Master Income Tax Class Notes PDF

Income Tax - Class Notes (Dean Marty-Nelson) By: Jessica Q. Birbrayer Class 1 CHAPTER 01 INTRO TO FEDERAL INCOME TAX Can bring a calculator into the exam. Multiplication, addition, an...

Income Tax - Class Notes (Dean Marty-Nelson) By: Jessica Q. Birbrayer Class 1 CHAPTER 01 INTRO TO FEDERAL INCOME TAX Can bring a calculator into the exam. Multiplication, addition, and subtraction. Will only use Cash Receipts reporting in this class. Tax Base ○ Income Tax - base on an annual system Tax on a person’s taxable income for the year VAT Tax ○ Europe uses a method of federal sales tax it is called the VAT. ○ Consumption Tax is imposed at the federal level at various stages of production. ○ Most of the European countries that have the VAT also have the income tax. Other base options - ○ Federal tax on wealth/property (similar to State Property taxes (e.g. house) % of appraised value of the real property At the federal level you would do a tax on some % of the value of taxpayer’s property To raise sufficient revenue for federal government Apply federal property tax not just on value of houses but also on personal property Some rate on all types of property/different rates? ○ Tax the increase in assets at the end of each year Value all property beginning of the year and again at the end of the year and tax any increase in value Tax Expenditure Provisions - are subsidies delivered through the tax code ○ Promote social and economic policy. ○ Provisions not necessary to the tax structure of the Code ○ Not for revenue raising ○ Government spending through the tax Code ○ Expenditures/subsidies in the Code to promote a social or economic policy that Congress wants to promote (p.6 in casebook) E.g., charitable deduction, exclusion of value of employer-provided health insurance, home ownership interest deduction. Sell home you can exclude 250,000/per individual 750,000 deductible in note interest in mortgage Birbrayer 1  ○ Economic Goal Expenditures Can work very effectively. E.g., post-2008 if a business purchased a large amount of equipment that will last many years, they can take the deduction in that year instead of overtime. Deductions for businesses to buy new equipment Sources of Tax Law ○ Congress passes the Internal Revenue Code (statutory law) Title 26 of U.S.C. ○ Treasury issues the regulations interpreting the code ○ IRS issues Rulings (Rev. Rules and PLRs) ○ If the IRS doesn’t agree with something you or your client did on tax return then you go to court. Courts for Tax Disputes ○ Tax Court Don’t pay first No jury trials Appeals to the Federal Circuit where the taxpayer resides (e.g, Florida taxpayer appeals go to 11th Cir.) ○ U.S. Court of Federal Claims Pay first, sue later for refund No Jury trials Appeals to US Ct of Appeals for the Federal Circuit ○ District Courts Pay first, sue later for refund Yes, Jury trials available Appeals to the Federal Circuit where the taxpayer resides (e.g, Florida taxpayer appeals go to 11th Cir.) Determining Tax Due (This is the whole course) ○ Part 1: Gross Income minus deductions = taxable income (two steps to this part) Step 1: Gross Income minus above the line deductions = Adjusted Gross Income (“AGI”) (e.g., federally declared casualty deduction only that exceed 10% AGI - if it’s over 10% then we will let you to deduct that; deduct the remaining % after the 10%) Step 2: Adjusted Gross Income (“AGI”) minus below the line deductions (aka itemized deductions) OR Standard = Taxable Income You either take the below the line deductions or the standard deductions. CANNOT TAKE BOTH. Birbrayer 2  ○ Part 2: Apply Tax Rates to “Taxable Income” to determine “Tax Liability” ○ Part 3: Tax Liability minus credits = Tax Due Book Problem: Caroline ○ “Gross Income” for the Taxpayer (Chapter 1, Problem 1) – ITem 1 Caroline Item #1(a) – 275,000 for consulting fees? §61(a)(1) Compensation for services - checks are deemed cash equivalents and are deemed gross income. Item #1(b) - Client who received $10,000 of consulting services paid Caroline not in cash but in $10,000 worth of landscaping services received? This is gross income §61 and Regulations §1.61-1. Still income even if “in-kind”. Value includible in gross income is Fair Market Value (FMV) of the services received §1.61-2(d)(1) Item #1(c) - Clients owe Caroline $20,000 for services they received. Not Gross Income Account Receivable - Accounting method 1.446-1(c), ○ Cash Receipts ○ Accrual Item #2 - $19,000 in interest income from an investment account managed at a bank. Gross income §61(a)(4). Item #4 - Dividends are gross income §61(a)(7) ABC Stock sold for $30,000 - taxed on the gains. §61(a)(3) which is $15,000. Gross income is the gains derived. Gain realized What is gain - §1001(a) ○ Amount Realized $30,000 - Adjusted Basis ($15,000) = gain of $15,000. = $320,000 Total in Gross Income From “Gross Income” subtract above-the-line deductions to determine AGI. TWEN Chapter 01 Intro to Federal Income Tax - WITH ANSWERS 1. Paul Plumber, a small business owner, performed plumbing services for Don Dentist and sent Don the bill. Don Dentist, however, was short on funds this month. Paul and Don agreed that, instead of paying for Paul's plumbing services in cash, Don Dentist would perform a much-needed root canal for Paul Plumber. The tax consequences for Paul Plumber of these events are: Answer: Paul will have gross income in an amount equal to the fair market value of the root canal services he received. Birbrayer 3  2. Of the following choices which most correctly defines a "tax expenditure" provision? Answer: A provision in the Code that is designed to advance a social or economic policy. 3. Scholars have noted that a source of complexity in the present-law tax system is the prevalence of tax expenditure provisions in the Code. Which of the following Code sections may be labeled a tax expenditure provision? Answer: Code Section 170(a) - which is the charitable deduction IN DETERMINING “GROSS INCOME” CHECK CONCEPTS AND CHECK FOR SPECIFIC INCLUSION & EXCLUSION SECTIONS. Fundamental concepts ○ Appreciation - wait till realization event ○ Return of capital not gross income - formula for gain/loss and basis rules (Ch.4 and 5) ○ Loan proceeds coupled with obligation to repay not gross income. ** END OF CLASS 1 ** CHAPTER 02 GROSS INCOME Several Chapters Start with Code §61 ○ Except as otherwise provided in this subtle, gross income means all income from whatever source derived” Regs. §1.61, Case Law, Concepts - Go beyond §61 Code for specific inclusion or exclusion sections Fundamental concepts ○ Appreciation? Wait till realization event (property - tax sale or exchange) ○ Return of capital not gross income - formula for gain/loss and basis rules ○ Loan proceeds coupled with obligation to repay not gross income (not taxable) Specific Code Inclusions ○ E.g., §74 (prizes/awards) Specific Code Exclusions ○ E.g., §101 (life insurance) ○ E.g., §102 (gifts) Birbrayer 4  From gross income we would subtract deductions Commissioner v. Glenshaw Glass (Sp. Ct. 1955) (pg. 35) ○ Glenshaw Glass antitrust case against Hartford ○ Parties settle ○ Cash payments for damages - $800,000 ○ Punitive $324,529 ○ Lost Profits.compensatory $474,470 ○ Eisner v. Macomber The “Old” Formulation for “Gross Income” “The gain derived from capital, from labor, or from both combined.” ○ The “New” Formulation for “Gross Income” ○ “Undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” Accessions Dominion ○ Congress intended to exert its maximum tax powers to find gross income Punitive damages are always taxed Old Colony Trust Co v. Commissioner (pg.40) ○ 1916 Company resolution passed to pay officers’ tax liability Compensation can be services, cash, and the form of somebody covering your debt. ○ 1918 Wood’s salary is $978,725 ○ April 1919 Wood’s tax for 1918 is due of $681,169 Company paid this ○ 1919 Wood’s salary $545,132 ○ April 1920 Wood’s tax for 1919 is due $351,179 Company paid this ○ In substance Wood got extra $681,169 in 1919 What the company paid was taxable as it was compensation ○ Made no difference whether the employee had bargained for payment of the taxes or merely acquiesced in it - Still compensation income ○ Court concluded the payment was in consideration for services and therefore was includable in income Birbrayer 5  Lessons from Old Colony Trust Co. ○ Form of income makes no difference ○ Discharge by a 3rd party of taxpayer’s obligation is equivalent to receipt by taxpayer ○ Covering someone’s obligation not likely to be a “gift” if employer/employee relationship Casebook Problem: Marcella “Gross Income” Problem (pg. 23) ○ 1(a) - Salary $150,000 and $30,000 withheld for federal income taxes and $11,000 in social security taxes and $9,000 for state income taxes Salary $150,000 §61(a)(1) - full amount is gross income Withholding for tax does not affect gross income ○ 1(b) - Cash bonus of $5,000 from the law firm in recognition of her work? $5,000 bonus is gross income - §61(a)(1) Not a gift The bonus is an undeniable accession to wealth - Regs. Section 1.61-2(a)(1) ○ 1(c) - Purchased walnut bookcase for only $150 from employer when it had FMV of $400 Bargain Purchase - IRS recognizes this, getting something below market price through negotiation, and thus not taxable. Has to be arms-length purchase This, however, could be labeled like disguised compensation. However, here the argument that this is a bargain purchase is stronger and thus not includible in gross income. Commercial Bargain Purchase - not gross income (e.g. $50 rebate from manufacturer of a lawnmower she had purchased) But see Reg. §1.61-2(d)(2)(i) - If property transferred as compensation for less than FMV, then difference is gross income. ○ 1(e) - Marcella and her brother. Brother built a greenhouse for her (FMV $2,500). Thanking sister for some legal work she had done. Is this a barter? See Rev. Rul. 79-24 Could be gift, could be barter, could be compensation ○ 1(f) - $2,000 reward - purse with cash and jewelry she found in cab; received $2,000 from grateful owner. §1.61-2 - gross income (taxable) Pellas v. Commissioner (pg. 46) ○ Contractor agreed to build a house at a certain price ○ Construction costs exceed price received ○ This was deemed a bargain purchase here by the court Birbrayer 6  ○ Tax Court: Purchase of property for less than its FMV does not generally constitute realization of income ○ Note: No employer/employee relationship here Cesari v. US (pg.37) ○ 1958 purchased used piano $15 at auction ○ 1964 found $4,467 in old currency inside ○ Is found money State law property issues - to see dominion is when the treasure is found Found money is taxable ○ Yes gross income §61; Regs. 1.61-14 Not a gift No exclusion section ○ When reduced to undisputed possession serves as the taxable reporting year TWEN Chapter 02 Gross Income - WITH ANSWERS 1. In year 1, in compensation for employee's services, employer transferred a designer watch with a fair market value of $10,000 to employee. Assume that in year 2 the employee sells the watch to a third party for $12,000. Which of the following most correctly describes the tax consequences for the employee/taxpayer in year 1 and year 2? Answer: Employee has $10,000 of compensation income in year 1. Employee has $2,000 of gain income in year 2. Gross Income §61(a)(1) Regs. §1.61-2(d) - Compensation other than Cash FMV of property taken in payment is compensation gross income T had $10,000 gross income in year 1 ○ Gain is found in §1001 Amount realized §1001(b) = $12,000 Don’t tax cost / basis Less adjusted basis §1012 = $10,000 Realized gain = $2,000 ○ As if T received $10,000 cash compensation, included that in income and used that cash to buy the watch for $10,000. Then taxpayer subsequently sold that watch for $12,000, so gain of $2,000. 2. In year 1, in compensation for an employee's services, employer transferred ABC stock worth $1,000 to his employee for a payment of $200 from the employee. How much gross income does the employee have in year 1? Answer:The employee has $800 of compensation gross income in year 1. Birbrayer 7  Example: Employee gets a watch FMV of $30,000 for services ○ Compensation income - Gross income §61(a)(1) ○ Regs. §1.61-2(d) ○ Employee sells the watch for $32,000 next month (same tax year) §1001(a) Amount realized §1001(b) - $32,000 Less Adjusted Basis §1012 - $30,000 Realized Gain $2,000 As if he had received $30,000 cash compensation, included that in income, and took that cash and bought the watch for $30,000, then sold it for $32,000 Problem #2 - Mitch’s XYY Stock ○ Year 1 M buys XYZ stock for 1,000 ○ End of Year 1 XYZ stock FMC $1,500 ○ Year 2 FMV $2,000 Albert makes offer M does not sell ○ Year 3 FMV $2,500 M borrows $2,000 pledges stock ○ Year 4 M repays loan of $2,000 ○ Year 5 FMC $3,000, M transfer stock to a creditor to settle a debt Amount realized §1001(b) $3,000 Less adjusted basis §1012 $1,000 Realized gain $2,000 ** END OF CLASS ** August 26, 2024 CHAPTER 03 EFFECT OF OBLIGATION TO REPAY NEW VERSION Obligation to Repay ○ Loan Proceeds Example Borrower obtains loan proceeds $100,000 to start a business Borrower signs a Note Lender gives Borrower $100,000 This is not gross income because she doesn’t have an accession to wealth. Loan Proceeds - Economics Assets = $100,000 Liabilities = $100,000 obligation to repay Fundamental Tax Rule - Loan proceeds are not included in gross income when obtained, because of offsetting obligation to repay ○ Loans Loan proceeds not an “accession to wealth” because of the offsetting liability to repay Birbrayer 8  What if instead of unconditional obligation to repay (e.g., borrower executed a promissory note) the money is received subject to a contingent repayment obligation? ○ North American Oil Consolidated v. Burnet (US Supreme Court 286 U.S. 417 (1932)) Land Case 1916 - Oil income to Receiver; Because of the dispute a receiver is appointed (managed the property) and the receiver is told that the receiver holds the money because of the dispute. 1917 - Oil income to North American Oil; Receiver releases funds to the corporation because the district court said the company was entitled to the funds; U.S. government appeals and on appeal the appellate court affirms with lower court. 1922 - Final appeal is in favor of North American Oil as the Supreme Court refuses to hear the land dispute case. Tax Case Issue: In what year will the funds be deemed gross income? In which year does the taxpayer/company have income from the oil profits? ○ Three possible years are possible: 1916, 1917, and 1922 1916 - when company made the profits Rates 2% Taxpayer argues “Constructive receipt” in 1916. ○ Constructive Receipt §1.451-2(a) - Income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is: Credited to his account, Set apart for him, Or otherwise made available So that he may draw upon it any time.. Supreme Court ruled that this wasn’t constructive receipt because the company couldn’t have possession of the money. No receiver held it, and taxpayer could not take it (or draw upon it). 1917 - when company got to handle the money Birbrayer 9  Rates 66% - taxes jumped to pay for cost of the war ○ Receiver pays the $171,979.22 to taxpayer/North American Oil ○ Claim of Right Doctrine - If a taxpayer receives earnings wunder a claim of right and without restriction as to its disposition, he has received income which his is required to [report] even though it may still be claimed that he is not entitled to retain the money. Supreme Court ruled that the tax was owed in the year 1917. 1922 - when final appeal is over Rates 12% Dicta: If the court had won and the company would have to give the money then the company can deduct the tax they paid in the future. Take a deduction in the year you had to give it back and not in any earlier year. ○ Cannot amend the earlier return because the earlier return is correct. Something happened in the future doesn’t change the fact that the earlier return was correct. ○ Year of repayment after a claim of right If taxpayer subsequently is required to give back some of the income included can the taxpayer amend the earlier year’s return? Taxpayer cannot amend earlier year but can take deduction in subsequent year Deduction in year of repayment OR §1341 - relief may apply in year of repayment ○ §1341 Mechanics (discussed again in Chapter 28) §1341(a) - still cannot amend (1) Income is under Claim of Right, (2) deduction, and (3) exceeds $3,000 The tax (in repayment year ) is the lesser of tax calculated by §1341(a)(4) or §1341(a)(5): Birbrayer 10  (4) repayment year taxable income taking the deduction North American Oil - 1922 tax rate was 12% (5) Current year (repayment year) taxable income without the deduction less additional tax paid in prior year because of the inclusion in the prior year North American Oil - additional tax paid in 1917 tax rate was 66% ○ Problem #1 (pg. 55) Jack received commission check of $25,000 Nov 1 of Yr. 5 Jack received commission check for $25,000 Dec. 1 of Yr. 5 Told mistaked in amount; employer says should have been $21,000 (Jack disputes this) Feb Yr. 6 Jack and employer come to an agreement ($23,000) Jack gives back $2,000 (not $4,000 which employer originally wanted) Jack has to report $25,000 in year of receipt/earlier year. If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, has has received income which he is required to report ○ In Yr. 1 he has the claim of right to the $25,000 ○ James v. U.S. (p.66) James had embezzled $738,000 Tax Case Didn’t report the embezzled funds Issue: Whether embezzled funds are gross income of the embezzler in the year in which funds are misappropriated under §61 ○ Does embezzler have income under Claim of Right Old tax cases distinguished between someone who embezzles and someone who extorts money Wilcox Case ○ Embezzled money ○ Embezzler didn’t have claim of right since “duty to repay” so more like a loan - made it more like a loan ○ Not income Rutkin Case ○ Extorted money ○ Extortioner’s victim less likely to demand repayment ○ So extortioner has gross income James case Birbrayer 11  Court gets rid of When a taxpayer acquires earnings - lawfully or unlawfully without consensual recognition of an obligation to repay and without restriction as to its disposition [under a claim of right], he has received income which he is required to [report]... even though may not retain and may be liable. James has to report the embezzled money as gross income. Embezzler has to pay taxes on the illegal funds. ○ Problem #2 (Rocky) $100,00 received from client for Rocky to invest Rocky instead gambled with client’s money Lost all $100,000 Client agreed to an 18-month repayment period; Tocky complied Rocky’s tax consequences on receiving/taking and repaying the $100,000? He is more like the embezzler Year of receipt $100,000 is the Gross Income; Year(s) of repayment $100,000 ○ If this was a loan and not embezzlement: year of receipt; no gross income; year(s) of repayment; no deduction ○ Security Deposits Prepayments of rent? Income when received Reg. §1.61-8(b) ○ Advanced rent (prepayment of rent) is income to Landlord when received ○ If tenant pays to cancel a lease early, that is gross income to Landlord when received (substitute for rent) Deposit? Not income because of offsetting obligation to repay ○ Commissioner v. Indianapolis Power & Light Company (p.70) TWEN Chapter 03 Effect of Obligation to Repay new version - WITH ANSWERS ○ Last year Bill borrowed $5,000 from First Bank and used the loan proceeds to pay for a vacation trip to Europe. This year, Bill repaid the $5,000 pursuant to the terms of the note he had signed. Which of the following most correctly explains the tax consequences of these transactions? In year 1, Bill does not include the $5,000 loan proceeds in gross income because of the offsetting obligation to repay the loan. In year 2, the principal payment is not deductible. ** END OF CLASS ** Birbrayer 12 CHAPTER 04 GAINS DERIVED FROM DEALING REAL PROPERTY August 28, 2024 §61(a)(3) Gross Income Includes – gains Reg §1.61-6(a) ○ Gain realized on sale or exchange of property is included in gross income, unless excluded by law ○ Generally, gain is excess of amount realized over the unrecovered cost or other basis for the property ○ See Code §1001 Formula for Gain ○ Gain - §1001(a) Amount Realized Less Adjusted basis = Realized Gain ○ §1001(b) Sum of money received plus the FMV of any property received Example: Stock bought for $2,000 sold for $5,000 ○ Use §1001(a) formula to figure out gain ○ Amount realized §1001(b) = $5,000 Less Adjusted Basis Adjusted §1011 basis as adjusted by §1016 Here we use 1012 cost basis (no adjustments) so basis is $2,000 per §1012 cost basis ○ Different Type of Bases Cost (§1012) - cost for time, unless another provision applies - this is the default Gift (§1015) - generally carryover donor’s basis Inter vivos gift - general rule donee gets the donor’s cost basis Death (§1014) - generally FMV at death of transferor Non-recognition (e.g., §1031 (lifetime exchange) or §1033 (condemnation)) - generally substituted basis for new property. Non-recognition (§1041) - spouses/incident to divorce, transferee takes transferor’s basis ○ Recall Adjusted Basis Adjust under §1016 for adjustments to basis ○ = Realized Gain of $3,000 §1001(c) - Unless otherwise provided the entire amount of realized gain is recognized (reported) Birbrayer 13  Casebook Problem - Problem 1; Chapter 4 (pg. 77) ○ Problem 1: Speculator bought 5-acre track of land 10 years ago for $100,000; sold it this year for $300,000 (land is not depreciable) Amount realized §1001(b) = $300,000 Less adjusted §1012 cost basis = $100,000 Realized gain = $2,000 §1001(c) - tells us we have to report the $2,000 realized gain. ○ Problem 1 VARIATION: T bought 5 acres 10 years ago for $100,000; subdivided into 5 separate 1 acre lots and sold each for $75,000 Reg. §1.61-6(a) Ex. (1) Taxpayer must abortion the taxpayer’s overall adjusted basis among the parcels in an equitable manner. Here since each lot 1 acre and each sold for $75,000 (could apportion ⅕ basis to each) Amount Realized §1001(b) of $75,000 Less Adjusted Basis §1012 of $20,000 = Realized Gain of $55,000 Case book Problem 2 (pg. 77) ○ 2(a) Maggie buys summer home for $500,000 $100,000 deposit and $400,000 bank loan What is Maggie’s basis in summer home? - Full $500,000 - Basis is the cost. Sp. Ct. Commissioner v. Tufts (pg. 85) ○ Taxpayer includes amount of loan in computing §1012 cost basis. Basis is $500,000 (cost basis) Basis is also $500,000 if instead of borrowing the $400,000 from the bank she borrowed it from the seller ○ 2(b) Maggie buys summer home for $500,000 ($100,000 deposit and $400,000 loan) She period $100,000 and is liable for $400,000 Cost basis is $500,000 Assume that Maggie has now paid $100,000 of the principal of her $400,000 loan (i.e., debt now $300,000) What is her basis? STILL $500,000 Paying off the principal does not reduce her basis. ○ 2(c) When mortgage down to $200,000 she refinance She takes out an extra $250,000 Her mortgage debt no $450,000 Uses $250,000 refinancing proceeds Birbrayer 14  $75,000 used to remodel kitchen - §1016(a)(1) adjusted basis up $125,000 used to buy separate land $50,000 used to go on European vacation - non deductible (personal expense §262 will block it) ○ 2(d) Maggie sells summer home. Purchase pays Maggie $300,000 and assumes balance of $400,000 of Maggie’s mortgage debt. $575,000 is the current basis Reg. §1.1001-2(a)(1) amount realized includes amount of liabilities form which taxpayer is relieved. Amount realized is $700,000 Recall: Old Colony Trust Company (assume liability) $700,000 (Amount Realized) -$525,000 (Adjusted Basis) =$125,000 gain for Maggie Purchaser takes basis of $700,000 in the home Even though they are assuming the mortgage TWEN Chapter 04 Gains Derived from Dealings in Property - WITH ANSWERS 1. Assume the facts from Problem 2 of Chapter 4 (i.e., Maggie buys summer home for $500,000 using $100,000 of her saved funds and $400,000 mortgage loan). Assume further that the facts of problem 2(c) apply (i.e., when mortgage debt is $200,000 Maggie refinances and borrows $250,000 and then uses the $250,000 refinancing proceeds as follows: $75,000 (capital improvement/investment) to remodel the summer home; $125,000 to purchase a track of investment land; and $50,000 for a vacation). Under these facts what is her basis in the summer home now? $500,000 2. Using the facts above, what is Maggie's basis in the investment land? $125,000 Case Book Problem 3 (pg. 78) ○ 3. Clare, collector of art, owes Liz for legal fees. Liz lawyer buys a painting from Clare Collector for $6,000 cash Liz’s basis is $6,000 according to §1012 cost basis which is the default unless told it is a death or gift or something else. Clare then uses the money to pay legal fees to Liz. Liz receives $6,000 in payment for legal services - this is gross income §61(a)(1) - compensation income. Birbrayer 15  What are the tax consequences 5 years later when Liz sells painting for $10,000 $10,000 (amount realized) Minus $6,000 (adjusted basis) = $4,000 in gain ○ Clare, collector art, owes Liz for legal fees VARIATION List Lawyer agrees to accept a painting (FMV of $6,000) as payment in full for legal fees owed her by Clare What tax consequences to Liz 5 year later when Liz sells painting for $10,000? Liz received $6,000 FMV of property in payment for legal services (compensation income) - form of compensation does not matter. ○ §61(a)(1) - compensation income ○ Reg. §1.61-1(a) Form doesn’t matter ○ Reg. §1.61-2(d) - FMV property received Basis in painting is $6,000 ○ As if she took $6,000 cash compensation and purchased painting for $6,000 Painting sale: ○ $10,000 (amount realized) ○ -$6,000 (basis) ○ =$4,000 gain Philadelphia Park (pg. 89) Taxable Exchange ○ Issue: What is Taxpayer’s basis in Franchise extension received in the taxable exchange? ○ Two Theories (1) cost basis in extension is FMV of ○ The cost basis of the property acquired in a taxable exchange is the FMV of the acquire property – not the value of the property given Problem 4 ○ Katie exchanges land with Patrick (both for personal use) Taxable Exchange Katie had land in Phoenix with FMV $750,000 she purchased it for $450,000; exchanged it for Patrick’s Lake Tahoe land with FMV of $750,000 which Patrick had a basis of $100,000. What is Katie’s gain on sale of Phoenix's land? Amount Realized is $750,000 -$450,000 (basis) =$300,000 gain Birbrayer 16  What is Katies’s basis in Lake Tahoe land? $750,000 ○ As if she had sole her Phoenix land for $750,000 and used proceeds to buy Lake Tahoe ** END OF CLASS ** September 4, 2024 CHAPTER 05 GIFTS, BEQUESTS, AND INHERITANCE GIFTS ○ §61 not limited to the listed items Glenshaw Glass - Is a gift accession to wealth? - YES; Note: unlike loans, gifts have no corresponding obligation to repay. Dominion & control Congress excludes gifts ○ Donee Excludes value of gift §102(a) General rule §102(a) “Gross income does not include value of property acquired by gift, bequest, devise, or inheritance” Applies to inter vivos and testamentary transfers Note: Neither statute (§102) nor its regulations define the term “gift” - case law does this for us. ○ Commissioner v. Duberstein (U.S. Sp. Ct. 1960) p. 104 Facts Berman and Duberstein had done business together Periodically Duberstein provided names of potential customers to Berman Bernam gives Duberstein a Cadillac (Berman Insists) Berman’s company takes business deduction for the value of the car Duberstein claims no income - gift ❗Duberstein Test Lack of obligation not enough to show gift (Old Colony - employer agree to pay taxes) If payment primarily made because of constraining force of a moral or legal duty or from anticipated benefit of an economic nature, it is not a gift (e.g. “tips” or “reward”) Birbrayer 17  Gift proceeds from detached, disinterest generosity, out of affection, respect, admiration, charity ○ Trier of fact decides based on experience with human conduct ○ Limitations of §102 Does not exclude gifts to employees (§102(c)) Beyond employee block business generally Note: §274(b)(1) - If corporation is supporting taxpayer’s “gift” argument, then corporation cannot take deduction (if over $25) ○ Problem #1(a) - Elizabeth receives a Rolex Watch from Corporate Client Transferor: Client of her law firm; happy holidays; in appreciation gives watch. Income to Elizabeth on receipt? - Reg. §1.61-1(a) - gross incomes includes income in whatever form, money, property, services §102(c) does it block it - no because she isn’t a direct employee; not employer/employee she is an independent contractor Is this a gift under Duberstein - Did the corporate lawyer client give the watch to Elizabeth as a result of “detached and disinterested generosity?” - No this watch is gross income ○ Other Limitations of §102 Does not exclude gifts of income (§102(b)) §102(b)(1) - can’t exclude the income generated from the gifted property (blocks §102(a) with regard the income generated from the gift) ○ Ex: Gift of IBM shares FMV of IBM stock is excluded; Value of stock is excluded from your gross income. FMV of IBM shares excluded (§102(a)). §102(b)(1) - income on the shares is not excluded. Dividends generated from the IBM shares are income/not excluded. §102(b)(2) - cannot exclude gift/devise of income (if gift is not the principal but the income of - then not excludable) ○ Ex: Trust provides “income to A for life, remainder to B” Income to A is not excluded §102(b)(2); Income A receives is gross income Remainder to B is excluded; FMV of remainder to be excluded (see example p.99) ○ Note: §102 does not provide basis rules for gifts Birbrayer 18 ○ Donee’s Basis in Gift Property – Taft v. Bowers (p. 100-101) Facts Father’s cost basis $1,000 Gift from father to daughter; time of gift FMV of property was $2,000 Daughter sells property and amount realized was $5,000 ○ Daughter does not want to be taxed on the appreciation before she got the property (so the $1,000 to $2,000) Court says the Donee accepted the gift… and as the property received, voluntarily assumed the position of her donor. So daughter’s basis was $1,000 not $2,000. ○ Problem #3(a) – Dan gift to son of lot Facts: Dan’s cost basis is $100,000 Dan deeds lot to Son as a gift with the FMV of $250,000 ○ Is there income to Dad when he makes the gift - NO Regs. §1.1001-1(e) analogy (part gift/part sale Amt realized of Dan = $0 - Adj. Basis = $100,000 Gain = $0 ○ Is there income to Donee on gift - NO §102(a) - should apply and not blocked by (b) or (c) What is son’s basis? ○ §1015(a) basis - Is the Donor’s basis of $100,000 ○ Problem #3(b) Same facts but assume son, Will, works for Dan Dan’s cost basis is $100,000 Dan deeds lot to Son as a gift with the FMV of $250,000 Income to Will? Probably Not ○ §102(c) Issue ○ Prop. Reg. Section 1.102-1(f)(2) Will has to show that the reason for the gift is because of the father/son relationship and not employer/employee relationship and that gift was made on a special day. ○ Its purpose substantially attributed to family relationship and not employment. ○ §1015(a) General Rule - Donee’s Basis is carryover/transferred (aka is the donor’s old basis) Exception to §1015(a) - to avoid trafficking in losses Transferred basis but if Birbrayer 19  ○ (1) Donor’s basis exceeded FMV at time of gift (built-in-loss property aka property value went down in donor’s hands), AND ○ (2) Donee subsequently sells it for loss (less than donee’s basis and FMV at time of sale) Then for loss purposes - donee;s basis is FMV at gift ○ Donee's basis in gift? §1015(a) basis transferred Exception applies when - built-in-loss property but only for ○ ❗ subsequent loss purposes Built-in-loss - Donor’s basis is > FMV of gift If don’t have built-in-loss, exception doesn’t apply, use transferred basis. ○ AND ○ Subsequent sale is for a loss (i.e., sale for an amount that is less than FMV of gift less the donor’s basis ○ Problem #3(e) – Dan gift to son of lot but built-in loss property Facts: Dan’s cost basis is $100,000 Dan deeds lot to Son as a gift with the FMV of $90,000 Son , WIll, sells for $80,000 Did donor’s basis exceed FMV at time of gift - yes - so there is a built in loss Question #1) Basis to Son, Will? Answer: $90,000 ○ §1015 General Rule: Carryover/Transferred ○ §1015 Exception applies when – Donor’s basis is > FMV of gift (built-in-loss) AND Subsequent sale is for a loss (i.e. sale for an amount that is less than FMV and gift and less than donor’s basis) Question #2) Amount of Tax on sale? Answer: $0 §1001(a) ○ Amount Realized = $80,000 ○ -Adjusted Basis - $90,000 ○ = Loss of ($10,000) §165(c) tells you when loss is deductible Birbrayer 20  TWEN Chapter 05 Gifts, Bequests, and Inheritance Quiz 1 - WITH ANSWERS ○ Refer to the facts of problem 3(e) on pages 93-94 of your casebooks (i.e., Dan’s cost basis in lot is $100,000; FMV of the lot at the time of the gift to son, Will, is $90,000). What would be the son's basis in the lot, if the son subsequently sold the lot for $80,000? $90,000 Problem #3(e) (variation) – Dan gift to son of lot but built-in loss property ○ Facts: Dan’s cost basis is $100,000 Dan deeds lot to Son as a gift with the FMV of $90,000 Son , WIll, sells for $95,000 ○ Question 1) - Basis of Son, Will? Answer: $95,000 Donor’s basis Was the built-in-loss at time of gift? - yes Yes donor’s basis of $100,000 > FMV at time of gift $90,000 But: was subsequent sale ($95,000) for less thant FMV at time of gift? - No ○ Question 2) - Amount of Tax on sale? Answer: $0 Section §1001(a) - Any gain? NO Amount Realized = $95,000 -Adjusted Basis = $100,000 = No Gain = $0 Son doesn’t have taxable gain because he uses general rule - transferred aka Dad’s basis Son has no loss either because for loss purposes his basis is FMV at time of gift $90,000 Actual loss has to be lower than FMV at time of gift and lower than Donor’s basis Party Gift/Part Sale - Consequences to Donor/Seller ○ Transferor’s gain or loss on part gift/part sale - Reg. §1.1001-1(e)(1) Gain to extent Transferor’s Amount Realized exceeds Transferor’s Adjusted Basis No loss Reg. §1.1001-1(e)(1) (second sentence) Transferor’s Basis Reg. §1.1015-4(a) ○ Reg. §1.1015-4(a) Transferee’s basis is the greater of: (1) amount transferee paid for the property, or (2) transferor’s adjusted basis at time of transfer Birbrayer 21  ○ But for determining Loss., transferee’s basis not greater than FMV at time of transfer Problem #3(c) - Variation - Dan part gift/part sale to son of lot (son pays $200,000 ○ Facts: Dan’s cost basis $100,000 Dan sells lot to son, Will, for $200,000; FMV at time of transfer $250,000 ○ Question 1) How much is Dan’s taxable gain? Reg. §1.1001-1(e)(1) Gain to extent Transferor’s Amount Realized exceeds transferor’s adjusted basis ○ §1001(a) Amount Realized = $100,000 -Adjusted Basis = $100,000 Dad’s Gain = $100,000 ○ Question 2) What is son’s basis? Reg. §1.1015-4(a) Greater of (1) amount transferee paid or (2) transferor’s adjusted basis Reg. §1.1015-4(a) and (b) Ex.2 = $200,000 of son’s basis ○ Question 3) What if Son sell it for $250,000? Reg. §1.1015-4(a) Greater of ○ (1) amount transferee paid or ○ (2) transferor’s adjusted basis §1001(a) Realized Gain = 250,000 Adjusted basis = -200,000 Son’s gain = $50,000 ○ Note: combined gain recognized of Son and Dad is $150,000 ** END OF CLASS ** CHAPTER 05 CONT. GIFTS, BEQUESTS (PART SALE/PART GIFT) Part Gift/ Part Sale Consequences to Donor/Seller ○ Transferor’s gain or loss on part gift/part sale: Reg. §1.1001-1(e)(1). Birbrayer 22  Gain to extent Transferor’s amount realized exceeds transferor’s adjusted basis. Loss - No Loss Reg. §1.1001-1(e)(1) (second sentence) Transferee’s Basis - Reg. §1015-4(a) ○ Transferee’s Basis Reg. §1015-4(a) Transferee’s basis is the greater of: (1) amount transferred paid for the property, or (2) Transferor's adjusted basis at time of transfer. Problem #3(c) - Variation Dan part gift/part sale to son of lot (son pays $200,000) ○ Facts: Dan’s cost basis $100,000 Dan sells lot to Son, Will, for $200,000 FMV at the time of transfer $250,000 ○ Question 1) How much is Dan’s taxable gain? Answer: $100,000 Reg. §1001-1(e)(1) Gain to extent Transferor’s Amount Realized exceeds Transferor’s Adjusted Basis. §1001(a) ○ Amount Realized $200,000 ○ Minus Adjusted Basis $100,000 ○ Gain = $100,000 ○ Question 2) What is Son’s basis in the property? Answer: $200,000 Reg §1015-4(a) - Greater of: (1) amount transferee paid ($200,000)or (2) transferor’s adjusted basis ($100,000). ○ Additional Fact: Son sell’s land for $250,000 Question 3) What is son’s basis. Answer: $200,000 Question 4) What is Son’s gain on sale (§1001(a))? $50,000 Amount realized $250,000 Minus Adjusted Basis $200,000 (Reg. §1.1015-4(a)) Gain = 50,000 ○ Note: Combined gain recognized by Dan and Son would be $150,000. Problem #3(c) - Dan part gift/part sale to son of lot (son pays $50,000) ○ Facts: Dan cost basis $100,000 Dan sells lot to Son, Will, for $50,000 FMV at the time of transfer $250,000 Birbrayer 23  ○ Question 1) How much is Dan’s taxable gain? $0 Reg. §1001-1(e)(1) Gain to extent Transferor's Amount Realized exceeds Transferor’s Adjusted Basis. No Loss Reg. §1001-1(e)(1) (Second Sentence) Amount Realized = $50,000 Minus Adjusted Basis = $100,000 Loss = ($50,000) ○ Question 2) Can Dan Take the Loss? Answer: No No, Reg. 1001-1(e)(1) No loss if amount realized is less than basis Dan made a gift of the FMV of the land over the amount he received (gift value $200,000) ○ Question 3) What is Son’s Basis? $100,000 Reg. §1.1015-4(a) Amount transferee paid - $50,000 Transferor’s adjusted basis = $100,000 So Son’s basis is $100,000 Problem #3(c) - Dan part gift/part sale to son of lot (son pays $200,000) and Son sells for $250,000 ○ Facts: Dan cost basis $100,000 Dan sells lot to Son, Will, for $50,000 FMV at the time of transfer $250,000 Son sells for $250,000 ○ Question 1) What is Son’s Basis? Answer: $100,000 Reg. §1.1015(a) = $100,000 Greater of (1) amount transferee paid ($50,000) or transferor’s adjusted basis ($100,000) ○ Question 2) What is Son’s gain on Sale? Answer: $150,000 Realized Gain = $250,000 Minus Adjusted Basis = $100,000 Gain = $150,000 ○ Note: Combined gain recognized by Dan and Son would be still $150,000 Problem #3(c) - VARIATION - Dan transfers lot and son, lot FMV at time of gift is $300,000, lot has mortgage of $150,000, Son assumes Dan’s mortgage of $150,000 on lot. ○ Facts Dan’s cost basis = $100,00 Birbrayer 24  In effect Dan sells lot to Son for $150,000 (assumption of Dan’s mortgage debt) FMV at time of transfer is $300,000 ○ Part Gift/Part Sale How much is Dan’s taxable gain? Reg §1.1001-1(e)(1) Gain to extent Transferor’s Amount Realized exceeds Transferor’s Adjusted Basis ○ How much is Dan’s taxable gain? Answer: $150,000 Reg. §1.1001-1(e)(1) Gain to extent Transferor’s Amount Realized exceeds Transferor’s Adjusted Basis Reg. §1.1015-4(a) Greater of (1) amount transferee paid or (2) transferor’s adjusted basis $150,000 ○ Reg. §1.1001-2(a)(1) amount realized includes amount of liabilities from which taxpayer is relieved Old Colony TWEN Chapter 05 Gifts, bequests (part sale/part gift) quiz 2 - WITH ANSWERS ○ 1) Review the facts for problem #3(d) (casebook pages 93-94). Set forth below how much Dan's amount realized would be under these facts? Review Regs. §1.1001-2(a)(1). Also, set forth below how much gain, if any, Dan would have under these facts. Review Regs. §1.1001-1(e)(1). Be sure to include the formula you would use for calculating Dan's gain or loss. Review Code §1001(a). Dan's realized amount is $150,000 minus Dan's basis of $100,000 = Dan's Gain of $50,000 ○ 2) Review the facts for problem #3(d). What is the son's basis in the lot? Review Regs. §1.1015-4(a). $150,000 Reg. §1.1015-4(a) Greater of (1) amount transferee paid ($150,000) or (2) transferor’s adjusted basis ($100,000). So Son’s basis is $150,000 ○ 3) Assume D purchased for investment one acre of land for $100,000 five years ago. This year, D transferred the one acre parcel of land to his son as a gift when the land had a fair market value of $250,000 and an adjusted basis to D of $100,000. At the time of the gift, D's land was encumbered with a mortgage of $125,000, and the son agreed to assume the mortgage. What are the correct tax consequences to D and what is Son's basis? D recognizes a gain of $25,000 due to the amount realized of $125,000 (mortgage value) less his adjusted basis of $100,000. Son takes a $125,000 basis in the land. ⚠️ IMPORTANT!!!! 1015 - is only inter vivos gifts ⚠️ Birbrayer 25  Problem #3(f) - Dan devises lot to Will and at Dan’s death lot has FMV of $250,000 ○ Facts: Dan’s §1012 cost basis is $100,000 Dan devises lot to son FMV at time of death $150,000 ○ Question 1) What is Son’s basis? Answer: $250,000 §1014(a)(1) - Stepped-up Basis $250,000 Problem #3(f) - VARIATION - Dan during lifetime gives lot to son, Will ○ Facts: Dan’s §1012 cost basis is $100,000 Dan fives lot to son as inter vivos gift FMV at time of gift is $250,00 ○ Question 1) What is Son’s basis? Answer: $100,000 §1015 Carryover $100,000 Problem #3h - Dan gives lot to GF who devises lot to Dan’s son, Will (Grandfather (GF) died 2 months after gift to Dan.) ○ Facts: Dan’s §1012 cost basis is $100,000 Dan gives lot to grandfather (GF) FMV at time of gift $250,000 GF devises lot to Will ○ Question 1) What is GF’s basis at gift? Answer: $100,000 (under §1015) ○ Question 2) What is the son's basis? Answer: $250,00 (under §1014(a)) §1014(e) - closes the I give to you and you give it right back - brings you back to §1015. Problem #3(g) - Dan devises lot to son at Dan’s death lot has FMV of $75,000 ○ Facts: Dan’s §1012 Cost basis $100,000 Dan devises lot to son FMV at death $75,000 ○ Question 1) What is Son’s Basis? §1014(a)(1) - Stepped-down Problem #2 (Maria) ○ Facts: At her father’s request, Maria moved out of her apartment and into his home. Birbrayer 26  Father said he’d devise the home to her if she cared for him for his last few years - If she agreed to the arrangement. She told him there was no need to make the devise. She was the only child who lived near enough (and had no other family commitments) Maria moved in Father died few years later and devised the home to Maria “In gratitude for her care” Maria and her siblings split the remainder of the estate ○ Question 1) Does Maria have Gross Income? Answer: Yes, this is compensation income. Question 1a) If so how much and when? ○ Question 2) What is her basis if she does (or doesn’t) have gross income? Her basis would be a §1014 step-up basis if she can prove that this is truly a devise. TWEN Chapter 05 Gifts, Bequests, and Inheritance Bonus Questions - WITH ANSWERS ○ 1. Father purchases stock for $5,000 and gives the stock to Son as a gift when the stock has a fair market value of $8,000. What are the income tax consequences if any to the Father of the gift? Father has no income tax consequences upon making this gift ○ 2. Refer to the facts above. What are the income tax consequences to the Son, if any, of the gift? Son has no income because Section 102(a) applies and is not blocked by 102(b) or (c) ○ 3. Refer to the facts above. What is the son's basis in the stock received as a gift from Father? Son has a 1015(a) basis of $5,000 ○ 4. Refer to the facts above. How much gain would Son recognize if he subsequently sold the stock for $9,500? Son would have realized gain of $4,500 ○ 5. Refer to the initial facts. How much gain would the son recognize if he subsequently sold the stock for $6,000? Son would have a realized gain of $1,000 ○ 6. Mom purchases stock for $5,000 and gives the stock to her son as a gift when the stock has a fair market value of $3,000. Assume that Son subsequently sells the stock for $6,000. What is Son’s basis in the stock under these circumstances and how much gain or loss, if any, would Son have on the Birbrayer 27  sale of the stock for $6,000? Son would have a basis of $5,000 and gain of $1,000. ○ 7. Refer to the initial facts in the previous question (i.e., Mom purchased stock for $5,000 that she gave to her son when the fair market value of the stock was $3,000). Assume for this question that Son subsequently sells the stock for $2,000. What is Son’s basis in the stock under these circumstances and how much gain or loss, if any, would Son have on the sale of the stock for $2,000? Son would have a basis of $3,000 and loss of $1,000. ○ 8. Refer again to the initial facts of the previous question (i.e., Mom purchased stock for $5,000 that she gave to her son when the fair market value of the stock was $3,000). Assume Son subsequently sells the stock for $4,000. What is Son’s basis in the stock under these circumstances and how much gain or loss, if any, would Son have on the sale of the stock for $4,000? Son would have a basis of $5,000 and no gain or loss. September 11, 2024 CHAPTER 06 SALE OF PRINCIPAL RESIDENCES & CHAPTER 07 PRIZES ANDS AWARDS Sale of Principal Residence & Scholarships and Prizes ○ §121 §121(a) Exclusion of Gain from Sale of Principal Residence if Taxpayer owned & lived in principal residence 2 years out of 5 years preceding sale Limited §121(b) Special Rules in §121(c); (d); (f) §121(b) Limitations §121(a) exclude gain on sale if own and use principal residence for at least 2 out of 5 years preceding sale §121(b)(1) Maximum exclusion $250,000 §121(b)(2) Maximum exclusion $500,000 joint returns if ○ (i) Either spouse meets “ownership”; ○ (ii) Both spouses meet “use”; and ○ (iii) Neither blocked by (b)(3) (neither used §121 within last 2 years) §121(b)(3) Look back 2 years (can’t use §121(a) exclusion if used in last 2 years) ○ Reg. §1.121-1 Reg. §1.121-1(b)(1) Residence can be houseboat, co-op, house trailer, etc. Birbrayer 28  Reg. §1.121-1(b)(2) If person is between 2 different residences; The one in which they spend the majority of the time as principal. If exactly 50/50 then we look at the facts ○ §121(a) Ownership and Use 2 out of 5 years Reg. §1.121-1(c)(1) 24 months (i.e., 730 days (365x2)) - doesn’t have to be in a row Reg. §1.121-1(c)(2) in establishing “use” occupancy is required (short-term absences are okay) Short temporary absences OK Problem #1(a) (pg. 117) - “Principal Residence” for 2 out of past 5 years for §121 ○ Facts: Jan. 1, 2021 buys house in LA Sept 1, 2022 - Dec. 31, 2022 She stays 3 months in hotel in NY Jan 1, 1012 buys condo in NY August 31, 2023 - Alternates months (4 months in NY and 4 months in LA) Sept. 1, 2023 Sells her LA house at substantial hain ○ Issue: did she own the LA home for 2 years or more during the 5-year period before she sold it? Answer: Yes Owned LA house for 2 years and 8 months (1/1/21 to 9/1/23) Ownership met ○ Issue: Did she use the LA home as her principal residence for periods aggregating 2 years? Time out of LA so need to analyze use as principal residence Reg. §1.121-1(c)(2) “short temp. Absences” - we count the time from 1/1/21 to Sept 1, 2022 = 20 months we count Reg. §1.121-1(c)(4) Example 5 [apply]? (4 months?) Example 5 allows for 2 months We aren’t going to count this Reg. §1.121-1(b)(2) “majority of time during the year” (if equal time, review factors) Reg. §1.121-1(b)(4) Example 1 Birbrayer 29  ○ Question: Did Susan own and use her LA residence as her principal residence for a period aggregating two years or more? Answer LA Residence is the principal residence. Problem #1(b) Adjoining Lot ○ Can she exclude from sale of adjoining lot that she used as garden? Answer: Yes, she can exclude it Reg. §1.121-1(b)(3)(i) Adjacent; Uses as part of principal residence; Sells within 2 years; Meets rest of §121 Problem #1 – Brian and Jennifer ○ Facts: Bought home for $650,000 in 2019 (§1012 cost basis is $650,000) Principal residence till 2022; Sold 2023 §1016 adjustment is $900,000 ○ Formula Amount Realized = $1,500,000 Less adjusted basis = $900,000 (* cost + improvements) Realized Gain = $600,000 ○ §121(b)(2) special rule for joint returns (Exclude 500,000) (A) filed a joint return for the year of sale? Yes (i) did either spouse meet ownership requirement? Yes (both) (ii) did both spouses meet use requirements of §121(a)? Yes (iii) was either spouse ineligible (i.e., used §121 exclusion within a 2 year period ending on date of sale)? N0 ○ Codes for analyzation §121(a) Exclusion of Gain from Sale of Principal Residence §121(b)(2) special rule for joint returns Questions Would it have mattered if title had been only in Jennifer’s name? §121(b)(2)(A)(i) requires only that “either spouse meets the ownership requirements Contrast that with the “use” as principal residence for 2 out of 5 years requirement §121(b)(2)(A)(ii) requires “both spouses meet the use requirements” ○ Answer: Exclude $500,000 Birbrayer 30  §121(b)(2)(B) Other joint returns ○ What if can’t meet §121(b)(2)(A)(i)-(iii) to qualify for the joint $500,000 exclusion See §121(b)(2)(B) - Each can take the amount they would have been entitled to if they had not been married. Problem #3 (pg. 118) - Tom and Chris married and move into new home in Miami ○ Facts: Tom and Chris realize gain on 2023 sale of their homes They are married, but can they exclude $500,000? See §121(b)(2)(1)(ii) Neither had lived in the other’s home so can’t meet “use” requirement How much gain can they exclude under §121? See §121(b)(2)(B) - Each can exclude the amount of gain if they had not been married. ○ Question 1) How much gain did Tom and Chris realize in 2023 of their homes? $150,000 - Tom ‘s Gain on Tom’s old house Amount Realized $550,000 Minus Adjusted Basis $400,000 Realized Gain = $150,000 $500,000 - Chris’s Gain on Chris’ old house Amount Realized $800,000 Minus Adjusted Basis = $300,000 Realized Gain = $500,000 ○ Question 2) How much gain did Tom and Chris realize on the 2023 sale of their homes? How much of that gain can they exclude because of §121? See §121(b)(2)(B) Each can exclude the amount of gain if they had not been married Tom can exclude his full $150,000 gain Chris can exclude max of $250,000 gain = $400,000 total TWEN Chapter 06 Sale of Principal Residence - WITH ANSWERS ○ Refer to the facts in Problem 3 on page 118 of your casebooks. Which of the following could have allowed Tom and Chris to maximize the benefits provided by Section 121, if they had consulted you before they sold their respective homes. Selling Tom's home in 2023 and then moving into Chris' home and selling Chris' home two years later when they filed jointly Birbrayer 31  Special Rules (c) and (d) ○ Death of Spouse §121(c) and (d)(2) - Example 5 (pg 122) Facts: July 1, 1997 M owned and used house (many years principal residence alone) July 1, 2020 M marries B and B moves in August 15, 2022 M dies; B inherits house and B continues to live there until he sells the next year Bill inherited/owned house for less than 1 year (8/15/22 to 6/1/23) and M is dead so how can he meet 2-year ownership rule? §121(d)(2) allows period deceased spouse owned and used property to count for surviving spouse ○ §121(c) - Job, Health, or Unforeseen Circumstances Regs. §1.121-3(g)(1) (See examples 4,5,and 6 (pages 126-127)) Multiply max exclusions ($250,000 or $500,000) by fraction Numerator is shortest number of days/months “owned”, “used” or “time between §121” Denominator is 730 days or 24 months Example Shortest days or months ____________________________ x Max excludable = 730 days or 24 months 250,000 or 500,000 12 months ____________________________ x $250,000 = $125,000 24 months Instead of Excluding nothing If used for 15 months, then She can exclude up to $125,000 15/24 is.625 x $250,000 the gain because of §121(c) $156,250 of gain excluded Regs. §1.121-3(g)(2) taxpayer uses for 12 months then sells because of job CHAPTER 7 Prizes and Awards ○ §74(a) General Rule - Prizes and Awards are Gross Income to transferee/recipient Prizes include in gross income UNLESS eligible for scholarship ○ §74(b) awards: ⚠️ Exception ⚠️- Really strict - Can exclude certain prizes and Birbrayer 32  (i.e., those primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement) As long as all 3 of the following met: §74(b)(1) recipient/taxpayer didn’t enter a contest or proceeding §74(b)(2) recipient not required to provide services as condition of prize; AND §74(b)(3) Recipient can’t get prize or award - the prize is transferred by the payor directly to a charity (§170(c) organization) or to a governmental unit Effect of §74(b) Exception if give to charity anyway? Meet §74(b) and give to charity = ○ No Gross Income ○ No Charitable Deduction Don’t meet §74(b) - Give to charity anyway ○ Yes Gross Income ○ Yes Charitable Deduction ○ Can refuse to accept so no gross income ○ Might not be the same: If don’t itemize (because standard deduction is greater) If taxpayer’s charitable contributions for the year exceed §170(c) limits If §74(b) exception applies no gross income; no charitable deduction; but get to designate the charity (get to pick your charity) ○ Real question: What if you accept it for self? ○ §74(c) ⚠️ Exception⚠️- limited- qualified employee service/safety achievement (tangible personal property (not cash) and meaningful ceremony) capped generally at $400 ○ §74(d) Olympic and Paralympic Medals ⚠️Exception ⚠️ ○ Regs. 1.74-1(a)(2) Gross income of non-cash awards is the FMV of the property received. McCoy v. Commissioner Facts: ○ 1956 Annual Sales Contest Birbrayer 33  ○ Taxpayer won Lincoln Capri two-door coupe ○ FMV? ○ Note: Receiving the car is gross income (accession to wealth) ○ Award from division of GE GE buys car from dealer - Cost to GE $4,452.54 ○ GE gives award to McCoy in FL ○ McCoy drove it from FL to his home in TN ○ 10 days later McCoy sells it for $1,000 cash and station wagon priced at $2,600 I.e., sells it for $3,600 ○ McCoy includes $3,600 in income ○ GE reports additional $4,452.54 comp to McCoy. ** END OF CLASS ** September 16, 2024 CHAPTER 07 CONT. (PRIZES/AWARDS) AND CHAPTER 08 LIFE INSURANCE McCoy v. Commissioner Facts: ○ 1956 Annual Sales Contest ○ Taxpayer won Lincoln Capri two-door coupe ○ FMV? ○ Note: Receiving the car is gross income (accession to wealth) ○ Award from division of GE GE buys car from dealer - Cost to GE $4,452.54 ○ GE gives award to McCoy in FL $3,900 FMV - Facts & Circumstances ○ McCoy drove it from FL to his home in TN ○ 10 days later McCoy sells it for $1,000 cash and station wagon priced at $2,600 i.e., sells it for $3,600 ○ McCoy includes $3,600 in income - say this is FMV ○ GE reports additional $4,452.54 comp to McCoy. For deduction purposes Questions: Was FMV (McCoy’s gross income) $4,452.54 or $3,600 or something else? Court’s Reasoning: When GE bought car from dealer it went down in value (walk off the lot drop) before McCoy got it. But also went down when used by McCoy. Birbrayer 34  Court Holding: $3,900 should be the FMV of the Lincoln reported. Amount and Timing of Gross Income ○ NOTE: taxpayer has gross income on receipt ○ Taxpayer has gross income (accession to wealth/prise income) Even if he had kept the car and had not exchanged it for a station wagon worth $2,600 and $1,000 cash. Cannot use the realization principle, which deals with gain/loss AFTER receipt, to avoid gross income on receiving the item FMV of prize included in year of receipt of prize McCoys Tax Having Sold the Capri ○ Income of $3,900 - the FMV when he got it ○ Recall he sold capri for $3,600 gross income (cash and station waggon) ○ What is gain/loss when he sells capri for station wagon/cash? §1001(a) Amount Realized §1001(b) $3,600 (cash +prop) Less Adjusted Basis §1012 $3,900 As if he had received $3,900 cash, included that in income, and took the cash and bought the capri for $3,900 Realized Loss = $300 (not deductible see §262) Loss not deductible because the car was used as a personal expense. ○ $3,900 is the compensation income - loss cannot be used to offset the compensation income Qualified Scholarships - Excluded §117 ○ Exclusion for degree candidates ○ For “qualified scholarship” §117(b) allows exclusion of: Qualified tuition for enrollment Fees (e.g., lab fees), books, supplies, and equipment required for courses Not excluded: room and board ○ Exclusion of §117(a) not available for compensation §117(c) For payment for teaching, research, or other services required as a condition for receiving a qualified scholarship or tuition deduction Birbrayer 35  Problem #3: Nancy Non-Resident at State Law School (pg. 139) ○ Facts: Law school waives difference between in-state tuition ($20,000) and out-of-state tuition ($40,000) Nancy works 200 hours for Professor on a book (unpaid but 3 credits) Other research assistants receive $10/hour ○ Questions: Can Nancy exclude the $20,000 tuition difference as a qualified scholarship under §117? or Is the $20,000 difference or some other amount compensation includible under §61? ○ §117(c) the exclusion for qualified scholarships - “shall not apply to portion received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship,” See Prop. Reg. §1.117-6(d)(2) - “payment for services” and examples 4,5, and 6 of §1.117-6(d)(4) ○ Answer: Most of the $20,000 is not compensation. The maximum she should be including is $2,000 and she should be able to exclude $18,000 - Example 5 is what we use this for. With the credits she gets in exchange you can argue to exclude the full $20,000. Argue that the whole thing is a scholarship. She could argue that this is just her taking another class for credit. Problem #4 - Al’s Basketball Scholarship (pg. 139) ○ Room/board not qualified ○ Tuition qualifies Excluded unless treated as compensation for services. See Rev. Rul. 77-263, 1977-2 C.B. 47 (athletic scholarship excluded as long as he doesn’t lose scholarship if doesn’t play) ○ Answer: $30,000 excluded; $10,000 included; $25,000 included CHAPTER 8 - LIFE INSURANCE Are life insurance proceeds gross income to the recipient? YES ○ Code for Gross Income? §61 ○ §61(a)(9) - includes income from Life Insurance contracts ⚠️ ○ Very large exception ⚠️to inclusions: §101(a)(1) exclusion from gross income for proceeds of life insurance payable by reason of the death of the insured. §101(a)(1) ○ §101(a)(1) - generally excludes the face amount of proceeds of life insurance policies from the gross income of the recipients Birbrayer 36  Similar to exclusion of §102(a) for devises and gift but different in that: Life Insurance often replaces lost earnings that would have been taxed if earner had lived. ○ You get to exclude the beneficiary of payment from gross income - not total loss of treasury because insured pays the premiums and those premiums were not deductible ○ Tax Consequences of Payment of Premiums Payment of premiums not deductible Treated as §262(a) personal living, or family expense Even in business setting generally not deductible §264(a)(1) Life Insurance ○ Myriad types of produces ○ Two elements: (1) pure insurance elements (e.g., protection against mortality loss) and (2) savings element ○ (e.g., term insurance) “mortality” gamble ○ savings element - “inside buildup” - (e.g., whole life has both a mortality feature and an interest type feature) ○ Types of Life Insurance Policies Term Life Insurance Policy Term Life Insurance Contract ○ Contract between Insured/owner & Insurance Company (3rd party beneficiary contact) Non-Tax Benefits: ○ If named beneficiary, insurance proceeds protected from deceased/insured’s creditors in many states (e.g., Fla.Stat §222.13) ○ If named beneficiary, insurance proceeds avoid probate process Federal Tax Consequences ○ Proceeds are included in gross estate of deceased for estate tax Income Tax - §101(a) excludes it from income Birbrayer 37  Example: ○ Facts: Husband takes out a term life insurance police Face Amount $500,000 Primary Beneficiary: Spouse Secondary Beneficiary: Children Pays $5,000 premium (non-deductible) He dies that uear Insurance company pays widow $500,000 ○ Payout $500,000 paid to Widow $495,000 (amount over $5,000 premium paid) is a windfall This is a mortality gamble and H won against L.I. company ○ Income Tax $500,000 is excluded from spouse’s gross income due to §101(a) Even though $495,000 is windfall Mortality Gamble: Government isn’t really losing revenues (in the aggregate) from the pure mortality portion ○ Premiums are not deductible ○ If insured died young, insurance company and IRS loose (premium less than payout and windfall is not taxed) ○ If insured dies old, insurance company and IRS win (Paid more in premiums than beneficiary gets form the insurance company and loss not deductible - don’t get a deduction even if payout is less than investment/premiums) Whole Life Policy In addition to mortality gamble includes a savings feature §101(a)(1) - proceeds paid by reason of death of the insured. ○ Even the savings portion and the inside build up are excluded Problem #2 - Rick buys whole life insurance (pg. 153) ○ Facts: Face amount $40,000; names wife beneficiary At his death, insurance company pays wife $40,000 face amount Rick had paid a total of $18,000 in premiums If he had purchased Term insurance his premiums would have been $6,000 Birbrayer 38  ○ Tax Consequences? Payments under a term life insurance policy and payments under a whole life insurance police are both excluded under §101(a)(1) Problem #3 - Paying $40,000 at death, insurance company holds for 18 months (pg. 153) ○ Facts: Face amount $40,000; names wife beneficiary Insurance company holds payment for 18 months then gives wife $47,500 ○ Tax consequences to wife when she receives $47,500 Exclusion does not cover post-death earnings. §101(c) any interest after death is taxable. TWEN Chapter 08 Quiz 1 Life Insurance - WITH ANSWERS ○ Refer to the facts in Problem #3 of Part A-Life Insurance of Chapter 8. Which of the following most correctly describes the tax consequences to Mary when she receives the $47,500? The $40,000 face amount would be excluded from her gross income, but the $7,500 additional amount is interest and would be included in gross income. Problem #1 - Paula is decreasing her life insurance policy (pg. 153) ○ Facts: When Paula bought the home she also purchase a life insurance policy on her life Face amount $100,000 which would cover the mortgage) Decreasing protection contracts Paula dies after 10 years She had paid $5,000 in premiums Devised her house to Andres Insurance Policy listed Andrew as beneficiary Andrew received $85,000 in insurance proceeds He used the $ to pay off rest of mortgage debt ○ Tax consequences to Andrew? Everything is excludable §101(a)(1) Problem #4 - John is a key employee of Closely Held Co. (pg. 153) ○ Facts: At retirement John purchased (for $60,000) from Closely Held Do. the life insurance policy Closely Held Co. had owned on John’s life Face Amount: $250,000 Cash Surrender Value $60,000 Closely Held had paid $75,000 in premiums After purchase, John made all subsequent premium payments Birbrayer 39  At John’s death, the insurance company pays $250,000 to the named beneficiary, son Phillip. ○ Tax consequences of $250,000 to the beneficiary? §101(a)(2) transfer for value 1st sentence: when transfer for value only amount excluded is the amount transferee paid (here $60,000) plus any premiums he paid after purchase EXCEPTION to general transfer for value §101(a)(2)(B) ○ Transfer to Insured himself (here John) ○ So full $250,000 excluded! What if Phillip purchased dad’s life insurance contract? - ○ It wouldn't be transferred directly to the insured so the exception would not apply and it would not be excluded. September 18, 2024 CHAPTER 08 CONT. LIFE INSURANCE AND ANNUITIES Life Insurance Proceeds ○ §101(a)(1) excludes amounts received by reason of death of insured ○ If received later (interest after death) not excluded see §101(c) ○ If received earlier not excluded by §101(a) unless fails in §101(g) ○ Be careful with transfer for value rules of §101(a)(2) Annuity – Generally ○ An annuity is a contract ○ Purchased from an insurance company ○ Company gets contract price and agrees to pay annuitant equal periodic cash payments (equal periodic account) ○ Payments begin at a set date for either: (1) a fixed term; or (2) rest of the annuitant’s life Tax Treatment of Annuity ○ §72(a) general rule - amounts received as an annuity will be treated as gross income ○ §72(b)(1), however, sets forth an exclusion ratio Gross income does not include - that part of any amount received as an annuity which bears the same ratio to such amount as the investment in the contract (as of the annuity starting date) bears to the expected return under the contract (as of such date) Birbrayer 40  ○ §72(c)(1) defines “investment in the contrat” - the amount paid for the contract ○ §72(c)(3) defines “expected return) (A) for life - actuarial tables (generally Regs. §1.72.9 Table V) (B) if not for life - aggregate amounts receivable ○ §72(b) Exclusion Ratio Investment in Contract —--------------------------------------- X Payment = Excludable Amount Expected Return (amount receivable; actuarial) Payment - Excludable Amount = Gross income inclusion (aka annuity gross income) Problem #1 – Annuitant paid $5,000 for $1,000/yr for 10 years (pg. 160) ○ §72(b) exclusion ratio ○ 5,000 —--------- X $1,000 = $500 (able to exclude) $1,000 X 10 = $10,000 ○ (includable aka annuity gross income) $500 = $1,000 - 500 Problem #2 – George pays $10,000 for an annuity for life paying $1,000/yr. George is 55. ○ §72(b) exclusion ratio ○ 10,000 —--------- X $1,000 = $349.65 (able to exclude) $1,000 X 28.6 = $28,600 Regs. §1.72-9 (table V) ○ (includable aka annuity gross income) $650.35 = $1,000 - 349.65 Annuitant dies too soon ○ §72(b)(3) amount of the unrecovered investment shall be allowed as a deduction to the annuitant for his last taxable year §72(b)(4) definition of unrecovered investment - “the investment in the contract” as of the annuity starting date [minus] reduced by [amounts received that were excluded] Birbrayer 41  Problem #3 - George dies after receiving 3 payments (recall: George pays $10,000 for annuity for life paying $1,000 per year) ○ §72(b)(3) deduction What amount previously excluded? $349.65 x 3 (years he got payments) = $1,048.95 Deduction for difference between investment in contract and amounts previously excluded $10,000 Minus $1,048.95 =$8.951,05 Problem #4 - George lives 30 years (recall: George pays $10,000 for annuity for life paying $1,000 per year) ○ Outlives life expectancy ○ §72(b)(2) - Recovered cost in 28.6 years ○ = Tax 100% of future payments (after the 28.6 years) TWEN Chapter 08 Annuities - WITH ANSWERS 1. This year Tina Taxpayer purchased an annuity contract for $50,000 providing an immediate annuity of $10,000 per year for the rest of her life. As of the annuity starting date (in this case the date of purchase) Tina’s age is 65. Which of the following most correctly describes how the first year’s $10,000 payment will be treated for tax purposes?$2,500 is excluded and $7,500 is included in the first year. 2. Assume the same initial facts as in the initial question regarding Tina (i.e., Tina Taxpayer purchased an annuity contract for $50,000 providing an immediate annuity of $10,000 per year for the rest of her life. As of the annuity starting date (in this case the date of purchase) Tina’s age is 65. Assume now that Tina Taxpayer only lived 7 years after her 65th birthday. What tax effect when she dies after receiving only 7 payments? a. Investment contract (50k) —------------------------------------- X 10k = $2,500 (Excludable) Expected return (200k) Gross income: $7,500 = 10k - $2,500 $2,500 x 7 = $17,500 50k - $17,500 = $32,500 of unrecovered investment 3. Assume the same initial facts as in the previous question (i.e., Tina Taxpayer purchased an annuity contract for $50,000 providing an immediate annuity of Birbrayer 42  $10,000 per year for the rest of her life. As of the annuity starting date (in this case the date of purchase) Tina’s age is 65. Assume now that despite her actuarial life expectancy, Tina, an avid swimmer, is still living 21 years after her 65th birthday. How will her 21st year payment be treated for tax purposes? Her 21st payment will be 100% included in gross income because she was only expected to live 20 more years. 4. This year Tom Taxpayer purchased an annuity contract for $60,000 providing an immediate annuity of $8,000 per year for the rest of his life. As of the annuity starting date (in this case the date of purchase) Tom’s age at his nearest birthday is 62. Calculate and explain how much, if any, of the first year’s $8,000 payment will be included in Tom Taxpayer’s gross income. (Use 62 as age for actuarial table because he is within 6 months of that bday) a. Investment contract (60k) —------------------------------------- X 8k = $2,667 excludable Expected return (180k) Gross income: $5,333 = 8k - $2,667 $5,333 will be included in Tom's gross income. 5. Assume the same initial facts as in the initial question regarding Tom (i.e., Tom Taxpayer purchased an annuity contract for $60,000 providing an immediate annuity of $8,000 per year for the rest of his life. As of the annuity starting date (in this c