Fundamentals Of Income Tax

Front 1

Units 1-5

Back 1

Unit I. Overview

Unit II. Basic definitions

Unit III. Statutory and administrative exclusions
Unit IV. Basis, realization, and recognition
Unit V. Treatment of the taxpayer's debt or obligation

Front 2

Tax Policy considerations (∃5)

I Overview: Basic Principles (1/4)

Back 2

Neutrality
Efficiency.
Not affect investment/consumption decisions.
Tax once, only once. (business deductions, etc.).
Equal income=Equal tax. Objective criteria.

Front 3

Substance over form
(administration) (fairness)

I Overview: Basic Principles (2/4)

Back 3

Administration: simple to apply; fair; certainty and closure; account for person’s likely capacity to pay (liquidity).
Fairness: Wealth, ability to pay; all bear equal burden; even enforcement.

Front 4

Economic Policy. (∃5)

I Overview: Basic Principles (2/4)

Back 4

Promote business and capital;
avoid deadweight loss (resources directed to less efficient investments);
encourage good business (incentive),
deter bad (punishment).

Front 5

Ideological Political Policy
What is the purpose of an income tax?

I Overview: Basic Principles (4/4)

Back 5

☯ Raising revenue is income tax’s main goal.
~not policy or ~principle.

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Income ⊆

Back 6

⊆ gross income, de minimus fringe benefits, imputed income, etc.
☯ inefficient to report every benefit received.

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De minimus fringe benefits ⊆ and ⊄

Back 7

⊆ workout facilities on work premises; travel expenses {⊆ meals, lodging, etc. | ⊄ extravagant, not necessary, etc.)

Front 8

Gross Income ≐ 3∈

I Overview: Computing Income Tax ( / )

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1) Accession to wealth, 2) fully realized, 3) over which TP has complete dominion.

⊆ dividends, interest income, rental income, etc.
⊄ diminimus fringe benefits, imputed income, etc.
⊄ loans
# gross income is subset of income.

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Business Deductions: (Bzd) §62:

I Overview: Computing Income Tax ( / )

Back 9

FILL IN

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Adjusted Gross Income ∮ and ☯

I Overview: Computing Income Tax ( / )

Back 10

∮ AGI:
GI - Bzd = AGI

☯ AGI accurately reflects income of business owners and non-business owners. Allows neutrality.

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Standard Deduction

I Overview: Computing Income Tax ( / )f

Back 11

FILL IN

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Personal Exemption (PE) ☯

I Overview: Computing Income Tax ( / )

Back 12

☯ Congress recognizes minimal living expenses necessary to survive and produce income. PE 2011 is $3,700.
∴ PE and SD

Front 13

Itemized Deductions ≐

Code?

Back 13

≐ All allowable deductions other then PE and Above line Deductions. ~PE ~Bzd ~diminimus

✓ Allowed under §§161-197 and §§ 211-223;
✗ not §62 or 63.

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Itemized Deductions 6⊆

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ID 6⊆ Casualty losses, extraordinary medical expenses, charitable deductions, state and local income and property taxes, and home mortgage interest expenses. (may trigger alternative minimum tax or other limitations)

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§1 Rate Structure ∮

Back 15

Tax Rate Structure (TRS) ∈ Taxable income (TI) ∩ Filing Status (FS).

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Tax Liability ∮

Back 16

Tax Liability (TL) ∈ TRS ∩ AGI.

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§63 Filing Status ≐ and 3∈

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FS 3∈ Relationship status (married filing jointly or separately, head of household, surviving spouse, or single), age, and sight capacity.

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Tax Due ∮

Back 18

Tax Due = TL - credits.

Front 19

Tax Credits. §’s and ∈

Back 19

Credits: §§ 25-33. §31
∃ Most common, for withheld wages.

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Reporting Tax
2 alternatives

Back 20

a) Calendar ∪ b) Fiscal

Front 21

Tax Shelters ☯

Back 21

☯ Most reduce income and tax in earlier years at the cost of higher income and tax in later years.

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Gross Income ≐ § 61

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§61 ≐ All income from whatever source derived, except where specifically exempt in the code.

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Gross Income ≐ Glenshaw

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1) any accession to wealth 2) fully realized 3) over which the taxpayer has complete dominion.

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Gross Income ⊆(15)

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(1)Compensation for services {⊆ fees, commissions, fringe benefits, and similar items}; (2)Gross income derived from business; (3)Gains derived from dealings in property; (4)Interest; (5)Rents; (6)Royalties; (7)Dividends; (8)Alimony and separate maintenance payments; (9)Annuities; (10)Income from life insurance and endowment contracts; (11)Pensions; (12)Income from discharge of indebtedness; (13)Distributive share of partnership gross income; (14)Income in respect of a decedent; and (15)Income from an interest in an estate or trust.

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“Arms-Length” Property Value ≐ (3 ∩)

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“The price at which the property would change hands between a willing buyer and willing seller, ∩ neither being under any compulsion to buy or sell and ∩ both having reasonable knowledge of all relevant facts.”

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Asset Valuation Factors:
Balance Taxpayer situation ♋ FMV

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1) Objective criteria of TP (income, net worth. Not preference).
2) FMV Objective criteria of asset: retail price, market value, income stream from asset, commercial or non-commercial; choice or forced receipt.
#Non-cash income must balance subjective value to TP and FMV.

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Secondary Market ≐

Back 27

≐ value of a good being sold by someone other than the authorized vendor.
⊙ selling a cruise ticket you won from a contest

Front 28

Tax Audits:
Burden of Proof
Burden of Persuasion
Burden of Production

Back 28

✭ BoP is preponderance of evidence.
✭ Burden of persuasion on gov (✭ tie goes to TP)
✭ Burden of production on TP (∵ best position to produce records)
#SoL. Gov can only initiate an audit within three years.

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Windfalls and Treasure Trove

(Cesarini)

Back 29

Cessarini

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Windfalls and Treasure Trove

(Glenshaw Glass)

Back 30

Glenshaw

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Service Compensation

Back 31

✭ If a taxpayer provides services to another and receives property or services in exchange, the taxpayer has gross income equal to the value of the property or services received.

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Arm’s Length Value (non-cash property) ≐
Value of Property Received…
Service <=> property.
Property <=> property

Back 32

≐ Value of property received is:
1) presumed equal to [value of service rendered or property exchanged] if known, ∪
2) stipulated value.

#relevant for adjusted basis purposes.

Front 33

Unit III. Statutory and administrative exclusions from gross income
(6 Sections)

Back 33

1) Imputed and psychic income
2) Meals and lodging and other fringe benefits
3) Gift, bequest or devise
4) Life insurance proceeds
5) Interest income on state and local bonds
6) Recoveries for personal and business injury

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1) Imputed and psychic income ≐ (3 ⊆)
Value ≐

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≐ TP creates or improves an asset ∩ performs a service for own benefit ∩ uses (or even holds) an asset that TP owns.

Value ≐ equals what the individual would pay another for the same benefit.

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Meals, Lodging, and other Fringe Benefits

(Benaglia)

Back 35

Bengalia

Front 36

2) Meals and lodging and other fringe benefits
Meals and Lodging
Test: Excludable from GI if…(3 ∈)

Back 36

Employees may exclude Meals and Lodging if:
1) “Furnished” to “entity” {⊆ employee, spouse, or dependents}; ∩
2) for the “convenience” of the employer; ∩
3) furnished on the employer’s business premises. ✭ Additionally, lodging must be a condition of employment.

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∮ Employee excludes meals.
∮ Employee excludes lodging.

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Meals: Furnished on business premises to entity for employer’s convenience.

Lodging: Furnished on business premises to entity for employer’s convenience as a condition of employment.

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Fringe Benefits
Whats the rule?

Back 38

✭ An employer may exclude Fringe Benefits from gross income.

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Precluded Fringe Benefits ⊆

Back 39

De minimis; Employer-provided eating facilities; On-site athletic facilities; No-additional-cost fringe benefits; Qualifying discounts on employer products or services; Working condition fringe benefits; group-term life insurance, health insurance, and dependent care assistance programs.

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Gift, bequest or devise

Duberstein

Back 40

Duberstein

Front 41

Gift, bequest or devise

Harris

Back 41

Harris

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3) Gift, bequest or devise
Whats the §102(a) rule?

⊄ ?

Back 42

✭ A Giftee may exclude gifts from gross income.

Precluded: value of gifts, bequest, devise, or inheritance.

{⊄ property from employer for benefit of employee}

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Gift ≠ Non-Gift
Factors

Back 43

1) Transferee is a natural object of bounty.
2) Transferor: is an + individual + corporation; + is the transferee’s employer; + deducts the payment; + has non-donative motives for the transfer.
3) The transfer is tied to specific services; + is one of a series of regular or periodic payments.

Front 44

Benefit ≠ Gift
CLARIFY. LOOK IT UP. Tax consequences.

Back 44

⦁ Benefit: ⊆ employer ♋ employee relationship. Employer may deduct as Bzd.
⦁ Gift: ⊄ employer/employee relationship.

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4) Life insurance proceeds

⦁ ≐ General Annuity policy
⦁ ≐ General Life insurance policy

Back 45

⦁ Classic Annuity policy ≐ the annuitant receives periodic payments, typically beginning at retirement and lasting until death.
⦁ Classic Life Insurance policy ≐ the insured’s beneficiaries receive a payment upon the insured’s death.

Front 46

5) Interest income on state and local bonds

≐ bond
≐ Tax Expenditure
≐ Putative Tax
≐ Deadweight Cost

Back 46

⦁ Bond ≐ a debt instrument.
⦁ Tax Expenditure ≐ the tax revenue lost b/c of a tax exemption.
⦁ Putative tax ≐ the difference between the investment returns on comparable taxable and tax-exempt investments.
⦁ Deadweight cost ≐ the excess, if any, of the tax expenditure over the putative tax.

#Gov wants State bond interests to equal federal so no deadweight losses are created.
☯ promotes investment in state gov.

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6) Recoveries for personal and business injury
§104(a)(2) TP may preclude if… (∈ 4)

Back 47

§ 104(a)(2) TP may preclude payments of damages from judicial resolution on account of personal physical injuries/sickness.

Payments ⊆ lump sum, periodic.
Damages ⊆ compensatory. ⊄ punitive.
Judicial Resolution ⊆ verdict; settlement; agreement.
Physical Injuries ⊄ emotional distress.

Front 48

Worker’s compensation benefits
(2⊆) Health Insurance; Disability Insurance

Back 48

⦁ Health insurance ⊆ employer ∩ employee provided. ⊄ government provided.

⦁ Disability insurance ⊆ purchased by employer ∩ employee.

Front 49

Tort settlements structures…
⦁ Lump Sum
⦁ Periodic Payments.

Back 49

⦁ Lump sum ⊆ Invest in a bank or investment account ∩ Purchase an annuity.
⦁ Periodic payments ⊆ From the tortfeasor ∩ Structured settlement.

Front 50

Unit IV. Basis, realization, and recognition
A) General Rule
B) Special Basis Rules

Back 50

A) General rule.
1) Basis determination
2) Recovery of investment;
3) Realization and recognition on sale or exchange.
B) Special basis rules.
1) Gifts
2) Bequests or devises.

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A) General rule
Terms

Back 51

Terms: realization, recognition, basis, amount realized, gain realized, loss realized, sale, exchange.

Front 52

Recognition Transactions ≠ Non-Recognition Transactions

Back 52

Recognition ⊆ Sale, trade, hybrid, etc.
Non-Recognition ⊆ De minimis imputed, gifts, bequest, Other tax rules.

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≐ Transaction

⊆
⊄

Back 53

An event where multiple parties exchange something of value for something of value.
⦁ $ <=> [P]. $ <=> {S}.
⦁ [Px] <=> [Po]. [P]<=> {s}
⦁ {s} <=> [P]. {s} <=> {S}

Transaction ⊄ gifts, loans, bequests,

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≐ Sale
≐ Liability
≐ Property Exchange

Back 54

⦁ Sale ≐ transfer of property for cash or the assumption of liabilities. [P] <=> $
⦁ Liability ≐ an obligation to pay money
⊆ Debt, mortgage, etc.
⦁ Property Exchange ≐ Transfer of property for non-cash property that differs materially in kind or extent. [C] <=> [H]

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Liability valuation

Back 55

Liability Value is equal in cash to the amount of the liabilities assumed/discharged.
Amount realized includes the amount of any liabilities assumed/discharged.

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Amount realized §1001(b).
Gain/Loss §1001.
Recognition §1001(c).

Back 56

⦁ §1001(b) Sum of money received plus FMV of property received.
⦁ §1001(a) Gain= A/R over A/B. Loss= A/B over A/R
⦁ §1001(c) Realized gain/loss in sale/disposition is recognized; @1031 or 1041.

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Recognition Exceptions
Non-recognition transactions
§ 1031
§ 1041

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§ 1031 Exchange of property held for productive use or investment.
§ 1041 Transfer of property between spouses or incident to divorce.

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1) Basis determination
§ 1012.

Back 58

§ 1012: A buyer's “basis in property acquired” in a “recognition transaction” equals his "cost" for the property.

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Valuation in different types of transactions

⦁ property for cash
⦁ property for services
⦁ property for assumption of liabilities

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⦁ ⚅ ⇆ $ ∴ € = $ spent
⦁ ⚅ ⇆ ☭ ∴ € = value of work (compensation)
⦁ ⚅ ⇆ ✄ ∴ € = amount of liabilities

✭ Consistent rules apply if the person acquires property for a combination of cash, non-cash property, services, and the assumption of liabilities.

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Basis adjustments ☯

⊆

Back 60

☯ Basis adjustments reflect an increase or decrease in the TP’s investment in the property for tax purposes.
⊆ Increase for improvements.
⊆ Decrease for wear and tear.

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Aggregation and Sever ability
Allocation of purchase price among assets.

Fair market value purchase: Allocation of purchase price among assets. Buyer’s cost basis and Seller’s amount realized.

Back 61

⦁ If Bob buys assets for an amount equal to their aggregate FMV ⊃ Bob’s cost basis for each asset is equal to that asset’s FMV.

⦁ If Sam sells assets for an amount equal to their aggregate FMV ⊃ Sam’s Amount Realized for each asset is equal to that asset’s FMV.

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2) Recovery of investment;

Back 62

2) Recovery of investment;

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3) Realization and recognition on sale or exchange.

Back 63

3) Realization and recognition on sale or exchange.

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Special Basis

(Taft v. Bowers)

Back 64

Special Basis

(Taft v. Bowers)

Front 65

B) Special basis rules.
§ 1015(a) Gifts
§ 1014(a) Bequest

Back 65

⦁ Gifts § 1015(a)
(i) € for gain is the donor’s adjusted basis, and
(ii) € for loss is the smaller of the donor’s adjusted basis or the FMV of gifted property at the time of the gift.

⦁ Bequest Section 1014(a)
Property acquired by bequest, devise or inheritance generally takes a € equal the property’s FMV at the decedent’s death.

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Unit V. Treatment of the taxpayer's debt or obligation

Back 66

A) Loan proceeds not income
B) Cancellation of indebtedness income
C) Payment of the debt of another
D) Transfers of property encumbered by a recourse debt (i.e., assuming a debt)
E) Transferring property subject to non-recourse debt

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A) Loan proceeds not income

Back 67

Loans. Not income.
☯ based on assumption the debt will be satisfied.

Front 68

Debt Reduction (∃2)

Back 68

1) Debt satisfaction (no income)
⊆ consideration or gift
2) Cancelation of debt (income)
⊆ any unsatisfied debt @ §108
@Bankruptcy @Insolvency

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Debt Satisfaction (∃2)

Back 69

✭ Debt is satisfied to the extent the creditor receives consideration for the debt ∪ makes a gift of the reduction to the debtor.
⦁ consideration or gift

Consideration ⊆ cash, property, or services
# not gross income.

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Debt Satisfaction -- tax consequences
✭ Creditor

✭ Debtor
⦁ No Income
⦁ Compensation Income
⦁ Gain or Loss

Back 70

✭ Creditor has no deduction for amount of debt satisfied.
✭ Debtor has:
1) No income or loss to the extent the debt is satisfied ∵ either the creditor makes a gift or the debtor pays cash ;
2) Compensation income for amount satisfied by services to creditor; or
3) Gain or loss for amount satisfied in exchange for non-cash property (debtor's amount realized equals that debt satisfaction).

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Cancellation of Indebtedness (COD)

(Kirby Lumber)

Back 71

Cancellation of Indebtedness (COD)

(Kirby Lumber)

Front 72

Cancellation of Indebtedness (COD)
(Zarin)

Back 72

Cancellation of Indebtedness (COD)
(Zarin)

Front 73

B) Cancellation of indebtedness income (COD)
≐

Back 73

COD ≐ Anything other than debt satisfaction.
@ under §108.

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Cancellation of Indebtedness Income ("COD") --

⦁ Tax consequences
⦁ Creditor
⦁ Debtor

Back 74

⦁ Creditor may have a deduction for amount canceled under §§165; 166.
⦁ Debtor has ("COD") included in gross income §61(a)(12), except under §108.

@ §108(a)(1)(A) and (B) Exceptions may limit the COD included in the debtor's gross income.

Front 75

COD Exceptions (∃2)
2@

Back 75

1@ Bankruptcy
2@ Insolvency

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§ 108 Income from discharge of indebtedness.
(a)(1) - in general
(a)(1)(A) - Bankruptcy
(a)(1)(B) - Insolvency

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(a) Exclusion from gross income.
(1) In general. 
Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if—
(A) the discharge occurs in a title 11 case,
(B) the discharge occurs when the taxpayer is insolvent,

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§108 (a)(1)(A) @Bankruptcy

Back 77

Title 11 Bankruptcy applies if: 1) TP under jurisdiction of court; and either discharge is 2) granted by court or pursuant to court approved plan. § 108(d)(2).

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§ 108 (a)(1)(B) - Insolvency

≐ Insolvent
≐ New Worth
≐ Insolvent Amount

# Limitation
# Timing

Back 78

TP Insolvent if: his Liabilities exceed his New Worth.
⦁ L>NW = Insolvent
⦁ Insolvent Amount: amount liabilities over net worth.

#Limitation: The COD exclusion can not exceed the insolvent amount.

⦁ Any excess amount of COD over the insolvent amount must be included in GI.
⦁ COD > Insolvent Amount = GI
∴ the debtor has includible COD to the extent the discharge creates positive net worth.
#Timing. This determination is made immediately before the debt discharge.

“net worth” ≐ aggregate FMV of liabilities

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C) Payment of the debt of another

⦁ Old Colony Trust

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C) Payment of the debt of another

⦁ Old Colony Trust

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D) Transfers of property encumbered by a recourse debt (i.e., assuming a debt)

✭ Recourse debt -- Amount realized on transfer
⦁ Debtor ⇆ Creditor
⦁ Debtor’s COD

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✭ Amount Realized: If Debtor transfers property that secures recourse debt to the creditor ⊃ Debtor’s A/R for that property is = amount of debt satisfied on the transfer.

⦁ The “amount satisfied” equals the value of the transferred property.

⦁ COD: If the creditor relinquishes the remaining debt without receiving additional consideration ∪ making a gift to the debtor ⊃ the debtor has COD equal to the amount of debt remaining.

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E) Transferring property subject to non-recourse debt

✭ Basis: Value of received Property subject to non-recourse debt

⦁§ 1012 Basis of Acquired Collateral Property
≐ Collateral Property

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✭ Basis: If TP receives Collateral Property ∩ the value of the property DOES exceed the debt amount ⊃ the TP’s € includes the amount of debt.

✭ If TP receives Collateral property ∩ the value of the property DOES NOT exceed the debt amount it is unclear whether:
⦁ TP has acquired the property for tax purposes; or
⦁ If TP is treated as acquiring the property for tax purposes, what basis the person takes in the property.

⦁ Collateral Property ≐ Property subject to non-recourse debt.

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E) Transferring property subject to non-recourse debt
✭ Non-recourse debt -- Amount realized on transfer
⦁ Transferor’s COD

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✭ IF TP transfers all property that secures a non-recourse debt ⊃ TP’s Amount Realized includes the amount of the debt if (2 ∪) --
1) The transferor acquired the property subject to the debt (to the extent TP included the debt amount in €); or
2) The transferor incurred the debt.
# Regardless of the property's value when transferred, the transferor will not have COD.
#If a debtor transfers the property that secures a non-recourse debt to the creditor, his or her amount realized generally equals the amount of the debt.
#Because the creditor has agreed to accept the property in full satisfaction of the debt, the debtor will not have COD, regardless of the property's value when transferred.

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Part-Sale/Part-Gift (PsPg)

⦁ Seller/Donor Gain

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✭ Gain: If S/D transfers property in a “part-sale/part-gift” transfer, then S/D has gain to extent the amount realized exceeds his adjusted basis in property transferred.

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Part-Sale/Part-Gift (PsPg)

⦁ Seller/Donor Loss
⦁ § 1.1001-1(e).

Back 84

✭ Loss: S/D does not recognize loss.

Front 85

Part-Sale/Part-Gift (PsPg)

⦁ Seller/Donor Basis

Back 85

✭ Basis: S/D takes a cost basis in any property received in the "sales" portion of the transfer. §1012.

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Part-Sale/Part-Gift (PsPg)
∮ Seller/Donor Gain
∮ Seller/Donor Loss
∮ Seller/Donor Basis

Back 86

∮ A/R exceeds € = Gain
∮ No Loss
∮ € in sales portion of PsPg

Front 87

Part-Sale/Part-Gift (PsPg)
✭ Buyer/Donee Basis (2 ∪)

⦁ § 1.1015-4(a)(1)

Back 87

✭ Basis: B/D takes € in property received equal to the GREATER of either:
1) The S/D’s € in that property; or
2) The FMV of the property the B/D transferred to the S/D.

Front 88

Part-Sale/Part-Gift (PsPg)
✭ Buyer/Donee Loss (2 ∪)

Back 88

✭ Loss: B/D’s € for loss in property received is the LESSER of either:
1) the S/D’s €; or
2) the FMV of gifted property at the time of the gift.

#same as gift under § 1015.

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Part-Sale/Part-Gift (PsPg)
✭ Buyer/Donee's Amount Realized
⦁ § 1001(b).

Back 89

✭ A/R: If a B/D transfers NON-CASH PROPERTY ⊃ B/D has gain or loss under § 1001.
B/D’s amount realized = the vale of the property received for the transferred property.

# Typically, that amount equals the value of the property transferred by the buyer-donee.