Federal Income Tax
Mary Ferrari
Fall 2016
1001 Formula
AR: 1001(b)
AB: 1012; 1014 (inheritance, FMV DoD); 1015 (gift – same as donee); 1016(a)(2) reduces basis for depreciation
= realized gain or loss under 1001(a)
If loss – is it allowed? 165
Recognize? Relevant exceptions:
121 – Exclusion of Gain from Sale of Principal Residence (gains only) (exclusion from income)
1031 – [“Like Kind”] Exchange of Property Held for Productive Use or Investment (G/L) (deferral)
1033 – Involuntary Conversions (must be similar or related in service or use) (GAINS only) (deferral)
1041 – Transfer of Property Between Spouses or Incident to Divorce (G/L) (deferral)
And the mechanism of the deferral is accomplished through the basis in the new property that you acquire.
Otherwise must recognize under 1001(c)
so into GI under 61(a)(3)
Characterize: sale or exchange? Yes. Capital asset? 1221(NOT A CA if it is depreciable property used in TB). Holding Period?
Is this gain from depreciable personal property? If yes, apply 1245.
The amount by which the lower of
the recomputed basis (basis + depreciation deductions taken) or the amount realized exceeds the adjusted basis shall be ordinary income.
If gain is split into two pieces, or if there is a loss:
Ask: Is there a 1231 gain/loss?
S/E of property used in TB? à 1231(a)(3)(A)or(B)(i) à goes into main pot.
Condemnation? à always main pot
Involuntary conversion? à firepot
NOW we can do 1231
Fire Pot:
1231(a)(4)(C)
If losses exceed gains, 1231 does NOT APPLY to the firepot loss.Would get taken out of 1231 and you characterize them under the normal rules so it becomes ordinary. GOOD bc then deductible in full ATL.
If gains exceed losses 1231 SHALL apply.So FP items move to 1231(a) MP.And if G>L, become LTC.
Main Pot:
1231(a)(1) gains exceed losses so it DOES apply à LTCG. cap gains is good bc preferential rate.
If L>G à doesn’t apply, OI. ordinary losses are better bc you deduct full.
1231 gives you opportunity to get LTG treatment even though not a sale or exchange. w/o 1231 you woud have ordinary income bc no sale or exchange. So 1231 allows you to have capital gain on insured, involuntary converted items.
So now 1211(b):
Capital loss only deduct up to amt of gain Plus if L exceed G lesser of 3000 or excess of L > G.
Would deduct ATL (62(a)(3)
Remainder carried over to next year per 1212.
Net capital gain? 1222.
Excess of NLTCG over NSTCL
Ex of LTCG ov LTCL ex of STCL ov STCG
STOCK IS NEVER IN 1231. Nor is building. Why not? à you already characterized them as capital previously. Stock in hands of investor is never 1231. 1231 = either not a CA in the first place, or if it is, no SE.
I. Intro/Defining the “Proper” Rate
Deficit v. Debt:
Deficit is the difference between income and outcome.
No deficit in year 2000; actually had a surplus to pay down debt.
Debt = what we borrow to make up shortfall from revenues.
Until 1913, no constitutionally valid income tax. 16th amendment allows congress to impose tax on income (16th amendment “authorized Congress to choose ‘income’ as the proper base” but it does not define the term “income”). Then Tarrif Act = first constitutionally valid income tax. Excerpt sets up same framework we have today.
Proper = political. There is no “proper” tax rate.
Four questions fundamental to construction of any income tax:
Tariff Act
What is the proper…
Rate? 1% per annum
Tax base? (what you’re taxing, the thing to which you apply the rate) entire net income
Tax-paying unit? (who?) citizens (no matter where they are living) or residents (with greencards)
Time period? preceding calendar year
The four questions remain today: proper rate, base, unit, and time period. Where do we find these things now? § 1 of IRC.
What is the US Code? à codification of federal statutes and organized by topics.
Title 26 = Tax
1986 Code – has been amended numerous times. Use TOC and be careful – definitions may only apply to certain parts.
§1(a)
Same four questions in 2015
The rate is progressive. But the rates under §1 are incorrect, need to go to ix (§1(f)(1) directs Secretary to create tables, as reflected in RP 2014-61 (pg ix).
Who is the Secretary? Secretary of the Treasury. § 77-01 = definitions. “When used in this title…” = 26, so applies across the code.
77-01 §(a)(11)(B) – notice the difference between (A) and (B).
Who drafts IRC? à Congress, not the IRS. IRS is the administrative agency stuck with enforcing the code.
The Secretary can delegate her obligation re: inflation adjustment.
Revenue Procedure – a pronouncement/publication by IRS to tell public of tax consequences of a particular transaction, essentially a hypo but involves similarities to real cases
Revenue Procedure 2014-61
§3 = 2015 tax tables.
Proper rate? 10%, etc. Tax brackets = percentages.Represent a progressive rate structure.Very compressed now versus in 1944 (pg 14)
Tax base? taxable income
Unit? 1(a) thru (e) delineate units.Married, head of house, surviving spouse…
Note: §(a)-(d) rates are the same.The difference is the amount of income subject to specific rates.Why? Married tax payer = two taxpayers, eligible for lower rate.It used to be exactly twice, but only the 10% is now.
Time period? Not specified.But we use 12 month period (not calendar, could be fiscal)
Taxing Formula
Page 9
Ask, where are we in this formula and why?
Start with Gross Income §61 (after exclusions)
Subtract §62 described deductions (there must be a separate authorizing section)
= adjusted gross income (“the line”)
subtract
ations for the enforcement of this title.”
So §1.61-1(a) – general definition of gross income:
“Gross income means all income from whatever source derived, unless excluded by law.” (How it differs from §61 – specifies that it must be excluded).And continues – “Gross income includes income realized in any form, whether in money, property, or services.”
The reg repeats and expands the definition of GI: “unless excluded by law” and “in any form.”
What if client offers to pay your dentist? You never receive the money but it is STILL taxable income, a “deemed transaction.” Treated as though the client paid the lawyer and then the lawyer paid the dentist (Old Colony).
Old Colony
RULE: TAXPAYER CANNOT AVOID TAXABLE INCOME BY NOT “RECEIVING” IT
In addition to salary, employer was paying his taxes. But the company was not withholding taxes, but computing the tax he WOULD have to pay and paying that.
Court said it was taxable income.
Wood tried to make a few arguments:
Gift? Would be excludable from GI even though an accession to wealth. But 102(c) – there is no such thing as a gift from employer to employee.It is always in recognition of services.
Tax on tax argument – ct said we’ll deal with that when it actually becomes an issue
Grossing up income – pay enough so that employee nets the desired amount.$1 mil?
G = net/1-tax rate
G = $1mil/1 – .396 = $1mil/.604 = $1,655,629
This does NOT implicate Old Colony
Barter Transaction
Client paints house in exchange for will. No cash changing hands at all. Barter transaction. But GI DOES include services, so both parties have gross income.
Revenue Ruling 79-24
Client paints house in exchange for will:
FMV of the services are includible in GI!
Work of art by artist in exchange for 6 months free rent
“Free” rent is still bartering
Also artists work = “services” – don’t think of a painting as property
Painting house – how do you measure what that’s worth?
§1.61-2(d) – FMV of what he GOT not what he provided
“If the services are rendered at a stipulated price, such price will be presumed to be the FMV of the compensation received in the absence of evidence to the contrary.”
Possible that they are not worth the same, but we ASSUME commercially reasonable people wouldn’t do that.
