Federal Income Tax- Spring 2012 Brown

Federal Income Tax 1

Federal Income Tax- Spring 2012 Brown

Calculation of Tax Liability

1. Gross Income [§ 61 – defines; § 1 – imposes a tax on GI]

-“Above the line” deductions [§ 62(a) – list of eligible deductions]

Adjusted Gross Income

- Personal Exemption(s) [§ 151] (subject to any phase out)

- Standard Deduction [§ 63(b), (c)] OR

- Itemized Deductions [§ 63(a), (d)]

Limitations on Itemized Deductions

§ 67(b) – ID other than the ones listed in 67(b) are allowed only to the extent they exceed 2% of TP AGI

§ 68 – Overall limitation on IDs for TPs w/AGI in excess of the “applicable amount,” defined in § 68(b)

Taxable Income (- Net capital gains [15%] – (unrecaptured §1250 gains [25%] + collectible gains [28%]))

* Tax Rate

Gross Tax Liability

- Tax Credits

Net Tax Liability OR Tax Refund

Introduction

1. Tax Policy
2. Fed Income Tax is progressive, not proportionate (flat tax)
3. Federal Insurance Comprehensive Act Tax(FICA – payroll tax) is a flat tax.
4. Ideal Income Base - Haig-Simons Definition
5. Two components
6. Value of rights exercised in personal consumption
7. Current-year receipts minus businessinvestmentdeductions.
8. Change in property value over X period
9. We adhere to Part I, but not Part II, b/c we have a realization requirement that you have to sell the property before you include it in the base. For admin reasons, it would be very hard for IRS to monitor all increases in value
10. Tax expenditures (spending by congress but through the tax code) are departures from ideal base
11. Inflation & Income Tax
12. Hellerman v. Comm’r (SCOTUS 1981)
13. Issue: whether gain from sale of property due to inflation is income?
14. Say should be taxed only on economic gain, not nominal gain
15. Holding: income is based on the meaning a layperson would give it, which means the “extra dollars” paid to them even in nominal gain does not equal their real gain in an economic sense
16. Compliance & Enforcement
17. Tax Return Preparation: ABA Formal Ethics Opinion 85-352 (1985)
18. Used to be a reasonable basis, now lawyer must have a good faith belief
19. § 6662 – penalty for substantial understatement of tax liability which can be avoided if the facts are adequately disclosed or if there is or was substantial authority for position taken
20. If there is substantial authority for their position, then okay, but if there is not, att’y must inform client about penalty
21. Tax Shelters
22. Special disclosure and penalty rules apply b/c of the special threat tax shelters & audit lottery
23. Listed transactions and reportable transactions have strict liability penalties attached for understating

The Scope of Gross Income

1. Cash Receipts: Does Source Matter? Generally, no.

1. Windfalls and Recovery of Capital
2. Windfalls [§ 61]
3. “GI means all income from whatever source derived…” – 61(a)
4. TP must include in income any windfalls they receive. All we need is an accession of wealth that is realized and subject to the TP’s dominion. If it is not out, it is in
5. Comm’r v. Glenshaw Glass (SCOTUS 1955)
6. Two actions re: antitrust violations
7. $324K of $800K settlement was in punitive damages (Glenshaw)
8. Argued that did nothing intentional
9. $125K of $375K was loss of profits, rest punitive b/c treble damages (William Goldman Theatres)
10. Issue: whether $ rec’d as exemplary damages for fraud or as punitive 2/3s portion of a treble-damage antitrust recovery must be reported as GI?
11. Holding: Punitive damages are “undeniable accessions to wealth, clearly realized & over which TPs have complete dominion.” Punitive damages must be included in GI
12. Limits Eisner v. Macomber to dividends, distinguishing “gain” from “capital”
13. Defined income as being derived from labor or capital
14. This case is ltd to its facts
15. SOURCE IS ALWAYS IRRELEVANT FOR INCLUDING IN GI
16. “except as otherwise provided”
17. Cesarini v. US (N.D. Ohio 1969)
18. Found $4,467 in old piano
19. Report on tax returns, but then file amended return asking for refund of taxes on that amount b/c it was (1) found; (2) income from the yr piano was bought and SOL blocks it now; and (3) entitled to capital gains treatment
20. Holding: State law applies. Under OH law, $ not disputed until discovered so not barred by SOL
21. “treasure trove regulation”: Reg § 1.61-14(a) “The finder of treasure trove is in receipt of TI, for FIT purposes, to the extent of its value in US currency, for the TP in which it is reduced to undisputed possession”
22. If a physical item, can defer reporting income until sell item; if cash, report the year in which it was found
23. IRS ignores reporting in year found for things like caught baseballs
24. BUT law says that you need to declare value when find it, and then declare appreciation when sell it
25. Recorded as ordinary income in this case
26. What if you buy something for a small value and it is worth a lot more than expected?
27. Accession to wealth
28. Ignore this in a stranger situation (would need to report if employer-employee relationship – Reg. § 1.61-2(d)(2)(i))
29. Becomes unrealized appreciation, must report when sold
30. What about rebates?
31. 1979 Rev. Rul.: ignore accession of wealth in an arms-length transaction
32. What about self-created, imputed income, i.e., catching a baseball?Deferral of tax until sell baseball, then it is a LTCG
33. GI includes income realized in any form, whether in money, property, or services.§1.61-1(a) [$10K bracelet found in piano – horizontal equity]
34. Recovery of Capital [§1001; § 1012]
35. § 1001(a) - Computation of Gain or Lossdefines the gain on the sale of property as the excess of the “amount realized” on the sale over the “adjusted basis” of the property
36. § 1001(b) - Amount Realized - Defines a TP’s amount realized on a sale as the cash received by the TP plus the FMV of any non-cash property received
37. § 1012 - Basis of Property - Cost - Defines a TP’s basis in an asset as “the cost of such property”
38. § 1016 provides for certain adjustments in moving from §1012 basis to “adjusted basis”

1. Gift and Bequests
2. Statutes [§102; §1.102-1(f)(2)]
3. GI does not include the value of property acquired by gift, bequest, devise, or inheritance [§102(a)]
4. Donor does not receive a deduction.A shift to the donee
5. Gains can be transferred, but not losses §1015(a)
6. Exclusion does not extend to the income earned on property given as a gift [§102(b)]
7. Business gifts generally are deductible only up to $25 per year per recipient [§274(b)]
8. Standard Inquiry[Duberstein is binding; Goodwin is not]
9. Comm’r v. Duberstein (SCOTUS 1960)
10. D receives Cadillac from Mohawk as a “gift” for giving M a list of potential customers
11. D did not intend to be compensated for the info
12. M deducts the value of the car as a business expense
13. D did not include in GI seeing car as a gift
14. Stanton v. US (Same opinion)
15. S worked at church, decided to go into business for himself
16. Church directors all liked him & wanted to give him a gift of $20K, instead of pension & retirement benefits
17. S did not include in GI
18. Issue: What is a gift in context w/ a business overtone?
19. Holding: Focus on the objectiveintent of the transferor – was it from a “detached and disinterested generosity,” “out of affection, respect, admiration, charity or like impulses”?
20. Car not a gift b/c seeking to encourage a business relationship
21. Must evaluate the facts of each case
22. Congress meant “gift” to be interpreted in the “colloquial sense”
23. Must be an objective inquiry into transferor’s intent
24. Factual Q
25. Deference to the trier of fact
26. When the recipient has performed some service for the transferor, the receipt is generally not a gift
27. Payment of a business nature when:
28. Thing of value given by employer to employee upon termination of employment
29. Payments in a business relationship, occasioned by the performance of some service

Value of Car / After-tax Cost to Mohawk / After-tax Benefit to Duberstein
M’s ltr indicates car is not a gift / $50K / $30K ($50K reduced by $20K tax savings from deduction) / $30K ($50K value of car, reduced by $20K tax liability)
M’s ltr indicates car is a gift / $30K / $30K (no deduction allowed by § 274(b)) / $30K (car treated as gift)

1. Post-Duberstein Amendments to Tax Code:
2. § 274(b) denies transferor a business expense deduction for any business gift
3. § 102(c) says that § 102(a) gift/inheritance deductions cannot apply to “any amount transferred by or for an employer to, or for the benefit of, an employee”

1. Gifts v. Compensation: Goodwin v. United States (8th Cir. 1995)
2. Goodwins denied refund for taxes paid on payments rec’d from members of Rev. Goodwin’s congregation
3. Church did not consider these “gifts” as income when setting Rev.’s annual compensation
4. Issue: is the money a gift under the Duberstein std?
5. Holding: TI b/c the special occasion gift was a regular, sizable payment made by person whom Rev. provides services, thus, a form of compensation
6. Gathered by congregation leaders
7. In a regular program, o/b/o congregation
8. Tips – § 6053
9. Employees who receive tips must include them in GI. Tips are required for services rendered. However, there is a reporting problem b/c they are receiving cash.
10. Jt Committee on Taxation, 1982
11. Must report all tips to employer for a month before the 10th day of next month
12. Large food and beverage establishments required to report to IRS (1) gross receipts of the establishment from food & beverage sales, (2) the amount of aggregate charge receipts, (3) the aggregate amount of tips shown on such charge receipts, and (4) reported tip income
13. No tip allocations need to be made if tipped employees voluntarily report tips aggregating 8 percent or more of gross receipts
14. Property as a Gift § 1015(a)
15. “Basis shall be the same as it would be in the hands of the donor”
16. Example: Mom gives house to son
17. Bought in 2009 for $100K
18. Give to son in Feb. 2011, FMV $110K
19. Son sells in Jan. 2012 for $135K
20. Mom:
21. AB $100,000(pays tax when bought property)
22. No tax on transfer b/c not a “sale or other disposition” § 1001(a)
23. But subject to transfer tax of amount over $13,000 based on FMV
24. When Mark sells it:
25. AB: $100K (same as donor)
26. AR: $135K
27. Realized gain included in GI: $35K
28. LTCG b/c donor’s holding period added to donee’s § 1223(2)
29. However, Su Lin would still be subject to the transfer tax over $13,000 if exceeded lifetime exemption
30. Employer/Employee Gifts
31. There cannot be a gift between employer & employee unless it can be proven the gift was not given in recognition of the employee’s employment (relatives or birthday) §102(c)
32. Prizes and Awards
33. Not defined in code; something given to you in recognition for an accomplishment/achievement
34. §74(a) - Except as otherwise provided in this section or in §117 (relating to qualified scholarships), GI includes amounts received as prizes and awards
35. Rev. Rul. 57-374: FMV of trip not included in GI where refuse an all-expense pd trip
36. Need an ascension of wealth

1. Personal Injury Damages [104(a)(2); 213(a)]
2. Statute
3. §104(a)(2) excludes from GI “any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) o/a/o personal physical injuries or physical sickness” – includes lost wages, pain & suffering, IIED, loss of consortium resulting from physical injuries
4. Physical manifestations, such as physical indications of emotional distress, of nonphysical injuries do not constitute a personal physical injury or sickness
5. However, last sentence of §104(a) says this does not applyif you go to a doctor to treat IIED, even if the expenses arise not from physical injuries, to that extent they will be excluded
6. Wages are excluded b/c of attorney’s fees – might not be able to deduct it (in the case of physical injury) § 162
7. Whistleblower/employment case: att’y’s fees treated as an above the line deduction § 62(a)(20) – but must include settlement in GI
8. Standard
9. Whether the settlement payment is excludable from GI under §104(a)(2) depends on the nature and character of the claim asserted, and not upon the validity of that claim. Look first to the settlement agreement language (lump sum jury verdict) and then to the payor’s intent
10. Amos v. Comm’r (TCM 2003)
11.  is a photographer, who Dennis Rodman kicked in groin during Chicago Bulls game
12. Had a preexisting back condition
13. Settled w/ Rodman – confidential agmt was part of consideration for payment
14. Issue: whether $200K settlement from 1997 is excludable?
15. Holding: $120K is, but $80K is not. Where damages rec’d in settlement, nature of the claim that was actual basis for settlement controls whether such damages are excludable
16. Two requirements TP must meet to exclude under § 104(a)(2) (Comm’r v. Schleier)
17. TP must demonstrate that the underlying COA give rise to recover based upon tort
18. TP must show damages were rec’d o/a/o personal injuries or sickness
19. Portion of settlement was to prevent  from disclosing, publicizing the facts, or assisting a criminal prosecution against Rodman

1. Is It Taxable If It Isn’t Cash? Generally, Yes, As far as §61 is Concerned
2. Goods & Services
3. GI includes income realized in any form, whether in money, property, or services.§1.61-1(a)
4. §61(a) requires an obj. measure (retail value) of FMV
5. Rooner v. Comm’r (TC 1987)
6. Partners in acct’g firm, received goods & services in exchange for payment for acct’g services provided
7. “cross-acct’g” w/ 4 clients
8. Became dissatisfied w/ cross acct’g, goods overpriced, services not satisfactorily performed – discounted those goods and services against what was owed to partnership
9. Clients not informed of adjustments
10. Issue: can they discount the retail prices of foods & services rec’d in exchange for acct’g services using subjective determination of value?
11. GI includes FMV of goods & services rec’d by them
12. Holding: § 61 requires objective measure of FMV – cannot adjust acknowledged retail price
13. If services are paid for in exchange for other services, the FMV of such other services taken in payment must be included in income as compensation §1.61-2(d)(1)
14. Meals & Lodging - §119(a), §1.119-1(a)
15. §119(a) - Exclusion from GI the value of meals & lodging furnished by an employer to an employee (her spouse, or dependents). Factual inquiry - substantial non-compensatorypurpose, ex. waiters & firefighters Reg. § 1.119-1
16. (1) For Meals to be excluded:
17. For convenience of the employer; and
18. = substantial noncompensatory purpose
19. The meals are furnished on the business premises
20. (2) For lodging to be excluded(§1.119-1(b))
21. Furnished on business premises of employer;
22. Furnished for convenience of the employer; and
23. Employee is req. to accept such lodging as a condition of his employment
24. Excludes rental value of employer-providing housing if:
25. (1) housing is located on business premises of employer
26. (2) employee must accept the housing as a condition of employment
27. (3) housing is furnished “for the convenience of the employer”
28. §119(d) - Lodging for Certain Educational Institutions
29. (1) Employees of educ. institutions are often provided nearby housing at below-market rent. The value of such lodging is excluded from GI of the employeeprovided that the employee pays rent for such lodging in an amount that equals or exceeds 5% of the FMV of the lodging
30. (2)(A)If the employee does not pay rent of at least 5% of the appraised value, TP receives TI in the amount of the difference between the rent paid, & the lesser of -
31. 5% of the FMV of thelodging, or
32. AVG rental paid by individuals not affiliated w/ the institution for lodging provided by the institution that is comparable to that provided to employee
33. (3) The term qualified lodging means lodging to which subsection (a) does not apply, and which is located or in the proximity of a campus of the education institution
34. Employer gets a deduction under § 162 for transfer of real property to an employee

1. Imputed Income and Unrealized Appreciation
2. Imputed Income
3. Non-cash benefits you create for yourself, in the absence of an exchange are not taxable
4. Performing a service in exchange for a service is to be included in GI (Rooney)
5. Imputed income from owner-used property is excluded from the scope of §61
6. Home mortgage interest deduction preserves the benefit of the imputed income exclusion for homeowners w/ mortgages
7. Loser is the renter – owner gets deductions, not person renting
8. Public Policy - Privacy & Liberty Problems - You don’t want to force people in the market place if they don’t want to go in. Encourages specialization of labor & efficiency. There are also reporting, administration, valuation, and liquidity problems
9. Unrealized Appreciation
10. As long as you do not sell (or otherwise dispose of) your shares, income tax will continue to disregard any increases or decreases in the value of the stock. However, Congress can change that and has the power to tax unrealized appreciation to the extent it sees fit
11. Results only in deferral of tax, taxed under §1001 for gain realized once you sell it
12. Public Policy - Valuation and liquidity
13. Valuation – Can look at the current price of the shares
14. Liquidity – However, TP could easily sell (or borrow against) some of the shares in order to pay a tax on the appreciation
15. But stepped up to FMV upon death § 1014
16. Employer-Provided Benefits
17. Employer-Provided Health Insurance [§106] [§105] [§125]
18. §106(a)excludes from the GI of an employee the value of employer-provided health insurance coverage to TP, spouse or his dependents(Reg. § 1.106-1)
19. §105(b)excludes from GI the value of benefits received under employer-provided health insurance, to the extent the benefits constitute reimbursement of medical expenses
20. Removes both premiums & benefits from income tax base
21. SameSexMarriage If an employer provides health insurance coverage for unmarried partners of its employees, the value of the partner coverage cannot be excluded from GI under DOMA (except if partner qualifies as a dependent of the employee under §152)
22. Cafeteria Plan [non discrimination applied]
23. Under §125, a TP who is offered a choice between cash & health insurance coverage, and who chooses insurance, will not be taxed under the doctrine of constructive receipt
24. Qualified benefits mean any benefit that is not includible in the GI of the employee by reason of an express provision of this chapter (§106, §105)§125(f)
25. One drawback of the cafeteria plans is that you have to estimate how much you put in. If you don’t spend it you may lose it
26. No Employee Health Care
27. §213(a) allows TP who do not have health insurance through their employers to claim their medical expenses as itemized deductions (only to the extent they exceed 7.5% of AGI)
28. Self-Employed Health Coverage
29. §162(l) self-employed people who provide their own health insurance coverage have an above the line deduction. Does not apply if you are an employee
30. Group-Term Life Insurance
31. §79(a) allows employees to exclude the value of group-term life insurance provided by their employers, for up to $50,000 of insurance. Employers may not discriminate
32. Amount over $50K is counted in GI
33. Certain Fringe Benefits
34. §132(a)- GI shall not include any fringe benefit which qualifies as a -
35. No-additional-cost service [§132(a)(1), §132(b), §1.132-2]
36. A service regularly provided to the public by the employer, which the employer can provide to the employee w/out incurring significant additional cost(incidental to primary service being provided by employer)
37. Non-discrimination rule applied [§1.132-8]
38. § 132(j)(1)nondiscrimination on exclusions for no-additional-cost services & qualified employee discounts
39. § 117(d)(3) nondiscrimination on exclusion for qualified tuition reductions
40. Air Transportation - Any use of air transportation by a parent of an employee shall be treated as use by the employee. §132(h)(3).