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Federal Income Tax
South Texas College of Law Houston
Siegel, Mark R.

 
Federal Income Taxation
Siegel – Fall 2013
U.S. tax system is a “Transactional System”, meaning that some event must occur to trigger tax liability
Gross Income                                                                                                                           4-Part test:
 I. Gross Income Defined – §61
 Except as otherwise provided, GI is all income from whatever source derived, including (but not limited to):
1.       Compensation for services
a.      Fees, commissions, fringe benefits, etc.
2.      Gross income derived from business
3.      Gains derived from dealings in property
4.      Interest
a.      But not the principal (which would be mere return of capital)
b.      But see §103(a) – interest paid on certain state and local bonds is excludable
5.      Rents
6.      Royalties
7.      Dividends
a.      Payments in the form of additional shares (instead of cash)
8.      Alimony and separate maintenance payments
9.      Annuities
10.   Income from life insurance and endowment contracts
11.    Pensions
12.   Income from discharge of indebtedness
13.   Distributive share of partnership gross income
14.   Income in respect of a decedent
15.   Income from an interest in an estate or trust
§1.61-1(a) – UNLESS excluded by law, GI includes income realized in any form (money, property, or services)
§1.62-2(d)(1) – Compensation paid other than in cash –
            If services are paid for in property or in other services, then the FMV of the property or other services
            taken in payment is included in GI as compensation (applies to non-immediate family members)
**GI includes the receipt of any benefit which is:
1.       NOT a mere return of capital,
2.      NOT accompanied by a contemporaneously acknowledged obligation to repay, &
3.      NOT excluded by a specific statutory provision
§1.61-2(d)(2) – Property transferred to employee or independent contractor –
            If employer transfers property to employee for services in an amount less than property’s fair value at
            the time of transfer, then the difference must be included.
                                    [FMV– Amt. paid by employee] = GI
            On subsequent resale:
                                    [AB = Amt. paid by employee + difference] Glenshaw Glass Co. definition of GI  
1.      Undeniable accessions to wealth
a.      +/- Net Worth
2.      CLEARLY REALIZED, &
a.      “The Realization Principle” – profit realization is triggered by an event, such as  a sale or disposition, and by mere fluctuations in property value
b.      Policy/Reasons:
                                                                i.      Value fluctuation
                                                              ii.      Liquidity
                                                            iii.      Practicality of appraisals
3.     Over which the taxpayers have complete dominion.
a.      Control
Haig-Simons definition of “Income”
                                    [Income = Personal Consumption + Change in Year End Wealth]             i.e. The sum of a person’s increases & decreases in Net Worth over an interval of time
            plus person’s consumption during that period (spending will decrease NW but it will not relieve GI)
Types of Compensation                                                                                                   (item #1 in §61)
1.       Direct Compensation
a.      Paid directly to the employee/taxpayer in exchange for their labor and services
b.      Unemployment Benefits – If paid to individuals pursuant to a federal or state program,
 fully taxable = GI
2.      Compensation in Kind
a.      Paid to someone other than the taxpayer in lieu of compensating the taxpayer
b.      Ex. Employer buys the employee’s spouse a new car, the value of which is includible in employee’s GI
3.      Indirect Compensation
a.      Transfer/payment on behalf of the taxpayer
b.      Ex. Insurance plans, benefits, relocation expenses, Paid Time Off (PTO)
Imputed Income ≠ GI
            Where the taxpayer derives a benefit from the value or usage of their own property or performs services
            for themselves, there is NO gross income  
            (ex. harvesting and consuming your own crops, preparing your own tax returns, etc.)    
II. Items Specifically Included in Gross Income (§§ 71-100)
A. Gains from Dealings in Property – §61(a)(3)
            *Unrealized gains are NOT taxable; realization is from the SALE/DISPOSITION of property
Gain is realized AND recognized unless an exclusion from GI, or a non-recognition provision, applies
1.      §1001 – Determination of “Amount of” and “Recognition of” Gain or Loss
a.     Computation
                                                              i.      “The excess of the Amount Realized (AR) therefrom over the Adjusted Basis (AB)”
1.       [AR – AB] = +                                                                                               GAIN
                                                            ii.      “The excess of the Adjusted Basis (AB) over the Amount Realized (AR)”
1.       [AB-AR] = + or when [AR-AB] = –                                                             LOSS
b.      Amount Realized – “sum of any money received plus the fair market value (FMV) of the
            property/services (other than money) received
c.       Recognition
                                                              i.      Except as otherwise provided, the entire gain or loss on the sale or exchange of property will be recognized, or included in GI
1.       Year in which sale/disposition occurred
d.      §1.61-6(a) – Parts of Property Sold in Separate Transactions:
                                                              i.      Treat each sale of a part as a separate transaction
1.       Gain or Loss to be computed separately for each part
2.     §1011 – Adjusted Basis (for Determining Gain or Loss)
a.      Basis = “How much have I got in it?”
                                                              i.      Cost, or amount paid
b.      AB = Basis, but may be adjusted as provided in §1016
c.       Philadelphia Park Amusement Co. v. United States
                                                              i.      Cost basis of property received in a taxable exchange (i.e. barter transaction) is the Fair Market Value of the property received in the exchange
d.      Loans & Debts
                                                              i.      Recourse Debt (“Assumption to the debt”)
1.       Borrower has personal liability
2.      Include in the AB
a.      Only if it was used to acquire or improve property
                                                            ii.      Non-recourse Debt (“Subject to the debt”)
1.       Borrower has NO personal liability (property as exclusive collateral)
2.      May be included in AB (see Estate of Franklin problem below)
3.      Crane v. Commissioner
a.      Amount of non-recourse mortgage assumed in the disposition of property must be included in seller’s AR and buyer’s AB    
                                                                                                                                      i.      Existing debt that buyer takes subject to acquiring property
4.      Commissioner v. Tufts
a.      For determining GAINS from dealings of property, a non-recourse debt will be treated as true debts for tax purposes
                                                                                                                                      i.      Non-recourse debt incurred to acquire the property
5.      Example: Mortgagor purchases land for $100K. He borrows $80K from the bank (nonrecourse) and pays that amount and additional $20K cash. Land is security for the mortgage, which bears an interest rate.
a.       Mortgagor’s AB is the full $100K  
6.      Example: Now the land has appreciated in value to $300K and only interest has been paid on the $80K mortgage. Mortgagor then takes out a second nonrecourse mortgage for $100K. Is there income from the second loan?
a.      No. Not an accession to wealth, and not used for the acquisition of property.
7.      Example: $100K of the second mortgage used to improve the land.
a.      AB = $200K   ($20K paid + $80K 1st loan + $100K 2nd loan)
b.      Now second loan is added to the basis because used to improve the land
8.      Example: Now the $100K of mortgage is used to buy stocks and bonds worth same amount.
a.      Basis in land is still $100K. The second loan is NOT included because it is not used to acquire or improve land.
9.      Example: Now principal amount of two mortgages is still $180K. Second mortgage still not used to improve or acquire property. Land worth $300K. Mortgagor sells property subject to both mortgages to another purchaser for $120K.
a.      Mortgagor                 $300K             AR       (120 sale + 180 total loans)
                                    $100K             AB       (20 paid + 80 first loan)
                                    $200K             GR+R
b.      Purchaser AB $300K (120 amount paid + 180 debt)
10.   Example: $100K mortgage used to purchase same amount of stocks and bonds. Mortgagor gives land subject to the mortgages (total $180) to son when land is still worth $300K.
a.      Mortgagor:                $180K                         AR       (180 total loans)
                                    $100K             AB       (20 paid + 80 first loan)
                                     $80K              GR+R
b.      Son:                            $300K             AR       (FMV)
                                    $180K             AB       (80 1st loan + 100 2n

                                 ii.      §1.105 -4 Transferee “Greater Of” Rule
1.       Transferee basis is the SUM of whichever is greater:
a.      The amount paid by the transferee for the property, or
b.      The transferee’s adjusted basis for the property at the time of the transfer
2.      For determining loss, the basis can NOT be greater than the FMV at the time of transfer
3.      Examples:
a.      1) A transfers property to B for $30K with a $30K AB and $60K FMV.
                                                                                                                                      i.      A:        Neither gain nor loss
                                                                                                                                    ii.      B:        $30K   AB as the amount paid by transferee
b.      2) A transfers property to B for $60K with a $30 AB and $90K FMV
                                                                                                                                      i.      A:        $30K GR+R
                                                                                                                                    ii.      B:        $60K   AB as the amount paid by transferee
c.       3) A transfers property to B for $30K with a $60K AB and $90K FMV
                                                                                                                                      i.      A:        $30K LR, NOT recognized
                                                                                                                                    ii.      B:        $60K   AB as the transferee’s AB > amount paid
d.      4) A transfers the property for $30K with a $90K AB and $60K FMV
                                                                                                                                      i.      A:        $60K LR, NOT recognized
                                                                                                                                    ii.      B:        $60K   AB because recall basis canNOT be > FMV
e.      Gift Tax Adjustment
                                                              i.      Gift Tax Paid x
                                                            ii.      Applies to whoever pays the tax (donor or donee)
                                                          iii.      CAPPED at $14K excluded per year, $5.25M for lifetime
f.        Net Gifts
                                                              i.      Conditional transfer that Donee pays the gift tax
                                                            ii.      Amount paid for the gift then reduces the Donor’s AR
7.      §1041 – Transfers of Property Between Spouses or Incident to Divorce
a.      No Gain OR Loss shall be recognized on a transfer of property from an individual transferor to:
                                                              i.      Spouse, or
                                                            ii.      Former spouse (only if transfer is incident to divorce)            
1.       Occurred within 1 year after date marriage ceased, OR
2.      Related to cessation of marriage
b.      Basis = Gift Treatment
                                                              i.      Transferee’s basis = Transferor’s Basis (even for LOSSES, which may be deductible!)
c.       Applies to transfers for:
                                                              i.      Cash or other property
                                                            ii.      Relinquishment of marital rights
                                                          iii.      Any other consideration
                                                          iv.      Assumption of liabilities in excess of the basis (unless transfer to a trust)