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Federal Income Tax
University of Toledo School of Law
Barrett, John Q.

Spring 2013        Federal Income Tax  Barrett
 
DIRECT vs. INDIRECT TAXES
§  Direct taxes are apportioned and NOT an income tax
o   Congress splits a tax increase amongst the states according to population
o   Need to be uniform geographically, but NOT as to type or amount of income
§  Indirect taxes are uniform
o   Paid by someone who can shift the burden to someone else; OR
§  Seller increasing the price of a product to cover the tax
o   Is not under a true obligation to pay the tax (buyer of a product does not need to buy)
 
THE TAX FRAMEWORK
§  Sec. 61: Gross Income
o   As a general rule, gains are income, UNLESS there is an exclusion
o   Sometimes something that is a gain on its face isn’t really a gain (loan borrowing)
§  Sec. 62: Adjusted Gross Income
o   Gross Income – specified deductions (above the line deductions)
§  Above the line deductions are allowed, whether or not a person itemizes
§  Eligibility for certain other deductions (medical expnses) depend upon TP’s AGI
§  Certain deductions are allowed and offered in two ways to everyone:
o   Standard (minimum/baseline deduction; increases after age 65 and for the blind)
§  Indexed for inflation
o   Itemized Deductions (Tier 1)
§  All deductions (below the line) other than those taken into account in calculating AGI (interest; taxes; theft/loss; charitable contributions & gifts; medical and dental expenses – to the extent they exceed 7.5% AGI; deductions received when annuity payments stop before the investment is recovered) AND
§  The deduction for personal exemptions under 151
o   Miscellaneous Itemized Deductions (Tier 2) only to extent they exceed 2% AGI
§  Anything not listed in 67(b)
·         Unreimbursed expenses of employees/trade or business expense
·         Expenses for the production of income
§  Total amount of misc. IDs is reduced by an amount equal to 2% of AGI
·         E.g. 1k in ID w/ AGI of 20k – must reduce ID by 400 and only claim 600
·         NEVER required to reduce below zero
§  Sec. 63: Taxable Income
o   For those who itemize:
§  AGI – (IDs + deduction for personal exemptions allowed by 151)
o   For those who do not itemize:
§  AGI – (standard deduction + deduction for personal exemptions allowed by 151)
o   Compare the amount of the two and claim the larger deduction
§  Sec. 71-86: Inclusions
§  Sec. 101-150: Exclusions
§  Sec. 151-152: Deductions for Personal Exemptions
§  Rates: Marginal Rate vs. Effective Rate
o   Marginal: highest rate you will pay
§  High rate will only be applied to the money that goes over ($10,001 hypo)
o   Effective: what you actually pay
§  Credits: Dollar-for-dollar offset against tax owed
§  Deductions: Reduction in your income
 
TAXABLE INCOME
§  Who/When do we tax
o   US citizens and resident aliens on all income from whatever source
o   Others (foreigners) on income derived from a US source
o   Gross income is the receipt of financial benefit which is:
§  Not a mere return of capital
§  Not accompanied by contemporaneously acknowledged obligation to pay
§  Not excluded by a specific provision
o   Not income UNTIL realized (received cash) AND recognized (gov’t says you gained)
o   Damages that simply make you whole are NOT income (no gain). 
o   The gain of projected profits or punitive/exemplary/treble damages IS income.
o   Five ways to gain: (1) Windfall; (2) Compensation; (3) Gift: generally excluded; (4) Inherit: generally excluded; (5) Purchase
§  Equivocal Receipt of Financial Benefit
o   Treasure troves are income at the time you own it; if no fed law, IRS looks to state law
o   Punitive damages cannot be classified as a gift (but see wrongful death exception).
§  The mere fact that payments are extracted from wrongdoers as punishment for unlawful conduct cannot detract from their character as TI to the recipients
o   Loans are not income – need to pay back (If borrow with no intent to repay = income)
§  Income without Receipt of Cash or Property
o   NOT GI: bldg rental value owned/occupied by TP (not gaining by using what you own)
o   NO tax on imputed income (benefit of own efforts; veggie garden, ↑ in wine value)
o   Barter (house painter and lawyer; barter club):FMV of services includible in GI
o   Rent-free 6 mos. to artist for painting to apt owner = FMV includible in GI to both
o   Sec. 61: If services are paid for other than in money, the FMV of the property or services taken in payment MUST be included in income. If the services were rendered at a stipulated price, such price will be presumed to be FMV in absence of contrary evidence
 
Timing Principles [IRC 451; 461; 267] §  Taxes based on GI for a 12 month period [individuals usually use calendar year; entities may elect a fiscal year (must end on the last day of a month)] §  GI is when received under cash method (mostly for individuals; not allowed for most C corps)
§  GI when accrued if accrual method
§  Deductions follow same approach (when paid/owed)
 
EXCLUSIONS FROM GROSS INCOME
Gifts, Bequests, Devise, & Inheritance [102] §  “Gift” not common law meaning
o   Income from gifted property and gift of income from property ARE both taxable
o   Intent of Transferor
§  Detached and disinterested generosity (what was dominant motive?)
·         Must not be deferred payment for services
§  Objective inquiry that is fact intensive (court uses informed experience and is highly suspicious with regards to business settings)
o   Three situations when contesting a will:
§  Lose the contest: will remains in full force and effect (not GI)
§  Win the contest: tear up the will and inherit as an heir (not GI)
§  Settle the contest: not GI
§  Gifts to Employees :: Sec. 102
o   Transfers while employed; at or after retirement; to survivors upon employees death
o   Must show not made b/c person is an employee ( “Natural objects of bounty” = family)
o   Payments (cash/gc) to employees are NOT gifts > personal property ONLY otherwise will be considered “final payment” for service rendered and thus income
o   EAA: NOT GI to extent deducta

ired to be included as GI to the extent that the portion represents a payment for teaching, research or other services by the student required as a condition for receiving the otherwise excludable amt
o   BUT a qualified tuition reduction may be excluded in the case of education below the graduate level or at the graduate level if the student is engaged in teaching or research activities (except where the reduction represents payment) (non-discriminatory)
o   127 Exclusion: Educational Assistance Programs – permits an employee to exclude up to $5,250 (excess = GI) from GI for amounts paid by the employer for ed. assistance at the undergrad and grad levels of education, provided the program meets certain requirements related primarily to non-discrimination in favor of highly compensated employees
§  Includes tuition, books, supplies and an employer provided educational course
§  Compensation by very nature = Not required to jump compensation hurdle
§  Must NOT provide a choice between money or taking a course
 
Gain from Dealings in Property [1001(a), (b) & (c); 1011(a); 1012; 1015] §  Gain/Loss = Amount Realized – Adjusted Basis (return of capital is NOT income)
§  Basis = what you have in property (Cost + or – any adjustments)
DETERMINATION OF BASIS
§  Property  Exchanged:
o   Basis is the FMV for what you receive in the exchange at the time you receive it (based on current basis in what is given compared to FMV of what is received)
§  If exclude lessee improvement from GI, exclude it from basis as well
o   When an exchange takes place, both parties must report that year
o   Exception for Like-Kind Exchanges
o   If Hard to Determine FMV = presumption that hard-to-determine property is equal to easily-determined property’s FMV
§  When you cannot determine FMV of EITHER item in an exchange, basically let each side keep their original basis
§  Property Acquired by Gift [1015]:
o   Basis is that of donor
§  If greater than FMV, basis is FMV if a loss occurs
·         If basis < or = FMV, transfer the original basis §  Gift tax payment increases basis o   Mixed gift/sale §  Donor’s gain is AR (amount realized) – AB (adjusted basis) §  Donee’s basis is greater of Donor’s basis or amount donee paid o   IRS lowers amount of loss you get to take = get the basis for what the GIVER had in it, BUT if when you sell, you are selling at a loss, basis switches to FMV for when you received to minimize loss