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Federal Income Tax
University of California, Hastings School of Law
Miller, John A.

Miller_Federal Income Tax_Spring_2015

Introduction

· Every tax involves the application of a rate to a base

o Tax base x rate = tax

· Tax Policy

o Ability to pay

o Fairness

§ Horizontal equity – treat likes alike

§ Vertical equity – treat those who are different, different

o Efficiency

§ Cost of collection and compliance

§ Minimize drag on the economy

o Neutrality

§ You’re going to tax in a way no matter how the taxpayer structures the transaction; they will pay the same tax. Treat events the same way.

· Structure of the income tax

o Pre-exclusion gross income – accession to wealth realized

· Marginal and effective rates

o Marginal rate – highest rate at different dollar amounts, the top bracket in which you are taxed

o Effective rate – average rate

· Base matters as much or more than the rate

· Individuals pay income and payroll (social security and Medicare)

· Corporations pay income and payroll

· Tax expenditures

o The income tax system is often used to subsidize something with deduction or a credit

o These tax expenditures have a policy basis outside of accurate measurement of income

o These things shrink revenues and thus may force rate increases

o In short, they cost money

o Bird example – the biggest benefiter is people who already buy birdseed.

o Health insurance example – congress decides to create a tax exclusion for employer paid health insurance

· Two key points

o The tax systems is a mechanism for spending money as well as collecting it

o Facially neutral rules often favor one group over another

· Case law

o Tax court

o Claims court

o District court – chances of winning are better in this court

o Only have to pay first in claims and district court then you get a refund if you win

· Assets = liabilities + equity

· Equity = assets – liabilities

Gross Income

· The definition

o Economic – net increase in wealth plus personal consumption

o Tax – accessions to wealth clearly realized. Glenshaw glass.

o Realization – An objective event fixing price and right to receive money or money’s worth (e.g., a sale or exchange or receipt of a paycheck)

· IRC 61 – income from whatever source derived

· Case authority (e.g. Glenshaw glass, cesarini)

· IRC 71 et seq. and regs.

· Cesarini/treasure trove case – treasure trove is gross income and it is taxable income.

· State law establishes taxpayer’s rights. Federal law tells you what those rights mean for tax purposes.

· Exclusions IRC 101 et seq.

o Gifts and inheritances IRC 102

o Gins from home sales IRC 121

o Government transfers Rev. Rul. 75-271

· Form of payment is irrelevant

· Reporting income on payment with property creates a cost basis in what is received

o Basis – is your way of measuring post tax dollars invested in property. It matters so much because income tax only tries to tax each dollar of income once. Basis is post tax investment and is protected from paying tax again.

§ i.e. get $10,000 worth of property as payment. Taxed on this. When you sell it for $25,000, only have to pay tax on the additional $15,000.

· Borrowing does not create income because even though you have accession of wealth you have debt. Liability offsets the increase in assets.

o Net worth = assets-liabilities

· Indirect payments are still income (old colony)

· Presumption is that an accession to wealth clearly realized is gross income under section 61.

· In order to overcome the presumption you need to find a specific exception.

· A found object should not be income until it is reduced to cash.

· It is income once you have control and right of possession under state law for an object.

Gains from Dealings in Property

· What is gain according to 1001(a) – gain is amount realized – adjusted basis.

· Gains from property dealings are a form of gross income 61(a)(3).

· What is amount realized according to 1001(b)?

o The amount of cash and the FMV of property received 1001(b). This included debt relief received in the transaction.

· What is FMV?

o What a willing buyer pays a willing seller with knowledge and no compulsion. Reg 20.2031-1(b)

· What is adjusted basis according to 1011?

o Basis is Cost 1012 Philadelphia Amuse

§ Case that tells us what it means to have a cost basis. Basis is the FMV of the property you receive. Basis represented the post tax dollars put into the property. Won’t be taxed again if sell it later. Basis puts us at a neutral beginning point.

o 1016 tells us how to adjust cost basis. Adjust up when we add more investment. Adjust down when we take depreciation on the property. 1016(a)(1) and 1016(a)(2) memorize these

· Amount realized (1001(b)) – adjusted basis (1012) = gain realized 1001(a)

· Why isn’t the entire amount received in a sale gain?

o Because return of basis merely places you back where you began. Only should be taxed once.

· How do we calculate a loss?

o Adjusted basis minus amount realized equals loss realized 1001(a)

· What does 1001(c) tell us are the tax consequences of a realized gain or loss?

o We must recognize it unless there is a provision which requires non-recognition e.g. 121, 165

· What does it mean to recognize a gain or loss?

o We report it as income or loss on our tax return.

· 3 steps to gain or loss recognition

o Gain or loss realized

o Gain or loss recognized

o Character of recognized gains or losses

· Borrowing and basis

o What is the effect on basis of using borrowed money to acquire property?

§ Crane case = if you take borrowed money and buy the property, you get a basis just as if you used your own money.

· Amount realized and debt assumption

o What is the effect of selling property subject to a debt that the buyer assumes?

§ Crane – That relief from the debt is also apart of your amount realized. It is like the buyer gave you the amount of cash.

Crane and tufts – but what about non-recourse borrowing, should it always go into basis (along with any cash paid)?

· Non-recourse loans are secured to assets only.

o If buyer takes over the debt, that amount goes into the seller’s amount realized.

· Brad buys a patent for $1000k (900k of which was a recourse loan). His basis is 1000k.

· Brad sells the patent 2 years later for 300k plus 800k loan assumption by buyer. His gain realized is 100k.

o 1100k amount realized – 1000k adjusted basis = 100k gain realized

· Angie buys Versace dress for $4k to wear to golden globes. Later she swaps it for a dress worth 10k. Angie has 6k of income on the swap.

· Angie buys a dress for $4k and swaps it for a dress worth $10k. Her basis in the new dress is $10k.

o Spent 4k and was taxed on 6k = 10k basis

· Brad and Angie buy a 1000-acre farm. Put the farm in a LLC and own 50-50. From a tax perspective, the formation of the LLC is a sale or exchange of property.

· Brad and Angie transfer the LLC to Newman’s for an interest in Newman’s corp. From a tax perspective, the transfer of the LLC is a sale or exchange of property.

· Brad and Angie liquidate the LLC and take the fee simple title to the organic farm. From a

· Jackson has stock with an AB of 10k and a FMV of 20k. Jackson transfers the stock to Lafite as a payment for a debt of 20k. Jackson must report 10k of income. Lafite’s basis is in the stick is 20k.

· Jackson has stock with an AB of 10k and a FMV of 20k. Jackson transfers the stock to Lafite as 14k in cash and a boat worth 6k. Jackson must report 10k of income. Lafite’s basis is in the stock is 20k.

· What is bit coin?

o Bit coin is a form of virtual currency

o Bit coins are property for purposes of section 1001

Gifts and Inheritances

· Gifts and Bequests

· What is a gift for income tax purposes?

o A transfer of property out of “detached and disinterested generosity.” Duberstein.

perty? Recourse

§ Relief of recourse debt not in excess of FMV of property surrendered is Amount Realized.

§ Relief of recourse debt in excess of FMV of property surrendered is COI income 1.1001-2(a)(2) 90-16

o How is discharge by lender treated in property transaction where lender takes back the property?

§ Relief of non-recourse debt upon transfer is always amount realized (even when it exceeds FMV of property surrendered) 1.1001-2(a)(1)

o Don’t need to know 108

o What is the tax consequence to a lender who forgives a debt?

§ A bad debt deduction under 166

o Andy gives his own cash of 20k and borrows 100k non-recourse to buy 120k. Later defaults and they take it. If the mortgage balance is 100k, the tax consequence is loss of 20k.

o Andy gives his own cash of 20k and borrows 100k non-recourse to buy depreciable whiteacre for 120k. Andy takes 40k of depreciation on whiteacre and his basis falls to 80k. He later defaults and the bank takes whiteacre in full settlement of the debt. If the mortgage balance is 100k, the tax consequence of for Andy is a gain of 20k.

o Andy gives his own cash of 20k and borrows 100k recourse to buy depreciable whiteacre for 120k. Andy takes 40k of depreciation on whiteacre and his basis falls to 80k. He later defaults and the bank takes whiteacre in full settlement of the debt even though whiteacre is only worth 80k. If the mortgage balance is 100k, the tax consequence of for Andy is COI of 20k.

Fringe Benefits

· Compensation other than wages or salary.

o Health insurance, life insurance, pension plan, free coffee, free parking, free gym membership

· Are fringe benefits gross income?

o They are accessions to wealth but they are often excluded from gross income by law

· How do taxes work?

o Every tax involves the application of a rate to a base.

· What fringes does section 132 exclude?

o No additional cost services

o Qualified employee discounts

o Working condition fringes

o De minimis fringes

· For no additional cost services and qualified employee discounts, retirees and surviving spouses and family members are treated as if they were an employee 132(h).

· What is the line of business limitation in section 132?

o For no additional cost services and qualified employee discounts, the employee must work in the line of business selling that service or product 132(c)(4)

· What nondiscrimination rules apply to 132 fringes?

o No additional cost services and qualified employee discounts are only available to highly compensated employees if also available to other employees 132(j)(1)

· What does section 119 do?

o It excludes meals and lodging provided to an employee by the employee’s employer when:

§ The meals and lodging are provided for the convenience of the employer

§ The employee is required to accept the lodging

§ The meals are provided on the employer’s premises

· This form of subsidy is debatable

o Creates bias in favor of employer provided as opposed to self financed health insurance

o Creates bias in favor of compensation paid as health insurance rather than as wages

o May encourage spiraling costs

o Tends to favor the haves over the have-nots