ANDREA MONROE TAX II SPRING 2013
The Annual Tax Accounting Period
Burnet v. Sanford & Brooks Co., 282 U.S. 359 (1931) – taxing annually the net income resulting from all transactions within the tax year, rather than the gains derived from particular transactions, is sustained by the Sixteenth Amendment.
“revenue ascertainable, and payable to, at regular intervals” cannot function if taxpayers are allowed to “postpone the assessment of the tax until the end of a lifetime or for some other indefinite period, to ascertain more precisely whether the final outcome of the period, or of a given transaction, will be a gain or a loss”
§1001 – calculates gain or loss realized in the current year by subtracting adjusted basis
§172 – Net operating loss (NOL) may offset income in other years – 2 years preceding the loss and 20 years following §172(d) only business losses (not standard deductions or personal exemptions)
The Concept of Realization Revisited
I. Adjusted Basis
1. §1012 – initial basis equals cost
a. Which includes the amount of nonrecourse acquisition indebtedness- Crane– nonrecourse acquisition indebtedness is included in basis
2. §1016(2)(A) – adjusted basis for deductions (proper adjustment)
II. Amount Realized
3. §1001(a) gain equals amount realized less the adjusted basis
4. §1001(b) – amount realized equals money plus FMV of property
a. Realization § 1.1001-1(a) – exchange of asset for another will qualify for as a realization so long as the exchanged assets “differ materially either in kind or in extent”
i. Cottage Savings properties are different in the sense that is material so long as their respective possessors enjoy legal entitlements that are different in kind or extent
b. FMV of property is not less than debt relief §7701(g) (Tufts) §1.1001-§1.1001-2(b), (c) Example 7
III. Amount Recognized
5. §1001(c)- generally amount realized equals amount recognized
Computation of realized gain or loss – Amount Realized upon sale or exchange (cash and FMV property) minus adjusted basis
Woodsam – taking out a nonrecourse loan against unrealized appreciation is not a sale or other disposition under §1001(a) – no realization
Cottage Savings US (1991) – exchange of assets results in realization (distinguished Eisner v Macomber – stock dividend something of value proceeding from the property – principle – properties are different in the sense that is material so long as their respective possessors enjoy legal entitlements that are different in kind or extent – not identical
Loans and Cancellation of Indebtedness Income §108
1. Borrowed money is not included in income because the receipt of funds is offset by obligation to repay and there is assumption of repayment.
2. When the debt is discharged §61(a)(12) provides that the income is taxable, which makes sense because there is no longer an assumption of repayment, and income should be recognized under annual accounting principles during the year that this is realized.
3. However, there are exclusions to the application of §61(a)(12) as provided under §108.
4. Here Section 108(a)(1)
a. [(B) applies since the taxpayer is insolvent] or
i. Section 108(d)(3) provides that insolvency means the excess of liabilities over the fair market value of assets as determined immediately before the discharge.
b. [(E) applies because the discharged indebtedness is qualified principal residence indebtedness. Note this provision is subject to a sunset in as of January 1, 2014, extended as a result of the fiscal cliff negotiations.] 5. However, there is a limitation to the insolvency exclusion under Section 108(a)(3) which limits the amount excluded to the amount by which the taxpayer is insolvent. Therefore, here since the liabilities only exceed the assets by $XX,XXX only this amount will not be subject to tax, whereas the remaining $XX,XXX will still be taxable.
6. Furthermore, the term “exclusion” from gross income in the case of insolvency is a bit of a misnomer because through the reduction of tax attributes under Section 108(b) the Code treats the insolvency exception acts more like a deferral.
7. Here, under 108(b)(2)( )the “exclusion” reduces the ( [A]net operating loss [E] the basis of the property of the taxpayer [F] passive activity loss and credit carryovers] 8. Therefore, Section 108(b)(3)(A), provides for a dollar for dollar reduction of [A] /[E] followed by a reduction of [E]/[F].
108(e)(4)(A) Acquisition by person related to debtor from unrelated person is treated as discharge of indebtedness
Section 267(b), (c)(4) relationshi
which the deduction was based, then the taxpayer must include the amount of the mistaken deduction (mistaken in hindsight) in income in the later year. Hilsboro (inclusionary rule)
§111(a) recovery of deductions that did not reduce taxable income is not included in gross income
§111(c) carryovers – reduce tax
§111 (exclusionary rule) do not apply tax benefit rule to the extent the taxpayer did not receive a benefit as a result of the deduction in the prior year.
Restoration of a Claim of Right
(1)Taxpayer included an item in income for prior year because it appeared to be an unrestricted right
(2) After close of that year, established that did not have a claim of right leading to a deduction to a deduction
(3) AND the deduction is more than $3,000
The tax for the taxable year shall be lesser
(4) tax with such deduction OR
(5) tax without deduction minus the decrease in tax that would have resulted in the prior taxable year if the item of income had not been included.
§1341 Taxpayer friendly- either substract income from current year to calculate tax – or subtract income from prior year to calculate credit – §1341(b)(1) – and refundable! Treated as overpayment
Hilsboro – tax benefit rule approximates results produced by transactional rather than annual accounting- protects against adverse effects of reporting based on assumptions that prove to be fundamentally inconsistent unforeseen events- if event occurred in the same year- there would have been no deduction – e.g. taking a business expense deduction for prepaid rent, but then using the property for personal use in the following year.
State tax refund – inclusionary – itemized but then get refund – include
Kirby excluded income – discharge of debt – Tax benefit- deduction of income
Amend if deduction was wrong based on facts available at the time- Tax benefit inclusion in later year if mistaken only with benefit of hindsight