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

a)      Calculating Tax Liability:
i)        Adjusted Gross Income = Gross Income [§61] – Above the Line Deductions [§62] ii)      Taxable Income = Adjusted Gross Income – Below the Line Deductions (standard or itemized) [§63] iii)    Generally
(1)   Taxable income = Gross Income – Deductions
iv)    Taxable Income x tax rate [§1] = Tax
v)      Tentative Tax – Credits = TAX
vi)    TAX – withholding [§31] = PAYMENT DUE OR REFUND OWED
b)      Three Questions for each item of income or deduction –
i)        (1) for what taxable year
ii)      (2) what is the character (ie. capital gain, loss, ordinary income or loss) of various items?
iii)    (3) is the gain or loss immediately recognized?
c)      Key definitions:
i)        Basis: amount of your investment in the property—what you bought your book for (§1012)
ii)      Amount Realized: sale proceeds from property—what you sell your book for
(1)   Realization Event: the point at which you cash in on your investment
(a) Realization- you have engaged in some type of transaction and, after that transaction, you have something materially different than you had before—you have extracted the value out of something
(i)    Income must be realized before it is taxable
(ii)   Realizable taxable transactions are generally sales, exchanges, in which you have something materially different than you have before
(b) Realization- When someone purchases something at a bargain price and gets something with more value then they thought they were buying (ex. buys a painting that turns out to be a Monet), there is no realization until they cash in on their investment. Only when they go to sell the bargain item will there be a realization event that requires the recording of gross income.
iii)    [§61(a)(3)] Gain = Amount Realized – Basis
(1)   Approach to Gains Derived From Dealings in Property
(a) Do we have a realization event? (e.g., sale or other disposition)
(b) If yes, calculate Section 1001 gain realized
(i)    Gain Realized = Amount Realized – Adjusted Basis
(ii)   Amount Realized = Money Received + FMV of other property received 
(c) Is the gain recognized (i.e., included in gross income)?
(i)    Or is there an applicable exclusion?
(ii)   Or is there an applicable non-recognition/ partial recognition provision 
(d) If gain, what is the character of the gain? (e.g., ordinary, capital, 1231, recapture, etc.)  
iv)    Deductions:
(1)   Approach
(a) Is there a Code provision allowing the item to be deductible?
(b) Is it subject to a general restriction or limitation on deduction?
(c) When is it deductible and in what amount?
(d) Note whether the item is subtracted in computing AGI (ie, is it an above the line deduction) or whether it is subject to the 2% floor for misc itemized deductions
(2)   Things to keep in mind
(a) You must find a specific code granting a deduction
(b) Deductions, as opposed to gross income, are construed narrowly
(3)   Two forms of deductions:
(a) Above the line
(i)    Subtracted directly from gross income – giving you adjusted gross income – the Code considers adjusted gross income, “income” for tax purposes. §62
(ii)   All taxpayers take these deductions whether they are itemizers or not
(iii) ***Beneficial because this is a direct subtraction from gross income, whether t/p chooses to itemize or take standard deduction. Then the t/p can still get the benefit of the standard deduction.***
(iv)Examples of above the line deductions:
1.    From trade or business income (62- defines AGI- only those deductions in 62 are taken into account in computing AGI- the ones in 62 are above the line) 
i.        Ordinary and Necessary Business Expenses [§ 162] ii.      Business Interest [§163] iii.    State and Local Business Taxes [§164] iv.    Business Property Losses [§165] v.      Business Bad Debts [§166] vi.    Depreciation [§167] vii. Charitable Contributions [§170] viii.Net Operating Loss Deduction [§172] ix.    Elective Deduction of Cost of Depreciable Property [§179] x.      Amortization of start-up expenditures [§195] xi.    Amortization of Goodwill and other intangibles [§197] 2.    From rental or royalty income
a.    Anything listed above or under §212 that are “attributable to the production of rents and royalties”
3.    Allowed to employees
a.    Only businesses expenses reimbursed by employer (plus narrow category of §162 expenses of certain performing artists and officials)
4.    Other
a.    Other deductions listed in §62(a)(5)-(17), including
i.        §215 alimony
ii.      §217 moving expenses
(b) Below the line[§63] (i)    The line is AGI
1.    As a result, these are subtracted from Adjusted Gross Income
(ii)   After you calculate AGI, you will break into two groups
1.    Itemizers- will take below the line deductions
2.    Non-itemizers- will take standard DD
(iii) Examples:
1.    For individuals who do not itemize:
a.    Standard Deduction
b.    Exemptions
i.        §151 personal exemptions for taxpayer and spouse
ii.      §151 exemptions for dependants
iii.    §63(f) additional amounts for the aged or blind persons
2.    For individuals who do itemize
a.    Preferred itemized deductions listed in §67(b), including (among others):
i.        §163 mortgage and investment interest
ii.      §164 state and local taxes
iii.    §165 losses from casualty, theft or gambling—business losses
iv.    §170 charitable contributions
v.      §213 medical expenses
b.    “Miscellaneous Itemized deductions” but only to the extent in excess of 2% of AGI. As defined by §67, these include (among others) [may not be deducted except the extend that in the aggregate all exceed the 2% of the taxpayer’s AGI]:
i.        unremimburesed employee business expenses
ii.      §212 expenses for the production of income
iii.    §212 expenses for the determination of tax liability
iv.    §183 hobby expenses
c.    Exemptions
i.        §151 personal exempti

n to wealth = gross income
(a) 3 part Ascension to wealth test: (GLENSHAW GLASS)
(i)    an (1) undeniable accession to wealth,
1.    that is (2) clearly realized
2.    and over which the taxpayers have (3) complete dominion.
(b) Examples:
(i)    Treasure Trove(Reg. § 1.61-14)/Cessarini (money in back of piano) example:
1.    Found money is gross income
(5)   Punitive Damages/Unearned Windfall: ascension to wealth.
(i)    Glenshaw Glass: punitive damages received in a lawsuit were unearned windfall, but were gross income.
(6)   Loans ≠ Gross Income – the proceeds from a loan are not gross income, b/c of the equal and offsetting obligation to repay
(7)   Non-cash benefits and imputed income
(a) Imputed/Self-created Income: 
(i)    Generally- NOT INCOME
1.    Not taxed, even though the IRC contains no specific exclusion to that effect
(ii)   Two categories of imputed income
1.    Imputed income from services
2.    Imputed income from property
(b) Bargain Purchases
(i)    Generally, Not Gross Income
1.    However, if property is transferred as compensation for services in an amount less than its FMV, the difference between the FMV and the amt paid is gross income
2.    Be on alert for a employer-employee relationships or transactions that aren’t at arms-length
(c) Barter Income: 
(i)    Mutual Exchange of services/property = gross income. 
(ii)   Exchange is a realization event – Each party is treated as if he had sold his services. Each party paid for the value he rec’d.
1.    Example: Rev. Ruling 79-24; Services exchanged by a lawyer and a housepainter are taxable income to each individual in the extent of the market value of the services rec’d.   
(8)   When is gross income reported?
(a) When it is realized
(b) Gross income is income in the year in which it is reduced to possession (Reg. 1.61-14(a))
(i)    In Cessarini case, was the money reduced to possession in the year they bought the piano or the year they found the money?
(ii)   Court looked to state property law for answer. The money didn’t vest until it was reduced to actual possession by the finder.
i.        Transaction is a Bargain Purchase
1.      Did Cesarini’s have g.i. upon acquiring piano?
a.       No. Undeniable accession to wealth but not clearly realized
b.      No realization event (until discovered it and cash in on investment in tax-realization event)