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
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
Income is only a measure of ability to pay (surrogate)
Property tax is another indicator
Imputed income is not taken account of
Goals
Fairness
Horizontal equity: with one's peers (similarly situated)
Vertical: people aren’t overly taxed based on extremes of wealth
We have the progressive income tax
Administrative feasibility: this might conflict with fairness
Soundness of economic effects (or economic rationality)
We should try and not perverse any perverse economic effects
Reliance: people do rely on and the tax law, so it can't be too flexible
Tax expenditure budget: some things are really direct expenditures as they really deduct from the treasury
Based on the notion that there is a natural, neutral or normal income tax, and departures from it are expenditures
Burdens of taxes are shifted through the economy
People assume that personnel income tax is shifted the least
Corporate shifting is uncertain
There will be substitution effects imposed by the tax
People may work harder (income effect) because of the tax
Money will be shifted to the more favorably taxed items
Putative tax for shifting things to thing that are tax preferred
Inflation
Bracket creep
Changes in deduction s for the cost of investment in productive property
Much of gains might be attributable to inflation
Taxable unit -- most married people file jointly
But one isn't required to report dependant's income
Secondary worker in a married couple is subject to the rate determined by the income of the primary worker
Present value of annuities are deemed to be rights
Things for convenience of employer are not income should be on the premises of the employer
There may be horizontal equity problems with this regime
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)
If there is no additional cost to the employer, and in his line of business it doesn't need to be included
Non-discriminatory employee discounts are also not income -- in the ordinary line of business
Cap of 20%
Amount of the exclusion will only be the discount (based on arms length transactoin, not a gross profit ratio)
Cafeteria plans are authorized,
Use it or lose it -- if can't change mind after the election
If there is a valuation of the goods, we look to the of the goods given an arms-length transaction
If things are non-business, and if they are non-compensatory business activity
Frequent flyer miles are considered to a right that is exercised
Gifts receive a transferred basis: no deduction and no income
Things received from decadents get stepped up basis
Constitutional challenge is that might not be an income tax
Under Irwin, if one splits a gift he who receives the interest pays the tax
Basis
Transferor's basis if one is selling something that is a gain
If something is a loss, one taxes the fair market value of it at the time of transfer
Donee's basis will include any addition taxes paid
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
Can be from home owners not having rents
Can be for below market rates on loans
Compliance
6 year limit criminal
no sol for civil
nonpayment is t-bill plus three
non-payment mean a 20% payment
fraud is a 75% payment
one can make amended returnsinnocent errors: would have to pay interst
terms of an employment contract are not determinative
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
AMT has different tax base (broader)
In taxing annuities there might be a different tax base
Consumption possibility
Unrealized gain is generally not taxable
Investments in human capital would really be a tax on consumption
Y=c+s is the same as c=Y-s
A consumption tax is really an income tax with a deduction for saving in any form
Qualified pension plans are an example of consumption taxes
Not current income -- IRA is 401k, and roth ira is 408s
Consumption tax is different than sales taxes, as sales taxes are based on transitions
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
Annual accounting
Today people can carry forward and Cary back losses
NOL can be carried forward and back
Can cary losses two year back
Can cary losses 20 years forward
Stcok is an exception to annual accounting
Gains must be realized
Stock dividends (split) -- must be a pay out (not just a watering) -- today the basis is allocated between new stock and old stocks
Increased wealth
Accumulation of company's profits incrased
Accumulation of prifits increased wealth
Cash would be taxable
Congress requires that US sharehodlers of foreign personal holding compnaies and certain foregin corporation report their properotion share of corporate income
Capital improves could be (or were) treated as income: abandonment can be a realization
Today such things are postponed
Legislature now says that gross income is only based on lease
Like kind exchanges are not taxable
Barters and swaps not in dollars won't be taxed (issue of imputed income)
A gain should not be recognized if it does not generate cash to pay the tax
CMOs or similar a way to realize loss -- even if they are a like kind transaciton (government lost)
Regulations about whether restructuring is realization on 303
Loss is calculated as difference aven amount realized
Like-kind exchanges won't apply to stocks, bonds and notes
Does apply to farms
Boot is deemed to be the first part which is recongizinable, if two things are hard to value
basis in a new like kind property is (basis in the old) + (any gain recongized on the transaction) –(fair market value of the boot)
any boot will take a basis equial to its fair market value – the tractor will take a basis of 8k – and the other boot was cash, ancd cash van eb viewed as having a basis equal to its famir market value – 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 – f
Non-recourse loans
Realized: there has been a severance of property (doesn’t matter if it was recourse or non-recourse)
Money received plus amount of fmv of other property
Property subject to liability (ie mortgage) -- whether recourse or not --
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.
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.)
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
Will be up to trier of fact
There is no business deduction for gifts in excess of $25 per individual
Tips and toeks are not gifts
Scholarships to degree candidates are not gifts
Exceptions to anntual accounting
Tax benefit
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
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
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) --
Inclusionary: taxpayers must include in income items over whichthey have an extended claims of right
Deuctions are fixed in light of the prior inclusion
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
It comes down to the interest that oen has in the revenues
It come down to when the taxpayer can claim it belonged to him
One could take incmoe the first year, and deduciton the sseocnd
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
Statue now applies to which it appeard that the taxpyaer had an unrestricted right to something
Mere errors are nto a contractual right
Repayment of embeezzled gains are not a contractual rightj
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
Property given to charity and given back is deductable (ie didn't pay capital gains)
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
State and local bonds exempt but one could say that their lower interst rate is a puitative tax
For higehr incomes incentive to buy is far grater
Industrial revenue bonds are limited by purpose
Cap in weach state of 50 per resident or 150 million
Restrictions on states confucting tax arbitrate
People could conduct artbitrge, if their marginal rate is high enough
US treasury bonds are sometimes exempt.
Loans
Loan proceeds don't change people's economic status, so they aren’t income
Discharge of indebtedness
Bankrupts have no includable income from a discharge
Income from discharge of indebtedness
One won't be taxed on banrucpy discharge
Purcahwse money debt is consuiderd to be a reduction in sale price
If oen is awarded a repayment of a loan, even though no benefit resutls they still have income
Can be a discharge if there is a settlemtn for a ower interst rate (even if in the banks' iterst)
A difference between the amount borrowed a paid is incmoe to the corporation (even if purchsed on the open market)
Contested liability exceptions
Disagreement that is later settled, since the amount is later settled, it ins't really a discharge of income
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.
Bankruptcy exception: agreement to pay less, although an economic benefit, the income is not taxable, when insolvent or in a title 11 bankruptcy case
This money is used to reduce any later NOL, or caryovers, or later basis in depreciable assets
Gift exception: (gifts are not included in recipients income) -- it becomes a gift (detatched and disinterested generosity)
Appreciation or depreciation of assets isn't included until realized
Gambling debts -- in view of state law of enforceability
One might treat gambling debts as something the Casino doesn't hope to repay anyway --
One might treat all gambling debts as offset against winning
Gift tax on appreciated stock
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 wouldn’t be personally liable for it
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.
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.)
If prop is transferred in settlment of a debt there is
Gain from paying off favorable loan
Gain fron the dispostion of the property
statutory solution which elimiantes benefits from encumberance debt
compensation for injuries
will be offset against basis, but can be a like kidn exchange if use to get something enw
tax free treatment doesn’t extend to putative damages
no taxation of interest on settlements of tort damages (can be tax advantages)
no taxation for recovery under insurance policy -- needs to be physical
compensation for loss
paying taxes is income --
if ones compensates one for paying too much taxes it isn't income, as it
personal losses that arise from theft aren’t income -- personal losses that arise from theft aren’t 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
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
Premiums are deductable by employee but not inc;uded in income -- employers pay for it with pre-tax sallaries
Extends to spouses
Splitting income and dealing with children
Under old system, Husband and wife could contractually allocate up their gains between the both of them
Former incentive was to split income to take advantage of minor children
Fruit and tree: In the past people would enter into contracts with their spouses to split income, thereby lowering their income
There have been cases where children who agreed with their parents to manage their career were entitled to deduct the payments, but merely sharing wasn’t enough
Gratuitous performance of services: (imputed income?)
No income arises where services are provided to directly to charitable organizations (ordinarily there would be a phaseout of contributions)
Now people are taxed in the right vests
There was one case, where someone was found to be liable for taxes for a fictitious job that someone got or their girlfriend
Joint returns: initially favored married couples, as it was available regardless of state law, then favored single people
Constructive receipt and deferred compensation and payment in trust
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
Payments turned over to an employer are not taxable (even if religious obligation)
Can't have unilatarela backturning
Assignment of Limited interests (ie life estates) are taxable to the recipient as the assignees become the owner of the beneficial interest
A cash paying taxpayer who assigns a stream of income (ie bond coupons) is taxable on them (ie deemed to realized)
They could be independent negotiable instruments
If ownership of a bond is stripped (ie princiapl from interst) it is treated as a sperate negoitable instrument
Kiddy tax: unearned income for a child under 14 is taxed at the parent’s marginal rate
Please visit
Gains by constructive receipt
If decision to delay payments is in good faith and enforceable there is no receipt
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 --
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.
OID is the unstated interstg in a dferred payment
The obligaor is entitled to deduct the amount aht the obligee is required to accrue
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)
Purpose is to prevnt deferring payuments until last year
Instead of dividing, one has to calcualte the npvs of the final amount each year (ie with an implied rate of interst)
Exceptions for oid for farms, princiapl residences, etc and htings less than 250k
When bonds mature they are ordinary incoem
OID would seem to impute two years of interst -- absed on the tax law
Open tranactions
One possibility: only one year, and no carry forward involved
Closed: income is npov of payments
Traxpayers lose value of deferral
Third is installment pyaments
Taxpayer can elect not to use it
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)
Not available, when not readily convertible to cash
Present view: things are apported by their basis
Tax sales are not closed until redemption ends
OID rules
Intersting income in any defrred income plan is income not capuital gain
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
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
The creats an intersting paralell to receipt (ie Drescher)
In the "all events" test, something that is unsecured (or subordinated) or is subject to an LDC is not recived
There are dollar limits to the use of plans by agencies with low tax brackets, as they get a benefit
If it is structure as a loan, it might be a way to defer payment
Dues for services that may at soiem point be rendered must be reported as current incoem
If one converts their income into an annuity (a truse novation) than one is receiving deferred compensation
If the novation occurs before the receit it will be taken as a deferral
Qualified plans
Even if the rights are vest they are not taxed until payment is received
Employers are entitled to immediate dedcution for amount spaid in
Penalities for early withday (condition on 384)
Stock options
Alternatives
Value of the option when granted
No taxed when granted, and no tax if not exercised, but tax on
If one gets transferrred a stock at a lower basis, one is assumed to have that lower bassis, even though they don’t they didn't pay cash for the lower basis
Premimum on stock options can be added to the basis on whicht hey are exercised
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
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
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
One's current basis is the premium plus the exercise price
Valuation of compensatory stock options
If publically traded use the stock price otherwise excess of stock's value over its execise price at time of exercise
One can negotate with the employer to forgo ISO in favor of more cash
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
Life insurance excluded -- but no deduction for premiums
Inters to buy this, in its simplest form is not deductible
Not available to those who the policy is transferred to
A life insurance policy is expressly denied if deduction if the employer pays for it
Gambling
Gains are taxable, but losses only to the extent of gains
Capital gains and losses (loses must be used only offset capital gains) – can carry forward
If something is divided, the recovery can be of the basis first (ie easement in real property)
Annuities
Recovery of basis uses an exclusion ratio
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
Annuities also get a timing benefit
If the distribution doesn'f follow a distribution scheme there are penaltieis
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
(18,000@1997 to 25k@2003)
There is ordinary loss where the taxpayer has a net loss, but provides for capital gain treatment where there is a net gain
Capital losses: individuals can deduct capital losses from gains, but individuals with overall capital losses, can only deduct 3k of gains in any year.
Corporation may only deduct capital losses from gains
This reduces incentive for people to manipulate losses into a single year, and reduction of selective culling of the portfolio
History and policy
History: before 1986 were allowed deduction for 60% of net capital gain, now the maximum rate is 28%
Policy
good
Capital gains are bunched in a single year (at the moment it doesn’t have a much force because people at the moment are paying less than the full maximum rate)
Incentive to hold assets for more (incentive towards illiquidity)
Inflation: if they are treated better, this mitigates possible losses due to inflation
Economic growth: incentive for greater economic growth
Could be incentives to new industry
Unrealized gains aren’t taxed
Reduction of tax capital gains based on selling stock
Bad
Basis: if income is classified as property, than there is a deduction for basis
Definition of capital asset: property (exceptions)
Inventory of stock of a business (and property held for sale to customers in ordinary course of business)
Real property or depreciable property use in a trade or business
Intellectual property held by creator (but not what is purchased from creator)
Accounts receivable in the ordinary course of business
US government publication held by someone who received them at a discount
Exceptions for depreciable or real property used in business
Loss and sale on small business stock
There is capital treatment for certain proceeds of timber and coal
Now taxpayers can exclude 50% of their gain from small business stock
Must be acquired on initial issuance from the company or underwriter (not from stockholder)
Must be held for more than 5 years
Stock involved in accounting, law, health, banking, minoring
Small business are companies with less than 50 million in assets
Gain from Original issue discount is ordinary income
Loans
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,
If it the bond is retired by the issuer
If the bond is decliared worthless
If the bond is a debt than it is an ordinary loss
Netting
First round
a taxpayer first nets Short (less than oen year) against losses
a taxpayer first nets long (more than oen year) against gains
second round
netting together
transfers persuant to mortgage
transfers as per a divorce or seperation: no gain or loss shalll be rearenogized on tgransfer of property between spouses
doesn't apply for accued interst
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)
marriage -- under new rules there is no stepped up basis
transfer between couple who are married are not really transfers
if one transfers properyt persuant to a divorse it is a realization event, and they are taxed as if it was a regulat transfer --
one can swap marital rights for more tangibel goods, and the less tangibel goods are deemed to cost what the others do
divorse is really a swap with a realization -- but the person who takes the property is the one who has the carried over basis
Alimony:
Has to be stream of payments
Msut agree that non-taxable and non-deuctable
Must be under a insturment of marriage or maintance
Must be in cash
Can't be members of the saem hosueshodl
Can't continue after death
Can't be for child support
Can't be a property settlement
Can't be frontloaded (ie can't be unequal from first years to later years) -- can't be a highg amount in first year
Alimony is not offst against gains
accrual problems
accrual of income
if payment to received
"all events test" -- if the right to receive the income can be determined with accurance
when there is a contingency, this means it hasn't been paid yet
if the even hasn't accourred, it has to be realized when the cash is received
deposits are not accrued income
goes to to the issue of solvency
averges expesese aren’t enough
accrual of deducitons: all events test can be applied if the benefit to the other (ie medical) is vested in the other
if the actual expeses havn't occurred there is no deduction -- even if the expnsee can be preducted
depsoites can be though of as non-includable loans
Mooney: (aircraft that came with a bond) --all events that would be deductbale hanv't ben paid for
Can be a quesitonof deductive npv or full amount
There can be deducatble reseverse for bad debts
(checks Moonie bonds) and tvm questions
checks are treated as delivered when received
charge cards are treated as loans
Deductions -- itemized deductiona re subject to a phaseout
Standard deduction (varies with income) -- flate rate (cliff effect)
Each qualifed depending gets somehting
Earned income tax credit
Refundable if people make less than a certain ampont (there are non-progressive taxes in the background)
Credit for elderly and permenelyt disable
Each dependant has a deduction as well
Personal exemption ges phased out
Casualty -- must be over 10% of AGi -- provides a form of insurance
Fire storm, shipreck,
Orindary loss not deducatble
Must be a suddnness
There could be public policy reasons (ie self-impsoed loss)
Medical -- doctor advised soemoen not to mow law, but didn't get a deduction
Putting kids in boarding school for medical condition could be a imputed income, but no dedcution
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
Issues of poublci choice
Charitable intent
Has to be done with disinterstest
Types of charities
Charitable recipients have to be real charities –
Public charities -- but if you transfer to a public charity you are outside of this rule
Red cross, acs, boy girl scouts
Private charities
Someone setting up a private foundation for charitable purposes
Can only be made uop to 50% of the contribution base for churchs
Private foundation are 30%
30% limit is in preopety who sale would have resulted in long term capuital gain
any excesses can be caried forward for 5 years
full FMV is deducted (not the fmv minus the basis
anything over 25 must be subtantiated -- not cancelled checks
regarded as a subsidy
taxes (persoanl deduciton)
fees not deductable
deduction for state taxes and more or less voluntary things
interest -- now there is only a deduciton for non personal interst
no deduction for acquisition indebteness
definitions
must be evidence of intention to create a relationup of debtor and credior
has effect on inflationary profile
interwst incurred in a trade or buisiness for the produciton of income is a proper adjustment
other than mortages, all other business not deduct is nondeductbile personal interst
can deducat home equity indebedness but not in excess of the fmv -- this creates intersting inequities
could be a question of consuming sooner rather than later
doesn't really matter what secures a loan, the inquiry is what it is used for
comingling -- things made withing fifteen days can elect to trat as borrowed funds
if funds can't be traced, the borrowed funds rise to the top
Ordinary and necessary business expenses are deductible -- note distiction between maintance and creating a new capanbility
General rule: no deudcitoni for the use of a huime for biz purpoes
Exceptions
Vacation homes
Home offices
Vacation homes -- they become dwelling units, if the taxpayer uses more than a specificed time
Passive investment: If a vacation home isn't used for personal purpses it is allowed eedcution for passive activities losses
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
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
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
Home offices
Very sepcric exclsuion
Vacation homes
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
Non-serious (investment) vacation homes: Are we outside of 280a-e ? limits on deductions on vacation homes – 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)
If you are over 15 days, than your expense can only be offset from income from the property (280a-c-5)
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 --)
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)
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)
Travling on business is usually deductable using a primary purpose test
Now spoues expesne are not deductable when attending a convention
Needs to be a direct realtionship ebtween a claimed dedcution
Any acitrivity which is of a type generally considerd to consitute entertain if it is directly realted to business
"associated with" might weaked the direct relation
meals are now deductable to 50% of the costsubstantiation requirement --treasry can do away with them
Can't be scaled tickets
stringent requiremetn fo ryachts, etc
there are exceptiosn in 274e
need to maintain records
sole propriters can't considere it all to be business
per diem rates might require no substantaituion
expesne lunchs nto with clients don't count
child care
adoption expense don't count
there are various reasons for disallowing child care expenses (p. 570)
could be an expense for overnight stays of children
phasedlown as income rises
cam in the allowable expense
travling
oen's home relfects a personal choice
no deductions for modification of mode of transportion if it makes it harder to take a chepear kind
thee conditions
reaosnable expense
must be while away from home
must be in perduit of biz
maintaining a rsidence is based on persoanal reasons
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
temporary jobs
I new job with indefinite is treated as a permanent
A person who takes a temporary job, provided it is part of the line of work is
Moving expense -- commuting not deductble
Deducatble if would add at least 50 miles to commute, in the year following the commite-- with no minimum threshold
Transportaiotn expense paid or incurred in going between the txpayer's reisdenc eeand temproary work location are deductable
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
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
Clothing
If used only on the job, deductable
Not worn outside
Can't be adaptable
Legal expense: look to the orgian of the claim
Hobby losses are not deductable, but if one tries to make a profit it is an ordinary expense
For the purpoese of normal accounting outlays a start-up costs
In improvements there may be imputed income, and if had paid someoen it would have only increased
Nine factors to tell primary purpoes
Alternative test is a benefit test -- where the court would look to pleasures
But income generated by a hobby can be offset by expesnes from that hobby
Will be a presumption that one is in business for a profit
One must be actively involved
One can work at their pricnaipala place of business
Capital improvements not deductible, but improvements to come up to code or federal inspection or maintain the norm probably are
Alternative tax regime might be a deduciton for loss but this raises the realizaiton problem – and under such logic would be to deny deduction for restoration to pretax condition
Education: deducatble if in the line of work, directly related and not a bridnge to another form of work
Legal fees
If the legal fee was not in the trade or business (or not in the accused trade or biusiness) not deducatble
Forcus on orgin of claim
Even things that may be forseeable, but are forced as a legal aciton (or threat of legal aciton) must be capitalized - but things that aren’t quire forseeable (ie governmetn warning to clean up hazardous waste) are deductable as expenses (and they could be ordinary and necessary expense)
Expense incurred in a failed tax shelter are disallowed
Practing lawyer who headers their own office would deduct
Unreimbursed expeses are deducatble subject to a 2% deductable
No deduction for personal, lviing or family expese
Capital assets must be capitalized, not deducted for both cash an accrual method payers
UNICAP - uniform capitalization requirements -- deson't apply to people with under 10 million dollars in receipts
Costs of producing self-created assets, must be capitalized
Sallies of purchasing agents must be allocated to inventory and recovered at time is sold as it is a cost of manufacturing
Not included: marketing and advertising, general and administrative expanses that don’t relate to sale or production (including public relations and shareholder relations)
Can take a deduciton for simple repairs
Futures Benefits test: Expense that don’t create an identifable asset, but might provde long term benefits msut also be capitalized (ie merger)
Use orgin of claim test to decide whether settlments should be deducted
Money paid for production of a manuscript would need to be capitalized, and not deducted
Cost of trucks could be used as a cost of creating capital itself
There may be problems, if one scaps a part of a famred-out prject, it the court imputes an additional loss to it
Prepaid expense (ie premiums) need to be capitalized
Mortgage points are excepted
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
Research and development doesn’t need to be capitalized
Cost of developing farms and orchards doesn’t need to be capitalized
Cost of land is a capital expense, but development is not
Note: now passive activities can’t be expensed and need to be capitalized
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
Accounting for capitalization -- IRS likes consistency
Not simply deducting the goods purchased during the year
Methods of valuation of purchases (whichever lower)
Cost: the amount at which it was included in the closing inventory of the preceding taxable year
Cost or market: for merchandise purchased after the beginning of the year, cost is invoice price plus transportation and other acquisition, less trade discounts
Produced: for merchandise produced during the year, cost is the total of direct costs (i.e. labor, etc.)
Identification: COGS is receipts-cost of goods using LIFO or FIFO:
If LIFO is used for tax purposes, it must be used for credit and tax purposes
Depreciation deductions (in property that has a finite life, and put out wealth) – incoming generating assets with a terminable life), no depreciation to personal residence, car or other property used for personal consumption
Things that can be deducted: good will in paid subscribers -- if the assets were purchased rather than created
Costs of intangible assets can be amortized of a 15 year period -- if the assets were purchased rather than created
License renewals have no determinable useful life
Useful life of goods
Methods – note: unless people take their deductions on January first, they only get ½ year’s worth of deprecation: the amount of the investment that a taxpayer can depreciate cannot exceed the differenc ebtween the asset’s cost and its salvage value -- but no salveage value for intangibles
Declining balance
Straight-line:
Economic depreciation: reduction in value each year (smaller deduction in each year)
Intangibles: taxpayer must make showing through facts and circumstances
ACRS
3 years: four years or less (race horses
five year: cars, trucks, office systems
seven
ten: orchards
15: intangibles assets such as good will
15-24
20: property other than residential prop with life of 25 year s or longer
27.5: apartment complexes
39: shopping complex and office building
15: railroad grading and tunnel bores
salvage: under MACRS, salvage valu eisn't important
methods of deprecation -- basis is reduced if depreciaiton is allowable, even if depreciation is not taken
rapid
polution control facilities
research and experimental expendiutres
straight line
declining balance
sum of the year digits
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
used for films, sound recording
advanced payments on rent can’t be deducted all in the year of payment
defining ordinary and necessary business expenese
one looks at the orgin of the claim but sees if they are directl related to the trade or business
can take into account public policy
honor bound obligations are not normal - but to save a buinsees might be necessary
if it has never made before it won’t be given a deduction for
reasonable compensations -- if things get too high will be questioned
must be reasonable
must be under 1 million
bribes
to government people are disallowed to government employees
other governments employs under the foreign corrupt practices act
settlements paid to settle violations of the anti-trust act
but, if the law generally isn’t enforced it might be acceptable
taxes to other nations
in generally deductible
taxes to disfavored nations or owns with no dip relations are not deductible
if restitution is a condition of reducing sense than not deductible
recaptured: the portion of a taxpayer gain that reimburse pas depreciation deductions consituttes ordinary come, the amount qualifies for capital gains
repartured ordinary income = ((final selling price asset) – (unrecovered basis aka original costs -depreciation))- (difference between original buying price and selling price)
recapture is not eligible for instlalment method
amount of recaputre reduce the amoun of the deduciton in the case of a gift of property to a charity
Tax shelters: exception to capitalization required: rentals are deductible, installment plans must be capitalized
Four princiapls
Which way is A better off from a tax perspective
Over time there will be the same total amount of expenses, under either alternative – but it is paid at different times
Can use different methods of balance
For LIFO and FIFO there is a conformity requirement for inventory and tax and accounting
For other things can have different methods
This is all a function of the type of property, and what types of rules cna be used to recover depreciation
Could be doctrines of disgusised sales
Can call things installment sales, a purchase for tax purpsoes
IRS isn’t bound to take taxpayer's characterization of a lease for granted
There have been investment tax credits given from time to time that would supplement depreciation -- not any more
In 1981 there were extreme depreciation, allowing deductions in first years
Sheltering income in tax shelters
Passive Activities Won't count as tax shelters
Reasons for tax shelters
Deferral
Taking costs that are currently deducible and receiving the corresponding return from the investment in a future year
Converstaion (ie transformation or expemption)
Ordinary income into tax-favbored income
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
Alternative was borrowing (interest deductable) to buy a deferred annuity (even at less of a tax risk)
Investment tax credit: people would borrow to pay for these things, and in essence it was a rebate of 10% on the borrowing
Requirements: non-recourse loans
Overvaluation:
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)
Transactions that lack economic substance, the interst deduction s will be ignored
Failed transaciton was a non-recourse promissory note to buy an annuity contract, which had an option to take out a loan on it
Options: The courts have considerd things to be more similar to an option than a sale Options
Depreciation will be based not on ownership, but on investment in property (ie there must be equity yielded)
There could be a point at whcuihgthe taxpayer becomes an economic owner
Now it is difficult for taxpayers generating deduction in excess of income from a particular investment to use excess deduction to offset other incoem
Passive investments
Definition
Must be a trade or business
For someone who rents buildings. Rental income is never passive (but must devote at least 750 hours to that)
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
Has to be a trade or businss which they don’t materially participate in
Regular, continuous and substantial
500 hours
100 hours
as much time on the activity as any other indiividual
circumstances show material participation
Can be caried forward indefinitely
Can only be deducted against passive gains
Can't be deducted against sallary or portfolio income
Restrictions on investment indebtedness
The amount of interest that may be deductable is limited to net investmenbt income
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
Can only deduct things up to the amount of risk in the investment
Debt used to purchase tax-favored investments ais not decutbale
Farm and orchand exceptins: feed and seed is only deductable when consumed
Tax shelters have to use accural method
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
Restrictions on leasebacks
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)
If there was a third party involved the court might respect more
IRS guideliens
Minum 20% uncondition risk invesmtn
No purchase optionsfmv purchase optiosn may be okay
Lessee investment procluded
No lesse laons or guarentees
Profit and cash flor must be currented
Properyt that only only be used forby the lessee is ineligible
Theory of depreciation
Problems
Allowing a deduction of full cost in purchase year would be overstatement
Allowing a deduction in year of disposal would be understatement
Economic depreciation: difference in cost at beginning and end of taxable years (anything greater would be a subsidy to investment)
Today (as opposed to before) -- the life a a prop is not longer calculated on an indiviudalized basis
For tangible assets tax depreciation is different than economic depreciation
Rules for depreciations
Useful life:
Tangible assets are five yeras
Personal property : -- swich to straight line when 150% of 200% becomes less than straight lines.
3 year property: tools and racehorses more than two years old when placed in service
for 3 year use double declining balnace
5: computers, typewriters, copiers, trucks, cargo containers and semiconductor making equipment
for 5 year use double declining balnace
7:/?: office furniture, fixtures and equipment, railroad tracks, and single-purpose agricultural and horticulture structures
for 7 year use double declining balnace
10: assets used in petrolem refinding
for 10 use 150% for 15 and 20 year
15: seqage tratement plants and elephone distrobution plants
for 15 use 150% for 15 and 20 year
20: municiapl sewers
for 20 use 150% for 15 and 20 year
conventions by years
1/2 in first year of service
if 40% of all property is in service in the last quarter of the yaer, a mid-quarter convention applies
there are optional recovery periods that will drelay deductions
real property: recovery period is
27.5 years for rsidential
39 for real
will use straight line -- in year of disposition, no proration by months of service
intangibles: pantents, copyrights are depreciated on a stright lie basis
goodwill (what can't be allocated when parcing out cost of acquisition)
goodwill is non-depreciable
subscribe lists can be allowed a deduction
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