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Federal Income Tax
South Texas College of Law Houston
McGovern, Bruce A.

I.                    Sources of Tax Law
a.       Legislative Branch
                                                               i.      Internal Revenue Code
                                                              ii.      Legislative History
b.       Executive Branch
                                                               i.      Treasury Department
1.       IRS (Internal Revenue Service)
a.       Treasury Regulation
b.       Revenue Rulings
c.        Revenue Procedures
d.       Private Letter Rulings
c.        Judicial Branch
                                                               i.      US Tax Courts
                                                              ii.      US District Courts
                                                            iii.      US Court of Federal Claims
d.       Calculating Tax Liability
                                                               i.      Gross Income – §61 minus
                                                              ii.      Above the line deductions – §62 equals
                                                            iii.      Adjusted Gross Income – §62 minus
                                                            iv.      Below the line deductions – deductions not listed in §62 minus
1.       Subject to §68 limitations and §67 floor
                                                             v.      Personal Exemptions – §151 equals
                                                            vi.      Taxable Income – §63 multiplied by
                                                          vii.      Tax Rate – §1 equals
                                                         viii.      Tax Liability minus
                                                            ix.      Credits equals
                                                             x.      Final Tax Liability
II.                  Chapter 2 – Gross Income
a.       §61
                                                               i.      Definition of gross income is all income from whatever source derived, including but not limited to: list in book
                                                              ii.      Court defines gross income as an accession to wealth, clearly realized, and over which the taxpayers have complete dominion – Glenshaw Glass
b.       Gross income is not realized on a bargain purchase until the sale or disposition of such property – Pellar v. United States
c.        Treasure Trove is includable in gross income because it is not expressly excluded from gross income – §1.61-14 – Cesarini v. US
d.       Paid trips by an employer are gross income unless required to go on trip – McCann v. US
e.        Service in exchange for another’s services goes into gross income – Revenue Ruling 79-24
f.        Transfers from employer to employee for less than FMV as compensation for services results in gross income in the amount of difference between FMV and transfer price – §1.61-2(d)(2)(i)
g.        Realization Requirement
                                                               i.      Must realize a gain in order for it to be considered gross income
1.       Realize gain when money is reduced to your undisputed possession
III.               Chapter 3 – Effect of Obligation to Repay
a.       Loans
                                                               i.      Loans are not an accession to wealth because the proceeds are accompanied by an offsetting liability and obligation to repay
                                                              ii.      Forgiveness of a loan does constitute gross income
b.       Claim of Right
                                                               i.      If a taxpayer receives earning under a claim of right and without restriction as to its disposition, he has received income that he is required to return even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent – North American Oil v. Burnett
c.        Embezzlement should be calculated into gross income even though there is an obligation to repay because the taxpayer does not recognize the obligation to repay – James v. United States
                                                               i.      Repayment of the illegal funds will entitle to the taxpayer to a refund
d.       Advance payments are considered gross income
                                                               i.      Advance rent payments do constitute gross income – §1.61-8(b)
e.        Deposits
                                                               i.      When the purpose of the deposit is to guarantee the customer’s payment of amounts owed to the creditor, such a deposit is treated as an advance payment, but when the purpose of the deposit is to secure a property interest of the taxpayer, the deposit is regarded as a true security deposit – Commissioner v. Indianapolis Power Company
                                                              ii.      Ways to determine if money is includable in gross income as an advance payment
1.       Who has control over the money when obligation to repay occurs
a.       If it is the person who receives the money – gross income
b.       If timing is in the other party’s control – not gross income
2.       Is there an obligation to repay
a.       No obligation to repay – gross income
b.       Obligation to repay – not gross income
f.        Advance trade discounts are not considered gross income because the person will have to pay back the money no matter what – Westpac v. Commissioner
IV.                Chapter 4 – Gains Derived from Dealings in Property
a.       §61(a)(3) – gains derived from dealings in property are includable in gross income
b.       Amount includable in gross income is the gain on such property – §1.61-6
                                                               i.      Amount Realized – Adjusted Basis = Gain – §1001(a)
1.       Amount Realized
a.       Sum of any monies received + fair market value of property received – §1001(b)
2.       Adjusted Basis
a.       §1011 – the basis as provided in §1012 and adjusted by §1016
b.       §1012
                                                                                                                                       i.      Basis is the cost of the property
                                                                                                                                      ii.      If have exchange of property the basis in new property will be the FMV of the property received
c.        §1016
                                                                                                                                       i.      If take out another loan or just put money into property will increase the basis in this property by the amount put into the property
1.       Ex. Remodel house
                                                                                                                                      ii.      If you depreciate your property you will need to reduce your basis by the amount of depreciation taken on the property
c.        Liabilities taken over by the purchaser
                                                               i.      §1.1001-2(a)
1.       Amount realized from the sale or disposition of property includes amount of liabilities from which the transferor is discharged as a result of the sale or disposition
2.       Adjusted basis of the transferee will reflect the amount discharge
d.       Exchange of Property
                                                               i.      Philadelphia Park Amusement v. United States
1.       Amount Realized – Fair Market Value of Property Received + Any monies received
2.       Adjusted Basis – Fair Market Value of Property Received
V.                  Chapter 5 – Gifts, Bequests, and Inheritance
a.       §102(a)
                                                               i.      Exclusion provision stating that the value of property acquired by gift, devise, bequest, or inheritance is excluded from gross income
b.       §102(b)
                                                               i.      Income from property in section (a) is not excluded from gross income
c.        §102(c) – Employee gifts
                                                               i.      Any amount transferred by or for an employer to, or for the benefit of, an employee is not excluded from gross income
d.       Nature of Gift
                                                               i.      How to determine if transfer is a gift or compensation
1.       Look to the intent or motive of the transferor – Commissioner v. Duberstein
a.       Detached, disinterested generosity indicates the transfer is a gift
2.       Look to the facts surrounding the transfer
a.       Look to relationship between parties – personal or strictly business
b.       Did the transferor deduct as a business expense – cannot have a business deduction and a gift for the same transfer
3.       §102(c) – employee gifts
a.       Gifts from employer to employee are not excludable from gross income
b.       Gifts from employee to employee do not fall within this provision
c.        §1.102-1(f)(2)
                                                                                                                                       i.      Transfers from an employer to an employee not made in recognition of the employee’s employment are excludable from gross income under §102
                                                              ii.      Limitation on transferor’s deduction for gifts
1.       §274(b)(1)
a.       Deductions for gifts are limited to $25
2.       If the transferor decides to deduct entire expense then it will not be an excludable gift anymore
e.        Nature of Bequest or Inheritance
                                                               i.      Bequests that are compensation for services will not be excludable under §102
1.       Look to the facts of the situation to determine if compensation for services
a.       Devise stock to attorney for lifetime services is not excludable from gross income – Wolder v. Commissioner
f.        Basis in Property Received by Gift, Bequest or Inheritance
                                                               i.      Basis in Property Received as a Gift
1.       §1015(a)
a.       Basis in property acquired by a gift, basis should be the same as it is in the hand

lusion the taxpayer may take:
a.       The shorter of:
                                                                                                                                       i.      The time or ownership within the past 5 years
                                                                                                                                      ii.      The time of use within the past 5 years
                                                                                                                                    iii.      The time since the last sale or exchange excluded under §121
                                                                                                                                    iv.      Divided by
b.       2 years
                                                                                                                                       i.      May be expressed in months (24), or days (730) – 1.121-3(g)
c.        This ratio is multiplied by the exclusion amount ($250,000 or $500,000) to get the amount that can be excluded
h.       Property of Deceased Spouse
                                                               i.      §121(d)(2)
1.       For an unmarried individual whose spouse is deceased on the date of the sale or exchange of property, the period such unmarried individual owned and used the property shall include the period such deceased spouse owned and used such property before death
VII.             Chapter 8 – Life Insurance and Annuities
a.       Life Insurance
                                                               i.      Two Forms of Life Insurance
1.       Term Life Insurance
a.       Insured is buying insurance for a specific term
                                                                                                                                       i.      Usually one year terms
b.       If person dies within the fixed term the insurance company pays the premiums but if the person does not die the benefit goes away unless the person renews the policy
2.       Cash Value Life Insurance
a.       Insured is essentially purchasing a form of permanent protection
b.       Premiums are much higher in the first few years because you are essentially paying for the costs of future premiums
                                                                                                                                       i.      Individuals can surrender the policy at any time and withdraw the cash value built up on the policy
                                                              ii.      Include in Gross Income
1.       §101(a)
a.       Gross income does not include amounts received under a life insurance contract if such amounts are paid by reason of the death of the insured
                                                                                                                                       i.      There is no difference in the treatment of a cash value policy v. term life policy – the entire amount of both policies will be excludable from gross income
b.       Must show:
                                                                                                                                       i.      Money paid under life insurance contract
                                                                                                                                      ii.      Payment is occurring because of death of insured
1.       If money goes directly to mortgagee instead of beneficiary to pay off note on house it might be hard to prove this element
c.        Transfer of Life Insurance Policy
                                                                                                                                       i.      §101(a)(2)
1.       If a life insurance policy is transferred for valuable consideration to another person that other person may only deduct from gross income the amount paid for the insurance policy plus any premiums paid by such person – This provision shall not apply if:
If such contract or interest therein has a basis for determining gain or loss in the hands of a transferee determined in whole or in part by