WHO IS THE TAXPAYER?
HYPOS on when
income is assigned [ppt 319]:
timing of transfer
retaining control
of underlying asset
Medina: drug
deal case: lifestyle shows he didn’t have the money
Lucas v Earl:
husband and wife case: tax those who earn the income
Today: joint-income
pensions: Congresses way around Earl for married couples
Blair: assigns
life estate in trust: valid
Asset = life estate
in trust; no control after transfer; therefore is effective
Helvery v Horst:
assigns bearer bonds (principal and interest): invalid
Assigns interest,
but maintains control over the principal. Note: was also transferred
shortly before due date ~ attempt at tax avoidance? BUT: what if clipped
all coupons well in advance of payment?
Meisner;
Royalties from song copyrights for divorce: valid
No control retained.
What if transferred
100% for 99 years? Significant portion of ‘bundle of right’ so also
strong argument.
Code §1(g)[3]:
Unearned income of children (kiddie tax)
14 years or younger
at least one parent
is living
parents could elect
to have unearned income taxed to them
presume unearned
income of child will come from ‘parents,;’ so will tax at parents
rate. (attempt to move down tax bracket)
Note: tax avoidance
possible if income is from grandparents in higher tax bracket
Allen: baseball
prodigy’s bonus goes in part to mother
He is taxed the
entire amount (mother performed no ‘services’ for Phillies – it
wasn’t her income.
WHAT IS
INCOME
Code §62 [49]:
Adjusted gross income defined (above the line deductions)
(a)(2)(A) Reimbursed
expenses
(a)(3): losses on
sale/exchange of property (allowed by 161) and capital losses
(a)(4) deductions
for rents and royalties
(a)(10): Alimony
(allowed by 215)
(a)(17) moving expense:
allowed by 217)
(a)(17) student
loans (allowed by 221)
Code §63 [52]:
Taxable income defined (below the line deductions)
(d) Itemized deductions
Deductions other
than 62 and 151 deductions
Sec67 (2%) limit
on misc. itemized deductions
Itemized:
Interest (163)
Tax (164)
Wagering losses
(165)
Charitable contributions
(170
Medical expenses
(213)
Basically: gross
income – deductions.
Distinction b/w:
Itemizers (161 deductions)
and
non-itemizers
(151 deductions)
GROSS
INCOME
Code §
61(a) [49]: All income from whatever source derived
(except
those specifically exempted ~ Glenshaw Glass)
(Not
loans ~ net out to zero)
Glenshaw Glass:
Three Part Test:
i)
Is it an accession to wealth?
ii)
Is it clearly realized? (sufficiently at hand?)
iii)
Does the tax payer have “complete dominion” (control) over it?
Code §111 [89]:
Recovery of tax benefit items (tax benefit rule)
What if money is
returned to you after you take a deduction for it?
(a) Income to extent
of deductions previously allowed for items
TEST:
amount deducted
in a prior year
resulted in a tax
benefit
recover inconsistent
w/ previous dedication
no other code section
prevents taxation
(tax benefit rule)
Alice Phelan:
tax rate on return of charitable land donations
Return of charitable
contribution gave rise to income to the extent of the deduction previously
allowed
Deduction “gain”
on returned “donated land” should be taxed at time of recovery
Basic principle
of ‘annual’ accounting
(timing and manipulation)
Estate of Stranahan:
Money for dividends: sale, not loan [see ppt.203]
“cash basis”
father sells anticipated stock dividends to son; reports payment as
ordinary income in year received: valid
IRS says it was
loan masquerading as a sale, but:
Cash basis taxpayer
ordinarily realizes income in year of receipt rather than year earned
Taxpayer who assigns
future income for consideration in bona fide commercial transaction
generally realizes ordinary income in year of receipt
Taxpayer is free
to arrange his financial affairs to minimize tax liability
Here: not claims
that transaction was a sham: consideration was based on reasonable estimation
of present value of future income
Presence of tax
avoidance motives will not nullify an otherwise bona fide transaction
(timing and manipulation)
Al-Hakim
v Comm: Client ‘loans’ money to agent
Sports agent receives
“loan” from client, then uses faux payments on loan to ‘offset’
fee owed him by client.
Court finds valid
loan (therefore, agent receives full amount of payment in year 1, but
does not have to record income until offset time) Note: tax consequences
for client. Today, invalid: see below
Code
§7872 [692]: “prevents no-interest loans”
Code §
6045: Barter Transactions
but will reach
brokers, dealers, and ‘barter exchanges’
If
your are ‘in the business’ and they are ‘in the business,’ then
it looks like a barter exchange.
Bery facts
driven: e.g., value of services (e.g., legal services v manicure) .
Or relationship among the principals (e.g. familial v casual acquaintance)
Generally: - if ‘quid-pro-quo,’ then taxable
- if not, then favor,
then not taxable
How
to distinguish barter from loan?
Loan
= no accession to wealth
Barter
= accession to wealth on both sides
-
Found property (when reduced to 'undisputed possession')
-
Bargain purchases (taxable when sold) Palmer v Comm. / Reg.1.64-14.
Code:
§ 108 [83]: Discharge from Debt
Code: §
61(a)(12)[49]: Gross income = income from discharge of indebtedness
Code: §
108 [83]: Income from Discharge of Indebtedness
Code: §
108(d)(1)[85]: Definition of indebtedness
Old Colony:
3rd party (by employer here) discharge of debt = income.
[reclassifies (deems) payment as coming from taxpayer rather than
3rd party].
Kirby Lumber:
Corp repurchase of bonds at below issue price is discharge [so even
if obligation is reduced by taxpayers own action, still gross income]
Cite:Reg.1.61-12(a).
- Note: if mom
pays your taxes; then is gross income under §108; but probably
excludable under §102.
Indebtedness
exceptions
(Exceptions
for bankruptcy (108(a)(1)(A); insolvency w/ limits (108(a)(1)(B). [83])
Code: §
108(a)(1)(A),(B) [83]: Exclusions for Bankruptcy/Insolvency,
but:
Code: §
108(b)(2)(e)[83]: Basis reduction (see 1017)
Code: §
1017(b)(2)(A),(B) 493]: Basis reduction analysis
Exclusion
Analysis:
i)
Is taxpayer insolvent b/4 discharge w/in meaning of 108? (d)(3).
ii)
Then can exclude up to extent of insolvency.
Basis
Reduction Analysis:
i) Calculate aggregate
basis of property held immediately after discharge.
ii) Calculate aggregate
liabilities immediate after discharge.
iii) If aggregate basis
is greater than aggregate liability, there will be a reduction in basis.
If not, no adjustment.
[see:
cashpoor hypo: ppt., p.41-45]
Recourse
vs. Non-Recourse debt [what’s the point?] [problems ppt.49]
Recourse: lend can
go after debtor personally for repayment.
Non-Recourse: lender
can only go after property securing debt.
Non-recourse debt
is included in basis. Crane
Non-Recourse
Debt:
Tufts: AR (relief
of debt) – AB = tax liability (cap ex treatment)
Recourse
Debt:
Rev.Ruling
90-16 [txt p.80]: (two step analysis) [SEE PPT. 54, for codes]
Sale or Exchange:
To extent FMV exceeds adjusted basis, the transfer of the property (recourse)
is a realized gain for the transferring taxpayer.
> FMV – AB = tax liability (cap ex ~ probably equal, therefore
zero)
Cancellation
of Debt: Also, taxpayer can be hit with income from discharge of
debt to extent that debt exceed FMV of property
> liability relief – FMV = realized gross income (ordinary gain)
International
Freignthing Corporation v Commissioner [stock shares as bonus =
gain]
If stock was wroth
more than basis (price at time of acquisition by the company), then
there was a gain realized by the company of the difference in the amounts.
Also see reg 1.61-2(d)(2)
EXEMPTIONS
FROM GROSS INCOME
Code § 102
[78]: Gifts and inheritance
What
is a gift?
Duberstein:
Key is detached and disinterested generosity” “out of affection,
respect, admiration, charity, or like impulses. (intention of transferor
controls).
Note: Employee
gifts (p.91) §102(c)(1), (2); §132(2): not excluded.
Tipping (clearly
not ‘detached and disinterested generosity): rate presumed to be 8%.
Code § 132
[105]: Certain fringe benefits (excluded from gross income)
[SEE txt 117: cites]
No-additional-cost
service (service is ordinarily offered for sale to customers, AND
no additional expense are incurred when providing to employees; e.g.,
empty seats on a passenger jet)
Qualified employee
discount (discount does not exceed gross profit percentage;
based on all products, OR reasonable classification of selected property)
Working
condition fringe (correlated w/ §§162 ir 167)
De minimis fringe
(value is so small as to make accounting for it unreasonable or administratively
impracticable; including: certain eating facilities)
Note: think
not just individual transaction amount, but also # of transactions
Transportation
fringe (e.g., commuter highway vehicle, parking; limits of $100;
$175)
Qualified moving
expense (correlated w/ §217)
Retirement planning
Military
(h)(i): Reciprocal
Agreements, for i and ii above, if
Written agreement
b/w employers
No employer incurs
any substantial costs
(j) Special rules
(i) and (ii0 apply
to highly compensated employees only if no discrimination (same
members of reasonable classification; not discriminating in favor of
highly compensated)
Gross income shall
not include value of on premise athletic facility (see definition)
(l) Does not apply
to Fringe Benefits provided elsewhere
§119: meals or
lodging furnished for convenience of employer
Meals furnished
on business premises
Lodging, if employee
is required to accept such lodging as condition of employment
Turner v Comm:
winning first-class tickets as ‘forced consumption’ (not needed
in ordinary course of their lives and would not have purchased ~ beyond
their means): include less-than-FMV into gross income. [what
is importance of this case?]
Cf Haverly v Comm:
unsolicited textbooks: must include FMV into gross income. [intent to
exercise complete dominion was demonstrated by donating samples to charity
and taking a tax deduction.]
Also: Employee
Gifts: § 102 (c)(1): “any amount transferred by or for an employer
to, or for the benefit of, an employee is not excludable, except:
74(c): Employee
Achievement Awards
If award cost does
not exceed amount allowable as a deduction to the employer (for the
cost of the award), then gross income of
the recipient includes
greater of
Amount greater than
deduction but less than value of award
Amount by which
award value exceeds allowable deduction
132 (e): De Minimus
Fringe
Any property or
service, the value of which so small as to make it unreasonable or administratively
impracticable (taking into account frequency provided)
Eating facility:
treated as de minimis fringe, if,
Located near business
premises, AND
Revenue from facility
normally equals or exceeds direct operating costs
Code § 119
[193]: Meals or lodging furnished for the convenience of employer
(interpreted
by: U.S. Jr. Chamber. of Com. v. U.S.)
To
be excludable, lodging must
i) be furnished for the convenience
of the employer
ii) employee is required to
accept lodging as condition of employment
(required for employee to properly
perform duties)
iii) lodging must be on the business
premises of the employer
(premises
of employer where duties of employee are to be performed)
Note: in this
determination, intention of employer is not very important. Provisions
of contract are not controlling. (e.g., even if employer intended as
part of compensation, employee could exclude if conditions met)
To
be excludable, meals must: be on the premises
Ophra Hypo:
see ppt. 100 ???
Code §
104 [79]: Compensation for injuries or sickness
- see ppt. 100
“putative damages”
and “non-physical damages” (emotional distress / discrimination
/ libel) are taxable”
- direct medical
expenses (a)(2): flush language [pp.102]
Review Problems
[ppt.103]
DEDUCTIONS
Code § 161
[130]: Allowances for deductions
Code §165 [147]:
Losses
(c) limitations
on losses to individuals: only for
Incurred
in trade/business
Incurred
in transaction entered into for profit, and
Casualty
losses
(h)(1): each item
must exceed $100; and total must exceed 10% of adjusted gross income
[hypo ppt. (ii)7]
IF personal casualty
gains exceed personal casualty losses:
All such gains treated
as capital gains
All such losses
treated as capital losses
Corbaley:
what is a casualty loss?
When unexpected,
accidental force is exerted on property and the taxpayer is powerless
to prevent [ppt. (ii)8]
RevRul 70-91: Rust
and corrosion of weather heater was gradually progressive, therefore
not casualty. But damage caused by bursting of water heater was.
Blackman:
allowing casualty loss where man sets own house on fire would be against
public policy.
Code §166(b)
[149]: Bad Debts
(a)(1) General Rule:
deduction allowed for any debt which becomes worthless during taxable
year
(b): See §1011
for determining amount
(d): individuals
do not get bad debt deduction for “non-business” (may be able to
take a capital loss?)
[e.g, if mother
loans money to daughter; the following year the debt is declare worthless,
then can deduct basis in that debt. Note: cash method = no basis; accrual
= basis (see ppt.192)]
Regs.1.166-5(a)(2):
Bad debt deduction
only if and when
becomes totally worthless; no deduction for nonbusiness debt which is
recoverable in part during the taxable year.
Code § 162
[130]: Trade or business expenses
a deduction of all
ordinary and necessary expenses in caring on any business, including
(ordinary = common & accepted means / not just “habitual” or
“normal”)
reasonable compensation
for services actually rendered
traveling expenses
(not lavish/extravagant given the circumstances), and
rentals or other
payments for use of property
Welch v Helverling[ppt111]:
what is ‘ordinary and necessary’
‘ordinary’:
common and accepted means
(habitual does not automatically mean ordinary)
‘necessary’:
for the development of the petitioner’s business
(at least appropriate and helpful)
Lilly
v Commissioner: Expense are deductible if common to the industry
Twity
Burger case (Jenkins) [ppt115]: if sufficient connection b/w expenditures
and taxpayer’s trade or business. Business Reputation argument.
Traveling: meals
and lodging away from home (a)(2); If i) reasonable and necessary; away
from home; not if expected to exceed one-year. (Flowers).
IRS: Home = principal
place of business
Circuits: Home =
where you live
Away from home:
Rev.Rule 93-86 [ppt.292]
Two homes: Hantzis.
[293] & Andrews [294]
Meals & entertainment
: ½ (274(n)(1): If away overnight.
Commuting: if overnight,
deductible [ppt.294]
Exceptions: reimbursed:
don’t want to hit the taxpayer twice
Moss: weekly
meals by lawyers not deductible [ppt.298]
Danville Plywood:
superbowl not deductible [ppt.299]
Primarily biz. Or
personal? [ppt.296]
Pevsner:
designer clothes as not deductible [ppt.300] Three rules:
Required for employment
Not adaptable
Not so warn
Coughlin:
Continuing education deductible if: maintaining or improving
skills (not meeting minimum educational requirements). [ppt.304]
Hudgens:
Hiatus argument: only if in same TorB before and after. [ppt.305]
Sharon: school
expenses not deductible; lisence fee amortizable; bar expenses deductible.
[ppt.308]
Higgins:
private stock trading not T&B expense. [ppt.310]
[company minister cases ppt. 113]
Exacto
Spring Corp. v Commissioner [CEO’s 1 mil. salary is reasonable]
162(a)(1)’s “reasonable”
requirement is to prevent dividends/gifts from being disguised as salary
(b/c apparent that payment is not for services to the company)
Reasonableness depends,
not on taxable income, but on corporation’s profitability (as that
is what investors care about; the investors’ ‘rate of return’)
)
Test: “independent
investor”: When the investors are obtaining a far higher return
than they had any reason to expect, the CEOs salary is presumptively
reasonable (can be rebutted if the company’s earnings are from something
other than the CEOs exertions.)
Note: some jurisdictions
still used the multifactor test disprioved of by Posner in the opinion
for this case.
Consider:
§ 162(m): Certain Excessive Employee Remuneration
(in general, limited
salary tax deduction for an employee to $1 million; but excludes “commission”—performance-based—remuneration)
Code § 212
[198]: Expenses for the production of income
(1) for production of income
(2) for income-producing property management
(3):
legal fees relating to tax advice
United
States v Gilmore [corp president cannot deduct his divorce costs]
Expense must “profit
seeking” nexus: must arise from “profit-seeking” activities (origin
of the claim test).
(c): Losses [ppt.311]
Horrmann:
ex-house is ‘property held for production of income
When he moved out
of house, no longer principle residence
Therefore, deprecation
and maintenance expenses are deductible
‘tipping point
b/w 212 property and 165 (entered into for profit): i.e., when can you
change your mind: “enter into” house to live, but “hold”
it for the production of income.
Reg1.262-1(b)(7):
attny’s fees for divorce
Kopp’s
Company v U.S. [Son’s auto accident costs are deductible]
b/c company was
named as defendant, therefore claim was not merely a personal claim;
it directly jeopardized its assets.
Code § 261
[223]: General rule for disallowance of deductions
Code § 262
[223]: Personal, living, and family expenses (plus phones)
Code § 183
[190]: Activities not engaged in for profit (hobbies) class
notes: down pink tab.
-
(a): if allowable under other sections (so as not to loose them)
- (b) limits
your deductions on losses from ‘ordinary and necessary’ hobby
expenses to your income
generated from the hobby.
- Note: related to
Sec. 67 (2%) limit on Misc. itemized deductions
Code § 163
[136]: Interest (deduction)
(a) Gen: deduction
on all interest on debt paid or accrued w/in taxable year
(h) disallowance
for personal interest (individuals); BUT:
(h)(2)(D) Ok for
“qualified residence interest”
Qualified residence
is (3)(A)(i) 1 million in ‘acquisition debt’, or
ii) 100,000 in ‘home equity’ debt
Code § 221
[210]: Student loan interest (deduction)
$2,5000 maximum
Probably only first
year (b/c of salary cap)
Code § 265
[229]: ”exemption on expenses incurred to produce income”
e.g., exception
for tax exempt items, e.g., tax exempt bonds
REVIEW PROBLEMS
#1 [PPT.137]
ACCOUTNING
ISSUES
Code §446 [343]:
Methods of accounting (ppt.177)
(a) General Rule:
Taxable income shall be computed under accounting method the taxpayer
uses to keep books
(b) If no method
has been regularly used, or if method does not clearly reflect income,
the Secretary can assign a method (that does clearly reflect income)
(c)Permissible Methods
[see ppt. 178]
Note: default is
cash basis
Code §451 [437]:
General Rule for Taxable Year of Inclusion
- (a) General Rule: Amount
shall be included in gross income for taxable year received unless
properly accounted for in a different period
Reg1.446-1:
General rule for methods of accounting
(c): permissible
methods
(i) Cash method:
deduction in year actually or constructive received
(ii) Accural method:
deduction in year when i) all events have occurred, ii)
the income and amount can be determined (reasonably),
and iii) economic performance has occurred. (e.g., when bill is sent.
[See pp.186-7])
Reg1.451-2(a):
Constructive receipt
When credited to
taxpayer’s account, set apart, or otherwise made available [see ppt.
187]
(taxpayer can’t
push away income to avoid constructive receipt)
It is NOT constructively
received if taxpayer’s control is subject to substantial limitations
or restrictions.
Code §461(h)
[359]: Economic performance
if only accrue liability
over time; only for the year at issue (e.g., year lease for 500k = 100k
per year
Hornung v CIR
[Cash basis taxpayer: no constructive possession of Corvette]
Basis of
constructive receipt is ‘unfettered control’ by the recipient over
the date of actual receipt
Here: car
was in different city in closed retail store; P did not have title or
keys or other evidence of ownership or right to possess car at that
time
Cf.:
Ames v Comm
[CIA agent had no constructive possession of Soviet bribes]
Constructive receipt
when ‘unqualified, vested right to receive immediate payment: unfettered
control over actual receipt
Here: did
not have ready access to money in account: had to arrange transfer;
no certainty that could be arranged; substantial risk; Soviets retained
control
Code §109 [89]:
Improvements by lessee on lessor’s property
Basis and deferral
No gross income
on improvements, unless made for rent
Will be taken in
to account when sold (since no basis adjustment)
Note: therefore,
w/ rent, basis adjustment
Rev. Proc. 71-21:
Payments received in one taxable year for services to be performed in
the next can be deferred
(credit card fee cases)
Barnett Bank v Comm:
Part of fees deferred (to match services performed)
Accrual method taxpayer
Reconcile tax and
financial accounting treatment
Burden is on taxpayer
to maintain books to allow verification
Note here: pro rata
refund if credit card is cancelled
Cf.
Signet Bank v Comm: No deferral of credit card fees
Here: under cardholder
agreement: fee paid in full upon issuance; not refundable, not contingent
on performing any services
Petitioner must
show that payment was made at least in part for services to be performed
in the next taxable year; here, agreement clearly shows this is not
the case
(Comm.’s considerable
discretion under §446(b))
Ford Motor v
Comm: changes method from accrual to cash basis
Structured settlement
for auto accident torts: Buys annuities, to be paid out over 40+ years;
claims deductions for total amount of payments due
Comm says: method
did not clearly reflect income (§446(b)); Comm has broad discretion
to make this determination: should not be ‘interfered w/ unless clearly
unlawful: Three stage analysis (txt 268)
Comm.’s discretion
is not limited to methods that Ford could have adopted on its own
Especially here:
‘incongruous result: the greater nominal liability for negligence,
the benefits
See also Reg.1.461-4(g)(8)
Code §461(h)(2)(C)
[360]: “economic performance occurs as payments to injured parties
are made”
Code §72 [60]:
“must also include portion of amount paid that represents interest
growth as gross income”
BASIS
in Property Transactions
Property Transactions
No taxable income until
"realization event" (ala
Glenshaw Glass)
(taxable income is
the gain)
Code §
1001 [487]: Determination of Amount of and Recognition of Gain or
Loss
Code §
1011 [488]: Adjusted basis (see 1012; 1016)
Code §
1012 [488]: Basis of Property: Cost (except cap ex) (not including
real prop. Tax)
Code §
1016 [491]: Adjustment to Basis
Property Transaction analysis:
1012: Basis
±1016:
Adjustments
1011: Adjusted
Basis
1001(b): Amount
Realized
<1011>:
Adjusted Basis
1001(a): Gain
/ Loss
(gains included in gross income; loss depends on type)
When
basis cannot be accurately determined:
- First Northwest:
Where property is sold, if the basis cannot be determined, all income
is taxable. (no basis offset).
- Cf.: Inaja: If basis cannot be determined, income will be sued
to reduce basis to zero. Remainder will be taxable. [better for taxpayers:
current value of money]
Code
§ 1014 [488]: Basis for Property Acquired From a Decedent
(a) (generally: fair
market value)
(b) (when to characterized
as ‘acquired from decedent).
[“Stepped-up” i.e.,
basis is the fair market value of the property on the date of the decedent’s
death. (yet another tax advantage to property owners over renters).]
[SEE ppt. 82]
(e) not one-year limitation on gift pass-back (then carryover) (post
1981)
- Note: for decedent who passes on appreciated property: no income.
Taft v Bowers
Code
§ 101 [76]: Certain Death Benefits
(treating life insurance)
Life Insurance:
bequests (cash) are tax free under §102. BUT: transaction which appear
to have a commercial flavor, rather than a testamentary flavor, tend
to be excepted from the exclusionary treatment. (see §101(a)(2)(A),(B).
- if paid ‘valuable consideration,’ then no exclusion beyond the
value of that consideration. But (exception to exception) (A) and (B).
[SEE ppt. 61-62]
Code
§1015 [490]: Basis for property acquired as gift
-
Basically: carry over basis: “my basis is your basis” (post-1920)
- Unless i)
if FMV is less than basis at time of gift, and
ii) at time of disposition, it is sold at a loss, then use FMV
(lesser of the two).
[But: see ppt. 79: no income if gain=loss/loss=gain]
(Note: no recognition until ‘sale or other disposition’)
Farid-es-sultaneh
v Comm: Pre-nup agreement payment not gift. Was payment for ‘valuable
consideration’: therefore, acquired basis of market-value at time
of transfer.
[See
‘paris’ hypo. Pp.t81]
Code § 1041
[507]: Transfers of property b/w spouses incident to divorce
Imposes ‘gift
treatment’ on transfers b/w spouses OR incident to divorce
Code § 71 [58]:
Alimony
Deductible by donee;
income to donor
Seven elements:
Cash (not property
~ 1041 covers)
Terminates upon
death of payee
Not front loaded
(otherwise looks like property settlement)
Received by or on
behave of (does not need to be direct)
Divorce decree (or
other written agreement)
Do not say “not
alimony”
Not child support
(not income; not deductible)
CAP EX ANALYSIS
[ppt.152]
Code § 263
[223]: Capital expenditures
May get depreciation
deduction under 167/168, if:
Held for production
of income
Has ascertainable
useful life.
(a)(2) general rule:
expenses for restoring property not deductible from income (would instead
be capital expenditure)
Revenue Ruling
2001-4 [airliner maintenance: deductible repairs or capital investment?]
What are capital
expenditures?
Appreciably prolong
the life of the property
Materially increase
its value, or
Make it adaptable
to a different use
Specifically, where
an expenditures is made as part of a plan of rehabilitation or modernization,
must be capitalized even though, standing alone, the item may be classified
as one of repair or maintenance.
Northwest Corp.: Asbestos case [ppt.157]
Fall River Gas
[cost of installing leased appliances into homes as capital expenditure]
Capital expenditure
is one which
Secures an advantage
to taxpayer for more than one year, and
Taxpayer acquires
something of ‘permanent use or value’
Here: taxpayer plainly
anticipated over-all duration of leases would result in rental income
and increased consumption of gas
Totality of expenditure
was made in anticipation of a continuing economic benefit over a period
of years
Note:
Dana Corp. v US: law firm retainer usually deducted as ‘ordinary
and necessary’ business expense as was to prevent firm from representing
adverse parties in takeover situations; but when large M&A fees
charged, retainer had to be capitalized.
Indopco
[expenses related to friendly takeover: capital investment]
Deductions are a
matter of ‘legislative grace’ and burden is on taxpayer to clearly
show provision
§263(a)(1): envisions
inquiry into the duration and extent of the benefits realized
Changing corporate
structure is not ‘ordinary and necessary’
Code §167 [150]:
Depreciation
(a) General Rule:
reasonable depreciation allowance for exhaustion, wear and tear (including
obsolescence) of:
Property used in
trade or business
Property held for
the production of income
(b) Correlation
w/ §168 (accelerated cost recovery system)
(c) Basis for depreciation:
§1011
Note: deduct
salvage value first. [see ppt.165 hypo]
Note:
§1016(a)(2): Downward adjustment to basis required even if you don’t
take the deduction: so must take! [ppt. 163-4 / hypo]: whenever depreciation
problem: basis adjustment.
Reg1.167(a)-1(b):
Useful life of asset
Not necessarily
‘inherent’ useful life; rather, period over which asset may reasonably
be useful to taxpayer in trade/business/production of income
Code
§179 [188]: Election to expense certain depreciable business assets
(ppt.180)???
treat as expense;
and therefore immediately write off
vs. 168 calculations:
then to tables
SEE HYPO ppt.180???
Code §168 [152]:
Accelerated cost recovery system
(ppt.168: ACRS/ hypo: 171-4)
‘assigns’ depreciation
years to property
only applies to
tangible real and personal property (intangibles are not eligible for
accelerated depreciation.
allows deprecation
for full basis (w/o salvage value subtraction)
When straight-line
is greater deduction, taxpayer can switch.
Note: 168(k):
sep.2001 property: see low orange tab in notes. [ppt.181]
Fribourg navigation
v Comm: [liberty ship bonanza] [ppt. 175]
Can sales of depreciable
asset for amount in excess of its adjusted bases at the beginning of
the year bar deduction of depreciation for that year?
Harrah’s Club
[casino must capitalize for restoration of antique autos]
Restoration increases
indefinitely the life of an antique car
Property w/ an indeterminate
life is not depreciable [ppt. 176]
(no limit can be
put on use of vehicles as museum objects)
Cf. Selig
v Comm: Depreciation deductions allowed for ‘state-of-the-art’
cars (Lotus and Ferrari)
Ccf.
Simon and Liddle: Allows deduction for ‘antique violin bows’
Tax court recognizes
that, while bows wear out, they have no determinable life. Moreover,
even a ‘played out’ ‘Tourte bow’ would be pricy as an antique
covetable. Affirmed by Second Circuit
Courts distinguish
‘artwork’ hanging on office wall.
CAPITAL
GAINS / LOSSES [mechanics: ppt. 213]
- Must have
sale or exchange (1222) or a capital asset (1221).
Code §1211
[526]: Limitation on capital losses (not corps)
[see ppt. 216-19]
Code §1212
[526]: Capital loss carrybacks and carryovers
[see ppt. 223]
Code §1(h)
[4] “maximum capital gains rate”
Gray v Darlington: capital gains
are not income.
- Not taxed at ordinary rate: taxed at ‘cap.gains rate.’
Why it matters:
avoid ‘bunching’ of gains into one year
Don’t want to
bump tax bracket
Want to take inflation
into account
Want to provide
investment incentives
Treatment
STG
are taxed at regular rates
LTG
are taxed at preferential ‘capital gains rate’
If
STL < LTG, then net CG, preferential treatment
If
L > G, then offset upto 1211(b) limits. (non corporate)
1211(b)
amount then ‘recharacterized’ as STG and new netting [under 1212]
If in new netting:
STL > LTG, then STL carryover
If in new netting:
LTL > STG, the LTL carryover
> SEE HYPOs: ppt. 228-33]
Code §1222
[530] Terms for capital gains/loss
(11): Net capital
gains = LTCG > STCL
(10): Net capital
loss = CL > CG (subject to 1211 limits)
(7):
Net long-term capital gain = LTCG > LTCL
(6):
Net short-term capital loss = STCL > STCG
(1): STCG
= gain on sale/exchange capital assets held one year or less
(2): STCL
= loss on sale/exchange capital assets held one year or less
(3): LTCG
= gain on sales/exchange of capital asset held for more than one year
(4): LTCL
= loss on sales/exchange of capital asset held for more than one year
Code §1221
[529] Capital Assets defined
‘property’ held
by the taxpayer that is NOT:
Stock in trade or
other types of ‘inventory, or Primarily held for sale to customers
in the ordinary course of trade/business
Property subject
to depreciation (§167) , or reap property used in trade/business
Copyrighted or artistic
composition or similar (intangible) property held by:
Taxpayer whose personal
efforts created such property, or
In case of letter/memorandum,
etc., taxpayer for whom such property was prepared
Accounts or notes
receivable
Hedging transactions
What
is a capital asset?
(for real estate sales)
Byram v US:
Seven pillars of capital gains treatment
Q: is primary purpose
for investment or for sales to customer in the ordinary courts of trade/business
Is a factual (cases-by-case)
consideration, looking into:
Nature and purpose
of the acquisition (and duration of ownership)
Extent and nature
of efforts to sell
Number / extent
/ continuity of sales
Extent of subdividing
/ developing / advertising
Use of business
office
Character / degree
of supervision / control
Time and effort
(ultimate
question for property is ‘purpose for which held’)
Hollis v US:
art expert pillaging Japanese market was making ordinary income
Merely designating
purchase/sell of art as ‘investment’ is not decisive
Contemplated that
sales were to be made immediate upon return
Considering nature
of market (esp. limited number of well-informed potential buyers), lack
of advertising not critical
Anticipated long-term
engagement in business
(Securities:
Corn products doctrine: ‘integral part of business’)
Corn Products
v Comm.: gains on futures transactions ‘vitally connected’ to
the companies manufacturing operations not capital investments [not
§1221]
Nothing in record
supports idea that ‘futures trades’ were ‘separate and apart’
from manufacturing operation (in contrast, appears vitally important)
Transactions sued
as substitute for building/operating additional storage facilities (closely
geared to manufacturing operation)
(Narrowing
Corn Products Doctrine)
Arkansas Best
v Comm.: Capital stock held by holding company was capital asset
Tax payers motivation/purpose
is irrelevant
It’s property
unless it’s a 1221 exception.
(puts corn products into ‘inventory’ exception)
What
is NOT a capital asset?
Hort v Comm:
Cancellation of a lease contract NOT ‘return of capital; rather, is
ordinary income
Payment was “merely”
substitute for the rent reserved in the lease (which §61 clearly characterizes
as gross income)
Cf.
McAllister v Comm.: Sales of life estate in trust fund is
return of capital
Distinguished from
Hort b/c here, is vested remainder (as opposed to Hort’s term-of-years)
Right to income
from life estate was a right in the estate itself (fee interest)
TRADE
OR BUSINESS PROPERTY
Code §1231
[533] Property used in trade or business & involuntary conversions
Basically:
if have net gains
both LT and ST:
Net 1231 gains =
LT cap treatment
Net 1231 losses
= ordinary loss treatment
If have net losses
in both, then
Losses are combined
and
Can be offset against
ordinary income (up to 3K)
If net loss in one,
net gain in another:
If excess ST gain,
the ordinary treatment
If excess LT gain,
then cap gain
If net loss (of
either) exceeds, then can be offset against upto 3K, w/ unlimited caryforward
1231
analysis : [ppt.255-263]
Is
it a 1231 transaction?
Involuntary Conversion
[netting: see ppt. 255]
(see 1231(a)(4)(C))
Is
it involuntary conversion? (stolen/destroyed)
Is
it
property
used in trade or business, or
any
capital asset held for more than one year AND held in connection with
trade or business or entered into for profit?
If
(4)(C) loss exceeds gain, not included in 1231 calculations)
Other
“property used in trade or business”
1231(b) [534]: such property defined (and exceptions)
General
rule (held more than one year: not inventory, etc.)
Timber,
Coal, or Domestic Iron Ore
Livestock
Un-harvested
Crop
What
is the net Gain / Loss of 1231 transactions?
If
1231 gains exceeded 1231 losses, then all such gains and losses
will be long-term (capital) gains and losses
(Note, this is an exception to the general rule of 1221(2) regarding
treatment of property used in trade or business.)
If
1231 losses exceed or equal gains, then all such gains and losses
are treated as ordinary.
Recapture
[ppt. 267]
- To prevent depreciation deductions
from being used to create capital gain; treats certain 1231 gains as
ordinary income. Our focus: 1245. [See
class notes, low blue. Diagram]
- Analysis: ppt. 270-
Code §1245
[542]: Gain from disposition of certain depreciable property
Income
producing income transferred to trust [ppt.251]
The beneficiaries,
not the trust, are taxed: so there is more property which can be distributed.
When income is paid
to beneficiaries, they are taxed. (102 does not exclude the amounts
from gross income. (b)Subchapter J.
Sale of a business
[ppt.
Code §1060
[513]: Special Allocation Rules for Certain Asset Acquisitions
- requires treatment
like certain corporate sales; however, taxpayer can escape that treatment
by signing an agreement on allocating purchase price among assets (unless
gov. finds overreaching). [ppt. 266]
Code §197 Amortization
of Goodwill and Other Intangibles [ppt 309]
Code §197(d)(1)(E)[194]:
“covenant not to compete = intangible = amortized”
pt266]
Williams v McGowan
(2nd Cr. Crt.App; 1945) L Hand opinion
Issue: whether sale
of going business is accounted as whole, or broken into fragments (e.g,
cash, receivables, inventory, fixtures, etc.)
Sec. 1221: property
is ‘capital asset’ except for three exceptions
Stock in trade…
or other inventory
Property held primarily
for sale to customers
Property used in
trade/business that is subject to depreciation
No way to treat
whole business as ‘stock in trade’
Congress ‘plainly’
did not regard whole as ‘capital assets’
Here: fixtures are
not capital b/c subject to depreciation allowance
Gain / loss on every
other item should be treated as ordinary