Federal Income Tax Peroni Fall 2015
Part I: Intro to Federal Tax
Intro to Federal Income Tax
Income tax introduced in 1913: 16th A.
Revisions in 1913, 1939, 1956, 1986
Courts:
Tax Court: only jurisdiction where deficiency need not be paid upfront; but must bring action within 90 day letter; Art I court with no lifetime tenure.
Golsen: considering precedential value of other circuits would undermine judicial efficiency; therefore, tax courts only follow local circuit.
District Courts: only venue with juries
Court of Federal Claims: Federal Circuit tends to be more sympathetic to taxpayer claims
Sources of tax authority:
Tax code: drafted by Congress
Treasure Regs: force of law under Chevron deference
Rev Rul, Rev Proc: only binding on treasury personnel: Skidmore deference
TAMs (agents requesting guidance from DC); PLRs (binding rulings on taxpayers)
Five Steps to Calculate Tax:
Gross Income: Sec 61 “except otherwise provided.” – more to come.
61 is tautological; Glenshaw Glass establishes 3 criteria for inclusion in gross income:
Must represent an increase in net worth
Must be clearly realized (and is this an adminstrative, contitutional, or legislative mandate?)
TP must exercise dominion and control over income
Sec 71-86 specific inclusion in gross income; Congressional affirmative definitions of broader income provisions of 61
Eg 74: elaboration of prizes, but leaves Q’s of valuation to fact finders
Sec 101-135: specific exclusion from gross income. Generally policy based reasons for exclusion
Sec 103: municipal bonds
Sec 104: injury recovery
Sec 108: COD exclusions
Sec 119: Meals and lodging for convenience of employer
Adjusted Gross Income (above the line deductions [allowances] for AGI): Sec 62
Taxable income: Sec 63
Personal Exemption: Sec 151 & 152 (defining dependents)
Deductions
Sch A itemized deduction or
Standard deduction. Rev Proc sets increases in deduction (and expemption/tax brackets
Calculation of Tax: Sec 1. (Sec 11 governs corp taxes)
Tax brackets modified annually in rev proc: 2014-61
Taxes payable after credits (dollar-for-dollar reduction in tax) and estimated/withheld taxes
Sec 31: Tax withheld from wages are a credit against tax liability
Tax Treatment of Income and Deduction
Income Items: Sec 61.
Cash/Accrual recognition and timing issues
Cash depends on having “unqualified right to receive”: actual or constructive receipt. See Sec 451 for recognition rules; 448 for applicability of cash method
Deductions: See Sec 161-224 generally
Above the line deductions authorized in Sec 62
Deductible test: Reg 1.446-1(c )(1)(ii)(A)
All events have occurred that establish the fact of the liability and
The amount of liability can be determined with reasonable accuracy. (Exactitude not demanded: amount computed by rate, formula ok; later adjustments are allowed.)
Additional reqmt of Sec 461(h): all events test cannot occur prior to economic performance (eg: contract for services performed years in future)
Major categories:
Trade or business expenses: 162
Deductions for production/collection of income: 212
Loss deductions: 165
Depreciation & amortization: 167, 168
Business/Investment deductions:
Higgins v. Comm’r (1941) held that investment expenses not for “trade or business” were non-deductible; Congress immediately enacted 212 to allow for such expenses.
Is it trade or business (162) or investment (212)?
212: expenses for production of income
“Trade or business” not defined in code: case law:
Burnet v. Clark (1932): CEO’s guarantee payment for corporation’s notes was denied NOL carryover: loss was not a business loss because given to protect stock investment. A corporation’s business not attributed to shareholders.
Snyder v. Comm’r (1935): stock trading on full time basis is business
Higgins (1941): close management of investment portfolio does not constitute business
Whipple v. Comm’r (1963): Promoter of corporation suffered bad debt loss; b/c not a lender or employee, this was done to protect as shareholder and thus nonbusiness. “Devoting time and energies to affairs of a corporation is not a trade or business…though may produce income via enhancement of investment value, this is distinct from process of investing and distinguished from trade or business”
US v. Generes (1971): Employees who suffer bad debt losses may only claim business loss if “protecting salary is dominant motivation for making loan.”
Comm’r v. Groetzinger (1987): full time gamblers entitled to business losses. Rejected idea that businesses are required to sell goods or services
Groetzinger/Snyder versus Higgins: a kind of “passive” return? But isn’t Higgins’s close management similara to full-time investors? Does it depend on livelihood question?
Is expense a valid 162 trade or business expense?
Allowed deduction for “ordinary and necessary expenses”
Welch v. Helvering (1933), p 197: Ordinary = common and accepted in business; necessary = appropriate or helpful; paying a company’s debs isn’t normal, so not a deductible expense.
Peroni’s preferred interpretation: paying old company’s debts is developing a long-lived asset in goodwill
Salaries must be “reasonable” under 162(a)(1); 162(m) inefffective at limiting executive salaries to $1M b/c compensation tied to performance
Requirement that expenses be for “carrying on” business – precludes 162 deduction for start up costs; this is authorized under provisions for 195.
Where may deductions be taken? For AGI, Itemized, or subject to 2% floor?
Deductions for AGI: Sec 62(a)
Trade or business other than employee
Itemized Deductions (Sch A): Sec 67 carves out deductions from the 2% floor, including 163 interest, 164 taxes, 165 losses, etc
2% misc itemized deductions: defined in the negative (ie everything not carved out by 62, 67): includes misc. unreimbursed empl expenses, 212 investment exp.
Limitations on Losses & deductions
2% Misc. Itemized Deduction AGI floor: incudes things not carved out by Sec 67
Itemized Deduction Floor: Reduces Sch A by 3% AGI: Sec 68.
68(c) has exception for medical expenses, investment interest, losses
Personal/Business/Investment Income and Expenses
Gambling:
Winnings: Sec 61 income
Losses: limited to w
th no regular place of business nor regular place of abode are considered to bring “home” with them as they move. Rev Rul 75-432.
Conflicting results: Taxpayer in ice show allowed no deduction (but lived with parents, no duplicative exp): Henderson v Commr; but similar facts (although paid rent), travel was deductible Sapson v. Comm’r. See also ship captain could deduct even tho no business reason for location of home Johnson v. Comm’r.
Legislators: Congress only allowed $3k for Washington abode; 162(h) allows state legislators living more than 50 miles from capitol to deduct using a formula
Special Rules for outside US: 274(c) – for. travel only partially deductible to business, not total days – unless exceptions of 274(c)(2) [n/a if less than week, any nonbusiness is less than 25%] and 1.274-4(d)(2) [weekends don’t count if spans workdays]
Business on cruises foreign and under 274(h)(2) unless flies under US flag and only has US ports of call.
Meetings and seminars outside of North America waived if relates to trade or business and is reasonable to be held outside North America as within North America – 274(h)(1)
Travel cannot in of itself be the purpose: so French teacher can’t take a trip to France to learn language and culture. 274(m)(2); 1.162-2(c )
Business Entertainment: 50% 274(n)(1)
Expenditures to entertain one or more other persons; includes boats, planes, clubs, etc: See Reg. 1.274-2(b)
274 has lots of disallowance rules:
No cost of using, maintaining, or operating facilities; 274(a)(1)(B)
No club deductions for those organized for “business, pleasure, recreation or other social purpose.” 274(a)(3)
Activities are disallowed unless either: [274(a)(1)(A)]
“directly related to active conduct of trade or business” [weeds out activities with general expectation of business benefit] or
“associated” with active conduct of T or B and proceeds/follows “substantial and bona fide business discussion” [require discussions of actual or contemplated transactions. Reg 1.274-2(d)(3)]
Allows deductions for those “closely connected with” taxpayer and guests; so spouses’ expenses are deductible. Reg. 1.274-2(d) (unlike spouse travel prohibition of Sec 274(m)(3))
Tickets limited to face value: Sec 273(l)(1)(A)
Gains and Losses, Capital Expenditures
Gains: excess of amount realized over adjusted basis.
Recognized when: 1) actual realization; 2) recognition applies; 3) no exclusion provision
Gain computation: Sec 1001(a)
Amount realized over adjusted basis
Compass Adjusted basis definition: Sec 1011
Cost basis: Sec 1012
Adjustments to cost basis: Sec 1016
