FEDERAL INCOME TAX OUTLINE
Professor Drennan – Southern Illinois University
A. GENERAL FORMULAS:
1. Gross Income – Certain Deductions = Adjusted Gross Income (AGI)
2. AGI – Personal Exemptions – either Standard or Itemized deduction = Taxable Income
3. Taxable Income X Tax Rate = Tax Liability
4. Tax Liability – Tax Credits = Tax Due (if positive number) or Refund (if negative number)
5. Calculate AMT. If AMT is greater than “tax due,” AMT becomes the amount due.
B. SIX FUNDAMENTAL TAX QUESTIONS:
1. Is it income?
a. Does the particular item fall within the definition of income under §61?
b. Does it fall within any of the statutory exclusions from income?
2. To whom is the income taxable? If a gift has been made, is income shifted to the donee. Consider the following.
a. Was the gift of property or of the income from property?
b. Was the gift of income from services?
c. Did the donor retain excessive controls?
d. If the gift was in trust, is income taxed to the grantor, the beneficiary, or the trust?
3. Is it deductible?
a. Does it qualify as a personal deduction? If so, it must fit within the statutory provisions for interest, charitable contributions, etc.
4. Does a sale of property produce gain or loss?
a. How much was the gain or loss?
1) What was the basis? Are there any adjustments to basis?
2) Was there a realization? If so what was the amount realized?
3) Does the transaction qualify for nonrecognition?
b. Is the asset a capital asset? If so, was there a sale or exchange?
5. Does the alternative minimum (AMT) apply:
a. What is T’s “alternative minimum taxable income?”
b. What is T’s exemption under the AMT?
c. What’s T’s AMT?
d. Is the AMT greater than T’s regular tax.
6. When is the item income or deductible?
a. Does T use the cash method, the accrual method, or the installment method?
b. If the transaction spans several years, should each year be taken separately, or can the entire period be considered?
II. IS IT GROSS INCOME?:
A. COMPENSATION FOR SERVICES:
1. General: cash or property received for services rendered is included in gross income, regardless of the form of such payment.
2. Payment of employee’s income taxes (or any other debts): it is considered additional compensation.
3. Frequent flier miles: aren’t included in income unless the frequent flier miles are turned into cash.
B. INCOME FROM CANCELLATION OF INDEBTEDNESS:
1. General (§108): treated as income unless it falls within several possible exemptions.
2. Exception as to insolvent T: cancellation of debt isn’t taxable if T is insolvent immediately before the cancellation.
a. Insolvency defined: either:
1) Insolvent: liabilities exceed assets.
2) Bankrupcty: T’s debts are discharged in a statutory bankruptcy proceedings.
b. Limitation: exclusion can’t exceed the amount T is insolvent.
c. Definition of assets: includes assets that are exempt from execution under state law (i.e., have to include items like fishing license).
d. Tax benefits: T must reduce certain tax benefits by the amount of the debt cancellation income not recognized which include:
1) Net operating loss carryovers.
2) Disallowed passive loss carryover.
3) Capital loss carryforwards.
4) Note: if these are insufficient to absorb the entire amount of untaxed income, the basis of assets must be reduced in accordance with §1017.
3. Exception for qualified real property business indebtedness: exclude debt cancellation when the debt is secured by real property in trade or business.
a. Acquisition or improvement (debts after 1993): debt must have been incurred in connection with the acquisition or improvement of the real property.
b. Note-basis: basis of all real property owned by T is reduced by the amount of debt cancellation income that was excluded.
c. Limitation: T can’t exclude more than the difference between the debt (before reduction) and the value of the property (reduced by the amount of any other debt to which it is subject).
4. Exception for deductible payments: no income for cancellation of a debt to the extent that payment of the debt would have given rise to a deduction (i.e., like owing money to charitable organization).
5. Cancellation as a gift: creditor’s reduction or cancellation of indebtedness is excluded if it is a gift to the debtor.
a. Note-detached generosity required: unless the creditor and debtor are family, the creditors intent would seldom be “detached generosity” required (i.e., usually just wants to keep debtor in business so he will remain a customer in the future and he can get more $).
6. Student loans: student loans discharged where borrower works for a certain time for certain employers don’t give rise to income.
taxable income (but benefits to nonmembers are gifts).
b. Bargain purchases: when a person sells property to another for less than its value:
1) Seller misinformed as to the value: or knows the value and must make a distress sale, there is no income or gift.
2) Seller’s motive’s proceed from disinterested generosity: is an excludible gift.
3) Distinguish-compensation cases: bargain purchases that are compensation for services produce income to person who rendered services.
3. Definition-inheritance: exclusion applies not only to property received under a will or intestate, but also to any other payment that is referable to such a gift or inheritance.
a. Will contest settlement: excluded from income.
b. Compensation for past services: bequest from an employer to an employee is taxable.
c. Payment for services to estate: bequest made to an executor isn’t exempt if intended as a substitute for fees payable for his service.
4. Income derived from gifts: any income subsequently derived by the donee from the property is taxable.
a. Distinguish-gift of future income: if the gift involved is solely of future income, than ALL money received is taxable to the donee.
G. GOVERNMENT BENEFITS:
1. Social security benefits (§86): are partially taxable, but SSI payments aren’t.
a. Taxable amount at lower levels of modified AGI:
1) Formula: SS benefits are taxed at an amount equal to the lesser of:
a) One-half of the benefits received during the year or.
b) One-half of the amount by which the sum of 50% of SS benefits plus T’s modified AGI (AGI increased by tax-exempt interest received during the year) exceeds a statutory floor.
2) Floor: $32,000 on joint return or $25,000 on a single return.
b. Taxable amount at higher levels of modified AGI: at higher income levels, up to 85% of the SS benefits during that year are taxable.
1) Income levels: $44,000 on joint return and $34,000 on single return.