Final Tax Outline PDF

**Ocampo Fed. Tax Outline (Fall 2023)\ ** Table of Contents {#table-of-contents.TOCHeading} ================= [Part I - Introduction 5](#_Toc153386208) [(1) Orientation 5](#orientation) [(A & B) A Look Forward/A Glimpse Backward (pp. 3-12) 5](#a-b-a-look-forwarda-glimpse-backward-pp.-3-12) [(C) The Income Tax and the United States Constitution (pp. 12-18) 5](#c-the-income-tax-and-the-united-states-constitution-pp.-12-18) [(D) The Tax Practitioner's Tools (pp. 18-38) 6](#d-the-tax-practitioners-tools-pp.-18-38) [(E) The Road Ahead (pp. 38-40) & Excerpt on Tax Policy 7](#e-the-road-ahead-pp.-38-40-excerpt-on-tax-policy) [(28) Procedure and Professional Responsibility 9](#procedure-and-professional-responsibility) [(A) Overview of Federal Tax Procedures 9](#a-overview-of-federal-tax-procedures) [(B) Special Rules Applicable to Deficiency Procedures 12](#b-special-rules-applicable-to-deficiency-procedures) [(C) Special Rules Applicable to Refund Procedures (pp. 996-1000) 12](#c-special-rules-applicable-to-refund-procedures-pp.-996-1000) [(29) Professional Responsibility Issues 13](#professional-responsibility-issues) [Part 2 -- Identification of Income Subject to taxation 14](#part-2-identification-of-income-subject-to-taxation) [(2) Gross Income: The Scope of Income Taxation 14](#gross-income-the-scope-of-income-taxation) [(A) Introduction to Income (Excerpt from Three Versions of Tax Reform; pp. 43-44) 14](#a-introduction-to-income-excerpt-from-three-versions-of-tax-reform-pp.-43-44) [(B) Equivocal Receipt of Financial Benefit (pp. 44-60) 15](#b-equivocal-receipt-of-financial-benefit-pp.-44-60) [(3) The Exclusion of Gifts and Inheritances 20](#the-exclusion-of-gifts-and-inheritances) [(A) Rules of Inclusion and Exclusion (pp. 65-66) 20](#a-rules-of-inclusion-and-exclusion-pp.-65-66) [(B) Gifts 20](#b-gifts) [(C) Bequests, Devises, and Inheritances (pp. 78-86) 22](#c-bequests-devises-and-inheritances-pp.-78-86) [(4) Employee Benefits 24](#employee-benefits) [(A) Exclusion for Fringe Benefits (pp. 89-98) 24](#a-exclusion-for-fringe-benefits-pp.-89-98) [(5) Awards 27](#awards) [(A) Prizes (pp. 108-110) 27](#a-prizes-pp.-108-110) [(B) Scholarships and Fellowships (pp. 110-113) 27](#b-scholarships-and-fellowships-pp.-110-113) [(6) Gain from Dealings in Property (pp. 115-116) 29](#gain-from-dealings-in-property-pp.-115-116) [(A) Factors in the Determination of Gain 29](#a-factors-in-the-determination-of-gain) [(B) Determination of Basis 29](#b-determination-of-basis) [ (4) Property Acquired from a Decedent 32](#property-acquired-from-a-decedent-pp.-131-133) [(C) The Amount Realized 33](#_Toc153386236) [(7) Life Insurance Proceeds and Annuities 36](#life-insurance-proceeds-and-annuities) [(A) Life Insurance Proceeds 36](#_Toc153386238) [(B) Annuity Payments 36](#_Toc153386239) [(8) Discharge of Indebtedness 38](#discharge-of-indebtedness) [(9) Damages and Related Receipts 41](#damages-and-related-receipts) [(A & B) Introduction to Damages in General 41](#_Toc153386242) [(C) Damages and Other Recoveries for Personal Injuries 42](#_Toc153386243) [(10) Separation and Divorce 44](#separation-and-divorce) [(A) Alimony and Separate Maintenance Payments 44](#_Toc153386245) [(B) Property Settlements 44](#_Toc153386246) [(11) Other Exclusions from Gross Income 46](#other-exclusions-from-gross-income) [Tax Expenditures general overview 46](#_Toc153386248) [(A) Gain from the Sale of a Principal Residence 46](#_Toc153386249) [(B) Income Earned Abroad 48](#_Toc153386250) [(C) Exclusions and other Tax Benefits Related to the Costs of **Higher Education** 48](#_Toc153386251) [(D) Federal Taxes and State Activities 50](#_Toc153386252) [Part Three -- Identification of the Proper Taxpayer 51](#part-three-identification-of-the-proper-taxpayer) [(27) Computations 51](#computations) [(A) Tax Rates 51](#_Toc153386255) [(12) Assignment of Income 52](#assignment-of-income) [(A) Introduction 52](#_Toc153386257) [(B) Income from Services (Including a discussion of the "marriage penalty" and "marriage bonus") 52](#_Toc153386258) [(13) Income Producing Entities 54](#income-producing-entities) [(A) Intro 54](#_Toc153386260) [Tax Rates on Income from Pass-Through Entities 55](#_Toc153386261) [Part Four -- Deductions in Computing Taxable Income 56](#part-four-deductions-in-computing-taxable-income) [(14) Business Deductions 56](#business-deductions) [(A) Introduction 56](#_Toc153386264) [(B) The Anatomy of the Business Deduction Workhorse: Section 162 56](#b-the-anatomy-of-the-business-deduction-workhorse-section-162) [(D) Other Business Deductions 60](#d-other-business-deductions) [(E) Depreciation 61](#e-depreciation) [(15) Deductions for Profit-Making, Nonbusiness Activities 64](#deductions-for-profit-making-nonbusiness-activities) [(A) Section 212 64](#_Toc153386269) [(16) Deductions Not Limited to Business or Profit-Seeking Activities 64](#deductions-not-limited-to-business-or-profit-seeking-activities) [(B) Interest 64](#_Toc153386271) [(C) Taxes 66](#_Toc153386272) [~~(17) Restrictions on Deductions~~ 67](#_Toc153386273) [(18) Deductions for Individuals Only 68](#deductions-for-individuals-only) [(A) Extraordinary Medical Expenses 68](#_Toc153386275) [(ABOVE THE LINE OR BELOW THE LINE / MISC): (B) The Concepts of Adjusted Gross Income and Itemized Deductions 70](#_Toc153386276) [(C) Standard Deduction 74](#_Toc153386277) [(D) Personal and Dependency Exemptions 75](#_Toc153386278) [Part Five -- The Year of Inclusion or Deduction 77](#part-five-the-year-of-inclusion-or-deduction) [(19) Fundamental Timing Principles 77](#fundamental-timing-principles) [(A) Introduction 77](#_Toc153386281) [(20) Integrity of the Taxable Years 78](#integrity-of-the-taxable-years) [Part Six -- The Characterization of Income and Deductions 81](#part-six-the-characterization-of-income-and-deductions) [(21) Capital gains and Losses 81](#capital-gains-and-losses) [(A) Introduction 81](#_Toc153386285) [(B & C) The Mechanics of Capital Gains/The mechanics of Capital Losses 81](#_Toc153386286) [(D) The Meaning of "Capital Asset" 81](#_Toc153386287) [(F) The Holding Period 82](#_Toc153386288) [Deductions Affected by Characterization Principles 84](#deductions-affected-by-characterization-principles) [B. The Charitable Deduction and Tax-Exempt Organizations 84](#_Toc153386290) [Part Seven -- Deferral and Nonrecognition of Income & Deductions 88](#part-seven-deferral-and-nonrecognition-of-income-deductions) [26. Nonrecognition Provisions 88](#nonrecognition-provisions) [A. Introduction (pp. 891-893) 88](#a.-introduction-pp.-891-893) [B. Like-Kind Exchanges 88](#b.-like-kind-exchanges) [PART EIGHT -- CONVERTING TAXABLE INCOME INTO TAX LIABILITY 90](#part-eight-converting-taxable-income-into-tax-liability) [27. Computations 90](#computations-1) [A.4. Tax Rates on Net Capital Gains and Dividends 90](#_Toc153386297) [B. Credits Against Tax 90](#_Toc153386298) [SLIDE OF THE BASIC TAX DUE CALCULATION 91](#slide-of-the-basic-tax-due-calculation) []{#_Toc153386208.anchor} Part I - Introduction ===================== (1) Orientation --------------- ### (A & B) A Look Forward/A Glimpse Backward (pp. 3-12) - Tax is a communication - Tax is applied in two primary forms - \(1) an application of tax principles to past events or transactions - \(2) advise on how tax principles will be applied to proposed events or transactions - First internal revenue tax law was established on March 3, 1791 (primarily on alcohol) - The code today contains all the law of a general and permanent character relating exclusively to internal revenue in force on January 2, 1939 this was a codification - Although these changes did not make it "simpler" - Four fundamental Income Tax Questions - \(1) what is taxed? - Threshold question: what is gross income? - What amounts are deductible, excludible, or otherwise not subject to tax? - \(2) when is it taxed? - When is the item included in gross income? - Important in the context of the time value of money and the benefit of deferral - When is a taxpayer allowed to claim a deduction? - \(3) how is it taxed? - Character of item (e.g. ordinary vs. capital gain) - Tax rates - \(4) who is taxed? - Who is the taxpayer with respect to the item? - e.g. baseball - Barry Bonds homerun ball - When is the baseball taxable -- when you recover it or when you sell it? - When you recover it - Mark McGuire Ball - H.R. 4552 ### (C) The Income Tax and the United States Constitution (pp. 12-18) - The federal government's power to tax is derived from Article 1, Section 8, Clause 1 of the Constitution - "Congress has the power to law and collect taxes, duties, imposts and excises" - Congress must impose direct taxes by the rule of apportionment, and indirect taxes by the rule of uniformity - Direct tax a tax demanded from the very person who is intended to pay it - Indirect tax a tax paid primarily by a person who can shift the burden of the tax to someone else or who at least is under no legal compulsion to pay the tax - Rule of apportionment - Applies to direct taxes - Requires that after Congress establishes a sum to be raised through direct taxation, the sum must be divided among the states in proportion to their respective populations - 16^th^ amendment provides that income taxes shall not be subject to the rule of apportionment regardless of the sources from which the taxed income is derived - Income tax is the nature of excise, the government is excising and taking or tis use a portion of the taxpayer's gain - Most taxing statutes are not vulnerable to constitutional attack - The taxing power of the federal government is vested in congress and congress exercises this power by enacting legislation - The exercise of the federal taxing power is by statute and the current statutory regime is the Internal Revenue Code of 1986 - How to approach tax questions: - \(1) what code provisions bear on the problem? - \(2) do the regulations shed any light on their meaning in the setting at hand? ### (D) The Tax Practitioner's Tools (pp. 18-38) - Code: §§ 7805 and 7806 - Legislative Materials - The Internal Revenue Code (Title 26 of U.S.C.), bills, hearings, committee reports, debates, prior laws, treaties - Administrative Materials - Regulations, rulings and other treasury documents, action on decisions - Judicial materials - Tax Court Decisions - The United States Tax Court is a de jure court under the legislative article of the constitution - 3 categories of Tax Court decisions: - \(1) the tax court sits in divisions so that only one of the 19 regular judges hear and decides a case - \(2) the decision may not be officially reported it involves primarily factual determination and the application of settled legal principles - \(3) some officially reported decisions are reviewed by the entire court - District Court Decisions - Court of Federal Claims Decisions - Court of Appeals Decisions - Supreme Court Decisions - Unofficial Tax Materials - ***Mayo Foundation for Medical Education and Research v. United States*** - Facts: - Employers and employees pay social security taxes on wages - But wages earned by students (incident to their studies) are exempt from social security taxes - In 1998, the eighth circuit held that the social security administration (SSA) could not categorically exclude medical residents from student status because its regulations required a case by case approach - In 2004 the treasury adopted a new regulation re*: when work is incident to a student's studies* - RULE: An employee's service is incident to his studies only when the educational aspect of the relationship between the employer and the employee, as compared to the service aspect of the relationship, is predominant - The services of a full time employee are not incident - Debate over whether medical residents fall under the student exemption to SSA taxes - *[Rule]* **where congress has expressly authorized an agency to promulgate administrative regulations, a regulation promulgated pursuant to that authority is entitled to deference by the courts** - Holding *Chevron U.S.A., Inc. v. Natural Resources Defense Counsel, Inc*. - The statute is silent or ambiguous on the question whether a medical resident working for the school full-time is a student for purposes of section 3121(b)(10) and the treasury's amended regulation is a permissible interpretation of the statute - *National Muffler* allows courts to afford an agency less deference in certain contexts, such as where that agency's interpretation of the law has been historically inconsistent - Court follows Chevron deference - We have found such express congressional authorization to engage in the process of rulemaking to be a very good indicator of delegation meriting Chevron treatment ### (E) The Road Ahead (pp. 38-40) & Excerpt on Tax Policy - Three long-standing criteria to evaluate tax policy *equity, economic efficiency, and simplicity/transparency/administrability* - [Equity] - Ability to pay those who are more capable of bearing the burden should pay more taxes - Relating to wealth, income, or consumption - Some argue consumption provides a better measure of a taxpayer's ability to pay - Benefits received principle - A useful way of thinking about equity in the tax system is the taxpayers ability to pay and who receives the benefits of the tax system - [Horizontal equity] taxpayers who have a similar ability to pay taxes receive similar tax treatment (e.g. owning vs. renting a home) - [Vertical equity] how do you tax people with different levels of income relative to each other (e.g. progressive tax rates, proportional tax rates, regressive tax rates) - Progressive tax rates tax liability as a percentage of income increases as income increases - Proportional tax rates taxpayers pay the same percentage of income, regardless of the size of their income - Regressive tax rates the tax liability becomes a smaller percentage of a taxpayer's income as their income increases - **Marginal statutory tax rates** the tax rate that a taxpayer pays on his or her next dollar of income earned as defined by law in the tax code - **Marginal effective tax rates** the actual rate of tax that a taxpayer faces on the next dollar of income earned when all other provisions of the tax (deductions, credits, etc... ) are included - **Average effective tax rates** the overall rate of tax a taxpayer pays as a percentage of his or her total income after all other provisions of the tax system (deductions, credits, etc.) are included - [Economic efficiency] - Tax code should interfere as little as possible with people's economic decisions - Minimizing efficiency costs is one criterion of a good tax, but the goal of tax policy is not to eliminate efficiency costs - **Tax liability + efficiency cost + compliance burden = total cost of a tax to taxpayer** - Equity concerns may force a trade-off between fairness and equity - Inefficiencies reduce the economic well-being of people in the aggregate, since resources are not direct to their highest valued uses - The tax preference for owner-occupied housing promotes the social goal of increased home ownership - [Simplicity, transparency, and administrability] - Compliance costs include the value of time and resources devoted to: (1) record keeping; (2) learning about requirements; (3) preparing and filing tax returns; and (4) responding to IRS notices and audits - Transparent tax systems include: - Taxpayers can easily calculate their liabilities - Taxpayers can grasp the logic behind tax laws and tax rates - Taxpayers know their own tax burden and the tax burden of others - Taxpayers are aware of the extent of compliance by others - Administrability government's ability to collect taxes as cost effectively as possible - Administering a tax system includes: - Processing tax returns and payment - Enforcing the tax code - Providing taxpayer assistance (28) Procedure and Professional Responsibility ---------------------------------------------- ### (A) Overview of Federal Tax Procedures *(1 & 2) Intro/The Self-Assessment System* (pp. 967 -- 969) - Code: §§ 6011(a); 6072(a); 6081(a) - Procedures which underly the collection of tax - U.S. has a "voluntary tax system" -- self-assessment - Burden on the taxpayer to calculate how much they owe and pay it - As opposed to the state property tax - The county, based on the information it has, sends you a bill based on how much it think your property is worth - **§ 6072** - The date for filing your tax return is April 15 - Mailing it in counts as timely filing - **§ 7503** - If a due date is a Saturday, Sunday, or any legal holiday recognized in DC, the due date is extended to the next day that is not a Saturday, Sunday, or legal holiday recognized in DC *(3 & 4) Administrative Procedures/Judicial Process* (pp. 969-981) - Code: §§ 6213(a); 6501(c)(4); 7463(a); 7482(a), (b)(1); Notes §§ 7430 and 7491 - In terrorem affect of IRS audits - Types of audits - Correspondence audits - Office examination - Field examination - Disputes with the auditor/disagree with the IRS - **90-day letter** -- has official relevance - Notice of deficiency -- legally owe the amount assessed against you - Have 90 days to petition the US tax court and have them review it - Redetermination of the asserted deficiency - Can do forum shopping because the tax court is not the only avenue, however, it is the only prepayment avenue (other methods require you to pay then sue for a refund in a district court or federal court of claims) - Official at the end of the 90 day period and the taxpayer owes it - Tax court - 90-day letter is the (only) ticket to the tax court - Article 1 court - HQ in DC - 19 judges who periodically travel across he country - Tax law experts - No jury - Prosecuting attorneys are from the IRS - Small case procedure - cannot appeal - Regular tax court decisions can be appealed - Appeals go to the appellate court in which the taxpayer resides - **Golsen Doctrine** - Tax court is its own independent judicial body not bound by the circuit courts - If there is tax court precedent, court follows that precedent - Only bound by the circuit court to which the case is appealable, if the circuit court has ruled on the issue - Interest accrues - Could just pay what the IRS says you owe - Then sue the government for a refund - Can sue in: - Federal District Court - Jury Trial - Court of Federal Claims - Judges have some technical expertise as some hear many tax cases - Ct of Appeals for Federal Circuit is the higher level court, so this is the precedent that must be followed - If pay, can stop interest from accruing ##### §6603 \-- can pay deposit for IRS to hold before paying fully paying the entire deficiency - Refund controversies - Refund claim - Form 1040x or amend Form 1040 - *Welch v. Helvering* (pp. 978-979) rebuttable presumption that the commissioner's determination of tax liability is correct - Regardless of the forum chosen, TP generally has to provide that the commissioner's determination was incorrect and to establish the TP's claim by a preponderance of the evidence - Unless the code otherwise allocates the burden of proof, the commission in any court proceeding involving an individual has the burden of proof with respect to factual issues if certain requirements are met - District Court - Must pay the alleged deficiency and sue the government for a refund - Stops interest from accruing - Access to a jury trial - Forum shopping not an option - Tax court follows controlling precedent from the circuit in which the TP resides - Court of Federal Claims - Must pay the alleged deficiency and sue the government for a refund - Stops interest from accruing - Based in DC - Can appeal to the court of appeals of the federal circuit - Forum shopping - Judges have some technical expertise (hear many tax cases) - Limitations to take into account - Statute of limitations for an amended return is three years from the date it was due - Government has three years to come after you - If close to the deadline, the IRS will ask for an extension (Form 872**)** -- usually in TP's best interest to agree (for the sake of negotiations) - Problem 1 pp. 987 - Forum questions ##### If no money to pay deficiency - ##### Probably go straight to the tax court ##### § 6694 - Penalties for understatement by tax preparer - ##### Tax attorneys could possibly be treated as tax preparer if giving significant legal advice that come into play - ##### No penalty: - \"Substantial authority\" for position - ##### Penalty - No disclosure - Disclosure - No penalty IF there\'s a \"*reasonable basis*\" for the position ##### Treasure Regulation (TR) § 1.6662-4 ### (B) Special Rules Applicable to Deficiency Procedures #### (1) Timing Rules, Interest, and Penalties (pp. 988-992) - [Code]: §§ 6501(a), (b)(1), (c)(1), (3), (4) & (e)(1)(A); 6503(a)(1); 6601(a)(2); 7502(a)91), (b), (f). Note §§ 6651; 6663; 7201; 7203; 7206 - The IRS generally must assess any amount of alleged underpayment within 3 years after a TP files the TP's return for a year, whether or not it was timely filed - If filed before the due date, it is deemed to be filed on the last possible day on which it can be timely filed - The 3 year period is extended to 6 years if the TP has omitted gross income in excess of 25 percent of the gross income reported on the return - Penalty is five percent of the tax per month - **Uniform accuracy-related penalty** - 20 percent of the portion of the TP's underpayments attributable to such actions (negligence, reckless/intentional disregard, substantial understatement or misstatement) - The amount of the underpayment of tax subject to the accuracy-related penalty is reduced by the portion attributable to (1) the tax treatment of item if there was or is substantial authority for such treatment, or (2) an item adequately disclose in the return or statement attached to the return if there is a reasonable basis for TP's tax treatment of the item - **Reasonable basis** - Relatively high standard that is significantly higher than not frivolous or patently improper - More than merely arguable/colorable - **Substantial authority** - Higher than reasonable basis standard but not as stringent as more likely than not - Weight of the authority supporting the position must be substantial in relation to the weight of authorities on the other side ### (C) Special Rules Applicable to Refund Procedures (pp. 996-1000) - [Code]: §§ 6511(a), (b); 6513(a); 6611(a); 6621(a)(1); 7502(a), (b), (f) - Excessive withholding from a taxpayer's salary or wages is treated as an overpayment for these purposes - In the course of an audit a taxpayer may make a payment against the amount of a prospective deficiency to stop the running of interest - *Statute of limitations* - A refund claim generally must be filed within the later of 3 years after the return was filed (again an early filing is deemed filed on the due date) or within 2 years of the date on which the tax was paid - A taxpayer is entitled to an income tax refund only if the taxpayer has in fact overpaid tax for that year - Refunds are different from ***recoupment*** different tax treatment to the same transaction in a different year or years - *Interest* - A taxpayer may be entitled to be paid interest at the overpayment rate on an overpayment of tax - Overpayment rate federal short-term rate plus 3 percentage points (same as under payment rate) - Interest on overpayment accrues from the date of overpayment to a date preceding the date of the refund check by not more than 30 days (29) Professional Responsibility Issues --------------------------------------- - [Code]: § 6694 - [Regulations]: §§ 1.6662-4(d)(1), (2), (3)(i), (ii), (iii) (p. 1830) - **Circular 230** contains rules governing the practice of attorneys, CPAs, and others before the IRS - Competent practice requires the appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged - Standards for Advising a Client with Respect to a Tax Return how aggressive can you be? - **Formal Opinion 314** an attorney may urge a client to take the position most favorable to the client on a tax return as long as there is a reasonable basis for the position - **Formal Opinions 85-352** - Revised Formal Opinion 314 - An attorney may advice the statement of positions most favorable to the client if the lawyer has a good faith belief that those positions are warranted in existing law or can be supported by a good faith argument for an extension, modification or reversal of existing law - Good faith requires some realistic possibility of success if the matter is litigated, but an attorney does not have to believe that the client's position will ultimately prevail in order to urge the client to assert it on a tax return - Circular 230 asserts a different standard an attorney may not advise a client to a take a position on a return that: - \(1) lacks a reasonable basis; - \(2) is an unreasonable position as described in Section 6694(a)(2); or - A position is unreasonable unless there is or was substantial authority for the position, or it is properly disclosed and there was a reasonable basis for the position - \(3) is a willful attempt by the attorney to understate the liability for tax or a reckless or intentional disregard of rules or regulations by the attorney as described in Section 6694(b)(2) - Problem pp. 1005 Part 2 -- Identification of Income Subject to taxation ====================================================== (2) Gross Income: The Scope of Income Taxation ---------------------------------------------- ### (A) Introduction to Income (Excerpt from *Three Versions of Tax Reform*; pp. 43-44) - Code: **§ 61** Gross Income Defined (pp. 60) - Three Versions of tax Reform: Improving an Existing tax Base - **Haig-Simons** definition of Income personal income may be defined as the algebraic sum of: (1) the market value of right exercised in consumption; and (2) the change in value of the store of property rights between the beginning and end of the period in question - In other words, it is merely the result obtained by adding consumption during the period to wealth at the end of the period and then subtracting wealth at the beginning - The *sine qua non* of income is gain, as our courts have recognized in their more lucid moments -- and gain to someone during a specified time interval - Hypo: - On Jan. 1 I have \$100,000 and on December 31 I have \$125,000 - Is my income \$25,000? Most likely not because this does not include expenses - This just represents the increase in savings without taking into account what I spent on housing, food, vacation... - Simply an increase in net worth - Consumption's role - I spent \$20,000 on expenses from January 1 to December 31 - Combine the \$20,000 spent on expenses plus the extra \$25,000 savings to arrive at \$45,000 in income - Under Haig-Simons, my income for some is the change in net worth/savings plus the amount of consumption that occurred during that period - Tax code does not follow Haig-Simons exactly - I bought a home for \$200,000 on Jan. 1. At the end of the year my neighbor sold her home, which is identical to mine, for \$250,000 - My net worth increased by \$50,000 - Under Haig-Simons, I have \$50,000 in economic income - Under the US tax system, do not include change in value of assets that we already own whose value fluctuate in our income wait until a realization event (typically a sale) occurs and then include the gain or loss in your income - Taking possession of an item (think homerun baseball) is a realization event - But once you have the asset, ignore the fluctuations until you sell it ### (B) Equivocal Receipt of Financial Benefit (pp. 44-60) - Code: **§ 61** Gross Income Defined (pp. 60) - Regulations: **§§ 1.61-1(a)** (pp. 918); **1.61-2(a)(1)**, **-2(d)(1)** (pp. 919); **1.61-14(a)** (pp. 923) - ***Cesarini v. United States*** - [Issue]: whether money found in a piano should be included in gross income - Starting point in determining whether an item is to be included in gross income is Section 61(a) gross income means all income from whatever source derived, including (but not limited to) the following... - Part III of subchapter B (sections 101 and following) deals with items specifically excluded from gross income, and found money is not listed in those sections either - The absence of express mention is any of the code sections requires a return to the "all income from whatever source derived" language of 61(a) and the express statement that income is not limited to the following fifteen examples - Regulation **§ 1.61-1(a)** Gross Income, reiterates this broad construction gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services - Revenue Ruling 61 **the finder of treasure-trove is in receipt of taxable income... for the taxable year in which it is reduced to undisputed possession** - Regulation **§ 1.61-14(a)** Miscellaneous Items of Gross Income in addition to the items enumerated in section 61(a), there are many other kinds of gross income. **Treasure Trove, to the extent of its value in US currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession** - Statute of limitations argument argued by TP - Problems of when titles vests or when possession is complete in the field of federal taxation, in the absence of definitive fed. Legislation, are determine by reference to the law of the state in which the taxpayer resides here, Ohio law applies - No relevant law in Ohio exists re: rights of finders common law applies so that "title belongs to the finder as against all the world except the true owner" - In Ohio, P must have actually found the treasure to have superior title over it they did not discover the money until 1964 - Ps did not reduced the money to their undisputed possession until they found it in 1964 - ##### *Old Colony Trust Co. v. Commissioner* - *[Issue]*: did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee? - *[Holding]*: **the payment of the tax by the employers was in consideration of the services rendered by the employee and was a gain derived by the employee form his labor** - The discharge by a third person of an obligation to him is equivalent to a receipt by the person taxed - The taxes were paid upon a valuable consideration, the services rendered by the employee as part of the compensation therefor. We think therefore that the payment constituted income to the employee - ##### *Commissioner v. Glenshaw Glass Co.* - *[Issue]*: whether money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble-damage antitrust recovery must be reported by a taxpayer as gross income under § 22(a) of the IRC - **§ 22 Gross Income (old version of section 61)** - Glenshaw Glass important for interpreting section 61, because congress made it clear they did not intend to make any substantive changes in 1954 - Congress applied no limitations as to the source of taxable receipts, nor restrictive labels as to their nature - The court has given a liberal construction to this broad phraseology in recognition of the intention of congress to tax all gains except those specifically exempted - Here we have instances of **undeniable accessions to wealth, clearly realized, and over which the taxpayers have [complete dominion] (!!)** - **Punitive damages are income** - The definition of gross income has been simplified, but no effect upon its present broad scope was intended - Certainly punitive damages cannot reasonably be classified as gifts, nor do they come under any other exemption provision in the code - ***Charley v. Commissioner*** - *[Issue]*: do travel credits converted to cash in a personal travel account established by an employer constitute gross income to the employee for federal income tax purposes? - Here, TP converted the miles to cash - The statute at issue, § 61, provides that gross income means all income from whatever source derived - *Commissioner v. Glenshaw Glass Co.* **gross income has been defined as a undeniable accession to wealth, clearly realized and over which the taxpayer has complete dominion** - The case can be analyzed in two ways - \(1) the travel credits which were converted to cash can be characterized as additional compensation - \(2) if it is assumed that the frequent flyer miles were not given to Philip by Truesdail, but belong to him all along, then the transaction can be viewed as a disposition of his own property - Gross income includes gains derived from dealings in property - Because Philip received the frequent flyer miles at no cost, he had a basis of zero. He then exchanged his frequent flyer miles for cash, resulting in a gain of \$3,149.93 (the fair market value of the property received minus the adjusted basis of zero) - Under the current facts, the travel credits were taxable income - [Notes] - **Loans are not taxable income** loans are based on concurrently acknowledged obligations to repay which, offsetting the receipt, negate any accession to wealth - A security deposit may be likened to a loan for tax purposes - If borrower has no intent to repay the loan and the lender is unaware of that fact, it is not a loan but an illegal appropriation of the would-be creditor's property and is income under section 61 - ***James v. U.S.*** **illegal income is taxable** - [Problems] (skip problem 5) - \(1) Would the results to the taxpayers in *Cesarini* be different if, instead of discovering \$4,467 in old currency in the piano, they discovered it was the first Steinway piano every built and is worth \$500,000? - No - \(2) winner attends the opening of a new department store and all persons attending are given free raffle tickets for a watch worth \$200. Disregarding any application of section 74, must winner include anything within gross income when she wins the watch in the raffle? - Yes winning a watch is accession to wealth (*Glenshaw Glass*) - \(3) employee has worked for employer's incorporated business for several years at a salary of \$80,000 a year. Another company is attempting to hire employee but employer persuades employee to agree to stat for at least two more years by giving employee 2% of the company's stock, which is worth \$100,000, and by buying employee's spouse a new car worth \$30,000. How much income does employee realize from all of these transactions? - The fair market value of the car (30k) and of the stock (100k) \$130,000 - \(4) insurance adjuster refers clients to an auto repair firm that gives adjuster a kickback of 10% of billings on all referrals - \(a) does adjuster have gross income? Yes - \(b) even if the arrangement violates local law? Yes - \(6) flyers receives frequent flyer mileage credits in the following situations/ Should flyer have gross income? - generally, when an individual purchases a plane ticket and receives frequent flyer miles, the individual is in a sense purchasing frequent flyer miles and there is no accession to wealth in this plain vanilla case - However, when you fly for your company and the company pays for the flight, the individual still generally receives the frequent flyer miles - In this scenario, you are not buying the frequent flyer miles (*Glensahw*) - Politically, it is difficult for the IRS - 2002 notice -- due to various issues, such as determining their value, the IRS announces it will not pursue anyone who uses frequent flyer miles received from business travel - Exception if you are converting these benefits to cash or there are circumstances in which you engage in some form of tax avoidance (*Charlie*) - \(a) flyer receives the mileage credits as part of a purchase of ticket for a personal trip. The credits are assignable. - yeah - \(b) flyer receives credits from the airlines for business flights paid for by the employer. The credits are assignable. - Yeah? -- indirect compensation for services - \(c) flyer receives the credits under the circumstances of (b) above, but they are not assignable. - No because no control over it ?? - maybe - \(d) same as (c) above, except flyer uses the non-assignable credits to take a trip - Indirect compensation for services - \(e) flyer opens a bank account, receives 50,000 thank you points from bank, and redeems the points for a flight valued at \$650 - Yes? - *(C) Income without Receipt of Cash or Property* (pp. 57-58) - Code: **§ 61** - Regulations: **§§ 1.61-2(a)(1), -2(d)(1)** - ***Helvering v. Independent Life Ins. Co.*** - *[Issue]*: whether a taxpayer must include in gross income the rental vale of a building owned and occupied by the taxpayer - If the statute lays taxes on the part of the building occupied by the owner or upon the rental value of that space, it cannot be sustained for that would be to lay a direct tax requiring apportionment - The rental value of the building used by the owner does not constitute income within the meaning of the sixteenth amendment **the rental value of a building occupied by its owner is not taxable as gross income** - ***[Imputed income]*** the value of what you do for yourself - **IRS does not include imputed income in gross income** - Hypo where taxing imputed income appears realistic (equity considerations) - Couple 1: both work outside the home and make a combined \$100,000 - Couple 2: one spouse works outside the home while the cares for the home - The spouse who works outside the home makes \$90,000 - The other spouse ensures a clean house - The couples are similarly situated but couple 1's starting pint for taxation is \$100,000 while couple 2's is \$90,000 - How do we address this inequity? - Deductions for personal type expenditures - Tax the value of the second spouse's house chores - ##### *Revenue Ruling 79-24 (FMV for services / property in exchanges)* - Per regulation **§ 1.61-2(d)(1),** if services are paid for other than in money (no receipt), the fair market value of the property or services taken in payment must be included in gross income - [Situation 1] - Lawyer performs legal services for a painter who in exchange, paints the lawyer's personal residence - The fair market value of the services received by the lawyer and the housepainter are includable in their gross income under section 61 - [Situation 2] - Owner of an apartment building provides a rent-free apartment to an artist in exchange for a work of art - The fair market value of the work of art and the six months fair rental value of the apartment re includable in the gross incomes of the apartment owner and the artist under section 61 - Problem 2 pp. 59 doctor needs to have his income tax return prepared. Lawyer would like a general physical checkup. Doctor would normally charge \$200 for the physical and Lawyer would normally charge \$200 for the income tax return preparation. - \(a) what tax consequences to each if they simply swap services without any money changing hands? - Reasonable value of the services (\$200) must be included in the gross income for both - \(b) does lawyer realize any income when she fills out her own tax return? - No, this is **imputed income** (*Helvering*) (3) The Exclusion of Gifts and Inheritances ------------------------------------------- ### (A) Rules of Inclusion and Exclusion (pp. 65-66) - Code: §§ 102(a) & first sentence of (b) - Regulation: § 1.102-1(f) (proposed) - Under *Glenshaw Glass*, what you receive as a gift or as inheritance appears to be income - However, this is not the case **102(a) gross income does not include the value of property acquired by gift, bequest, devise or inheritance** - The transferor does not get to include the gift as a deduction - Transferor must be aware of possible gift tax issues ### (B) Gifts - #### The Income Tax Meaning of Gift (pp. 66-76) - Code: § 102(a) - [Rules]: - ##### To determine if gift, trier of fact will look at the situation and the relevant facts to determine whether or not truly a \"gift\" - ##### Look to the intent of the donor... defer heavily to trier of fact - ##### Gift needs \"detached disinterested giving\" - Not any benefit - Key example: giving to your kid - ***Commissioner v. Duberstein*** - [Issue]: whether a specific transfer to a taxpayer amounted to a gift to him within the meaning of the statute - Situation 1: Gift of a Cadillac for pointing someone towards clients - Situation 2: Trinity Church corporation gave its former comptroller \$20,000 and characterized the severance as a gratuity - The present situations are great examples of issues that arise they present situations in which payments have been made in a context with business overtones -- an employer making a payment to a retiring employee; a businessman giving something of value to another businessman who has been of advantage to him in his business - The court has indicated that a voluntary executed transfer of his property by one to another, without any consideration or compensation therefor, though a common-law gift, is not necessarily a gift within the meaning of the state - - **The mere absence of a legal or moral obligation to make such a payment does not establish that it is a gift** - **A gift in the statutory sense proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses and in this regard, the most critical consideration is the transferor's intention** - Problems pp. 76 - \(2) at the Heads Eye Casino in Vegas, Lucky gives the maître d' a \$50 tip to assure a good table and give the croupier a \$50 token after a good night with the cubes. Does either the maître d' or the croupier have gross income? - Both have gross income of \$50 - #### (2) Employee Gifts (pp. 76-78) - Code: § 102(c) - Regulation: § 1.102-1(f) (proposed) - The message of Section 102(c)(1) an employee shall not exclude from gross income any amount transferred by or for an employer, to, or for the benefit of, an employee - The fair market value of an employee award is includible in the employee's gross income under section 67, and is not excludable under sections 74 or 102 - [Exception] - The regulations recognize that to tax all transfers from an employer to an employee would be unfair, and they carve out an exception for extraordinary transfers to the natural objects of an employer's bounty if the employee can show that the transfer was not made in recognition of the employee's employment - Under section 132(e) certain traditional retirement gifts are treated as de minimis fringe benefits - Under section 74(c) certain employee achievements awards are freed from tax - Section 274(b)(1) generally limits the deductible amount of business gifts to \$25 per done per year but it defines the term gift with minor exceptions, as items excludable from the recipient's gross income under section 102 - As employee gifts are now includable in gross income under 102(c), they are not subject to section 274(b)(1) and the ceiling is only applicable to non-employee business gifts - Problem 3 pp. 78 Employee receives a \$5,000 trip on employee's 50^th^ birthday. To pay for the cost of the trip, employer contributed \$2,000, and fellow employees of employee contributed \$3,000. Does employee have gross income? - the \$2,000 from the employer is gross income 102(c) kicks in - the \$3,000 from fellow employees may be a gift, focus on who is giving the gift - If think you may be given to later; or employee makes you, NOT A GIFT - If just doing it out of admiration of the fellow employee: PROBABLY A GIFT ### (C) Bequests, Devises, and Inheritances (pp. 78-86) - Code: § 102(a), (b) and (c) - Regulation: § 1.102-1(a), -1(b) - Rules: §102 -- GI doesn't count for gifts, bequests, devises, and inheritances -- SUBJECT TO EXCEPTIONS (OR IF DOESN'T SEEM LIKE GIFT/INHERITANCE and just compensation) - ***Lyeth v. Hoey*** - [Issue]: whether property received by petitioner from the estate of a decedent in compromise of his claim as an heir is taxable income whether property received by an heir from the estate of his ancestor is acquired by inheritance, when it is distributed under an agreement settling a contest by the heir of the validity of the decedent's will - **The amount received by an heir under an agreement compromising a contest of his ancestor's will is considered to fall under the exemption of 102(a)** - ***Wolder v. Commissioner*** - [Issue]: whether an attorney contracting to and performing lifetime legal services for a client receives income when the client, pursuant to the contract, bequeaths a substantial sum to the attorney in lieu of the payment of fees during the client's lifetime - The contract on effect was one for the postponed payment of legal services by a legacy under the will for services rendered during he decedent's life - ***Duberstein* *the court held that the true test is whether in actuality the gift is a bona fide gift or simply a method for paying compensation*** - **The congressional purpose is to tax income comprehensively. A transfer in the form of a bequest was the method that the parties chose to compensate Mr. Wolder for his legal services and that transfer is therefore subject to taxation, whatever its level whether by federal or by local law may be** - Problems pp. 86-87 skip1(i), 2, and 3 - \(1) consider whether is likely that § 102 applies in the following circumstances - \(a) Father leaves Daughter \$20,000 in his will 102 applies - \(b) Father dies intestate and Daughter receives \$20,000 worth of real estate as his heir 102 applies - \(c) Father leaves several family members out of his will and Daughter and the others attack the will. As a result of the settlement of the controversy Daughter receives \$20,000 102 applies (*Lyeth*) - \(d) Father leaves Daughter \$20,000 in his will stating that the amount is in appreciation of Daughter's long and devoted services to him - 102 can still possibly apply - Generic references to loving daughter - Was there an actual agreement? - \(e) Father leaves Daughter \$20,000 pursuant to a written agreement under which Daughter to care for Father in his declining years this is income and 102 dos not apply - \(f) same agreement as in (e), above, except that Father died intestate and Daughter successfully enforced her \$20,000 claim under agreement against the estate income, 102 does not apply - \(g) same as (f) except that Daughter settles her \$20,000 claim for a \$10,000 payment income, 102 does not apply - \(h) Father appointed Daughter executrix of his estate and Father;s will provided Daughter was to receive \$20,000 for sevices as executrix income, 102 does not apply (4) Employee Benefits --------------------- ### (A) Exclusion for Fringe Benefits (pp. 89-98) - Code: § 132 - Regulations: §§ 1.132-1(b)(4); 1.132-2(a)(1). (2) & (3); 1.132-6(d)(2)(i); 1.132-6€(1); 1.132-8(a)(1), -8(a)(2)(i) - [Fringe benefits] e.g. retail employee receives a discount, employer pays for parking... - Starting point is § 61, everything is included - Next, § 132 addresses fringe benefits not required to be included in gross income (primary statute addressing fringe benefits) - § 119 addresses meals and lodging that need not be included - **132(a)** exclusion from gross income -- gross income shall not include any fringe benefit which qualifies as a: - [(1) no-additional-cost service]; - e.g. airline or railroad seats and hotel rooms furnished to employees, if they are working in those respective businesses, in a way that does not displace non-employee customers, and free telephone service to telephone employees within existing capacity of the employer company Reg. § 1.132-2(a)(2) - reciprocal agreements are also allowed if the services in question are in the employee's line of business Code §§ 132(i), 132(b)(1) & Reg. § 1.132-2(b) - [(2) qualified employee discount]; - Courtesy discounts - Property capped at the profit on the good and services capped at 20% § 132(c)(1) - [(3) working condition fringe]; - § 132(d) - E.g. use of a company car for business purposes, on the job training provided by the employer... - § 132(j)(3) auto-salesman use of an employee-provided demo car - [(4) de minimis fringe]; - § 132(e) - E.g. occasional personal use of company copy machine, free coffee - [(5) qualified transportation fringe]; - §132(f) - E.g. transit pass, token card, qualified parking - [(6) qualified moving expense reimbursement]; - [(7) qualified retirement planning services] - § 132(j)(4) athletic facilities - For 132(a)(1) & (2), the definition of an employee is expanded to include not only persons currently employed but also retired and disabled ex-employees and the surviving spouses of employees or retired or disabled ex-employees as well as spouses and dependent children of employees 132(h) - Concern re: disproportionate share of tax free fringe benefits going to higher paid individuals **§ 132(j) anti-discrimination provision** - Qualified Employee Discounts (I.R.C. §132(c): - Can exclude - For services \-- up to 20% of the price of the service - For property \-- Gross Profit Percentage - De minimis Fringe (I.R.C. § 132(e)) - 1(n) \-- §132(a)(8) - Qualified Transportation Fringe - Can exclude if parking near building BUT not residential purposes - Discrimination only applies §132(a)(1) & (2) \-- no additional cost services / qualified employee discounts - Limited to \$175 \-- per month - Problem 1 pp. 97 skip 1(g), (h), (j), (k), (o), & (p) consider whether or to what extent the fringe benefits listed below may be excluded from gross income and, where possible, support your conclusion with statutory authority - \(a) employee of a national hotel chain stays in one of the chain's hotels in another town rent-free while on vacation. The hotel has several empty rooms - 132(a)(1) as defined in 132(b) - Empty rooms so this is allowed - \(b) same as (a) except that the desk clerk bounces a paying guest so employee can stay rent-free **reg. § 1.32-2(a)(2)** and (5) (pp. 973) - Because you kicked out paying customers, do not qualify for 132(a)(1) - \(c) same as (a) except that employee pays the bill and receives a cash rebate from the chain **reg. §1.132-2(a)(3)** (pp. 973) - rebates are also excludable - \(d) same as (a) above except that employee's spouse and dependent children travelling without employee use the room on vacation - Certain individuals treated as employees for purposes of subsection 132(a)(1) and (2) 132(h) - 132(a)(1) applies - Additional problem X, airline employee's wife uses voucher to fly stand-by on a flight which would regularly cost \$500 132(a)(1) applies - Additional problem Y, same as X but voucher is used by a sibling 132(h) does not include siblings and thus 132(a)(1) does not apply - Additional problem Z, same as X but voucher is used by a parent 132(h)(3) has a specific carve out for parents in the case of air transportation - \(e) same as (a) except employee stays in the hotel of a rival chain under a written reciprocal agreement under which employee pays 50% of the normal rent - Reciprocal agreements allowed under 132(i) - \(f) same as (a) except employee is an officer in the hotel chain and rent-free use provided only to officers of the chain and all other employees pay 60% of the normal rent reg. **§ 1.132-8(a)(2)(i)** - Anti-discrimination rule and vertical equity issues - 132(j) only applies to 132(a)(1) and (2) - \(i) employee sells insurance and employer insurance company allows employee 20% off the \$1,000 cost of the policy 132(a)(2) - \(l) employer has a bar and provides the employees with happy hours cocktails at the end of each week's work reg **§§ 1.132-6(b)** (pp. 981) and **reg. § 1.132-6(e)(1) (pp. 982)** - \(m) employer gives employee a case of scotch each Christmas **reg. § 1.132-6(e)(1)** - \(n) employee is an officer of corporation which pays employee's parking fees at a lot one block from the corporate HQ. Non-officers pay their own parking fees. Assume there is no post-2001 inflation - 132(a)(5) qualified transportation - 132(f) qualified transportation fringe - 132(f)(2) places a \$175 cap on parking - After 2017, no qualified deduction for parking - Anti-discrimination doesn't really apply here - **[Random Exceptions]:** - Code § 79 life insurance premium - Premiums on group life policy up to \$50,000 can be deducted - Code § 106 employer sponsored health insurance does not need to be included in employee's gross income - Code § 107 allows exclusion in case of a minister of the gospel -- gross income does not include the value of a house or parsonage provided by the church (5) Awards ---------- ### (A) Prizes (pp. 108-110) - Code: §§ 74; 274(j); Note §§ 102(c), 132(a)(4), (e) - Reg: §§ 1.74-1(a), -1(b), -1(c)(1) (proposed) - 74(b) old version allowed for prizes such as the Nobel prize to go untaxed, but today the prize has to be donated to the government or a charitable organization - **[74(a): GENERAL RULE]:** Except as otherwise provided in this section or in section 117 (relating to qualified scholarships), gross income includes amounts received as prizes and awards. - The only way to exclude the prize is if you prematurely give it away - REMEMBER: Oprah giving away Pontiac cars (marketing scheme) - [Exceptions]: - I.R.C. §74(c) - Exception for Certain Employee Achievement Awards: - If nominal award for certain employee achievement, do not have to include (excluded) - i.e. Congrats for working X years, here\'s \$X) - I.R.C. §74(d) - Exception for Olympic and Paralympic Medals and Prizes - Does not count for value of medal awarded or prize received AND money from US Olympic Committee for competition - Exception \-- if total T.I. exceed \$1,000,000 - Half of such amount if MFS ### (B) Scholarships and Fellowships (pp. 110-113) - Code: §§ 117; 127(a), (b)(1), (c)(1) - Reg. §§ 1.117-6(b), -6(c)(1)-(4), -6(d)(1)-(3) - (a): Gross income does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization... ##### Note: doesn\'t include room and board [PROBLEMS] 1. Student working toward an A.B. degree is awarded a scholarship of \$15,000 for full tuition and for room and board during the academic year. The tuition, including the cost of books, is \$10,000 and the room and board costs \$5,000. As a scholarship recipient, Student is required to do about 300 hours of research for the professor to whom he is assigned. Nonscholarship students, if hired, receive \$10.00 per hour for such work. a. What tax consequences to student? i. Not gross income for student (IRC §117) but limitation (§117(c)) \-- payment for research as a condition... (300 hrs \* \$10 = \$3,000) \[depends on what it is tied to \-- tuition or board?\] ; also doesn\'t count for room and board (\$5,000) \-- so \$8,000 gross income? \-- the rest is excludable (\$7,000 excluded) - \[if scholarship is tied to the room & board then still only \$5,000 has to be included\] b. What tax consequences to Student if all students are required to do 300 hours of research for faculty? i. Same thing regardless of if all services are required of all persons (p.110 of book) \-- in the proposed regulations allegedly c. What result if Student is not required to do any research but receives the \$15,000 as an athletic scholarship i. Excluded \[note, still just the tuition and books, not the whole room and board\] (proposed)? d. What tax consequences to Student if Students receives only a tuition scholarship worth \$9,000 (no books) because Student\'s spouse is an employee at a neighboring educational institution and the tuition scholarship is part of a nondiscriminatory plan between several institutions applicable to all employees of such institutions? i. Under \$5,250 of educational assistance (§127(a)(2)) \-- must be written, nondiscriminatory \-- counts for spouses because §132(h) def of employee (6) Gain from Dealings in Property (pp. 115-116) ------------------------------------------------ ### (A) Factors in the Determination of Gain - Code: §§ 1001(a), (b),(c); 1011(a); 1012 - Reg: § 1.1001-1(a) - Cost recovery how do we reconcile the fact that you invested money, now that you are experiencing returns on that investment? - Basis the unrecovered investment you have in that property from a tax perspective - how much do I have in it? - Basis is not value - If a property purchased at \$10,000 increases to \$15,000, the value is \$15,000 while the basis remains at \$10,000 - Generally: **Gain (loss) = Amount realized -- adjusted basis** ##### Amt realized = Cash + FMV of property ##### "Recognize": including in GI ### (B) Determination of Basis - *(1) Cost as Basis* (pp. 119-120) - Code: §§ 1011(a); 1012; 1016(a)(1) - Reg: § 1.61-2(d)(2)(i); 1.1012-1(a) - In most situations, a taxpayer's acquisition basis in property is the cost basis determined when the property is purchased - The concept of cost generally includes amounts paid as transaction costs to facilitate the acquisition - E.g. attorney's fees and broker's commission are included in the cost of a purchase of land [PROBLEMS] 1. Owner purchases some land for \$10,000 and later sell it for \$16,000. a. Determine the amount of Owner\'s gain on the sale: i. \$6,000 \[I.R.C. §1011)(a)\] b. What difference in result in (a) above , if owner purchased the land by paying \$1,000 for an option to purchase the land for an additional \$9,000 and subsequently exercised the option i. No difference, practically paid \$10,000 c. What result to owner in (b), if rather than ever actually acquiring the land Owner sold the option to Investor for \$1,500 i. Gain of \$500 because essentially another property (CITE) d. What difference in (a), if owner purchased the land by making a \$2,000 cash payment from Owner\'s funds and an \$8,000 payment by borrowing \$8,000 from the bank in a recourse mortgage (on which Owner is personally liable)? Would it make any difference if the mortgage was a nonrecourse liability (on which only the land was security for the obligation)? i. In terms of basis, still \$10,000 e. (OMITTED) f. (OMITTED) g. What difference in result (a), if when the land had a value of \$10,000, owner, a real estate salesperson, received it from Employer as a bonus for putting together a major real estate development? Owner paid \$3,000 of income tax on the \$10,000 fair market value receipt of the land. i. Same basis \-- basically FMV (§1.61-2: \"if transferred... amount less than its FMV, then regardless of whether the transfer is in the form of a sale or exchange, the difference between the amount paid for the property and the amount of its FMV at the time of the transfer is compensation and shall be included in the gross income of the employee... Its basis shall be the amount paid for the property increased by the amount of such difference included in gross income.) ALSO IRC §1012(b) \-- special rule for apportioned real estate taxes \| ii. so no reduction in basis for the amount of taxes paid for property taxes iii. THUS, \$6,000 of gain? h. What difference if Owner is a salesperson in an art gallery and owner purchases \$10,000 painting from the art gallery, but is required to pay only \$9,000 for it (instead of \$10,000 because Owner is allowed a 10% employee discount which is excluded from gross income under §132(a)(2), and Owner later sells the painting for \$16,000 i. Still gain of \$6,000 because basis would be FMV. \^\^ same reasoning as above - ##### *(2) Property Acquired by Gift* (pp. 121-123) - Code: § 1015(a) ##### For gifts prior to 1921, the basis shall be the FMV of the property at the time of the acquisition (old rule) ##### For gifts after 1921, 1015(a) hold that if the property is acquired by gift, the basis will be the same as it was under the hands of the donor - - - - - - - - Reg: § 1.1015-1(a) - ***Taft v. Bowers*** ##### Petitioners who are donees of stocks, seek to recover income taxes exacted because of advancement in the market value of those stocks while owned by the donors - In 1916 A purchased 100 shares of stock for \$1,000 which held until 1923 when the FMV was \$2,000. He gave them to B who sold them in 1923 for \$5,000. The USA claims that B must pay income taxes upon \$4,000 while B maintains that only \$3,000 can be regarded as income ##### Deems 1015(a) constitutional - [Hypo] ##### Dad buys property at a cost of \$120,000 and gifts it to son when the FM value is \$100,000 ##### Not a built in gain, but a built in loss ##### 1015(a) if the basis is greater than the FMV at the time of the gift, "then for the purpose of determining loss the basis shall be such FMV" ##### Here the FMV is \$100,000 and therefore the basis is \$100,000 - Problem 1 pp. 128 donor gave property under circumstances that required no payment of gift tax. What gain or loss to done on the subsequent sale of the property if: ##### (a) the property had cost donor \$20,000, had a \$30,000 FMV at the time of the gift, and donee sold it for: - \(1) \$35,000 15,000 gain - \(2) \$15,000 5,000 loss - \(3) \$25,000 5,000 gain ##### (b) the property had cost donor \$30,000, had a \$20,000 FMV at the time of the gift and done sold it for: - \(1) \$35,000 5,000 gain - \(2) \$15,000 5,000 loss - \(3) \$24,000 4,000 gain (BUT 0 TAX RESULT) - Split value exception neither a gain nor a loss because carryover basis would result in a loss, but the FMV at the time of gift gives you a gain - ##### *(3) Property Acquired between Spouses or Incident to Divorce (pp. 128-130)* ##### Code: § 1041(a) & (b); 1015(e) ##### Reg: § 1.1041-1T(a) & (d) ##### [Rules]: - ##### No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)--- (I.R.C. §1041(a)) - ##### A spouse - ##### Former spouse if the transfer is an incident of divorce - ##### For basis, the transfer would be treated as a gift; AND the adjusted basis will be transferred to the transferor (I.R.C. §1041(b); §1015(e)) - ##### *Note*: no split basis ##### Section 1041 accords almost complete tax neutrality to transfers of property between spouses and between formers spouses if, in the latter instance, the transfer is incident to divorce no gain or loss is realized - ##### This rule applies whether the transfer of property is for cash or other property, for the relinquishment of material rights or for any other consideration or for the assumption of liabilities in excess of basis ##### Under 1041 in the case of any transfer of property between spouses or formers spouses, the transferee is treated as if the property were acquired by gift, and the basis of the property in the hands of the transferee is the same as the basis of the property in the hands of the transferor - ##### The 1041 transferee spouse or former spouse always takes a transferred basis, even for computing loss ##### [Problems] pp. 130-131 ##### (1) Andre purchased some land ten years ago for \$40,000 cash. The property appreciated to \$70,000 at which time Andre sold it to his wife Steffi for \$70,000 cash, its fair market value ##### (a) what are the income tax consequences to Andre? - ##### 1041(a)(1) no gain or loss shall be recognized on a transfer of property from an individual to a spouse ##### (b) what is Steffi's basis in the property? - ##### 1041(b) \$40,000 basis ##### (c) what gain to Steffi if she immediately resells the property? - ##### \$30,000 gain if she sells it to a third party for \$70,000 ##### (d) what results in (a), (b), and (c) if the property had declined in value to \$30,000 and Andre sold it to Steffi for \$30,000? Reg. 1041-1T(d) (pp. 1530) answer A-11 - ##### no gain or loss recognized under 1041 (so no built in loss) the same ##### (e) what results (gains, losses, and bases) to Andre and Steffi if Steffi transfers other property with a basis of \$50,000 and value of \$70,000 (rather than cash) to Andre in return for his property? reg 1.1041-1T(a) - ##### Andre's \$30,000 gain in disposition of his property is not recognized by 1041 and his basis in the property received from Steffi is \$50,000 - ##### Steffi's disposition of property results in a \$20,000 gain not recognized by 1041 and her basis in Andre's property is \$40,000 - #### (4) Property Acquired from a Decedent (pp. 131-133) - Code: § 1014(a)(1), (b)(1) & (6), (e) - Reg: § 1.1014-3(a); 20.2031-1(b) - [Rules:] - Under 1014(a) property acquired from a decedent generally receives a basis equal to its fair market value on the date on which it was valued (TIME OF DEATH usually) for federal estate tax purposes stepped-up basis if the property appreciated and a stepped-down basis if the property depreciated - Section 1014 applies not only to property held by the decedent at death, but also to some property that decedent transferred during life if the value of the property is nevertheless required to be included in decedent's gross estate for federal estate tax purposes - *Lock-in effect* seniors who have assets that have significantly appreciated in value want to avoid selling prior to death because if their intent is to give it to their children, they can avoid significant tax implication - 1014(b)(6) community property - 1014(e) addresses situations where individuals may take advantage of the stepped-up basis that results from 1014(a) - Problem 1 pp. 133 in the current year, giver holds wo blocks of identical stock, both worth \$1,000,000. Giver purchased the first block years ago for \$50,000 and the second block more recently for \$950,000. Giver plans to make an inter vivos gift of one block and retain the second until death. Which block of stock should giver transfer inter vivos and why? - Basis of block 1: \$50,000 \$950,000 gain - Basis of block 2: \$950,000 \$50,000 gain - Should transfer block 2 inter vivos and block 1 at death you always want a bigger basis []{#_Toc153386236.anchor}[(C) The Amount Realized] (pp.133-152) - Code: § 1001(b) - Reg: § 1.1001-1(a); 1.1001-2(a), (b), (c) examples 1 & 2 ##### (side note) -- Cryptocurrency treated like property - ##### *International Freighting Corporation, Inc. v. Commissioner* (2d Cir, 1943) - International Freight address amount realized for services - International Freight provided bonuses in the form of company stock which cost the International Freight \$16,153.36 but whose market value was \$24,858.75. On its tax return, International Freight took a deduction of \$24,858.75 - *Issue*: whether the transaction resulted in taxable gain to TP Yes - The stock was not a gift because it was compensation for services actually rendered - No relevance that the TP had not been legally obligated to award any shares or pay any additional compensation - Compensation for services is a realization event - *Horizontal equity* treat companies that sell the stock and pay the cash as bonus the same as companies who simply provide the stock as a bonus - ##### *Crane v. Commissioner* - Crane was the sole beneficiary and executrix of her husband's will. He left her an apartment building and lot subject to a mortgage w/a principal debt of \$255,000.00 and interest in default of \$7,042.50. She later sold to a 3rd party for \$3,000 cash, subject to the mortgage, and paid \$500 (3,000 -- 500 = 2,500 in boot) for sale expenses. - [Issue]: how a taxpayer who acquires a depreciable property subject to an unassumed mortgage, holds it for a period, and finally sells it so encumbered, must compute her taxable gain - [Holding]: the entire amount of the defendant's unpaid mortgage should be included in the amount realized include original fees in the cost basis - **A taxpayer who sold property encumbered by a nonrecourse mortgage (the amount of the mortgage being less than the property's value) must include the unpaid balance of the mortgage in the computation of the amount the taxpayer realized on the sale.** - Crane argued she had no basis - **[FN 37]**: If the value of the property is less than the amount of the mortgage, a mortgagor who is not personally liable cannot realize a benefit equal to the mortgage. Consequently, a different problem might be encountered where a mortgagor abandoned the property or transferred it subject to the mortgage without receiving boot. - Reasoning: - The amount realized by Crane included both the \$2,500.00 boot as well as the principal amount of the mortgage, which altogether totaled \$257,500.00. - interpreting the term property to mean equity would negate the purpose of allowing depreciation deductions in the first place. - A taxpayer who sells property subject to a mortgage receives a benefit equal to the value of the mortgage. - ##### *Commissioner v. Tufts* - Building was worth less than the amount of debt on the building at the time of disposition - As opposed to *Crane* where the building was worth a bit more than the economic value of the building - [Issue]: whether the rule from *Crane*, applies when the unpaid amount of the nonrecourse mortgage exceeds the fair market value of the property sold - [Holding]: a taxpayer who sells property encumbered by a nonrecourse mortgage must include the unpaid balance of the mortgage in the computation of the amount the TP realized on the sale even if the unpaid amount on the nonrecourse mortgage exceeds the fair market value of the property sold - [Problems]: - Problem 1: - Mortgager purchases a parcel of land from Seller for \$100,000. Mortgagor borrows \$80,000 from Bank and pays that amount and an additional \$20,000 of cash to Seller giving Bank a nonrecourse mortgage on the land. The land is the security for the mortgage which bears an adequate interest rate. - \(a) Mortgagor\'s cost basis? - \$100,000 \[\$80,000 + \$20,000\] - \(b) two years later when the land has appreciated in value to \$300,000 and Mortgagor has paid only interest on the \$80,000 mortgage, Mortgagor takes out a second nonrecourse mortgage of \$100,000 with adequate rates of interest from Bank again using the land as security. Does Mortgagor have income when she borrows the \$100,000? - No, no accession of wealth? \-- no gain or loss because no disposition of land - \(c) What is Mortgagor\'s basis in the land if the \$100,000 of mortgage proceeds are used to improve the land? - \$200,000 (added more debt) - \(d) What is Mortagor\'s basis in the land if the \$100,000 of mortgage proceeds are used to purchase stocks and bonds worth \$100,000 - No change in the basis \-- Still \$100,000 - \(e) What result under the facts of (d) above, if when the principal amount of the two mortgages is still \$180,000 and the land is still worth \$300,000, Mortgagor sells the property subject to both mortgages to Purchaser for \$120,000 of cash? What is Purchaser\'s cost basis in the land? - \$300,000 (\$180,000 discharge liability + \$120,000 cash) \[TR §1.1001-2\] \-- Gain = amount realized - cost basis - Amount realized = \$300,000 - Cost basis for purchaser = \$300,000 - Cost basis for mortgagor = \$100,000 basis ?? - Gain = \$200,000? - \(h) what results to mortgagor under (d) if the land declines in value from \$300,000 to \$180,000 and mortgagor transfers the land by means of a quitclaim deed to bank. (DON'T KNOW IF THIS IS RIGHT) - Amount realized in the 180k of loan still on the property minus the basis which is still 180k = 0k gain - How do we get to 80k - TP 20k of his own funds and did not put anything else into the cost of the property - Economically, TP receives 100 in the loan that he invest in stock - Put 20k in but got 100k cash - On a net basis he benefitted by 80k - \(i) what results to mortgagor under the facts of (h) if the land declines in value from \$300,000 to \$170,000 at the time of the quitclaim deed - *Tufts* same rules apply even when there is a loss - Amount realized is not just the only cash received, but also the full outstanding balance of the nonrecourse debt secured by the lot, even if the value of the land is less than the outstanding debt - On a net basis, still benefitted from the 80k - \(2) investor purchased three acres of land, each acre worth \$100,000 for \$300,000. Investor sold one of the acres in year one for \$140,000 and a second in year two for \$160,000. The toal amont realized by the investor was \$300,000 which is not in excess of her total purchase price. Does investor have any gain or loss on the sales reg. 1.61-6 gains derived from dealings in property (DIDN'T GO OVER IN OUR CLASS) - If you sell a portion of property, analyze each portion as a separate disposition of property - Take original 300,000 and divide it among each acre - Amount realized is 140k so you have a 40k gain - Gain on acre 2 = 60k (7) Life Insurance Proceeds and Annuities ----------------------------------------- []{#_Toc153386238.anchor}[(A) Life Insurance Proceeds] (pp 157-160) - Code: § 101(a)(1) Note § 101(g) - Reg: § 1.101-1(a)(1) - [Rules]: ##### 101(a) gross income does not include amounts received under a life insurance contract if such amounts are paid by reason of the death of the insured ##### 101(g) allows insured persons who are still alive to take a payment and not include it in gross income if they are terminally or chronically ill ##### Aka: life insurance proceeds are (generally) not taxable []{#_Toc153386239.anchor}[(B) Annuity Payments] (pp. 161-165) - Code: § 72(a)(1), (b), (c) - Reg: § 1.72-4(a); 1.72-9 (Table V) - [Rules]: ##### Exclude a certain amount, based on exclusion ratio (see below) - ##### (because basically just return on the money you already had -- so only tax what you get in return (the premium)) - An annuity in this context is a promise to pay a certain amount (calculated in various ways) for a certain amount of time (calculated in various ways) under a contract - Period of payments in many cases is a fixed amount of time and if you die during that period, the payments will be made to your estate - Another time period is an individual's life span - E.g. \$1,000 for the rest of my lie - Age of the person and life expectancy - Opposite of life insurance - Life insurance expect to die and receive a payout - Annuity expect to live and receive a pay out - Tax consequences - E.g. pay \$9,000 for an annuity contract - 5 annual payments of \$2,000 - From a tax perspective I paid \$9,000 and over the course of the payments I will receive \$10,000 - Here, cost was \$9000 but payment was \$10,000 - Best way to treat it - Treat the initial payments as recovering your cost -- cost first - Of the 10,000 - 9,0000 was recovering my initial cost - At the fifth payment, you experience 1,000 of income - How the code treated annuities until the fifties - Section 72 calculations - 9,000 divided by 10,000 =.9 (90%) - For every payment, 90% percent is excluded from gross income - Amount excluded in each 2,000 payment is 1,800 - Only include 200 in gross income per payment - Simple Annuity (slide) ##### \$9,000 Cost for Annuity Contract ##### 5 Annual Payments for \$2,000 ##### Exclusion Ratio = [\$\\frac{\\mathbf{\\text{Investment}}\\mathbf{\\ }\\mathbf{\\text{in}}\\mathbf{\\ }\\mathbf{\\text{contract}}}{\\mathbf{\\text{Expected}}\\mathbf{\\ }\\mathbf{\\text{Return}}\\mathbf{\\ }\\mathbf{\\text{under}}\\mathbf{\\ }\\mathbf{\\text{Contract}}}\$]{.math.inline} - [\$\\frac{9}{10} = \\frac{\\\$ 9,000}{\\\$ 10,000\\ (5\*\\\$ 2,000)}\$]{.math.inline} - \$1800 is excluded; \$200 included in GI ##### {#section.ListParagraph} - [PROBLEMS] - Problem 1: ##### In the current year, T purchases a single life annuity with no refund feature for \$48,000. Under the contract T is to receive \$3,000 per year for life. T has a 24-year life expectancy. - (a): To what extent, if at all, is T taxable on the \$3,000 received in the first year? - (\$3,000 \* 24 = \$72,000.00)... \$48,000/\$72,000 = \$0.67 = Exclusion Ratio... can exclude \$2,000 ; \$1,000 gross income (3,000 \* 2/3) \[Regs: §1.72-4(a) / I.R.C. §72(b)\] - (b): If the law remains the same and T is still alive, how will T be taxed on the \$3,000 received in the 30th year of the annuity payments? - All gross income; (§72(b)(2)) - the portion of any amount received as an annuity which is excluded from gross income shall not exceed the unrecovered investment in the contract immediately before the receipt of such amount - ##### (c): If T dies after 9 years of payments will T or T\'s estate be allowed an income tax deduction? How much? - ##### T allowed income tax deduction; I.R.C. §72(b)(3)(A)(ii) \-- unrecovered investment... which was not included in gross income shall be allowed as a deduction to the annuitant for his last taxable year \-- (8) Discharge of Indebtedness ----------------------------- - [Code]: § 61(a)(12); 108(a), (b)(1)-(3), (d)(1)-(5), (e0(1), (2) & (5); 1017(a), (b)(1)-(3)(B) Note 108(f)(5), (h) - [Reg]: § 1.61-12(a); 1.1001(a), (c) example 8 - On p. 181, note that Code § 108(a)(1)(E) regarding qualified principal residence indebtedness has been extended through the end of 2025, although the \$2,000,000 exclusion maximum has been reduced to \$750,000 pursuant to 108(h)(2). Also, note that Code § 108(f)(5) expands the exception for most student loan discharges from 2021 through 2025 and is not limited to death or disability. - ***United States v. Kirby lumber Co.*** If the corporation purchases and retires any of such bonds at a price less than the issuing price of face value, the excess of the issuing price of face value over the purchase price is gain or income for the taxable year - [*Kirby Lumber* adds means to section 61(a)(12) requiring that income from the discharge of indebtedness be included in gross income] - The taxable event is the freeing of assets that previously were held subject to the obligation - Bonds are evidence of indebtedness/borrowing obligation - [Exceptions to *Kirby Lumber*] - Insolvency exception no income arises from a discharge of indebtedness if the debtor is insolvent both before and after the transaction and if the transaction leaves the debtor with assets whose value exceeds remaining liabilities, income is realized only to the extent of the excess - A debt cancellation which constitutes a gift or bequest is not treated as income to the done debtor - Discharge of qualified real property business indebtedness - Elective and exhaustive - 108(f) relieve from obligations to repay student loans - ***Revenue Ruling 2008-34*** - Law school loan forgiveness program qualifies under 108(f) - Problems ##### [Problem 1]: Poor borrowed \$10,000 from Rich several years ago. What tax consequences to Poor if Poor pays off the so far undiminished debt with: - \(a) A settlement of \$7,000 of cash? - \$3,000 in GI - \(b) A painting with a basis and FMV of \$8,000 - \$2,000 in GI - \(c) A painting with a value of \$8,000 and a basis of \$5,000 - \$2,000 in from cancellation of indebtedness but also gain of \$3,000 from disposition of property (\$5,000 total in GI); *See International Freighting* case - \(d) Services, in the form of remodeling Rich\'s office, which are worth \$10,000 - No gain / (loss) \[Treas. Reg. §1.61-12\] (\$10,000 of compensation of services) - \(e) Services that are worth \$8,000 - \$2,000 in GI because of cancellation of indebtedness; (\$8,000 of compensation for services) - \(f) Same as (a), above, except that Poor\'s Employer makes the \$7,000 payment to Rich, renouncing any claim to repayment by Poor. - \$3,000 in GI; (\$7,000 compensation for services) ##### [Problem 4:] Businessperson borrows \$100,000 from Creditor to start an ambulance service and then purchases ambulances for use in the business at a cost of \$100,000. Assume the ambulances are Businessperson\'s only depreciable property and, unrealistically, that after some time their adjusted basis and value are still \$100,000. What are consequences in the following circumstances: - \(a) Businessperson is solvent but is having financial difficulties and Creditor compromises the debt for \$60,000 - \$40,000 of GI - \(b) Same as (a), except that Creditor is also the ambulance dealer who sold the ambulances to Businessperson - If sold directly, which arose out of purchase, if reduced and such reduction didn\'t happen in a Title 11 case and didn\'t occur when the purchaser was insolvent, then such reduction will be treated as purchase price reduction; basically only paid \$60,000 of it (basis) - \$40,000 of GI - \(c) Assume that Businessperson declares bankruptcy and the \$100,000 liability is discharged at the time that Businessperson\'s adjusted basis in the ambulances (as a result of Dep) is \$75,000 - If Title 11 case, no inclusion to GI (I.R.C. §108(a)(1)) - \(d) Assume that Businessperson is insolvent because Businessperson\'s liabilities of \$100,000 exceed the \$90,000 value of the ambulances (whose adjusted basis is \$75,000). Creditor discharges \$40,000 of the \$100,000 liability without any payment. - Facts: - \$100,000 Liability - \$90,000 FMV of assets - \$75,000 Adj. Basis - \$40,000 discharged - \[I.R.C. 108(a)(1)(B))\] - No GI for discharge of indebtedness if... the discharge occurs when the taxpayer is insolvent - Insolvent when Liabilities \> FMV of assets - \[I.R.C. §108(a)(3) - Amount excluded shall not exceed the amount by which the taxpayer is insolvent\] - Insolvent by \$10,000 - SO: of the \$40,000 discharged, \$10,000 is not taxed; \$30,000 is included in GI ##### [Problem 5]: Decedent owed Friend \$5,000 and Nephew owed Decedent \$10,000 - \(a) At Decedent\'s death Friend neglected to file a claim against Decedent\'s estate in the time allowed by state law and Friend\'s claim was barred by the statute of limitations. (Let\'s defer our concern for Nephew.) What result to Decedent\'s estate? - Normal discharge of \$5,000 - in GI - \(b) What result to the estate in (a) (with Decedent still in cold storage) if instead Friend simply permitted the statute to run stating that she felt sorry for Decedent\'s widow, the residuary beneficiary of his estate? - Treated as a Gift; Not included in GI - \(c) Now, what result to nephew if Decedent\'s will provided that his estate not collect Nephew\'s debt to the estate? - Cancelled debt... so more like a bequest. Nephew does not have to include in GI (9) Damages and Related Receipts -------------------------------- []{#_Toc153386242.anchor}[(A & B) Introduction to Damages in General] (pp. 187-190) - ***Raytheon Production Corporation v. Commissioner*** - TP settled a lawsuit under the federal anti-trust laws against R.C.A. The issue was whether the settlement was required to be included in the TP's gross income - [Holdings:] - **Recoveries which represent a reimbursement for lost profits are income damages for violation of the anti-trust acts are treated as income where they represent compensation for loss of profits** - Test **in lieu of what were the damages awarded** - If damages recovered in lieu of something taxable, generally taxable (subject to exceptions in statutes / common law) - Reasoning since the profits would be taxable income, the proceeds of litigation which are their substitute are taxable in like manner - In *Raytheon*, the good will of the business was damaged - Good will viewed as an intangible asset - *Under the in lieu of test, recovery for damages to property does not have to be included except for recovery that exceeds the cost of the property (subtract the basis before you start counting income)* - [Problems] ##### Problem 1: Plaintiff brought suit and unless otherwise indicated successfully recovered. Discuss the tax consequences in the following alternative situations: - \(a) Plaintiff\'s suit was based on a recovery of an \$8,000 loan made to Debtor. Plaintiff recovered \$8,500 cash, \$8,000 for the loan plus \$500 of interest. - \$8,000 would be excluded... \$500 would be taxed - \(c) Plaintiff\'s suit was based on a breach of a business contract and Plaintiff recovered \$8,000 for lost profits and also recovered \$16,000 of punitive damages - \$8,000 of lost profits is taxed; \$16,000 is also taxed \[*Glenshaw Glass*\] - \(d) Plaintiff\'s suit was based a claim of injury to the goodwill of Plaintiff\'s business arising from a breach of a business contract. Plaintiff had a \$4,000 basis for the goodwill. The goodwill was worth \$10,000 at the time of the breach of a contract. - \(1) what result to P if the suit is settled for \$10,000 in a situation where the goodwill was totally destroyed? - Can recover \$4,000 that is not taxable \-- can recover as much as adjusted basis; \$6,000 past that is included in GI - \(2) What result if P recovers \$4,000 of cash because the goodwill was partially destroyed and worth only \$6,000 after the breach of contract - Same as above; \$4,000 is not taxable \-- basis would then be \$0 - \(3) What result if P recovers only \$3,000 of cash because the goodwill was worth \$7,000 after the breach of contract - Same reasoning as above; \$3,000 is not taxable \-- adjusted basis would then be reduced to \$1,000 []{#_Toc153386243.anchor}[(C) Damages and Other Recoveries for Personal Injuries] (pp. 191-194; 197-198) - Code: § 104(a) - Reg: § 1.61-14(a); 1.104-1(a)(c) - [Rules]: ##### To the extent 104(a)(2) applies, everything you recover is tax free, even if it would have been taxable under the in lieu of test ##### Emphasis on PHYSICAL personal injuries or sickness - ##### Not able to recover from nonphysical injuries (such as defamation, sex and age discrimination, and emotional distress). - ***Revenue Ruling 79-313*** - Injuries from auto accident, fifty annual payments which will increase by five percent each year - *Issue*: are payments received by the TP, under the circumstances described, excludable from the gross income of the TP under 104(a)(2) - [Reg 1.104-1(c)] damages received includes those received from a settlement agreement - [Revenue ruling 65-20] when the TP actually received the present value of an award for personal injury in a lump sum and invests it, the interest ea

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