Income is said to be a base -- or surrogate measure of one's ability to pay
Those with greater incomes should have greater burdens (controversial)
Could result in higher areas of savings
Most revenue comes from exise, customs, social securities
Power
Article I, Section 8 gives congress the power to lay and collect
Article I, Section II, requred that a direct tax be apportioned according to the census (first tax declared unconstitional)
16th Amendment gave congress the power to lay and collect taxes on incomes from among the several states
basic formula:
deciding which taxpayer things should be attributed to
in a system with graduated tax rates, high bracket taxpayers might attempt to shift to reduce tax liabilities (related)
assignment of income
husband and Wife assignment of income from services (e. g. a contracts declaring people to be joint tenants of all property)
must be taxed to the person who earns it
– tax can’t be escaped from anticipatory contracts
community property state would give people a present vested interest in things (by law).
states later adopted community laws
joint filing for spouses extends the advantages of income splitting – which makes for different rate schedules -- there is now a marriage penalty
employers payment to ren of employees – educational benefits.
7th circuit held that they were taxable
may avoid having this impured by operation of law, or by rules set by a 3rd-party which no one had any control over
assignment of income from an employee back to employer
so long as there is an unqualified use – under these circumstances the court held that things should not be held under a refused or announced period -- in this case, it was for future income (not past services)
income from property is taxed to the owner
income from property: once someone gets the right, it is deemed to be a receipt – it seemed to be the enjoyment of income
interest in property: Life estate whose income is assigned – once there is an assignment of a beneficial interest –
property in trust
where a taxpayer extablishes a grantor trust:revocable trusts make one taxable
five years is still control
can use tree and fruit metaphore (e. g. Corpus)
if there is a reversionary interst
power to revoke
Kiddy Tax: Parents wouldn’t be taxed, but Congress would tax the child would be taxed at the parent’s top marginal rate for children under the age of 14
Timing (when is it income)
Taxpayers like to defer the income and accelerate deductions (government would want to reverse) -- also because tax laws may change from year to year
Methods of accounting
Cash
Income reported when it is actually or constructively received
Promissory notes are not considered to be promises
Cash also includes contructive receipt
Income, although not actually reduced to possession, when it is credit, set apart, etc. So that he may draw upokn it at any time, if notice of intention to withdraw had been given, or if notice has been subject to restrictions
One needs to have unfettered control over the date of actual receipt
Timing of deductions
Payment by check is sufficient, no matter when the check is cashed
There is no paralell on the doctrine of constructive receipt
Pre-payments (e. g. insurance payments, or cost of a lease)
If a pre-payment results in an asset beyond the useful life, the taxpyaer will be required to pro-rate beyond the useful life.. if aa cashpayer was required to pro-rate
In the accrual taxpayer will matter when the amounts can be determined with reasonable accuracy – this may be well in advance of the receipt of the income
Pro-rating is necessary: these issues have troubled the courts with regard to places like AAA, or companies selling things like advanced sporting events
This is, the same as what the accrual method taxpayers would do (especially in financial accounting)
accrual -- some businesses are prohibited
accural basis taxpayers can accru things in the year at which the liabilities exist
might have pro-ratta share of subscriptions
liabilities might be determined in the year that the liabilities have determined tha fix the fact of libailities, and the amount
all events test
deduction can be taken, even if there is a remote possibility
self-insurance: reserve accounts for medical insurance are diallowed – the events establishing the fact of libaility don’t occur until the employee can take the claim
economic performance requirement
there cannot be acceleration that is so great
All events test shall not be treated as met if it happens before any economic performance has been met with respect to the item
E. g. coverage is an economic performance, but a bond is not
All events will be considred satisfied for certain recurring expenditures
Workers comp and tort are only happening when the events occur (there was an incentive to structure long-term payment plans)
Accrual basis taxpayers are now forced to use a cash-method, the accrual basis taxpayer can’t take deductions until payment is made
Exceptions
Installment sales is defined as Instead of the full gain (fair market value) taxpayer will report only a proportion of the gain – in each period one will be taxed upon the gross profit ratio – GPR = ((selling price – basis))/selling price
Remainder of each payment is treated as a tax free recovery
Interest is treated as taxable income
Taxpayer can defer gain as payments are received
This is only by election
Annual accounting (businesses can adopt artificial year)
congress could have set up a transaction-based system
Transactions that span numerous years: if operating loses can’t be used in a year, "it is the essence that it should product revenue payable at regular intervals"
Net Operating Loss Rules (carry-forward)
Can carry loss back three years
Can carry forward 15 years
Tax benefit rule: "well ingrained in our tax laws that return of property must be treated as income in the year of recovery" – property that was once the subject of deduction was eligible because that property was used for a particular purpose -- recovery of the property is inconsistent
Inclusionary: can take a deduction in an earlier year from which is receives a tax benefit
An actual recovery of the physical property is not necessary required
Tax benefit rule can be triggered by things that are fundamentally inconsistent with the earlier deduction
Exclusionary: in a later year, from which it recovers the property, from which it gave rise to the deduction, it could have wound up with a greater deduction: there is no income if the earlier deduction didn’t provide a tax benefit (e. g. operating loss in the year of the charitable contribution)
Claim of Right: if there is a dispute over the disposition that is resolved in favor of the taxpayer (if they have use of the funds, without restriction), they have to report them in the year that they would have been received
If they have to repay funds, than they would have had to take a deduction
Taxpayer can’t revisit year – must take a deduction in the year of repayment
Character of income (Capital gains) is defined as investment asset (stock in a corporation) -- 28% cap is applicable to net capital gains
Definition: Property held by the taxpayer, but doesn’t include: (excluding business assets) business inventory, copyrights, depreciable property, accounts or notes receivable in ordinary course of business, certain government publications
Investment property is what is left
Difficulty with land purchased for development
In 1960 decision – "primarily" means "of first importance" or principally"
Rebuttable assumption that hedging (futures) are business expenses, not investment -- limited to the inventory exception -- now this only applies to heding transactions
Dual motive: Purchase with a substantial investment motive was a capital asset even though there was a substantial business motive
But acquiring of capital in an investment – if the same stock is sold at a loss, but emphisizing the loss.
There is no "integral to business" exception to capital asset status"
Dividing into short term and long term (lt capital gains are more than one year)
Net capital gain is defined as excess of long term capital gains over short term capital losses
In a non-recognition capital gain, things can be taxed
Policy: a portion of the gain reflects inflationary gain
Note capital gains rates remain constant
Doesn’t vary based on number of years
Taxing bunching of gains at full amount might be a hardship
Adjusted gross income (will determine eligibility for other deductions)
Gross income:
Theory
Market value of rights exercised in consumption minus the change in value of the store in property rights --
Some people use fiscal years
Anything you have consumed you have received
Increases and decrease in the value of property
Treasury: income realized in any form: money, property, or services
Also fair market value of property, or services
IRS definition (not as comprehensive)
Exception as otherwise provided, Gross income is all income from whatever sources derrived, including:
Doesn't included unrealized stock gains
Any property should be included in the gross income --
Compensation income
Salary -- whether are are compensated in cash, property or services, the value of your compensation must be included
Includes non-cash forms
If a company pays somone's taxes directly, the court found that this was the equivilent of receiving the funds (this was in consideration for services)
There are some tax-free fringe benefits
Timing of gross income from compensation
Cash method: will report in year of receipt
Highly compensated employees could defer
Annuities (non-qualified deferred compensations_
Non-assignable but guarenteed receipt, they should include the value of the policy in the year they purchased the policy -- he had received an obligation of a third party to pay out under the terms of the annuity contract (might be different if forfeitable)
If the employee pays for something, the fmv will be subtracted from what she pays to arrive at the amount included
This is a reference to an economic benefit (it was vested)
Qualified pension plans
Can't discriminate in favor of compensated employees -- the employees won't have to pay tax until they receive money
Consequences to plan can be made without any imedatite tax consequence
When property is tranferred, they will be transferred when the rights vest -- when they are not subject to forfeiture
Only have to be taxed when transferrable, except for qualified pension plans
Gains from dealings in property
Don't report gains through realization
For selling or otherwise disposing
Amount: realization amount minus adjusted basis
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
Basis is defined as cost that one paid for the property
The 1001 formula is designed to calculate net profit from the sale or exchange: Cash is included, the court in Crane concluded that basis in property included the amount of the mortgage
Mortgages incurred in the purchase of the property, are included in the cost of the property, even if it is a non-recourse mortgage
Interest on borrowing is deductible
Under Crane the amount of the borrowing could be included in property. -- there could be high enough interest and the like that would be used to shelter income.
If you receive property and you are taxed on the value of the property, your cost basis is the value of those purposes – e. g. this defines the tax cost
Full amount of mortgages have to be included in the sale or exchange
Passive-active loss rules -- have to have an active part to take losses
One does not have to recognize in certain points
Recognition: gain is reported for tax purpose
Taxable exchanges (e. g. extension for deed)
Basis is the original amount received -- check this
Gifts
Appreciation
No cost
Basis is a "substituted basis"
General rule is that the basis is the same as the donor’s basis -- appreciation is preserved
Recipient in a gift becomes the surrogate for the donor
Property that has declined in value
Two conditions: must be lost property to the donor, and the recipient must be selling the property at a loss as well
Making of the gift is not considered to be a realization event
Where the basis of the property is higher – than the basis, for purposes of determining the loss is the fair market value of the gift
Inherited property -- stepped up/down basis
Basis received is the fair market value at the deceant’s death.
Executor can value based on something six months later
The inheritance could also be also done – one could take a lower fair market value of basis
Adjustments to basis
Additional cost will increase basis (e. g. improvements to basis
Downward adjustments to basis – adjustments for depreciation
Depreciation allows people to deduct things early – each time a property is depreciated, the basis is zero
Transfer of property between spouses
Treated as a transfer by gift
Basis is the adjusted basis of the transferor
Property settlement at the end of a divorce
These are treated as a realization event, and the donor is required to recognize a gift -- overruled
Transfers incident to a divorce receive a cary-over basis -- this is a non-recognition rule
Alimony -- taxable to the recipeint under Section 71 – payor can deduct -- can opt for reversal
Needs to be in writing to be Alimoney – must be received under a witten decree
Spouses can’t be members of the same household
No liability to continue payments after the death of the spouse, after the spouce stops (e. g. post-death payments
Must be paid in cash or equivalent –
Lump-sum that look like property settlments
Property settlememts are not decutable to either spource
If the cash payment could be classified
Large cash payments in the first two years, these rules will be reversed – e. g. will become income
Non-recognized gains (the gain won’t escape tax forever) -- deferral rules
Theory is that the taxpayer has changed the form of the investment, but hasn’t cashed out. – usually a corelarry basis rule that goes with it
Corolarry basis rule requires the recipient to take the donor’s basi
Like-kind exchange
Can swap for a property of the same fair market value without paying a tax on the appreciated property
Since the property are like-kind one has not cashed out on the investment
Need to keep the same basis in the new property
Can’t be used for liquid assets
Can’t be used for personal property
Involuntary converstion is defined as fire, theft, condemnation
Even though one has technically realized a gain, one has kept their money in the same place (check this)
Sale of primary residence
If you sell your principal residence at a gain, you have a two –year window to purchase a principal residence (two years back and fourth)
Gain is recognized to the extent that the sale price of the old home exceeds the new home
Basis of the new home is the cost of the new home, but ne must subtract out the relized gain you escaped -- this is considered the roll-over provision
Taxpayers over the age of 55, can elect to excluded the first 120k worth of gain from the sale of a residence
One who dies in their home will be able to step up the basis at death
Interest
Rents
Royalties
Dividends
Non-compensatory items included in gross income
Compensatory damages taxable
Punitive damages (windfall) are also income (undeniable accession to wealth, that is clearly realized.) (also treasure trove income when realized)
Look to state law regarding property's right to determine when it has been reduced to wealth -- so money has to be reported when found (usually)
If one finds that something is worth more (ie something is more valuable in its very essence, and that essence cannot be separately titled) y don't have to report income until the difference in value is realized -- bargain purchases don't lead to immediate income. One just has a lower basis
Prizes and awards are also included as income, except scholarships
Prizes received for literay, scientific can be excluded, if you were selected without any action (application) on the taxpayer's party. Must not be required to render any future services. Award must be transferred directly to a charity. If you accept, it is taxable
Borrowed money: gross income doesn't include amounts that are borrowed
One has an offsetting obligation to repay
Stolen funds -- must be reported
Could be an immediate obligation to repay (legal obligation to repay)
Needs to be consensual recognition of an obligation to repay
There is also tax fraud
Income from discharge of indebtedness
Bonds issued for par value (ie buying back own bonds on open market for less than par, there is a realization of gross income)
Exceptions in statutes
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 (detached and disinterested generosity)
Appreciation or depriation of assets isn't included until realized
Other receipts
Pro-ratta stock dividend (ie maintaining the same percentage) -- this is no real income -- a cash dividend would included, because it is severed and derived from the property
Note: today windfalls and troves are still considered income
Congress, today could adopt a statute which would include the appreciation and depreciation of gross income constitutionally
Makes policy sense to impose a policy standpoint, because it gives us a good definition of realization. --
Exclusions from gross income
Employment related
If a transfer has a "compensatory flavor" than it is probably taxable
Meals and lodging furninshed to employee, spouse, dependants
Must be for convience of employer
On call, etc.
Has to be on premises
Can't provide a cash supplement
Must be required to accept perk as a condition of employment
Although meals and loding are a benefit -- employees are deprived of an opportunity, than some portion of the value would be above the amount that the employee would have already spent
Might be difficult to value, and apportion
Insurance is excluded
Some very narrow tuition
Fringes excluded
No additional cost service
If the employer offers this cost anyway to employer
Airline employees and their parents
Also includes spouses
Qualified employee discounts -- up to a maximum
Working condition fringe: property or services provided to the extent that if the employee would have paid for the services, the payment would have been deductable under section 162 as an ordinary and neccary expense or as depretiation
Ie transportion to an executive in a company jet to to get -- would have to be incldued and then deducted
Deminimum fringe, which by their smallness makes the value of it unreasonably small
Qualified transportation fringe
Transit passes and parking
Qualified moving expense reimbursements
Personal Damage awards -- settlement is sufficient
Exclusion for only physical injuries or sickness (not libel)
Old language was "tort" or "tort-type"
The award is not based on an ascension to wealth
If it is in contract action, there will be no exclusion
Focus of the inquiry should be on the nature of the original claim
To focus on the remedies available, if the cause of damage includes tort damage possibility
Punitive damages are taxable -- both physical and non-physical
Exclusion also includes periodic payments
Defendant could invest the funds and pay with interest
Reimbursements can be deducted for workmen's comp
Health or accident insurance which is not provided is deducted
The value of employer-provided insurance is excluded
Death benefits limited to $5k
Business damage awards
Recovery for lost profits are taxable
Recovery for lost property are taxable to the extent of basis -- any amount received above will be considered to be taxable
Gift and inheritance exclusions -- this is an exclusion to the recipient (no dollar)
gifts
Definition of gift:
For purposes of code:a gift has to proceed from detached and disinterested generosity -- fact dependant
There is a gift and estate tax imposed on the donor over 10k -- a tax on the power to transfer wealth
There is a concern for a double tax
Encouragement for gift-giving, or valuation
Recipeints receive a stepped-up value because gain or loss from changes in value hasn't' been realized.
The making of a gift is not a realization event -- the section doesn't talk about what happens to the donor.
The recipeint has the same basis that the donor had
Rents, dividends: The exclusion does not apply to the income that comes from the property
Irrebuttable presumption that Employers never make gifts to employees -- ever
Inheritances - value of property received by request, devise or inheritance
Might be a double-taxation reasoning behind this, but this does give people a stepped-up basis
The bequester never pays an icnome tax on increase in wealth
No dollar limit from income tax
Not determined by state law
Inheritance by compromise of contested will is still excludable
Something that is a bequest under state law is not a bequest -- transfers that have a compensatory flavor
Gross income doesn't include interest from state or local bonds
Gross income doesn't include redemption of exempted savings bonds used to pay for higher education
Subtract deductions
Above the line
Can subtract things attributable to a trade or business carried on by a taxpayer, and don’t incldue expenses of an employee
Include sole proprieter and what an employee deducts
All business expenses will be accounted for in a basis, deduction, or credit
Possibilites Timing of these deductions
Immediately in full (most advantage)
Ordinary and necessary expenses
Capitalized is defined as expense can’t be immediately deducted bust must be included in the basis of the property
E. g. cost of raw land – maintained as the basis in the land trhough the basis offset in the formula in 1001
Depreciation or amortization is defined as can deduct a proportion over a number of years – include it in basis but can include
Included in basis, but when there property is realized
Reasonable allowance for the exhaustion, wear and tear of things
Rather than deduct the cost of the asset immeadiately – this lets the taxpayer recover the cost over its useful life
This permits a resonable allowance without specificying how this can be calculated
This should that amount which should be set aside for the taxable year in accordance with a reasonably consistant plan, will at the end of the life, equal the cost of the original property
Methods
Starting with basis -- ACRS
Tangible property – accelerated cost recovery system – tangible assets are classified and assigned to specific recovery periods Car=5 years; non-residential real estate=39 years
Intangible assets: amortization: Pollution Control Facilities. Goodwill are amortizable (15 years). Customer lists. When a buyer acquires a business along with its substription list, the later reflects goodwill as a going concern; going concern value; workforce in place; lists; franchises
Applicable depreciation method
Non-residential real estate or residential property – straight line method, equal portion of the cost over each year
Double-decling balance: taxpayer in the first year takes double the percentage in the straight line method, will continue until a switch to the straight line balance would yield a larger balance
Business can take deductions on interest paid -- e. g. borrowing in connection with a trade or business
State and local taxes are deductible
Ordinary and necessary business – deductible in full in the year it occurred
Salaries
Travel expenses while away from home in pursuit of the business
Rental
Necessary is defined as "appropriate and helpful" -- ordinary and necessary
Doesn’t need to be habitual, just has to be common and acceptable
Could even go to a "moral obligation" or "protection of reputation" expense from a repayment of investment losses to investors
Capital expenditures (e. g. adding permanent improvements) are not deductable as expenses (gets added to basis)
Ordinary and necessary business expenses are things that will not be used up over the taxable year
Cost of repairs that neither materailly add to, or prolong their lives, may be deducted as an ordinary and necessary expenses
Test: whether the test will result from the taxpayer realizing the benefits beyond the year which it was made
Advertising is still immediately deductible
Proposed Uniform Capitalization Rules – in producing real or tangible personal property must be capitalized, such they incur substantial expenses – they would have been required to amortize the cookbooks or films over the years – there is now an exception for qualified artistic works (include definition of artists)
Many expenses though of as uniform and necessarey mus tnow be capitalized.
Can amortize things over 62 months that are exploratory
Managing investments can be deductible, so long as it is ordinary and reasonable
They are now largely parallel
Can sustain deductions over the taxable year, and not compensated by deductions -- business and investment losses, and certain limited investment losses
Limitations
limits capital losses to 1211 and 1212 losses
capital loses is defined as loses for exchange or sale of capitl asset
capital asset is an investment asset (e. g. stock in a corpration heldo for asset) -- --- losses are limited to the extent of gains
can carry forward or cary back under
individual taxpayers limited to 3,000 or the excess
excess losses may be carried forward by special rules in 1212
Congress has put in the "Cherry-picking provisions"
Tax shelter industry responces (limited partnerships)
For tax purposes, the partnership doesn’t pay taxes, but passes through the partnership to the partners (e. g. in early years, the venture wouldn’t generate any income – but there w would be interest on deductible equipment)
At risk rules
Losses from an activity are only deductible to the extent to the extend that they are at risk – only to the extent of the money contributed, and the adjusted basis that was pledged or tendered
taxpayers are not at risk of the take on non-recourse debt
limits on losses from passive activities – needs to be material participation -- one needs to be involved materially involved
passive losses can’t be used to shelter or offset income from other sources, unless they actively participate in the business.
Passive activity losses can only offset passive activity gains
Creation of artificial losses disallowed
Disallowance of cetain related parties
Family members
Controlled corproation
Grantors
Fidcuciaries
Trusts
Hobby losses
Although business and investment losses are decutable, personal losses are not deductable
Alimony is above the line deduction
Moving expenses are now deductible, so long as one is at least 50 miles father in the new residence – moving expenses are limited to the reasonable expense of moving
Please visit
Additional deductions
Standard deduction
Inflation adjusted
Personal deduction
Itemized deduction
Qualified residence interest – e. g. home mortgage interest
Personal interest disallowed
Credit cards, school loans, etc.
Qualified residence interest is allowed
Can deduct interst on loans secrued by the residence – e. g. improvements
Also goes for a seond house – e. g. vacation house
Limited to a total of 1 million for both houses -- excess not deductable
Can deduct interest on equity loan interest up to 100,000 – that is used for any purpose
State, local, real, personal, property taxes -- not federal taxes
Personal losses from casualty lossses
Fire, storm, etc.
Can only deduct if you are not otherwise reimbursed for the loss
limitations
limited to things extend over 100
can only deduct net casualty loss to the extent that it exceeds 10% of one’s Adjusted Gross Income
unreimbursed medical -- to the extent that they exceed 7.5% of the agi
reimbursed expenses can be exlcuded
but someone who is not reimbursed, one is limtied to 7.5% of the agi -- and onyl the amount of th eexcess.
Medical care includes, diagnosis, cure, and transportation for, primary for an essential to
This also includes medical insurance premiums
Can’t get rental expenses -- or meals and lodging away from home
Can’t get deduction for resort area medical care
The fact that something might be a capitalization won’t disqualify it, but if it improves the value of the home, than that increase is not deuctable
Gifts to charity
Full fmv deductions are limited in certain cases to charitites
Miscellaneous items
Miscellaneous deductions are allowed only if the aggregate is greater than 2% of the gross income
Itemized deductions other than the list provided
Main category of miscellaneous deductions are unreimbursed employee expenses
Journals, dues
Exemptions for self, spouse, dependant (inflation adjustment)
Total is taxable income
Tax rates
0 (with exemption)
15
28
31
36
39.6
tables explain at which point you move between brackets (change based on characteristics of return)
as the taxable income rate increases, only the marginal rate increase
tax rates are graduated
effective tax rates are what is less than on the last dollar earned
the top marginal rate for high income tax payers may, in fact be higher
personal exemption fades out
limitation on itemized deductions
Audits
Random audits (small percentage)
Unusual items that are out of line
Statute of limitations is three years -- within the filing of the tax return
False, fraudulent returns there is no statute of limitations
Audit results
No change
Proposed adjustments to the taxpayer’s return in a "30 day letter"
Tax court jurisdiction
Taxpayer can seek administrative review in 30 days -- not litigation
90 day letter: formal notice of deficiency
Federal District Court
Can get there if there is an overpayment of taxes, knowing that there is some dispute and than seeking a refund -- refund suits go to the district court
Appeal goes to the same circuit which the taxpayer resides
