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Tax
Seton Hall Unversity School of Law
Coverdale, John F.

Tax

Coverdale

Spring 2012

1. Computing What is Owed

a. Gross Income

i. All income from whatever source derived except as otherwise provided by statute (61)

· May be realized in any form: money, property, or services

ii. Do not include excluded items

iii. Subtract all deductions

b. Adjusted Gross Income

i. GI less certain costs of earning income and other items including alimony

c. Compute Taxable Income (aka base)

i. TPs adjusted gross income less the sum of 1) taxpayer’s personal exemptions and 2) the greater of a) the taxpayers standard deduction or b) the TPs itemized deductions

ii. Personal exemptions

· One for 1) TP; 2) TPs spouse; 3) each of TPs dependents s.151

iii. Itemized deductions

· All deductions other than the personal exemption deduction and the deductions allowable in computing adjusted gross income under s.62 s.63d

· Watch for deduction vs. capitalization

d. Amount of tax due on taxable income

i. Section 1 of code

· Rates of Tax can be 3 Sorts

o Progressive: as base increase you owe more tax and the percentage of income taken in tax goes up

o Proportional: a flat percentage is applied across the board

o Regressive: percentage taken decreases as price goes up

§ SS tax can be used as example since capped

· Depends on marital status

ii. Rate terminology

· Marginal tax rate: tax rate at each bracket

· Effective rate: take total amount of tax and divide that from total income per year

e. Reduce Tax Due by Credits

i. Credit: direct reduction in tax

· Dollar value of deduction depends on particular TPs applicable tax rate, but credit is the same dollar value for all TPs

· Ex:$1000 deduction saves TP A in 35% bracket $350 tax, but TP B in 20% bracket saves $200, while $1000 credit saves everyone $1000

f. Method of Accounting

i. Cash method: individuals

ii. Accrual method: businesses

GROSS INCOME

2. Gross include includes all income realized in any form: money, property, services

a. All gains except those specifically exempted

b. An accession to wealth, clearly realized, and over which the TPs have complete dominion

i. Accession to wealth

· Defined as anything of value

· Technically scholarship would apply, but congress made an exception

ii. Clearly Realized

· There must be a realization event: an actual exchange or sale which results in something materially different from what TP originally had

· Mere appreciation of wealth is not taxed.

· Realization is a constitutional requirement and Congress can’t constitutionally tax unrealized gain (Macomber)

iii. Over which Taxpayers have complete dominion

· Control over

· May have a right to income without dominion

· Not considered income until given control

3. Compensation for Services

a. Income realized in any form whether money, property or services

i. If services paid for in property – FMV of Property Received

· Service provider will have basis in property equal to FMV he received

· FMV = the price a willing buyer would pay a willing seller with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts

ii. If paid for in the form of services – FMV Services Received

· If services are paid for in property or services taken in payment, the FMV of what was received

· If services were rendered at a stipulated price, such price will be presumed to be FMV of the compensation received in absence of evidence to the contrary.

iii. Barter of Services

· If TPs exchange services, each has income equal to FMV of the services received

iv. Compensation income is ordinary income

v. Timing: when to include depends on accrual or cash method

b. Imputed Income ≠ income

i. The economic benefit arising from self-help, via performing services for oneself, family, or others is not income

ii. Imputed income from owning and using ones property

· Ex: A and B have $250k. A uses it to buy house which has a rental value of $25k per year. B invests it and gets $25k in profit in interest, and B rents a house identical to A’s for 25K per year. Each has a $250k asset, each has a $25k benefit from the asset. But B’s return on investment is taxed while A’s return is not taxed

iii. Commissions

· Agent who received commission on his own life insurance policy taxed Minzner)

· Salesman who got commission for his own house sale taxed (Deachler)

4. Income: All gains that are clearly realized regardless of source

a. Punitive damages are taxable

i. There is no Constitutional barrier to the imposition of tax on punitive damages. Because it’s not compensation for damages (harm) and is making up for financial harm, it is counted as income.

· Glenshaw Glass – TP received treble damages under antitrust laws

ii. Actual damages as compensation for loss of profits taxable

iii. What about actual damages for a tort (like medical expenses for injury??)

b. Discharge of indebtedness

i. If someone pays income tax/loan for you, even if they do so out of consideration for the services you’ve rendered for them, it is still to be considered a gain derived from your labor and is subject to taxation.

c. Recovery of Capital

i. Creation of or paying back of loans is not income for either party

ii. Also hence why we only tax the interest portion of a non-deductible IRA (since the recovery of already taxed money is not taxed again)

d. Qui Tam payments taxable

i. Qui Tam payments are taxable as gross income because all rewards are includable in gross income. Quit Tam is the same as a reward, that’s part of GI Roco v. Comiss

· Qui Tam: a private person may bring an action against any person who knowingly presents to the gvmt false or fraudulent claim (whistleblower)

e. Treasure trove is taxable

i. Treasure trove, to the extent of its value in US currency, constitutes GI for the taxable year in which it is reduced to undisputed possession (new case!)

· Reduced to possession – follows state law, or in absence of common law rule “title belongs to the finder as against all the world except the true owner” …aka the date when it’s found

· Note that if the treasure trove is resold, it’s not taxed on the previous owner (ie if piano with cash in it was resold the seller wouldn’t be taxed)

f. Rewards for employment

i. Employee pays for a trip that is a reward for services rendered by the employee, value of the reward is regarded as income (new case)

· FMV would be the cost of the trip to the company

· Note that you should distinguish between reward and actual business trip

ii. Stock Transfers as compensation

· Property which was included in a TPs income when received by him, is treated as having a base equal to its value at the date of receipt

o Ex: Employee gets $500 worth of stock in exchange for payment of $100. $400 of income even though the stock was not yet sold. If in year 2, she sells the stock for $600, she must pay tax on $200 only. If she sold stock in year 1 for $600, then all $600 is taxable income.

· Pensions as compensation/reward

o Employee gets $10,000 pension down payment in account by company. He can only access this once he turns 65. Still he is taxed on it this year

iii. Discharge of Indebtedness

· The payment of taxes on behalf of an employee constitutes income to that employee and he should still be taxed on it. Old Colony Trust Company v Commissioner

g. Regulation 1.61-8(a): gross income includes rentals received or accrued for the occupation of real estate or the use of personal property. For the inclusion of rents in income for the purpose of the retirement in

He transfers the land to the lawyer for 10k. However, for tax purposes, this is looked at actually as a sale or disposition of the property for 6ok, therefore if his original basis was 30k, he has a 30k basis. Client should be required to report the amount of difference between the client’s realized 60k and his adjusted basis of 30k. We treat this as though there was first a sale (he sold house) and use proceeds to pay the lawyer, not as one fell swoop type transaction.

3. INVESTMENT INCOME

a. Income from profit-motivated activities that do not rise to the level of T/B

i. T/B: In order to be in the trade or business, TP must be involved in the activity with re

b. Stocks

i. Activities of owning stock and buying/selling for one’s own account are not T/B, regardless of frequency of trade or the amount of time devoted to the activity

ii. Gain must be realized

· Don’t tax mere appreciation in value

iii. Dividends

· Count as income (like rent or interest) – it’s a realization on investment

· Not added to the Basis in the stock

4. IMPACT OF LIABILITIES

a. Recourse liabilities incurred by taxpayer in acquisition of property are included in the taxpayer’s basis in property and recourse liabilities of seller, assumed by the purchaser, are included in the seller’s amount realized. Treasury Regulation 1.1001—2(a)

i. Recourse and non-recourse debt is treated the same.

ii. Recourse Note- this type of debt allows the lender to collect from the debtor and the debtor’s assets in the case of default as opposed to foreclosing on a particular property or asset as with a home loan or auto loan. Nonpayment of recourse debt allows the lender the right to collect assets or pursue legal action.

iii. Nonrecourse Note- a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender’s recovery is limited to the collateral. If the property is insufficient to cover the outstanding loan balance (for example, if real estate prices have dropped), the difference between the value of the collateral and the loan value becomes a loss for the lender.

b. Obligation to repay entitles the taxpayer to include the amount of the loan in computing his basis in the property. Regardless of if the funds came from a loan or a personal bank account, the basis in the property is the same.

c. HYPO pp 81

i. Dan purchases a home for $300,000 and borrows $250,000 from the bank via a recourse note and pays the other $50,000 out of savings. Three yrs later, Dan still owes $230,000 to the lender but sells the prop to Mike for $325,000. Mike paid $95,000 cash to Dan and assumed the $230,000 liability.

· Dan’s adjusted basis in the prop is $300,000. The liability was assumed by Mike and there was a $25,000 appreciation. Dan’s gain is $25,000.

o 95K in cash + 230 assumed mortgage

· Amount realized of $325,000 ($95,000 cash and $230,000 liability assume) minus adjusted basis ($300,000) equals gain of $25,000.

o 325k – 300k = 25K

o D realized 25K total gain on sale