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Federal Income Tax
University of Connecticut School of Law
Pomp, Richard D.

POMP, Federal Income Tax,Spring 2015

Introduction

Computation of Gains and Losses from Sales of Property

Gain/Loss = Amount realized – adjusted basis

§1001(a)

Amount Realized = the sum of any money received + the FMV of other property received

§1001(b)

Adjusted Basis=(+ first mortgage, any capital expenditures) – depreciation costs

§1011

Basis = Cost of property + 1st mortgage + any capital expenditures

§1012

Basic Principles

A TP wants to postpone the payment of taxes
The Treasury wants present payment of taxes

Marginal Tax Rate v. Effective Tax Rate

Effective Rate = average tax rate and is lower than marginal tax rate ( because marginal is applied to last dollar earned)
Marginal Tax Rate= the % of tax applied to your income for each tax bracket in which you qualify (progressive system)

This is what we use

Definitions

Gross Income (§61)- “All income from whatever source derived”

Exclusions—An item of income that does not have to be included in GI.

Basically has the effect of taxing excluded item at 0%.

Adjusted Gross Income (AGI) = Gross Income – Certain Deductions listed in § 62(a)

Deductions could include certain expenses .

Taxable Income (§ 63) =Adjusted GI – [Personal Exemptions + greater of a) TP’s Standard Deduction or b) Itemized deductions]

Applied to the applicable marginal tax rate to determine his tax liability.

Net Worth—Excess of a TP’s Assets over her Liabilities.

If have a negative net worth = Insolvent

Credits v. Deductions

Would always prefer CREDIT over DEDUCTION regardless of marginal tax rate

Credit:

A $ for $ decrease in taxable income.
2 Classes:

Non-refundable Credits—best a TP can achieve is to reduce her tax liability to zero.

Examples—child tax credit; education credits

Refundable Credits—If the credits exceeds tax due, TP is entitled to an immediate tax refund or to credit against future taxes, to the full extent of the credit.

Examples—taxes withheld on wages; earned income credit

Deduction

shaves money off your taxable income, so the value depends on your tax bracket

TO Calculate After Tax $ Benefit Of A Deduction

=Marginal tax rate X amount deducted

Gross Income

Gross Income=Compensation for Services (Cash + Income In-Kind)

§61: Gross income: “all income from whatever source derived”…including but not limited to:

Compensation for services
Gross income derived from business
Gains derived from dealings in property
Interest
Rents
Royalties
Dividends
Alimony & separate maintenance payments
Annuities
Income from life insurance & endowment contracts
Pensions
Income from discharge of indebtedness
Distributive share of partnership GI
Income in respect of decedent
Income from an interest in estate or trust

Items Which Are Not Income

Compensatory Damages (they make you whole for something lost)
Imputed Income (value of services one performs for oneself)
Capital Recovery

Entitled to receive his or her capital investment tax-free

Loans/Borrowed Money

Creation/repayment of loan is not taxable

Forgiveness/discharge of loan can generate income

Gifts

Definition of Income:

Eisner v Macomber (1920).

Income defined as gain derived from “labor, capital or both”
Proved difficult to apply.

If no labor/capital then no income? (What happens if win lottery?)

Commissioner v. Glenshaw Glass Co. (1955)—Modern Approach

Definition: Income is the “accession to wealth, clearly realized, over which the TP has complete dominion.”

Recognizes Congress’ intent to tax gains.

Makes Punitive Damages Taxable (because getting something additional)
Compensatory Damages NOT Taxable (they make you whole for something lost)

Don’t Care About the Source:

If you find something:

If you something of value basis = FMV and include in income

Regardless of whether it’s cash or painting or something else

If purchase something and ends up having a higher appraised value:

Appraised value not included in income and the basis remains what you paid for it

Appraised value is not a factor because you have realized any gain thus only a factor when u sell at higher price.

Cesarini v. U.S

Facts: Husband and wife purchased a piano cheap find old currency in the piano

Initially reported the found money on their return but then eliminated later and requested a refund

Holding: Taxable

When he found the income taxable because it’s not as if the piano was more valuable than previously thought he just got an added bonus

Income In Kind

Income received “in kind” are things not in the form of cash
Creates problem of valuation and realization

Repayment of Obligations

IF someone pay’s TP’s debt its taxable because received a benefit

Ex. If my employer pays my credit card bills or car loan, or VISA bill all taxable income.

Old Colony v. Comm. (Willy Wood got taxes paid for him by his employer)

Court: payment of tax grew out of employment context/ is compensation for services. Was a benefit/gain and is taxable.

§119(a) Repayment of Personal Expenses (Providing Meals and Lodging)

Meals and lodging furnished to employee, spouse, dependents are excluded from GI, IF:

It is for the convenience of the employer and
It is on business premises, and

If not on business premise but required SOL

For lodging that is a condition of the employment.

Applies to employee’s spouse and dependents

Being owner and employee doesn’t prevent exclusion

Ex. Coors built a house on business premises. Coors owns the company, signed a K that he must live on premises.

Still not income although he’s the owner
Note: company writes off the house as a business expense or can pays tax at a different rate saving the owner money

No exclusion if:

If Optional: 119(a)(2)

Not a problem if have option of brining own meal.. still considered mandatory

Meals

free)

Any service provided by employer to an employee of another employer shall be treated as provided their boss if:

(1) Such service is provided pursuant to a written agreement between such employers and

(2) Neither employer incurs any substantial additional costs (including foregone revenue)

Has to be in the same line of business so fulfills the “primary line of business”

Qualified Employee Discount (c)

Limited to goods in the line of business

Can exclude:

For Property – can exclude up to employer’s gross proft % of sale price to customers (not for real or investment property)

% of sales price excluded from income= Gross Profit % =(Aggregate Sales – Cost of Goods Sold)/Aggregate Sales)

You report the remaining amount of what you paid as income

For Services – Can exclude a discount up to 20% of the sales price

Note:

Non-discrimination applies § 132(j)
Spouses and dependents treated as employee §132(h)

Working Condition Fringe (d)

Any property/services provided to employee that would be treated as a trade/business expense deduction under §162 , or 167 if employee had for paid for it ,
Examples: employer office furniture/equipment, transportation while on business trips, journal subscription for work

De Minimis Fringe (e)

FMV is too small to be included (keep in mind the frequency of such)

Infrequent Takeout food is considered deminimus

Also: occasional parties, coffee, occasional sports/theater tix. Etc.

If getting something that would create an administrative burden like free thanksgiving turkey probably –deminimus

Eating Facilities Are Included If:

Located on or near business premises and
The facility at least breaks even with direct operating costs or exceeds those costs

Direct operating costs= salary of the cook, supplies, but not necessarily utilities those are indirect costs

Qualified Transportation Fringe (f)

Benefits like transit pass, qualified parking, transportation in a commuter highway vehicle are excluded from income

Qualified parking= parking provided to employee on or near business premise of employer
Commuter vehicle= seats at least 6 ppl and 80% of milage is used transporting employees

So long as it is in connection with travel between employee’s residence and place of work

132(f)(2) – caps the exclusion for qualified transportation

$100/mo for commuter/transit
$175/mo qualified parking
Bike reimbursement