Federal Taxation Outline
Maine, Fall 2014
Structure of Federal Income Tax
[[Gross Income – Deductions = Taxable Income ] x Tax Rates = Pre-Credits Tax Liability] – Tax Credits = Final Tax Liability or Return
Basic Structure of the Income Tax
§ Federal government imposes a tax on income.
§ Internal Revenue Code – The Code is the primary source of federal tax law
o Note: Always go to the Internal Revenue Code first. If there is a Code provision on point, then cite it.
§ Treasury Regulations
o The REGS are the most important administrative interpretation of the Code. Congress granted general authority to the Treasury Department to promulgate regulations to interpret and give meaning to the Code. As a result of congressional grant of power, treasury regulations generally have the force and effect of law.
§ Three trial courts have original jurisdiction over tax cases: (1) the U.S. District Court; (2) the U.S. Claims Court; and (3) the U.S. Tax Court.
§ Tax Rates are NOT applied to gross income. They are applied to TAXABLE INCOME.
§
Chapter 2: Gross Income: Section 61 – MAP 2.0
1. THE REALIZATION EVENT
o The realization requirement determines the proper TIMING of taxation by telling us when income or gain should be recorded
o Income is “undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion.” Glenshaw Glass Co.
o Ex: If you won a car, you need to include it in gross income
o GI Considerations
§ TIMING: when GI should be recorded
o An item of income must be allocated to the proper taxable year (PTY).
o PTY which is generally governed by the TP method of accounting (cash v accrual) MAP 11.0 & 11.2
o Increases in the value of property are not taken into account for tax purposes when they accrue each year, but only when they are realized by a potentially taxable event (when the taxpayer actually sells the property). 2
§ PROPER TP: who must report the GI
§ PROPER CHARACTER:
o An item of income may be characterized as either ordinary income or capital gain
o Ordinary income is taxed at progressive rates
o Capital gains are taxed at lower rates MAP 14
§ PROPER AMOUNT TO REGARD – REG 1.61-2d
o If property is included in gross income (treasure trove or bartered) the FMV of property recvd is amt of income reported.
o If services are included in gross income (barter) the FMV of services received is amt to be include
2. FORM & RECIEPT OF ANY GROSS INCOME: any form and from anyone
o Gross income may be realized in any form (whether in money, property, or services), and does not have to be received directly by the taxpayer
§ (e.g., payment of an employee’s taxes by his employer). Old Colony Trust Co v. Commissioner.
3.THE IRS CODE, REGS & GROSS INCOME
o § 61 defines what GI includes BUT IS NOT LIMITED TO
§ Includes: compensation for services, fees, commissions, fringe benefits, Business GI, Gains from Property dealings, interest, rents, royalties, dividends, alimony, annuities, life insurance income, pensions, income discharge of indebtedness, distributive partnership GI, income from interest in estate or trust
o Compensation for Services Defined – REG 1.61-2
§ Wages, salaries, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, marriage fees & other contributions received by a clergyman svcs
3. SPECIFIC EXAMPLES:
o Generally INCLUDED IN GI Under §71
§ Alimony MAP 3.1
§ Annuity Payments MAP 3.2
§ Prizes and Awards MAP 3.3
§ Gaining $ or property Illegally – INCLUDED IN GI
o If TP obtains money or property illegally (such as embezzled funds or insurance proceeds from arson),
o TP must include the unlawful receipts in GI despite the taxpayer’s legal obligation to restore the funds.
o Since repayment is unlikely, the receipts must be included in gross income.
o When a person steals money, he/she does not intend to pay the money back.
§ TREASURE TROVE – INCLUDED IN GI THE 1st YEAR POSSESION IS UNDISPUTED
o constitutes GI for the taxable year in which it is reduced to undisputed possession REG 1.61-14
o Old currency FOUND was not “reduced to undisputed possession” until its ACTUAL discovery. Thus, the US was NOT barred by the SOL from collecting the taxes during the year it was found. Cesarini.
§ BARTERED TRANSACTIONS – INCLUDED IN GI
o Either for property, services or other
o Example: A lawyer and painter were members of a barter club. The lawyer provided legal services to the painter and, in return, the housepainter painted the lawyer’s house. The Service held that the fair market value of the services recvd by the lawyer and the housepainter were to be included in their gross incomes under § 61. Both have incomes. It is the value of what you are receiving
o Generally EXCLUDED FROM GI under §101 etc
§ Life Insurance, Gift and Inheritances, amounts under accident/health plans,
§ income from discharge of indebtedness 108 and educational benefits,
§ meals/lodging for convenience of ee and certain fringe benefits,
§ gain from sale of principal residence, Compensation for injuries/sickness 104,
§ Borrowing Money – EXCLUDED FROM GI
o An offsetting obligation to return or repay the funds negates any accessions to wealth.
o There has been no change in the taxpayer’s net worth.
§ Imputed Income – See Below
§ Frequent Flyer Miles – GENERALLY EXCLUDED – see below
§ Bargain Purchases – See below
§ Bankruptcy or insolvency -§108 excludes discharge-of-indebtedness income from gross income if the discharge occurs in certain circumstances, such as bankruptcy or insolvency.
§ Damages received from TORT actions – 104
4. ADMINISTRATIVE EXCEPTIONS even though there is a wealth accession, IRS wont tax you on it if:
o Imputed income
§ When TP performs services for his own benefit or produces goods for his own consumption, the TP has economic gain EQUAL to the amount he saves by not having to pay someone else to provide the services or goods.
o This type of economic gain is called imputed income since the income is attributed to the value of labor or property the taxpayer performs or produces for himself
§ The government does not tax imputed income
§ Exception: BARTERED transactions
o Bargain purchases
§ The government does not require a buyer to report the benefit of a bargain at the time of purchase, regardless of whether the buyer knew the purchased item was more valuable than the seller knew.
§ Exception: If property is transferred to an employee, as compensation for services, for an amount less than its fair market value, then regardless of whether the transfer is in the form of a sale or exchange, the difference between the amount paid for the property and the amount of its fair market value at the time of the transfer is compensation and shall be included in gross income of the employee. Sec. 1.61-2(d)(2)(i)
o Frequent Flyer Trips – generally EXCLUDED from GI
§ If the free trip was recvd as a result of frequent personal travel paid for by you, there arguably is no income. You are just getting the money back
§ Shankar Case: Tax Court said it WAS taxable because he got the m
n he found it. If he sells it for the fair market value then nothing will be gained. So he should not be hit again with the tax).
n Illegal gains (steal a car need to report it in gross income)
n Adverse possession
o What is basis
§ Amount you have invested in the property
§ Good thing – reduces gain and thus taxable gain
§ Why is it important
o Keeps track of what you have already been taxed
o $ already been taxed; thus makes sure you are not double taxed
o Keep your receipts – for improvements – less amount realized later!!
CALCULATING BASIS
o Gain = Amt Realized – Adj Basis (1011)
o Loss = Adj Basis – Amt Realized (1001a)
o Amt Realized = any money received + FMV of the property (other than money) received. (1001b) + recourse debt discharged (1.1001-2) + nonrecourse debt to which property subject (Crane).
o Adj Basis = TP’s original basis (1012) adjusted due to other events (1016). Generally determined by reference to cost + improvements (1012)
§ Step 1 = determine original basis
o what you paid for and other costs that went into acquisition (inspection, etc) 1012
o If property recvd is Gift : basis the same as the donor’s AB at time of gift (1015)
§ Exception: if value of property at time of gift was LESS than donor’s AB, then basis is lower FMV of property 1015
o If property recvd from Devise: basis is the FMV of property at time of death (1014)
o If property was acquired other than by purchase and included in GI when received (Treasure Trove, Prizes and Awards, Illegal Gains, Compensation for Services): Basis is FMV at time of reporting 1.61
o If property was purchased: Basis is cost, including cash paid plus debt incurred 1012
o If property was acquired in a taxable exchange: Basis is FMV of the property received at the time of exchange Philadephia Park Amusement
§ Step 2 = Adjustments to Basis
o Improvements add to basis. 1016
o Tax Depreciations reduce basis 1016
3. RECOGNITION of realized gains and losses
o Once Gain or Loss is Calculated, must determine if recongized
o Recognized = reportable on the tax return for the year of disposition
§ General rule: the entire gain or loss realized on a sale or other disposition of property is recognized for tax purposes, unless an exception is provided in the Code. 1001c
o NonRecogniction Treatment
§ If gain is subject to a nonrecognition treatment, it is not included in gross income
o Gain on like kind exchange of property
o Gain on involuntary conversion of property
o Gain on disposition of property to spouse or former spouse
o Gain on corporate formation
o Gain on partnership formation
§ If the gain is entitled to a nonrecognition treatment, the gain is merely postponed until a later year
o Like when the property received in this year’s transaction is subsequently disposed of in a transaction in which no non-recognition provision applies
