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Federal Income Tax
Villanova University School of Law
Book, Leslie M.

Professor Book Spring 2017 Intro to Fed Tax Final Outline
 
 
APPROACH TO DETERMINE TAX LIABILITY
 
Chapter 1: Introduction
 
Code: §§ 1(a) -(d); 3(a); 11(a); 61; 62(a); 63(a); & 7805(a)
 
Overview
Basic Questions Addressed by Income Tax System
What items of income or economic gain will be includable in gross income?
What items of expense will be allowable as deductions?
When is an amount includable in income; when is the taxpayer entitled to claim a deduction for an amount that is clearly deductible?
Who includes the item in their income or takes the deduction?
What is the character of the item of income or deduction?
Background
Individual income tax contributes the most revenue to treasury
In 2014: 1,395 billion dollars, 46.2% of revenue (See PPT for statistics)
Congress uses the tax system to:
Raise revenues
Can manipulate tax liability in a number of ways
Increase tax rate (most obvious)
Deductions w/ 2% floor (more back handed way)
Tax as a tool of social policy
To implement economic policy
Combat income inequality
Promote income redistribution
Progressive tax rates (more $, more taxed)
Capital gains tax preference — assets owned largely by wealthy
Computation
Step 1: Determine Gross Income § 61
Include §61(a): G/I means all income from whatever source derived, including (but not limited to) the following items:
(1) compensation for services, including fees, commissions, fringe benefits, and similar items;
(2) gross income derived from business;
(3) gains derived from dealings in property;
(4) interest;
(5) rents;
(6) royalties;
(7) dividends;
(8) alimony and separate maintenance payments;
(12) income from discharge of indebtedness;
(14) income in respect of a decedent; and
(15) income from an interest in an estate or trust.”
Exclude:
Imputed income, bargain purchases, appreciation in value w/o realization
Gifts, Bequests, & Inheritance (§102)
Sale of Principal Residence (§121)
Compensation for Injuries & Sickness (§104(a))
Loans (Obligations to Repay – Tufts)
Certain Discharge of Indebtedness (§108(a))
Insolvency Exception
Bankruptcy
Purchase Money Debt Reduction Exception
Disputed Debt Exception
Step 2: Calculation of Adjusted Gross Income § 62
AGI = gross income – ATL deductions. §62(a)
AGI = an “interim measure of taxable income”
Dividing line btw those deductions allowed to all TPs regardless of whether they itemize (ATL) & those which may be taken only if TP itemizes (BTL)
GI minus the following ATL deductions:
(1) Trade & Business Deductions § 162
All Ordinary and Necessary Expenses (§162(a))
Salaries/Wages Paid (§162(a)(1))
Compensation for personal services (§162(a)(1))
Trade/Business Losses (§165(a))
Bad Business Debts (§166(b))
Traveling expenses (§162(a)(2))
Clothing (§1.262-1(b)(8))
Rental Payment (§162(a)(3))
Business Interest (§163(a))
Depreciation (§167(a))
Election to Expense Depreciable Assets (§179)
(2) Certain Trade & Business Deductions of Employees
(3) Deductions Under § 161 for Losses from Sale/Exchange of property
(4) Deductions Attributable to Rents & Royalties Under §§ 161, 212
(10) Alimony § 215
Step 3: Determine Taxable Income § 63
Taxable income = AGI – Deductions – Personal Exemptions
§ 161: Allowance of Deductions
“In computing taxable income under section 63, there shall be allowed as deductions the items specified in this part, subject to the exceptions provided in part IX (sec. 261 and following, relating to items not deductible).”
Every time you have an expense that you believe is deductible, you must fine a specific Code section authorizing the deduction.
Itemize or Standard Deduction?
If taxpayer’s below the line deductions exceed the standard deduction, the taxpayer should itemize.
§ 67: provides a 2% floor on miscellaneous itemized deductions, these deductions are only allowed to extent that aggregate of such deductions exceeds 2% of AGI.  
§67(b) defines miscellaneous itemized deductions as itemized deductions OTHER THAN:
§ 163 (interest)
§ 164 (state taxes)
§ 165(c)(2),(c)(3), or (d) (casualty/theft loss)
§ 213 (medical expenses)
Subtract personal exemptions regardless of what deduction TP elects
Step 5: Multiply Taxable Income by Tax Rate § 1
Step 6: Subtract Tax Credits §§ 21-53
Caroline Taxpayer
Included/excluded in gross income:
$275,000 received in cash and checks from consulting business (§ 61(a)(1))
$10,000 value of landscaping services rendered to her mother in exchange for her consulting services (§ 61(a)(1))
Form of compensation one receives makes no difference in determining what constitutes gross income (§ 1.61-1(a))
If services are paid for in exchange for other services, FMV of services is included as compensation (§ 1.61-2(d)(1))
Assignment of income doctrine prevents income shifting
$19,000 received in interest income (§ 61(a)(4))
$15,000 gain from sale of stock (§ 61(a)(3))
$1,000 dividend (§ 61(a)(7))
NOT $30,000 owed for consulting work
Did not actually or constructively receive this (§ 1.446-1(c)(1)(i))
= $320,000 in gross income
Above the line deductions
$60,000 in wages (§ 162(a), ATL under § 62(a)(1))
$20,000 for business-related expenses (same)
$10,000 depreciation for business related property (§ 167(a))
NOT $5,000 spent commuting to work
Nondeductible personal expense (§ 1.162-2(e), § 1.262-1(b)(5))
= $90,000 ATL deductions
Adjusted gross income = $320,000 – $90,000 = $230,000
Below the line deductions
$1,000 bank’s fee for managing Caroline’s investment (§ 212)
$18,000 QRI (qualified residence interest) (§ 163(h))
$5,200 real property taxes (§164(a)(2))
$14,000 state income tax (§ 164(a)(3))
$9,000 charitable contribution (§ 170) (DIDN'T COVER)
NOT $6,000 principal payments on mortgage (personal expenditure)
= $47,200 BTL deductions
BUT are any subject to the 2% floor? Yes, $1,000 management fee under § 212; 2% of $230,000 = $4,600 and $1,000 < $4,600, so that expense will not be deductible = $46,200 BTL Taxable income = AGI of $230,000 – itemized deductions (or standard deduction) of $46,200 – personal exemptions of $3,800 = $180,000 of taxable income   GI (Sec 61)                Consulting cash/checks                               275,000                Landscaping service to mom                      10,000                Interest and Dividends                                20,000                Gain on Stock sale                                         15,000                                                                                           Total: 320,000 ATL DEDUCTIONs (sec 62)                Wages                                 60,000                Office supplies                 20,000                Depreciation                     10,000                              

§ 1.61-2(d)(1).If services are rendered at a stipulated price, such price will be presumed to be the FMV of the compensation received.  Rev.Ruling 79-24 (1979)In return for legal services performed by Lawyer for House Painter, HP painted L’s home àFMV of services received by Lawyer & Painter are includable in their GIs Apartment owner received artwork created by artist in return for 6 months rent-free use of an apartment à FMV of artwork & 6 months FRV of apt are includable in GIs of Owner & ArtistTreasure trove is realized in the taxable year in which it is reduced to undisputed possession & included in G/I in value in US currency. § 1.61-14.Cesarini ($ in piano case): treasure must be reported in year foundPayment of income taxes by an employer for an employee constitutes taxable income to the employee. Old Colony Trust Co. (US 1929).If an employer-paid trip for employee is a reward for employee’s services, the value of the reward must be regarded as G/I to the employee. McCann. McCann’s went to Vegas for work seminar, all expenses paid by employer, that was only extended to select employees who reached required sales mark. Court cited § 1.61-1(a), this is G/I — TP had to include FMV of trip Qui tam payments are analogous to a reward for helping the gov’t, included in G/I.  Roco (TC 2003).Recipient must include in G/I the FMV of a prize in the year it is awarded (Donuts)Limitations on Gross Income Realization Requirement Gain or loss can be realized from the conversion of property into cash or from exchange of property for other property differing materially in kind or extent.  § 1.1001-1(a). To “differ materially” property exchanged must embody legally distinct entitlements. Cottage Savings.Exchange of loans made to different obligors & secured by different homes embodied legally distinct entitlements. Exchange of Stock A for Stock B involves materially different property w/ legally distinct entitlements because interest in separate corporate ventures, different legal obligations, etc. (in-class example). Mere appreciation in value, absent a realization event, is not G/I. Macomber.Mere issuance of additional shares to each SH ≠ realization event Corp had 100 shares outstanding, A & B each owned 50 Corp issued one-for-one stock dividend (A & B each 100 shares)Result? Still each own 50% of Corp.  Difference is only the # of shares they hold, w/ each individual share now worth less than it was before. Note: if Corp gave out dividends would constitute G/I under § 61(a)(7). Justifications for realization requirement: Measuring appreciation in all property of every TP would present enormous administrative problems for TPs & IRS Fundamentally unfair to treat unrealized gain as income because TP might lack the cash necessary to pay resulting taxes & might thus be forced to sell assets