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Taxation of Individual Income
WMU-Cooley Law School
Torielli, Gina M.

Tax Outline

Summer 2012 – Professor Torieli

1. The Exam:

60 Multiple Choice (1 point each = 60 points)

i. No true/false questions

ii. All calculation questions are MC

1 Essay Questions (40 points)

i. No strictly “number crunching” questions

ii. Questions similar to those we considered in class

iii. If applicable, use IRAC to answer question

2. Bring a Calculator and ruler to the Exam!

3. Exam Approach:

a. When you don’t know where to start–

b. Maybe figure out which of the 5 major topics is at issue.

c. Then, try IRAC.

4. When you are studying and can’t answer a question:

a. Look at a step-by-step.

5. 5 Major Topics:

What is GI?

Whose GI is it?

What can be deducted?

When must the income be reported & when can a deduction be taken?

When there is a disposition should a special tax rate apply (character)?

Gross Income

1. Gross Income: GI is an accession to wealth, clearly realized, over which the TP has dominion/control. (Glenshaw Glass)

2. Rule: GI is income from all sources derived, unless there is a specific exclusion.

3. GI includes:

a. Treasure trove: treasure troves are included in GI the year the item is found (must be no question TP entitled to keep). (Cesarini)

b. Payment by 3rd party: When a 3rd party pays any of your debt, liability, or other obligation, you have GI. (Old Colony)

c. Barter services: property or services received in exchange for property or services, even if received as part of a barter transaction, are GI.

d. Compensation for services: compensation for services, regardless of the form the compensation takes, is GI. (IRC 61 & McCann)

e. Claim of right doctrine: any funds or property that com into TP’s control, where he is free to do with as he wants & he claims is his (even if he may have to repay later) are GI in the year received. (North American Oil)

f. Income from illegal sources: funds from illegal sources are GI. (James)

g. Advance payments: advance payments received are GI. (Ind. Power & Light)

i. Who controls where the money ends up?

– If the payer can get it back, it is not GI

(1) Ex. security deposits and loans are not GI

– If the receiver keeps it no matter what the payer does, it is GI.

h. Property dealings: Any gain from the sale or trade of property is GI. (IRC 61)

4. GI does not include:

Bargain purchase are not GI until the sale of the item (Pellar)

Loans are offset by an obligation to repay so they are not income (Ind. Power & Light)

i. Ex. Mortgages, car loans, security deposits

Coupons or rebates are just a reduction in purchase price and are not GI

5. Gifts & inheritances may not be GI (Duberstein; IRC 102)

Based on donor’s intent: look at all the facts & circumstances to determine

i. If meant as a reward for doing something (tokes), not a gift, GI

Must be detached & disinterested (love & affection) to not be GI

6. Life Insurance (IRC 101)

Proceeds from a life insurance policy, by death of policy holder, are not GI.

Interest earned on life insurance proceeds is GI.

If both proceeds & interest are received, prorate each payment evenly, only the interest portion is GI.

i. If the beneficiary is receive payments over his life: (IRC 72)

– & he lives beyond his life expectancy (as defined by the government), continue to prorate at same percentage

– & he passes away sooner than life expectancy, there is no deduction for unrecovered policy proceeds by others

7. Awards & Prizes: FMV is included in GI. (IRC 74 & McCoy)

a. There are 3 exceptions:

i. “Just say no”: if you turn it down without controlling it, it’s not GI

ii. Meritorious Awards: not GI if the prize/award is: (must have all)

– Received in recognition of a religious, charity, scientific, educational, artistic, literary, or civic achievement;

– Recipient nominated by others, without any action on his part to enter the contest;

– Recipient must not be required to render substantial future services;

– The prize or award is given away by the recipient

iii. Employers Award: not GI if the prize/award is: (must have all)

– Given by an employer to the employee;

– It is tangible personal property (like a watch, not $$$);

– Its cost is under a specific dollar amount; &

– It’s given as a reward for length of service or safety.

8. Qualified Scholarships

a. Not GI: tuition & fees

b. Is GI:

i. room & board

ii. compensation for services, including quid pro quo (Bingler v. Johnson)

9. Cancellation of Debt: Is GI, but there are exceptions (IRC 61 & Kirby Lumber)

a. Is the Cancellation of Debt GI?

i. Is there an obvious debt owed? (without contingents giving outs)

ii. Was the debt cancelled? (not disguised as compensation or gifts)

iii. If debt was cancelled, does an exception apply? If not, debt forgiveness is GI.

Exceptions

i. Debtor is in bankruptcy

ii. Debtor is insolvent, but only if debtor is still insolvent after discharge.

iii. Debtor becomes solvent because of the discharge, amount above the line is GI (was $5k insolvent, forgiven $6k, has $1k GI)

10.Damages

Nonphysical damages (business, discrimination, defamation) are GI

i. Medical expenses related to physical manifestations of non-physical injury is not GI (heart attack after incident)

Expenses from personal, physical injury are not GI (medical bills, pain & suffering)

Punitive damages are GI

11. Fringe Benefits:

a. Certain benefits excluded from GI

i. Meals & Lodging

– Meals & Lodging provided to a spouse & dependents are GI.

– Meals provided for the convenience of the employer & furnished on the business premises of the employer are not GI (employer has a cafeteria that is free to all employees so they are close if needed)

ii. No-Addit

capital expenditure)

b. Ordinary (Welch v. Helvering)

i. customary or expected in the life of a business

c. Necessary

i. “appropriate & helpful” to the business

Paid or incurred during the taxable year

In carrying on a trade or business

i. “an activity in which TP is involved with continuity & regularity & for which TP’s primary purpose for engaging in activity is income or profit” – Not a hobby (Comm’r v. Groetzinger)

4. Pre-operating expenses (not capital expenditures)

Consist of:

i. Investigatory Costs

ii. Start Up Costs (anything before doors open)

b. Are not deductible unless:

i. If TP fails “carrying on any trade or business” requirement, but meets remaining elements of IRC 162(a), TP can elect to amortize the expenses over 15 years. Can deduct 1st $10,000 in year business started.

ii. If business never opens, no deductions

5. Investment expenses:

a. Deduction for “ordinary & necessary” expenses are allowed for:

i. Producing or collecting income,

ii. Maintaining property held for the production of income (safe deposit box), or

iii. Tax preparation.

6. Capital Expenditures V. Expenses

a. Not deductible

i. IRC 263

ii. Treasury Reg 1.263(a)-1

b. Expense:

i. The asset has a life less than 1 year (office supplies)

ii. The expenditure doesn’t create a benefit that lasts beyond 1 year.

c. Capital expenditure: adds to value of property = an increased basis

i. Separate & distinct asset that has life beyond 1 year (Lincoln Savings)

ii. Expenditures produce significant benefits that extend beyond tax year in question (INDOPCO)

iii. Capital Expenditures must be one of the following:

– Significant benefit beyond 1 year (prepaids)

– Asset Acquisition costs

– Defending or perfecting title

– Cost of constructing an asset (Idaho Power)

– Entering a new line of business (v. expansion, which is an expense)

– Billboards, signs, etc. (v. other advertising)

iv. Selected Categories of Capital Expenditures

– Cost of Acquisition & Costs Incurred in Perfecting & Defending Title

(1) Woodward case – “origin of the claim” doctrine for legal fees (IRC 263A)

v. Repair v. Improvement

– Repair : keeping the property in an ordinary, efficient operating condition; restore to state it was in before situation prompting expenditure. (expense?)