Bryan – UNC Law – Income Tax Fall 2013
– 62 – Above the line deductions
o 62(a)(1) – Business expenses above the line
o 62(a)(2)(A) – If you are employee can only deduct business expenses that are reimbursed (otherwise itemize)
§ 62(c) – says they must substantiate expenses
– List of common above the line deductions: Moving expenses, retirement savings, capital losses, and alimony
– List of common below the line deductions: personal exemption, standard deduction, charitable contributions, medical expenses, and net personal casualty losses
v Introduction (Chapter 1) (3 classes)
§ Income as Tax Base, Tax Terms and Computation
· Code sections 61, 262(a)
§ Tax Rates
§ Present Value and the Benefit of Deferral
· Code : 61; 1001(a) and (b) (1st sentence); 1012
· Regulation : 1.61-1(a).
v Some Characteristics of Gross Income (Chapter 2) (4-5 weeks)
§ Noncash Benefits
¨ Meals and Lodging Provided to Employees
Ø Code section 119(a), (b)(4)
Ø Regs. 1.119-1(a)(1) and (2); (b); (c); (f), ex. 1, 2, 3, 5, 6, 9
¨ Other Fringe Benefits and Section 132
Ø Code: 106(a); 162(a); 132(a)-(d), (e)(1), (f), (h)(1)-(3), j(1), (j)(4)
¨ Economic Effects
§ Windfalls, Prizes and Awards
· Code section 74(a) and (b); Reg. 1.61-14
§ Imputed Income
§ Gifts
¨ Basic Concepts
Ø Code: 102(a)
Ø Reg: 1.102-1(f) (proposed)
¨ Basis of Gift Property and Transfer of Unrealized Gains and Losses
Ø Code: 165(a) and (c); 1001(a), (b) (1st sentence), and (c)
Ø Code: 1011, 1012, 1015(a)
Ø Reg. 1.1015-1(a)(1) and (2)
¨ Transfers at Death
Ø Code: 1014(a)(1) and (2); 1014(e)
§ Recovery of Capital
¨ Partial Sales
Ø Code : 1001(a), 1001(b), 1011, 1012
Ø Reg. 1.61-6(a) (including examples 1 and 2)
¨ Annuities
Ø Code sections 72(a)(1), (b), (c)(1) and (c)(3)(A)
¨ Tangent on Depreciation
Ø Code: 167(a); 1016(a)(2)
§ Annual Accounting and its Consequences; Net Operating Losses
· Code: 172(a), 172(b)(1)(A), (b)(2) (first two sentences) and (b)(3)
· Code: 111(a) and (c)
§ Recoveries for Personal and Business Injuries
· Code: 104(a) and 104(c)
§ Loans and Discharge of Indebtedness
¨ General Principles of Loans and Section 108
Ø Code: 108(a)(1)-(3); (b)(1)-(3); (d)(1)-(3); e(5); skim 108(f)
¨ Transactions that Don’t Result in COD
¨ Transfer of Property Subject to Nonrecourse Debt
Ø Review Code section 167(a).
¨ Transfer of Property Subject to Recourse Debt
§ Illegal Income
· Text: 181-86; Reg. 1.61-14
§ Interest on State and Municipal Bonds
· Code : 103(a)
§ Gain on the Sale of a Home and Section 121
· Code: 121(a), (b), (f); 165(c)
· Regulations under section 121, focusing on section 1.121-1(a); (b)(1), (b)(2), (b)(4) Examples 1 and 2; 1.121(c)(1) and (2); (c)(4); (e)(1)-(3); 121-3.
v Problems of Timing (Chapter 3) (2 weeks)
§ Gains and Losses from Investment in Property
¨ Realization of Gains and Losses
Ø Code sections 165(a)-(c), 1211, 1212(b); Reg. 1.165-1(b), (d)(1); 1.1001-1(a)
¨ Recognition of Gains and Losses and Like-Kind Exchanges
Ø Code sections 1031(a), (b), (c), (d), (e); 1223(1)
Ø Regulations 1.1031(a)-1; (a)-2(a), (a)-2(b)(l) and (b)(2); (a)-2(c);
Ø 1.1031(b)-1(a) and (b)-1(b)
§ Installment Sales
· Code: 453(a)-(d), (f)(2)-(5), (j)(2); 453B(a), (b), (g); Reg. 1.1001-1(a)
§ Deferred Compensation
§ Transfers Incident to Marriage and Divorce
¨ Property Settlements
Ø Code sections 1041(a), (b) and (c); 1223(2) and Reg 1.1041-1T
¨ Alimony and Child Support
Ø Code sections 71 and 215; 62(a)(10)
Ø Reg. 1.71-1 T (#1, 2, 5, 6, 7, 8, 9, 13, 15, 16, and 17)
v Deductions for the Costs of Earning Income (Chapter 6) (5-6 classes)
§ Current Expenses versus Capital Expenditures
· Code: 62(a)(1), 162(a); 212; 263; 263A(a), (b), (c)(1)-(3), (h)(1), (h)(2), (h)(3)(A)-(C)
¨ Regulations: 1.162-20(a)(2); 1.167(a)-3 ; 1.263(a)-1T; 1.263(a)-2T(d)(1) and (e)(1); (h), (i) and (j) (although I don’t expect you to understand all of the examples); 1.263(a)-4(a) and -4(d)(3).
§ Repair and Maintenance Expenses
· Code section 165(a) and (c)
· Reg. 1.162-4; 1.165-7(a)(2); 1.162-20(a)(2)
§ “Ordinary and Necessary”
· Reg. 1.162-5 (skip the examples under 5(b)(2)); 1.212-1(f)
¨ Costs of Illegal or Unethical Activities
Ø Code sections 162(c), (f), (g); 280E
¨ Reasonable Compensation
Ø Code section 162(m)(1)
Ø Reg. 1.162-7(a); 1.162-8; 1.162-9
§ More on Depreciation
· Code sections 167(a); 168(a)-(c), (e); 168(i)(1); 197(a), (b), (c)(1), (d)(1)
· Code sections 179(a), (b)(1)-(2), (d)(1)
· Reg. 1.167(a)-3
v Allowances for Mixed Business and Personal Outlays (Chapter 5) (6-7 classes)
§ Controlling the Abuse of Business Deductions
· Code sections 162(a), 62(a), 62(c), 63(d), 67(a) and (b)(1)-(5); 262
· Reg. 1.67-1T(a); 1.162-6; 1.162-17(b); 1.274-5T(f)(2); 132-5(a)(1)
¨ Hobby losses
Ø Hobby losses to the extent deductible under section 183
§ Code sections 162(a); 212; 165(c)(1) and (2); 167; 183(a)-(d), 263(a)(1)
§ Reg. 1.183-2(a) and (b)
· Unreimbursed employee business expenses
¨ Treated as “miscellaneous itemized deductions” (MID’s) under section 67
· Home Offices and Vacation Homes
¨ Code sections 280A(a); (b); (c)(1); (c)(3); (c)(5); (d)(1)-(3)(A); (f)(1); (g)
· Income Unconnected to a Trade or Business
¨ Code sections 212; 62(a)(4); 67(a); 280A
§ Travel and Entertainment Deductions
· Code sections 274(a), (c) and (d)
· Code sections 274(e)(1), (e)(2)(A), (e)(3), (e)(4), (e)(5)
· Code sections 274(g), (h), (i), (k), (l), (m)
· Code sections 274(n)(1) and (2)(A)-(B)
· Reg. 1.162-2; 1.162-17; 1.274-2(b)(1)(i)-(ii); 1.274-5T
§ Child-Care Expenses
· Skim Code section 21
§ Commuting and More Travel Expenses
· Reg. 1.162-2(a) and (b)
§ Clothing Expenses
§ Legal and Education Expenses
· Code sections 62(a)(20); 212
· Reg. sections 1.212-1(a), (d), (k), (l), (m)
v Personal Deductions, Exemptions, and Credits (Chapter 4) (4-5 classes)
§ Overview
· Code sections 62(a)(1)-(7), (10), (15), (17)-(20) ; 63(a), (b), (c)(1)-(4), (d), (e), (f)
§ Casualty Losses
· Code sections 165(a); (b); (c); (h)(1); (i); 1.165-7(a)(3), -8(a)-(b)
§ Extraordinary Medical Expenses
· Code sections 104(a)(3), 105(a)-(c), 106(a), 213(a), (b), (d)(1)-(3), (d)(9); 162(l)(1)
· Regulations 1.105-2; 1.213-1(a), (e)(1)-(3), (g)(1)-(2)
§ Interest
· Code sections 62(a)(17); 163(a), (d)(1)-(3); skim 221
· Code sections 163
§ Charitable Contributions
· Code sections 170(a)(1), (c), (e)(1), and (l), 1221(a)(1)
· Skim Code sections 170(f)(8), (f)(11), (f)(12), (f)(16), (f)(17)
· Regulations 1.170A-1(g)
§ Taxes
· Code section 164(a); 275(a); skim 164(b)(5)
§ Personal and Dependency Exemptions; Credits
· Skim Code sections 151 and 152
v Capital Gains and Losses (Chapter 8) (2 classes)
Ø Code sections 1221(a); 1211(b); 1212(b) 1222(1)-(8); 1223(1), (2) and (10); 1231(a)(1)-(3), and 1231(b)
TAX OUTLINE
· 274b never applies to an employer—may not have a gift to an employee
· Scholarships are excluded from income but only if it is used for tuition purposes (not for room and board)
· Remember to bifuricate: You have to include the cancellation of debt as an income gain; also, you would still have to acknowledge the loss in value of the home even if it was nondeductible (this would be your basis subtracted from the FMV)
· Personal use assets do not get loss deductions—see §165
· Cash cannot be a de minimis fringe (§132)
· Know to think about §121 any time there is a sale of a residence
· For losses, four questions you have to ask in order
o 1) Is the loss realized?; 2) Is the loss recognized?; 3) Is the loss allowed? (This is where you look to 165(c); 4) If and only if you can deduct the loss, what is the character of the loss? (Is it is a capital loss or a regular loss?)
· If there is a nonrecourse loan, if property is purchased with a FMV less than the basis, then the owner will be encouraged not to repay the debt unless the value of the property exceeds the basis—give owner FMV in a case like this
o For nonrecourse loan, the debtor is not personally liable (whereas in a recourse loan, he is)
· Don’t forget amount of other basis—in examples, look out for the tractor (boot) so it can be included for depreciation deductions
o Also, never forget about capital asset distinctions—long-term means it is longer than one year
· We do not tax unrealized appreciations—wait to tax gain until it is realized
· Prizes are included in gross income but gifts are not (until realized)
· Capital losses only deductible when considerin
AGI is the floor from which we calculate certain itemized deductions (i.e. medical expenses, unreimbursed business expenses, and casualty losses)—AGI = GI – business expenses
Tax Rates
1) Proportional: Everyone pays the same percentage no matter how much they make
2) Regressive: The more you make, the lower percentage you are taxed
3) Progressive: The more you make, the higher percentage you are taxed
Pain theory: Giving up that last dollar for a rich person hurts less than it would hurt a poor person
How does the progressive rate structure work?
Effective rate is an average of what you have been taxed under the system
The richer you are, the closer your effective rate will be to your marginal rate
Marginal tax rates: The tax rate applied to a taxpayer’s last dollar of income
The marginal rate is the rate applicable to the last, and the next, increment of income
Ex: 31K—only worry about the tax rate that would be applied to the extra 1K in the next bracket not the entire 31K would be taxed at the new rate (but marginal rate refers to that last 1K percentage)
Present Value and Deferral
Twist on basis: §1.61-2(d)(1)—have to include the property as income if services are paid for in property
Amount Realized – Basis = Gain or (Loss) (1001(a))
Generally, compensation must be included in Gross Income, whether paid in cash or property
When property included in Gross Income on receipt, then
Basis = Amount Included in GI—just as if employer paid compensation in cash & employee used cash to purchase the property
Deferrals: Taxpayers generally find it advantageous to find ways to defer their tax liability to future years
· The advantage of deferral is simple: A tax liability deferred from the present to the future gives the taxpayer the use in the interim of the amount that would otherwise have been paid presently in taxes
o The reverse when paying an obligation—Want to pay a tax later because the value will be lower
· Another way to look at deferral is to calculate the present value of a future payment
o The process of calculating the present value of a future amount is called discounting to present value and the present value is sometimes called the discounted present value
§ FV = PV (1 + r)n
· As interest rates go up, the present value needed to reach the future value goes down
· The PV goes down as the term of the deferral is lengthened—the longer the better
o You’ll earn more in a longer period, so you can invest less to have the same amount at the end
o The PV goes down if the discount rate is assumed to be higher
· So basically, the more money you can defer, the more time it will have to draw interest and the more interest it creates, the more money you make in the long run even if that money is taxed at a high tax rate later
· Advantages of a deferral:
o Hypothetically, the tax rate could decrease in the future (although, it could increase)
o You are able to earn interest off the money you are able to defer tax liability on
§ Ex. $1,000 of tax liability deferred for 10yrs at 6% after tax interest rate
§ At the end of 10yrs, you will have $1,792
§ If you pay now, you will not have that money gaining interest
§ Therefore, the future value of the tax deferral is $792
o Another potential way to calculate the value is through a discount rate
§ In our hypothetical, the discount rate is .558
§ Therefore, you could fund your $1,000 tax liability in 10yrs by setting aside $558 today
§ Then, you could spend $442 today
o $442 is how much you will be better off today, whereas $792 is how much you will be better off in 10yrs
