Tax Final Outline

- Connect the Dots - ALL of IRC that we talked about - Multiple Choice - Mostly about Business expenses (above the line deductions) - Short Essays - Concepts talked about a lot in class - Compare & Contrast (Small Essays) - Alimony vs. Child Support - Depreciation v. Amortization (cost recovery aspects for businesses) - 1031 vs. 1033 - Know the 10 Major cases - Anything after 1986 - Glenshaw, Lucas v. Earl, etc. - Realized Gain = Can have it but dont put it on tax return - Recognized Gain = Actually put it on tax return

The Tax Tree

Income Exclusions = Gross Income Above the Line Deductions = Adjusted Gross Income Personal/Dependency Exemptions Standard OR Itemized Deductions = Taxable Income = Calculated Tax Owned Credits = Amount of Tax

INCOME
61 What Is Income
- Income is EVERYTHING - ALWAYS broadly conceived - Very few exclusions (ONLY by legislative grace) - Be very careful w/ exceptions - DEFAULT = income (if questioning) - If there is an exclusion MUST comply perfectly w/ the requirements - 3 Types of Gains & Losses/ Income - 1) Ordinary Income & Losses - 2) Capital Gains & losses - 3) 1231 Gains & Losses - Cesarini v. US - 1957: Taxpayers buy used piano - 1964: Taxpayers find money inside the piano - Taxpayers argue for refund - Found money - If IS income Income in 1957 - If IS income in 1964 = CAPITAL GAIN - Any type of treasure trove is income to you. It falls under 61. No statutory exemption for treasure trove! - Found money is taxable as ordinary income in the year in which the taxpayer attains uncontested possession of it - Under 61 money is taxable in the year it was actually found and that the sum is properly taxable at ordinary income rates - ***Treasure trove is GROSS income*** - Commissioner v. Glenshaw Glass - Undeniable accession of wealth, clearly realized & over which the taxpayer has complete dominion - The general definition of GROSS INCOME includes all amounts recovered as result of a lawsuit that represent an increase in wealth to recipient and not merely compensation for non-contractual losses - Rule 22: Gross income includes gains, profits, and income derived from salaries, wages, or compensation for personal services - Gross Income defined as undeniable accession of wealth, clearly realized and over which taxpayer has complete dominion - Old Colony Trust Co. - When Employer pays Employees taxes to IRS 2

- Treat as if Cash Employee AND Employee IRS - The payment by employer of income taxes assessable against the employee constitutes additional taxable income to such employee - If you pay someones taxes for services rendered it is compensation and is NOT excludable and under 61 is taxable - Rule 213: The discharge by third person of obligation to him is equivalent to receipt by person taxed - 102(c)(1): An employer/employee relationship will look more like income than a gift (usually a compensation for labor) - Direct v. Indirect Compensation: - Buy employees wife a new car = INDIRECT - Bonus of $20,000 = DIRECT - This is not a gift because conditioned upon employment to employer - Improvements to HOME are also income - Includes: - Treasure Trove - Illegal receipts - 3rd Party Satisfaction of Obligation - Cancellation of Debt - Transfer of gain property to satisfy obligation - Prizes & Awards - Advance payments - But NOT: - Bargain purchases - Free samples - Unrealized appreciation in value - Imputed income - Loans/Deposits - Amounts realized from property disposition up to the basis - Estates & Trusts = Taxable Entities

- (minus) EXCLUSIONS
- 2 Types of Methodologies - 1) Is it a true exclusion? - OR - 2) Is it really income? - Can sometimes be disguised compensation - If a question looks like income & smells like income BUT is called a gift disguised compensation = INCOME & NOT a gift

- Inheritance

102 Gifts & Inheritances

- Charley v. Commissioner: Running a horse testing program and as a result he is effectively buying first class tickets to visit the horses/people and billing his clients and then cashing in on the frequent flyer miles earned - Congress has deemed you to deduct it if they decide that through statute you are able to exclude it from a taxable aspect (otherwise, EVERYTHING is income) - Travel credits do constitute taxable income! - The petitioner was wealthier after transaction than before - The ascension of wealth is the receipt of the income - Travel credits accumulated and retained by employee in course of employment constitute gross income subject to taxation - Frequent flier miles constitute taxable income! - Commissioner v. Duberstein: - In order to be a giver under 102: the amounts received must have been given a detached and disinterested generosity, out of affection, respect, admiration, charity, etc. - The court has indicated that a voluntary transfer of his property by one to another without consideration or compensation therefore through a common-law gift is NOT necessarily a gift within the meaning of the statute BUT where the payment is in return for services rendered it is irrelevant that the donor derives no economic benefit from it - In this case: gave the individual valuable business information and got a gift in return - RULE: the most critical consideration is the transferors intention and what controls is the intention with which payment however voluntary has been made - Any services made by employee are taxable - 108(a) Certain forms of COD income - 109 Lessee improvements

64(c) Employee Achievement Awards

- Must relate to service OR safety - Employed for at least 5 yrs to qualify - Less then 10% of employees have received the award during the year 4

- IF has 3 elements it will is EXCLUDABLE - 1) Length of service OR safety - 2) Part of meaningful ceremony/pomp & circumstance - 3) Must NOT be disguised compensation

74 Prizes & Awards

- TAXABLE - UNLESS explicit exception/excluded - 2 Limited EXCEPTIONS: - 1) Recognize achievements in religious, charitable, scientific, educational, artistic, literary, or civil field - AND - 2) MUST immediately donate/transferred it to a governmental entity OR qualified charity - EX: Extreme Makeover home IS taxable

117 Scholarships/ Fellowships

- EXCLUDES income received from a qualified scholarship - MUST focus on the specifics of the scholarship - Tuition & Fees = excludible - Room & Board = taxable (NOT excludable) - Contingent Employment OR other contingency= taxable (NOT excludible) - Athletic scholarship = excludible

119 Meals & Lodging

- Meals: - Furnished by OR on behalf of employer - For convenience of employer - On business premises of employer - Lodging: - Furnished by OR on behalf of employer - For the convenience of the employer - On business premises of employer - Employee required to accept as condition of employment

132 De Minimis Fringe:

- After accounting for frequency SO small as to make accounting unreasonable or impractical - EX: coffee doughnuts @ work OR parking - Working Condition Fringe: - If the employee paid for the property OR services at issue, would

the employee be entitled to deduct the cost under 162 or 167? - YES than exclude the value of the property or services at issue - Qualified Transportation Fringe: - Transportation in commuter highway vehicle - Transit pass $100/ month aggregate limitation - Qualified parking $175/ month aggregate limitation - On- Premises Athletic Facility - On business premises - Operated by employer - EVERYONE is able to use it - Substantially ALL use by employees/spouses/kids

121 Gain from Sale of Principal Residence

- When you can EXCLUDE your gain from sale of principal residence - 121(a): Elements for Exclusion - Ownership Test MUST live in for at least 2 of 5 yrs - Use test MUST use for at least 2 of 5 yrs - 121(b): Limitations On Exclusion - $250K MAX Exclusion (if Single) - $500 MAX for Married Filing Jointly - ONLY on sale/exchange every 2 yrs - 121(c): Reduced Exclusion - Applies where taxpayer flunks 121(a) OR where 121(b)(3) applies - If you sell your home = capital asset - CAPITAL in nature - Mortgages = deductable under 121

135 Income From US Savings Bonds Used to Pay For Higher Ed.
- Savings bond income used to pay higher education EXCLUSION from gross income of interest on certain federal bonds used to finance education costs - Example of furthering social welfare - Government wants you to buy savings bonds, so they give you a tax break if you do

= (equals) GROSS INCOME (minus) ABOVE THE LINE DEDUCTION

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- 161 Allowance of deductions - Business Expenses - MUST be an asset used in trade OR business that is ordinary AND necessary AND reasonable - EX: Transplant hospital buys helicopter Probably able to deduct - EX: Lawyer buys helicopter Probably NOT able to deduct

162 Trade Or Business Expense

- (a) ELEMENTS - Ordinary = common & accepted . . . in the life of the group, the community - Necessary - Expense - Paid OR Incurred - In carrying on - A trade OR business - 165 Losses - 167 Depreciation - 2 types: - (1) Straight line - (2) MACRS/ NEW ACERS - Vehicles = 5 year recovery period - 212 Investment & Rental Activity - 179 Exclusion to Expense Certain Depreciable Business Assets

Capital Expenditure v. Expenses 162 Expenses:

- EX: Painting shutters - Some are able to be DEPRECIATED - EX: Compensation for employees= DEDUCTABLE - BUT $1 million ceiling - Certain types of compensation are NOT included in the ceiling - Always look at reasonableness & whether or not it would meet the cap - 244 & 172 Entertainment Expenses - Directly related to the active conduct of business - General Phase Out If you spend $100, you can legally DEDUCT 50% - UNLESS it is not face value - EX: You can NOT deduct a scalped baseball ticket - CANNOT deduct alcohol 7

- 4 Things to Show to Deduct a Business Expense - 1) Legit business expense - 2) That you were in fact there - 3) That it was reasonable - 4) That you an substantiate

Capital Expenditures:
- EX: Plumbing - DEDUCTABLE

- Improvements - Capitalize a cost IF it adds to the value (OR substantially prolongs the useful life) of an asset - EX: Midland Empire - Adaptations - Capitalize a cost IF it ADAPTS property to a new OR difference use - New Assets - Capitalize a cost IF it RESULTS in the acquisition OR creation of an asset having a useful life SUBSTANTIALLY beyond the taxable year - If it lasts LONGER than 1 yr OR changes the building - EX: Pluming - INDOPCO v. Commissioner (1992) - Capitalize a cost IF it produces significant benefits that EXTEND beyond the taxable year - FACTS: wanted to write off the merger as a business expense (immediate deduction) - This is dealing w/ intangible issues (future benefits the entity would get) - THIS = capital improvement NOT an expense - Home Office = DEDUCTABLE for ONLY that % that use as office - MUST ONLY use the space as business office - NEVER deduct fixed expenses - EX: insurance or mortgage - ONLY deduct variable expenses - EX: cable, electric, heating, internet phone bill

195 Start- Up Costs

Start Up I Carrying on Business 8

< ----------------------------------I------------------------------------------ Consulting Fees Consulting Fees Attorney Fees Attorney Fees Travel Expenses Travel Expenses Employee Training Employee Training New Buildings New Building Equipment Equipment - Exacto Spring Corp. v. Commissioner (1999) - First court to abandon the multi-factor test AND adopt Independent Invest Test as the EXCLUSIVE method of determining whether a business may deduct compensation under 162

212 Seeking Profit BUT NOT Necessarily In Trade/ Business

- EX: rental car/ rental property - People in business of profit incentives - Opportunities where you get deductions for having a profit w/ NON business activities = Passive in nature

Cost Recovery Systems

- 1) Depreciation 167 OR 168 - For TANGIBLE assets - EX: Building (NOT land) - Returns the cost of the asset back to you over the course of its useful life (useful life is dictated by IRS) - 2 Types: - 1) MACRS/ NEW ACRES (default) - AKA: Modified Costs Recovery System - Certain % each yr - Very front loaded (get more $ in 1st few yrs) - 2) Straight Line - EX: Asset cost $100 - You get $10 back each year for 10 years - Vehicle = 5 yr recovery period - 2) Amortization 197 - For INTANGIBLE assets - Straight line - EX: Patents, Trademarks, Licenses - Recover the cost over 15 yrs - 3) Depletion - Cost Depletion = Based on the value you feel is underground 9

OR - Percentage Depletion = Take a % that you deduct every yr from your gross sales

179 Election to Expense Certain Depreciable Business Assets

- If you are a SMALL business - IRS allows you to deduct $100K of capital expenditures you would normally have to depreciate - Allows you to treat as a business expense you can IMMEDIATELY deduct - Moving Expenses - MUST Satisfy 2 Requirements: - 1) Employed there for 29 weeks out of the year - 2) Deductions have to be for the yr it was incurred - ALL must be reasonable = Separate set of rules of moving out of country

= (equals) ADJUSTED GROSS INCOME (minus) PERSONAL/DEPENDENCY EXCEPTIONS

- Subject to your AGI (amount of gross income) - WANT your AIG as LOW as possible (b/c = less taxes to pay) - Subject to wacky faze-outs - Personal Commuting Mileage =NOT deductable - 262 Personal Expenses - Charitable Contributions & Gifts - MUST be: - 1) Qualified recipient ( 170(c)) = - 1) Federal, state or local government entity - 2) Certain religious, charitable, scientific, literary, educational, amateur sports & prevention of cruelty to children & animals organization - 3) Certain war veterans organizations - 4) Domestic fraternal societies, orders, or associations - 5) Non-profit cemetery companies & corps - Verifying Charitable Status Recipient - Request copy of exception letter - IRS Publication 78 (searchable online) - All IRC 10

- 2) Contribution voluntary transfer of $ OR property - 3) Amount of deduction Total deduction amount Amount deductible in yr of contribution - 4) VOLUNTARY - Limited to $250 per year - Medical Expenses - MOST are NOT deductable - EXCEPT those recommended by Dr OR disease prevention - NOT deductable IF Voluntary - DEDUCTABLE IF Birth defect OR fixing something from an accident - SUBJECT to a floor = usually about 7 % - 213(d)(9) DISALLOWS cosmetic surgery (NO deduction) - ON THE EXAM: - Determine if it was Dr. recommended - If it reasonable given facts/circumstances - Even they ARE deductable subject to 7 % floor (depending on your AGI) - 280 (a): Reductions Related to a Home & Use of that Home - If you rent your house, is that deductable? YES - BUT w/ limitations & exceptions

(minus) STANDARD OR ITEMIZED DEDUCTIONS

- Standard = set number of deductions - Itemized = individual deductions Add ALL itemized together - Take the HIGHER of the 2 (whichever gives you MORE deductions)

= (equal) TAXABLE INCOME (minus) CREDITS

- $ for $ Deduction - Can be refundable OR NON refundable depending on the type of credit - EX: NON Refundable = Adoption - Which is better $100 credit OR $100 deduction? $100 Credit - Personal Credits - Credits for adoption = social engineering - $10K per child in the year of adoption - Child Tax Credit $1000 per child

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- IRC 25A Allows credits, which reduce tax income but cannot generate refund (Clinton made this. These are credits dollar-to-dollar reduction of taxed owed) - Allowed for student for higher education - Hope Scholarship & Lifetime Learning (EX of credits) - Reduce tax liability - Democrats = tax credits; Republican = tax cuts - Hope Scholarship (per student) - MUST be at an accredited institutions for 1st 2 yrs of education - Per student credit - 100% of 1st $1000 spent on qualified tuition & fees - AND - 50% of the 2nd $1000 w/ a maximum of $1500 - Offset by scholarships/grants/reduction - NO felony drug convictions - Lifetime Learning Credits (per family) - For ANY postsecondary education, NO TIME LIMIT - Per taxpayer credit - 20% of ALL qualified tuition AND fees UP TO $10K - W/ a MAXIMUM of $2000 - Reduced at $40/$80K and phased out at $50/$100K - Offset by scholarship/grants/reduction - Earned Income Credits - Working tax payer w/ low income to provide them w/ support - REFUNDABLE - Democratic gives credits & Republicans lower taxes

Recapture of Assets
- 1231 Assets, Capital in nature BUT able to depreciate in a business - Under MACRS - 1245 Personal OR Tangible assets - 1250 Intangible assets OR Real Property - EX: buildings/structures on land OR the land - What Uncle Sam giveths Uncle Sam Taketh

Insurance
- NOT normally taxable - As long as you collect it AFTER the person dies - UNLESS you sell it BEFORE the person dies - EXCEPTION: If you sell an insurance policy prior to death AND use the money to pay for medical expenses IF you have a terminable illness 12

- 3 Parties in a Life Insurance Policy: - 1) Insured person who dies (NEVER has income tax liability) - 2) Beneficiary person who gets the proceeds (NEVER has income tax liability) - 3) Owner person who has all the rights to the policy (MAY have income tax liability - IF he/she dies b4 the insured does) - Inheritance OR proceeds from life insurance = EXCLUDED - NOT taxed IF Paid by reason of death - HOWEVER, interest OR amount paid in annuity over the amount of the policy is TAXABLE - People use insurance to create safe financial future - IRC 101(a)(1): EXCLUDE the proceeds of such policies from gross income of recipients - BUT exclusion applies ONLY to amounts paid by reason of death of insured - EXCEPTION: when even though a policy is chased out during the insured lifetime gain on the policy is EXCLUDED from gross income - IRC 101(c): ANY interest payments = TAXABLE like interest earned in bank account - IRC 101(d): take life insurance & divide by life expectancy - Transfer for Value Rule if buy policy, the amount EXCLUDED cannot exceed the amount paid for it - IRC 101(g): if a terminally ill person sells his life insurance policy b/c want money THAT gain is treated as if it has been received by reason of death = EXCLUDABLE - If insured dies AND beneficiary takes life insurance in cash = EXCLUDED - Formula: investment in K total investment return - IRC 101(d): = life insurance life expectancy - Lump sum = tax FREE - Formula = (amount received as an annuity) x (investment in contract) (expected return)

Annuity

- An Annuity = Arrangement under which 1 buys a right to future money payments - Guarantee payment - Effectively a return of capital, spread over the life of the annuity 13

- CAN be NON-taxable depending on HOW it is structured - Return of your capital is NON-taxable - The interest = TAXABLE - EX: $100/month for the rest of your life (i.e., set # for set period) Amount excluded CANNOT exceed amount paid for the policy EXCLUDABLE amount = amount of policy life expectancy INCLUDABLE amount = yearly payment excludable amount If outlive the expected life expectancy ENTIRE annuity = INCLUDED 3 Types of Annuities: - 1) Single Life Annuity calls for fixed money payments to the annuity for her life after which all rights under the K cease - 2) Self & Survivor fixed payments are made during life AND continues after death - 3) Joint & Survivor pays amount jointly to 2 annuitants while both are living AND payments continue to survivor

- Endowment K when purchaser buys right to receive amount per month AND continue in event of death before expiration term - Variable Annuity combination annuity w/ mutual fund concepts

AMT (Alternative Minimum Tax)

- Effects individuals AND corporations ONLY - If you are wealthier, once you finish the tax return you are altered to be an AMT - Which means you have more taxes taken out - Mitigates what you can deduct b/c you are wealthier

Child Support & Alimony

- 71 (b) & (c) Child Support - Any amount specified in instrument will be reduced on child attaining a specified age, marrying, dying, leaving school, or other contingency, then amount will be treated as fixed EXCLUSIONS = child support, gifts, inheritance, etc which are EXCLUDED - PayeEE spouse = EXCLUDED from income - PayOR spouse = DEDUCTABLE to you = tax neutral (b/c you have the requirement of providing for that child regardless of the relationship of the parents) - Look for payment that is dropping off as result of turning 18 - PayOR write check to payee to take care of the kids - The money does NOT get taxed b/c the income of money is to support the children who are suppose to be taken care of regardless of the divorce (this assumes the payOR is the primary breadwinner) 14

Alimony - Alimony 71(b) - (1) Payment in cash (or check or money order) - (1)(A): Received by (or on behalf of) recipient under a divorce or separation instrument - (1)(B): Instrument does NOT designate the payments as nonalimony - (1)(C): Payor & recipient are NOT members of the same household if legally separated; and - (1)(D): NO liability to continue making payments(or any substitute for payments) after the death of the recipient - Alimony breaches the fruit/tree doctrine Allows you to ASSIGN your income AND take a DEDUCTION - PayOR spouse = Full DEDUCTION - PayEE spouse = INCOME/ INCLUDABLE (by legislative grace) - If you represent the spouse RECEIVING the alimony want payOR to take out a life insurance plan as part of the divorce decree - So that the ex-wife becomes the beneficiary if the husband dies & gets paid & money can be used to support the children (if not beneficiary, wife becomes creditor and is one of the last to be paid upon the death) - 71(f) Alimony Recapture Rules/Provision - If the 3rd yr of payment is LESS THEN the 1st 2 yrs IRS will go back & reverse what was done - When inordinately large amounts of alimony & support are paid in the 1st or 2nd yr in relation to the 3rd yr an amount is recaptured in the 3rd yr - It takes from the amount included on the payOR spouses income or yr 3 & deduction in the same yr by the payee spouse - ONLY way to prevent this is to have EQUAL payments every yr - PayOR spouse tries to bake in tax neutral child support & property settlement to get a deduction - EXCEPTIONS: Spouse dies OR payee spouse remarries - Decrees for support & payment under continuing liability to pay fixed portion of income - If amounts paid w/in yr 1, 2, & 3 are ALL w/in $15K of each other NO recapture

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- 1041 & 1015 Property Between Spouses in a Divorce - If payments qualify as alimony OR separate maintenance, statute permits allocation of tax in accordance w/ expressed wishes pf parties, if NOT there is NO tax (tax neutral splitting) - EX: Have IRA that is worth $1 million & split it. You get $500K & wife gets $500K. - Has $500 basis. If cash out get $450K. TREATED AS A GIFT - 1) Tax Neutral - 2) Carryover basis - 3) Treated as a GIFT - IRA - Husband - Wife -$100K Basis - $50K - $50K - $500K FMV - $250K - $250K - IRC 1041: Transfer of property between spouses or incident to divorce - General Rule: NO gain or loss shall be recognized on transfer of property from individual to (or in the trust for the benefit of) - Spouse - Former spouse - Transfer treated as a gift: TransfeEE has transferors basis - In case of any transfer of property described in (a) - For purposes the property shall be treated as acquired by transferee as gift - Basis of transferee in property shall be adjusted basis of transfer - Incident of divorce: A transfer of property is incident to divorce if such transfer: - Occurs w/in 1 yr after date on which marriage ceases - OR - Is related to cessation of marriage - IRC 1041: accords almost complete tax neutrality to transfers of property between spouses & between former spouses if the transfer is incident to divorce NO gain or loss is recognized - In a divorce, the assets are divided - Anytime you put money away pre-tax (qualified assets) are taxable when cashed OR divided EXCEPT - These qualified assets are divided in half in terms of value & basis - EX: $1 million asset, each get $50K, each basis = same - Divorce is NOT a taxable event - EX: clients get divorced & later feels bad & wants to give her more money from a qualified asset that he received- but if he were to open it a huge tax automatically gets invoked so he should go back & amend the divorce decree (b/c the divorce is a non taxable event) & make it part of the order & do it that way 16

Alimony Payments Made By 3rd Party - IRC 215, 682, 72 - Income of alimony trusts, EXCLUDED from payORs gross income is TAXABLE to payee - Paying a 3rd party to assist spouse - Paying to 3rd entity treated as alimony - Same as trust INCLUDED to her (payeEE) & DEDUCTION to me (payOR)

Non-Recognition

- The Non-Recognition provisions of the Code POSTPONE taxation until taxpayer finally sells or otherwise disposes o the taxpayers property - Deferral is generally accomplished by giving the taxpayer an EXCHANGED basis in the property received in a non-recognition transaction - 2 Principle Justifications for Non-recognitions: - 1) Continuation of investment in property - 2) Inability to pay the tax at realization - EX: 1041 in divorce, property can be divided & not create a taxable event - EX: Farms & other special occupations/industries (swapping crops) - EX: Sale of personal residence - EX: Like King Exchange [1031(a)(1)] - Exchange - Old property held for use in business OR for investment - Solely - For property of like kind - New property to be held for sue in business OR for investment - MUST transfer real property for real property, etc. - Voluntary - Defer taxable event - EX: Guy buys plane wants a new one instead of selling it & creating a taxable event swap it w/ someone else defers the taxable event - Broadly construed - EX: Involuntary Conversion [1033] - Involuntary - Narrowly conceived - MUST set up the SAME business somewhere else - MUST be w/in a certain time frame - If you do NOT Treated as sale/exchange = TAXABLE - If you rebuild w/in certain time = non recognition

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- EX: When MI was making 696, MI bought home & businesses to make the road - Normally b/c of emanate domain the people would get paid = ascension of wealth - BUTTTTT: - As long as people followed rules of 1033, they did not have to pay taxes on the money - Some people saw it as a chance to start something new they were taxed!

Tax Rates

- MUST determine filling status: - 1) Unmarried individual/ Single - 2) Married Filling Jointly - 3) Married Filling Separately - Do this if 1 spouse has tax issues - 4) Head of household - If NOT married - AND - Have dependents - Tax Rates: - Progressive rate from 5%-35% depending on your BRACKET - If someone makes $100K 1st $75K is taxed @ 5%-28% rate - 2nd $15K is taxed @ 35% rate - Capital Gain = 15% flat rate - Ordinary Rates = 35%

Gains From Dealings In Property

- Determines the amount of tax on the gain/exchange of property - 61(a)(3): Gross income includes GAINS derived from dealings in property - 1001(a): Formula for Computing Gain ** (Amount Realized) (Adjusted Basis) = Realized Gain ** - 1001(b): Amount realized = (cash received) + (FMV property received) - 1011(a): Taxpayers basis under 1012, as adjusted by 1016 - 1012: Basis = generally defined as cost - 1016(a): Adjusted Basis - 27 Adjustments to basis - INCREASE basis for IMPROVEMENTS made to property

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- REDUCE basis by the amount of DEPRECIATION deductions - Either lessens OR increases your tax - 1001(c): Realized Gain = except as provided, ALL gains are RECOGNIZED/ INCLUDED

Tax Treatment of Taxpayer Costs

- 3 Possible Natures of Income: - 1) Capital Expenditure - 2) Expense - 3) Loss

- 3 Possible Activity to Which Costs Relates - 1) Personal - 2) Business - 3) Investment - Capital Expenditure + Personal = NO deduction - Taxpayer gets basis - Capital Expenditure + Business/ Investment = NO deduction - Taxpayer gets basis - AND - MAY get cost recovery deduction over useful life - Expense + Personal = NO deduction - W/ very limited exceptions (EX: home mortgages) - Expense + Business = DEDUCTION (above the line) - Expense + Investment = DEDUCTION (below the line) - Loss + Personal = NOT recognized - EXCEPT casualty OR theft losses - Loss + Business = RECOGNIZED - NO limits - SOME exceptions - Loss + Investment = RECOGNIZED

453(c): Definition of Installment Method

- Income Recognized = (Payment Received) x (Gross Profit/ Total K Price) - Installment Sale Method: (Gross Profit) / (Total K Price) = Gross Profit % (GPP) - To determine AMOUNT INCLUDED Apply GPP to TOTAL payments received during yr - Gross Profit (Selling Price) (Adjusted Basis) - Selling Price = Gross selling price w/ NO lessening for

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debt or selling expenses - Adjusted Basis (AB) = normal AB including selling expenses for non-dealer sales of real property AND casual sales of personal property - Total K Price (Selling Price) (Qualified Debt) - Qualified Debt = any debt secured by the property AND any debt incurred in acquiring OR operating the property - Any qualified debt in EXCESS of AB (OR any nonqualifying debt) treated as payment in yr of sale (how it is treated) - Related parties are EXEMPT (IRC tells definition of relative for THIS ) - Even if they are allowed, IRS may make you jump through hoops to get it

165 Losses (The ONLY losses that are DEDUCTABLE)

- 165(c)(1): Business - 165(c)(2): Transaction entered into for profit - 165(c)(3): Casualty/ Theft - MUST have a loss that falls w/in the definition of casualty OR theft - Business losses AND thefts = FULLY deductable - Personal losses AND thefts = subject to deductions (usually depends on insurance) - MUST factor in insurance - Difference between what insurance pays & value on the house - McWilliams v. Commissioner - When you have related parties you CANNOT generate a loss because there is a fear you are creating a fake loss - ONLY if it is reasonable, justifiable OR legit business transaction - MUST: - 1) ID related parties - 2) Do you have a loss? - 3) Is it deductable? - A loss attributed to an ACTUAL business transaction - Any property held by taxpayer IS capital asset EXCEPT: - 1221(a)(1): inventory AND property held for sale to customers in the ordinary course of business - 1221(a)(2): depreciable personal property AND real property used in business - 1221(a)(4): receivables acquired in the ordinary course of business

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Qualified Residence Interest

- 163(h)(3)(A)(i): ACQUISITION OF DEBT w/ respect to a qualified residence $1 million or LESS = deductable - 163(h)(3)(A)(ii): HOME EQUITY DEBT w/ respect to a QUALIFIED RESIDENCE - Up to $100K - 163(h)(3)(B) - (i)(I): Incurred to buy, build, or improve QR - (i)(II): Secured by QR - (ii): $1 million limit - 163(h)(4)(A)(i): Principal residence + 1 other residence - 163(h)(3)(C): - Not acquisition debt - Secured by QR - (FMV Acquisition debt) limit - $100K limit

Introduction to Accounting Methods

***CASH Method*** ENDS: 12/31 Has INCOME when: RECEIVED: - Constructive receipt - Cash equivalence ACCRUAL Method Timing Issue ENDS: Corp. decides EARNED: - All vents Test - Collection doubts - Contested income - Unenforceable claims - Advance payments - In yr work done NOT when collect $ OWED: - All Events Plus Test - Economic performance - Contested liabilities

MAY claim a DEDUCTION when:

PAID: - When payment occurs - Advance payments - Individuals = Cash Basis Tax Payers - Do NOT take deductions UNTIL they actually happen - Certain business entities (EX: Partnerships, C-Corps, S-Corps, LLCs) ESPECIALLY if they have inventory = Accrual Tax Payers - End at different time depending on when they make the most money - EX: Nordstroms ends 1/31.

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529 Plan Higher education fund for your children

on it

- Can front load for gift tax purposes AND have NO income taxes

6015 Innocent Spouse Relief

- Depends on whether or NOT you have already been sued - KNOW what is on your joint tax return BEFORE you sign it - 6015(b): Basic Relief - Must have filed a JOINT return - Understatement due to evil spouses error - Innocent spouse did NOT know of the understatement - AND - Has NO reason to know of it - Inequitable to hold the innocent spouse liable - Innocent spouse makes timely election - 6015(c): Apportioned Relief - MUST have filed a JOINT return - Timely election made - NO longer married OR NOT in same household for past yr - No actual knowledge of the item giving rise to the deficient - OR - Had knowledge BUT under duress - 6015(f): Equitable Relief - Inequitable to hold innocent spouse liable - 6015(b) & (c) dont work - Hobby Expenses = NOT deductible - 183: Hobby Loss Rule - Deductions are limited to what you made a profit off of - Can ONLY loose what you have invested - If it is NOT part of my active trade / business/ not materially participating in the business = NOT a deduction - If you have a horse farm - MUST show profit for 2 of 7 yrs = DEFENSE that it is NOT a hobby - Helps show that it is truly a business/trade - If you have something OTHER THAN a horse harm - Must show income on it for 3 of 5 yrs to claim a deduction - Active v. Passive Income

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- Active = Teaching at the school - Passive = Any business profit seeking activity that the taxpayer owner does NOT materially participate - EX: Owning Starbucks & not working there - 469: Passive Activity Rules - Prohibits certain taxpayers from certain activities - Limited/mitigating the deductions give you more income & more taxes - 7 Ways to Determine Whether the Material Participation Test is Satisfied - 586: Tuition payments MAY be deductable w/ regard to business expenses

Return of Capital Doctrine Loans & Interest

- Return of capital theory, if you are returning money back it is NOT income to that person giving the loan - Return of capital is neutral because what is given back is what you already had - IF there is interest, that is the only thing that is taxable

- Interest - ALWAYS have interest when you give things as a gift - Otherwise they will have to pay a lot of taxes - Loans - 7872(c): 5 NON Gift Loans 1) Between a corporation & 1 of its shareholders 2) Between an employer & employee OR between an independent K & person to whom he provides services AKA: compensation loans 3) W/ a principle purpose to avid any federal tax 4) Catch-all subcategory of other below-market loans Their interest arrangements have a significant effect on any federal tax liability of the lender/borrower 5) To a qualifying continuing care facility pursuant to a continuing care K

151: Personal Exemptions For Dependents

- Qualified Child - 1) MUST be a child of the taxpayer (son, daughter, step, adopted & foster) - 2) MUST have the same principle place of abode as taxpayer for MORE THAN 1 yrs - Temporary absence is OK if for special circumstances (EX: pursuant for education)

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- 3) MUST meet the age requirement - If either under 19 at the close of the calendar yr - OR - Is a student who has NOT attained age 24 at end of such calendar yr - 4) Must NOT have provided over of individuals own suppose for calendar yr - Qualified Relative - 1) MUST be a qualified child - 2) MUST bear the relationship listed under 152(d)(2) - 3) Person claimed as dependent may NOT have gross income in excess of the exemption amount of that yr - 4) MUST provide over 12 of the support for that individual during that yr - Commissioner v. Banks (2002) - Lawyers contingency fee = INCOME - Even if you dont get the benefit from it - Capital Gains - Sale OR exchange = taxable event - EX: Person sells art and they sold so many IRS said it was inventory - Inventory = subject to ordinary income - NOT inventory = Capital asset = preferential treatment - Holding Period - Hold an asset for MORE THAN 1 yr = LONG term capital gain - Subject to 15% tax rate - Hold an asset for 1 yr OR less = SHORT term capital gain - Subject to ordinary income rate = 35% - EXCEPTION: If you INHERET something from grandma and you have it for less 2 months & want to sell it automatically get LONG TERM capital gain rate - To Determine Tax Rate . . . MUST ASK: - 1) Do you have a capital asset? - 2) Is it for a personal or business? - 3) Short or long term? - Short Term Capital Gain Short Term Capital Loss = Net Short Term Capital Gain/Loss - Long Term Capital Gain Long Term Capital Loss = Net Long Term Capital Gain/Loss - Net Long Term Net Short Term = Capital Gain Rate 24

- Capital Gain Rate: - 693: Most = 15% - Others = 28% - EX: Several types of collectibles on capital gain (stamps, gems, artworks, coins) -

1211 Capital Losses

- Netting losses short term add them up

- COD = Cancellation of Debt = An ascension of wealth - EX: Become a Dr. & Join the army - Normal Capital Assets Individuals Own: - Car, House, Bonds & Stocks, Boats - ANY personal asset ALWAYS = capital in nature - Ordinary Income Taxation - Compensation - Any type of ascension of wealth s 61 - Subject to ordinary income tax - Taxed at highest marginal rate - When you sell an asset, you have to pay the government back for the depreciation you took on that asset - ANY amount you make ABOVE what you initially paid for it you keep - EXAMPLE: 1000(cost basis) - 500 (depreciated) = 500 (adjusted basis) - EXMAPLE: 1200 (sold item for) - 500 (what got deprecated) = 700 (gain) - EXAMPLE: 700 (gain) - 500 (what was deprecated = taxable) = 200 (actual gain) - Gain is divided into 2 parts - (1) $500 = ordinary income (b/c that was what you deprecated it for) - & (2) $200 = capital gain (what you made on the sale above what you paid) - Howard v. Bugbee v. Commissioner USE for debt question - Was there a valid buyer/lender relationship? - Was this a true business venture?

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- If yes CAN take losses - If no several tax issues - If you can prove a valid business relationship CAN treat as short term capital loss - When there is a debt collection: - 1) If there a debt? - 2) If it a bad debt? - Bad debt = is there reasonable thinking that you will NEVER collect on the debt - 3) It is a business bad debt? - If YES to ALL 3 FULLY DEDUCTABLE as a capital loss

Assignment of Income

- Assigning income to someone else does NOT transfer tax liability

- Open Transaction Gain is based on sales for the next some yrs - Things are STILL open - Closed Transaction Taxpayer elects out of 453 - OID (Original Income Discount) - Hidden transaction - Looks to be a return BUT there is income labiality to it - Hidden interests - A form of disguised interest - Have to go through an OID analysis - IRD (Income in Respect of Descendent) - Based on work product - Income INCLUDED & for estate tax purposed - Earned income during life, but paid after death - Whether or not there is an economic event? - Is there ascension of wealth? - Salary, dividend, or some type of benefit - OR - Sale or exchange = - Taxable event THAT is subject to preferential tax rate (15%) - If NOT sale or exchange = ORDINARY income = 35% tax rate - EVERYTHING we own is typically = CAPITAL in nature - So Whenever you EXPOSE of capital asset You DEDUCT - Own MORE THAN 1 yr = CAPITAL asset = 15% rate - Own 1 yr OR LESS = ORDINARY income = 35% rate - EXCEPT: Inheritances 26

- Masters Exception If you own a home & rent it out for LESS THEN 14 days ALL income you generated = Tax FREE

Discharge of Indebtness

- If money is forgiven / If Discharge of indebtedness = INCOME - UNLESS explicitly excluded by legislative grace - If tuition is refunded OR excused = EXCLUDABLE - Is the loan that is being forgiven a result of/ related to the acquisition, construction OR financial improvement of the house??? - B/c if it is NOT =INCOME & INCLUDABLE - Congress made AN EXCLUSION of debt for up to $2 million of ANY loan forgiven - EVEN thought people are going to loose their house & have their loans forgiven - United States v. Kirby Lumber - The cancellation of debt = gross income to borrower - Freeing of assets - Symmetry - Loan proceeds NOT included in gross income upon receipt b/c of obligation to repay - Cancellation of obligation to repay removes the reason from excluding the proceeds from income - EXCLUSIONS/EXCEPTIONS to Kirby (Safe Harbor) - NO income If debtor is insolvent before OR after - 1) Insolvency More money going out than coming in (more liabilities than assets) - If you lend me back money & I pay you back = INCOME - UNLESS it falls in an EXCEPTION - 2) EX: Gift Donor says he will forgive & give it as a gift - Donor CAN donate UP TO $13K = GIFT & NOT generate income - NO income liability on person GIVING the gift - BUT income liability on person RECEIVING if gift OVER $13K - 3) Debt Discharge INSIDE Bankruptcy Amount is applied to reduce taxpayers tax attributes - Directed at businesses - Carry over losses - Capital losses - 4) Certain Reductions As Purchase Price Adjustment if debt has been transferred by seller to 3rd party OR if property has been transferred by buyer to 3rd party 27

- If you do a short sale = NO tax liability - Discharge of Indebtedness - Income realized when indebtedness IS forgiven OR in other ways cancelled - EX: If a corporation has issued a $1000 bond that is later repurchased for $900 it increases its worth by $100 - Debt Discharge OUTSIDE Bankruptcy amount of debt is EXCLUDED up to amount that is insolvent - ANY balance of debt discharged which is NOT EXCLUDED treated in same manner as debt cancelation

104 106 Damages for Injuries

Compensatory, if physical= NON taxable Compensatory, if NON physical = TAXABLE Punitive, if physical = TAXABLE Punitive, if NON physical = TAXABLE

Income Earned Abroad

- IRC 911 - To qualify for EXCLUSION an American citizen MUST be resident of foreign county OR had uninterrupted period during taxable yr (@ least 330 days) - Maximum exclusions = $80K AND is indexed for inflation - Exclusion could be available for housing expenses

Exclusions & Other Tax Benefits Related to Costs of Higher Education

- IRC 221: Allows interest DEDUCTION for some interest payments on qualified education loans - IRC 222: Allows DEDUCTION for qualified tuition AND related expenses - IRC 529: Qualified Tuition Programs deferred program that allows you to guard you money away - Allow taxpayers to prepay higher education costs by purchasing tuition credits - Each states had it own (EX: MI MET Program) - Some time in future can use it, putting money into it and it wont be taxable as long as use it to educate your child - Put money into a 529 Plan - Do NOT have to pay federal OR MI taxes on it EVER (it is all pre-taxed money) - As long as it goes to a qualified higher education program for your kids

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- It is EXCLUDABLE & gives kids the incentive to go to college - Raff IRA: put already taxed money in it - Trade IRA: dont pay taxes upfront and have to pay later. Forced to take distribution - IRC 530: Coverdell educational savings accounts EXEMPT from tax - $2000 increments to pay for education in future - Contributions MUST be made prior to 18th b-day

Federal Taxes & State Activities

- Governments chance to promote infrastructure - IRC 103, 115, 141, 142, 148, 149 - IRC 103(a): EXCLUDES interest on ANY state OR local bond from gross income BUT does NOT extend to private activity bongs - Public bonds = for public services - Private bonds = particular park or community - Qualified Bonds = EXCEPT facility bonds, etc - Private Activity bonds = obligations to finance nongovernmental undertakings - Part of bond used for private use - Arbitrage Bonds = ANY portion is use to acquire investment property which produces yield which is high than bond

Assignment of Income
- Lucas v. Earl - Wanted to assign income he didnt make yet to his wife to avoid tax income - Ct said: although it was a valid K, money CANNOT escape taxability from the one who earned it no matter how skillfully the K was devised - Fruit of the Tree Doctrine - Taxpayer = Tree - Money earned as income = Fruit - If the fruit is coming off that tree then THAT tree pays THAT tax - The tax is assessed to the one who EARNED it (the tree) - EX: do something for someone, they give you $, you say no dont give it to me- give it to him, I owe him money - Even though OTHER person gets the money YOU pay the taxes - You CANNOT assign away your tax liability - EXCEPT alimony

162 & 263 EXPENSES

- 162: Allows taxpayer to deduct expenses paid or incurred 29

during taxable year - Midland Empire Packing Co. v. Commissioner: Repairs to property made during taxable year are deductible as ordinary and necessary business expense. - The expenditure did not add value or prolong expected life or property - Ordinary does not need to be habitual

Income Producing Entities

- 3 principal types of income: (1) partnerships, (2) corporations, & (3) trusts - 1) Corporations 11 when corporate after tax income is distributed as dividends to shareholders, it is taxed to shareholders in individual capacities - Difference Between Partner & Corporation: Partner is not insulated from partnership income a shareholder is insulated from income of corporation. - A corporation = an entity separate and apart from its shareholders - C-Corporation: Standard corporation, taxed at 2 levels: - 1) At the Entity Level they file a Form 1120 AND generates it - 2) At Ownership Level dividends that are distributed out to shareholders and they fill out a Form 1040 - Traditional business entities: provide limited liability earnings - Sub Chapter/S-Corporation: Cannot have more than 100 shareholders - Entity Level no tax, however you do file a tax return and that Form is 1120S - Shareholder Level taxed on all that flow through earnings on Form 1040 - Same limited liability as a C-Corp and is easily recognizable - No tax at entity level and tax attributes flow through at entity level. Limited number shareholders, narrow definition of what a shareholder can be, and restrictions on trusts and estates. - 2) Partnerships/LLC 703 persons carrying on a business as partners all will be liable for income tax only in their separate or individual capacities which is determined by agreement with partners. 30

- Made up of partners with the intent to form a partnership and they themselves create a partnership for business purposes - General Partnership: File Form 1065: pay no taxes because the partners pay all taxes, as long as general partner is liable for everything. Partner - Limited Partnership: File their own Form 1040, only limited to extent of the investment. Member (can cut your own deal) - DO NOT become a limited partner, you want a LLC (use a limited liability company) - Choose an LLC for Sub Chapter S Entity - LLC: Limited Liability Company - 3) Trusts: Falls between a partnership and a corporation. In determining the taxable income of the trust, a deduction is allowed for amounts required to be or otherwise paid to beneficiaries. - TrustOR = creates trust - TrustEE = managing document - Beneficiaries = received monies, FORM 1041 Simple and Complex Trusts - Simple Trusts: distributes everything to beneficiaries because it is most efficient - Complex Trusts: may distribute to beneficiaries only if necessary. Trust pays tax on this, not that efficient. - Most trusts are complex trusts - The taxpayer is using a trust to avoid paying income taxes - A trust is an entity that is established when the grantor with a beneficiary (someone who benefits from the trust) and with some type of principle income or assets which are funded in the trust - Basis in Property Received: AB of OLD property Money Received (boot) + Recognized Gain (value above the property) Recognized Loss = AB of NEW property

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