not too high (e.g., for a head of household it does not exceed $125,000), and he is not listed on anyone else’s return (§ 151(d)(3)). |
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Term
| When is someone allowed to take a personal exemption for a spouse under § 151? |
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Definition
| Either if you file a joint return, or is you file a separate return, but the spouse has no income and is not listed on anybody else’s return. |
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Term
| What is a “qualifying child” under § 152(c)? |
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Definition
| A “qualifying child” is a dependent within the meaning of § 151 and can be listed on another person’s tax return for a personal exemption. Here, there are four characteristics: (1) Relationship, (2) Residency, (3) Age, and (4) Support. The person has to be a child, grandchild, sibling, or child of a sibling. The person has to live with the one claiming the deduction for more than half of the year (not including time away for education). The person has to be less than 19 if not in school and less than 24 if in school. Finally, the “child” must not have provided more than half of their support. |
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Term
| What is a “qualifying relative” under § 152(d)? |
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Definition
| A “qualifying relative” is a dependent within the meaning of § 151 and can be listed on another person’s tax return for a personal exemption. Here, there are four requirements. First, the person can’t be a qualifying child. Second, the relationship has to be one that is recognized in the statute. Third, the person’s earnings can’t be greater than the deduction. Fourth, you have to provide more than half of the support for that person. However, if a large group is taking care of the person, they can agree on the person who will claim the deduction. |
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Term
| Two spouses file separately and have custody of one child together, although they live apart. Who can claim the exemption? |
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Definition
| If between a parent and a non-parent, the exemption goes to the parent. If between two non-parents, the exemption goes to the one with the higher adjusted gross income. If between two parents, the exemption goes to the parent with whom the child lives the longest during the year. If the child splits his time equally, the exemption will go to the parent with the higher adjusted gross income. |
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Term
| What is the standard deduction? |
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Definition
| Under § 63(c), any taxpayer can take the standard deduction to arrive at their taxable income if they do not elect to use itemized deductions. Not adjusting for inflation, the basic standard deduction is $6,000 for a joint return or a surviving spouse, $4,400 for heads of household, and $3,000 for everyone else. § 63(f) provides an additional deduction for blind people and people over 65. In addition, § 63(c)(7) provides an increase in standard deduction for state property taxes (up to $1,000). For certain dependents (under § 152), their basic standard deduction can’t exceed the greater of the sum of their earned income and $250 or $500. |
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Term
| What is a miscellaneous itemized deduction? |
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Definition
| A deduction not listed in § 67(b) (e.g., state and local taxes and interest). These deductions are subject to a floor of two percent of adjusted gross income. |
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Term
| A husband and wife enter into a contract whereby he shifts half of his earned income to her on an annual basis. The two file separately. Can the wife claim this as income on her tax return? |
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Definition
| No. These are the facts of Lucas v. Earl. In that case, the Supreme Court held that the “fruit must be taxed to the tree on which it grew.” In other words, because the husband earned the income, he must claim it as his own income on his return. This is the general rule for assignment of income from earnings. |
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Term
| What is the “Renouncement Rule” in assignment of income from earnings? |
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Definition
| The “renouncement rule” comes from Commissioner v. Giannini. There, the court held that income from earnings may be assigned to someone else if: (1) Prior to earning the income, (2) the taxpayer disclaims his income, and (3) does not direct where the income should go. There is an exception for the “prior to earning the income” element if the taxpayer renounces the income completely and does not direct where it goes. |
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Term
| What is the “Executor Exception” in assignment of income from earnings? |
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Definition
| The executor exception gives executors of estates six months to disclaim the fees after they have earned them. This rule is meant to protect individuals who do not realize that they are entitled to a fee until they have started working. Here, there must be some evidence of intent to render gratuitous services. There may also be an implied waiver with a continuous failure to claim commissions. |
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Term
| What is the “Agency Exception” in assignment of income from earnings? |
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Definition
| This is an exception to the general rule that the fruit must be taxed to the tree from which it grew. When an agent earns income on a principle’s behalf, the income may be taxed to the principle, and not the agent. An example is in Rev. Rul. 74-581, where a faculty member had agreed to accept a salary from the law school while working on behalf of them for clients in the clinical program. |
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Term
| A owns a bond, which periodically bears interest. Without giving away the bond itself, A hands over the right to receive the interest to his son, B. Who may report the interest as income? |
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Definition
| The interest is A’s income. These are the facts of Helvering v. Horst. In that case, again, the Supreme Court held that the fruit must be taxed to the tree to which it grew. Since the father still owned the bond, and the bond was bearing the interest, the income is the father’s and not the son’s. This is the general rule for assignment of income in property. |
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Term
| W creates a trust giving his son, E, a life estate in the income of the trust. E assigned to his daughter, L, an interest of $10,000 a year in the trust. E made similar assignments with the rest of his children. The trustees distributed the income directly to L and the other children. Who is required to report the income? |
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Definition
| The children of E. These are the facts of Blair v. Commissioner. E had a property right in the income, but not remainder rights. Because E distributed whole portions of his property right, he properly assigned the income to his children. Thus, the difference between Blair v. Commissioner and Helvering v. Horst was that Blair gave is children whole slices of the “cake,” whereas Helvering only gave one layer, like the icing. The former is permissible, but the latter is not—the taxpayers must assign all “layers” of the property interest. |
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Term
| To offset an interest deduction, T accelerated his income by selling anticipated future dividends to his son for $115,000. Does this create an assignment of interest problem? |
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Definition
| No. These are the facts of Estate of Stranahan v. Commissioner. In that case, the court reasoned that the taxpayer was not attempting to shift his income to another person. Rather, he was assigning it for value, which is permissible under the tax code, because he will still be taxed on the value he receives for his assigned interests. Simply because it was advantageous to the taxpayer to accelerate his income does not make this a suspect transaction—a taxpayer is free to arrange his financial affairs to minimize his tax liability. |
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Term
| S signed a contract, selling her property interest in a gas station to A. Before the closing, however, she conveyed her interest in the gas station to her children. At the time of the closing, S showed up with her children and they all executed the deed together. In this situation, who gets taxed on the sale of the gas station? |
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Definition
| S gets taxed on all of it. These are the facts of Susie Salvatore. There, the court held that this was another version of the “ripe fruit problem.” The income from the sale of the gas station was earned at the time S signed the contract. Thus, S attempted to transfer the income after it was already earned, when it was too late for her to transfer. |
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Term
| What is the default method of accounting, and how does a taxpayer change his accounting method once he has filed his first return? |
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Definition
| For all entities except for C corporations and partnerships including C corporations, the cash method is the default method. The consent of the Commissioner must be obtained in order to change accounting method. One must generally show a business purpose for making the change. |
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Term
| What are the general requirements under §§ 446(a)-(b) for choosing an accounting method? |
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Definition
| The taxpayer must use the same method of accounting that he uses for keeping his books, and the method must also “clearly reflect income.” |
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Term
| What is the general rule for receipts and disbursements under the cash method of accounting? |
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Definition
| Include items of gross income in the year actually or constructively received. Deduct in the year of actual payment. |
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Term
| When is a payment constructively received? |
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Definition
| Under Reg. § 1.451-2, income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time. Income is not constrictively received if the taxpayer’s control of its receipt is subject to substantial limitations. According to Professor Moran, the pertinent question to ask is: could Superman have gotten the payment? If so, then the payment is constructively received, since Superman is only bound by law. |
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Term
| What are the factors to consider in the “cash equivalent test” and what is the test’s importance? |
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Definition
| The cash equivalent test is for determining whether there has been actual payment in the case of a check, promissory note, or I.O.U. Under this test, you ask: (1) whether there was a promise to pay; (2) if the obligor is solvent; (3) if the promise is unconditional and assignable; (4) if the promise is not subject to set-offs; and (5) whether the promise is frequently transferable at a discount no greater than the prevailing cost of money. |
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Term
| A receives a check at 6:00 p.m. on December 31 of Year 1, when it is too late to take the check to the bank. He cashes the check on January 3rd of Year 2. Under the cash method, what year does A have income? |
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Definition
| Year 1. Under the cash method, the taxpayer includes gross income in the year of actual or constructive receipt. A has actual receipt, because his check meets all of the requirements of the “cash equivalency test”—as a general rule, checks will meet all of the factors. |
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Term
| B receives a promissory note on June 2 of Year 1, which is not payable until March 3 of Year 2. B attempted to sell the note in Year 1 to several banks, but to no avail. B receives his payment on April 20 of Year 2. Under the cash method, what year does A have income? |
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Definition
| Year 2. These are the facts of Williams. There, the court held that because the obligor was not solvent and because the promissory note had no fair market value, it did not meet the cash equivalency test. The note served as mere evidence of indebtedness, and was not an actual payment. |
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Term
| C is a professional football player. He won a car on Sunday December 31, 1960. At the time, Sports Magazine had already purchased the car for him and it had been “set apart” for him. However, the dealership was in New York and it was closed, so there would have been no way for him to get the car. Under the cash method, what year does C have income? |
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Definition
| Year 1. These are the facts of Hornung v. Commissioner, although the case was not decided the right way. In Year 1, C had a property interest in the car, which had been “set apart” for him. Only physical circumstances were in his way. Thus, this case survives the “Superman test” for constructive receipt. |
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Term
| B is a cash-method taxpayer. In Year 1, he pre-pays $1,500 total on a 3-year insurance policy. In what year may B take the deduction for his payment? |
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Definition
| Under Boylston Market and § 461(g)(1), this expenditure must be capitalized with deductions taken ratably over the asset’s useful life. Thus, B may take a $500 deduction in Year 1, Year 2, and Year 3. The rule is that an expenditure which results in the creation of an asset that has a useful life extending “substantially beyond” the close of the taxable year may not be deducted in the year that the payment was made. |
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Term
| B is a cash-method taxpayer. In July 5 of Year 1, B purchases for $300 an insurance policy, which expires on June 20 of Year 2. In what year may B take the deduction for his payment? |
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Definition
| Year 1. Under the “one year rule” prepaid expenses (other than those governed by a specific statute) may be deducted in the year when they were pair, even though they span a period of two taxable years, as long as the expenses do not relate to a period greater than one year. |
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Term
| What are the conditions under which the § 461(g)(2) exception for “points” on a mortgage? |
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Definition
| Points are like a prepayment and are thus an exception to the § 461(g)(1) exception for prepaid interest. Under § 461(g)(2), the taxpayer can deduct the “points” in the year paid. For this provision to apply, the loan has to be in connection with the improvement or renovation of the taxpayer’s principal place of residence, has to be standard in the area, and payments have to have to be out of the taxpayer’s pocket. In order to take a deduction for the points, you have to pay them.v |
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Term
| T donates money to a charitable organization, C, by sending a check in the mail in Year 1. C receives the check and cashes it in Year 2. When can T take their § 170 deduction under the cash method? |
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Definition
170 deduction under the cash method?
Year 1. Contributions by check are deductible in the taxable year in which the check is delivered provided the check is honored and paid and there are no restrictions as to the time and manner of payment thereof. |
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Term
| In 1941, the Board of Directors of A-Corp. voted for an employee’s salary and set that salary aside. In 1942 A-Corp. paid the employee’s salary. When can A-Corp take its deduction under the cash method? |
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Definition
| 1942. These are the facts of Vander Poel. In that case, the tax court held that there’s no such thing as constructive payment. Even though the employee constructively received his salary in 1941, deductions are only allowed when the money is paid and due. |
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Term
| In general, when do you have income under the accrual method of tax accounting? |
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Definition
| Under the “all events test,” you have income when all events fixing the right to receive it have occurred and the amount of income can be determined with reasonable accuracy. |
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Term
| In Year 1, TP performs services for Client B. However, Client B goes bankrupt and it is not clear that they will be able to pay them back for the services. Under the accrual method, when does TP have income? |
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Definition
| TP has income in Year 1, when the services were performed and all events fixing the right to receive income have occurred. Even though it is clear that TP will not be paid, TP will have to accrue now and take the bad debt deduction later. |
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Term
| In 1980, TP was awarded a judgment against B in District Court for $100,000. In 1983, the judgment was affirmed. In 1985, the U.S. Supreme Court denied B’s petition for writ of certiorari. When does TP have income under the accrual method? |
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Definition
| 1985, when B exhausted his appeals. For legal claims, the date of final judgment means that all events have transpired, fixing the right to income. In general, if there’s litigation, your right will be fixed when there’s no longer a possibility for future litigation. |
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Term
| In 1915, the government filed suit, claiming ownership of TP’s land. In 1916, the court appointed a receiver to operate the property and hold income while litigation ensued. In 1917, TP was paid the 1916 profits by order of the District Court. The government appealed, and in 1920, the COA affirmed. In 1922, a further appeal to SCOTUS was dismissed. When does TP have income? |
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Definition
| 1917. These are the facts of North American Oil. In that case, the Court established the “claim of right” doctrine, which provides that if you receive property under a claim of right (you claim that it is yours by right), you will be taxed on that property, even though your right has not yet been fixed. |
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Term
| Lessee makes a $30,000 pre-payment in 1949 to be applied as rent in 1959. Under the accrual method, when does Lessor have income? |
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Definition
| 1949. These are the facts of New Capital Hotel. In that case, the court held that the lessor received the money for the last year’s rent under a claim of right, which is distinguishable from a security deposit. |
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Term
| What are the two major exceptions to the “claim of right” doctrine? |
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Definition
| (1) When the method more “clearly reflects income” under Artnell. That case involved proceeds of advance sales of tickets for baseball games and revenue for future related services, which allowed for “certainty” on a “fixed schedule.” (2) Congressional carve-outs, including the carve-out for magazine subscriptions, prepaid dues for organizations, and refunds for magazines and periodicals. |
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Term
| What are the three congressional carve-outs to the claim of right doctrine? |
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Definition
| (1) Under § 455, for magazine subscriptions, you match income to the production of the magazine; (2) Under § 466, for prepaid dues for organizations, you match income with services; and (3) Under § 458, for magazine refunds, you never report the income because you take the income and later. |
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Term
| What is the general rule for taking a deduction under the accrual method of tax accounting? |
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Definition
| When all events fixing the liability occur, the amount can be determined with reasonable accuracy, and there is economic performance. |
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Term
| Under § 461(h)(2)(A), what are the three ways to show economic performance? |
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Definition
| (1) Transaction for services: economic performance occurs when the person provides the services; (2) Transaction for property: economic performance occurs when the person gives the property; (3) Transaction for use of property: economic performance occurs when such use of property occurs. |
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Term
| What four requirements must be met for the recurring items exception under § 461(h)? |
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Definition
| (1) The “all events test” must otherwise be met; (2) Economic performance must occur within the shorter of either a reasonable time or eight and a half months after the close of the tax year in which the taxpayer accrues the item; (3) The item is recurring in nature and the taxpayer treats it consistently; and (4) The item is either not material or accruing the item under the all events test provides better matching of income and expense than the economic performance standard could provide. |
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Term
| On December 15, 2006, X executed a contract with Y for the provision of services. The contract provides for services to begin on January 15, 2007, and end on January 31m 2007. Under the term of the contract, payment for the services is due to Y on January 15, 2007, and X pays Y for the services on January 15, 2007. Can C use the recurring items exception under § 1.461-5? |
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Definition
| No. The mere execution of a contract, without more, does not establish the fact of a liability for services, which is the first requirement for the recurring items exception. |
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Term
| On December 15 of Year 1, Debtor legitimately disputes his obligation to pay Year 1’s interest but Debtor pays it and, in Year 2, sues to recover it. What are the tax consequences for both parties? |
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Definition
| Lender has income in Year 1. Lender has received the income under a claim of right. Debtor should not be able to get a deduction because of the legal contingency. However, he can take the deduction if he meets the requirements of § 451(f): (1) The debtor contests liability; (2) Pays anyway; (3) There is litigation after the payment; and (4) Accrual under § 461(h) would have occurred but for the contest. This is a way of getting around the all events fixing liability test. |
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Term
| X-Corp., an accrual method taxpayer, leases a parcel of land from B, a cash method taxpayer. B owns 20 shares of X. S, B’s spouse, owns 15 shares of X. The B and Z partnership, in which B has a 50% interest, own 20 shares of X. Does § 276 forced matching apply? |
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Definition
| Yes. If there is an accrual payor and a cash payee and the taxpayers are related, § 267 forces them both to be cash method for that particular transaction. If the taxpayer has a 50% interest in the corporation, then he is “related” under the meaning of § 276(b). Here, the taxpayer owns 20% directly. Then, he owns 15% indirectly through his spouse, and 20% indirectly though his partnership. Thus, § 276 forced matching applies. |
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Term
| X-Corp., an accrual method taxpayer, leases a parcel of land from B, a cash method taxpayer. B owns 20 shares of X. S, B’s spouse, owns 15 shares of X. The S and Z partnership, in which S has a 50% interest, own 20 shares of X. Does § 276 forced matching apply? |
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Definition
| NO. If there is an accrual payor and a cash payee and the taxpayers are related, § 267 forces them both to be cash method for that particular transaction. If the taxpayer has a 50% interest in the corporation, then he is “related” under the meaning of § 276(b). Here, the taxpayer owns 20% directly. Then, he owns 15% indirectly through his spouse, but the link from his spouse’s partnership to his spouse to him is too attenuated. Thus, § 276 forced matching does not apply. |
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Term
| What are the three main rates for long-term capital gains? |
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Definition
| Capital gains are either in the 28% group, the 25% group, or the 15% group. “Collectables” and § 1202 stock are in the 28% group. Depreciable real property is in the 25% group. Gains on most long-term capital assets not in the other two groups (stocks, bonds, investment land) is in the 15% group. However, if the taxpayer’s marginal rate is less than 25%, this last group is taxed at a 0% rate. |
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Term
| What is the holding period required for a long-term gain? |
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Definition
| Under §1222, the holding period is one year. |
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Term
| How much capital loss can a corporation deduct? |
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Definition
| Corporations can only deduct capital losses up to the amount of capital gains. |
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Term
| How much capital loss can an individual deduct? |
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Definition
| Non-corporate taxpayers get to deduct capital losses against capital gains, plus $3,000 of capital loss against ordinary income. (§ 1211(b)). |
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Term
| How do you determine if something is inventory or property held for sale to customers under § 1221(1) and why is it important? |
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Definition
| Under § 1221(1), inventory or property held for sale to customers is NOT a capital asset. To determine whether it is inventory, you look to the intent of the taxpayer to see if the property was “primarily” for sell or if selling was “of first importance. For example, in Mauldin, even though the taxpayer originally bought land to raise cattle (which would make it a capital asset), he began dividing and selling the lots and intended to hold them for inventory. |
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Term
| What are the tax consequences of “hedging transactions,” where you’re trying to protect the price of your inventory? |
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Definition
| §§ 1222(7)-(8) provide that if you purchase stock or commodities as a hedge, then you have ordinary income, not capital assets. See Corn Products, where the Court held that if corn would be inventory to corn products, then corn futures would be inventory to corn products. |
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Term
| If a debtor satisfies a debt with appreciated property, is that a sale or exchange? |
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Definition
| Yes. See Kenan v. Commissioner, where the trust gave the niece 5 million dollars in appreciated stock instead of five million dollars in securities. |
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Term
| If a creditor receives an amount to extinguish a debt, is that a sale or exchange? |
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Definition
| No. See Hudson v. Commissioner, where X obtained a judgment against Y and X sold the judgment to the taxpayer. |
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Term
| How do you count the holding period for capital assets? |
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Definition
| Do not count the day of purchase, but count the day of sale. You count by months—even though some months are shorter and some months are longer, it does not matter. |
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Term
| T’s father bought 100 shares of stock on January 10 of year one at $30 per share. On March 10 of year one when they were worth $40 per hare he gave them to T who sold them on January 15 of year two for $50 a share. What tax consequences for T? |
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Definition
| T has $2,000 of long-term capital gain, which will be taxed at a 15% rate. Under §§ 1223(2) and 1015, T has a transferred basis of $30 and also a tacked holding period of one year. |
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Term
| What is the Alternative Minimum Tax (AMT)? |
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Definition
| The AMT was created in response to high-income taxpayers who were taking advantage of too many tax breaks and paying very little tax. This is basically a parallel tax system, with a flat tax on adjusted gross income. Taxpayers must calculate a separate liability without all of the preferences under the tax code and compare it to the alternative minimum tax. |
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Term
| What are other ways in which governments can raise money instead of or in addition to tax? |
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Definition
- Fines and Penalties
- User Fees
- Selling Natural resources or selling the right to extract natural resources
- Borrowing
- Conquest
- Foreign Aid
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Term
| What is the difference between a sales tax and an excise tax? |
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Definition
| The tax base. Sales tax taxes the cost, and excise tax taxes the amount. |
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Term
| What are the three times prior to the 16th Amendment in which the Federal Government laid any type of tax? |
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Definition
- Revolutionary War
- War of 1812
- Civil War
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Term
| When did the "class tax become the mass tax"? |
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Definition
| It was in 1942, during WWII, when the government started withholding and taxing even lower income people. |
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Term
| What is the relationship between Tax Treaties and the Internal Revenue Code? |
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Definition
| They both have the same force of law, however, if there is a conflict between a treaty and the code, the treaty will prevail. |
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Term
| Rank the following in order of authority: IRC, Constitution, Legislative Regulations, Revenue Rulings, Revenue Procedures, Interpretive Regulations, Tax Treaties |
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Definition
- Constitution
- Tax Treaties (only above the IRC if conflict)
- IRC
- Legislative Regulations (force of the statute)
- Interpretive Regulations
- Revenue Rulings (binding against the agency)
- Revenue Procedures (internal rules of conduct)
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Term
| What is an Action on Decision? |
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Definition
| The IRS issues an Action on Decision in which it states its position in which it has lost a Tax Court case, saying whether it agrees or disagrees with the decision. This does not affect the taxpayer who has just won, but it is notice as to whether the IRS will contest the issue in future cases. |
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Term
| Is the IRS obligated to follow the holding of the Tax Court or the Court of Claims? |
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Definition
| No. (Only as to the individual case.) |
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Term
| How do you compute a person's liability under the alternative minimum tax? |
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Definition
- Calculate the Alternative Minimum Taxable Income (AMTI) by making §§ 56 and 58 adjustments to the person's ordinary taxable income. Here, only limited itemized deductions are allowed and no personal exemption or standard deduction is allowed.
- Increase this amount by the § 57 tax preference items.
- Apply the applicable exemption, as determined by the taxpayer's classification and the year.
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Term
| Does a taxpayer recognize income on the receipt of free poker lessons from a neighbor in exchange for cleaning the neighbor's house? |
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Definition
| Yes. This is an exchange of services. § 61 includes "all income from whatever source derived." |
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Term
| What is imputed income and when is it taxed? |
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Definition
| Imputed income is the value of services that taxpayers provide for themselves, or, under Dean, the income that a taxpayer's property produces for them. Examples include doing your own taxes or growing your own tomatoes. Under the IRC, these things are NEVER taxed. |
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Term
| Mr. Charley purchases a book for $1000. When the value of the book rises to $3,000, he sells the book to a tax-exempt charity for $1,500. What is his gain, amount realized, and charitable deduction? |
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Definition
Gain = $1,000 (because the basis is cut by half); Amount Realized = $1,500 (for selling half of the property); Charitable Deduction = $1,500 (for the donation half).
The charity's basis is $2,000 ($1,500 plus $500). |
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Term
| On March 18, 2008, Ellen, a practicing attorney, paid $1,500 for a fire insurance policy on her office. The policy covers the period April 1, 2008 through March 31, 2013. Ellen is a cash method taxpayer. How much is Ellen permitted to deduct in 2008? |
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Definition
| $225, which is $1,500 divided by 9/60. There are 9 months in 2008 out of 60 total months of the policy. |
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Term
| L bought property for $10,000. L rents property to K for 5 years, collecting $1,000 a year in rent. K also spends $5,000 constructing a large, unsolicited statue of herself on the property. L sells the property in in year six for $20,000. What is L's gain? What is L's income? |
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Definition
| L has $10,000 in gain. Under § 1019, she does not include the $5,000 for the statute in the basis of the property, but she is taxed on it in the form of any value added to the land which she sells. L's income over the five years is $5,000. Under § 109, she does not include K's "improvement" as income. |
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Term
| B actively manages a dozen apartment buildings, providing customary tenant services and maintaining the common areas. Are the apartment buildings a capital asset for B? |
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Definition
| No, under § 1221(2). B's active management constitutes a trade or business. Thus, they are real property used in a trade or business. |
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Term
| Are "supplies of a type regularly used or consumed by the taxpayer in the ordinary course of a trade or business" a capital asset? |
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Definition
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Term
| During this year, Paul recognizes a long-term capital gain of $5,000, and a short-term capital gain of $7,000. He incurs a long-term capital loss of $3,000. These are his only property transactions for the year. How much gain must Paul include in gross income? |
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Definition
| $12,000, which is the sum of long and short term gains. Gains, unreduced by losses, are included in gross income under §§ 61(a)(3), 1001(a). |
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Term
| During this year, Paul recognizes a long-term capital gain of $5,000, and a short-term capital gain of $7,000. He incurs a long-term capital loss of $3,000. These are his only property transactions for the year. How much is Paul's net capital gain for this year? |
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Definition
| $2,000. Net capital gain is net long-term capital gain reduced by short-term capital loss. See § 1222(11). |
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Term
| What is "capital gain net income" and how is it different from gross income? |
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Definition
| Capital gain net income is the excess of capital gains over capital losses. All capital gains, regardless of loss, are included in gross income. |
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Term
| During this year, P recognizes a long-tern capital gain of $5,000, and a short-term capital gain of $7,000. He incurs a long-term capital loss of $18,000. These are his only property transactions. How much of the $18,000 can P deduct? |
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Definition
| $15,000. Paul is allowed to deduct capital losses to the extent of capital gains ($12,000), plus $3,000. See § 1211(b). |
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Term
| In 2007, P recognizes a long-tern capital gain of $5,000, and a short-term capital gain of $7,000. He incurs a long-term capital loss of $18,000. He engages in no property transactions in 2008. Can he take a deduction? |
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Definition
| Yes. For $3,000. Under § 1212(b)(1)(B), Paul treats the $3,000 of net long-term capital loss not deducted last year as long-term capital loss this year. |
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Term
| During this year, P recognizes a long-tern capital gain of $5,000, and a short-term capital gain of $7,000. He incurs a long-term capital loss of $18,000. These are his only property transactions. P is a corporation. How much of the $18,000 can P deduct? |
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Definition
| $12,000. Corporations can only deduct losses against gains. |
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Term
| During this year, C recognizes a LTCG of $15K and a STCG of $8K. She incurs a LTCL of $10K and a STCL of $20K. How much of her losses is C allowed to deduct this year? |
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Definition
| $26K. C is allowed to deduct capital losses to the extent of capital gains ($23K), plus $3K. |
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