• Problems with cash system
    1. Cost of capital investment may not be deduct down the outlay is made, but only as the asset is sold or when it is used
    2. Will have problems with escrow, ad people are deemed to have it
  • Income "gain from capital, labor or both" -- but it is the right exercised in consumption and the change in value of the store in property rights -- now there much be realization and something people have complete dominion and control over
    1. Income is only a measure of ability to pay (surrogate)
      1. Property tax is another indicator
    2. Imputed income is not taken account of
    3. Goals
      1. Fairness
        1. Horizontal equity: with one's peers (similarly situated)
        2. Vertical: people arenít overly taxed based on extremes of wealth
          1. We have the progressive income tax
      2. Administrative feasibility: this might conflict with fairness
      3. Soundness of economic effects (or economic rationality)
        1. We should try and not perverse any perverse economic effects
    4. Reliance: people do rely on and the tax law, so it can't be too flexible
    5. Tax expenditure budget: some things are really direct expenditures as they really deduct from the treasury
      1. Based on the notion that there is a natural, neutral or normal income tax, and departures from it are expenditures
    6. Burdens of taxes are shifted through the economy
      1. People assume that personnel income tax is shifted the least
      2. Corporate shifting is uncertain
      3. There will be substitution effects imposed by the tax
      4. People may work harder (income effect) because of the tax
      5. Money will be shifted to the more favorably taxed items
      6. Putative tax for shifting things to thing that are tax preferred
    7. Inflation
      1. Bracket creep
      2. Changes in deduction s for the cost of investment in productive property
      3. Much of gains might be attributable to inflation
    8. Taxable unit -- most married people file jointly
      1. But one isn't required to report dependant's income
      2. Secondary worker in a married couple is subject to the rate determined by the income of the primary worker
    9. Present value of annuities are deemed to be rights
    10. Things for convenience of employer are not income should be on the premises of the employer
      1. There may be horizontal equity problems with this regime
      2. Would create vertical problems, especially for employers with less than adequate workplaces
  • Fringe benefit problem (if it is part of salary, employer will deduct and employee will include)
    1. If there is no additional cost to the employer, and in his line of business it doesn't need to be included
    2. Non-discriminatory employee discounts are also not income -- in the ordinary line of business
      1. Cap of 20%
      2. Amount of the exclusion will only be the discount (based on arms length transactoin, not a gross profit ratio)
    3. Cafeteria plans are authorized,
      1. Use it or lose it -- if can't change mind after the election
    4. If there is a valuation of the goods, we look to the of the goods given an arms-length transaction
    5. If things are non-business, and if they are non-compensatory business activity
    6. Frequent flyer miles are considered to a right that is exercised
  • Gifts receive a transferred basis: no deduction and no income
    1. Things received from decadents get stepped up basis
    2. Constitutional challenge is that might not be an income tax
    3. Under Irwin, if one splits a gift he who receives the interest pays the tax
    4. Basis
      1. Transferor's basis if one is selling something that is a gain
      2. If something is a loss, one taxes the fair market value of it at the time of transfer
      3. Donee's basis will include any addition taxes paid
    5. If one borrows against appreciated property they will nto be taxed on the additional amount of collateral, even though they have additional wealth -- the basis will be reduced by depreciation and the amount of the loan, and the tax principles will stay constant
  • Imputed income -- from
    1. Can be from home owners not having rents
    2. Can be for below market rates on loans
  • Compliance
    1. 6 year limit criminal
    2. no sol for civil
    3. nonpayment is t-bill plus three
    4. non-payment mean a 20% payment
    5. fraud is a 75% payment
    6. one can make amended returnsinnocent errors: would have to pay interst
      1. terms of an employment contract are not determinative
    7. terms of a contract are not telling or whose benefit or convenience things are
  • tax base is defined as what the government has chose to tax -- in our case, gross income
    1. AMT has different tax base (broader)
    2. In taxing annuities there might be a different tax base
  • Consumption possibility
    1. Unrealized gain is generally not taxable
      1. Investments in human capital would really be a tax on consumption
      2. Y=c+s is the same as c=Y-s
    2. A consumption tax is really an income tax with a deduction for saving in any form
      1. Qualified pension plans are an example of consumption taxes
        1. Not current income -- IRA is 401k, and roth ira is 408s
      2. Consumption tax is different than sales taxes, as sales taxes are based on transitions
        1. Consumption taxes might encourage people to to save and to attain a cerain target
  • High marginal rates can't be taken seriously when wealthy can control things more
  • Timing
    1. Annual accounting
      1. Today people can carry forward and Cary back losses
      2. NOL can be carried forward and back
        1. Can cary losses two year back
        2. Can cary losses 20 years forward
      3. Stcok is an exception to annual accounting
    2. Gains must be realized
      1. Stock dividends (split) -- must be a pay out (not just a watering) -- today the basis is allocated between new stock and old stocks
        1. Increased wealth
        2. Accumulation of company's profits incrased
        3. Accumulation of prifits increased wealth
      2. Cash would be taxable
      3. Congress requires that US sharehodlers of foreign personal holding compnaies and certain foregin corporation report their properotion share of corporate income
    3. Capital improves could be (or were) treated as income: abandonment can be a realization
      1. Today such things are postponed
      2. Legislature now says that gross income is only based on lease
    4. Like kind exchanges are not taxable
      1. Barters and swaps not in dollars won't be taxed (issue of imputed income)
    5. A gain should not be recognized if it does not generate cash to pay the tax
    6. CMOs or similar a way to realize loss -- even if they are a like kind transaciton (government lost)
      1. Regulations about whether restructuring is realization on 303
      2. Loss is calculated as difference aven amount realized
      3. Like-kind exchanges won't apply to stocks, bonds and notes
      4. Does apply to farms
      5. Boot is deemed to be the first part which is recongizinable, if two things are hard to value
        1. basis in a new like kind property is (basis in the old) + (any gain recongized on the transaction) Ė(fair market value of the boot)
        2. any boot will take a basis equial to its fair market value Ė the tractor will take a basis of 8k Ė and the other boot was cash, ancd cash van eb viewed as having a basis equal to its famir market value Ė having 15k of cash, the tax system has allowd us 23k of credit, and what this leaves us with is a final basi sin the property pf 23k Ė f
    7. Non-recourse loans
      1. Realized: there has been a severance of property (doesnít matter if it was recourse or non-recourse)
        1. Money received plus amount of fmv of other property
        2. Property subject to liability (ie mortgage) -- whether recourse or not --
        3. If the value of the property is less than the amount of a mortgage, a mortgagor who is not personally liable, can't realize a benefit -- so a different problem might be encounter if they transferred the proper (or abandoned) without boot -- i.e. no equity in the property.
        4. If a property is encumbered by non-reocurse mortgage that is assumed as consideration, than it is as counted as a gain in wealth (amount realized is the amount realized plus the fmv that was received.)
        5. If one must treat a mortgage exactly as if they are their personal obligations, than they treat an assumption of the debt by another as a gain in wealth
  • Gifts
    1. Will be up to trier of fact
    2. There is no business deduction for gifts in excess of $25 per individual
    3. Tips and toeks are not gifts
    4. Scholarships to degree candidates are not gifts
  • Exceptions to anntual accounting
    1. Tax benefit
      1. When a item of a transaction generates a tax benefit in an earlier year, and then products a negative tax consequences in a later year
        1. Exclusionary: Recovery of an amount previously deducted will not be incldued in income to the extedn that the earlier deduction did not reduce the amount of tax imposed
        2. Inclusionary: If the item previous generated a deduction, ie a loan which was deducted as a bad debt -- ie the tax benefit doctrine requiest the inclusion in income of the amount involved when events fundamentally inconsistant with a prior deduciton occur unless a statutory nonregongition rule apples
  • Claim of right (modification of annutal accounting): one can only report the income at the time that the "last evet" (or order to pay (ir or when something becomes incontestable) --
    1. Inclusionary: taxpayers must include in income items over whichthey have an extended claims of right
    2. Deuctions are fixed in light of the prior inclusion
    3. If the amount of the deduciton exceeds 3k, and there is an unrestricted right, the taxpayer has a choice between a refun of the additional tax generated by the prior inclusion, or a deduction at the current year's marginal rate
    4. It comes down to the interest that oen has in the revenues
    5. It come down to when the taxpayer can claim it belonged to him
    6. One could take incmoe the first year, and deduciton the sseocnd
    7. If the deduction in the later yaer is greater than 3k, the tax is the lesser of the amoun tdetermined by claiming a deduction in the ordinary manner or by forgoing the deduciton and claiming a credit in the year of repayment
      1. Statue now applies to which it appeard that the taxpyaer had an unrestricted right to something
      2. Mere errors are nto a contractual right
      3. Repayment of embeezzled gains are not a contractual rightj
    8. Changes in bracket: there is no tax benefit doctirne if the differnce ivolves a change in margainal rates between the year of deduciton and the year of inclusion
      1. Property given to charity and given back is deductable (ie didn't pay capital gains)
    9. Changes in policy from paying things, that would put people down a bracket, to not being put down a bracket doesn't nto require back taxes
  • Bonds
    1. State and local bonds exempt but one could say that their lower interst rate is a puitative tax
    2. For higehr incomes incentive to buy is far grater
      1. Industrial revenue bonds are limited by purpose
      2. Cap in weach state of 50 per resident or 150 million
    3. Restrictions on states confucting tax arbitrate
    4. People could conduct artbitrge, if their marginal rate is high enough
    5. US treasury bonds are sometimes exempt.
  • Loans
    1. Loan proceeds don't change people's economic status, so they arenít income
    2. Discharge of indebtedness
      1. Bankrupts have no includable income from a discharge
  • Income from discharge of indebtedness
    1. One won't be taxed on banrucpy discharge
    2. Purcahwse money debt is consuiderd to be a reduction in sale price
    3. If oen is awarded a repayment of a loan, even though no benefit resutls they still have income
    4. Can be a discharge if there is a settlemtn for a ower interst rate (even if in the banks' iterst)
      1. A difference between the amount borrowed a paid is incmoe to the corporation (even if purchsed on the open market)
    5. Contested liability exceptions
      1. Disagreement that is later settled, since the amount is later settled, it ins't really a discharge of income
      2. Reduction in purchase price (ie see that the property is defected after giving a promisory note). Purchase money debt reduction: in the purchase of property.
    6. Bankruptcy exception: agreement to pay less, although an economic benefit, the income is not taxable, when insolvent or in a title 11 bankruptcy case
      1. This money is used to reduce any later NOL, or caryovers, or later basis in depreciable assets
    7. Gift exception: (gifts are not included in recipients income) -- it becomes a gift (detatched and disinterested generosity)
    8. Appreciation or depreciation of assets isn't included until realized
    9. Gambling debts -- in view of state law of enforceability
      1. One might treat gambling debts as something the Casino doesn't hope to repay anyway --
      2. One might treat all gambling debts as offset against winning
  • Gift tax on appreciated stock
    1. If one pays the gift tax on stock, one has an additional basiss that is stepped uop proporitonal to the net appreciation of the gift
  • Encumberances -- it is considered incoem even if you wouldnít be personally liable for it
    1. If the value of the property is less than the amount of a mortgage, a mortgagor who is not personally liable, can't realize a benefit -- so a different problem might be encounter if they transferred the proper (or abandoned) without boot -- i.e. no equity in the property.
    2. If a property is encumbered by non-reocurse mortgage that is assumed as consideration, than it is as counted as a gain in wealth (amount realized is the amount realized plus the fmv that was received.)
    3. If prop is transferred in settlment of a debt there is
      1. Gain from paying off favorable loan
      2. Gain fron the dispostion of the property
    4. statutory solution which elimiantes benefits from encumberance debt
  • compensation for injuries
    1. will be offset against basis, but can be a like kidn exchange if use to get something enw
      1. tax free treatment doesnít extend to putative damages
    2. no taxation of interest on settlements of tort damages (can be tax advantages)
    3. no taxation for recovery under insurance policy -- needs to be physical
  • compensation for loss
    1. paying taxes is income --
      1. if ones compensates one for paying too much taxes it isn't income, as it
    2. personal losses that arise from theft arenít income -- personal losses that arise from theft arenít income
  • Illegal income isn't income that is offset by basis (as is a no interest loan) since one always has a duty to repay
    1. Ironically in "borrowing" schemes the taxed funds come out of the founds that would be repaid
  • Medical expense are only dedctable, (in the current year) to the extent they exceed 7.5% of gross income
    1. Premiums are deductable by employee but not inc;uded in income -- employers pay for it with pre-tax sallaries
      1. Extends to spouses
  • Splitting income and dealing with children
    1. Under old system, Husband and wife could contractually allocate up their gains between the both of them
    2. Former incentive was to split income to take advantage of minor children
      1. Fruit and tree: In the past people would enter into contracts with their spouses to split income, thereby lowering their income
        1. There have been cases where children who agreed with their parents to manage their career were entitled to deduct the payments, but merely sharing wasnít enough
        2. Gratuitous performance of services: (imputed income?)
          1. No income arises where services are provided to directly to charitable organizations (ordinarily there would be a phaseout of contributions)
    3. Now people are taxed in the right vests
      1. There was one case, where someone was found to be liable for taxes for a fictitious job that someone got or their girlfriend
    4. Joint returns: initially favored married couples, as it was available regardless of state law, then favored single people
    5. Constructive receipt and deferred compensation and payment in trust
      1. Receipt for payments received from benefits from earnings from company -- even if paid to children. Realized at realization, but payments that are not linked to sallaries can be deductible when paid into trusts
      2. Payments turned over to an employer are not taxable (even if religious obligation)
      3. Can't have unilatarela backturning
    6. Assignment of Limited interests (ie life estates) are taxable to the recipient as the assignees become the owner of the beneficial interest
      1. A cash paying taxpayer who assigns a stream of income (ie bond coupons) is taxable on them (ie deemed to realized)
        1. They could be independent negotiable instruments
      2. If ownership of a bond is stripped (ie princiapl from interst) it is treated as a sperate negoitable instrument
    7. Kiddy tax: unearned income for a child under 14 is taxed at the parentís marginal rate
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  • Gains by constructive receipt
    1. If decision to delay payments is in good faith and enforceable there is no receipt
    2. Original issue discount: to the extent that a debt instrument does not provide for current payment of an adequate amount of interest, interest must be accrued, whether cash or accrual method --
      1. Disgusied intest payments or OID. The imputed pricniapl amount is the presnt discount value of the stated obligation, and is achieved by applyy the federqal discount rate in 1274d.
      2. OID is the unstated interstg in a dferred payment
      3. The obligaor is entitled to deduct the amount aht the obligee is required to accrue
        1. Ie when a bond is old for cash, the OID is the difference between the issue price and the redepmtpion price (the price as which the bond is required to be paid by the borrower)
      4. Purpose is to prevnt deferring payuments until last year
      5. Instead of dividing, one has to calcualte the npvs of the final amount each year (ie with an implied rate of interst)
      6. Exceptions for oid for farms, princiapl residences, etc and htings less than 250k
      7. When bonds mature they are ordinary incoem
      8. OID would seem to impute two years of interst -- absed on the tax law
    3. Open tranactions
      1. One possibility: only one year, and no carry forward involved
      2. Closed: income is npov of payments
        1. Traxpayers lose value of deferral
      3. Third is installment pyaments
        1. Taxpayer can elect not to use it
        2. If there is OID or unstated interst, he will get the proportion of his basis every yuear of theinstallment (ie if basis is 40% of the deal, 40% will be the basis in each installment)
          1. Not available, when not readily convertible to cash
      4. Present view: things are apported by their basis
      5. Tax sales are not closed until redemption ends
    4. OID rules
      1. Intersting income in any defrred income plan is income not capuital gain
    5. In installment sales, one who has sold property in return for deferred payments can preorate the gain recongized on the sale among the payments received
      1. Not good for dealers in property, or property over 150k. Above the the taxpyer has to pay interst on tax deferred by use of the method., Tover 150k, tamsut treat any money received from a loan secured by an installment obligation as payment of the opbligation
        1. The creats an intersting paralell to receipt (ie Drescher)
    6. In the "all events" test, something that is unsecured (or subordinated) or is subject to an LDC is not recived
      1. There are dollar limits to the use of plans by agencies with low tax brackets, as they get a benefit
      2. If it is structure as a loan, it might be a way to defer payment
      3. Dues for services that may at soiem point be rendered must be reported as current incoem
    7. If one converts their income into an annuity (a truse novation) than one is receiving deferred compensation
      1. If the novation occurs before the receit it will be taken as a deferral
      2. Qualified plans
        1. Even if the rights are vest they are not taxed until payment is received
        2. Employers are entitled to immediate dedcution for amount spaid in
      3. Penalities for early withday (condition on 384)
      4. Stock options
        1. Alternatives
          1. Value of the option when granted
          2. No taxed when granted, and no tax if not exercised, but tax on
        2. If one gets transferrred a stock at a lower basis, one is assumed to have that lower bassis, even though they donít they didn't pay cash for the lower basis
        3. Premimum on stock options can be added to the basis on whicht hey are exercised
        4. ISO: (incentive stock options) -- no tax cosnequences when granted and the employee is taxed at capital grain s rathes when the stock is received on exercise of the option is sold
          1. Must reatin for two years, and one year after the grant, and the op tion price must be less than the FMV of th stocok ta the time the option is granted
        5. If ther eis no fmv, thant there there is no tax at the time the option is granted, and a tax at the time of eexercise on the spread between the fmv of the stock and the option price
        6. One's current basis is the premium plus the exercise price
      5. Valuation of compensatory stock options
        1. If publically traded use the stock price otherwise excess of stock's value over its execise price at time of exercise
        2. One can negotate with the employer to forgo ISO in favor of more cash
    8. Winnings received in trust are deemed to be constructively received because thei guardian acts in their place -- providd that there is no credit risk`
  • Life insurance
    1. Life insurance excluded -- but no deduction for premiums
    2. Inters to buy this, in its simplest form is not deductible
    3. Not available to those who the policy is transferred to
    4. A life insurance policy is expressly denied if deduction if the employer pays for it
  • Gambling
    1. Gains are taxable, but losses only to the extent of gains
  • Capital gains and losses (loses must be used only offset capital gains) Ė can carry forward
    1. If something is divided, the recovery can be of the basis first (ie easement in real property)
      1. Annuities
        1. Recovery of basis uses an exclusion ratio
        2. Exclusion ratio: Purchaser of a life annuity would divide the purcahse price by her actuailly predict life span and offsent the annual annuit payment by that amount1
        3. Annuities also get a timing benefit
        4. If the distribution doesn'f follow a distribution scheme there are penaltieis
    2. A limited amount of the cost of certain property (all persoanl property) used in a trade or businsess may be trated as a current expense
      1. (18,000@1997 to 25k@2003)
    3. There is ordinary loss where the taxpayer has a net loss, but provides for capital gain treatment where there is a net gain
      1. Capital losses: individuals can deduct capital losses from gains, but individuals with overall capital losses, can only deduct 3k of gains in any year.
      2. Corporation may only deduct capital losses from gains
      3. This reduces incentive for people to manipulate losses into a single year, and reduction of selective culling of the portfolio
    4. History and policy
      1. History: before 1986 were allowed deduction for 60% of net capital gain, now the maximum rate is 28%
      2. Policy
        1. good
          1. Capital gains are bunched in a single year (at the moment it doesnít have a much force because people at the moment are paying less than the full maximum rate)
          2. Incentive to hold assets for more (incentive towards illiquidity)
          3. Inflation: if they are treated better, this mitigates possible losses due to inflation
          4. Economic growth: incentive for greater economic growth
          5. Could be incentives to new industry
          6. Unrealized gains arenít taxed
          7. Reduction of tax capital gains based on selling stock
        2. Bad
    5. Basis: if income is classified as property, than there is a deduction for basis
    6. Definition of capital asset: property (exceptions)
      1. Inventory of stock of a business (and property held for sale to customers in ordinary course of business)
      2. Real property or depreciable property use in a trade or business
      3. Intellectual property held by creator (but not what is purchased from creator)
      4. Accounts receivable in the ordinary course of business
      5. US government publication held by someone who received them at a discount
      6. Exceptions for depreciable or real property used in business
      7. Loss and sale on small business stock
        1. There is capital treatment for certain proceeds of timber and coal
        2. Now taxpayers can exclude 50% of their gain from small business stock
          1. Must be acquired on initial issuance from the company or underwriter (not from stockholder)
          2. Must be held for more than 5 years
        3. Stock involved in accounting, law, health, banking, minoring
        4. Small business are companies with less than 50 million in assets
      8. Gain from Original issue discount is ordinary income
      9. Loans
        1. If a loan is evidence by a bond, it is a capital asset and aif there is a sale it gives raise to cpauital gain or loss,
          1. If it the bond is retired by the issuer
          2. If the bond is decliared worthless
        2. If the bond is a debt than it is an ordinary loss
    7. Netting
      1. First round
        1. a taxpayer first nets Short (less than oen year) against losses
        2. a taxpayer first nets long (more than oen year) against gains
      2. second round
        1. netting together
  • transfers persuant to mortgage
    1. transfers as per a divorce or seperation: no gain or loss shalll be rearenogized on tgransfer of property between spouses
      1. doesn't apply for accued interst
      2. valuation: in an arms length transaction, the hard to value properyt will bne predumed to be what the asy to valie propery is (ie trading a stock for a post-marriage settlement)
    2. marriage -- under new rules there is no stepped up basis
      1. transfer between couple who are married are not really transfers
      2. if one transfers properyt persuant to a divorse it is a realization event, and they are taxed as if it was a regulat transfer --
      3. one can swap marital rights for more tangibel goods, and the less tangibel goods are deemed to cost what the others do
    3. divorse is really a swap with a realization -- but the person who takes the property is the one who has the carried over basis
    4. Alimony:
      1. Has to be stream of payments
      2. Msut agree that non-taxable and non-deuctable
      3. Must be under a insturment of marriage or maintance
      4. Must be in cash
      5. Can't be members of the saem hosueshodl
      6. Can't continue after death
      7. Can't be for child support
      8. Can't be a property settlement
        1. Can't be frontloaded (ie can't be unequal from first years to later years) -- can't be a highg amount in first year
        2. Alimony is not offst against gains
  • accrual problems
    1. accrual of income
      1. if payment to received
        1. "all events test" -- if the right to receive the income can be determined with accurance
          1. when there is a contingency, this means it hasn't been paid yet
        2. if the even hasn't accourred, it has to be realized when the cash is received
        3. deposits are not accrued income
        4. goes to to the issue of solvency
      2. averges expesese arenít enough
    2. accrual of deducitons: all events test can be applied if the benefit to the other (ie medical) is vested in the other
      1. if the actual expeses havn't occurred there is no deduction -- even if the expnsee can be preducted
      2. depsoites can be though of as non-includable loans
      3. Mooney: (aircraft that came with a bond) --all events that would be deductbale hanv't ben paid for
    3. Can be a quesitonof deductive npv or full amount
    4. There can be deducatble reseverse for bad debts
      1. (checks Moonie bonds) and tvm questions
    5. checks are treated as delivered when received
    6. charge cards are treated as loans
  • Deductions -- itemized deductiona re subject to a phaseout
    1. Standard deduction (varies with income) -- flate rate (cliff effect)
      1. Each qualifed depending gets somehting
      2. Earned income tax credit
        1. Refundable if people make less than a certain ampont (there are non-progressive taxes in the background)
        2. Credit for elderly and permenelyt disable
      3. Each dependant has a deduction as well
      4. Personal exemption ges phased out
    2. Casualty -- must be over 10% of AGi -- provides a form of insurance
      1. Fire storm, shipreck,
      2. Orindary loss not deducatble
      3. Must be a suddnness
      4. There could be public policy reasons (ie self-impsoed loss)
    3. Medical -- doctor advised soemoen not to mow law, but didn't get a deduction
      1. Putting kids in boarding school for medical condition could be a imputed income, but no dedcution
    4. Charitable contributions -- the charities don't pay tax -- deduciton s are limited to the less of the basis of the prooperyt or the fmv -- but if you transfer to a public charity you are outside of this rule
      1. Issues of poublci choice
      2. Charitable intent
        1. Has to be done with disinterstest
      3. Types of charities
        1. Charitable recipients have to be real charities Ė
          1. Public charities -- but if you transfer to a public charity you are outside of this rule
            1. Red cross, acs, boy girl scouts
          2. Private charities
            1. Someone setting up a private foundation for charitable purposes
      4. Can only be made uop to 50% of the contribution base for churchs
      5. Private foundation are 30%
      6. 30% limit is in preopety who sale would have resulted in long term capuital gain
      7. any excesses can be caried forward for 5 years
      8. full FMV is deducted (not the fmv minus the basis
      9. anything over 25 must be subtantiated -- not cancelled checks
      10. regarded as a subsidy
    5. taxes (persoanl deduciton)
      1. fees not deductable
      2. deduction for state taxes and more or less voluntary things
    6. interest -- now there is only a deduciton for non personal interst
      1. no deduction for acquisition indebteness
      2. definitions
        1. must be evidence of intention to create a relationup of debtor and credior
        2. has effect on inflationary profile
      3. interwst incurred in a trade or buisiness for the produciton of income is a proper adjustment
      4. other than mortages, all other business not deduct is nondeductbile personal interst
      5. can deducat home equity indebedness but not in excess of the fmv -- this creates intersting inequities
      6. could be a question of consuming sooner rather than later
      7. doesn't really matter what secures a loan, the inquiry is what it is used for
      8. comingling -- things made withing fifteen days can elect to trat as borrowed funds
        1. if funds can't be traced, the borrowed funds rise to the top
    7. Ordinary and necessary business expenses are deductible -- note distiction between maintance and creating a new capanbility
      1. General rule: no deudcitoni for the use of a huime for biz purpoes
        1. Exceptions
          1. Vacation homes
          2. Home offices
            1. Vacation homes -- they become dwelling units, if the taxpayer uses more than a specificed time
              1. Passive investment: If a vacation home isn't used for personal purpses it is allowed eedcution for passive activities losses
              2. If a unit is used for personal purposes, but more than the specified amount of time, but is rented out for less than 15 days, then the owners excldues the rental income and can't claim deduciton than for interst and taxes (that would be deductable anyway
                1. If the unit is used for personal purpsoes less than 1 days, tdeduction is on a pro-ratta bais, and is subejct to the limiation on deduciton of passive activies
                2. If a unit is used for personal purpose more than the speciifed amount than expese other than interst muyst be prorated, but prorated expese can't exceed the rent received
              3. Home offices
                1. Very sepcric exclsuion
          3. Vacation homes
            1. Split of a vacation home (with more than 14 days of person use). 2k of real estate taxes (state), rent income of 8k, and annual depreciation and maintance of 10k, and 12k
            2. Non-serious (investment) vacation homes: Are we outside of 280a-e ? limits on deductions on vacation homes Ė cap on what percentage can be taken, if you are there less than 14 days, can take deduction from all income (e. g. sallary) -- (number of day of use over days in year)
            3. If you are over 15 days, than your expense can only be offset from income from the property (280a-c-5)
            4. To decide how much of the real estate taxes are deductable from the income, the ratio is number of days rented at fair market value over days in year (365) * real estate taxes subtract all from income (8k --)
              1. This is the amount that can be deducted the expense: 8k-(2k*85/365) = 7534 (7534 the sole income which the other expense can be offset against)
              2. Even though we have 10k of expenses, we can only use 7534 to offset income + plus the real estate taxes (9534) (as opposed to real estate taxes and maintance totally 12k)
          4. Travling on business is usually deductable using a primary purpose test
            1. Now spoues expesne are not deductable when attending a convention
            2. Needs to be a direct realtionship ebtween a claimed dedcution
            3. Any acitrivity which is of a type generally considerd to consitute entertain if it is directly realted to business
              1. "associated with" might weaked the direct relation
          5. meals are now deductable to 50% of the costsubstantiation requirement --treasry can do away with them
            1. Can't be scaled tickets
          6. stringent requiremetn fo ryachts, etc
            1. there are exceptiosn in 274e
        2. need to maintain records
          1. sole propriters can't considere it all to be business
          2. per diem rates might require no substantaituion
          3. expesne lunchs nto with clients don't count
      2. child care
        1. adoption expense don't count
        2. there are various reasons for disallowing child care expenses (p. 570)
        3. could be an expense for overnight stays of children
        4. phasedlown as income rises
        5. cam in the allowable expense
      3. travling
        1. oen's home relfects a personal choice
        2. no deductions for modification of mode of transportion if it makes it harder to take a chepear kind
        3. thee conditions
          1. reaosnable expense
          2. must be while away from home
          3. must be in perduit of biz
        4. maintaining a rsidence is based on persoanal reasons
        5. when traving expese are more than the working expeses, this usually m4eans tht it would be disallowed, as there are few polcity reasons for it
        6. temporary jobs
          1. I new job with indefinite is treated as a permanent
          2. A person who takes a temporary job, provided it is part of the line of work is
        7. Moving expense -- commuting not deductble
          1. Deducatble if would add at least 50 miles to commute, in the year following the commite-- with no minimum threshold
          2. Transportaiotn expense paid or incurred in going between the txpayer's reisdenc eeand temproary work location are deductable
            1. If a taxyaper has one or more regualtion work location away from home, the taxpayer may deduct daily transportaion expense incurred in going between the taxpayer's residence and a temproary location in the same trade or business regarless of distance
            2. If the residence is the princiapl place o fbuisnee within, the taxyaper may deduct daily traporation expense incurrend in gg between the resicen and another work location in the same trade or biz
          3. Clothing
            1. If used only on the job, deductable
            2. Not worn outside
            3. Can't be adaptable
          4. Legal expense: look to the orgian of the claim
      4. Hobby losses are not deductable, but if one tries to make a profit it is an ordinary expense
        1. For the purpoese of normal accounting outlays a start-up costs
        2. In improvements there may be imputed income, and if had paid someoen it would have only increased
        3. Nine factors to tell primary purpoes
        4. Alternative test is a benefit test -- where the court would look to pleasures
        5. But income generated by a hobby can be offset by expesnes from that hobby
        6. Will be a presumption that one is in business for a profit
        7. One must be actively involved
        8. One can work at their pricnaipala place of business
      5. Capital improvements not deductible, but improvements to come up to code or federal inspection or maintain the norm probably are
        1. Alternative tax regime might be a deduciton for loss but this raises the realizaiton problem Ė and under such logic would be to deny deduction for restoration to pretax condition
      6. Education: deducatble if in the line of work, directly related and not a bridnge to another form of work
      7. Legal fees
        1. If the legal fee was not in the trade or business (or not in the accused trade or biusiness) not deducatble
        2. Forcus on orgin of claim
      8. Even things that may be forseeable, but are forced as a legal aciton (or threat of legal aciton) must be capitalized - but things that arenít quire forseeable (ie governmetn warning to clean up hazardous waste) are deductable as expenses (and they could be ordinary and necessary expense)
      9. Expense incurred in a failed tax shelter are disallowed
        1. Practing lawyer who headers their own office would deduct
          1. Unreimbursed expeses are deducatble subject to a 2% deductable
        2. No deduction for personal, lviing or family expese
    8. Capital assets must be capitalized, not deducted for both cash an accrual method payers
      1. UNICAP - uniform capitalization requirements -- deson't apply to people with under 10 million dollars in receipts
        1. Costs of producing self-created assets, must be capitalized
        2. Sallies of purchasing agents must be allocated to inventory and recovered at time is sold as it is a cost of manufacturing
        3. Not included: marketing and advertising, general and administrative expanses that donít relate to sale or production (including public relations and shareholder relations)
      2. Can take a deduciton for simple repairs
      3. Futures Benefits test: Expense that donít create an identifable asset, but might provde long term benefits msut also be capitalized (ie merger)
        1. Use orgin of claim test to decide whether settlments should be deducted
      4. Money paid for production of a manuscript would need to be capitalized, and not deducted
        1. Cost of trucks could be used as a cost of creating capital itself
        2. There may be problems, if one scaps a part of a famred-out prject, it the court imputes an additional loss to it
      5. Prepaid expense (ie premiums) need to be capitalized
        1. Mortgage points are excepted
      6. If no expenses were incurred for developing a farm, by the taxpayer but the farm was purchased anyway, the costs for the purchase of the growing crops are not deducible are capitalized and included in the crops basis
    9. Research and development doesnít need to be capitalized
    10. Cost of developing farms and orchards doesnít need to be capitalized
      1. Cost of land is a capital expense, but development is not
      2. Note: now passive activities canít be expensed and need to be capitalized
      3. If no expenses were incurred for developing a farm, by the taxpayer but the farm was purchased anyway, the costs for the purchase of the growing crops are not deducible are capitalized and included in the crops basis
    11. Accounting for capitalization -- IRS likes consistency
      1. Not simply deducting the goods purchased during the year
        1. Methods of valuation of purchases (whichever lower)
          1. Cost: the amount at which it was included in the closing inventory of the preceding taxable year
          2. Cost or market: for merchandise purchased after the beginning of the year, cost is invoice price plus transportation and other acquisition, less trade discounts
          3. Produced: for merchandise produced during the year, cost is the total of direct costs (i.e. labor, etc.)
        2. Identification: COGS is receipts-cost of goods using LIFO or FIFO:
          1. If LIFO is used for tax purposes, it must be used for credit and tax purposes
    12. Depreciation deductions (in property that has a finite life, and put out wealth) Ė incoming generating assets with a terminable life), no depreciation to personal residence, car or other property used for personal consumption
      1. Things that can be deducted: good will in paid subscribers -- if the assets were purchased rather than created
      2. Costs of intangible assets can be amortized of a 15 year period -- if the assets were purchased rather than created
      3. License renewals have no determinable useful life
      4. Useful life of goods
        1. Methods Ė note: unless people take their deductions on January first, they only get Ĺ yearís worth of deprecation: the amount of the investment that a taxpayer can depreciate cannot exceed the differenc ebtween the assetís cost and its salvage value -- but no salveage value for intangibles
          1. Declining balance
          2. Straight-line:
          3. Economic depreciation: reduction in value each year (smaller deduction in each year)
        2. Intangibles: taxpayer must make showing through facts and circumstances
        3. ACRS
          1. 3 years: four years or less (race horses
          2. five year: cars, trucks, office systems
          3. seven
          4. ten: orchards
          5. 15: intangibles assets such as good will
          6. 15-24
          7. 20: property other than residential prop with life of 25 year s or longer
          8. 27.5: apartment complexes
          9. 39: shopping complex and office building
          10. 15: railroad grading and tunnel bores
      5. salvage: under MACRS, salvage valu eisn't important
      6. methods of deprecation -- basis is reduced if depreciaiton is allowable, even if depreciation is not taken
        1. rapid
          1. polution control facilities
          2. research and experimental expendiutres
        2. straight line
        3. declining balance
        4. sum of the year digits
        5. income forecast: current year's depreciation deduction is derived from a projection of future income. That portion of basis equal to a fraction of which the numerator is the current year's income and th edenominator is the estimate total inicome to be derived from the asset for its entire useful life
          1. used for films, sound recording
    13. advanced payments on rent canít be deducted all in the year of payment
    14. defining ordinary and necessary business expenese
      1. one looks at the orgin of the claim but sees if they are directl related to the trade or business
        1. can take into account public policy
      2. honor bound obligations are not normal - but to save a buinsees might be necessary
      3. if it has never made before it wonít be given a deduction for
      4. reasonable compensations -- if things get too high will be questioned
        1. must be reasonable
        2. must be under 1 million
      5. bribes
        1. to government people are disallowed to government employees
        2. other governments employs under the foreign corrupt practices act
        3. settlements paid to settle violations of the anti-trust act
        4. but, if the law generally isnít enforced it might be acceptable
      6. taxes to other nations
        1. in generally deductible
        2. taxes to disfavored nations or owns with no dip relations are not deductible
      7. if restitution is a condition of reducing sense than not deductible
    15. recaptured: the portion of a taxpayer gain that reimburse pas depreciation deductions consituttes ordinary come, the amount qualifies for capital gains
      1. repartured ordinary income = ((final selling price asset) Ė (unrecovered basis aka original costs -depreciation))- (difference between original buying price and selling price)
      2. recapture is not eligible for instlalment method
      3. amount of recaputre reduce the amoun of the deduciton in the case of a gift of property to a charity
    16. Tax shelters: exception to capitalization required: rentals are deductible, installment plans must be capitalized
      1. Four princiapls
        1. Which way is A better off from a tax perspective
        2. Over time there will be the same total amount of expenses, under either alternative Ė but it is paid at different times
          1. Can use different methods of balance
            1. For LIFO and FIFO there is a conformity requirement for inventory and tax and accounting
            2. For other things can have different methods
        3. This is all a function of the type of property, and what types of rules cna be used to recover depreciation
        4. Could be doctrines of disgusised sales
          1. Can call things installment sales, a purchase for tax purpsoes
      2. IRS isnít bound to take taxpayer's characterization of a lease for granted
    17. There have been investment tax credits given from time to time that would supplement depreciation -- not any more
      1. In 1981 there were extreme depreciation, allowing deductions in first years
    18. Sheltering income in tax shelters
      1. Passive Activities Won't count as tax shelters
      2. Reasons for tax shelters
        1. Deferral
          1. Taking costs that are currently deducible and receiving the corresponding return from the investment in a future year
        2. Converstaion (ie transformation or expemption)
          1. Ordinary income into tax-favbored income
      3. Basic tax shelter -- where interest and depreciation were more than income, the taxapyer could then defer any recapture (or "give back") until when the property was sold
        1. Alternative was borrowing (interest deductable) to buy a deferred annuity (even at less of a tax risk)
        2. Investment tax credit: people would borrow to pay for these things, and in essence it was a rebate of 10% on the borrowing
      4. Requirements: non-recourse loans
      5. Overvaluation:
        1. Overpayment (but deferred payment) for a product, getting depreciation deductions, followed by a gain based on the discharge of indebtedness when the investors default on the loan (installment)
        2. Transactions that lack economic substance, the interst deduction s will be ignored
          1. Failed transaciton was a non-recourse promissory note to buy an annuity contract, which had an option to take out a loan on it
      6. Options: The courts have considerd things to be more similar to an option than a sale Options
      7. Depreciation will be based not on ownership, but on investment in property (ie there must be equity yielded)
        1. There could be a point at whcuihgthe taxpayer becomes an economic owner
        2. Now it is difficult for taxpayers generating deduction in excess of income from a particular investment to use excess deduction to offset other incoem
    19. Passive investments
      1. Definition
        1. Must be a trade or business
          1. For someone who rents buildings. Rental income is never passive (but must devote at least 750 hours to that)
          2. Up to 25k of annual losses may be deducted from real estate ernatla activities of indivudal who meet a lesser stnadard of participation, but this expemption is phased out as income rises from 100 to 150k
        2. Has to be a trade or businss which they donít materially participate in
          1. Regular, continuous and substantial
          2. 500 hours
          3. 100 hours
          4. as much time on the activity as any other indiividual
          5. circumstances show material participation
      2. Can be caried forward indefinitely
      3. Can only be deducted against passive gains
      4. Can't be deducted against sallary or portfolio income
    20. Restrictions on investment indebtedness
      1. The amount of interest that may be deductable is limited to net investmenbt income
        1. Inclues capital gain only if the taxpayer elects to forgo the lower maximum rate on such and, in effect, treat the captial gain as ordinary income -- but the interest disallowed can be deducted in later years
        2. Can only deduct things up to the amount of risk in the investment
      2. Debt used to purchase tax-favored investments ais not decutbale
      3. Farm and orchand exceptins: feed and seed is only deductable when consumed
      4. Tax shelters have to use accural method
    21. Penalites -- there is now a 10% penality on what is derrived from a tax shelter and now a 20% payment of any substantail understament of income tax
    22. Restrictions on leasebacks
      1. Definition: lower tax bracket payer buys something, sells it to higher payer (often most of the cost in the form of a note), and than the higher leases it to the lower. The lease payments are offset by the purchase payments. The lower will get the tax benefits (capitalization) with buying something for its price (minus whatever cash was received in addition to the promissoryu note from the higher payer)
        1. If there was a third party involved the court might respect more
      2. IRS guideliens
        1. Minum 20% uncondition risk invesmtn
        2. No purchase optionsfmv purchase optiosn may be okay
        3. Lessee investment procluded
        4. No lesse laons or guarentees
        5. Profit and cash flor must be currented
        6. Properyt that only only be used forby the lessee is ineligible
  • Theory of depreciation
    1. Problems
      1. Allowing a deduction of full cost in purchase year would be overstatement
      2. Allowing a deduction in year of disposal would be understatement
    2. Economic depreciation: difference in cost at beginning and end of taxable years (anything greater would be a subsidy to investment)
    3. Today (as opposed to before) -- the life a a prop is not longer calculated on an indiviudalized basis
    4. For tangible assets tax depreciation is different than economic depreciation
    5. Rules for depreciations
      1. Useful life:
        1. Tangible assets are five yeras
        2. Personal property : -- swich to straight line when 150% of 200% becomes less than straight lines.
          1. 3 year property: tools and racehorses more than two years old when placed in service
            1. for 3 year use double declining balnace
          2. 5: computers, typewriters, copiers, trucks, cargo containers and semiconductor making equipment
            1. for 5 year use double declining balnace
          3. 7:/?: office furniture, fixtures and equipment, railroad tracks, and single-purpose agricultural and horticulture structures
            1. for 7 year use double declining balnace
          4. 10: assets used in petrolem refinding
            1. for 10 use 150% for 15 and 20 year
          5. 15: seqage tratement plants and elephone distrobution plants
            1. for 15 use 150% for 15 and 20 year
          6. 20: municiapl sewers
            1. for 20 use 150% for 15 and 20 year
          7. conventions by years
            1. 1/2 in first year of service
            2. if 40% of all property is in service in the last quarter of the yaer, a mid-quarter convention applies
          8. there are optional recovery periods that will drelay deductions
        3. real property: recovery period is
          1. 27.5 years for rsidential
          2. 39 for real
          3. will use straight line -- in year of disposition, no proration by months of service
        4. intangibles: pantents, copyrights are depreciated on a stright lie basis
        5. goodwill (what can't be allocated when parcing out cost of acquisition)
          1. goodwill is non-depreciable
          2. subscribe lists can be allowed a deduction
          3. there is now a 15 year amoritziation of intangibles (copyrights, films sounds recordings) unless self-createred or seperately acquired
  • Alternative minimum tax -- kicks in to provide lesser deductions, but only to the extent that the alternative minimum tax exceeds the lower, normal tax
  • Costs in Defending title will be capitalized
  • Procedure
    1. One can get into tax court without paying
  • Taxes are dusually dedctable --sales tax is not
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