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

·         Figure out the Rate of tax. Table .01
o   Are they married filing jointly, married filing separate, head of house, or single?
·         Find out your AGI
o   AGI = GI – Above the line deductions
·         Figure out taxable income
o   AGI – either (standard deduction and personal exemptions) or (itemized deductions and personal exemptions)
§  Will choose whichever is greater. (the standard deduction or the aggregate of the below the line deductions)
·         When itemizing you will decide whether the below the line deductions are miscellaneous and thus subject to the 2% floor.
·         In other words if the miscellaneous itemized deductions are not greater than 2% of the AGI then they don’t count. If they are, then only the amount over the 2% floor count.
·         The standard deduction under appendix table .11 is $11,400 for married couples filing jointly, $8,400 for heads of household, and $5,700 for unmarried individual and spouses filing separately.
§  The personal exemption is $3,650/ TP, spouse, and dependent children
·         Once you’ve figured this out, you then look at your capital gains.
o   Any capital gains will be taxed at 15%
o   You then add that amount to your previous taxable income.
·         Finally you subtract any credits and then you will have your tax liability.
·         TAX LIABILITY = AGI – personal exemptions – (standard or itemized) + [NCG x 15%] – credits
·         Sec. 61(a): “Except as otherwise provided in this subtitle, GI means all income from whatever source derived, including (but not limited to) the following items.”
o   (1) compensating for services
§  Includes wages, salaries, commissions, tips, bonuses (including Christmas), termination or severance pay, rewards, jury fees, marriage fees and other contributions received by a clergyman for services, military pay, retired pay of employees, pensions, and retirement allowances.
§  Fringe benefits include: an employer-provided aircraft, free or discounted commercial flight, vacation, discounted property or services, membership in a country club or other social club, tickets to an entertainment or sporting event.
§  Fringe benefits not included: qualified tuition reductions provided to an employee, meals or lodging furnished to an employee for the convenience of the employer, no additional cost services, qualified employee discounts, working condition fringes, and de minimus fringes, vehicle or flight provided to employee under 105.
o   (2) GI derived from business
o   (3) gains derived from dealings in property
o    (4) interest
o   (5) rents
o   (6) royalties
o   (7) dividends
o   (8) Alimony and separate maintenance payments
o   (9) annuities
o   (10) income from life insurance and endowment contracts
o   (11) Pensions
o   (12) Income from discharge of indebtedness
o   (13)Distributive share of partnership GI
o   (14) Income in respect of a decedent
o   (15) Income from an interest in an estate or trust
·         GI includes income realized in any form, whether in money, property, or services.
o   If income is derived from services or property you include the FMV of the services or property in GI.
o   When property is traded for services or services are traded for services, it usually included in GI as compensation. However, if no compensation was ever contemplated by one party, it may be considered a gift to that party who never contemplated compensation.
o   Imputed income such as self help, using your own services, or using your own property is not includible in GI.
·         Income must be included in GI when there is an undeniable accession to wealth, clearly realized, and over which the TPs have complete dominion.
·         1.61-14 notes miscellaneous items of GI including: punitive damages, exemplary damages, another person’s payment of the TP’s income taxes, illegal gains, and treasure troves.
·         Essentially, if the TP does not yet have complete dominion over the money and there is still an obligation to repay, then it does not have to be included in GI until the TP has received the money and has complete dominion over it.
·         Claim of Rights Doctrine – §1341 –
o   General Rule. – If
§  (1) an item was included in GI for a prior year bc it appeared that the TP had an unrestricted right to the item;
§  (2) a deduction is allowable for the taxable year bc it was established after the close of such prior taxable year that the TP did not have an unrestricted right to such item or to a portion of such item; and
§  (3) the amount of such deduction exceeds $3,000,
Then the tax imposed by this chapter for the taxable year shall be the lesser of the following:
§  (4) the tax for the taxable year computed with such deduction; or
§  (5) an amount equal to –
·         (A) the tax for the taxable year computed without such deductions, minus
·         (B) the decrease in tax under this chapter for the prior taxable year which would result solely from the exclusion of such item (or portion) from GI for such prior taxable year (or years).
·         Deposit v. Advance payment
o   Security deposit is used to secure payment for damaged property. Other deposits are used to secure your seat in a class etc.
§  Security deposits are not included in GI since there is no complete dominion over the money. May never get it if there is no damage to the property.
§  Seems more like a deposit if you can get a full refund of your money at any time – just call up any time before the course starts and I’ll refund your money.
o   Advanced payment is used to secure future rents.
§  This is included in GI since it is used to pay the last month’s rent anyways.
§  If interest is being paid then it is strongly in favor of not being an advanced payment, but a security deposit.
§  Just bc there is a contingent obligation to repay doesn’t mean the TP doesn’t have dominion – Ex of the teacher who offered a full refund to student’s who failed the state exam after taking her class.
·         If such a situation happens then it falls under 1341 – claim of rights.
·         What does “gains” mean?
o   Reg. 1.61-6(a) – gain is the excess of the amount realized over the basis for the property sold or exchanged. (amount realized) – (adjusted basis) = net gain
§  Amount realized = the sum of any money received + the FMV of any property.
§  Adjusted basis = cost of the property – depreciation and expenditure.
·         When a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts.
·         Loan proceeds are included in the basis bc there is an obligation to repay. If the loan is taken from an individual and not a bank and there is still an obligation to repay then it is still included in the basis.
·         When refinancing a home loan, only money from that new loan that actually goes back into the home will be added to the basis.
·         When a buyer takes on a liability it is included in the amount realized.
In computing the gain or loss from the subsequent sale of property, its basis shall be the amount paid for the property increased by the amount of such difference included in GI.
The creator of the painting will have a basis in the painting in the amount of the supplies used to create it. Cannot include the labor.
·         Gifts
o   §102 – One of the exceptions to the rule that all income is included in GI.
Two limitations on §102(a): 102(b) says exclusion of §102(a) does not apply if:
The gift, bequest, devise, or inheritance is of income from property
It is “of income from property” if it is paid, credited, or to be distributed out of income at intervals.
So the gift itself is the income from property.
to any income that is produced by the gift. (The gift is not the income so it can be excluded, but any income later produced by that gift may not be excluded.)
Transfer from employer to employee cannot be excluded.
Unless it can be shown that the transfer is not made in recognition of the employee’s employment.
Accordingly, 102(c) should not apply to amounts transferred between related parties if it can be shown that it is a result of the familial relationship and not employment.
Basis of Gifts – 1015
For determining Gain – Same as the basis held by the donor.
This is sometimes referred to as transferred basis bc it allows shifting of tax burden associated with property
For determining Loss – The lessor of either the FMV or the basis held by the donor.
It is a gift if you can prove that it was detached, disinterested, generosity.
Must be determined whether in actuality the gift is a bona fide gift or simply a method for paying compensation. This que

s 5 years, such property has been owned and used by the TP as the TP’s principal residence; or
o   (II) the period after the date of the most recent prior sale or exchange by the TP to which subsection (a) applied and before the date of such sale or exchange, bears to
·         (ii) 2 years.
o   (d) Special Rules
§  (1) If a husband and wife file a joint return then subsections (a) and (c) shall apply if either spouse meets the ownership and use requirements.
§  (2) In the case of an unmarried individual whose spouse is deceased on the date of the sale or exchange of the property, the period of such unmarried individual owned and used such property shall include the period such deceased spouse owned and used the property.
·         Ex of non-qualified use:
o   If a couple owns a home for 5 years and uses it as their principal residence for all but 1 year in the middle of the 5. They then sell it and recognize a gain of $400,000.  The result is that 1/5 of the time they owned the home is treated as nonqualified use. As such 1/5 of the $400,000 gain is not excludable from GI. This means that $80,000 must be included in GI.
·         Only one spouse has to meet the ownership requirement, but both spouses must meet the use requirement. Also, neither spouse may have claimed the 121 exclusion in the last 2 years.
·         Under 121©(1) when the move is due to circumstances outside of the TP’s control, they can still get a 121 exclusion even if they don’t meet the requirements.
o   You must first determine which is shorter (if both are applicable): the amount of time used as a principal residence OR the amount of time which has passed since the last time the TP has taken advantage of the 121 exclusion.
§  So the formula is either:
·         Amount of time used as principal residence / 2 years = limited amount that may be excluded by TP.
·         Amount of time which has passed since last took advantage of 121 exclusion / 2 years = limited amount TP may exclude
o   For Ex: If she has lived in the house for 18 months out of 2 years, so she doesn’t meet he use requirement, but had to move bc of a change of job, then the formula will be 18/2 years (or 24 months) = .75
§  This means that you can exclude 75% of the $250,000 limit on an individual TP.
·         So if you had $250,000 of gain then you can exclude 75% or $187,500.
§  If you are married and one spouse just doesn’t meet the use requirement then the spouse who does meet all the requirements may exclude the entire $250,000. The spouse who does not will have to work through this ratio and then the two amounts can be added together to get the limit on their exclusion as a married couple filing jointly.
·         Bc of the federal defense of marriage Act, gay couples cannot file joint returns. If one spouse owns the home, the other is not treated as owning the home unless their name is actually on the title.
There are several factors to determine where your principal residence is.
Place of employment
Principal place of abode of the TP's family members
Address listed on the TP's federal and state tax returns, driver's license, automobile registration, and voter registration card
The mailing address for bills and correspondence
Location of the TP's banks
Location of religious organizations and recreational clubs
If a TP has owned and used as their principal residence 2 different homes in the last 5 years, then they may exclude either home, but not both.
Short temporary absences still count as “use” even if you are renting out the home during your absence.