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Income Taxation
University of South Carolina School of Law
Handel, Richard

RICK HANDEL FOR INCOME TAX FALL 2011

FORMULAS

Gross income= All income from whatever source derived

Adjusted Gross Income= Gross Income – §62 Deductions

Taxable Income=Adjusted Gross Income –Greater of Std ded. or Itemized ded. – Personal Exemptions

Transfer of Property Formulas

Gain = Amount Realized (A/R) – Adjusted Basis (A/B)

Amount Realized = Cash + Amount of Property Received

Basis for Gift = Donor basis unless FMV

When transfer buy property, A/B in property = amt of mortgages (except mortgage for car or other item) + cash paid for property, When selling A/R= Amount of mortgages + Cash received. Gain on Sale=A/R-A/B. Loans for other items are included in gain. If gift property w/ loans then amt of mortgages is treated as paid by donee.

Charity deductions limited to 150% of gross income

Annuities: Amount of annual payment excluded from income= Cost of the plan/life expectancy or

Annual Payment * [(Investment in Contract-Refund)/(Life Expectancy * Annual Payment)]

Deduction for early death = Policy Cost – (Years Paid* Amount excluded annually excluded from income)

Medical Expenses from Employer & Personal Policy. Personal policy all excluded but employer only excluded for amount paid for expenses to calculate = [(Employer payout/Total payouts received from all policies) * Actual Med Expenses]. Then subtract from total employer payout to get amt included in income.

Alimony Recapture which is income for payor in yr 3 & deducted by payee =YR2Recap + Yr 1 Recap

YR2RECAP=YR2-(YR3+15000). YR1RECAP=YR1 -{[(YR2-YR2RECAP)+YR3]/2 +15000}

Loss of totally destroyed= A/B. Deductible Loss = A/B – Insurance Proceeds. If Insurance > A/B excess is gain.

1.165-7(b)(1)- Amount of casualty loss is the property is the lessor of the A/B before OR FMVBEFORE – FMVAFTER

Difference in amount of loss and insurance proceeds= deductible casualty loss or casualty gain

To compute adjusted basis of damaged property = (Original A/B- Insurance proceed)- (Loss= Lesser of A/B before OR FMVBEFORE – FMVAFTER. – insurance proceeds) + Amount Spent on Repairs.

Installment Payment Income= Amt received * (gross profit/total K price).

When using appreciated assets to satisfy an obligation you have gain or loss.

I. IDENTIFICATION of INCOME SUBJECT TO TAXATION

A. GROSS INCOME

§ 61(a): Except as otherwise provided in this subtitle, gross income means all income from whatever source derived . . This section really defines what gross means. Includes interest, dividends, capital gains, prizes etc.

Cesarini v. United States (N.D. Ohio 1969)

Buyer of piano found money in it while after buying it. Money didn’t count as income until he found it & “reduced to undisputed possession.” treasure trove = income when found/realized

Old Colony Trust Co. v. Comm’r (1929)

Company agrees to pay the tax on executive’s salary. Ct says this is compensation because it results from his employment. Company was paying an obligation of the employee. No difference that it was paid directly to the govt because employee is better off. Amount of money paid is like salary & taxpayer must account for the income, but the company can deduct it as ordinary business deduction since it is the same as paying a larger salary. Tp must pay taxes on the additional amount received from his employer.

Comm’r v. Glenshaw Glass Co. (1955)

INCOME: “undeniable accessions to wealth, clearly realized, over which the taxpayers have complete dominion”

Don’t need capital gain for income. Punitive damages are income in this case. Illegal gains are income (not in case)

Imputed Income- satisfactions from durable goods owned and used by taxpayer and goods and services that come out of the taxpayers personal exertions. Things you grow and services performed for yourself are not income. If do remodel in exchange for rent, then have gain for the cost of rent- expenses.1.61-8(c)pg.914

Helvering v. Indep. Life Ins. Co. rental value of a building occupied by the owner does not constitute income

Rev. Rul. 79-24 [barter club]§ 1.61–2(d)(1): if services are paid for other than in money, FMV of property/services taken in payment must be included in income. Ex. Exchange house painting for legal services. Fmv of services is §61

Dean v. Comm’r Property held in the name of a corporation of which the taxpayer and his wife are sole shareholders fair rental value of the residence property is included in gross income.

GROSS INCOME INCLUDES RECEIPT OF ANY FINANICAL BENEFIT WHICH IS:

not a mere return of capital, or not accompanied by a contemporaneously acknowledged obligation to repay (loan), OR not excluded by a specific statutory provision.

EXCLUSION of GIFTS and INHERITANCES

§102(a): Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.

§102(b): Subsection (a) shall not exclude from gross income: (1) the income from any property referred to in subsection (a); or (2) where the gift, bequest, devise, or inheritance is of income from property, the amount of such income. [income from gift of property included in gross income ie Dividends from stock received as gift] pg. 99

1. GIFTS

a. THE INCOME TAX MEANING OF GIFT

Comm’r v. Duberstein (1960)

“A gift . . . proceeds from a ‘detached and disinterested generosity,’ ‘out of affection, respect, admiration, charity or like impulses.’” Duberstein received car for giving good leads on new business. Transferor’s intent to induce more leads. Other is gift because he signed away his rights when he received it.

Govt.’s proposed test for employer gift (personal vs. business reasons) → REJECTED

In deciding if it’s a gift the donor’s/transferor’s intent for the “gift” is most critical → QUESTION OF FACT

PROPOSITIONS:

(1) employer to employee payments, even though voluntary = taxable

(2) business deduction inconsistent w/ concept of a gift (can’t deduct a gift as employer if it is a gift)

(3) business corporation cannot properly make a gift of its assets

Tips are gifts because they’re involved interests not detached ones. Paid past service or for more good service. Employees paid by

b. EMPLOYEE GIFTS → generally, not excludible from gross income

§102(c)(1): [An employee] shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of, an employee.

EXCEPTIONS to § 102(c):

(1) § 1.102–1(f)(2):. if the employee can show that the transfer was not made in recognition of the employee’s employment then it its not included in income. Or if substantially attributed to family relationship. Pg. 948

(2) § 132(e): some traditional retirement gifts = de minimis fringe benefits (food, pencils, watch at retire 129)

a. 132 also includes things like transportation, moving, discounts, athletic facilities which are exempt

(3) § 74(c): certain employee achievement awards freed from tax (tenure, safety award, limited on amount pg.90)

(4) Or give it all to charity because you can get deductions as long as you don’t exceed limits.

§ 274(b)(1): Business Can’t deduct gifts to non-employees if they exceed $25 total in 2 years? unless its an item with the company name on it that costs less than $4 dollars and there are lots of them or it’s a sign/display rack. Pg. 265

Look at source of the gift if from board of corp then likely not but if its from collection of workers then yes

2. BEQUESTS (personal prop), DEVISES (real prop), and INHERITANCES (receive because of intestate)

Lyeth v. Hoey Property received from estate of a decedent in compromise of his claim as an heir (settlement) is not taxable as income. Will contest suit won then would be deduct as inheritance by §102 so same is true for settlement because of his “standing as an heir.”

United States v. Merriam Where testator made cash bequests to executors of the estate “in lieu of all compensation or entitled to as executors or trustees” bequests are exempt from taxation. Because if have to perform service then executor must earn it but if paid because acts as executor and only has to comply in good faith in order to receive and not perform the services. If have to perform services to receive then taxable.

Wolder v. Comm’r-Transfer at death in lieu of payment for services rendered is taxable because money is compensation and in consideration for services. Parties contracted for services. Will satisfied the contractual obligation. In effect just postpones payment for the services. In Wolder it was for legal services.

Quantum meruit claim is about consideration and services rendered so settlement or award is taxable. If an employee might be under 102(c).

B. GAINS FROM DEALINGS IN PROPERTY

§ 1001(a): The gain from the sale or other disposition of property is amount realized – adjusted basis. (AR-A/B)

§ 1001(b): The amount realized from the sale or other disposition of property shall be the sum of any money received plus the FMV of the property (other than money) received.

§ 1001(c): Except as otherwise provided the entire amount of the gain or loss on the sale or exchange of property shall be recognized.

§ 1011(a): The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the [§ 1012] basis . . . , adjusted as provided in § 1016.

§ 1016(a): Proper adjustment in respect of the property shall in all cases be made—(1) for expenditures, receipts, losses, or other items, properly chargeable to capital account . . . improvements and depreciation

1015=Gift; 1014= decedent; 1041= spousal transactions/during divorce; 1016= Cap. improvement/ depreciation

1. DETERMINATION OF BASIS A/B= Cash Paid+ Mortgage or the FMV of what you received in an exchange

a. COST BASIS

Phila. Park Amusement Co. v. Uni

as part of bonus. Company has gain of FMV-A/B and employee has basis of FMV of stock. Payoff obligation its just like selling it. If own stock, under 1032 company has no income.

Crane v. Comm’r [mtgs. included in A/R when property transferred] How to calculate gain when selling a property with a mortgage on it. Mortgage 260 and received $2500 so A/R=262500. Basis is not equity (Prop Value – Mortgage)

(1) proper basis = value of property, undiminished by mortgages (FMV = unencumbered value)

(2) amount of the mortgage = properly included in amount realized on the sale

(3) A mortgagor who sells the property subject to the mortgage and for additional consideration, realizes a benefit in the amount of the mortgage as well as the boot. [A/R=amount of mortgage + extra cash] [Gain= A/R-A/B]

Comm’r v. Tufts (Crane only looks at mortgage= FMV Tufts says Mortg included in A/R even if FMV< Mtg)

Non-recourse loan if FMV < mtg. = still include mortgage amount in A/R assume it is repaid. No income when take out mortgage/loan. IF FMV=170 A/B=100 & loans=180(one not on prop), if bank takes property for loans then A/R=180 because you assume loans are repaid.

Recourse loan- if FMV < mtg. then A/R=FMV so in same situation you have 70k gain but you owe still unless its discharged under 108. See for example 1.1001-2(a & c)

If take out loan and use it to improve property then amount spent from loan is added to A/B of property. Loans for stock, car or other thing not added to basis become gain if sell property for amount of all mortgages.

**If gift property subject to loans (one included in basis & one not) 100k stock loan and 80k mortgage, then it is treated like a part sale & part gift under 1.1015-4 so donee’s A/B would be higher of: donor’s A/B (here donor paid 20k + mtg=100) or amount paid (here the value of mtgs. 180). It is like donee paid 180k for the donor and that is now his basis. Donor realizes gain of 80k [(A/R=180)-(A/B of prop=100)=80] (Spouse in situation would have same basis of 100k). When receiving property as gift subject to loans, it is as if the donee paid the donor the amount of the loans in exchange for the property that is why it is treated as part sale & part gif.

§ 1.1001–1(e): Where a transfer of property is in part a sale & in part a gift, the transferor/donor has a gain to the extent that the amount realized by him exceeds his adjusted basis in the property. However, no loss is sustained on such a transfer if the amount realized is less than the adjusted basis. If FMVA/R=Mtg amounts, see pg 1506

Gift amount = FMV- A/R (Cash paid + amount of mortgages) No loss if Mtg < A/B.

§ 1.1015–4(a): Where a transfer of property is in part a sale & in part a gift, the basis of the property in the hands of the transferee is the greater of how much the transferee paid or the transferor’s adjusted basis.

C. Life Insurance

§101-Amount payable by death of insured is excluded from gross income. If you transfer for valuable consideration, transferee can only exclude from income amount paid as consideration & any premiums paid on it. (a)(2) Still exempt if someone has a policy on my life and they gift it to me (gift basis transfer) or if you transfer a policy on your life to a partner of the insured ,partnership where insured is partner or corporation which the insured, is a shareholder or officer. Can take out policy on someone else’s life with permission. (c) can have insurance co hold money & pay you as an annuity or interest but interest is taxed. (d) If you receive an annuity in lieu of lump sum, exclude same amt as normally annuity Except if you live longer than expected life of annuity you still get to exclude the same proportion as before from income but if you die early company makes profit. If receive annuity, exclude from income = (amount of insurance policy/life expectancy)(g) accelerated death, if terminally (24 months) or chronically ill may transfer/sell and amount will be tax free.