A. Non Cash Benefit

Federal Tax Professor Joyce Fall 2002

Income A. Non cash Benefit a. Gross income is income realized in any form, whether in money, property, or services. §61a b. Commissioner v. LoBue i. Stock is taxable gain ii. LoBue was given the option of buying stock within the company to ensure his future performance iii. Court says this does not qualify under the gift exception; LoBue received a substantial economic and financial benefit from his employer to get better work from him iv. The court found when assets are transferred to an employee to ensure better services they are compensation and not a proprietary interest. It makes no difference that the payment was in stocks rather than money v. The taxable gains should be measured at the time the options were exercised and not the time they were granted c. Benaglia v. Commissioner i. Petitioner operated a hotel in Hawaii and he and his wife resided there and ate all of their meals within the hotel ii. If the Commissioner finds income or compensation such as food and lodging to be income, the burden is on the tax payer to provide evidence to show it was not income iii. Under these circumstances, it was necessary for the Petitioner to stay at the hotel in order to fulfill his duties. Under such circumstances, the value of the meals and lodging is not income to the employee, even though it may relieve him of an expense which he would otherwise bear. The advantage is merely incident of the performance of his duties iv. See §119—Meals or lodging; this ended the problem with such cases as Benaglia B. Imputed Income a. Benefits gained that aren’t part of any commercial transaction (occupy their own home, care for their own children, prepare their own taxes) b. Property other than cash; most common example is the owner occupied home. See the example on pg 82 c. Services—benefit of the services that one performs for oneself is called imputed income d. Revenue Ruling—Law §1.612(d)(1); if services are paid for other than in money, the fair market value of the property or services taken in payment must be included in income C. Windfalls and Gifts a. §102; general rule; gross income does not include the value of property acquired by gift, bequest, or inheritance b. Windfall is defined as punitive damages derived from culpable conduct of a third party c. Commissioner v. Glenshaw i. The fact that payments were extracted from the wrongdoers as punishment for unlawful conduct cannot detract from their character as taxable income to the recipients ii. Windfalls such as exemplary damages for fraud and the punitive damages are considered income to the recipient d. Gifts: under §102 gifts are excluded from taxable income e. Commissioner v. Duberstein i. Duberstein had given important information to another who in return for the information had given him a gift of a Cadillac ii. The issue in this case became whether or not the Cadillac was intended as a gift or as payment for services rendered iii. The statutory meaning of “gift” a detached and disinterested generosity iv. The court suggested a test in which a gift should be defined as transfers for personal, as distinguished from business v. The court says that a case-by-case basis will apply to decide whether the transfer is a gift or a transfer. A consideration of all the factors is necessary vi. A gift is proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses, not from the constraining force of any moral or legal duty or from the incentive of anticipated benefit vii. The determining factor is to be the donor’s intention under a reasonable person’s standard viii. The court found in this case, the car was considered taxable income f. Determining Basis of transferred property i. Taft v. Bowers 1. Under §1015; the donee of a gift must take the donor’s own basis as his basis in the gift property for purposes of determining gain on sale by the donee 2. To determine a loss on a subsequent sale, the donee must take as his basis the lesser of a. The donor’s own basis b. Fair market value (FMV) of the property at the time of the gift ii. §1014(a)—Basis of property acquired from a decedent 1. The basis of the property shall be the FMV of the property at the time of the decedent’s death D. Recovery of Capital a. §1011—Adjusted Basis for determining gain or loss b. §1012—Basis of Property: the cost of such property except as otherwise provided c. Recovery of Capital is not income d. Philadelphia Amusement Co v. US i. Suit by corporate taxpayer to recover alleged overpayment of income taxes ii. When property is exchanged for property in a taxable exchange the taxpayer is taxed on the difference between the adjusted basis of the property given in exchange and the fair market value of the property received in exchange e. §1001—Computation of gain or loss i. The gain from a sale or other disposition of property shall be the excess of the amount realized over the adjusted basis ii. The loss shall be the excess of the adjusted basis over the amount realized 1. Where amount realized is defined in §1001(b) is the sum of any money received plus the fair market value of the property received f. Sale of Easements i. Inaja Land Co. v. Commissioner 1. No part of the recovery was paid for loss of profits, but was paid for the conveyance of a right of way and easements, and for damages to petitioner’s land and its property rights as owner 2. Capital recoveries in excess of cost do constitute taxable income 3. since there was apportionment with reasonable accuracy of the amount received not being possible, and this amount being less than petitioner’s cost basis for the property, I can not be determined that petitioner has realized gain in any amount E. Annual Accounting, Claim of right and Tax Benefit Rule a. §1341—Claim of Right—includes something as income in an earlier year and then has an offsetting deduction in a later year when the income is lost i. US v. Lewis 1. Taxpayer sought to get back money which he claimed as income on his returns when he forced to return it to his employer 2. The court held that: If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent 3. Income taxes must be paid on income received during an annual accounting period. ii. Congress agreed that result in Lewis inequitable and provided relief 1. The starting point was a deduction in the year or repayment rather than reopening of the earlier year 2. if the deduction exceeds 3K the tax is the lesser of the amount determined by claiming a deduction in the ordinary manner or by forgoing the deduction and claiming a credit in the year of repayment for the tax that would have been saved by excluding the item in the earlier year b. Tax Benefit Rule--§111—The taxpayer claims a deduction in an earlier year, and then in a later year the deducted amounted is in some sense recovered or regained (ex. Deductions for bad debts, taxes, losses by theft, worthless assets) i. Exclusionary Aspect of the tax benefit rule 1. If a deduction did not reduce the taxpayer’s tax liability for any year and any loss carryovers resulting from it have expired without being used, the recovery of the amount deducted need not be included in income ii. Inclusionary aspect of the tax benefit rule 1. When the tax payer has received a tax benefit from a deduction and the includibility or amount of the subsequent offsetting gain is not otherwise clearcut F. Recoveries for Injuries a. Damage awards for lost profits are taxed in the year received b. Punitive damages are also taxed in the year received c. In the case of individual taxpayers, awards are generally tax-free provided the payment is attributable to personal injury (however tax-free does not extend to the punitive damages arising from a personal injury case G. Debt Discharge a. §108—Income from discharge of indebtedness i. Loan Proceeds are not income 1. They are not includable in gross income and loan repayments are not deductible 2. The reason is that loans do not improve one’s economic condition b/c they are offset by corresponding liability 3. Loan does not increase the net worth ii. True discharge of indebtedness 1. US v. Kirby Lumber Co a. A lumber company issued bonds for 12 million, than later that same year bought in the open market 1 million dollars worth of the same bond for 862K, the difference of the price being 138K b. The question is whether this gain of 138K is taxable gain or income c. If the corporation purchases and retires any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price is gain or income for the taxable year iii. Relief Provisions 1. One should not hit another when the person is down, if the taxpayer was insolvent or was proceeding under the Bankruptcy act the income from discharge of indebtedness is excluded, but certain tax attributes must be reduced so that if all goes well and the taxpayer has profits that would otherwise escape taxation iv. Zarin v. Commissioner 1. §108 defines “the general rule that gross income includes income from the discharge of indebtedness.” 2. “Indebtedness of taxpayer means any indebtedness a. For which the taxpayer is liable b. Subject to which the taxpayer holds property H. Illegal Income a. Gilbert v. Commissioner i. Gilbert unlawfully withdrew money from business accounts ii. Under James v. US; embezzled funds can constitute taxable income to the embezzler 1. Even if the taxpayer may be required to repay the money he may still be adjudged liable to restore it. 2. In a typical embezzlement situation, the embezzler intends at the outset to abscond the funds, and he repays the money during the same taxable year, he will not be taxed (James) 3. However if he spends the money instead, he may not escape taxation by simply issuing a promissory note to repay. iii. In this case when Gilbert took the money he recognized his obligation to repay and intended to do so. iv. Gilbert thought he was doing this in the best interest in the corporation, even though he lacked the proper authorization. v. It is clear that at no time did Gilbert intend to keep the corporation’s fund vi. The court found where a TP withdraws funds from a corporation which he fully intends to repay and which he expects with reasonable certainty he will be able to repay, and believes his withdrawls will be approved by the corporation, and where he makes a prompt assignment of the assets, he does not realize income under the James Test vii. In this case there was and express consensual recognition of his obligation to repay Problems of Timing

A. Realization 1. Taxpayers generally want to defer tax liability; while the IRS wants to accelerate it; b/c money has a time value and can generally earn a positive rate of interest 2. In general, gain or loss in a change in the value of an assets held by the taxpayer is not taken into account under the income tax until a “realization” even occurs (such as a sale) 3. Eisner v. Macomber a. A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders; its property is not diminished, and their interests are not increased; the proportional interest of each shareholder remains the same. The corporation is no poorer and the stockholder is no richer than they were before b. Income is defined as the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. c. The question is whether a stock dividend can be brought under this definition d. The essential and controlling fact is that the stockholder has received nothing out of the company’s assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. e. It is clear then that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer b/c of an increase of his capital, at the same time shows he has not realized or received any income in the transaction f. However, if the TP chooses to sell his stock dividend he then may realize taxable income g. Must treat the corporation as a separate entity from the stockholder h. Stockholder’s share in the accumulated profits of the company is capital and not income, it cannot be taxed. i. Under the 16th Amendment congress does not have the power to tax a true stock dividend made lawfully and in good faith, or the accumulated profits behind it as income of the stockholder. j. §305 has now legislated this rule 4. Losses-Cottage Savings a. Petitioner Cottage Savings is a savings and loan association; they held numerous long-term, low-interest mortgages that declined in value when interest rates surged in the 70s. b. In order to benefit such S&L would have gained from selling their devalued mortgages in order to realize tax-deductible losses. c. It was determined that S&L’s didn’t need to report losses associated with mortgages that are exchanged for “substantially identical” mortgages held by other lenders d. Under §1001(a)—test for realization: to realize a gain or loss in the value of property, the taxpayer must engage in a sale or other disposition of the property e. Disposition of property: does the property have to be materially different? i. Even though not specified in §1001(a); the court found that disposition of property requires them to be materially different ii. Since congress has delegated power to the commissioner we must follow his suggestions in the rules and regulations as long as they are reasonable look to §1.1001-1 iii. Court found this be a reasonable interpretation of the code thus requiring material difference f. What is material difference? i. In Macomber it was found that a TP only realizes increased worth of property only by receiving “something of exchangeable value proceeding from the property” ii. Other case law—different: as long as their respective possessors enjoy legal entitlements that are different in kind or extent 1. Separate groups of stock are not materially different if they confer the same proportional interest of the same character in the same corporation 2. But are materially different if they if they are issued by different corporations 3. Or if they confer different rights and powers in the same corporation iii. RULE: as long as the property entitlements are not identical, their exchange will allow both the Commissioner and the transacting taxpayer easily to fix the appreciated or depreciated values of the property relative to their tax bases. Embody legally distinct entitlements g. §109—Improvements by lessee on lessor’s property i. Gross income does not include income derived by a lessor of real property on the termination of a lease ii. §1019—Neither the basis nor the adjusted basis of any portion of real property shall be increased or diminished on account of the income derived by the lessor in respect to such property that is excludable under §109 iii. Helvering v. Bruun—rejected by the statutes 1. Tenant erected a new building upon TP property; the landlord was held taxable for this new building; however the effect of §109 is to overrule this case. B. Recognition a. §1031—Exchange of property held for productive use or investment i. §1031(a) Nonrecognition of gain or loss from exchanges solely in kind b. Express Nonrecognition Provisions i. Assets that are worth less than there basis, create a tax incentive for the TP to sell so the deduction will be realized immediately and not deferred ii. Appreciated assets (assets that are worth more than there basis), create the opposite version, “lock in” or a tax incentive to sell. iii. IRC says that a sale or exchange will not have current tax consequences iv. Realization v. recognition 1. Realization is whether something of tax significance happened in the first place 2. Recognition question involves asking whether a specific, generally statutory “nonrecognition” rule applies to mandate disregard of the realization event 3. §1031 applies to exchanges of certain business or investment property that are held to be of a like kind 4. No gain or loss is recognized upon an exchange of property held for productive use in trade or business or for investment solely for the property of a like kind to be held either for productive use in trade or business or for investment 5. The words “like kind” have reference to the nature or character of the property and not to its grade or quality; one kind or class of property may not, under this section, be exchanged for property of a different kind or class 6. Cannot represent totally different types of underlying investment and thus are not property of like kind v. Jordan Marsh v. Commissioner 1. Necessary to determine if it was a sale or an exchange or property for other property of the like kind with the meaning of 1031 2. §1031 was enacted as and exception to §1002 (the sale or exchange of property the entire amount of gain or loss is to be recognized by the taxpayer 3. §1031 was enacted b/c congress was concerned with inequity, in the case of an exchange, of forcing a tp to recognize a paper gain which was still tied up in a continuation investment of the same sort 4. look up in book vi. Boot and Basis—see pg 280 1. Boot—is the word used by tax practitioners to refer to money, and property other than money, that, under a provision like 1031 is transferred as part of the like-kind exchange but is not like-kind property 2. The transfer of a boot will affect basis and may result in the recognition of gain 3. If there is no gain to be recognized, the boot is not taxable, it is the gain that is recognized (and taxable), to the extent of boot, not the boot itself 4. If there is gain, it is recognized to the extent of the boot; the amount of gain recognized is the lesser of the amount of gain realized or the amount of the boot 5. Basis—the basis for the property received will be the same as the basis of the property relinquished. vii. Gain on the Sale of a Home—pg 291-292 1. §121(a)—allows for an exclusion from income a certain gain on the sale or exchange of a home. 2. The TP must have owned the home and used it as a principal residence for periods aggregating at least two years over the five-year period ending on the date the TP sold it. 3. Generally the sale of a vacation home does not apply 4. Usually limited to 250K 5. For married people it is limited to 500K 6. Cannot apply to any taxpayer more than once every two years viii. Constructive Sales 1. pg 291-292

Deductions A. Business v. Personal 1. §162—Trade or Business Expenses --there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business 2. §212—Expenses for production of income --in the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year, for the production or collection of income; for the management, conservation, or maintenance or property held for the production of income; or in connection with the determination, collection, or refund of any tax 3. §262—Personal, living, and family expenses --NO deduction shall be allowed for personal, living, or family expenses Travel Expenses 4. Commissioner v. Flowers  This was the case of the taxpayer who lived in Jackson, Mississippi but worked in Mobile, Alabama.  The TP deducted traveling expenses and food and lodging  Under §162(a)(2); three conditions must be met: o The expense must be reasonable and necessary traveling expense, as that term is generally understood. Includes such items as transportation fares and food and lodging expenses incurred while traveling o Must be incurred “while away from home” o Must be incurred in pursuit of business. Must be a direct connection between the expenditure and the carrying on of the trade or business of the taxpayer or of his employer. Must be necessary or appriopriate to the development and pursuit of the business or trade  This case took issue with the meaning of the word “home” , but the court chose not to focus on that and rather took up the requirement that the expenditures needed to be related to the railroad’s business  The court found that clearly the expenses were not incurred in the pursuit of the business of the taxpayer’s employer  The added costs were unnecessary and inappropriate to the development of the railroad’s business as were his personal and living costs in Jackson.  They were incurred solely as the result of the taxpayer’s desire to maintain a home in Jackson while working in Mobile. The railroad did not require him to maintain a home in both cities.  The travel expenses in pursuit of business within the meaning of 162(a)(2), could arise only when the railroad’s business forced the taxpayer to travel and to live temporarily at some place other than Mobile, thereby advancing the interests of the railroad 5. Hantzis v. Commissioner  The law student was going to school in Harvard, and got a summer internship in NYC and tried to deduct the apartment she kept in NYC as a business expense as part of her internship  §162(a)(2)—the travel expense deduction is intended to exclude from taxable income a necessary cost of producing that income  TP travel expenses would be costs of earning an income and not merely incidents of personal lifestyle  The ultimate allowance or disallowance of a deduction is a function of the court’s assessment of the reason for taxpayer’s maintenance of the two homes. 5. Daily transportation expenses incurred in going between a taxpayer’s residence and a work location are nondeductible commuting expenses.

Child Care-Expenses

 Smith v. Commissioner o This doesn’t allow the TP to argue the “but for” o Ask Casey

B. Capital Expenditure v. Expense c. §263(a)—no deductions shall be allowed for: any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate d. Repair and Maintenance Expenses—Deductible as ordinary and necessary business expense i. Midland Empire Packing Co v. Commissioner 1. Capital expenditure v. Capital outlay 2. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. Not adding to the value of the property or prolonging its life 3. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements, or additions which prolong the life of the property, increase its value, or make it adaptable to a different use 4. One is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings. 5. Federal meat inspectors advised the TP that he had to discontinue the use of the water from wells and oil-proof the basement, or else shut down the plant 6. It was the cost of this work which TP seeks to deduct as a repair; the evidence is that the expenditure did not add to the value or prolong the expected life of the property over what they were before the event occurred which made the repairs necessary 7. Repairs merely served to keep the property in an operating condition over its probable useful life for the purpose for which it was used. 8. Commissioner claims these expense were not ordinary, however protecting a business from the seepage of oil from a nearby refinery, would seem to be the normal thing to do 9. the lining of the basement was essentially a repair, and as such is deductible as an ordinary and necessary business expense ii. §162; generally allows a deduction for the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business iii. §263; generally prohibits deductions for capital expenditures e. Deductions for the costs of earning income i. Current expenses v. Capital Expenditures 1. Salary expenses are seen as current cost of doing business and are deductible under §162 a. A Restaurant that pays its cook 50K receives a deduction of 50K in that same year 2. However, investments must be capitalized rather than currently deducted a. A new factory is treated as an investment b. The cost of the factory is reflected in its basis, which may be recovered upon sale, or earlier, through depreciation 3. Encyclpaedia Britannica v. Commissioner a. §263(a) forbids the immediate deduction of “capital expenditures” even if they are ordinary and necessary business expenses b. Expenditures for services rather than for acquisition of an asset are deductible immediately rather than being capital expenditures c. The work was intended to yield EB income over a period of years. d. The object of §§ 162 and 163 are to match up expenditures with the income they generate e. Where the income is generated over a period of years the expenditures should be classified as capital f. If you hire a carpenter to build a tree house that you plan to rent out, his wage is a capital expenditure to you g. May not deduct as a current expense what realistically are capital expenditures, when the expense is tied to producing or acquiring a specific capital asset

C. Legal Expense a. US v. Gilmore i. Under §212 this guy tried to deduct legal expenses for his divorce, as a means of conserving property held for the production of income ii. Husband’s main concern was to protect the stock assets he held in GM from his wife iii. Only kind of expenses that are deductible under §212 are those that relate to business iv. Where a suit or action against a taxpayer is directly connected with, or proximately resulted from, his business, the expense incurred is a business expense v. In litigation of this kind the claim depends on whether or not the claim arises in connection with the taxpayer’s profit-seeking activities, not the consequences that might result to a taxpayer’s income-producing property from failure to defeat the claim vi. In this case it is enough to say that the wife’s claim stemmed entirely from the marital relationship and not, under any circumstances from income-producing activity D. Education a. Carroll v. Commissioner i. Trying to justify a deduction of classes related to the job under §162(a)—relative to improving job skills to maintain his position as a detective ii. Must be justified as maintaining or improving skills required by him in his employment iii. The course has to be generally and basically related to the duties of the job iv. To allow as a deduction the cost of a general college education would surely go beyond the original intention of Congress E. Goodwill a. Welch v. Helvering i. This guy decided to pay back the debts of his company in order to solidify credit and standing ii. The court focused on the requirements that the payments be both necessary and ordinary iii. Ordinary means that payments for such a purpose, whether the amount is large or small, are the common and accepted mens of defense against attack F. Depreciation--HELP a. There should be an offset against revenues for the cost of “wasting” assets that are used for the production of those revenues but have a life extending beyond the current tax year b. Since the tractor will have a substantial value at the end of that year, allowing a deduction of the full cost in the first year would result in an understatement of income c. Some allocation of a portion of the cost of the tractor to each year of its use d. Economic depreciation—cost of each year’s operations the difference between the value of the asset at the beginning of the year and the value at the end of the year i. However this is often nearly impossible to figure out e. Building blocks of depreciation i. Determination of useful life ii. Taking account of salvage value 1. salvage value is assumed to be zero iii. Application of a method of allocating the cost, in excess of salvage value, over the useful life 1. Straightline method a. Equal portion of the total cost of the asset is allocated to each year 2. Accelerated Method a. Declining Balance Method i. Straightline percentage is determined and then this percentage is increased by a specified factor ii. Resulting percentage is applied to the cost of the asset reduced by the amounts previously deducted

Splitting of Income A. Income from Personal Services 1. For income tax purposes, individual members of families or households, other than husband and wife are, generally speaking, treated as separate taxpaying units and legal rights, rather than economic reality 2. Income from Services: Diversion By Private Agreement a. Lucas v. Earl i. No more shifting of income between husband and wife ii. The husband assigned one-half of his salary and all other income to his wife years in advance and for the rest of his life iii. The court held the husband taxable on income in 1920 and 1921, not withstanding the valid contract to his wife. iv. The judge found Mr. Earl had earned the income and that the tax law showed and intent to tax income to the taxpayer who earned it v. There is the principle that he who earns it pays the tax. Not only are you the economic generator but also vi. §102 excludes gift of property, b: gifts of income b. Poe v. Seaborn i. H & W filed separate tax returns ii. Acquired property together iii. All property was held as community property and no one had any individual property iv. In community states, were the property was owned one-half by the wife and one-half by the husband the court allowed them to file separate tax returns claiming one-half of ownership regardless who owned the income c. The marriage penalty i. In 1948 Congress allowed all married couples in all states to file joint returns and compute the total tax by first computing a tax on half of the total and then doubling that amount, thereby providing two starts at the bottom of the rate structure, regardless of how income was earned and regardless of legal claims to it ii. The effect for couples with one spouse who earning substantially more than the other is a “marriage bonus” iii. The effect was that equal-income couples paid equal taxes d. Armantrout v. Commissioner i. If in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed the excess of …shall be included in the gross income of the person who performed such services ii. The amounts paid by the Educo trust constituted additional compensation to petitioners and are includable in their taxable income

B. Income from Property a. Generally, income from property is treated for tax purposes as owned by the owner of the property and is taxed to that person, at that person’s rate b. Unearned income of a child under age 14 is taxed at his or her parents’s marginal rate §1(g) c. Distinguishing between gifts of property and gifts of income generated from property d. 102a & 1015 imply that it is alright to transfer an interest to a relative and have them have the gain. 102b income from the property is not excluded it is only the present value. So rent can be included in the kids income. i. Blair v. Commissioner 1. The will creating the trust entitled the petitioner during his life to the net income of the property held in trust. He thus became the owner of an equitable interest in the property 2. The beneficiary may thus transfer a part of his interest as well as the whole 3. Since the assignments were valid, the assignees became the owners of the specified beneficial interests in the income and therefore were the once responsible for the tax on them ii. Helvering v. Horst 1. The power to dispose of income is the same as ownership to of it 2. Assignment by which the disposition of income is controlled when the service precedes the assignment and in both cases it is the exercise of the power of disposition of the interest or compensation with the resulting payment to the donee which is the enjoyment by the donor of income derived from them 3. If a parent has an interest and then transfers the rent to that child for 5 years of rent, with a remainder going to the grandchild. If you have a remainder the child pays the tax. 4. If a parent has an interest and transfers it to a child for 5 years with a reversion then the parent pays the interest. 5. If a parent has a 10 year interest and transfers it to B. 6. When there is no reversion in the property, and when it is chronologically coterminous then the child must pay the property. 7. §873 Trusts- If you put blackacre in trust, pay the income pay that income to my 2 year old child for his life, with a reversion, then the child will pay the tax. That reversion will be worth less than 5% of the value of the property in which you retain the reversion, you have successfully shifted the property. 8. Even though there is no reversion, if the rent accrues it is too late for the child to pay the tax. If you try to transfer something that has already accrued it is too late to transfer it. 9. If you shift before the gain has accrued then they would be allowed to split the income, but not once its too late. 10. iii. Helvering v. Eubank 1. The majority relied on Horst, there was a better case to rely on Lucas v. Earl. Accepted as being the other shoe that dropped, the first being Lucas v. Earl. 2. Lucas v. Earl governs whether the work is done or not done. iv. Heim v. Fitzpatrick 1. This inventor has not already sold the patent in return for royalties. If you sell the patent and then assign your rights from the sale, it will be deemed assignment of income. 2. It does not talk about Lucas v. Earl. 3. Important because it deals with what happens when it is not property.

LoBue hypothetical

1. LoBue sends his stock option to his son. You analyze this because it is either Heim or Eubanks/Lucas. Property with Heim, Not- Property with Eubanks.

2. § 1041 if I have the property and it gains and I transfer it to my wife, no gain it is treated as a gift and she gets my basis. §1041 is subservient to the Lucas case, overturned by RR 2002-22.

Even if there is Blair or Heim, if the child is under 14 then you have to place it under §1g. The unearned income of a child under 14, after a certain threshold, for example this year $1600, is taxed at the parent’s rate to the child. Pretty much doesn’t allow assignment.

C. Use of Partnerships and Corporations D. Alimony a. §71—gross income includes amounts received as alimony or separate maintenance payments b. §215—in the case of an individual, there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual’s taxable year c. Under §71, the payment must be in cash, must be received under an “instrument” of divorce or separate maintenance; parties must not have agreed that payment will be nontaxable to the payee and nondeductible by the payer; must be members of the same household; cannot continue after the death of the payee; must not be for child support; d. To distinguish between alimony and cash property settlement §71(f) provides that only payments that are substantially equal for the first three years will treated as alimony

Pg 310 problems:

1. Not deductible because its not in writing. Sections 71 & 215 do not apply. We then turn to section 61, he received gain from her paying him $2000 per month. Intra-family transfers for support even when there is gain are not taxable. This is no longer intra- family because they are divorced. § 61 is stopped by §1041 transfers of property between spouses or ex-spouses are not income. The transferee treats it like a gift. All cash is property. §1041 does not prevent it either.

2. 60k for the first 2 years then 5k for each year after that. These are cash payments in writing, and therefore §§71 and 215 apply. No frontloading.

3. If she dies in year 2, 71(D)(1)(d) if there is a provision that the husband should pay even after the wife dies then it is not deemed alimony. Therefore, there is no frontloading. No excess deductions in years 1 & 2, no deductions are allowed at all. Once you determine if 71 applies, then 215 is determined. Additionally you know that she does not have to include the income under §61 because it is a gift. §1041 and old case law treats it as a gift. Normally the right to change the beneficiary of an insurance policy indicates ownership. Life insurance is not cash under §61, because while it is property it is not cash.

4. Because the child support is fixed at $40k and then would be reduced to $0 the whole amount is deemed child support and none is deemed alimony. None of this is alimony. This is treated as child support from the beginning.

5. She was required to give him cash and not property. The stocks were not cash and thus property. Therefore §71 does not apply. Not income of §61 because of §1041 treats it as a gift.

Itemized Deductions 1. Personal Deductions, exemptions, and credits  PD are deducted form income in order to determine taxable income  May give up itemized deductions and claim a standard deduction  PD have nothing to do with the production of income  Casualty Losses o §165(c)(3) o losses from fire, storm, shipwreck, or casualty or from theft 2. Extraordinary Medical Expenses  Med expenses are deductible to the point that they exceed 7.5% of the adjusted gross income §213(a)  §162(1)—a deduction of 30% of the cost of health insurance premiums paid by self-employed people  Medical insurance premiums are not deductible under §213 3. Charitable Contributions  Allows individuals and corporations to claim as itemized deduction and charitable contribution §170(a)(1)  When a taxpayer masks a gift of property whose sale would produce long-term capital gain, the amount allowed as a deduction is the full fair market value of the property 4. Interest  Personal interest on a home mortgage loan is deductible if it is “qualified residence interest” §163(h)(3)  Where qualified residence interest is defined as o Acquisition indebtedness—debt incurred to buy, build, or improve personal residence, and which is secured by the personal residence o Home equity indebtedness—any debt secured by a personal residence, with a limit of 100K but no in excess of the FMV of the residence §163(h) (3)(C) o You cannot deduct credit card interest because it is personal interest. 5. Taxes  §164 allows certain taxes to be claimed as itemized “personal” deductions  example—state and local taxes  §151 grants each taxpayer a deduction for personal exemption 6. Allowances for mixed and personal outlays  §212—covers expenses of generating income from sources other than a trade or business

Capital Gains and Losses A. Background  A distinction has been drawn between ordinary income (e.g., salaries, interest, dividends and profits from running a business) and capital gain (gain from the sale or exchange of property such as real estate, stocks and bonds)  Long term gain which is gain which is gain from the disposition of assets held for more than one year; and short-term gain, which is gain from the disposition of assets held for one year or less  §1222 sets out gains and losses  If the rules for netting out is a net-long term gain, that gain is taxed at a favorable rates.  If the result is a net loss, the loss may be used to offset 3K of ordinary income  Any excess is disallowed and is carried forward to subsequent years, when it may be used to offset capital gains or, again up to the 3K of ordinary  The maximum rate for individuals on the most common types of long term capital is 20%, while ordinary income is now subject to a maximum marginal rate of 39.6% §(1)(a)-(d)(h)(1).  For corporations the maximum rate on capital gain is 35%  Capital Gain is gain from the sale of property  Capital gain or loss arises from the sale or exchange of a capital assets §1222  The two requirements are o Sale or exchange o Capital assets  Capital asset is defined in §1221 as all property with five listed exceptions, the major function of the five exceptions is to deny capital gain treatment for the ordinary gains and losses from operating a trade or business  SEE the five exceptions in 1221  §1244 provides that loss on the sale of “small business stock” is treated as an ordinary loss even though it is plain that such stock is a capital asset within the contemplation of §1221 and therefore any gain on its sale is capital gain B. Limitations on Deduction of Capital Losses  Individuals may deduct capital losses from capital gain, but individuals with capital losses in excess of capital gain may deduct only 3K of such losses in any year.  Corporations may only deduct capital losses from capital gain C. Property held “primarily for the sale to customers”  Van Suetendael v. Commissioner o Petitioner took the view that all securities he sold were non-capital assets o If the petitioner was engaged in selling these assets as a business they would not be considered capital assets o It is not founded that the petitioner held the stocks for speculation or for investment; in this case he acted no different than an ordinary purchaser o Petitioner intended to sell the securities in any way he could and to any purchaser regardless of whether or not the purchaser could be deemed a “customer” within the meaning of the statute o It is therefore held that the securities sold by the petitioner were capital assets and thereby subject to the limitations set forth in §1211(b)  Biedenharn Realty Co v. US o Winthrop factors—substantially; frequency of sales; improvements; solicitation and advertising efforts; and broker’s activities  Recapture o When a business asset is disposed of, any gain is treated as capital gain o Depreciation deduction is an offset to ordinary income o Any gain on disposition is treated as ordinary income by virtue of depreciation deductions

Final Exam:

4 hour, 3 question exam. Open Everything