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Federal Income Tax
University of California, Hastings School of Law
Martinez, Leo P.

TAX

MARTINEZ

FALL 2011

Section 61 – GI defined

TI = GI – deductions

Cesarini – Section 61 is so broad everything should be considered included unless explicitly excluded

Old Colony Trust – If someone else discharges a liability that you have, it is as if you have been given that money (counts as GI)

In this case employer paid employee’s tax burden, but this counts as GI so employee had to pay taxes based on original salary plus amount of tax liability paid by employer

Bartering is GI

Section 102 – Gifts and Inheritance

(a) – GI does not include gifts or inheritance

(b) – However income from property received via gift/inheritance is GI

(c) – Gifts to employee from employer are not excluded from GI

Section 74(c) – exclusion for employee achievement awards

274(b) – applies exclusively to business and employee relationships

Safe harbor for employee gifts up to $25

274(j) – general no deduction for employee achievement awards

Glenshaw Glass – definition of GI = accessions to wealth, clearly realized, over which taxpayer has complete control (includes punitive damages)

Dean v. Commissioner – if T lives in rental property owned by corporation of which he is sole shareholder, fair rental value should be included in GI

If someone gives you something, this is GI

If you buy something and it ends up being more valuable than you thought, this is not GI (unless you sell it)

Duberstein (pg 69)

Actually 2 cases

-Duberstein makes referrals to Berman which Berman benefits from

Berman gives him a car in return, not obligated to do so

Duberstein didn’t even really want the car

Berman writes off cost of car as business expense

Held: the car is GI, not a gift, Intention of giver is significant

Hypo: professor writes articles favorable to oil industry

Oil gives him gold watch

This is GI, not a gift, because oil encouraging him to continue writing

Not out of goodness of their hearts

Section 132 – Fringe Benefits

Excludes certain fringe benefits from GI

(1) no-additional-cost service,

Like open room in hotel, open seat on airplane

(2) qualified employee discount,

Property/services to the extent… (maximum discount)

For goods, the gross profit percentage of the price at which the property is being offered by the employer to customers

(Aggregate sales price – cost)/aggregate sales price

For services, 20%

(3) working condition fringe,

(4) de minimis fringe,

(5) qualified transportation fringe,

(6) qualified moving expense reimbursement,

(7) qualified retirement planning services, or

(8) qualified military base realignment and closure

fringe.

Section 1001 – Determining Gain/Loss

(a) defines G and L

(b) AR = $ received + FMV ppt (fair market value profit percentage)

(c) G/L recognized except -> 61(a)(3)

If T buys an option to buy land, then sells the option, he has G/L based on basis and sale of the option

Any recourse loan taken to buy something counts in the AB

Section 1016(a) – adjustment to basis for capital accounts

Proper adjustment must be made for all…

(1) capital accounts

(e) O buys land at 10k, spends 2k to improve land, sells for 18k

2k is added to AB, so total AB is 12k

G = 6k

If owner improves land himself, it is chargeable to a capital account under 1016(a)(1)

If a tenant made the improvements, would not be added to O’s AB, under sec 109

If O got the land for free from employer, his AB is FMV when he got it

Any additional income tax due to the gift has no further tax consequence

Philadelphia – If two people trade property, the value of each property is presumed to be equal

Section 1015 – basis in gifts

(a)(1) – AB = donor’s AB

(a)(2) – if AB > FMV, then AB = FMV (to prevent getting a loss)

If Donor’s AB = 30k, FMV = 20k, and recipient tries to sell for 25k

Sale price – AB = 25k – 30k = -5k

This is a loss, so this doesn’t work under 1015(a)

Applying (a)(2) we substitute FMV for AB

20k – 25k = 5k

In this situation there is no gain or loss, very unusual

Section 1014 – basis in property from decedent

AB = FMV at death

Hypo: D buys stock at $100, it appreciates to $10M by D’s death. Inheritor’s AB is $10M

(b) – defines property acquired from decedent

If a spouse dies, the surviving spouse gets a step-up in basis

(e) – if donor gives decedent prop w/in 1 yr of decedent’s death, and donor gets prop back, donor gets decedent’s AB, not the FMV at death

To prevent ppl from giving prop to elderly to get step up in basis

Note: recipient gets FMV at decedent’s death, even if it is lower than AB

So if you are giving a gift while alive it is better to give something w/higher basis, to reduce recipient’s G

But if you will something, give them the thing w/higher value, because the basis will step up to FMV at your death

Basis in payments of stock

International Freighting

T is planning on giving bonuses to its employees in the form of stock

T’s AB is 16k

When employees received the stock, FMV = 24k

T deducts 24k from its income taxes

Held: T should have counted the 8k G (from 16k to 24k) as GI

Because T got 24k of value from giving them as bonuses, T’s AR in the transfer to employees was 24k

24k – 16k (AB) = 8k G

Crane

AR on sale of a property subject to a mortgage includes value of the mortgage

If T sells prop worth $0 with 100k loan on it, sells it for $100k, AR = 200k

Footnote 37 – Mortgagor who transfers property that is worth less than the outstanding debt on the property cannot realize a benefit equal to that mortgage

Example: suppose Professor sells me a marker for $100M of nonrecourse debt

I would be a fool not to buy it, because if I default on the loan, Professor’s onl

llowed an income tax deduction? How much?

Annuitant gets a deduction according to unrecovered I

T received 27k in payments, so the unrecovered investment of 21k is a tax deduction

Section 61(a)(12) – Income from Discharge of Indebtedness

US v. Kirby Lumber (163)

Kirby Lumber issues bonds worth $12 million

They are entering into a K where the buyers of bonds will be paid interest by Kirby

When the bonds lose 137k of value, Kirby buys them back

SC held the 137k counts as GI

Zarin (pg 164)

T tires to pay $3.4M in debt with checks that bounce

They settle for $500,000

Ct decides the debt is not within either §61(a)(12) or §108

Since the debt is not enforceable under NJ law…

Chips are not property, they are evidence of debt

Because they are not property, there is no property to be the subject of indebtedness (which is required by §108)

Problem – this case predates Tufts

Before Tufts, if you give something up and its worth less than the debt, you aren’t really giving anything up

Section 108 – excludes discharge of debt from GI for following circumstances

(a)(1)(A) – title 11

(B) – insolvency

(C) – farm debt

(D) – other than C – qualified real property

(E) – qualified residence – Jan 1, 2013

(b) – tax attributes that are effected by this

a-c above

(1)(3) basis reduction

(f) – student loans

Problem 1 (pg 180)

P borrows 10k from R a few yrs ago. What tax consequence if poor pays off the so far undiminished debt wih…

(a) – settlement of 7k cash

3k income, debt discharged in that amount

(c) – same as (b) but FMV of 8k and basis of 5k

AB = 5k

FMV = 8k

Gain = 2k

Always use FMV (exchanging value for value), not AB

(d) – P performs services worth 10k

It is treated as if R paid for the services up front

(e) – what if services worth only 8k

8k is payment

2k is income – 61(a)(12)

Problem 2

M buys land for investment from S for 100k, with 20k cash and 80k from recourse mortgage from bank. M is personally liable for the loan and the land is security for the loan. When land value increases to 300k M borrows another 100k from bank incurring personal liability, with land as security. Several yrs later when the principal is still 180k the land declines in value to 170k, M transfers land to the bank and bank discharges all of M’s debt