Download Fed Pers Income Tax

Federal personal income tax
I.
Some context and historical background
a. Current significance
b. History
Early American revenue came almost exclusively from tariffs.
Pollack v. Farmer’s Loan & Trust (1895): declared a tax on income unconstitutional.
Constitution give Congress the right to tax. Limitations on this right is also included
in Article 1 § 2 and § 9. Means that any direct taxes must be apportioned among the
states based on their population, so that it is equal per capita. There is no way to do
this with personal income tax, so if you say that personal income tax is a direct tax,
then it would be unconstitutional. Then comes the 16th Amendment passed in 1913.
Allows Congress to tax with out apportionment.
c. Progressivity
d. The basic goals of any tax system
i. Fairness:
1. Horizontal equity: two similarly situated tax payers should pay the
same amount. Difficulty is determining how people can be
similarly situated.
2. Vertical equity: allocated tax burdens fairly as we go up the
income scale.
ii. Economic rationality (Neutrality): All things being equal, we don’t want
to distort normal economic behavior…we don’t want people doing
something or refraining from doing something only for tax purposes. For
example, A is willing to pay $100/wk to have her house cleaned. B is
willing to clean the house for take-home pay of $80. There is $20 of
available surplus benefit to society available in the transaction. However,
if a 25% income tax is imposed, B’s take-home pay is only $75. This
would distort/destroy an economic transaction that would otherwise
happen. In reality, people do things for reasons unrelated to the economic
elements of the transaction. Also, there is no way to have a tax without
distorting behavior in some way, so the goal is to minimize the distortion.
iii. Administrability
II.
The characteristics of income
1.
A flow: Income can only be measured in time. Since 1913, we've had the
measure of the flow over one year (annual accounting principal). Usually a
calendar year.
2. Some examples
a.
Paycheck: if an employee gets $5K in cash as a monthly salary, it is
definitely income. If the employee gets the same amount in a check, it is
counted as income, even if it hasn't cleared yet. It is considered a "cash
equivalent." There is always some level of contingency. The tax code
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confronts the issue to determine what level of contingency is enough. Same
for direct deposits.
b.
Windfall: Outside of employee context, $5K cash found in a bag by TP is
also income. Fairness (horizontal equity) because a person would have to
claim the money if they got it by working, so it is fair for the TP who got the $
with no effort to also claim it.
c.
"Swag bag:" A star agrees to host an award show for free. In her room is a
gift basket worth $5K. Taxable compensation? Note that precise terms of the
compensation are not negotiated in advance and there is no expectation or
obligation to pay/give. Yes, a quid pro quo is taxable as compensation,
however, this is not an easy case and it might be difficult to agree on the
FMV.
d.
Benefits in kind (Payments from 3rd parties): when an employer pays an
employee's rent as part of his compensation, it is considered an "accession to
wealth," and is taxable. This is fair (horizontally equity) because a similarly
situated employee that gets paid the same amount in a cash salary and uses the
salary to pay the landlord is in the same position.
Note that § 61 defines fringe benefits, etc. as income as the default position "unless
otherwise excluded." So, exclusions such as health care benefits are income, but
are not taxable because of specific exclusions in other areas of IRC.
3.
Income in Kind/Non-cash receipts
a.
Discharge of an obligation: Old Colony (p. 35)
i.
Facts: Mr. Wood is the president of the American Woolen
Company. His tax liability based on his salary earned in 1918 and
1919 was paid by the Company per a company resolution. Supreme
Court says that taxes paid by employer is income.
ii.
Rule: The discharge by a third person of an obligation to him is
equivalent to receipt by the person taxed [CB 37]
iii.
Income analysis: the fact that the expense being covered by the
employer is taxes doesn't change the fact that it is a benefit.
iv.
Held: It is an accession to wealth.
IRC § 61. Gross income defined.
(a) General definition. Except as otherwise provided in this subtitle [IRC Sections 1
et seq.], gross income means all income from whatever source derived, including (but
not limited to) the following items:
(1) Compensation for services, including fees, commissions, fringe benefits, and
similar items;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(6) Royalties;
(7) Dividends;
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(8) Alimony and separate maintenance payments;
(9) Annuities;
(10) Income from life insurance and endowment contracts;
(11) Pensions;
(12) Income from discharge of indebtedness;
(13) Distributive share of partnership gross income;
(14) Income in respect of a decedent; and
(15) Income from an interest in an estate or trust.
CFR § 1.61-1 Gross income.
(a) General definition. Gross income means all income from whatever source derived,
unless excluded by law. Gross income includes income realized in any form, whether in
money, property, or services. Income may be realized, therefore, in the form of services,
meals, accommodations, stock, or other property, as well as in cash. Section 61 lists the
more common items of gross income for purposes of illustration. For purposes of further
illustration, § 1.61-14 mentions several miscellaneous items of gross income not listed
specifically in section 61. Gross income, however, is not limited to the items so
enumerated.
CFR § 1.61-2 Compensation for services, including fees, commissions, and similar
items.
(a) In general. (1) Wages, salaries, commissions paid salesmen, compensation for
services on the basis of a percentage of profits, commissions on insurance premiums,
tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury
fees, marriage fees and other contributions received by a clergyman for services, pay of
persons in the military or naval forces of the United States, retired pay of employees,
pensions, and retirement allowances are income to the recipients unless excluded by law.
Several special rules apply to members of the Armed Forces, National Oceanic and
Atmospheric Administration, and Public Health Service of the United States; see
paragraph (b) of this section.
(2) The Code provides special rules including the following items in gross income:
(i) Distributions from employees' trusts, see sections 72, 402, and 403, and the
regulations thereunder;
(ii) Compensation for child's services (in child's gross income), see section 73 and the
regulations thereunder;
(iii) Prizes and awards, see section 74 and the regulations thereunder.
(3) Similarly, the Code provides special rules excluding the following items from
gross income in whole or in part:
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(i) Gifts, see section 102 and the regulations thereunder;
(ii) Compensation for injuries or sickness, see section 104 and the regulations
thereunder;
(iii) Amounts received under accident and health plans, see section 105 and the
regulations thereunder;
(iv) Scholarship and fellowship grants, see section 117 and the regulations
thereunder;
(v) Miscellaneous items, see section 122.
(d) Compensation paid other than in cash--(1) In general. Except as otherwise provided
in paragraph (d)(6)(i) of this section (relating to certain property transferred after June
30, 1969), if services are paid for in property, the fair market value of the property taken
in payment must be included in income as compensation. If services are paid for in
exchange for other services, the fair market value of such other services taken in payment
must be included in income as compensation. If the services are rendered at a stipulated
price, such price will be presumed to be the fair market value of the compensation
received in the absence of evidence to the contrary. For special rules relating to certain
options received as compensation, see §§ 1.61-15, 1.83-7, and section 421 and the
regulations thereunder. For special rules relating to premiums paid by an employer for
an annuity contract which is not subject to section 403(a), see section 403(c) and the
regulations thereunder and § 1.83-8(a). For special rules relating to contributions made
to an employees' trust which is not exempt under section 501, see section 402(b) and the
regulations thereunder and § 1.83-8(a).
III.
Employer-provided food and lodging
1. Benaglia (p. 39):
2. Hired as the original manager of the Royal Hawaiian Hotel. He and his wife get a
cash salary of ~$10K + they stay in the hotel and received their meals there, for a
FMV of ~$7K.
a. Possible alternatives
i. No income or possibly no income to employee, but income to
spouse
ii. FMV: too high because Benaglia wouldn't view the value as this.
iii. Cost to hotel
iv. Substitution Cost or cost of equivalent arrangements.
v. Subjective value to Benaglia himself. What is his accession of
wealth that makes him better off. Theoretically, this is the best
value to use, but not practical. His 6,000th meal at the hotel is
going to be worth less to him than the first, and he has to eat what
they serve and arrange his life around living there. This is very
difficult to administer.
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3.
4.
5.
6.
7.
8.
b. Holding: Board concludes that it is not income because the lodging and
meals are provided for the convenience of the employer. The duties of the
manager of the hotel cannot be performed unless he is always on call.
c. Fundamental problem: what does "convenience of the employer" have to
do with it. Shouldn't the question be whether the employee has received
an accession to wealth? Because it is presumed that something done for
the convenience of the employer, the employee doesn't value it at a high
level. Prof: we shouldn't assume that the employee has received no
accession to wealth, but the Board errs on the side of assuming no income.
Present Treatment § 119: enacted after Benaglia, largely codifies the result. Can
think of 119 of both adopting and repudiating Benaglia. Adopts the convenience
of the employer doctrine. However, 119 is an exception, so but for this exception,
the meals/lodging would be income under § 61.
a. Lodging is required to be accepted.
Questions pp. 49-50.
Employer Benefits are presumptively income @ FMV unless they fall into one of
the exceptions. Difficulties:
a. valuation, since emp'e doesn't necessarily value the benefits as FMV.
b. Compliance: people don't think of these things as income. Also, people
became accustomed to these benefits not being taxed before the IRC
began focusing on it.
§ 119: can think of it as having three components
a. Furnished
b. On employer's premises
c. For the convenience of employer
d. Lodging has additional component: employee must be required to accept
as a condition of e'ment. Doesn’t have to be written in K, more of a
substantive question.
Note that this essentially repudiates Benaglia to the extent that the case was
talking about the general definition of income that would be defined under § 61,
before the exceptions in § 119 were codified.
In applying a statute, each word really matters.
a. Business premises defined:
b. Place where e'ee performs most of his duties
c. Place where e'er does most of its business.
IRC § 119. Meals or lodging furnished for the convenience of the employer.
(a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to
employment. There shall be excluded from gross income of an employee the value of any
meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of
his employer for the convenience of the employer, but only if-(1) in the case of meals, the meals are furnished on the business premises of the
employer, or
(2) in the case of lodging, the employee is required to accept such lodging on the
business premises of his employer as a condition of his employment.
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(b) Special rules. For purposes of subsection (a)-(1) Provisions of employment contract or state statute not to be determinative. In
determining whether meals or lodging are furnished for the convenience of the employer,
the provisions of an employment contract or of a State statute fixing terms of employment
shall not be determinative of whether the meals or lodging are intended as compensation.
(2) Certain factors not taken into account with respect to meals. In determining
whether meals are furnished for the convenience of the employer, the fact that a charge is
made for such meals, and the fact that the employee may accept or decline such meals,
shall not be taken into account.
(4) Meals furnished to employees on business premises where meals of most employees
are otherwise excludable. All meals furnished on the business premises of an employer
to such employer's employees shall be treated as furnished for the convenience of the
employer if, without regard to this paragraph, more than half of the employees to whom
such meals are furnished on such premises are furnished such meals for the convenience
of the employer.
(d) Lodging furnished by certain educational institutions to employees.
(1) In general. In the case of an employee of an educational institution, gross income
shall not include the value of qualified campus lodging furnished to such employee
during the taxable year.
(2) Exception in cases of inadequate rent. Paragraph (1) shall not apply to the extent
of the excess of-(A) the lesser of-(i) 5 percent of the appraised value of the qualified campus lodging, or
(ii) the average of the rentals paid by individuals (other than employees or students
of the educational institution) during such calendar year for lodging provided by the
educational institution which is comparable to the qualified campus lodging provided to
the employee, over
(B) the rent paid by the employee for the qualified campus lodging during such
calendar year.
The appraised value under subparagraph (A)(i) shall be determined as of the close of
the calendar year in which the taxable year begins, or, in the case of a rental period not
greater than 1 year, at any time during the calendar year in which such period begins.
(3) Qualified campus lodging. For purposes of this subsection, the term "qualified
campus lodging" means lodging to which subsection (a) does not apply and which is-(A) located on, or in the proximity of, a campus of the educational institution, and
(B) furnished to the employee, his spouse, and any of his dependents by or on behalf
of such institution for use as a residence.
(4) Educational institution, etc. For purposes of this subsection-(A) In general. The term "educational institution" means-(i) an institution described in section 170(b)(1)(A)(ii) [IRC Sec. 170(b)(1)(A)(ii)]
(or an entity organized under State law and composed of public institutions so
described), or
(ii) an academic health center.
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(B) Academic health center. For purposes of subparagraph (A), the term "academic
health center" means an entity-(i) which is described in section 170(b)(1)(A)(iii) [IRC Sec. 170(b)(1)(A)(iii)],
(ii) which receives (during the calendar year in which the taxable year of the
taxpayer begins) payments under subsection (d)(5)(B) or (h) of section 1886 of the Social
Security Act [42 USCS § 1395ww] (relating to graduate medical education), and
(iii) which has as one of its principal purposes or functions the providing and
teaching of basic and clinical medical science and research with the entity's own faculty.
CFR § 1.119-1 Meals and lodging furnished for the convenience of the employer.
(a) Meals—
(1) In general. The value of meals furnished to an employee by his employer shall be
excluded from the employee's gross income if two tests are met: (i) The meals are
furnished on the business premises of the employer, and (ii) the meals are furnished
for the convenience of the employer. The question of whether meals are furnished for
the convenience of the employer is one of fact to be determined by analysis of all the
facts and circumstances in each case. If the tests described in subdivisions (i) and (ii)
of this subparagraph are met, the exclusion shall apply irrespective of whether under
an employment contract or a statute fixing the terms of employment such meals are
furnished as compensation.
(2) Meals furnished without a charge. (i) Meals furnished by an employer without
charge to the employee will be regarded as furnished for the convenience of the
employer if such meals are furnished for a substantial noncompensatory business
reason of the employer. If an employer furnishes meals as a means of providing
additional compensation to his employee (and not for a substantial noncompensatory
business reason of the employer), the meals so furnished will not be regarded as
furnished for the convenience of the employer. Conversely, if the employer furnishes
meals to his employee for a substantial noncompensatory business reason, the meals
so furnished will be regarded as furnished for the convenience of the employer, even
though such meals are also furnished for a compensatory reason. In determining the
reason of an employer for furnishing meals, the mere declaration that meals are
furnished for a noncompensatory business reason is not sufficient to prove that meals
are furnished for the convenience of the employer, but such determination will be
based upon an examination of all the surrounding facts and circumstances. In
subdivision (ii) of this subparagraph, there are set forth some of the substantial
noncompensatory business reasons which occur frequently and which justify the
conclusion that meals furnished for such a reason are furnished for the convenience
of the employer. In subdivision (iii) of this subparagraph, there are set forth some of
the business reasons which are considered to be compensatory and which, in the
absence of a substantial noncompensatory business reason, justify the conclusion that
meals furnished for such a reason are not furnished for the convenience of the
employer. Generally, meals furnished before or after the working hours of the
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employee will not be regarded as furnished for the convenience of the employer, but
see subdivision (ii)(d) and (f) of this subparagraph for some exceptions to this
general rule. Meals furnished on nonworking days do not qualify for the exclusion
under section 119. If the employee is required to occupy living quarters on the
business premises of his employer as a condition of his employment (as defined in
paragraph (b) of this section), the exclusion applies to the value of any meal
furnished without charge to the employee on such premises.
(ii)(a) Meals will be regarded as furnished for a substantial noncompensatory
business reason of the employer when the meals are furnished to the employee during
his working hours to have the employee available for emergency call during his meal
period. In order to demonstrate that meals are furnished to the employee to have the
employee available for emergency call during the meal period, it must be shown that
emergencies have actually occurred, or can reasonably be expected to occur, in the
employer's business which have resulted, or will result, in the employer calling on the
employee to perform his job during his meal period.
(b) Meals will be regarded as furnished for a substantial noncompensatory
business reason of the employer when the meals are furnished to the employee
during his working hours because the employer's business is such that the
employee must be restricted to a short meal period, such as 30 or 45 minutes, and
because the employee could not be expected to eat elsewhere in such a short meal
period. For example, meals may qualify under this subdivision when the employer
is engaged in a business in which the peak work load occurs during the normal
lunch hours. However, meals cannot qualify under this subdivision (b) when the
reason for restricting the time of the meal period is so that the employee can be
let off earlier in the day.
(c) Meals will be regarded as furnished for a substantial noncompensatory
business reason of the employer when the meals are furnished to the employee
during his working hours because the employee could not otherwise secure
proper meals within a reasonable meal period. For example, meals may qualify
under this subdivision (c) when there are insufficient eating facilities in the
vicinity of the employer's premises.
(d) A meal furnished to a restaurant employee or other food service employee for
each meal period in which the employee works will be regarded as furnished for a
substantial noncompensatory business reason of the employer, irrespective of
whether the meal is furnished during, immediately before, or immediately after
the working hours of the employee.
(e) If the employer furnishes meals to employees at a place of business and the
reason for furnishing the meals to each of substantially all of the employees who
are furnished the meals is a substantial noncompensatory business reason of the
employer, the meals furnished to each other employee will also be regarded as
furnished for a substantial noncompensatory business reason of the employer.
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(f) If an employer would have furnished a meal to an employee during his working
hours for a substantial noncompensatory business reason, a meal furnished to
such an employee immediately after his working hours because his duties
prevented him from obtaining a meal during his working hours will be regarded
as furnished for a substantial noncompensatory business reason.
(iii) Meals will be regarded as furnished for a compensatory business reason of the
employer when the meals are furnished to the employee to promote the morale or
goodwill of the employee, or to attract prospective employees.
(b) Lodging. The value of lodging furnished to an employee by the employer shall be
excluded from the employee's gross income if three tests are met:
(1) The lodging is furnished on the business premises of the employer,
(2) The lodging is furnished for the convenience of the employer, and
(3) The employee is required to accept such lodging as a condition of his
employment.
The requirement of subparagraph (3) of this paragraph that the employee is required to
accept such lodging as a condition of his employment means that he be required to
accept the lodging in order to enable him properly to perform the duties of his
employment. Lodging will be regarded as furnished to enable the employee properly to
perform the duties of his employment when, for example, the lodging is furnished because
the employee is required to be available for duty at all times or because the employee
could not perform the services required of him unless he is furnished such lodging. If the
tests described in subparagraphs (1), (2), and (3) of this paragraph are met, the
exclusion shall apply irrespective of whether a charge is made, or whether, under an
employment contract or statute fixing the terms of employment, such lodging is furnished
as compensation. If the employer furnishes the employee lodging for which the employee
is charged an unvarying amount irrespective of whether he accepts the lodging, the
amount of the charge made by the employer for such lodging is not, as such, part of the
compensation includible in the gross income of the employee; whether the value of the
lodging is excludable from gross income under section 119 is determined by applying the
other rules of this paragraph. If the tests described in subparagraph (1), (2), and (3) of
this paragraph are not met, the employee shall include in gross income the value of the
lodging regardless of whether it exceeds or is less than the amount charged. In the
absence of evidence to the contrary, the value of the lodging may be deemed to be equal
to the amount charged.
(c) Business premises of the employer--(1) In general. For purposes of this section, the
term “business premises of the employer” generally means the place of employment of
the employee. For example, meals and lodging furnished in the employer's home to a
domestic servant would constitute meals and lodging furnished on the business premises
Federal Personal Income Tax – Fall 2009, Joondeph
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of the employer. Similarly, meals furnished to cowhands while herding their employer's
cattle on leased land would be regarded as furnished on the business premises of the
employer.
(2) Certain camps. For taxable years beginning after December 31, 1981, in the case
of an individual who is furnished lodging by or on behalf of his employer in a camp
(as defined in paragraph (d) of this section) in a foreign country (as defined in §
1.911-2(h)), the camp shall be considered to be part of the business premises of the
employer.
(f) Examples. The provisions of section 119 may be illustrated by the following
examples:
Example (1). A waitress who works from 7 a.m. to 4 p.m. is furnished without charge
two meals a work day. The employer encourages the waitress to have her breakfast on his
business premises before starting work, but does not require her to have breakfast there.
She is required, however, to have her lunch on such premises. Since the waitress is a food
service employee and works during the normal breakfast and lunch periods, the waitress
is permitted to exclude from her gross income both the value of the breakfast and the
value of the lunch.
Example (2). The waitress in example (1) is allowed to have meals on the employer's
premises without charge on her days off. The waitress is not permitted to exclude the
value of such meals from her gross income.
Example (3). A bank teller who works from 9 a.m. to 5 p.m. is furnished his lunch
without charge in a cafeteria which the bank maintains on its premises. The bank
furnishes the teller such meals in order to limit his lunch period to 30 minutes since the
bank's peak work load occurs during the normal lunch period. If the teller had to obtain
his lunch elsewhere, it would take him considerably longer than 30 minutes for lunch,
and the bank strictly enforces the 30-minute time limit. The bank teller may exclude from
his gross income the value of such meals obtained in the bank cafeteria.
Example (4). Assume the same facts as in example (3), except that the bank charges the
bank teller an unvarying rate per meal regardless of whether he eats in the cafeteria. The
bank teller is not required to include in gross income such flat amount charged as part of
his compensation, and he is entitled to exclude from his gross income the value of the
meals he receives for such flat charge.
Example (5). A Civil Service employee of a State is employed at an institution and is
required by his employer to be available for duty at all times. The employer furnishes the
employee with meals and lodging at the institution without charge. Under the applicable
State statute, his meals and lodging are regarded as part of the employee's compensation.
The employee would nevertheless be entitled to exclude the value of such meals and
lodging from his gross income.
Example (6). An employee of an institution is given the choice of residing at the
Federal Personal Income Tax – Fall 2009, Joondeph
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institution free of charge, or of residing elsewhere and receiving a cash allowance in
addition to his regular salary. If he elects to reside at the institution, the value to the
employee of the lodging furnished by the employer will be includible in the employee's
gross income because his residence at the institution is not required in order for him to
perform properly the duties of his employment.
Example (7). A construction worker is employed at a construction project at a remote
job site in Alaska. Due to the inaccessibility of facilities for the employees who are
working at the job site to obtain food and lodging and the prevailing weather conditions,
the employer is required to furnish meals and lodging to the employee at the camp site in
order to carry on the construction project. The employee is required to pay $40 a week
for the meals and lodging. The weekly charge of $40 is not, as such, part of the
compensation includible in the gross income of the employee, and under paragraphs (a)
and (b) of this section the value of the meals and lodging is excludable from his gross
income.
Example (8). A manufacturing company provides a cafeteria on its premises at which
its employees can purchase their lunch. There is no other eating facility located near the
company's premises, but the employee can furnish his own meal by bringing his lunch.
The amount of compensation which any employee is required to include in gross income
is not reduced by the amount charged for the meals, and the meals are not considered to
be furnished for the convenience of the employer.
Example (9). A hospital maintains a cafeteria on its premises where all of its 230
employees may obtain a meal during their working hours. No charge is made for these
meals. The hospital furnishes such meals in order to have each of 210 of the employees
available for any emergencies that may occur, and it is shown that each such employee is
at times called upon to perform services during his meal period. Although the hospital
does not require such employees to remain on the premises during meal periods, they
rarely leave the hospital during their meal period. Since the hospital furnishes meals to
each of substantially all of its employees in order to have each of them available for
emergency call during his meal period, all of the hospital employees who obtain their
meals in the hospital cafeteria may exclude from their gross income the value of such
meals.
IV.
Section 132
IRC § 132. Certain fringe benefits.
(a) Exclusion from gross income. Gross income shall not include any fringe benefit
which qualifies as a-(1) no-additional-cost service, [no discrimination allowed]
(2) qualified employee discount, [no discrimination allowed]
(3) working condition fringe,
(4) de minimis fringe,
(5) qualified transportation fringe,
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(6) qualified moving expense reimbursement,
(7) qualified retirement planning services, or
(8) qualified military base realignment and closure fringe.
(b) No-additional-cost service defined. For purposes of this section, the term "noadditional-cost service" means any service provided by an employer to an employee for
use by such employee if-(1) such service is offered for sale to customers in the ordinary course of the line of
business of the employer in which the employee is performing services, and
(2) the employer incurs no substantial additional cost (including forgone revenue) in
providing such service to the employee (determined without regard to any amount paid
by the employee for such service).
(c) Qualified employee discount defined. For purposes of this section-(1) Qualified employee discount. The term "qualified employee discount" means any
employee discount with respect to qualified property or services to the extent such
discount does not exceed-(A) in the case of property, the gross profit percentage of the price at which the
property is being offered by the employer to customers, or
(B) in the case of services, 20 percent of the price at which the services are being
offered by the employer to customers. [gross profit is irrelevant for services]
(2) Gross profit percentage.
(A) In general. The term "gross profit percentage" means the percent which-(i) the excess of the aggregate sales price of property sold by the employer to
customers over the aggregate cost of such property to the employer, is of
(ii) the aggregate sale price of such property.
(B) Determination of gross profit percentage. Gross profit percentage shall be
determined on the basis of-(i) all property offered to customers in the ordinary course of the line of business of
the employer in which the employee is performing services (or a reasonable classification
of property selected by the employer), and
(ii) the employer's experience during a representative period.
(3) Employee discount defined. The term "employee discount" means the amount by
which-(A) the price at which the property or services are provided by the employer to an
employee for use by such employee, is less than
(B) the price at which such property or services are being offered by the employer to
customers.
(4) Qualified property or services. The term "qualified property or services" means
any property (other than real property and other than personal property of a kind held
for investment) or services which are offered for sale to customers in the ordinary course
of the line of business of the employer in which the employee is performing services.
(d) Working condition fringe defined. For purposes of this section, the term "working
condition fringe" means any property or services provided to an employee of the
employer to the extent that, if the employee paid for such property or services, such
Federal Personal Income Tax – Fall 2009, Joondeph
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payment would be allowable as a deduction under section 162 or 167 [IRC Sec. 162 or
167].
(e) De minimis fringe defined. For purposes of this section-(1) In general. The term "de minimis fringe" means any property or service the value
of which is (after taking into account the frequency with which similar fringes are
provided by the employer to the employer's employees) so small as to make accounting
for it unreasonable or administratively impracticable.
(2) Treatment of certain eating facilities. The operation by an employer of any eating
facility for employees shall be treated as a de minimis fringe if-(A) such facility is located on or near the business premises of the employer, and
(B) revenue derived from such facility normally equals or exceeds the direct
operating costs of such facility.
The preceding sentence shall apply with respect to any highly compensated employee
only if access to the facility is available on substantially the same terms to each member
of a group of employees which is defined under a reasonable classification set up by the
employer which does not discriminate in favor of highly compensated employees. For
purposes of subparagraph (B), an employee entitled under section 119 [IRC Sec. 119] to
exclude the value of a meal provided at such facility shall be treated as having paid an
amount for such meal equal to the direct operating costs of the facility attributable to
such meal.
 Examples include the typing of personal letters by a company administrative

assistant, the occasional personal use of a copy machine, occasional company cocktail
parties or picnics, transportation provided for the security of the employee, occasional
entertainment tickets, coffee, donuts, and soft drinks provided employees, to name a
few.
The regulations state that meals or meal reimbursement provided to employees who
work late are excludable if three conditions are met:
o (1) they are only provided occasionally
o (2) they are provided when the employee works overtime, and
o (3) they are provided to enable the employee to work overtime. See Reg.
§1.132–6(d)(2) [EE 59, Q 21(b)
(f) Qualified transportation fringe.
(1) In general. For purposes of this section, the term "qualified transportation fringe"
means any of the following provided by an employer to an employee:
(A) Transportation in a commuter highway vehicle if such transportation is in
connection with travel between the employee's residence and place of employment.
(B) Any transit pass.
(C) Qualified parking.
(D) Any qualified bicycle commuting reimbursement. [max of $20 per qualified
bicycle commuting month.]
(2) Limitation on exclusion. The amount of the fringe benefits which are provided by
an employer to any employee and which may be excluded from gross income under
subsection (a)(5) shall not exceed-(A) [Caution: For taxable years beginning in 2009, see § 3.12 of Rev. Proc. 2008-66
(26 USCS § 1 note) for provision that the monthly limitation under this subparagraph
Federal Personal Income Tax – Fall 2009, Joondeph
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is $ 120.] $ 100 per month in the case of the aggregate of the benefits described in
subparagraphs (A) and (B) of paragraph (1),
(B) [Caution: For taxable years beginning in 2009, see § 3.12 of Rev. Proc. 2008-66
(26 USCS § 1 note) for provision that the monthly limitation under this subparagraph
is $ 230.] $ 175 per month in the case of qualified parking, and
(C) the applicable annual limitation in the case of any qualified bicycle commuting
reimbursement.
In the case of any month beginning on or after the date of the enactment of this
sentence [enacted Feb. 17, 2009] and before January 1, 2011, subparagraph (A) shall be
applied as if the dollar amount therein were the same as the dollar amount in effect for
such month under subparagraph (B).
(3) Cash reimbursements. For purposes of this subsection, the term "qualified
transportation fringe" includes a cash reimbursement by an employer to an employee for
a benefit described in paragraph (1). The preceding sentence shall apply to a cash
reimbursement for any transit pass only if a voucher or similar item which may be
exchanged only for a transit pass is not readily available for direct distribution by the
employer to the employee.
(4) No constructive receipt. No amount shall be included in the gross income of an
employee solely because the employee may choose between any qualified transportation
fringe (other than a qualified bicycle commuting reimbursement) and compensation
which would otherwise be includible in gross income of such employee.
(5) Definitions. For purposes of this subsection-(A) Transit pass. The term "transit pass" means any pass, token, farecard, voucher,
or similar item entitling a person to transportation (or transportation at a reduced price)
if such transportation is-(i) on mass transit facilities (whether or not publicly owned), or
(ii) provided by any person in the business of transporting persons for
compensation or hire if such transportation is provided in a vehicle meeting the
requirements of subparagraph (B)(i).
(B) Commuter highway vehicle. The term "commuter highway vehicle" means any
highway vehicle-(i) the seating capacity of which is at least 6 adults (not including the driver), and
(ii) at least 80 percent of the mileage use of which can reasonably be expected to
be-(I) for purposes of transporting employees in connection with travel between their
residences and their place of employment, and
(II) on trips during which the number of employees transported for such purposes
is at least 1/2 of the adult seating capacity of such vehicle (not including the driver).
(C) Qualified parking. The term "qualified parking" means parking provided to an
employee on or near the business premises of the employer or on or near a location from
which the employee commutes to work by transportation described in subparagraph (A),
in a commuter highway vehicle, or by carpool. Such term shall not include any parking
on or near property used by the employee for residential purposes.
(D) Transportation provided by employer. Transportation referred to in paragraph
(1)(A) shall be considered to be provided by an employer if such transportation is
furnished in a commuter highway vehicle operated by or for the employer.
Federal Personal Income Tax – Fall 2009, Joondeph
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(E) Employee. For purposes of this subsection, the term "employee" does not include
an individual who is an employee within the meaning of section 401(c)(1) [IRC Sec.
401(c)(1)].
(F) Definitions related to bicycle commuting reimbursement.
(i) Qualified bicycle commuting reimbursement. The term "qualified bicycle
commuting reimbursement" means, with respect to any calendar year, any employer
reimbursement during the 15-month period beginning with the first day of such calendar
year for reasonable expenses incurred by the employee during such calendar year for the
purchase of a bicycle and bicycle improvements, repair, and storage, if such bicycle is
regularly used for travel between the employee's residence and place of employment.
(ii) Applicable annual limitation. The term "applicable annual limitation" means,
with respect to any employee for any calendar year, the product of $ 20 multiplied by the
number of qualified bicycle commuting months during such year.
(iii) Qualified bicycle commuting month. The term "qualified bicycle commuting
month" means, with respect to any employee, any month during which such employee-(I) regularly uses the bicycle for a substantial portion of the travel between the
employee's residence and place of employment, and
(II) does not receive any benefit described in subparagraph (A), (B), or (C) of
paragraph (1).
(g) Qualified moving expense reimbursement. For purposes of this section, the term
"qualified moving expense reimbursement" means any amount received (directly or
indirectly) by an individual from an employer as a payment for (or a reimbursement of)
expenses which would be deductible as moving expenses under section 217 [IRC Sec.
217] if directly paid or incurred by the individual. Such term shall not include any
payment for (or reimbursement of) an expense actually deducted by the individual in a
prior taxable year.
(h) Certain individuals treated as employees for purposes of subsections (a)(1) and (2).
For purposes of paragraphs (1) and (2) of subsection (a)-(1) Retired and disabled employees and surviving spouse of employee treated as
employee. With respect to a line of business of an employer, the term "employee"
includes-(A) any individual who was formerly employed by such employer in such line of
business and who separated from service with such employer in such line of business by
reason of retirement or disability, and
(B) any widow or widower of any individual who died while employed by such
employer in such line of business or while an employee within the meaning of
subparagraph (A).
(2) Spouse and dependent children.
(A) In general. Any use by the spouse or a dependent child of the employee shall be
treated as use by the employee.
(B) Dependent child. For purposes of subparagraph (A), the term "dependent child"
means any child (as defined in section 152(f)(1) [IRC Sec. 152(f)(1)]) of the employee-(i) who is a dependent of the employee, or
(ii) both of whose parents are deceased and who has not attained age 25.
Federal Personal Income Tax – Fall 2009, Joondeph
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For purposes of the preceding sentence, any child to whom section 152(e) [IRC Sec.
152(e)] applies shall be treated as the dependent of both parents.
(3) Special rule for parents in the case of air transportation. Any use of air
transportation by a parent of an employee (determined without regard to paragraph
(1)(B)) shall be treated as use by the employee.
(i) Reciprocal agreements. For purposes of paragraph (1) of subsection (a), any service
provided by an employer to an employee of another employer shall be treated as
provided by the employer of such employee if-(1) such service is provided pursuant to a written agreement between such employers,
and
(2) neither of such employers incurs any substantial additional costs (including
foregone revenue) in providing such service or pursuant to such agreement.
(j) Special rules.
(1) Exclusions under subsection (a)(1) and (2) apply to highly compensated employees
only if no discrimination. Paragraphs (1) and (2) of subsection (a) shall apply with
respect to any fringe benefit described therein provided with respect to any highly
compensated employee only if such fringe benefit is available on substantially the same
terms to each member of a group of employees which is defined under a reasonable
classification set up by the employer which does not discriminate in favor of highly
compensated employees.
(ii) there are substantial restrictions on the personal use of such automobile by such
salesman.
(4) On-premises gyms and other athletic facilities.
(A) In general. Gross income shall not include the value of any on-premises athletic
facility provided by an employer to his employees.
(B) On-premises athletic facility. For purposes of this paragraph, the term "onpremises athletic facility" means any gym or other athletic facility-(i) which is located on the premises of the employer,
(ii) which is operated by the employer, and
(iii) substantially all the use of which is by employees of the employer, their
spouses, and their dependent children (within the meaning of subsection (h)).
V.
Other fringe benefits
Tax Treatment of Insurance for Medical Care [CB 119]
Premiums
Employer-Provided Coverage
Excluded, § 106
Individually Purchased Insurance
Limited Deduction, §
213(d)(1)(D)
Self-insurance
N/A
Proceeds
Excluded § 105(b)
Excluded § 104(a)(3)
Limited Deduction, §
213(a)
§ 106. Contributions by employer to accident and health plans.
Federal Personal Income Tax – Fall 2009, Joondeph
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(a) General rule. Except as otherwise provided in this section, gross income of an
employee does not include employer-provided coverage under an accident or health plan.
§ 125. Cafeteria plans.
(a) In General. Except as provided in subsection (b), no amount shall be included in the
gross income of a participant in a cafeteria plan solely because, under the plan, the
participant may choose among the benefits of the plan.
(d) Cafeteria plan defined. For purposes of this section
(1) In general. The term "cafeteria plan" means a written plan under which-(A) all participants are employees, and
(B) the participants may choose among 2 or more benefits consisting of cash and
qualified benefits.
(f) Qualified benefits defined. For purposes of this section, the term "qualified benefit"
means any benefit which, with the application of subsection (a), is not includible in the
gross income of the employee by reason of an express provision of this chapter [IRC
Sections 1 et seq.] (other than section 106(b), 117, 127, or 132 [IRC Sec. 106(b), 117,
127, or 132]). Such term includes any group term life insurance which is includible in
gross income only because it exceeds the dollar limitation of section 79 [IRC Sec. 79]
and such term includes any other benefit permitted under regulations. Such term shall
not include any product which is advertised, marketed, or offered as long-term care
insurance.
Flexible Spending Arrangements [CB 122 Note 5]
§ 125 authorizes an employer-created programs known as flexible spending
arrangements, which can be used to pay or reimburse otherwise uninsured employee outof-pocket medical care expenses.
 Incurred during a 12-month coverage period, with grace period of 2 months 15
days after close of plan period
 For medical services and eligible drug store purchases
 Use it or lose it
 Reimbursed at the time of the expense, regardless of the amount contributed to the
plan as of that date (usually through salary reduction).
 Election to contribute made in advance of coverage year. Irrevocable.
 Contributions are characterized as employer-provided health care coverage for tax
purposes.
 Payments from the account are viewed as proceeds of employer-provided medical
care insurance.
§ 129. Dependent care assistance programs.
(a) Exclusion.
Federal Personal Income Tax – Fall 2009, Joondeph
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(1) In general. Gross income of an employee does not include amounts paid or
incurred by the employer for dependent care assistance provided to such employee if the
assistance is furnished pursuant to a program which is described in subsection (d).
(2) Limitation of exclusion.
(A) In general. The amount which may be excluded under paragraph (1) for
dependent care assistance with respect to dependent care services provided during a
taxable year shall not exceed $ 5,000 ($ 2,500 in the case of a separate return by a
married individual).
(B) Year of inclusion. The amount of any excess under subparagraph (A) shall be
included in gross income in the taxable year in which the dependent care services were
provided (even if payment of dependent care assistance for such services occurs in a
subsequent taxable year).
(C) Marital status. For purposes of this paragraph, marital status shall be
determined under the rules of paragraphs (3) and (4) of section 21(e).
(b) Earned income limitation.
(1) In general. The amount excluded from the income of an employee under subsection
(a) for any taxable year shall not exceed-(A) in the case of an employee who is not married at the close of such taxable year,
the earned income of such employee for such taxable year, or
(B) in the case of an employee who is married at the close of such taxable year, the
lesser of-(i) the earned income of such employee for such taxable year, or
(ii) the earned income of the spouse of such employee for such taxable year.
(2) Special rule for certain spouses. For purposes of paragraph (1), the provisions of
section 21(d)(2) [IRC Sec. 21(d)(2)] shall apply in determining the earned income of a
spouse who is a student or incapable of caring for himself.
§ 79. Group-term life insurance purchased for employees.
(a) General rule. There shall be included in the gross income of an employee for the
taxable year an amount equal to the cost of group-term life insurance on his life provided
for part or all of such year under a policy (or policies) carried directly or indirectly by
his employer (or employers); but only to the extent that such cost exceeds the sum of-(1) the cost of $ 50,000 of such insurance, and
(2) the amount (if any) paid by the employee toward the purchase of such insurance.
VI.
Barter exchanges
Revenue Ruling 79-24
Gross income; barter transactions. Certain members of barter clubs must include in
income the fair market value of services received in exchange for services rendered.
Likewise, the owner of an apartment building who receives a work of art created by a
professional artist in return for the rent-free use of an apartment must include in income
the fair market value of the work of art, and the artist must include the fair rental value of
Federal Personal Income Tax – Fall 2009, Joondeph
Page 18
the apartment.
VII.
Windfalls
a. Commissioner v. Glenshaw Glass Co. (p. 90)
Involves two cases that have been consolidated - Glenshaw and William Goldman
Theaters. Both are Ps that had initiated anti-trust suits and won.
Glenshaw won a settlement : $800K, made up of $325K punitive + $475K
compensatory.
William Goldman Theaters: $125K economic damages + $250K punitives
In both cases, Ps reported the compensatory portions of recovery, but not the
punitives. They recognized that the compensatory damages replaced lost profits.
Replacement Rule: what does recovery replace? What would have been the tax
treatment of the item that is being replaced? This will be the tax rate.
 Compensatory damages: make whole, compensate
 Punitive damages: Punish D and deter others. Considered a windfall to P
because they just happen to be the beneficiary here, but this amount is not
compensation for anything.
Issue: do punitive damages have to be included in income? Trial courts said no, but
the USSCT says it is income.
Rule: definition of income on p. 92: "Here we have instances of undeniable
accessions to wealth, clearly realized, and over which the taxpayers have
complete dominion." [EE 37]
b. Different sorts of damages
c. Treatment of punitive
d. Windfalls more generally
§ 85. Unemployment compensation.
(a) General rule. In the case of an individual, gross income includes unemployment
compensation.
(b) Unemployment compensation defined. For purposes of this section, the term
"unemployment compensation" means any amount received under a law of the United
States or of a State which is in the nature of unemployment compensation.
(c) Special rule for 2009. In the case of any taxable year beginning in 2009, gross
income shall not include so much of the unemployment compensation received by an
individual as does not exceed $ 2,400.
VIII.
Gifts
a. Alternatives
b. Justifications for §102
c. Duberstein
Federal Personal Income Tax – Fall 2009, Joondeph
Page 19
i. Background
ii. Legal standard
iii. Application
d. Employees
e. Section 274(b)
Transactions have Donor and Recipient
Hypo: A gives B $100. Under the "accession to wealth" definition, it would be
includable income of $100 and a deduction for donor of $100. Under § 102(a), gifts are
not included in income, which also means no deduction for the donor.

Why are gifts excluded from income?
Administrability would be a nightmare to track the gifts and to value them.
Enforcement would also be difficult. Also think about progressivity, where the IRC is a
progressive code, and wants to prevent a significant evasion of progressivity, where
people could shift income from higher tax payers to lower tax payers through gifts.
Because gifts are treated differently than income, we need a rule to define them. See
Duberstein
Commissioner v. Duberstein (and Stanton (p. 179))
Berman (President of Mohawk Metal Corporation) gives Duberstein a Cadillac as a
"thank you" for giving him some business leads.
Stanton gets $20K from the Trinity Church as a "gratuity" for his years of service to the
church.
Rule: Justice Brennan defines a gift (p. 182): "A gift in the statutory sense, proceeds
from a detached and disinterested generosity, out of affection, respect, admiration,
charity, or the like impulse." Look at transferor’s intent. This is a much narrower
conception of income than the common law definition, which treats as a gift anything that
is not given out of "legal or moral obligation." Trier of fact must weigh all of the factors.
Was the Cadillac a gift? Factual question to be reviewed on a "clearly erroneous"
standard of review. = No, not a gift. USSCT upheld the lower court's finding of fact that
the car was payment for services rendered.
Stanton is a little more complicated because the trial court determined it was a gift, but
provided no factual background. On remand, trial court determines it was an unselfish
gift.
Statutory Framework to add on:
§ 102(c) Employee gifts. Per se, there are so gifts from employers to employees. If
Stanton were tried today, it would probably not be a gift because of this provision.
§ 274(b): provides a limited deduction for limited business-related gifts of up to $25 per
person/yr.
Federal Personal Income Tax – Fall 2009, Joondeph
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§ 102. Gifts and inheritances.
(a) General rule. Gross income does not include the value of property acquired by gift,
bequest, devise, or inheritance.
(b) Income. Subsection (a) shall not exclude from gross income-(1) the income from any property referred to in subsection (a); or
(2) where the gift, bequest, devise, or inheritance is of income from property, the
amount of such income.
Where, under the terms of the gift, bequest, devise, or inheritance, the payment, crediting,
or distribution thereof is to be made at intervals, then, to the extent that it is paid or
credited or to be distributed out of income from property, it shall be treated for purposes
of paragraph (2) as a gift, bequest, devise, or inheritance of income from property. Any
amount included in the gross income of a beneficiary under subchapter J [IRC Sections
641 et seq.] shall be treated for purposes of paragraph (2) as a gift, bequest, devise, or
inheritance of income from property.
(c) Employee gifts.
(1) In general. Subsection (a) shall not exclude from gross income any amount
transferred by or for an employer to, or for the benefit of, an employee.
(2) Cross references. For provisions excluding certain employee achievement awards
from gross income, see section 74(c) [IRC Sec. 74(c)].
For provisions excluding certain de minimis fringes from gross income, see section
132(e) [IRC Sec. 132(e)].
§ 274. Disallowance of certain entertainment, etc., expenses.
(b) Gifts.
(1) Limitation. No deduction shall be allowed under section 162 or section 212 [IRC
Sec. 162 or 212] for any expense for gifts made directly or indirectly to any individual to
the extent that such expense, when added to prior expenses of the taxpayer for gifts made
to such individual during the same taxable year, exceeds $ 25. For purposes of this
section, the term "gift" means any item excludable from gross income of the recipient
under section 102 [IRC Sec. 102] which is not excludable from his gross income under
any other provision of this chapter [IRC Sections 1 et seq.], but such term does not
include-(A) an item having a cost to the taxpayer not in excess of $ 4.00 on which the name of
the taxpayer is clearly and permanently imprinted and which is one of a number of
identical items distributed generally by the taxpayer, or
(B) a sign, display rack, or other promotional material to be used on the business
premises of the recipient.
(2) Special rules.
(A) In the case of a gift by a partnership, the limitation contained in paragraph (1)
shall apply to the partnership as well as to each member thereof.
Federal Personal Income Tax – Fall 2009, Joondeph
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(B) For purposes of paragraph (1), a husband and wife shall be treated as one
taxpayer.
IX.
Transfers of unrealized gain and loss
a.
b.
c.
d.
Basis and cost recovery
Taft v. Bowers
Surrogate taxation
Current statutory framework
i. §1001
ii. §1011
iii. §1012
iv. §1015
v. §1014
e. Handout 3
Taft v. Bowers (p. 165)
Issue: When we have a gift of property, what is the basis in the property that was
received? Whether § 1015 is unconstitutional because it would require a person to report
income that wasn't all gained during the time they held the asset.
A buys shares for $1,000
A gives shares to B when FMV = $2,000. No tax consequence here, b/c = gift.
B sells shares for $5K. What is tax consequence here?
§ 1015 carry-over basis. Presumptively, recipient assumes basis of donor.
Amount realized: $5K.
Basis (carried over from A): $1,000
Gain = difference of $4K




Current Statutory Framework
§ 1001:
Gain = amount realized - adjusted basis
Loss = adjusted basis - amount realized
Amount realized = FMV of everything received in the transaction ($ + property)
§ 1011 & § 1012:
Basis: a measure of the TP's investment in the proprty in already taxed dollars.
o
Original basis = original costs
§ 1015: Threshold question: was FMV less than donor's basis at time of transfer?
Gain
Basis
FMV (at time of gift) > donor's
basis
Loss Basis
Carry-over Carry-over
Federal Personal Income Tax – Fall 2009, Joondeph
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FMV(at time of gift) < donor's
basis
Carry-over FMV @ time of
gift
Exception requiring use of FMV where property is valued below basis at the time of
gift prevents gifting of losses to shift deductions to people in a higher tax bracket.
Note: this results in a gain basis and a loss basis.
§ 1014: Gift at death: basis = FMV at time of decedent's death (stepped-up basis)
This is the 4th or 5th biggest tax subsidy in the IRC.
Comment: this also wipes out any unrealized losses, so if a person knows they are going
to die soon, they should sell any property that has declined in value to be able to
recognize the losses.
Note: estate and gift tax is phased out in 2010, but then everything goes back to its 2001
state in 2011. Part of this bill is that § 1014 gets replaced by § 1022, which is a modified
version of § 1015 that imposes a stepped-up basis for property transferred at death.
However, it is very likely that the law will be modified before it takes effect in 2011 and
§ 1022 will probably never go into effect.
All of the problems on Handout 3 are when the gift/property is given in its entirety.
What do we do when the property is split, say between the underlying property and
the income from the property? How do we allocate basis between those two
recipients? See Irwin v. Gavit.
§ 1001. Determination of amount of and recognition of gain or loss.
(a) Computation of gain or loss. The gain from the sale or other disposition of property
shall be the excess of the amount realized therefrom over the adjusted basis provided in
section 1011 [IRC Sec. 1011] for determining gain, and the loss shall be the excess of the
adjusted basis provided in such section for determining loss over the amount realized.
(b) Amount realized. The amount realized from the sale or other disposition of property
shall be the sum of any money received plus the fair market value of the property (other
than money) received. In determining the amount realized-(1) there shall not be taken into account any amount received as reimbursement for real
property taxes which are treated under section 164(d) [IRC Sec. 164(d)] as imposed on
the purchaser, and
(2) there shall be taken into account amounts representing real property taxes which are
treated under section 164(d) [IRC Sec. 164(d)] as imposed on the taxpayer if such taxes
are to be paid by the purchaser.
(c) Recognition of gain or loss. Except as otherwise provided in this subtitle [IRC
Sections 1 et seq.], the entire amount of the gain or loss, determined under this section, on
the sale or exchange of property shall be recognized.
§ 1011. Adjusted basis for determining gain or loss.
Federal Personal Income Tax – Fall 2009, Joondeph
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(a) General rule. The adjusted basis for determining the gain or loss from the sale or
other disposition of property, whenever acquired, shall be the basis (determined under
section 1012 [IRC Sec. 1012] or other applicable sections of this subchapter [IRC
Sections 1001 et seq.] and subchapters C [IRC Sections 301 et seq.] (relating to corporate
distributions and adjustments), K [IRC Sections 701 et seq.] (relating to partners and
partnerships), and P [IRC Sections 1201 et seq.] (relating to capital gains and losses)),
adjusted as provided in section 1016 [IRC Sec. 1016].
§ 1012. Basis of property--cost.
(a) In general. The basis of property shall be the cost of such property, except as
otherwise provided in this subchapter [IRC Sections 1001 et seq.] and subchapters C [IRC
Sections 301 et seq.] (relating to corporate distributions and adjustments), K [IRC
Sections 701 et seq.] (relating to partners and partnerships), and P [IRC Sections 1201 et
seq.] (relating to capital gains and losses).
(b) Special rule for apportioned real estate taxes. The cost of real property shall not
include any amount in respect of real property taxes which are treated under section
164(d) [IRC Sec. 164(d)] as imposed on the taxpayer.
(c) Determinations by account [Caution: This subsection takes effect on January 1, 2011,
as provided by § 403(e)(1) of Act Oct. 3, 2008, P.L. 110-343, which appears as a note to
this section.].
(1) In general. In the case of the sale, exchange, or other disposition of a specified
security on or after the applicable date, the conventions prescribed by regulations under
this section shall be applied on an account by account basis.
(2) Application to certain funds.
(A) In general. Except as provided in subparagraph (B), any stock for which an
average basis method is permissible under section 1012 [this section] which is acquired
before January 1, 2012, shall be treated as a separate account from any such stock
acquired on or after such date.
(B) Election fund for treatment as single account. If a fund described in subparagraph
(A) elects to have this subparagraph apply with respect to one or more of its
stockholders-(i) subparagraph (A) shall not apply with respect to any stock in such fund held by
such stockholders, and
(ii) all stock in such fund which is held by such stockholders shall be treated as
covered securities described in section 6045(g)(3) [IRC Sec. 6045(g)(3)] without regard
to the date of the acquisition of such stock.
A rule similar to the rule of the preceding sentence shall apply with respect to a
broker holding such stock as a nominee.
(3) Definitions. For purposes of this section, the terms "specified security" and
"applicable date" shall have the meaning given such terms in section 6045(g).
Federal Personal Income Tax – Fall 2009, Joondeph
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(d) Average basis for stock acquired pursuant to a dividend reinvestment plan [Caution:
This subsection takes effect on January 1, 2011, as provided by § 403(e)(1) of Act Oct. 3,
2008, P.L. 110-343, which appears as a note to this section.].
(1) In general. In the case of any stock acquired after December 31, 2010, in
connection with a dividend reinvestment plan, the basis of such stock while held as part
of such plan shall be determined using one of the methods which may be used for
determining the basis of stock in an open-end fund.
(2) Treatment after transfer. In the case of the transfer to another account of stock to
which paragraph (1) applies, such stock shall have a cost basis in such other account
equal to its basis in the dividend reinvestment plan immediately before such transfer
(properly adjusted for any fees or other charges taken into account in connection with
such transfer).
(3) Separate accounts; election for treatment as single account. Rules similar to the
rules of subsection (c)(2) shall apply for purposes of this subsection.
(4) Dividend reinvestment plan. For purposes of this subsection-(A) In general. The term "dividend reinvestment plan" means any arrangement under
which dividends on any stock are reinvested in stock identical to the stock with respect to
which the dividends are paid.
(B) Initial stock acquisition treated as acquired in connection with plan. Stock shall be
treated as acquired in connection with a dividend reinvestment plan if such stock is
acquired pursuant to such plan or if the dividends paid on such stock are subject to such
plan.
§ 1014. Basis of property acquired from a decedent.
(a) In general. Except as otherwise provided in this section, the basis of property in the
hands of a person acquiring the property from a decedent or to whom the property passed
from a decedent shall, if not sold, exchanged, or otherwise disposed of before the
decedent's death by such person, be-(1) the fair market value of the property at the date of the decedent's death,
(2) in the case of an election under either section 2032 or section 811(j) of the Internal
Revenue Code of 1939 where the decedent died after October 21, 1942, its value at the
applicable valuation date prescribed by those sections,
(3) in the case of an election under section 2032A [IRC Sec. 2032A], its value
determined under such section, or
(4) to the extent of the applicability of the exclusion described in section 2031(c) [IRC
Sec. 2031(c)], the basis in the hands of the decedent.
(b) Property acquired from the decedent. For purposes of subsection (a), the following
property shall be considered to have been acquired from or to have passed from the
decedent:
(1) Property acquired by bequest, devise, or inheritance, or by the decedent's estate
from the decedent;
(2) Property transferred by the decedent during his lifetime in trust to pay the income
for life to or on the order or direction of the decedent, with the right reserved to the
decedent at all times before his death to revoke the trust;
Federal Personal Income Tax – Fall 2009, Joondeph
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(3) In the case of decedents dying after December 31, 1951, property transferred by the
decedent during his lifetime in trust to pay the income for life to or on the order or
direction of the decedent with the right reserved to the decedent at all times before his
death to make any change in the enjoyment thereof through the exercise of a power to
alter, amend, or terminate the trust;
(4) Property passing without full and adequate consideration under a general power of
appointment exercised by the decedent by will;




Referred to as stepped-up basis [CB 169]
Converts the deferral inherent in the realization requirement into outright tax
forgiveness.
Encourages people to hold on to their appreciated property until death.
Avoids forced liquidation of property in order to pay tax at time of transfer
§ 1015. Basis of property acquired by gifts and transfers in trust.
(a) Gifts after December 31, 1920. If the property was acquired by gift after December
31, 1920, the basis shall be the same as it would be in the hands of the donor or the last
preceding owner by whom it was not acquired by gift, except that if such basis (adjusted
for the period before the date of the gift as provided in section 1016 [IRC Sec. 1016]) is
greater than the fair market value of the property at the time of the gift, then for the
purpose of determining loss the basis shall be such fair market value. If the facts
necessary to determine the basis in the hands of the donor or the last preceding owner are
unknown to the donee, the Secretary shall, if possible, obtain such facts from such donor
or last preceding owner, or any other person cognizant thereof. If the Secretary finds it
impossible to obtain such facts, the basis in the hands of such donor or last preceding
owner shall be the fair market value of such property as found by the Secretary as of the
date or approximate date at which, according to the best information that the Secretary is
able to obtain, such property was acquired by such donor or last preceding owner.
X.
Gifts of divided interests in property
a. Introduction
b. Irwin v. Gavit
c. Justifications
d. Handout 4
Irwin v. Gavit (p. 157) continued on 9/9/09
Holding now codified in § 102(b)(2)

Can be analogized by the hypo:
o Trust distributes:
 income for the next 15 years to son-in-law (Palmer) and
 property to granddaughter in 15 years when she turns 21 (Marcia)
Discussion: if the gift were given outright to Marcia, she would pay tax on the income
generated from the property, so the court says Congress couldn't possibly have intended
Federal Personal Income Tax – Fall 2009, Joondeph
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the statute to allow the income from the property to be tax exempt merely because the gift
is split between income and principal.
What does this mean for basis?
Because the property is transferred to her at the death of the transferor, she receives it at
the stepped-up basis (assume = $100K). So, when Marcia sells for $125K, she gets to
exclude $100K from her income.
o None of the basis goes with the person who receives the income stream from the
property. It all goes with the person who gets the property.
How basis is allocated has nothing to do with the value of the respective interests. It is
more administrable to just have the entire basis go to the person receiving the property.
DISCUSSION OF HANDOUT 4
XI.
Capital gains
a.
b.
c.
d.
e.
A form of income
Not a separate tax
Definition
A preference
Capital losses
Merely another form of income, like wages, compensation, dividends, interest, windfalls,
etc.
o Principal rules: [CB 24]
o Unrealized appreciation is not taxed
o Income may be realized from an item of appreciated property by sale, by
exchange for other property, or in a variety of other ways.
o Even if income is realized, there may be statutory provisions providing
that it will not be recognized. Recognition may be postponed or
eliminated.
o Recognized gain may be classified as long-term capital gain if it arises
from the sale or exchange of a capital asset held for more than one year.
o Gain on the sale or other disposition of any property is the amount realized
on the disposition, less the TP’s adjusted basis. [CB 26]
o Basis is usually cost, but there are exceptions.
o Capital losses are subtracted from capital gains before applying any of the
special capital gain rate provisions. If capital losses exceed capital gains,
deductibility of the excess losses is generally limited to $3,000 per year. §
1211 [CB 1056]
 Disallowed losses carry over to future years. § 1212. [CB 1057]
o Short-term capital gains [CB 1057 § 1222]: net against short-term capital
losses. Don’t get preferential rate treatment like long-term capital gains.
 First step: ST gains are offset against ST losses and LT gains are
offset against LT losses.
 If there is an excess of losses in either category (ST or LT), these
are offset against one another as the last step.
Federal Personal Income Tax – Fall 2009, Joondeph
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 Capital loss limitation draws no distinction between ST and LT
losses.
Capital Gains (§ 1221): gain on the disposition of a capital asset.
Capital Asset: (generally) all property other than inventory.
Capital Loss: only deductible to the extend of capital gains in the same year + $3,000
(any remainder carries over)
Preferential Treatment: Currently, highest marginal rate for ordinary income is 35%.
Highest marginal rate for long-term capital gains is 15%. Long-term generally means
property held for at least one year.
XII.
The recovery of capital: the concept of basis
a. The timing of cost recovery
b. Inaja Land Co. v. Commissioner
i. Background
ii. Competing arguments
iii. How much recovery?
iv. Current rule
c. Adjustments to basis
Inaja Land Company, Ltd., v. Commissioner of IRS (1947)
Inaja owns land along the Owens river, which gets polluted when the City of Los Angeles
builds an aqueduct upstream. Inaja paid $61K for the property. Recovered $49K ($50K
less $1000 spent on attorney) from L.A. in settlement for the overflow onto his property
from the city.
o IRS contends that the $49K is lost profits based on the recovery theory, which
would make the entire recovery taxable at ordinary income rates.
o Inaja contends that the $49K is payment for an easement (sale of a portion of the
property). Tax consequences flowing from this: he would have to report income
from the sale, but he gets to exclude the amount of his basis and he will be taxed
on his gain at a capital gains rate.
Initial fight is about the $$ being recovery of lost profits as income (Commissioner's
view) or recovery for a sale or damage to underlying property (TP's view). TP's view
allows him to allocate basis.
Held: Court buys TP's arg that the payment was for damage to the property itself, not
income from the property.
Orig. Cost: $61K. So, how much is treated as recovery of capital? If exactly half the
property were affected, it would be easy to allocate basis from half of the original cost.
Issue here is that it is difficult to describe the property interest conveyed and how it
affects the land. Here, it is not possible for Inaja to determine the percentage of his
property that has been allocated to the City of Los Angeles.
Federal Personal Income Tax – Fall 2009, Joondeph
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General Rule: § 1.61-6 where a TP sells a portion of his property, he must allocate his
basis ratably among the parts.
 Rule for speculative allocation: A taxpayer should not be charged with gain on
pure conjecture unsupported by any foundation of ascertainable fact.
Applied/Holding: Since Inaja cannot determine the portion of the property conveyed by
the easement, the Court allows the entire payment he received ($49K) to be considered
return of basis.
Prof: this almost never applies because it is usually possible to allocate basis.
SUPPOSE INAJA SELLS THE PROPERTY LATER . . .
Amount realized: $70K
Basis: $61K - $49K = $12K
Gain: $70K - 12K basis = $58K
COUNTER FACTUAL
If Inaja had lost and reported the $49K as income, when he sells for $70K, his basis is
still $61K and gain is $9K. Total reported income is still $58K.
XIII.
Annuities
a. Alternative timing rules
b. Section 72
c. Handout 5
Annuity [CB 305]: a simple annuity contract is one under which an issuer, usually a life
insurance company, promises to make periodic payments for the life of an annuitant.
Annuity payments are income to the recipient to the extent they represent some gain over
what was paid for the K.
(p. 291 - 294)
Annuitant pays $3,790 for an annuity that pays $1,000 per year for 5 years, which is an
annual rate of return of 10%.
Proposals for timing of income:
YR 1
YR 2
YR 3
YR 4
YR 5
0
0
0
basis is down to $790, so
income is $210
$1000
Income as Earned: Every 379
payment makes up a
different proportion of
interest and principle.
317
249
174
91
242
242
242
242
242
Inaja application (not
the rule)
§ 72: Income = pmt less
amount excluded ($758)
under excl. ratio:
(3790/5000 = 75.8%)
Federal Personal Income Tax – Fall 2009, Joondeph
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Exclusion Ratio: investment/expected return.
Note: that § 72 is a preferential tax treatment because it allows you to defer some of the
tax on the gain you have earned on the policy into the future.
SEE HANDOUT #5
§ 72. Annuities; certain proceeds of endowment and life insurance contracts.
(a) General rule for annuities. Except as otherwise provided in this chapter [IRC Sections
1 et seq.], gross income includes any amount received as an annuity (whether for a period
certain or during one or more lives) under an annuity, endowment, or life insurance
contract.
(b) Exclusion ratio.
(1) In general. Gross income does not include that part of any amount received as an
annuity under an annuity, endowment, or life insurance contract which bears the same
ratio to such amount as the investment in the contract (as of the annuity starting date)
bears to the expected return under the contract (as of such date).
(2) Exclusion limited to investment. The portion of any amount received as an annuity
which is excluded from gross income under paragraph (1) shall not exceed the
unrecovered investment in the contract immediately before the receipt of such amount.
(3) Deduction where annuity payments cease before entire investment recovered.
(A) In general. If-(i) after the annuity starting date, payments as an annuity under the contract cease
by reason of the death of an annuitant, and
(ii) as of the date of such cessation, there is unrecovered investment in the contract,
the amount of such unrecovered investment (in excess of any amount specified in
subsection (e)(5) which was not included in gross income) shall be allowed as a
deduction to the annuitant for his last taxable year.
(c) Definitions.
(1) Investment in the contract. For purposes of subsection (b), the investment in the
contract as of the annuity starting date is-(A) the aggregate amount of premiums or other consideration paid for the contract,
minus
(B) the aggregate amount received under the contract before such date, to the extent
that such amount was excludable from gross income under this subtitle [IRC Sections 1 et
seq.] or prior income tax laws.
(3) Expected return. For purposes of subsection (b), the expected return under the
contract shall be determined as follows:
(A) Life expectancy. If the expected return under the contract, for the period on and
after the annuity starting date, depends in whole or in part on the life expectancy of one
or more individuals, the expected return shall be computed with reference to actuarial
tables prescribed by the Secretary.
Federal Personal Income Tax – Fall 2009, Joondeph
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(B) Installment payments. If subparagraph (A) does not apply, the expected return is
the aggregate of the amounts receivable under the contract as an annuity.
(4) Annuity starting date. For purposes of this section, the annuity starting date in the
case of any contract is the first day of the first period for which an amount is received as
an annuity under the contract; except that if such date was before January 1, 1954, then
the annuity starting date is January 1, 1954.
CFR § 1.61-6 Gains derived from dealings in property.
(a) In general. Gain realized on the sale or exchange of property is included in gross
income, unless excluded by law. For this purpose property includes tangible items, such
as a building, and intangible items, such as goodwill. Generally, the gain is the excess of
the amount realized over the unrecovered cost or other basis for the property sold or
exchanged. The specific rules for computing the amount of gain or loss are contained in
section 1001 and the regulations thereunder. When a part of a larger property is sold, the
cost or other basis of the entire property shall be equitably apportioned among the several
parts, and the gain realized or loss sustained on the part of the entire property sold is the
difference between the selling price and the cost or other basis allocated to such part. The
sale of each part is treated as a separate transaction and gain or loss shall be computed
separately on each part. Thus, gain or loss shall be determined at the time of sale of each
part and not deferred until the entire property has been disposed of. This rule may be
illustrated by the following examples:
Example (1). A, a dealer in real estate, acquires a 10-acre tract for $10,000, which he
divides into 20 lots. The $10,000 cost must be equitably apportioned among the lots so
that on the sale of each A can determine his taxable gain or deductible loss.
Example (2). B purchases for $25,000 property consisting of a used car lot and
adjoining filling station. At the time, the fair market value of the filling station is $15,000
and the fair market value of the used car lot is $10,000. Five years later B sells the filling
station for $20,000 at a time when $2,000 has been properly allowed as depreciation
thereon. B's gain on this sale is $7,000, since $7,000 is the amount by which the selling
price of the filling station exceeds the portion of the cost equitably allocable to the filling
station at the time of purchase reduced by the depreciation properly allowed.
XIV.
Recovery of loss
a. Clark v. Commissioner
i. Background
ii. Old Colony revisited
iii. Analysis
b. Handout 6
Edward H. Clark [CB 82]
Illustrates annual accounting principal.
1932: Clark and his wife file a joint return on the advice of tax counsel.
Federal Personal Income Tax – Fall 2009, Joondeph
Page 31
IRS contacts Clark about a shortfall of $34,590.27, of which, $19,941.10 was avoidable if
they had filed separate returns.
1934: Tax counsel pays Clarks $19,941.10 as compensation for the mistake. IRS says
they have to claim this as income.
Issue: does this payment constitute income?
IRS cites Old Colony and says that the payment is a situation where a third party paid the
tax liabiltiy for the Clarks.
Prof: in Old Colony the payment of taxes was part of the compensation package. Here,
not so. If Clarks hadn't had to pay the $19K to the IRS, these are after tax dollars that
they would have been able to enjoy. The payment just restores this loss.
Point: the restoration of a loss is not thought of as a restoration of wealth.
 Damages for personal injury are likewise not income [CB 85]
Does Clark create horizontal equity? He would be equal with a taxpayer that received
good tax advice and didn't overpay his taxes, but unequal to the person who got bad tax
advice and received no recovery from the negligent advisor.
 No real answer. There is inequity with one group or the other.
Discussion of Handout 6
Amending tax returns:
 Statute of limitations is generally 3 years
 Amend when the filing was in error. The TP discovers a mistake on the return
that has already been filed, and that was plainly a mistake at the time she filed her
return based on the facts that existed at the time of the filing.
 There was no error at the time of filing: Account for the occurrence of something
that makes the filing erroneous in retrospect in the year of such occurrence.
RECOVERY OF LOSSES
Two steps to the inquiry:
1. Is the recovery income under § 61? (Raytheon)
2. If yes, is it nonetheless excludable? (such as by § 104(a))
§ 165. Losses.
(a) General rule. There shall be allowed as a deduction any loss sustained during the
taxable year and not compensated for by insurance or otherwise.
(b) Amount of deduction. For purposes of subsection (a), the basis for determining the
amount of the deduction for any loss shall be the adjusted basis provided in section 1011
[IRC Sec. 1011] for determining the loss from the sale or other disposition of property.
(c) Limitation on losses of individuals. In the case of an individual, the deduction under
subsection (a) shall be limited to
Federal Personal Income Tax – Fall 2009, Joondeph
Page 32
(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered into for profit, though not connected with
a trade or business; and
(3) except as provided in subsection (h), losses of property not connected with a trade
or business or a transaction entered into for profit, if such losses arise from fire, storm,
shipwreck, or other casualty, or from theft.
XV.
Recovery of damages for personal and business injuries
a. Overview
b. Raytheon
i. Recoveries for lost profits
ii. Recoveries for damage to goodwill
iii. Court’s holding
c. Section 104
d. Handout 7
e. Other recoveries
Raytheon Production Corp. v. Commissioner (p. 86)
Raytheon manufactures tubes very profitably. RCA makes radios and has patents that
allow it to control the market. RCA decides to make tubes and requires everyone who
has a license from it to manufacture radios to buy its tubes, leading to a monopoly that
drives Raytheon out of business. Raytheon becomes a licensee of RCA and waives its
counter-claims. Later finds out that RCA has settled other anit-trust actions, dissolving
Raytheon's waiver and Raytheon brings an anti-trust suit.
Raytheon gets a $410K settlement. Says $60K is profits and $350K is recovery for injury
and not includable in income. Court addresses whether this is correct or if it is income.
Replacement Rule [CB 88-89]: the test is not whether the tort was one in tort or K, but
the question is "In lieu of what were the damages awarded?"
 If the $350K were recovery of lost profits, it would be income.
Court says the $350K is recovery for injury to goodwill (reputation). So is this taxable?
Rule: "Although the injured party may not be deriving a profit as a result of the damage
suit itself, the conversion thereby of his property into cash is realization of any gain made
over the cost or other basis of the good will prior to the illegal interference." Thus,
compensation for the loss of Raytheon's good will in excess of its cost is gross income.
Holding/Application: amount realized ($350K) - basis ($0) = gain ($350K income)
Why is goodwill basis $0? Self-generated good will that wasn't paid for, just earned from
doing business, often don't create basis.
§ 104(a): creates an exclusion for items that would otherwise be includable in income.
Excludes:
 (1) Workmen's comp recoveries
Federal Personal Income Tax – Fall 2009, Joondeph
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

(2) damages (not punitive) received on account of personal physical injury or
physical sickness. Look at triggering event.
[CB 98-99] under the reaonsing in Burke, damages for sex discrimination and
racial discrimination under Title VII and damages under the Americans with
Disabilities Act would all be exempt under § 104(a)(2). But not age
discrimination.
§ 104. Compensation for injuries or sickness.
(a) In general. Except in the case of amounts attributable to (and not in excess of)
deductions allowed under section 213 [IRC Sec. 213] (relating to medical, etc., expenses)
for any prior taxable year, gross income does not include-(1) amounts received under workmen's compensation acts as compensation for personal
injuries or sickness;
(2) the amount of any damages (other than punitive damages) received (whether by suit
or agreement and whether as lump sums or as periodic payments) on account of personal
physical injuries or physical sickness;
(3) amounts received through accident or health insurance (or through an arrangement
having the effect of accident or health insurance) for personal injuries or sickness (other
than amounts received by an employee, to the extent such amounts (A) are attributable to
contributions by the employer which were not includible in the gross income of the
employee, or (B) are paid by the employer);
(4) amounts received as a pension, annuity, or similar allowance for personal injuries or
sickness resulting from active service in the armed forces of any country or in the Coast
and Geodetic Survey or the Public Health Service, or as a disability annuity payable
under the provisions of section 808 of the Foreign Service Act of 1980 [22 USCS §
4048]; and
(5) amounts received by an individual as disability income attributable to injuries
incurred as a direct result of a terroristic or military action (as defined in section
692(c)(2) [IRC Sec. 692(c)(2)]).
For purposes of paragraph (3), in the case of an individual who is, or has been, an
employee within the meaning of section 401(c)(1) [IRC Sec. 401(c)(1)] (relating to selfemployed individuals), contributions made on behalf of such individual while he was
such an employee to a trust described in section 401(a) [IRC Sec. 401(a)] which is
exempt from tax under section 501(a) [IRC Sec. 501(a)], or under a plan described in
section 403(a) [IRC Sec. 403(a)], shall, to the extent allowed as deductions under section
404 [IRC Sec. 404], be treated as contributions by the employer which were not
includible in the gross income of the employee. For purposes of paragraph (2),
emotional distress shall not be treated as a physical injury or physical sickness. The
preceding sentence shall not apply to an amount of damages not in excess of the amount
paid for medical care (described in subparagraph (A) or (B) of section 213(d)(1) [IRC
Sec. 213(d)(1)]) attributable to emotional distress.
§ 105. Amounts received under accident and health plans.
Federal Personal Income Tax – Fall 2009, Joondeph
Page 34
(a) Amounts attributable to employer contributions. Except as otherwise provided in this
section, amounts received by an employee through accident or health insurance for
personal injuries or sickness shall be included in gross income to the extent such amounts
(1) are attributable to contributions by the employer which were not includible in the
gross income of the employee, or (2) are paid by the employer.
(b) Amounts expended for medical care [Caution: For provisions applicable to taxable
years beginning on or before December 31, 2004, see 2004 amendment note below.].
Except in the case of amounts attributable to (and not in excess of) deductions allowed
under section 213 [IRC Sec. 213] (relating to medical, etc., expenses) for any prior
taxable year, gross income does not include amounts referred to in subsection (a) if such
amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for
expenses incurred by him for the medical care (as defined in section 213(d) [IRC Sec.
213(d)]) of the taxpayer, his spouse, and his dependents (as defined in section 152
[IRC Sec. 152], determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B)
thereof). Any child to whom section 152(e) [IRC Sec. 152(e)] applies shall be treated as a
dependent of both parents for purposes of this subsection.
(c) Payments unrelated to absence from work [Caution: For provisions applicable to
taxable years beginning on or before December 31, 2004, see 2004 amendment note
below.]. Gross income does not include amounts referred to in subsection (a) to the
extent such amounts-(1) constitute payment for the permanent loss or loss of use of a member or function of
the body, or the permanent disfigurement, of the taxpayer, his spouse, or a dependent (as
defined in section 152 [IRC Sec. 152], determined without regard to subsections (b)(1),
(b)(2), and (d)(1)(B) thereof), and
(2) are computed with reference to the nature of the injury without regard to the period
the employee is absent from work.
§ 1.104-1 Compensation for injuries or sickness.
(c) Damages received on account of personal injuries or sickness. Section 104(a)(2)
excludes from gross income the amount of any damages received (whether by suit or
agreement) on account of personal injuries or sickness. The term “damages received
(whether by suit or agreement)” means an amount received (other than workmen's
compensation) through prosecution of a legal suit or action based upon tort or tort type
rights, or through a settlement agreement entered into in lieu of such prosecution.
[Joondeph] On the recovery of damages when the triggering event is emotional (rather
than a personal physical injury or physical sickness), the lower courts have uniformly
held that the recoveries must be included in income (except to the extent that they cover
actual medical expenses incurred as a result of those emotional injuries). This is a
defensible reading of the exclusion under 104(a)(2). Notice, though, that it does not really
answer whether such recoveries are income within the meaning of § 61 in the first place.
One could make a pretty strong argument that, when a taxpayer suffers emotional distress
and then is merely compensated for it, or made whole, she has not experienced an
Federal Personal Income Tax – Fall 2009, Joondeph
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"accession to wealth" and thus does not have income. But the courts have uniformly
drawn a strong negative inference from 104(a)(2)'s exclusion. If it is a personal injury
that falls outside the exclusion, they have held it included.
XVI.
Income from the discharge of indebtedness
a. Loan proceeds
b. Kirby Lumber
i. Corporate bonds
ii. The fluctuating value of debt
iii. Analysis
iv. The use of loan proceeds
c. Section 108
i. Purchase-money debt
ii. Insolvency relief
d. Diedrich
i. Background
ii. Competing arguments
iii. Alternative approach: part sale, part gift
iv. [Joondeph] Let me repeat something for emphasis: the fact that the
liability at issue in Diedrich was a "gift tax" is irrelevant. Totally.
What matters is that it was a liability. It was a financial obligation
of the parents. As you well know by now, there are no income
taxes for gifts. There are sometimes excise taxes imposed on the
transfer of wealth, both at the federal and state level. But those are
not income taxes, and they are not really a part of this class. Again,
what matters to understanding Diedrich is that it was a financial
liability owed by the parents, paid by the children, in exchange for
the stock.
e. Reg. §1.1001–1(e)
f. Section 1011(b)
Loan proceeds do not equal income. Because the money comes with an offsetting
liability, so there is no accession to wealth. However, if the debt is not fully repaid, the
underlying assumption for the exclusion of income (that the debt will be repaid) is not
applicable and the unpaid amount is income.
United States v. Kirby Lumber Co. (p. 416)
Kirby issues stock, which is a loan from the bondholders to the issuer (Kirby). K buys
back $1M of bonds (face value) for $862,000. Difference is $137,521.30, which should
be reported as gain. Note that it doesn't matter what the person receiving the loan does
with the money.
Potential reasons that value of debt may change after issuance:
1. Market Interest Rate goes up. Perhaps the value of the bond went down
because the interest rate on the market has gone up, making current bond
Federal Personal Income Tax – Fall 2009, Joondeph
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holders willing to sell their bonds at a discount to recover principal back and
reinvest at a higher rate.
2. Calculation of risk. As risk of default increases the value of holding onto the
debt goes down.
§ 108. Income from discharge of indebtedness.
Discussion of sub point (a): Note that these are all deferral privileges. It defers the
recognition to some future time.
Sub point (e)(5). Purchase-money reduction for solvent debtor treated as price reduction.
Occurs such as when a buyer is making payments on a dishwasher, has some issues with
the product, and the seller forgives the last payment as a concession for defects. This
forgiveness of the amount due would be considered a purchase price adjustment and not
forgiveness of debt.
Diedrich v. Commissioner (p. 491)
Parents transfer stock to their three children on the condition that the children pay the gift
tax for the stock.
Parents' basis in stock: $50K ($51,073)
Recipients agree to pay: $60K ($62,992)
FMV of stock at the time of the transfer: $300K
Kids arg: the amount of the tax is a gift to their parents and should be excluded under §
102(a). Problem with this argument: a gift must be motivated be a detached and
disinterest generosity (Duberstein). Transfer by the kids was not disinterested, it was
more like an exchange.
Court says this is more like an exchange. Kids are relieving parents of their tax liability,
so it falls under income "from discharge of indebtedness."
Gain: Amount realized (~$60K) - basis (~$50K) = ~$10K.
Effects on the children:
Generally, a person's basis in stock is the price paid. Same applies here because this is
treated as a sale for $60K. Thus, this is their basis.
Counterfactual Analogy to part sale/part gift scenario:
100,000 shares with FMV of $300K = $3/share.
Amount realized by parents: ~$60K = 20,000 shares
Parents basis: ~$50K = $.50/share
Basis in shares sold at FMV = $.50 * 20,000 = $10,000.00
Thus, gain is $60,000-$10,000 (basis) = $50,000.00. Then the gift is 80,000 shares.
Children's basis in the shares when they subsequently sell:
1. Shares received by gift = carry over basis of $.50 per share * 80,000 shares =
$40,000
2. Shares purchased basis: $60K
Federal Personal Income Tax – Fall 2009, Joondeph
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3. Total basis: $40K + $60K = $100K
Gain on sale for FMV $300K - $100K basis = $200K
Because of Time value of money, Deidrich is better because it defers recognition of
income until later. Also, it is likely that parents are in a higher tax bracket than children,
so it might be better for them to shift the tax liability to the children.
Hypo demonstrating exception
$300K straight gift of shares to kids from parents. Tax consequences for straight gift is
no gain to parents and kids get the carry-over basis from parents as $50K.
But, if parents "sell" shares to kids for 1 cent, the kids's basis is 1 cent, parents don't get
to take the loss (basis $50K - amount realized 1 cent = $49,999.99 loss). See IRC § 1001
Also note the gift/sale split as shown by § 1011(b) when a charitable organization
involved as a good example of how this works. Applying that here:
FMV: $100
Donor's basis: $5
"Sells" to charity at the bargain price of $20
The portion sold is ratio ($20 sale price/FMV $100) = 20%. Basis in the amount sold is
20% * donor's basis ($5) = $1. Gain is $20 amount realized - $1 basis = $19 gain. Gift is
remaining portion of 80%.
§ 108. Income from discharge of indebtedness.
(a) Exclusion from gross income.
(1) In general. Gross income does not include any amount which (but for this
subsection) would be includible in gross income by reason of the discharge (in whole
or in part) of indebtedness of the taxpayer if-(A) the discharge occurs in a title 11 case,
(B) the discharge occurs when the taxpayer is insolvent,
(C) the indebtedness discharged is qualified farm indebtedness,
(D) in the case of a taxpayer other than a C corporation, the indebtedness
discharged is qualified real property business indebtedness, or
(E) the indebtedness discharged is qualified principal residence indebtedness
which is discharged before January 1, 2010.
(d) Meaning of terms; special rules relating to certain provisions.
(1) Indebtedness of taxpayer. For purposes of this section, the term "indebtedness
of the taxpayer" means any indebtedness-(A) for which the taxpayer is liable, or
(B) subject to which the taxpayer holds property.
(2) Title 11 case. For purposes of this section, the term "title 11 case" means a case
under title 11 of the United States Code (relating to bankruptcy), but only if the
taxpayer is under the jurisdiction of the court in such case and the discharge of
indebtedness is granted by the court or is pursuant to a plan approved by the court.
Federal Personal Income Tax – Fall 2009, Joondeph
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(3) Insolvent. For purposes of this section, the term "insolvent" means the excess of
liabilities over the fair market value of assets. With respect to any discharge, whether
or not the taxpayer is insolvent, and the amount by which the taxpayer is insolvent,
shall be determined on the basis of the taxpayer's assets and liabilities immediately
before the discharge.
(e) General rules for discharge of indebtedness (including discharges not in title 11
cases or insolvency). For purposes of this title-(5) Purchase-money debt reduction for solvent debtor treated as price reduction. If(A) the debt of a purchaser of property to the seller of such property which arose
out of the purchase of such property is reduced,
(B) such reduction does not occur-(i) in a title 11 case, or
(ii) when the purchaser is insolvent, and
(C) but for this paragraph, such reduction would be treated as income to the
purchaser from the discharge of indebtedness,
then such reduction shall be treated as a purchase price adjustment.
CFR § 1.1001-1 Computation of gain or loss.
(e) Transfers in part a sale and in part a gift. (1) Where a transfer of property is in part
a sale and in part a gift, the transferor has a gain to the extent that the amount realized by
him exceeds his adjusted basis in the property. However, no loss is sustained on such a
transfer if the amount realized is less than the adjusted basis. For the determination of
basis of property in the hands of the transferee, see § 1.1015-4. For the allocation of the
adjusted basis of property in the case of a bargain sale to a charitable organization, see §
1.1011-2.
(2) Examples. The provisions of subparagraph (1) may be illustrated by the following
examples:
Example 1. A transfers property to his son for $60,000. Such property in the hands of
A has an adjusted basis of $30,000 (and a fair market value of $90,000). A's gain is
$30,000, the excess of $60,000, the amount realized, over the adjusted basis, $30,000. He
has made a gift of $30,000, the excess of $90,000, the fair market value, over the amount
realized, $60,000.
Example 2. A transfers property to his son for $30,000. Such property in the hands of
A has an adjusted basis of $60,000 (and a fair market value of $90,000). A has no gain or
loss, and has made a gift of $60,000, the excess of $90,000, the fair market value, over
the amount realized, $30,000.
Example 3. A transfers property to his son for $30,000. Such property in A's hands has
an adjusted basis of $30,000 (and a fair market value of $60,000). A has no gain and has
made a gift of $30,000, the excess of $60,000, the fair market value, over the amount
Federal Personal Income Tax – Fall 2009, Joondeph
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realized, $30,000.
Example 4. A transfers property to his son for $30,000. Such property in A's hands has
an adjusted basis of $90,000 (and a fair market value of $60,000). A has sustained no
loss, and has made a gift of $30,000, the excess of $60,000, the fair market value, over
the amount realized, $30,000.
XVII.
Transfers of property subject to debt
a. A primer on depreciation
b. Crane v. Commissioner
i. Crane’s original basis
ii. Crane’s amount realized
iii. Tax logic
c. Nonrecourse debt in excess of the property’s value
d. The problem
e. Tufts v. Commissioner
i. Partnerships and motives
ii. Competing arguments
iii. Holding
iv. The O’Connor alternative
f. Handout 8
Depreciation: is a deduction (or allowance) to account for the expected decline in value
of a long-lived wasting asset used to generate income (in a business or for investment)
 Example: TP buys machine for $10,000 with a 5 year life. Straight line
depreciation allows a deduction of $2k per year and it is worthless after 5
years.
 Requires an adjustment to basis for any basis that has been recovered.
Crane v. Commissioner [CB 456]
Note that the numbers in the case don't exactly add up, so #s from class discussion are
slightly different.
Acquisition of property through inheritance from deceased husband:
FMV at time of death: $262,000
Debt: $262,000
Issue 1: FMV of what?
Crane argues that she only receives the equity, which is $0.
Prof: if this were true, how much depreciation would she be entitled to take? None.
Depreciation is merely a means of recovering basis in an asset. Here, Crane took
depreciation deductions of $25,500 on the building/improvements (not on the land
because it is not a wasting asset)
IRS argues that Crane's basis is the FMV of the property. Court has a detailed analysis to
support that it is not the FMV of the equity, but the property itself. Thus, this is her basis,
which is $262K.
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Broader principle: we treat debt proceeds the same as cash.
Issue 2: Where depreciation is appropriate (because the court deems her to have positive
basis), what adjustments are appropriate [CB 460].
Her basis is adjusted based on the adjustments she took of $25,500.
Thus, her updated basis is $262,000 - $25,500 = $236,500.00 (note this is slightly
different than amounts in case)
Issue 3: what is her amount realized? [CB 461]
She sells for net cash proceeds of $2500 and recipient assumes all of the debt on the
property. She must include this in the amount realized, along with the amount
outstanding on the mortgage.
Amount realized: $262K debt relief + $2500 net cash received
Gain: Amount realized - basis ($236,500)
Commissioner v. Tufts [CB 468]
Using round numbers . . .
$1,850,000 borrowed to purchase apartment building. Mostly funded by debt. No initial
equity.
$45,000 cash contributions at later dates.
$440,000 depreciation deductions
In 1972, FMV = $1.4M. Partners walk away from property. Sell their interests to Fred
Bayles for <$250 to cover transaction fees.
Original Basis: $1,850,000 + $45,000
Adjusted Bases: subtract depreciation deductions of $440,000 = $1,455,000.00
TP's position is that they realized a loss:
Effectively sold for $1.4M - adjusted basis ($1,455,000) = $55,000.00 loss
IRS position: Amount realized = $1,850,000 debt forgiveness.
Less $1,455,000 basis
= $395,000 gain
However, we don't do it this way in the vast majority of transactions because they are
typically recourse to the borrower.
Justice O'Connor's concurring opinion suggests bifurcating the transactions.
Part 1: Treat property as a sale at FMV.
Amount realized: $1.4 less adjusted basis ($1,455,000) = $55,000.00 loss on sale
Part 2: Debt forgiveness income
Loan balance: $1,850,000 less property "sale" = $450,000 income from the discharge of
debt.
If you sum the two, it nets income to TPs of $395,000.
Federal Personal Income Tax – Fall 2009, Joondeph
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Prof: this more accurately characterizes what is going on. This is how you would do it
where the debt is recourse to the borrower, which is more typical.
§ 1011. Adjusted basis for determining gain or loss.
(b) Bargain sale to a charitable organization. If a deduction is allowable under section
170 [IRC Sec. 170] (relating to charitable contributions) by reason of a sale, then the
adjusted basis for determining the gain from such sale shall be that portion of the adjusted
basis which bears the same ratio to the adjusted basis as the amount realized bears to the
fair market value of the property.
CFR § 1.1001-2 Discharge of liabilities.
(a) Inclusion in amount realized--(1) In general. Except as provided in paragraph
(a)(2) and (3) of this section, the amount realized from a sale or other disposition of
property includes the amount of liabilities from which the transferor is discharged as a
result of the sale or disposition.
(2) Discharge of indebtedness. The amount realized on a sale or other disposition of
property that secures a recourse liability does not include amounts that are (or would
be if realized and recognized) income from the discharge of indebtedness under
section 61(a)(12). For situations where amounts arising from the discharge of
indebtedness are not realized and recognized, see section 108 and § 1.61-12(b)(1).
(3) Liability incurred on acquisition. In the case of a liability incurred by reason of
the acquisition of the property, this section does not apply to the extent that such
liability was not taken into account in determining the transferor's basis for such
property.
(4) Special rules. For purposes of this section-(i) The sale or other disposition of property that secures a nonrecourse liability
discharges the transferor from the liability;
(ii) The sale or other disposition of property that secures a recourse liability
discharges the transferor from the liability if another person agrees to pay the liability
(whether or not the transferor is in fact released from liability);
(iii) A disposition of property includes a gift of the property or a transfer of the
property in satisfaction of liabilities to which it is subject;
(iv) Contributions and distributions of property between a partner and a partnership
are not sales or other dispositions of property; and
(v) The liabilities from which a transferor is discharged as a result of the sale or
disposition of a partnership interest include the transferor's share of the liabilities of
the partnership.
Federal Personal Income Tax – Fall 2009, Joondeph
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XVIII.
The realization requirement
a. Three steps to recognition
b. Cottage Savings
i. Background
ii. Court’s analysis
c. Costs and benefits
d. Exceptions
Generally speaking, no realization event happens from a property that is merely
increasing in value.
3 steps to recognition.
1. Income in an economic sense
2. Realization
3. No non-recognition provision that applies
Hypo: TP purchases a house for $500K. 10 years later, FMV = $750K. There has been
an accession to wealth of $250K, which is income in an economic sense. However,
without a realization event, there is no tax consequence. If TP sells for $750K, then there
is income of $250K. However, there is an express non-recognition provision in § 121
that allows a TP to exclude $250K of income from the sale of a primary residence.
Cottage Savings Assn. v. Commissioner [CB 247]
A savings and loan was holding a large number of devalued mortgages because they were
at low interest rates and market rates had shot up. Because of their financial struggles
(investor panick and regulatory oversight rules), the S&Ls didn't want to report their huge
losses. Thus, the federal regulators (FHLBB) issued a ruling Memorandum R-49 that
allowed S&Ls to swap their notes among each other that would allow them to create
realization events, but not have to recognize the full amount of their losses in one year.
Test for gain on the disposition of property (p. 249): an exchange of property can be
treated as a disposition if the properties exchanged are “materially different – that is, so
long as they embody legally distinct entitlements.” [CB 253]
See § 165(a) for the general rule of deducting losses in the calendar year they are
sustained [under XIV] and § 1001(a) for computation of gain or loss [under IX].
26 CFR § 1.165-1 Losses.
(a) Allowance of deduction. Section 165(a) provides that, in computing taxable income
under section 63, any loss actually sustained during the taxable year and not made good
by insurance or some other form of compensation shall be allowed as a deduction subject
to any provision of the internal revenue laws which prohibits or limits the amount of the
deduction. This deduction for losses sustained shall be taken in accordance with section
165 and the regulations thereunder. For the disallowance of deductions for worthless
securities issued by a political party, see § 1.271-1.
Federal Personal Income Tax – Fall 2009, Joondeph
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XIX.
Express nonrecognition provisions
a. Involuntary conversions
i. Gain recognized
ii. New basis
b. Like-kind exchanges
i. Requirements
ii. Without boot
iii. With boot
iv. With boot other than cash
v. With the swapping of debt
c. Sales of principal residences
Formulas from Joondeph:
1. Involuntary conversions
a. Gain recognized = lesser of (a) the gain realized or (b) the amount of the
recovery not reinvested in property that is similar or related in use within 2
years
b. Basis in new property = FMV of new property - amount of unrecognized
gain (gain realized on the conversion but not recognized)
2. Like-kind exchanges
a. Gain recognized = lesser of (a) the gain realized or (b) the fair market
value of the boot received
i. This is the gain recognized on the like-kind property; if the
taxpayer transfers boot other than cash, she may have to recognize
gain on that, as the exchange constitutes a realization event
b. Basis in new like-kind property (when receiving boot) = basis in old likekind property + gain recognized - FMV of boot received
c. Basis in new like-kind property (when transferring boot) = basis in old
like-kind property + FMV of boot transferred
d. Basis in non-like-kind property (boot) received = FMV
e. When a like-kind-exchange involves the discharge of debt attached to the
exchanged properties, the net debt relief (which can only go to one of the
two parties) is treated the same as cash boot
Comments to review Cottage Savings
Justice Marshall sets the standard as "Legally distinct entitlement" associated with each
of the mortgage packages creates sufficient evidence that the properties are materially
different, triggering a realization event.
Marshall's discussion is supported by § 1031:

§ 1031 permits the non-recognition of gain when there is an exchange of
"like-kind" properties. Normally, recognition occurs upon realization. Thus, §
1031 presupposes that there is a realization or we wouldn't need the nonrecognition provision.
Federal Personal Income Tax – Fall 2009, Joondeph
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Policy discussion of § 1031:
Benefits
Costs
Hassle in Valuation
Keeping track of basis
Liquidity (can't pay
the tax if you haven't
realized the tangible
gain)
Horizontal equity
Vertical equity (those that generally benefit are more affluent)
Neutrality: lock-in of assets because people don't want to sell
due to tax consequences. Also assets that don't generate
realization generate greater investment because it is a better
investment for people if they can defer tax payments until the
asset is disposed.
Note: no one is ever better or worse off because of a realization event. This is just a
good moment to account for the income from the asset that has appreciated in value.
Amount realized v. recognition
§ 1001(c): describes amount realized. Non-recognition is when the amount realized
doesn't have to be reported on the tax return. Sometimes, this means that the income is
permanently excluded, but some provisions, such as § 1031, just defer the recognition of
the income until a later date.
Sidenotes: we start with a presumption that there is income when there has been an
accession to wealth, clearly realized, over which the TP has complete dominion
(Glenshaw Glass). However, there are a few exceptions to this where income must be
reported w/o realization (option traders that have to mark-to-market). This is not a
constitutional requirement, but comes from . . .

§ 1001(c): creates presumption of income unless another provision of the
code creates an exception, such as § 1031.
§ 1033 Involuntary Conversions. Gain recognized = lesser of

Gain realized

Amount not reinvested in property that is similar or related in use

Note: amount realized from involuntary conversion is treated as a sale
(Raytheon)
Hypo: Bldg FMV = $8M and adjusted basis = $2M. Burns to the ground. Recovery of
$7M. Reinvests $6M in new bldg.
Amount realized: $7M
Basis: $2M
Gain realized (may not be same as gain recognized): $5M

Compare to amount not reinvested: $7M recovered, but $6M reinvested =
$1M not reinvested.

$1M is less than $5M, so gain recognized is $1M.
Federal Personal Income Tax – Fall 2009, Joondeph
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Basis in new property (§ 1033) = FMV of new property ($6M) - unrecognized gain
($4M) = $2M
Prof: the $4M of unrecognized gain is preserved/deferred to be recognized
when the property is ultimately sold.
If hypo above were changed so that $8M is reinvested, there is $0 that is not
reinvested. Thus, the gain recognized is $0. Basis in new property is FMV ($8M)
- unrecognized gain ($5M) = $3M.
§ 1031 Exchange of property held for productive use or investment
Like kind

All real property is like in kind

Tangible personal property is classified by Regs
Use of the property

Both the property transferred and the property received must be used by
the TP for trade or business, or investment purposes.

Analyzed from the perspective of each individual TP. It doesn't matter if
the other party who transferred or receives the property uses it for a use that
doesn't generate income.
Must be property for property, if TP touches the cash at all, the transaction doesn't
qualify
Gain recognized = Lesser of

Gain realized or

FMV of boot received
New Basis = old basis + gain recognized - FMV of boot received.
Hypo: A has property with FMV of $100 and Basis of $20. B has property with FMV
of $100 and basis of $60.
A's position in the swap:
Amount realized: $100
Basis: $20
Gain realized: $80
Gain recognized: $0
B's position in the swap:
Amount realized: $100
Basis: $60
Gain realized: $40
Gain recognized: $0
To the extent the TP realizes the gain in the form of another property, there is no
recognition.
Hypo 2: A has property with FMV of $120 and Basis of $20. B has property with FMV
of $100 and basis of $60. They swap, with A receiving B's property + $20 in cash.
A's position in the swap:
Amount realized: $100 property + $20 cash (boot) = $120
Basis: $20
Gain realized: $100
Federal Personal Income Tax – Fall 2009, Joondeph
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Gain recognized: $20
A's basis in new property: $20 (old basis) + gain recognized ($20 boot) - FMV of
boot received ($20) = $20.00
Boot: the non-like kind property in a like-kind exchange
§ 1031. Exchange of property held for productive use or investment.
(a) Nonrecognition of gain or loss from exchanges solely in kind.
(1) In general. No gain or loss shall be recognized on the exchange of property held for
productive use in a trade or business or for investment if such property is exchanged
solely for property of like kind which is to be held either for productive use in a trade or
business or for investment.
(2) Exception. This subsection shall not apply to any exchange of-(A) stock in trade or other property held primarily for sale,
(B) stocks, bonds, or notes,
(C) other securities or evidences of indebtedness or interest,
(D) interests in a partnership,
(E) certificates of trust or beneficial interests, or
(F) choses in action.
For purposes of this section, an interest in a partnership which has in effect a valid
election under section 761(a) [IRC Sec. 761(a)] to be excluded from the application of all
of subchapter K [IRC Sections 701 et seq.] shall be treated as an interest in each of the
assets of such partnership and not as an interest in a partnership.
(3) Requirement that property be identified and that exchange be completed not more
than 180 days after transfer of exchanged property. For purposes of this subsection, any
property received by the taxpayer shall be treated as property which is not like-kind
property if-(A) such property is not identified as property to be received in the exchange on or
before the day which is 45 days after the date on which the taxpayer transfers the
property relinquished in the exchange, or
(B) such property is received after the earlier of-(i) the day which is 180 days after the date on which the taxpayer transfers the
property relinquished in the exchange, or
(ii) the due date (determined with regard to extension) for the transferor's return of
the tax imposed by this chapter [IRC Sections 1 et seq.] for the taxable year in which the
transfer of the relinquished property occurs.
(b) Gain from exchanges not solely in kind. If an exchange would be within the
provisions of subsection (a), of section 1035(a) [IRC Sec. 1035(a)], of section 1036(a)
[IRC Sec. 1036(a)], or of section 1037(a) [IRC Sec. 1037(a)], if it were not for the fact
that the property received in exchange consists not only of property permitted by such
provisions to be received without the recognition of gain, but also of other property or
money, then the gain, if any, to the recipient shall be recognized, but in an amount not in
excess of the sum of such money and the fair market value of such other property.
Federal Personal Income Tax – Fall 2009, Joondeph
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(c) Loss from exchanges not solely in kind. If an exchange would be within the
provisions of subsection (a), of section 1035(a) [IRC Sec. 1035(a)], of section 1036(a)
[IRC Sec. 1036(a)], or of section 1037(a) [IRC Sec. 1037(a)], if it were not for the fact
that the property received in exchange consists not only of property permitted by such
provisions to be received without the recognition of gain or loss, but also of other
property or money, then no loss from the exchange shall be recognized.
(d) Basis. If property was acquired on an exchange described in this section, section
1035(a) [IRC Sec. 1035(a)], section 1036(a) [IRC Sec. 1036(a)], or section 1037(a) [IRC
Sec. 1037(a)], then the basis shall be the same as that of the property exchanged,
decreased in the amount of any money received by the taxpayer and increased in the
amount of gain or decreased in the amount of loss to the taxpayer that was recognized on
such exchange. If the property so acquired consisted in part of the type of property
permitted by this section, section 1035(a) [IRC Sec. 1035(a)], section 1036(a) [IRC Sec.
1036(a)], or section 1037(a) [IRC Sec. 1037(a)], to be received without the recognition of
gain or loss, and in part of other property, the basis provided in this subsection shall be
allocated between the properties (other than money) received, and for the purpose of the
allocation there shall be assigned to such other property an amount equivalent to its fair
market value at the date of the exchange. For purposes of this section, section 1035(a)
[IRC Sec. 1035(a)], and section 1036(a) [IRC Sec. 1036(a)], where as part of the
consideration to the taxpayer another party to the exchange assumed (as determined
under section 357(d) [IRC Sec. 357(d)]) a liability of the taxpayer, such assumption shall
be considered as money received by the taxpayer on the exchange.
§ 1033. Involuntary conversions.
(a) General rule. If property (as a result of its destruction in whole or in part, theft,
seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily
or involuntarily converted-(1) Conversion into similar property. Into property similar or related in service or use
to the property so converted, no gain shall be recognized.
(2) Conversion into money. Into money or into property not similar or related in
service or use to the converted property, the gain (if any) shall be recognized except to
the extent hereinafter provided in this paragraph:
(A) Nonrecognition of gain. If the taxpayer during the period specified in
subparagraph (B), for the purpose of replacing the property so converted, purchases other
property similar or related in service or use to the property so converted, or purchases
stock in the acquisition of control of a corporation owning such other property, at the
election of the taxpayer the gain shall be recognized only to the extent that the amount
realized upon such conversion (regardless of whether such amount is received in one or
more taxable years) exceeds the cost of such other property or such stock. Such election
shall be made at such time and in such manner as the Secretary may by regulations
prescribe. For purposes of this paragraph-(i) no property or stock acquired before the disposition of the converted property
shall be considered to have been acquired for the purpose of replacing such converted
property unless held by the taxpayer on the date of such disposition; and
Federal Personal Income Tax – Fall 2009, Joondeph
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(ii) the taxpayer shall be considered to have purchased property or stock only if, but
for the provisions of subsection (b) of this section, the unadjusted basis of such property
or stock would be its cost within the meaning of section 1012 [IRC Sec. 1012].
(B) Period within which property must be replaced. The period referred to in
subparagraph (A) shall be the period beginning with the date of the disposition of the
converted property, or the earliest date of the threat or imminence of requisition or
condemnation of the converted property, whichever is the earlier, and ending-(i) 2 years after the close of the first taxable year in which any part of the gain upon
the conversion is realized, or
(ii) subject to such terms and conditions as may be specified by the Secretary, at the
close of such later date as the Secretary may designate on application by the taxpayer.
Such application shall be made at such time and in such manner as the Secretary may by
regulations prescribe.
26 CFR § 1.1031(a)-1 Property held for productive use in trade or business or for
investment.
(a) In general--(1) Exchanges of property solely for property of a like kind. Section
1031(a)(1) provides an exception from the general rule requiring the recognition of gain
or loss upon the sale or exchange of property. Under section 1031(a)(1), no gain or loss is
recognized if property held for productive use in a trade or business or for investment is
exchanged solely for property of a like kind to be held either for productive use in a trade
or business or for investment. Under section 1031(a)(1), property held for productive use
in a trade or business may be exchanged for property held for investment. Similarly,
under section 1031(a)(1), property held for investment may be exchanged for property
held for productive use in a trade or business. However, section 1031(a)(2) provides that
section 1031(a)(1) does not apply to any exchange of-(i) Stock in trade or other property held primarily for sale;
(ii) Stocks, bonds, or notes;
(iii) Other securities or evidences of indebtedness or interest;
(iv) Interests in a partnership;
(v) Certificates of trust or beneficial interests; or
(vi) Choses in action.
Section 1031(a)(1) does not apply to any exchange of interests in a partnership
regardless of whether the interests exchanged are general or limited partnership
interests or are interests in the same partnership or in different partnerships. An
interest in a partnership that has in effect a valid election under section 761(a) to be
excluded from the application of all of subchapter K is treated as an interest in each of
the assets of the partnership and not as an interest in a partnership for purposes of
Federal Personal Income Tax – Fall 2009, Joondeph
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section 1031(a)(2)(D) and paragraph (a)(1)(iv) of this section. An exchange of an
interest in such a partnership does not qualify for nonrecognition of gain or loss under
section 1031 with respect to any asset of the partnership that is described in section
1031(a)(2) or to the extent the exchange of assets of the partnership does not
otherwise satisfy the requirements of section 1031(a).
(2) Exchanges of property not solely for property of a like kind. A transfer is not
within the provisions of section 1031(a) if, as part of the consideration, the taxpayer
receives money or property which does not meet the requirements of section 1031(a),
but the transfer, if otherwise qualified, will be within the provisions of either section
1031(b) or (c). Similarly, a transfer is not within the provisions of section 1031(a) if,
as part of the consideration, the other party to the exchange assumes a liability of the
taxpayer (or acquires property from the taxpayer that is subject to a liability), but the
transfer, if otherwise qualified, will be within the provisions of either section 1031(b)
or (c). A transfer of property meeting the requirements of section 1031(a) may be
within the provisions of section 1031(a) even though the taxpayer transfers in
addition property not meeting the requirements of section 1031(a) or money.
However, the nonrecognition treatment provided by section 1031(a) does not apply to
the property transferred which does not meet the requirements of section 1031(a).
(b) Definition of “like kind.” As used in section 1031(a), 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 that section, be exchanged for property of a
different kind or class. The fact that any real estate involved is improved or unimproved
is not material, for that fact relates only to the grade or quality of the property and not to
its kind or class. Unproductive real estate held by one other than a dealer for future use or
future realization of the increment in value is held for investment and not primarily for
sale. For additional rules for exchanges of personal property, see § 1.1031(a)-2.
(c) Examples of exchanges of property of a “like kind.” No gain or loss is recognized
if (1) a taxpayer exchanges property held for productive use in his trade or business,
together with cash, for other property of like kind for the same use, such as a truck for a
new truck or a passenger automobile for a new passenger automobile to be used for a like
purpose; or (2) a taxpayer who is not a dealer in real estate exchanges city real estate for a
ranch or farm, or exchanges a leasehold of a fee with 30 years or more to run for real
estate, or exchanges improved real estate for unimproved real estate; or (3) a taxpayer
exchanges investment property and cash for investment property of a like kind.
(d) Examples of exchanges not solely in kind. Gain or loss is recognized if, for
instance, a taxpayer exchanges (1) Treasury bonds maturing March 15, 1958, for
Treasury bonds maturing December 15, 1968, unless section 1037(a) (or so much of
section 1031 as relates to section 1037(a)) applies to such exchange, or (2) a real estate
mortgage for consolidated farm loan bonds.
(e) Effective date relating to exchanges of partnership interests. The provisions of
paragraph (a)(1) of this section relating to exchanges of partnership interests apply to
Federal Personal Income Tax – Fall 2009, Joondeph
Page 50
transfers of property made by taxpayers on or after April 25, 1991.
§ 121. Exclusion of gain from sale of principal residence.
(a) Exclusion. Gross income shall not include gain from the sale or exchange of property
if, during the 5-year period ending on the date of the sale or exchange, such property has
been owned and used by the taxpayer as the taxpayer's principal residence for periods
aggregating 2 years or more.
(b) Limitations.
(1) In general. The amount of gain excluded from gross income under subsection (a)
with respect to any sale or exchange shall not exceed $ 250,000.
(2) Special rules for joint returns. In the case of a husband and wife who make a joint
return for the taxable year of the sale or exchange of the property-(A) $ 500,000 Limitation for certain joint returns. Paragraph (1) shall be applied by
substituting "$ 500,000" for "$ 250,000" if-(i) either spouse meets the ownership requirements of subsection (a) with respect to
such property;
(ii) both spouses meet the use requirements of subsection (a) with respect to such
property; and
(iii) neither spouse is ineligible for the benefits of subsection (a) with respect to
such property by reason of paragraph (3).
(B) Other joint returns. If such spouses do not meet the requirements of subparagraph
(A), the limitation under paragraph (1) shall be the sum of the limitations under
paragraph (1) to which each spouse would be entitled if such spouses had not been
married. For purposes of the preceding sentence, each spouse shall be treated as owning
the property during the period that either spouse owned the property.
(3) Application to only 1 sale or exchange every 2 years.
(A) In general. Subsection (a) shall not apply to any sale or exchange by the taxpayer
if, during the 2-year period ending on the date of such sale or exchange, there was any
other sale or exchange by the taxpayer to which subsection (a) applied.
(B) Pre-May 7, 1997, sales not taken into account. Subparagraph (A) shall be applied
without regard to any sale or exchange before May 7, 1997.
(4) Special rule for certain sales by surviving spouses. In the case of a sale or exchange
of property by an unmarried individual whose spouse is deceased on the date of such sale,
paragraph (1) shall be applied by substituting "$ 500,000" for "$ 250,000" if such sale
occurs not later than 2 years after the date of death of such spouse and the requirements
of paragraph (2)(A) were met immediately before such date of death.
[(5)](4) Exclusion of gain allocated to nonqualified use.
(A) In general. Subsection (a) shall not apply to so much of the gain from the sale or
exchange of property as is allocated to periods of nonqualified use.
(B) Gain allocated to periods of nonqualified use. For purposes of subparagraph (A),
gain shall be allocated to periods of nonqualified use based on the ratio which-(i) the aggregate periods of nonqualified use during the period such property was
owned by the taxpayer, bears to
Federal Personal Income Tax – Fall 2009, Joondeph
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(ii) the period such property was owned by the taxpayer.
(C) Period of nonqualified use. For purposes of this paragraph-(i) In general. The term "period of nonqualified use" means any period (other than
the portion of any period preceding January 1, 2009) during which the property is not
used as the principal residence of the taxpayer or the taxpayer's spouse or former spouse.
(ii) Exceptions. The term "period of nonqualified use" does not include-(I) any portion of the 5-year period described in subsection (a) which is after the
last date that such property is used as the principal residence of the taxpayer or the
taxpayer's spouse,
(II) any period (not to exceed an aggregate period of 10 years) during which the
taxpayer or the taxpayer's spouse is serving on qualified official extended duty (as
defined in subsection (d)(9)(C)) described in clause (i), (ii), or (iii) of subsection
(d)(9)(A), and
(III) any other period of temporary absence (not to exceed an aggregate period of
2 years) due to change of employment, health conditions, or such other unforeseen
circumstances as may be specified by the Secretary.
(D) Coordination with recognition of gain attributable to depreciation. For purposes
of this paragraph-(i) subparagraph (A) shall be applied after the application of subsection (d)(6), and
(ii) subparagraph (B) shall be applied without regard to any gain to which
subsection (d)(6) applies.
(c) Exclusion for taxpayers failing to meet certain requirements.
(1) In general. In the case of a sale or exchange to which this subsection applies, the
ownership and use requirements of subsection (a), and subsection (b)(3), shall not apply;
but the dollar limitation under paragraph (1) or (2) of subsection (b), whichever is
applicable, shall be equal to-(A) the amount which bears the same ratio to such limitation (determined without
regard to this paragraph) as
(B) (i) the shorter of-(I) the aggregate periods, during the 5-year period ending on the date of such sale
or exchange, such property has been owned and used by the taxpayer as the taxpayer's
principal residence; or
(II) the period after the date of the most recent prior sale or exchange by the
taxpayer to which subsection (a) applied and before the date of such sale or exchange,
bears to
(ii) 2 years.
(2) Sales and exchanges to which subsection applies. This subsection shall apply to any
sale or exchange if-(A) subsection (a) would not (but for this subsection) apply to such sale or exchange
by reason of-(i) a failure to meet the ownership and use requirements of subsection (a), or
(ii) subsection (b)(3), and
(B) such sale or exchange is by reason of a change in place of employment, health, or,
to the extent provided in regulations, unforeseen circumstances.
Federal Personal Income Tax – Fall 2009, Joondeph
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Federal Personal Income Tax
Part II
A. The recognition of losses § 165(a)
1.
Overview
2.
United States v. S.S. White
a.
The relevant standard
b.
As applied here
c.
Subsequent events
United States v. S.S. White Dental Manufacturing Co. [CB 801]
Facts: TP invested $130K into a German company, through a combination of purchasing
all of its stock and making loans to the company. In 1918, the German gov't takes control
of the TP's company. In 1920, the TP gets $6k back. Later, the TP files a claim for
$70K, which is recognized, but not paid.
Issue: Whether the loss, concededly sustained by the TP through the seizure of the assets
of the German company in 1918, was so evidenced by a closed transaction within the
meaning of the quoted statute and treasury regulations as to authorize its deduction from
gross income of that year.
Rules: [802] A loss must be evidence by closed and completed transactions. Where all
the surrounding and attendant circumstances indicate that a debt is worthless and
uncollectible and that legal action to enforce payment would in all probability not result
in the satisfaction of execution on a judgment, a showing of these facts will be sufficient
evidence of the worthlessness of the debt for the purpose of deduction.
Prof: note that declines in value without a realization event to not allow a deduction.
Difference here is that TP was actually deprived of its ownership in the company when
the German gov't took possession of it.
Analysis: TP had no reasonable expectation that they would get any recovery. TP gets a
deduction for its basis.

1920: $6k back, so they claim $6k of income

Later: must report the $70K of income in the year received.
3.
B.
Another application
The use of hindsight
1.
Annual accounting
2.
Burnet v. Sanford & Brooks
a.
Taxpayer’s argument
b.
Court’s holding
c.
Comparison to Clark
Burnet v. Sanford & Brooks Co. [CB 140] (Annual Accounting Principle)
TP had a contract with the United States to dredge the Delaware River. TP reported
losses on the K, but ultimately recovered $176K on a suit under the K.
Issue: whether the gain or profit which is the subject of the tax may be asceratined, as
here, on the basis of fixed accounting periods, or whether, as is pressed upon us, it can
Federal Personal Income Tax – Fall 2009, Joondeph
Page 53
only be net profit ascertained on the basis of particular transactions of the TP when they
are brought to conclusion.
They were entitled to the loss deductions when realized, but they had no income to
offset it.
1913
1915
1916
1920
Taxable
Income
-$60K
-$60K
-$56K
$176K income
Tax Liability
0
0
0
$35K
Distinguish from recovery in Clark, where TP is reimbursed for additional tax liability
by tax professional who gave them bad advice. Clark doesn't have to claim income
because they never had a deduction to begin with.
§172: net operating loss carryover deductions
(a) Deduction allowed. There shall be allowed as a deduction for the taxable year an
amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus
(2) the net operating loss carrybacks to such year. For purposes of this subtitle [IRC
Sections 1 et seq.], the term "net operating loss deduction" means the deduction allowed
by this subsection.
(b) Net operating loss carrybacks and carryovers.
(1) Years to which loss may be carried.
(A) General rule. Except as otherwise provided in this paragraph, a net operating
loss for any taxable year-(i) shall be a net operating loss carryback to each of the 2 taxable years preceding
the taxable year of such loss, and
(ii) shall be a net operating loss carryover to each of the 20 taxable years following
the taxable year of the loss.
(2) Amount of carrybacks and carryovers. The entire amount of the net operating loss
for any taxable year (hereinafter in this section referred to as the "loss year") shall be
carried to the earliest of the taxable years to which (by reason of paragraph (1)) such
loss may be carried. The portion of such loss which shall be carried to each of the other
taxable years shall be the excess, if any, of the amount of such loss over the sum of the
taxable income for each of the prior taxable years to which such loss may be carried. For
purposes of the preceding sentence, the taxable income for any such prior taxable year
shall be computed-(A) with the modifications specified in subsection (d) other than paragraphs (1), (4),
and (5) thereof, and
(B) by determining the amount of the net operating loss deduction without regard to
the net operating loss for the loss year or for any taxable year thereafter,
Federal Personal Income Tax – Fall 2009, Joondeph
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and the taxable income so computed shall not be considered to be less than zero.
(3) Election to waive carryback. Any taxpayer entitled to a carryback period under
paragraph (1) may elect to relinquish the entire carryback period with respect to a net
operating loss for any taxable year. Such election shall be made in such manner as may
be prescribed by the Secretary, and shall be made by the due date (including extensions
of time) for filing the taxpayer's return for the taxable year of the net operating loss for
which the election is to be in effect. Such election, once made for any taxable year, shall
be irrevocable for such taxable year.
(c) Net operating loss defined. For purposes of this section, the term "net operating loss"
means the excess of the deductions allowed by this chapter [IRC Sections 1 et seq.] over
the gross income. Such excess shall be computed with the modifications specified in
subsection (d).
(d) Modifications. The modifications referred to in this section are as follows:
(1) Net operating loss deduction. No net operating loss deduction shall be allowed.
(2) Capital gains and losses of taxpayers other than corporations. In the case of a
taxpayer other than a corporation-(A) the amount deductible on account of losses from sales or exchanges of capital
assets shall not exceed the amount includable on account of gains from sales or
exchanges of capital assets; and
(B) the exclusion provided by section 1202 [IRC Sec. 1202] shall not be allowed.
(3) Deduction for personal exemptions. No deduction shall be allowed under section
151 [IRC Sec. 151] (relating to personal exemptions). No deduction in lieu of any such
deduction shall be allowed.
(4) Nonbusiness deductions of taxpayers other than corporations. In the case of a
taxpayer other than a corporation, the deductions allowable by this chapter [IRC
Sections 1 et seq.] which are not attributable to a taxpayer's trade or business shall be
allowed only to the extent of the amount of the gross income not derived from such trade
or business. For purposes of the preceding sentence-(A) any gain or loss from the sale or other disposition of-(i) property, used in the trade or business, of a character which is subject to the
allowance for depreciation provided in section 167[IRC Sec. 167], or
(ii) real property used in the trade or business,
shall be treated as attributable to the trade or business;
(B) the modifications specified in paragraphs (1), 2(B), and (3) shall be taken into
account;
(C) any deduction for casualty or theft losses allowable under paragraph (2) or (3) of
section 165(c) [IRC Sec. 165(c)] shall be treated as attributable to the trade or business;
and
(D) any deduction allowed under section 404 [IRC Sec. 404] to the extent attributable
to contributions which are made on behalf of an individual who is an employee within the
meaning of section 401(c)(1) [IRC Sec. 401(c)(1)] shall not be treated as attributable to
the trade or business of such individual.
Federal Personal Income Tax – Fall 2009, Joondeph
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
Note that the exclusion in (d) that excludes the Net Operating Loss deduction
from the calculation prohibits you from including loss carry back from prior
years.
§ 441. Period for computation of taxable income.
(a) Computation of taxable income. Taxable income shall be computed on the basis of
the taxpayer's taxable year.
(b) Taxable year. For purposes of this subtitle, the term "taxable year" means-(1) the taxpayer's annual accounting period, if it is a calendar year or a fiscal year;
(2) the calendar year, if subsection (g) applies;
(3) the period for which the return is made, if a return is made for a period of less than
12 months; or
(4) in the case of a DISC filing a return for a period of at least 12 months, the period
determined under subsection (h).
(c) Annual accounting period. For purposes of this subtitle, the term "annual accounting
period" means the annual period on the basis of which the taxpayer regularly computes
his income in keeping his books.
(d) Calendar year. For purposes of this subtitle, the term "calendar year" means a
period of 12 months ending on December 31.
(e) Fiscal year. For purposes of this subtitle, the term "fiscal year" means a period of 12
months ending on the last day of any month other than December. In the case of any
taxpayer who has made the election provided by subsection (f), the term means the
annual period (varying from 52 to 53 weeks) so elected.
C.F.R § 1.165-1 Losses.
(d) Year of deduction. (1) A loss shall be allowed as a deduction under section 165(a)
only for the taxable year in which the loss is sustained. For this purpose, a loss shall be
treated as sustained during the taxable year in which the loss occurs as evidenced by
closed and completed transactions and as fixed by identifiable events occurring in such
taxable year. For provisions relating to situations where a loss attributable to a disaster
will be treated as sustained in the taxable year immediately preceding the taxable year in
which the disaster actually occurred, see section 165(h) and § 1.165-11.
(2)(i) If a casualty or other event occurs which may result in a loss and, in the year of
such casualty or event, there exists a claim for reimbursement with respect to which
there is a reasonable prospect of recovery, no portion of the loss with respect to
which reimbursement may be received is sustained, for purposes of section 165, until
it can be ascertained with reasonable certainty whether or not such reimbursement
will be received. Whether a reasonable prospect of recovery exists with respect to a
claim for reimbursement of a loss is a question of fact to be determined upon an
Federal Personal Income Tax – Fall 2009, Joondeph
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examination of all facts and circumstances. Whether or not such reimbursement will
be received may be ascertained with reasonable certainty, for example, by a
settlement of the claim, by an adjudication of the claim, or by an abandonment of the
claim. When a taxpayer claims that the taxable year in which a loss is sustained is
fixed by his abandonment of the claim for reimbursement, he must be able to produce
objective evidence of his having abandoned the claim, such as the execution of a
release.
(ii) If in the year of the casualty or other event a portion of the loss is not covered by
a claim for reimbursement with respect to which there is a reasonable prospect of
recovery, then such portion of the loss is sustained during the taxable year in which
the casualty or other event occurs. For example, if property having an adjusted basis
of $10,000 is completely destroyed by fire in 1961, and if the taxpayer's only claim
for reimbursement consists of an insurance claim for $8,000 which is settled in 1962,
the taxpayer sustains a loss of $2,000 in 1961. However, if the taxpayer's automobile
is completely destroyed in 1961 as a result of the negligence of another person and
there exists a reasonable prospect of recovery on a claim for the full value of the
automobile against such person, the taxpayer does not sustain any loss until the
taxable year in which the claim is adjudicated or otherwise settled. If the automobile
had an adjusted basis of $5,000 and the taxpayer secures a judgment of $4,000 in
1962, $1,000 is deductible for the taxable year 1962. If in 1963 it becomes
reasonably certain that only $3,500 can ever be collected on such judgment, $500 is
deductible for the taxable year 1963.
(iii) If the taxpayer deducted a loss in accordance with the provisions of this
paragraph and in a subsequent taxable year receives reimbursement for such loss, he
does not recompute the tax for the taxable year in which the deduction was taken but
includes the amount of such reimbursement in his gross income for the taxable year
in which received, subject to the provisions of section 111, relating to recovery of
amounts previously deducted.
(3) Any loss arising from theft shall be treated as sustained during the taxable year in
which the taxpayer discovers the loss (see § 1.165-8, relating to theft losses).
However, if in the year of discovery there exists a claim for reimbursement with
respect to which there is a reasonable prospect of recovery, no portion of the loss
with respect to which reimbursement may be received is sustained, for purposes of
section 165, until the taxable year in which it can be ascertained with reasonable
certainty whether or not such reimbursement will be received.
(4) The rules of this paragraph are applicable with respect to a casualty or other
event which may result in a loss and which occurs after January 16, 1960. If the
casualty or other event occurs on or before such date, a taxpayer may treat any loss
resulting therefrom in accordance with the rules then applicable, or, if he so desires,
in accordance with the provisions of this paragraph; but no provision of this
paragraph shall be construed to permit a deduction of the same loss or any part
thereof in more than one taxable year or to extend the period of limitations within
Federal Personal Income Tax – Fall 2009, Joondeph
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which a claim for credit or refund may be filed under section 6511.
C.
Claim of right
North American Oil Consolidated v. Burnet (1932) [CB 431]
a.
1916, 1917, or 1922?
b.
The claim of right doctrine
c.
Justifications
Facts: In 1916, the oil company was operating on land owned by the United States, when
the U.S. made a claim of beneficial ownership and filed a suit for ouster. A receiver was
appointed, who took custody of the income from the field for that year. In 1917, the TP
prevails in the District Court and the receiver turns over the 1916 income to TP. The
U.S. appeals, ultimately losing in the USSCT in 1922.
Issue: When does the TP have to report the 1916 income?
Analysis:
TP arguments are:
1. Receiver must report in 1916.
2. TP reports the income in 1916.
3. TP reports the income in 1922, after the litigation was finally terminated in its
favor.
Court rejects #1 because NAOC has income from many other sources and the receiver
won’t know the effect of the income in the context of its 1916 tax return, so it wouldn’t
be an equivalent tax result for the receiver to report the income.
Court rejects #2 because “[t]here was no constructive receipt of the profits by the
company in that year, because at no time during that year was there a right in the
company to demand that the receiver pay over the money.”
Court rejects #3 because:
Rule: If a TP 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 be
still claimed that he is not entitled to retain the money, and even thought he may still be
adjudged liable to restore its equivalent. Thus, the TP must report the income when:
1. Takes the $
2. Treats it as its own
3. Concedes no offsetting obligation
Prof: suppose the U.S. had prevailed in 1922 and NAOC had to repay the 1916 income in
that year. They would claim this as a deduction. No amendment to the income claimed
in 1917, because it wasn’t based on a mistake of fact at the time the return was filed.
United States v. Lewis (1951) [CB 433]
a.
Question of remedy
b.
Lewis’s claim
c.
Court’s holding
c.
And amended returns
Facts: Lewis received a bonus of $22k in 1944, which he reported in income. His
company says there was a calculation error and he was only entitled to receive $11K.
Federal Personal Income Tax – Fall 2009, Joondeph
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Subsequent litigation in state court results in a judgment that requires Lewis to repay
$11k in 1946 under compulsion of the court. The Commissioner says Lewis is entitled to
a deduction for this $11k repayment in 1946, but Lewis wants to amend his 1944 return
because his marginal rate in 1944 was much higher, due to high marginal tax rates
imposed during the war.
Prof: Lewis wants a credit for tax paid on the $11k in 1944. Note, this is different than a
deduction, which would reduce the amount of income claimed, whereas the credit is a
dollar-for-dollar reduction in tax owed.
Rule: same from North American Oil.
Held: The court sticks with the annual accounting principle and refuses to give him the
credit. Lewis only gets a deduction.
 This is corrected by § 1341, at least where the deduction was at least $3k. TP gets
to choose between:
o The deduction in 1946
o A credit for the decreased tax liability that would have been owed if the
deduction had been claimed in 1944.
§ 1341. Computation of tax where taxpayer restores substantial amount held under
claim of right.
(a) General rule. If-(1) an item was included in gross income for a prior taxable year (or years) because it
appeared that the taxpayer had an unrestricted right to such item;
(2) a deduction is allowable for the taxable year because it was established after the
close of such prior taxable year (or years) that the taxpayer did not have an unrestricted
right to such item or to a portion of such item; and
(3) the amount of such deduction exceeds $ 3,000,
then the tax imposed by this chapter for the taxable year shall be the lesser of the
following:
(4) the tax for the taxable year computed with such deduction; or
(5) an amount equal to-(A) the tax for the taxable year computed without such deduction, minus
(B) the decrease in tax under this chapter (or the corresponding provisions of prior
revenue laws) for the prior taxable year (or years) which would result solely from the
exclusion of such item (or portion thereof) from gross income for such prior taxable year
(or years).
For purposes of paragraph (5)(B), the corresponding provisions of the Internal
Revenue Code of 1939 shall be chapter 1 of such code (other than subchapter E, relating
to self-employment income) and subchapter E of chapter 2 of such code.
(b) Special rules.
(1) If the decrease in tax ascertained under subsection (a)(5)(B) exceeds the tax
imposed by this chapter for the taxable year (computed without the deduction) such
excess shall be considered to be a payment of tax on the last day prescribed by law for
Federal Personal Income Tax – Fall 2009, Joondeph
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the payment of tax for the taxable year, and shall be refunded or credited in the same
manner as if it were an overpayment for such taxable year.
§ 111. Recovery of tax benefit items.
(a) Deductions. Gross income does not include income attributable to the recovery
during the taxable year of any amount deducted in any prior taxable year to the extent
such amount did not reduce the amount of tax imposed by this chapter.
(c) Treatment of carryovers. For purposes of this section, an increase in a carryover
which has not expired before the beginning of the taxable year in which the recovery or
adjustment takes place shall be treated as reducing tax imposed by this chapter.
Federal Personal Income Tax – Fall 2009, Joondeph
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A primer on accounting methods
1.
Section 446
2.
The cash method
3.
The accrual method
Accounting Methods: Governed by § 446.
Cash receipts and disbursements vs. accrual. Individuals are generally on the cash
method and businesses are generally on the accrual method (tends to more accurately
reflect income).
TP usually can pick the method, with a few limitations:
 § 446a – must be consistent with the way TP keeps his books.
o Prof: business like to show more income, but this means they also have to
pay more tax.
 Gov’t retains the right to change the method of reporting income if they believe it
is more accurate.
Cash method: income when the TP receives or constructively receives the item (cash,
property, services). Liability recognized when paid.
Accrual:
 income recognized when
1. all events have occurred to secure the right
2. the amount can be determined with reasonable accuracy
 Liability recognized when the above criteria #1 and 2 are met, + economic
performance. This additional requirement prevents recognizing liability in
advance and taking deductions based on mere agreement at a certain date, when
payment may not be made for a long time.
Hypo:
2008: Attorney receives to provide document for $1000. Draws up and delivers the
document. Incurs expenses of $750.
2009: receives $1000 payment from client.
 Cash method: deduct expenses in 2008. Recognize income in 2009 when
received.
 Accrual method: deduct expenses in 2008. Recognize income in 2008 because:
o All of the events have occurred to establish the right to the income and the
amount can be determined with reasonable accuracy.
§ 446. General rule for methods of accounting.
(a) General rule. Taxable income shall be computed under the method of accounting on
the basis of which the taxpayer regularly computes his income in keeping his books.
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(b) Exceptions. If no method of accounting has been regularly used by the taxpayer, or if
the method used does not clearly reflect income, the computation of taxable income shall
be made under such method as, in the opinion of the Secretary, does clearly reflect
income.
(c) Permissible methods. Subject to the provisions of subsections (a) and (b), a taxpayer
may compute taxable income under any of the following methods of accounting-(1) the cash receipts and disbursements method;
(2) an accrual method;
(3) any other method permitted by this chapter [IRC Sections 1 et seq.]; or
(4) any combination of the foregoing methods permitted under regulations prescribed
by the Secretary.
(d) Taxpayer engaged in more than one business. A taxpayer engaged in more than one
trade or business may, in computing taxable income, use a different method of
accounting for each trade or business.
C.F.R. § 1.446-1 General rule for methods of accounting.
(c) Permissible methods--(1) In general. Subject to the provisions of paragraphs (a) and
(b) of this section, a taxpayer may compute his taxable income under any of the following
methods of accounting:
(i) Cash receipts and disbursements method. Generally, under the cash receipts and
disbursements method in the computation of taxable income, all items which
constitute gross income (whether in the form of cash, property, or services) are to be
included for the taxable year in which actually or constructively received.
Expenditures are to be deducted for the taxable year in which actually made. For
rules relating to constructive receipt, see § 1.451-2. For treatment of an expenditure
attributable to more than one taxable year, see section 461(a) and paragraph (a)(1)
of § 1.461-1.
(ii) Accrual method. (A) Generally, under an accrual method, income is to be
included for the taxable year when all the events have occurred that fix the right to
receive the income and the amount of the income can be determined with reasonable
accuracy. Under such a method, a liability is incurred, and generally is taken into
account for Federal income tax purposes, in the taxable year in which all the events
have occurred that establish the fact of the liability, the amount of the liability can be
determined with reasonable accuracy, and economic performance has occurred with
respect to the liability. (See paragraph (a)(2)(iii)(A) of § 1.461-1 for examples of
liabilities that may not be taken into account until after the taxable year incurred, and
see §§ 1.461-4 through 1.461-6 for rules relating to economic performance.)
Applicable provisions of the Code, the Income Tax Regulations, and other guidance
published by the Secretary prescribe the manner in which a liability that has been
incurred is taken into account. For example, section 162 provides that a deductible
liability generally is taken into account in the taxable year incurred through a
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deduction from gross income. As a further example, under section 263 or 263A, a
liability that relates to the creation of an asset having a useful life extending
substantially beyond the close of the taxable year is taken into account in the taxable
year incurred through capitalization (within the meaning of § 1.263A-1(c)(3)) and
may later affect the computation of taxable income through depreciation or otherwise
over a period including subsequent taxable years, in accordance with applicable
Internal Revenue Code sections and related guidance.
(B) The term “liability” includes any item allowable as a deduction, cost, or
expense for Federal income tax purposes. In addition to allowable deductions, the
term includes any amount otherwise allowable as a capitalized cost, as a cost
taken into account in computing cost of goods sold, as a cost allocable to a longterm contract, or as any other cost or expense. Thus, for example, an amount that
a taxpayer expends or will expend for capital improvements to property must be
incurred before the taxpayer may take the amount into account in computing its
basis in the property. The term “liability” is not limited to items for which a legal
obligation to pay exists at the time of payment. Thus, for example, amounts
prepaid for goods or services and amounts paid without a legal obligation to do
so may not be taken into account by an accrual basis taxpayer any earlier than
the taxable year in which those amounts are incurred.
(C) No method of accounting is acceptable unless, in the opinion of the
Commissioner, it clearly reflects income. The method used by the taxpayer in
determining when income is to be accounted for will generally be acceptable if it
accords with generally accepted accounting principles, is consistently used by the
taxpayer from year to year, and is consistent with the Income Tax Regulations.
For example, a taxpayer engaged in a manufacturing business may account for
sales of the taxpayer's product when the goods are shipped, when the product is
delivered or accepted, or when title to the goods passes to the customers, whether
or not billed, depending on the method regularly employed in keeping the
taxpayer's books.
D.
Tax benefit doctrine [See CB 155].
1.
Alice Phelin Sullivan Corp.
2.
Inclusionary side
3.
Exclusionary side
4.
Sanford & Brooks revisited
If a TP takes a deduction, and in a subsequent year an event occurs that is fundamentally
inconsistent with the premise on which the deduction was initially based, the TP must
include the amount of the prior deduction in the year of the subsequent event.
Exclusionary side: if TP derived no benefit from the prior deduction, you don’t have to
include the recovery in income when it comes back.
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Tax benefit rule doesn’t help Sanford & Brooks because there was no change or event
that rendered the deduction inappropriate. Their issue is just a timing of income
problem/mismatch of the tax years to the income received.
F.
The constructive receipt and economic benefit doctrines
§451(a); Reg. §1.451–1(a), Reg. §1.451–2
Problems: Handout 11
Constructive Receipt pp 311–324
Only matters for cash based tax payers.
 A mere promise to pay, not represented by notes or secured in any way, is not
regarded as receipt of income within the intendment of the cash receipts and
disbursements method. [CB 314].
 TP may not deliberately turn his back on income and thereby select the year for
which he will report it. It will be included if it appears that the money was:
o Available to him (his right to receive it was not restricted)
o His failure to receive it was his own choice. [CB 315].
Economic Benefit Doctrine: Two Conditions that must be satisfied for receipt of
property: [CB 310]
1. Money is set aside irrevocably (fully vested) in trust, escrow, and the like and
2. secured from the payor’s creditors
§ 451. General rule for taxable year of inclusion.
(a) General rule. The amount of any item of gross income shall be included in the gross
income for the taxable year in which received by the taxpayer, unless, under the method
of accounting used in computing taxable income, such amount is to be properly
accounted for as of a different period.
C.F.R. § 1.451-1 General rule for taxable year of inclusion.
(a) General rule. Gains, profits, and income are to be included in gross income for the
taxable year in which they are actually or constructively received by the taxpayer unless
includible for a different year in accordance with the taxpayer's method of accounting.
Under an accrual method of accounting, income is includible in gross income when all
the events have occurred which fix the right to receive such income and the amount
thereof can be determined with reasonable accuracy. Therefore, under such a method of
accounting if, in the case of compensation for services, no determination can be made as
to the right to such compensation or the amount thereof until the services are completed,
the amount of compensation is ordinarily income for the taxable year in which the
determination can be made. Under the cash receipts and disbursements method of
accounting, such an amount is includible in gross income when actually or constructively
received. Where an amount of income is properly accrued on the basis of a reasonable
estimate and the exact amount is subsequently determined, the difference, if any, shall be
taken into account for the taxable year in which such determination is made. To the
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extent that income is attributable to the recovery of bad debts for accounts charged off in
prior years, it is includible in the year of recovery in accordance with the taxpayer's
method of accounting, regardless of the date when the amounts were charged off. For
treatment of bad debts and bad debt recoveries, see sections 166 and 111 and the
regulations thereunder. For rules relating to the treatment of amounts received in crop
shares, see section 61 and the regulations thereunder. For the year in which a partner
must include his distributive share of partnership income, see section 706(a) and
paragraph (a) of § 1.706-1. If a taxpayer ascertains that an item should have been
included in gross income in a prior taxable year, he should, if within the period of
limitation, file an amended return and pay any additional tax due. Similarly, if a
taxpayer ascertains that an item was improperly included in gross income in a prior
taxable year, he should, if within the period of limitation, file claim for credit or refund of
any overpayment of tax arising therefrom.
C.F.R. § 1.451-2 Constructive receipt of income.
(a) General rule. Income although not actually reduced to a taxpayer's possession is
constructively received by him in the taxable year during which it is credited to his
account, set apart for him, or otherwise made available so that he may draw upon it at
any time, or so that he could have drawn upon it during the taxable year if notice of
intention to withdraw had been given. However, income is not constructively received if
the taxpayer's control of its receipt is subject to substantial limitations or restrictions.
Thus, if a corporation credits its employees with bonus stock, but the stock is not
available to such employees until some future date, the mere crediting on the books of the
corporation does not constitute receipt. In the case of interest, dividends, or other
earnings (whether or not credited) payable in respect of any deposit or account in a
bank, building and loan association, savings and loan association, or similar institution,
the following are not substantial limitations or restrictions on the taxpayer's control over
the receipt of such earnings:
(1) A requirement that the deposit or account, and the earnings thereon, must be
withdrawn in multiples of even amounts;
(2) The fact that the taxpayer would, by withdrawing the earnings during the taxable
year, receive earnings that are not substantially less in comparison with the earnings
for the corresponding period to which the taxpayer would be entitled had he left the
account on deposit until a later date (for example, if an amount equal to three
months' interest must be forfeited upon withdrawal or redemption before maturity of
a one year or less certificate of deposit, time deposit, bonus plan, or other deposit
arrangement then the earnings payable on premature withdrawal or redemption
would be substantially less when compared with the earnings available at maturity);
(3) A requirement that the earnings may be withdrawn only upon a withdrawal of all
or part of the deposit or account. However, the mere fact that such institutions may
pay earnings on withdrawals, total or partial, made during the last three business
days of any calendar month ending a regular quarterly or semiannual earnings
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period at the applicable rate calculated to the end of such calendar month shall not
constitute constructive receipt of income by any depositor or account holder in any
such institution who has not made a withdrawal during such period;
(4) A requirement that a notice of intention to withdraw must be given in advance of
the withdrawal. In any case when the rate of earnings payable in respect of such a
deposit or account depends on the amount of notice of intention to withdraw that is
given, earnings at the maximum rate are constructively received during the taxable
year regardless of how long the deposit or account was held during the year or
whether, in fact, any notice of intention to withdraw is given during the year.
However, if in the taxable year of withdrawal the depositor or account holder
receives a lower rate of earnings because he failed to give the required notice of
intention to withdraw, he shall be allowed an ordinary loss in such taxable year in an
amount equal to the difference between the amount of earnings previously included in
gross income and the amount of earnings actually received. See section 165 and the
regulations thereunder.
(b) Examples of constructive receipt. Amounts payable with respect to interest coupons
which have matured and are payable but which have not been cashed are constructively
received in the taxable year during which the coupons mature, unless it can be shown
that there are no funds available for payment of the interest during such year. Dividends
on corporate stock are constructively received when unqualifiedly made subject to the
demand of the shareholder. However, if a dividend is declared payable on December 31
and the corporation followed its usual practice of paying the dividends by checks mailed
so that the shareholders would not receive them until January of the following year, such
dividends are not considered to have been constructively received in December.
Generally, the amount of dividends or interest credited on savings bank deposits or to
shareholders of organizations such as building and loan associations or cooperative
banks is income to the depositors or shareholders for the taxable year when credited.
However, if any portion of such dividends or interest is not subject to withdrawal at the
time credited, such portion is not constructively received and does not constitute income
to the depositor or shareholder until the taxable year in which the portion first may be
withdrawn. Accordingly, if, under a bonus or forfeiture plan, a portion of the dividends
or interest is accumulated and may not be withdrawn until the maturity of the plan, the
crediting of such portion to the account of the shareholder or depositor does not
constitute constructive receipt. In this case, such credited portion is income to the
depositor or shareholder in the year in which the plan matures. However, in the case of
certain deposits made after December 31, 1970, in banks, domestic building and loan
associations, and similar financial institutions, the ratable inclusion rules of section
1232(a)(3) apply. See § 1.1232-3A. Accrued interest on unwithdrawn insurance policy
dividends is gross income to the taxpayer for the first taxable year during which such
interest may be withdrawn by him.
G.
Qualified retirement plans
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Most Americans have some form of deferred compensation through “qualified employee
plans.” A few ways these work:
1. E’er contributions are tax free. Exception to economic benefit doctrine, even
though the contributions are fully vested and protected from the employer’s
creditors.
2. E’ees can contribute a portion of their salary tax free. (401k, 403b)
3. Growth is untaxed.
All taxed as ordinary income at withdrawal, on the theory that it is deferred
compensation.
H.
Income from services
Income Attribution Cases: everyone agrees that there is income and the timing of
recognition is not an issue, but the dispute is about who must claim the income.
Lucas v. Earl (1930) [CB 1930]
a.
Why does it matter?
b.
Broader implications
Facts: In 1901, Mr. & Mrs. Earl enter into a K to hold his earnings in joint tenancy and
share it equally. This K was made before any personal income tax in the U.S. (passed in
1913). They each report half of the earnings on their individual tax returns.
Note: at this time, everyone filed their own income and there was no provision for jointly
owned earnings.
IRS says Mr. Earl must report all of his income on his return. Why? Marginal tax rates
result in less tax if a portion of Mr. Earl’s income is reported by W.
Rule: the IRS can tax the income beneficially received. Income from services is taxed to
the person who earned, regardless of any K to the contrary or transfers to avoid receipt of
the income. Even if the K is legally binding and enforceable against the earner. Prof: the
transfer from H to W is motivated by disinterested generosity and is a gift.
Held: Mr. Earl must report all of his earnings on his tax return.
Poe v. Seaborn (1930) [CB 942]
H & W are married. In Washington, as a matter of state property law, any income made
by a spouse was owned jointly by H&W. Each reports half of the earnings of the
community on their individual tax return.
Rule: where income division is mandated by state law, it can be divided among H & W.
Different from Lucas v. Earl because Lucas had a voluntary K, whereas Seaborn was just
following Washington’s CP laws.
TAX TREATMENT OF MARRIED COUPLES SINCE Seaborn
Prof: this creates great disparity between tax treatment between couples in CP states and
those in CL states for no good reason. It creates disuniformity in the application of
national law. This wasn’t as big of a deal at the time because most people didn’t pay
income tax and there were only a few CP states. Later, Congress changes the tax code to
create a joint filing system and bring everyone down to the tax rate that was paid in the
CP states. Married couple’s paid less tax than singles. This changed in the 1960s when it
became more acceptable not to get married. Congress responded by creating a separate
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rate schedule for individuals, which resulted in the “marriage penalty,” where two
individuals with roughly the same income level paid more tax when they got married than
they did together before marriage. Why? It is mathematically impossible to accomplish
three things at the same time:
1. Progressive rate schedule
2. Treat all married couples with the same total income identically
3. Marriage neutral
I.
Income from property
2.
Horizontal and vertical “slices”
3.
Sales distinguished
4.
Irwin v. Gavit revisited
5.
Section 1(g)
Income from property can be transferred to other people for tax purposes in some
circumstances. This requires transferring the property itself. Issue is:
 Has the TP actually transferred the property?
 Has the TP merely transferred income from property?
Blair v. Commissioner (1937) [CB 1019]
Facts: Blair owns income from a trust. He transfers a several different portions of the
interest to his children.
Analysis: Blair transferred the actual interest in the trust by assignment, so the property
itself was transferred.
Held: Blair doesn’t pay the tax. His children must pay it because they own the property.
Helvering v. Horst (1940) [CB 1030]
Facts: Horst owns a bond that has interest coupons. He transfers some of the interest
coupons to his son before the due date (maturity).
Prof: he doesn’t have constructive receipt because they haven’t matured.
Held: Horst must still pay the tax. Income to Horst and gift to the son.
Difference between Blair and Horst:
 Horst retains the underlying property (reversion interest) in the bond. Known as
vertical interest.
 Blair’s interest in the income from trust is coterminous with the interest he
assigned to his kids, meaning he retains no reversion after their interest ends.
Known as horizontal interest.
What if Blair only gave a 5 year interest to his daughter? This is not a coterminous
interest, not a property interest, which changes the result. Blair would pay the tax and the
income would be a gift to the daughter.
Main point: is the interest that has been transferred, completely coterminous with the
interest that has been transferred (no reversion behind it)? If yes, then tax liability is
transferred.
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Don’t forget the general rule, that people who receive income, they are taxed on the
income. Here, we examine an exception for circumstances in which a donor has given an
income interest while retaining a reversion interest in the property that generates that
income.
These rules don’t apply to a sale, only a gift.
If parents transfer property to a dependent property under the age of 18, the income
generated from that property will be taxed at the same rate that the parents would have
paid. § 1(g). This takes away the ability for parents to play the game with property
transfers to pay tax at a lower marginal rate.
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J.
Transfers incident to marriage and divorce
A.
B.
United States v. Davis
Section 1041
United States v. Davis (1962) [CB 991]
1.
A “taxable event”?
2.
Measuring the gain
3.
Mrs. Davis
a.
Basis?
b.
Income?
Facts: H owned 1,000 shares of stock in DuPont Corp and transfers them to W in
exchange for her release of rights against H upon divorce. Stock had been held in H’s
name and had appreciated in value.
Issue 1: Is this a taxable event? Is this a realization event?
Rule: § 1001 IRC (see Cottage Savings, S.S. White)
Analysis: Clearly there is no sale at this point, so does this fall into the “other
disposition” category?
H argues that this is like a division of property between two co-owners, which would not
be a disposition event and generates no tax. Court rejects this. Says the transfer is more
like a transfer in exchange for the release of an independent legal obligation. She has
marital rights against H and exchanges those rights for the stock.
Held: Thus, it is an exchange of legally recognized entitlements, and is a realization
event.
Issue 2: How do you measure the gain? (Note, lower court stopped here and held that the
gain couldn’t be taxed because they couldn’t ascertain the value of W’s rights in order to
calculate gain.)
Rule: Gain is the amount realized less basis (995).
Rule 2: Where two properties are exchanged in an arm’s-length transaction, it is
reasonable to presume that the value of the properties is equal.
Analysis: H’s amount received is a release of W’s property rights. W received the stock,
which can be valued.
Held: it is reasonable to presume that the value to H of the release is equal to the value of
the stock received by W.
Prof: What would W’s basis is the stock be? FMV at the date of the transfer. She has
effectively purchased the stock.
Does W have to recognize any income when she receives the stock? She is getting a
legal recovery/settlement (see Raytheon and Glenshaw Glass).
Rule: Analyze what the recovery is replacing.
Here, the stock is replacing the right to intestate succession (non-taxable), reasonable
support within the marriage (non-taxable), and help around the house (non-taxable).
Since the settlement is replacing non-taxable income, W is not taxed on the recovery.
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§ 1041. 2 rules:
1. No consequences for a transfer when done between spouses or to an ex-spouse as
an incident to divorce.
2. Tranferee takes the transferor’s basis.
Justifications for § 1041: to reduce uncertainty and greater equality.
§ 1041. Transfers of property between spouses or incident to divorce.
(a) General rule. No gain or loss shall be recognized on a transfer of property from an
individual to (or in trust for the benefit of)-(1) a spouse, or
(2) a former spouse, but only if the transfer is incident to the divorce.
(b) Transfer treated as gift; transferee has transferor's basis. In the case of any transfer
of property described in subsection (a)-(1) for purposes of this subtitle [IRC Sections 1 et seq.], the property shall be treated as
acquired by the transferee by gift, and
(2) the basis of the transferee in the property shall be the adjusted basis of the
transferor.
(c) Incident to divorce. For purposes of subsection (a)(2), a transfer of property is
incident to the divorce if such transfer-(1) occurs within 1 year after the date on which the marriage ceases, or
(2) is related to the cessation of the marriage.
(d) Special rule where spouse is nonresident alien. Subsection (a) shall not apply if the
spouse (or former spouse) of the individual making the transfer is a nonresident alien.
(e) Transfers in trust where liability exceeds basis. Subsection (a) shall not apply to the
transfer of property in trust to the extent that-(1) the sum of the amount of the liabilities assumed, plus the amount of the liabilities to
which the property is subject, exceeds
(2) the total of the adjusted basis of the property transferred.
Proper adjustment shall be made under subsection (b) in the basis of the transferee in
such property to take into account gain recognized by reason of the preceding sentence.
K.
Alimony
1.
The general scheme
2.
Before 1984
3.
Current statutory requirements
a.
§71(b) and (c)
b.
Excessive front-loading rules of §71(f)
4.
Handout 13 (problems 1–5)
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Three types of transactions that can occur incident to divorce that affect the PAYOR and
the RECIPIENT:
1. Alimony: § 215. Deduction for payor and income inclusion for recipient.
2. Child Support: § 71. No deduction for payor or inclusion for recipient.
3. Property Settlements: governed by § 1041. Treated as a gift. No deduction for
payor or inclusion for recipient.
Bernatschke v. United States (1966) [CB 982] (This case precedes the current § 71)
Facts: Couple gets divorced and H puts $$ into an annuity that pays ~$25K per year to
W. IRS says this is alimony. W says it is a property settlement. Significant because the
property settlement would be tax free and W would get basis, thus, W would only pay tax
on the gain over her basis.
Analysis: Focus is on the intent of the parties, which indicates that the payments were not
alimony
 None of them mentioned alimony
 The amount represents 1/3 of his property, which is roughly akin to her dower
rights under IL law, making it look like a property settlement.
 No discussion of her needs, or his income.
 She has the right to select the beneficiary.
 The rights to the payments don’t stop if she remarries.
Held: Payments are not alimony.
Prof: What is the tax treatment to W as an annuity.
Basis: FMV of what she got in return (equal exchange hypothesis). Can assume her
dower rights were worth $650K because that is what she received, and she used this to
purchase the annuity. Thus, her basis in the property (annuity) is $650K.
Annuities apply § 72 inclusion ratio. Assume life expectancy of 40 years.
Total investment in the K ($650K)/Expected payout ($25K/year X 40 years = 1 million)
= 35%
Amount included in income = $25K x 35% = $8,750
Amount excluded from income: $16,250
§ 71 current version: disregards intent of the parties and creates a bright line rule that
creates alimony if a payment meets certain requirements:
 Cash payment (not property, stocks, bonds, etc.)
 Pursuant to a judicial decree or a written agreement between the parties.
 Parties have not opted out of the alimony treatment by stating that the payments
are not alimony in the written agreement.
 Payor spouse and recipient spouse are not members of the same household.
(prevents divorce for tax planning reasons)
 Payment obligation stops at death. (if it were devisable, it would be more like
property and should be considered a property treatment)
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
It isn’t child support. (What matters is whether the instrument says it is child
support, or if the payment has a contingency that is dependent on the child, or
does the payment stop at a conspicuous time, such as when the child turns 18 or
21.) If so, this portion that is child support would not be considered alimony.
Front loading per § 71: if payments are excessively front-loaded, this is more like a
property settlement, so the code re-characterizes this.
 You can’t compute front loading until after year 3.
§ 71. Alimony and separate maintenance payments.
(a) General rule. Gross income includes amounts received as alimony or separate
maintenance payments.
(b) Alimony or separate maintenance payments defined. For purposes of this section-(1) In general. The term "alimony or separate maintenance payment" means any
payment in cash if-(A) such payment is received by (or on behalf of) a spouse under a divorce or
separation instrument,
(B) the divorce or separation instrument does not designate such payment as a
payment which is not includible in gross income under this section and not allowable as
a deduction under section 215 [IRC Sec. 215],
(C) in the case of an individual legally separated from his spouse under a decree of
divorce or of separate maintenance, the payee spouse and the payor spouse are not
members of the same household at the time such payment is made, and
(D) there is no liability to make any such payment for any period after the death of
the payee spouse and there is no liability to make any payment (in cash or property) as a
substitute for such payments after the death of the payee spouse.
(2) Divorce or separation instrument. The term "divorce or separation instrument"
means-(A) a decree of divorce or separate maintenance or a written instrument incident to
such a decree,
(B) a written separation agreement, or
(C) a decree (not described in subparagraph (A)) requiring a spouse to make
payments for the support or maintenance of the other spouse.
(c) Payments to support children.
(1) In general. Subsection (a) shall not apply to that part of any payment which the
terms of the divorce or separation instrument fix (in terms of an amount of money or a
part of the payment) as a sum which is payable for the support of children of the payor
spouse.
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(2) Treatment of certain reductions related to contingencies involving child. For
purposes of paragraph (1), if any amount specified in the instrument will be reduced-(A) on the happening of a contingency specified in the instrument relating to a child
(such as attaining a specified age, marrying, dying, leaving school, or a similar
contingency), or
(B) at a time which can clearly be associated with a contingency of a kind specified in
subparagraph (A),
an amount equal to the amount of such reduction will be treated as an amount fixed as
payable for the support of children of the payor spouse.
(3) Special rule where payment is less than amount specified in instrument. For
purposes of this subsection, if any payment is less than the amount specified in the
instrument, then so much of such payment as does not exceed the sum payable for support
shall be considered a payment for such support.
(d) Spouse. For purposes of this section, the term "spouse" includes a former spouse.
(e) Exception for joint returns. This section and section 215 [IRC Sec. 215] shall not
apply if the spouses make a joint return with each other.
(f) Recomputation where excess front-loading of alimony payments.
(1) In general. If there are excess alimony payments-(A) the payor spouse shall include the amount of such excess payments in gross
income for the payor spouse's taxable year beginning in the 3rd post-separation year,
and
(B) the payee spouse shall be allowed a deduction in computing adjusted gross
income for the amount of such excess payments for the payee's taxable year beginning in
the 3rd post-separation year.
(2) Excess alimony payments. For purposes of this subsection, the term "excess
alimony payments" mean the sum of-(A) the excess payments for the 1st post-separation year, and
(B) the excess payments for the 2nd post-separation year.
(3) Excess payments for 1st post-separation year. For purposes of this subsection, the
amount of the excess payments for the 1st post-separation year is the excess (if any) of-(A) the amount of the alimony or separate maintenance payments paid by the payor
spouse during the 1st post-separation year, over
(B) the sum of-(i) the average of-(I) the alimony or separate maintenance payments paid by the payor spouse
during the 2nd post-separation year, reduced by the excess payments for the 2nd postseparation year, and
(II) the alimony or separate maintenance payments paid by the payor spouse
during the 3rd post-separation year, plus
Federal Personal Income Tax – Fall 2009, Joondeph
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(ii) $ 15,000.
(4) Excess payments for 2nd post-separation year. For purposes of this subsection, the
amount of the excess payments for the 2nd post-separation year is the excess (if any) of-(A) the amount of the alimony or separate maintenance payments paid by the payor
spouse during the 2nd post-separation year, over
(B) the sum of-(i) the amount of the alimony or separate maintenance payments paid by the payor
spouse during the 3rd post-separation year, plus
(ii) $ 15,000.
(5) Exceptions.
(A) Where payment ceases by reason of death or remarriage. Paragraph (1) shall not
apply if-(i) either spouse dies before the close of the 3rd post-separation year, or the payee
spouse remarries before the close of the 3rd post-separation year, and
(ii) the alimony or separate maintenance payments cease by reason of such death or
remarriage.
(B) Support payments. For purposes of this subsection, the term "alimony or separate
maintenance payment" shall not include any payment received under a decree described
in subsection (b)(2)(C).
(C) Fluctuating payments not within control of payor spouse. For purposes of this
subsection, the term "alimony or separate maintenance payment" shall not include any
payment to the extent it is made pursuant to a continuing liability (over a period of not
less than 3 years) to pay a fixed portion or portions of the income from a business or
property or from compensation for employment or self-employment.
(6) Post-separation years. For purposes of this subsection, the term "1st postseparation years" means the 1st calendar year in which the payor spouse paid to the
payee spouse alimony or separate maintenance payments to which this section applies.
The 2nd and 3rd post-separation years shall be the 1st and 2nd succeeding calendar
years, respectively.
(g) Cross References.
(1) For deduction of alimony or separate maintenance payments, see section 215 [IRC
Sec. 215].
(2) For taxable status of income of an estate or trust in the case of divorce, etc., see
section 682 [IRC Sec. 682].
Excessive front-loading rules under §71(f) [Joondeph]
Section 71(f), which is quite mechanistic, mandates that if the supposed alimony
payments are excessively front-loaded, the excessive amounts must be “recaptured” in
the third year after the divorce. In the third year, the excessive amounts are deducted by
the recipient and are “recaptured”—that is, included in income—by the payor.
Consider the example of supposed alimony on the following schedule:
Federal Personal Income Tax – Fall 2009, Joondeph
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Year 1
Year 2
Year 3
$75,000 (Y1)
$75,000 (Y2)
$10,000 (Y3)
Step 1: Compute the excess payment for Year 2
XSY2 = Y2 – ($15,000 + Y3)
= $75,000 – ($10,000 + $15,000)
= $50,000
Step 2: Compute the excess payment for Year 1
XSY1 = Y1 – ($15,000 + Y2*/Y3 avg.)
=
amount of Y2 payment that qualifies as alimony (that is, Y2 –
Y2*
XSY2)
Y2* =
$75,000 – $50,000 = $25,000
Y2*/Y3 avg.= ($25,000 + $10,000) / 2 = $17,500
XSY1 = $75,000 – ($15,000 + $17,500)
= $75,000 – $32,500 = $42,500
Total excess payments
= $50,000 + $42,500 = $92,500
* * *
Thus, in this example, the total amount of excessively front-loaded payments (which we
cannot compute until Year 3 is complete) is $92,500.
As a result, in Year 3 the recipient is entitled to a deduction of $92,500, and the payor
must include $92,500 in income.
L.
Child support
A.
The basic rules
B.
Payments in default: Diez-Arguelles
1.
Bad debt generally
2.
Basis
C.
Handout 13 (problem 6)
§ 1041 limits transfers of property as “incidents of divorce” only for 1 year, but CFR
above says 6 years. Which is it?
Beyond 6 years, nothing qualifies. Within 1 year, it always qualifies, regardless of what
the decree/instrument says. If it is between year 2 – 6, the payment must be pursuant to
the decree/instrument in order to qualify under § 1041.
Diaz-Arguelles
W and H divorce and H is ordered to pay child support. By 1998, H is behind in
payments for about $4400 and $3000 behind in 1999.
Federal Personal Income Tax – Fall 2009, Joondeph
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W declares these back payments as a non-business bad debt per § 166 and deducted the
amount from gross income.
TP argument. Per § 166, “where any nonbusiness debt becomes worthless within the
taxable year, the loss resulting therefrom shall be considered a loss from the sale or
exchange, during the taxable year, of a capital asset held for not more than 1 year.”
Capital losses are only deductible to the extent of capital gains + $3,00 per year. If W
doesn’t have gains to offset, she can only deduct $3k.
Court rejects TP argument because she has no basis in the debt.
§ 166. Bad debts.
(a) General rule.
(1) Wholly worthless debts. There shall be allowed as a deduction any debt which
becomes worthless within the taxable year.
(2) Partially worthless debts. When satisfied that a debt is recoverable only in part, the
Secretary may allow such debt, in an amount not in excess of the part charged off within
the taxable year, as a deduction.
(b) Amount of deduction. For purposes of subsection (a), the basis for determining the
amount of the deduction for any bad debt shall be the adjusted basis provided in section
1011 [IRC Sec. 1011] for determining the loss from the sale or other disposition of
property.
(d) Nonbusiness debts.
(1) General rule. In the case of a taxpayer other than a corporation-(A) subsection (a) shall not apply to any nonbusiness debt; and
(B) where any nonbusiness debt becomes worthless within the taxable year, the loss
resulting therefrom shall be considered a loss from the sale or exchange, during the
taxable year, of a capital asset held for not more than 1 year.
(2) Nonbusiness debt defined. For purposes of paragraph (1), the term "nonbusiness
debt" means a debt other than-(A) a debt created or acquired (as the case may be) in connection with a trade or
business of the taxpayer; or
(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade
or business.
(e) Worthless securities. This section shall not apply to a debt which is evidenced by a
security as defined in section 165(g)(2)(C) [IRC Sec. 165(g)(2)(c)].
(f) Cross references.
(1) For disallowance of deduction for worthlessness of debts owed by political parties
and similar organizations, see section 271 [IRC Sec. 271].
(2) For special rule for banks with respect to worthless securities, see section 582 [IRC
Sec. 582].
Federal Personal Income Tax – Fall 2009, Joondeph
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§ 215. Alimony, etc., payments.
(a) General rule. 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.
(b) Alimony or separate maintenance payments defined. For purposes of this section, the
term "alimony or separate maintenance payment" means any alimony or separate
maintenance payment (as defined in section 71(b)) which is includible in the gross
income of the recipient under section 71.
Federal Personal Income Tax – Fall 2009, Joondeph
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M.
An overview of deductions
1.
What are they?
2.
What is their value?
3.
Basic statutory framework
4.
Overarching limitations
a.
Standard vs. itemized deductions
b.
Section 68
c.
Section 67
Deductions: are reductions in the income that is reported by the TP and the impact of a
deduction depends on the TP’s marginal rate.
 It is necessary that the TP has actually expended something (or is being treated as
though they have expended something). Deductions are fundamentally different
that exclusions.
 Ask: Can the TP reduce her income to account for the expenditure?
Rationale:
 To arrive at a better measure of income (such as ordinary and necessary business
expenses that determine the true net income of the business)
 Better measure ability to pay
 Non-tax subsidies
§ 162: If we have an expense that is incurred as part of an effort to generate income, it
can be deducted.
§ 262: this is the other end of the spectrum. Personal and family expenses are not
deductible from income. Prof: if these expenses were deducible, there would be no tax
base.
Discussion of above the line and below the line deductions, and Form 1040.
Below the line:
 Itemized Deductions (claimed by roughly 35%, particularly home owners. Most
are personal and not for the generation of income, such as extraordinary medical
expenses, personal casualty losses, home mortgage interest, state and local taxes,
charitable contributions) OR
 Standard Deduction: (claimed by 65%) effectively creates a 0% rate bracket,
combined with personal exemptions.
§ 162. Trade or business expenses.
(a) In general. 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,
including-Federal Personal Income Tax – Fall 2009, Joondeph
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(1) a reasonable allowance for salaries or other compensation for personal services
actually rendered;
(2) traveling expenses (including amounts expended for meals and lodging other than
amounts which are lavish or extravagant under the circumstances) while away from
home in the pursuit of a trade or business; and
(3) rentals or other payments required to be made as a condition to the continued use
or possession, for purposes of the trade or business, of property to which the taxpayer
has not taken or is not taking title or in which he has no equity.
For purposes of the preceding sentence, the place of residence of a Member of Congress
(including any Delegate and Resident Commissioner) within the State, congressional
district, or possession which he represents in Congress shall be considered his home, but
amounts expended by such Members within each taxable year for living expenses shall
not be deductible for income tax purposes in excess of $ 3,000. For purposes of
paragraph (2), the taxpayer shall not be treated as being temporarily away from home
during any period of employment if such period exceeds 1 year. The preceding sentence
shall not apply to any Federal employee during any period for which such employee is
certified by the Attorney General (or the designee thereof) as traveling on behalf of the
United States in temporary duty status to investigate or prosecute, or provide support
services for the investigation or prosecution of, a Federal crime.
§ 262. Personal, living, and family expenses.
(a) General rule. Except as otherwise expressly provided in this chapter [IRC Sections 1
et seq.], no deduction shall be allowed for personal, living, or family expenses.
OVERARCHING LIMITATIONS
§ 68 is a phase-down of the itemized deductions. If adjusted gross income gets above a
certain threshold ($166,800 for 2009, indexed to inflation), they start losing a portion of
the itemized deductions. Threshold amount is the same for married couples as singles,
imposing a big marriage penalty. If over the threshold, REDUCE by the LESSER of
these two:
 3% of AGI over threshold OR
 80% of otherwise allowable deductions.
 Ex.: AGI $266,800 is over threshold by $200K. 3% of this is $6,000, so itemized
deductions are reduced by this. However, the phase down cannot eliminate more
than 80% of their itemized deductions.
 Changes in the law: 3% goes down to 2% in 2009, 1% in 2010, and then comes
back again in 2011 as 3%.
§ 68. Overall limitation on itemized deductions.
Federal Personal Income Tax – Fall 2009, Joondeph
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(a) General rule In the case of an individual whose adjusted gross income exceeds the
applicable amount, the amount of the itemized deductions otherwise allowable for the
taxable year shall be reduced by the lesser of-(1) 3 percent of the excess of adjusted gross income over the applicable amount, or
(2) 80 percent of the amount of the itemized deductions otherwise allowable for such
taxable year.
(b) Applicable amount [Caution: For taxable years beginning in 2009, see § 3.11 of Rev.
Proc. 2008-66 (26 USCS § 1 note) for provision that the "applicable amount" of adjusted
gross income under this subsection, above which the amount of otherwise allowable
itemized deductions is reduced under this section, is $ 166,800 (or $ 83,400 for a
separate return filed by a married individual).].
(1) In general. For purposes of this section, the term "applicable amount" means $
100,000 ($ 50,000 in the case of a separate return by a married individual within the
meaning of section 7703).
(2) Inflation adjustments. In the case of any taxable year beginning in a calendar year
after 1991, each dollar amount contained in paragraph (1) shall be increased by an
amount equal to-(A) such dollar amount, multiplied by
(B) the cost-of-living adjustment determined under section 1(f)(3) for the calendar
year in which the taxable year begins, by substituting "calendar year 1990" for "calendar
year 1992" in subparagraph (B) thereof.
(c) Exception for certain itemized deductions. For purposes of this section, the term
"itemized deductions" does not include-(1) the deduction under section 213 (relating to medical, etc. expenses),
(2) any deduction for investment interest (as defined in section 163(d)), and
(3) the deduction under section 165(a) for casualty or theft losses described in
paragraph (2) or (3) of section 165(c) or for losses described in section 165(d).
(d) Coordination with other limitations. This section shall be applied after the
application of any other limitation on the allowance of any itemized deduction.
§ 67 places a limit on “miscellaneous itemized deductions.”
 Defined in a negative way. All deductions except…
o Unreimbursed employee business expenses. There is a floor on this.
Expenses must exceed 2% of gross income. This knocks out most of these
expenses and only gives a deduction for those that are significant.
 The principal miscellaneous deductions are: [CB 546]
o Unreimbursed employee business expenses
o Investment expenses
o Tax counsel
o Assistance fees
o Hobby expenses
Federal Personal Income Tax – Fall 2009, Joondeph
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

Legislative History: Since many TPs incur some expenses that are allowable as
miscellaneous itemized deductions, but these expenses commonly are small in
amount, Congress concluded that the complexity created by prior law was
undesirable. But, TPs with unusually large employee business or investment
expenses should be allowed to deduct them. The use of the deduction floor also
takes into account that some miscellaneous expenses are sufficiently personal in
nature that they would be incurred apart from any business or investment
activities (membership dues to professional orgs, subscriptions to publications).
[CB 547]
§ 67 was enacted with § 274(n), which disallows 50% of certain otherwise
deductible expenses for food, drink, and entertainment. [CB 548]
§ 67. 2-percent floor on miscellaneous itemized deductions.
(a) General rule. In the case of an individual, the miscellaneous itemized deductions for
any taxable year shall be allowed only to the extent that the aggregate of such deductions
exceeds 2 percent of adjusted gross income.
(b) Miscellaneous itemized deductions. For purposes of this section, the term
"miscellaneous itemized deductions" means the itemized deductions other than-(1) the deduction under section 163 (relating to interest),
(2) the deduction under section 164 (relating to taxes),
(3) the deduction under section 165(a) for casualty or theft losses described in
paragraph (2) or (3) of section 165(c) or for losses described in section 165(d),
(4) the deductions under section 170 (relating to charitable, etc., contributions and
gifts) and section 642(c) (relating to deduction for amounts paid or permanently set aside
for a charitable purpose),
(5) the deduction under section 213 (relating to medical, dental, etc., expenses),
(6) any deduction allowable for impairment-related work expenses,
(7) the deduction under section 691(c) (relating to deduction for estate tax in case of
income in respect of the decedent),
(8) any deduction allowable in connection with personal property used in a short sale,
(9) the deduction under section 1341 (relating to computation of tax where taxpayer
restores substantial amount held under claim of right),
(10) the deduction under section 72(b)(3) (relating to deduction where annuity
payments cease before investment recovered),
(11) the deduction under section 171 (relating to deduction for amortizable bond
premium), and
(12) the deduction under section 216 (relating to deductions in connection with
cooperative housing corporations).
(13) [Redesignated]
N.
Casualty losses
1.
The purpose of §165(c)(3)
Federal Personal Income Tax – Fall 2009, Joondeph
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2.
3.
Definition
Handout 14
§ 165(c) Only personal deduction we will discuss.
 Personal casualty losses: general rule is that losses are deductible. However, no
deductions are allowed on personal assets from mere personal consumption. The
one exception for this is a casualty loss.
 The loss must be sustained. Must be a “closed and completed transaction.” Is
there is a reasonable prospect of recovery, there is no deduction until the prospect
is extinguished.
 Must be no compensation for the loss (involuntary conversion).
 Rule [CB 598]: “other casualty” is generally held whenever a force is applied to
property which the owner/TP is either unaware of because of the hidden nature of
such application or is powerless to act to prevent the same because of the
suddenness thereof.
 Deduction is the lesser of:
o Decline in FMV OR
o TP’s adjusted Basis
o Not compensated by insurance
 Reduced by $100 per casualty event (to eliminate negligible claims)
 Deduction not to exceed 10% of AGI floor
§ 165. Losses.
(a) General rule. There shall be allowed as a deduction any loss sustained during the
taxable year and not compensated for by insurance or otherwise.
(b) Amount of deduction. For purposes of subsection (a), the basis for determining the
amount of the deduction for any loss shall be the adjusted basis provided in section 1011
for determining the loss from the sale or other disposition of property.
(c) Limitation on losses of individuals. In the case of an individual, the deduction under
subsection (a) shall be limited to
(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered into for profit, though not connected with
a trade or business; and
(3) except as provided in subsection (h), losses of property not connected with a trade
or business or a transaction entered into for profit, if such losses arise from fire, storm,
shipwreck, or other casualty, or from theft.
(h) Treatment of casualty gains and losses.
(1) $ 100 limitation per casualty. Any loss of an individual described in subsection
(c)(3) shall be allowed only to the extent that the amount of the loss to such individual
Federal Personal Income Tax – Fall 2009, Joondeph
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arising from each casualty, or from each theft, exceeds $ 500 ($ 100 for taxable years
beginning after December 31, 2009).
(2) Net casualty loss allowed only to the extent it exceeds 10 percent of adjusted gross
income.
(A) In general. If the personal casualty losses for any taxable year exceed the
personal casualty gains for such taxable year, such losses shall be allowed for the
taxable year only to the extent of the sum of-(i) the amount of the personal casualty gains for the taxable year, plus
(ii) so much of such excess as exceeds 10 percent of the adjusted gross income of
the individual.
(B) Special rule where personal casualty gains exceed personal casualty losses. If the
personal casualty gains for any taxable year exceed the personal casualty losses for such
taxable year-(i) all such gains shall be treated as gains from sales or exchanges of capital assets,
and
(ii) all such losses shall be treated as losses from sales or exchanges of capital
assets.
(3) Special rule for losses in federally declared disasters.
(A) In general. If an individual has a net disaster loss for any taxable year, the
amount determined under paragraph (2)(A)(ii) shall be the sum of-(i) such net disaster loss, and
(ii) so much of the excess referred to in the matter preceding clause (i) of
paragraph (2)(A) (reduced by the amount in clause (i) of this subparagraph) as exceeds
10 percent of the adjusted gross income of the individual.
(B) Net disaster loss. For purposes of subparagraph (A), the term "net disaster loss"
means the excess of-(i) the personal casualty losses-(I) attributable to a federally declared disaster occurring before January 1, 2010,
and
(II) occurring in a disaster area, over
(ii) personal casualty gains.
(C) Federally declared disaster. For purposes of this paragraph-(i) Federally declared disaster. The term "federally declared disaster" means any
disaster subsequently determined by the President of the United States to warrant
assistance by the Federal Government under the Robert T. Stafford Disaster Relief and
Emergency Assistance Act.
(ii) Disaster area. The term "disaster area" means the area so determined to
warrant such assistance.
C.F.R. § 1.165-7 Casualty losses.
(a) In general--(1) Allowance of deduction. Except as otherwise provided in paragraphs
(b)(4) and (c) of this section, any loss arising from fire, storm, shipwreck, or other
casualty is allowable as a deduction under section 165(a) for the taxable year in which
the loss is sustained. However, see § 1.165-6, relating to farming losses, and § 1.165-11,
relating to an election by a taxpayer to deduct disaster losses in the taxable year
Federal Personal Income Tax – Fall 2009, Joondeph
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immediately preceding the taxable year in which the disaster occurred. The manner of
determining the amount of a casualty loss allowable as a deduction in computing taxable
income under section 63 is the same whether the loss has been incurred in a trade or
business or in any transaction entered into for profit, or whether it has been a loss of
property not connected with a trade or business and not incurred in any transaction
entered into for profit. The amount of a casualty loss shall be determined in accordance
with paragraph (b) of this section. For other rules relating to the treatment of deductible
casualty losses, see § 1.1231-1, relating to the involuntary conversion of property.
(2) Method of valuation. (i) In determining the amount of loss deductible under this
section, the fair market value of the property immediately before and immediately
after the casualty shall generally be ascertained by competent appraisal. This
appraisal must recognize the effects of any general market decline affecting
undamaged as well as damaged property which may occur simultaneously with the
casualty, in order that any deduction under this section shall be limited to the actual
loss resulting from damage to the property.
(ii) The cost of repairs to the property damaged is acceptable as evidence of the loss
of value if the taxpayer shows that (a) the repairs are necessary to restore the
property to its condition immediately before the casualty, (b) the amount spent for
such repairs is not excessive, (c) the repairs do not care for more than the damage
suffered, and (d) the value of the property after the repairs does not as a result of the
repairs exceed the value of the property immediately before the casualty.
(b) Amount deductible--(1) General rule. In the case of any casualty loss whether or not
incurred in a trade or business or in any transaction entered into for profit, the amount of
loss to be taken into account for purposes of section 165(a) shall be the lesser of either-(i) The amount which is equal to the fair market value of the property immediately
before the casualty reduced by the fair market value of the property immediately after
the casualty; or
(ii) The amount of the adjusted basis prescribed in § 1.1011-1 for determining the
loss from the sale or other disposition of the property involved.
However, if property used in a trade or business or held for the production of income
is totally destroyed by casualty, and if the fair market value of such property
immediately before the casualty is less than the adjusted basis of such property, the
amount of the adjusted basis of such property shall be treated as the amount of the
loss for purposes of section 165(a).
O.
Travel and entertainment
1.
“Mixed motive” expenses generally
2.
Statutory framework
3.
Rudolph v. United States
a.
Question presented
Federal Personal Income Tax – Fall 2009, Joondeph
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4.
5.
6.
b.
Court’s disposition
c.
Standard of §162
Section 274
The interaction of §§ 132, 162, and 274
Moss v. Commissioner
Personal Deductions (travel and entertainment) ASK:
1. Deduction Permitted per § 162? Is this an ordinary and necessary business
expense (§ 162(a) – standard for this is laid out in Rudolph).
2. Deduction disallowed per § 274?
Rudolph v. United States (1962) [CB 668]
Facts: Rudolph and his wife go on a trip to New York City, provided by his employer,
Southland Insurance Company, along with 150 other agents. One morning was devoted
to a business meeting and group luncheon, the rest of the time to travel, sightseeing,
entertainment, fellowship or free time. The entire trip lasted a week. Rudolph didn’t
include the value of this trip in his income. The IRS assessed a deficiency for the value
of the trip. Writ of certiorari dismissed.
Prof: it is a factual determination as to whether it is an ordinary and necessary business
expense and there is no clear error.
Justice Harlan analyzed the case in a separate opinion. Looked at two questions:
1. Is this includable in income?
2. If Rudolph had to pay for it himself, would it be a deduction under 162(a)?
Prof: these are essentially the same question because a working condition fringe
Rule: is the primary purpose/dominant motive for the expense business related? If yes, it
is deductible under § 162(a).
Held: here, the primary purpose was not business related, and thus, not deductible.
§ 274 is an overlay to § 162: those expenses that constitute entertainment, travel, etc.,
certain expenses are reduced or disallowed that would otherwise qualify under § 162.
What does 274 do?
 Sets up a stricter standard for deductions than § 162 [§ 274(a)(1)(A).
 Some business expenses to generate goodwill are not deductible.
o Directly related to a bonifide business discussion at the dinner/event, or
o immediately preceding the entertainment.
 (d) creates a number of substantiation requirements for the expenditures. (see
(d)(4)). Burden is on TP to substantiate.
 Business meal expense cannot be lavish or extravagant under the circumstances.
Meals at nice restaurants are OK. This provision is rarely used.
 § 274(n) imposes the 50% limitation on all meal and entertainment expenses.
 The limitations apply to the TP who ultimately claims the deduction, regardless of
the person/employee/company representative that actually enjoys the meal.
Federal Personal Income Tax – Fall 2009, Joondeph
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Example: Adobe e’ee entertains a customer:
 Takes a cab ($20) to dinner ($100) and a Shark’s game ($120). She is reimbursed
$240 by the e’er.
Discuss business at the
Doesn’t discuss business at
dinner (meets the directly
the dinner (or before or
related test)
after), and doesn’t qualify
under § 274
Employee
Receives the benefit of the
She still gets to exclude it
dinner and game, but doesn’t
under § 132(d). It is
have to report any benefit
sufficient that it meets the
because it is a working
primary purpose test and she
condition fringe under §
doesn’t have to worry about
132(d), where the expense
§ 274. However, the e’er
qualifies as a deduction under
must
§ 162.
Employer
Gets the deduction, but limited No deduction for
by 50%. Deduction is $110.
amusement, recreation, or
Cab ride is not considered
entertainment, but the cab
entertainment, meals or
ride is deductible (so long as
recreation, so this still entitles
it satisfies the primary
the employer to a $20
purpose test of § 162(a)).
deduction.
§ 274. Disallowance of certain entertainment, etc., expenses.
(a) Entertainment, amusement, or recreation.
(1) In general. No deduction otherwise allowable under this chapter shall be allowed
for any item-(A) Activity. With respect to an activity which is of a type generally considered to
constitute entertainment, amusement, or recreation, unless the taxpayer establishes that
the item was directly related to, or, in the case of an item directly preceding or following
a substantial and bona fide business discussion (including business meetings at a
convention or otherwise), that such item was associated with, the active conduct of the
taxpayer's trade or business, or
(B) Facility. With respect to a facility used in connection with an activity referred to
in subparagraph (A).
In the case of an item described in subparagraph (A), the deduction shall in no event
exceed the portion of such item which meets the requirements of subparagraph (A).
(2) Special rules. For purposes of applying paragraph (1)-(A) Dues or fees to any social, athletic, or sporting club or organization shall be
treated as items with respect to facilities.
(B) An activity described in section 212 [expenses for the production of income,
income property, or tax determination] shall be treated as a trade or business.
Federal Personal Income Tax – Fall 2009, Joondeph
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(C) In the case of a club, paragraph (1)(B) shall apply unless the taxpayer establishes
that the facility was used primarily for the furtherance of the taxpayer's trade or business
and that the item was directly related to the active conduct of such trade or business.
(3) Denial of deduction for club dues. Notwithstanding the preceding provisions of this
subsection, no deduction shall be allowed under this chapter for amounts paid or
incurred for membership in any club organized for business, pleasure, recreation, or
other social purpose.
(d) Substantiation required. No deduction or credit shall be allowed-(1) under section 162 or 212 for any traveling expense (including meals and lodging
while away from home),
(2) for any item with respect to an activity which is of a type generally considered to
constitute entertainment, amusement, or recreation, or with respect to a facility used in
connection with such an activity,
(3) for any expense for gifts, or
(4) with respect to any listed property (as defined in section 280F(d)(4)),
unless the taxpayer substantiates by adequate records or by sufficient evidence
corroborating the taxpayer's own statement (A) the amount of such expense or other item,
(B) the time and place of the travel, entertainment, amusement, recreation, or use of the
facility or property, or the date and description of the gift, (C) the business purpose of the
expense or other item, and (D) the business relationship to the taxpayer of persons
entertained, using the facility or property, or receiving the gift. The Secretary may by
regulations provide that some or all of the requirements of the preceding sentence shall
not apply in the case of an expense which does not exceed an amount prescribed
pursuant to such regulations. This subsection shall not apply to any qualified
nonpersonal use vehicle (as defined in subsection (i)).
(e) Specific exceptions to application of subsection (a). Subsection (a) shall not apply to(1) Food and beverages for employees. Expenses for food and beverages (and facilities
used in connection therewith) furnished on the business premises of the taxpayer
primarily for his employees.
(2) Expenses treated as compensation.
(A) In general. Except as provided in subparagraph (B), expenses for goods,
services, and facilities, to the extent that the expenses are treated by the taxpayer, with
respect to the recipient of the entertainment, amusement, or recreation, as compensation
to an employee on the taxpayer's return of tax under this chapter and as wages to such
employee for purposes of chapter 24 (relating to withholding of income tax at source on
wages).
(B) Specified individuals.
(i) In general. In the case of a recipient who is a specified individual, subparagraph
(A) and paragraph (9) shall each be applied by substituting "to the extent that the
expenses do not exceed the amount of the expenses which" for "to the extent that the
expenses".
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(ii) Specified individual. For purposes of clause (i), the term "specified individual"
means any individual who-(I) is subject to the requirements of section 16(a) of the Securities Exchange Act
of 1934 with respect to the taxpayer or a related party to the taxpayer, or
(II) would be subject to such requirements if the taxpayer (or such related party)
were an issuer of equity securities referred to in such section.
For purposes of this clause, a person is a related party with respect to another
person if such person bears a relationship to such other person described in section
267(b) or 707(b).
(3) Reimbursed expenses. Expenses paid or incurred by the taxpayer, in connection
with the performance by him of services for another person (whether or not such other
person is his employer), under a reimbursement or other expense allowance arrangement
with such other person, but this paragraph shall apply-(A) where the services are performed for an employer, only if the employer has not
treated such expenses in the manner provided in paragraph (2), or
(B) where the services are performed for a person other than an employer, only if the
taxpayer accounts (to the extent provided by subsection (d)) to such person.
(4) Recreational, etc., expenses for employees. Expenses for recreational, social, or
similar activities (including facilities therefor) primarily for the benefit of employees
(other than employees who are highly compensated employees (within the meaning of
section 414(q)). For purposes of this paragraph, an individual owning less than a 10percent interest in the taxpayer's trade or business shall not be considered a shareholder
or other owner, and for such purposes an individual shall be treated as owning any
interest owned by a member of his family (within the meaning of section 267(c)(4)). This
paragraph shall not apply for purposes of subsection (a)(3).
(5) Employee, stockholder, etc., business meetings. Expenses incurred by a taxpayer
which are directly related to business meetings of his employees, stockholders, agents, or
directors.
(6) Meetings of business leagues, etc. Expenses directly related and necessary to
attendance at a business meeting or convention of any organization described in section
501(c)(6) (relating to business leagues, chambers of commerce, real estate boards, and
boards of trade) and exempt from taxation under section 501(a).
(7) Items available to public. Expenses for goods, services, and facilities made
available by the taxpayer to the general public.
(8) Entertainment sold to customers. Expenses for goods or services (including the use
of facilities) which are sold by the taxpayer in a bona fide transaction for an adequate
and full consideration in money or money's worth.
(9) Expenses includible in income of persons who are not employees. Expenses paid or
incurred by the taxpayer for goods, services, and facilities to the extent that the expenses
are includible in the gross income of a recipient of the entertainment, amusement, or
recreation who is not an employee of the taxpayer as compensation for services rendered
or as a prize or award under section 74. The preceding sentence shall not apply to any
amount paid or incurred by the taxpayer if such amount is required to be included (or
would be so required except that the amount is less than $ 600) in any information return
filed by such taxpayer under part III of subchapter A of chapter 61 and is not so included.
Federal Personal Income Tax – Fall 2009, Joondeph
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For purposes of this subsection, any item referred to in subsection (a) shall be treated as
an expense.
(k) Business meals.
(1) In general. No deduction shall be allowed under this chapter for the expense of any
food or beverages unless-(A) such expense is not lavish or extravagant under the circumstances, and
(B) the taxpayer (or an employee of the taxpayer) is present at the furnishing of such
food or beverages.
(2) Exceptions. Paragraph (1) shall not apply to-(A) any expense described in paragraph (2), (3), (4), (7), (8), or (9) of subsection (e),
and
(B) any other expense to the extent provided in regulations.
(l) Additional limitations on entertainment tickets.
(1) Entertainment tickets.
(A) In general. In determining the amount allowable as a deduction under this
chapter for any ticket for any activity or facility described in subsection (d)(2), the
amount taken into account shall not exceed the face value of such ticket.
(B) Exception for certain charitable sports events. Subparagraph (A) shall not apply
to any ticket for any sports event-(i) which is organized for the primary purpose of benefiting an organization which
is described in section 501(c)(3) and exempt from tax under section 501(a),
(ii) all of the net proceeds of which are contributed to such organization, and
(iii) which utilizes volunteers for substantially all of the work performed in carrying
out such event.
(2) Skyboxes, etc. In the case of a skybox or other private luxury box leased for more
than 1 event, the amount allowable as a deduction under this chapter with respect to such
events shall not exceed the sum of the face value of non-luxury box seat tickets for the
seats in such box covered by the lease. For purposes of the preceding sentence, 2 or more
related leases shall be treated as 1 lease.
(m) Additional limitations on travel expenses.
(1) Luxury water transportation.
(A) In general. No deduction shall be allowed under this chapter for expenses
incurred for transportation by water to the extent such expenses exceed twice the
aggregate per diem amounts for days of such transportation. For purposes of the
preceding sentence, the term "per diem amounts" means the highest amount generally
allowable with respect to a day to employees of the executive branch of the Federal
Government for per diem while away from home but serving in the United States.
(B) Exceptions. Subparagraph (A) shall not apply to-(i) any expense allocable to a convention, seminar, or other meeting which is held
on any cruise ship, and
(ii) any expense described in paragraph (2), (3), (4), (7), (8), or (9) of subsection
(e).
Federal Personal Income Tax – Fall 2009, Joondeph
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(2) Travel as form of education. No deduction shall be allowed under this chapter for
expenses for travel as a form of education.
(3) Travel expenses of spouse, dependent, or others. No deduction shall be allowed
under this chapter (other than section 217) for travel expenses paid or incurred with
respect to a spouse, dependent, or other individual accompanying the taxpayer (or an
officer or employee of the taxpayer) on business travel, unless-(A) the spouse, dependent, or other individual is an employee of the taxpayer,
(B) the travel of the spouse, dependent, or other individual is for a bona fide business
purpose, and
(C) such expenses would otherwise be deductible by the spouse, dependent, or other
individual.
(n) Only 50 percent of meal and entertainment expenses allowed as deduction.
(1) In general. The amount allowable as a deduction under this chapter for-(A) any expense for food or beverages, and
(B) any item with respect to an activity which is of a type generally considered to
constitute entertainment, amusement, or recreation, or with respect to a facility used in
connection with such activity,
shall not exceed 50 percent of the amount of such expense or item which would (but for
this paragraph) be allowable as a deduction under this chapter.
(2) Exceptions. Paragraph (1) shall not apply to any expense if-(A) such expense is described in paragraph (2), (3), (4), (7), (8), or (9) of subsection
(e),
(B) in the case of an expense for food or beverages, such expense is excludable from
the gross income of the recipient under section 132 by reason of subsection (e) thereof
(relating to de minimis fringes),
Moss v. Commissioner (1985) [CB 676]
Facts: small law firm representing clients in insurance defense. Lawyers are in court all
day, most days. Senior partner has to bless all settlements, so lawyers meet at a local café
for lunch every day to discuss cases.
Moss argues that these are ordinary and necessary expenses per § 162(a).
Analysis: directly related to, immediately preceding, or following business discussion?
Yes. But problem is with § 162, because judge says that the primary purpose of the lunch
isn’t business.
Prof: when might food be necessary? For “social lubrication,” “fosters camaraderie and
makes business dealings friendlier and easier. It thus reduces the costs of transaction
business…” At least, don’t need this daily, but if they met less often, the expenses might
be deductible. But, no one disputes that the meeting was unnecessary, so if there were
costs to the meeting, those would be deductible.
Held: Not deductible.
Business meals [Handout 15]: ASK
 Is there something about the interaction of the two where having the meal
together would change the interaction (social lubrication)
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o Nature of the relationship
o Frequency
Childcare and Commuting (Mixed Business and Personal Expenses Continued)
Communing expenses and child care: the administrative burden of determining when
these motivated by personal or business reasons is too big, so the regulations have erred
on the side of categorically determined that these will always be personal (although there
are still deductible travel expenses). However, § 21 has created some credit for childcare
expenses.
CHILDCARE
 Congress has provided two ways to help people with childcare:
o § 129: exclusion of up to $5k for dependent care services extended from
an employer to an employee, per year, per tax return. Covered by § 125,
so constructive receipt does not apply, where e’ees can take this as a
benefit (rather than salary) and it is still excludable.
 § 21 Congress decided to provide some relief through § 21.
o Smith (1940) [CB 643]
o Controlling precedent that childcare expenses are considered to be
personal expenses (even though part of the reason for them might be that a
parent is working).
o Credit: reduces tax liability. Provided for:
 Must be employment related expenses, in order to be gainfully
employed.
 (b)(2): care of qualified individual or services in the home.
 Qualified individuals:
 Children under age 13
 Dependent or spouse physically or mentally incapable of
taking care of themselves.
o Multiply (Employment related expenses) X (applicable %) = CREDIT
o Applicable %: 35% for AGI from $0 to $15K. Phases down to 20% as a
floor of 20%
o Credit cannot exceed
 the salary of the lower earning spouse or
 $3,000 for 1 child or $6,000 for 2 children
o This section works together with § 129. Typically, a person must either
chose to take the deductions under § 129 or provide their own childcare
under § 21, but it will be usually be determined by whether an employer
offers childcare. To the extent that the TP excludes under § 129, the credit
here must be reduced.
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

Example: AGI %20K. Applicable % is 32%. They receive $5,000 worth of
childcare from the employer. Assume marginal tax rate of 15%.
o Credit: $5,000 X 32% = $1600 credit
o If they exclude the $5,000 from income, they save $5,000 X 15% = $750.
o Thus, they are better off taking the credit here.
Childcare: can be preschool, babysitter, etc. Pretty flexible. Overnight camps are
disqualified, but day camp is usually OK.
Policy implications of deductions, credits, etc.
 The structure of the tax code creates a disincentive for a second income earner in
a married couple to go to work, because their income is combined for purposes of
applying marginal tax rates. So, the second earner, instead of getting the benefit
of the 0% tax bracket on their first dollars, they come into the work force at the
higher marginal rate. Combined with the cost of childcare, it is very difficult for
the second income earner to make enough money to incentivize him/her to work.
§ 21. Expenses for household and dependent care services necessary for gainful
employment.
(a) Allowance of credit.
(1) In general [Caution: For provisions applicable to taxable years beginning on or
before Dec. 31, 2004, see note below relating to amendment made by § 203 of P.L. 108311.]. In the case of an individual for which there are 1 or more qualifying individuals
(as defined in subsection (b)(1)) with respect to such individual, there shall be allowed as
a credit against the tax imposed by this chapter [IRC Sections 1 et seq.] for the taxable
year an amount equal to the applicable percentage of the employment-related expenses
(as defined in subsection (b)(2)) paid by such individual during the taxable year.
(2) Applicable percentage defined. For purposes of paragraph (1), the term 'applicable
percentage' means 35 percent reduced (but not below 20 percent) by 1 percentage point
for each $ 2,000 (or fraction thereof) by which the taxpayer's adjusted gross income for
the taxable year exceeds $ 15,000.
(b) Definitions of qualifying individual and employment-related expenses. For purposes
of this section-(1) Qualifying individual. The term "qualifying individual" means-(A) a dependent of the taxpayer (as defined in section 152(a)(1) [IRC Sec. 152(a)(1)])
who has not attained age 13,
(B) a dependent of the taxpayer (as defined in section 152 [IRC Sec. 152], determined
without regard to subsections (b)(1), (b)(2), and (d)(1)(B)) who is physically or mentally
incapable of caring for himself or herself and who has the same principal place of abode
as the taxpayer for more than one-half of such taxable year, or
(C) the spouse of the taxpayer, if the spouse is physically or mentally incapable of
caring for himself or herself and who has the same principal place of abode as the
taxpayer for more than one-half of such taxable year.
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(2) Employment-related expenses.
(A) In general. The term 'employment-related expenses' means amounts paid for the
following expenses, but only if such expenses are incurred to enable the taxpayer to be
gainfully employed for any period for which there are 1 or more qualifying individuals
with respect to the taxpayer:
(i) expenses for household services, and
(ii) expenses for the care of a qualifying individual.
Such term shall not include any amount paid for services outside the taxpayer's
household at a camp where the qualifying individual stays overnight.
(B) Exception. Employment-related expenses described in subparagraph (A) which
are incurred for services outside the taxpayer's household shall be taken into account
only if incurred for the care of-(i) a qualifying individual described in paragraph (1)(A), or
(ii) a qualifying individual (not described in paragraph (1)(A)) who regularly
spends at least 8 hours each day in the taxpayer's household.
(C) Dependent care centers. Employment-related expenses described in
subparagraph (A) which are incurred for services provided outside the taxpayer's
household by a dependent care center (as defined in subparagraph (D)) shall be taken
into account only if-(i) such center complies with all applicable laws and regulations of a State or unit
of local government, and
(ii) the requirements of subparagraph (B) are met.
(D) Dependent care center defined. For purposes of this paragraph, the term
'dependent care center' means any facility which-(i) provides care for more than six individuals (other than individuals who reside at
the facility), and
(ii) receives a fee, payment, or grant for providing services for any of the
individuals (regardless of whether such facility is operated for profit).
(c) Dollar limit on amount creditable. The amount of the employment-related expenses
incurred during any taxable year which may be taken into account under subsection (a)
shall not exceed-(1) $ 3,000 if there is 1 qualifying individual with respect to the taxpayer for such
taxable year, or
(2) $ 6,000 if there are 2 or more qualifying individuals with respect to the taxpayer for
such taxable year.
The amount determined under paragraph (1) or (2) (whichever is applicable) shall be
reduced by the aggregate amount excludable from gross income under section 129 [IRC
Sec. 129] for the taxable year.
(d) Earned income limitation.
(1) In general. Except as otherwise provided in this subsection, the amount of the
employment-related expenses incurred during any taxable year which may be taken into
account under subsection (a) shall not exceed--
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(A) in the case of an individual who is not married at the close of such year, such
individual's earned income for such year, or
(B) in the case of an individual who is married at the close of such year, the lesser of
such individual's earned income or the earned income of his spouse for such year.
(2) Special rule for spouse who is a student or incapable of caring for himself. In the
case of a spouse who is a student or a qualifying individual described in subsection
(b)(1)(C), for purposes of paragraph (1), such spouse shall be deemed for each month
during which such spouse is a full-time student at an educational institution, or is such a
qualifying individual, to be gainfully employed and to have earned income of not less
than-(A) $ 250 if subsection (c)(1) applies for the taxable year, or
(B) $ 500 if subsection (c)(2) applies for the taxable year.
In the case of any husband and wife, this paragraph shall apply with respect to only
one spouse for any one month.
COMMUTING: What is the line that distinguishes commuting expenses (nondeductible) from travel expense (deductible)? See Handout 16.
Moving expense § 217: A new job must be at least 50 miles farther from his former
residence than was his former principal place of work.
Also, must work for a substantial amount of time after the move. This prevents moving
for retirement purposes and then only working for a week to try to create a deductible
expense.
Commissioner v. Flowers (1945) [CB 654]
Facts: Lawyer took a job with a railroad based in Mobile, but kept his home in Jackson.
Tried to deduct his trips between the two cities.
Rule: Three conditions must be satisfied before a traveling expense deduction may be
made under § 162(a)(2):
1. The expense must be a reasonable and necessary traveling expense
2. Must be incurred while “away from home.”
3. Must be incurred in pursuit of business.
Analysis: the railroad did not require him to travel on business from Jackson to Mobile or
to maintain living quarters in both cities. All of his work in Jackson could normally have
been performed in the HQ at Mobile. The railroad gained nothing from the arrangement,
except the personal satisfaction of the TP. The exigencies of business and not the
personal convenience of the TP must be the motivating factors.
Held: Such is not the case here. The expenditures are non-deductible living and personal
expenses.
§ 162. Trade or business expenses.
(a) In general. 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,
including-Federal Personal Income Tax – Fall 2009, Joondeph
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(2) traveling expenses (including amounts expended for meals and lodging other than
amounts which are lavish or extravagant under the circumstances) while away from
home in the pursuit of a trade or business; and




Tax home: the place at which the TP conducts the trade or business. [CB 659]
Home depends on whether the post is temporary (such as filling in for a person on
sick leave) or permanent. [CB 660]. Even if the e’ee is conducting a trade or
business each year at the same two recurring, seasonal places of e’mt, the tax
home does not shift during alternate seasons, but remains stationary at the
principal post of duty throughout the taxable year.
Temporary = employment expected to last for less than one year. The expenses
are deductible so long as, and at every point until the TP reasonable expects the
assignment to be less than one year (otherwise, the home is too permanent and not
deductible). ASK: at every point, does the TP believe that he will only be there
for a year?
OVERNIGHT RULE to determine whether an e’ee is considered to be on travel
status:
o when the trip lasts substantially longer than an ordinary day’s work,
o the e’ee cannot reasonably be expected to make the trip without being
released from duty for sufficient time to obtain substantial sleep or rest,
and
o the release from duty is with the e’er’s acquiescence or is required by
regulations.
Hantzis v. Commissioner (1981) [CB 662]
Facts: during law school, woman gets a summer job in New York, but her husband stays
in Massachusetts. TP tried to deduct her expenses related to traveling to between NY and
MA, her meals, and her apartment in NY.
Issue: is the reason for her maintenance of a second home related to a trade or business?
Rule: only a TP who lives in one place, works in another and has business ties to both is
in the ambiguous situation that the temporary employment doctrine is designed to solve.
§ 217. Moving expenses.
(a) Deduction allowed. There shall be allowed as a deduction moving expenses paid or
incurred during the taxable year in connection with the commencement of work by the
taxpayer as an employee or as a self-employed individual at a new principal place of
work.
(b) Definition of moving expenses.
(1) In general. For purposes of this section, the term "moving expenses" means only
the reasonable expenses-(A) of moving household goods and personal effects from the former residence to the
new residence, and
Federal Personal Income Tax – Fall 2009, Joondeph
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(B) of traveling (including lodging) from the former residence to the new place of
residence.
Such term shall not include any expenses for meals.
(c) Conditions for allowance. No deduction shall be allowed under this section unless-(1) the taxpayer's new principal place of work-(A) is at least 50 miles farther from his former residence than was his former
principal place of work, or
(B) if he had no former principal place of work, is at least 50 miles from his former
residence, and
(2) either-(A) during the 12-month period immediately following his arrival in the general
location of his new principal place of work, the taxpayer is a full-time employee, in such
general location, during at least 39 weeks, or
(B) during the 24-month period immediately following his arrival in the general
location of his new principal place of work, the taxpayer is a full-time employee or
performs services as a self-employed individual on a full-time basis, in such general
location, during at least 78 weeks, of which not less than 39 weeks are during the 12month period referred to in subparagraph (A).
For purposes of paragraph (1), the distance between two points shall be the shortest of
the more commonly traveled routes between such two points.
CFR § 1.62–2 Reimbursements and other expense allowance arrangements.
(e) Substantiation--(1) In general. An arrangement meets the requirements of this
paragraph (e) if it requires each business expense to be substantiated to the payor in
accordance with paragraph (e)(2) or (e)(3) of this section, whichever is applicable,
within a reasonable period of time. See § 1.274–5T or § 1.162–17.
(2) Expenses governed by section 274(d). An arrangement that reimburses travel,
entertainment, use of a passenger automobile or other listed property, or other
business expenses governed by section 274(d) meets the requirements of this
paragraph (e)(2) if information sufficient to satisfy the substantiation requirements of
section 274(d) and the regulations thereunder is submitted to the payor. See § 1.274–
5. Under section 274(d), information sufficient to substantiate the requisite elements
of each expenditure or use must be submitted to the payor. For example, with respect
to travel away from home, § 1.274–5(b)(2) requires that information sufficient to
substantiate the amount, time, place, and business purpose of the expense must be
submitted to the payor. Similarly, with respect to use of a passenger automobile or
other listed property, § 1.274–5(b)(6) requires that information sufficient to
substantiate the amount, time, use, and business purpose of the expense must be
submitted to the payor. See § 1.274–5(g) and (j), which grant the Commissioner the
authority to establish optional methods of substantiating certain expenses.
Substantiation of the amount of a business expense in accordance with rules
prescribed pursuant to the authority granted by § 1.274–5(g) or (j) will be treated as
substantiation of the amount of such expense for purposes of this section.
Federal Personal Income Tax – Fall 2009, Joondeph
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(3) Expenses not governed by section 274(d). An arrangement that reimburses
business expenses not governed by section 274(d) meets the requirements of this
paragraph (e)(3) if information is submitted to the payor sufficient to enable the
payor to identify the specific nature of each expense and to conclude that the expense
is attributable to the payor's business activities. Therefore, each of the elements of an
expenditure or use must be substantiated to the payor. It is not sufficient if an
employee merely aggregates expenses into broad categories (such as “travel”) or
reports individual expenses through the use of vague, nondescriptive terms (such as
“miscellaneous business expenses”). See § 1.162–17(b).
P.
Current expenses and capital expenditures
1.
A note on terminology
2.
The concept of capitalization
3.
Some examples
QUESTION: Must ask this for any expenditure that is incurred while generating income.
Distinction between current expenses (immediately deductible in the year in which the
expenditure was incurred) and capital expenditures (goes into the relevant asset’s basis)
on the other.
 Adding to basis allows the capital expenditure to be recovered later. Either when:
o depreciation expense (if a wasting asset) is recognized later.
o Ultimate disposition (on a non-wasting asset, such as land).
 Note that in business contexts, companies always want the current deduction.
However, for improvements to a personal residence, which are non-deductible, a
TP would prefer to add these to their basis to recognize a lower gain upon sale.
Capital asset: an asset the sale of which will generate a capital gain/loss. Generally
considered all property other than inventory.
 This is different than capitalization, which means that a cost is added to an asset’s
basis.
Capitalization: any cost, direct or indirect, that goes towards the creation or acquisition
of a long-lived (more than 1 year) asset must be capitalized.
Ex. 1: TP purchases vacant land.
 Must be capitalized because it lasts for more than 1 year. It is a capital
expenditure that goes into the basis.
 Depreciation allowance? No, because it is a non-wasting asset.
Ex. 2: TP purchases an office building.
 Capital expenditure adds to the basis.
 Depreciation: land does not depreciate. The building is a wasting asset, so this
portion can be depreciated.
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Ex. 3: TP pays rent for space in a building. Here, it depends on what the building is
being used to do. If it is being used by a law firm, these services are not contributing to a
long-lived asset, so the rent would be immediately deductible. If instead, the rent is being
paid to house attorneys that are working on a patent, the rent would have to be capitalized
as part of the costs to create the patent (a capital asset).
Mt. Morris Drive-In Theatre, Co. (1955) [CB 766]
1.
Nature of dispute
2.
Holding and implications
3.
Repairs vs. improvements
Facts: Neighboring land owners. Owner of the northern parcel changes the grade of the
property to have a better view of the stream. This creates flooding on the neighboring
south parcel, which damages crops, etc. Southern owner sues, and they settle with an
agreement for Mt. Morris to create a drainage system. Mt. Morris is a business, so they
take a deduction as the cost of settlement. Commissioner classifies this as a capital
expenditure that benefits the drive-in.
Why: Majority argues that the expense should have been incurred while building the
theatre as a normal need for the construction. They can’t just avoid doing foreseeable
work, do it a year later, and then call it an expense.
Held: the cost of acquiring and constructing the drainage system was a capital
expenditure.
Repairs (expensed) vs. Improvements (capital cost): If you have damage to business
property, you can take an immediate deduction for this under § 165. This will be
measured by the cost to repair. Alternatively, you can add the cost to the basis, but also
deduct for the expense to repair, keeping basis the same and getting the immediate
deduction. Gets to the same result with two different approaches.
 Improvements take on their own basis because they occur at a different time than
the asset was first put into use.
Commissioner v. Idaho Power Co. (1974) [CB 770]
1.
The first layer
2.
The second layer
3.
Section 263A
4.
Capitalization generally
5.
Cost of goods sold
6.
Exceptions
Facts: company buys trucks that are used to construct a power plant.
Hypothetical facts: 5-year property, cost of $50K. There is no immediate deduction at
the purchase because they are a long-lived asset. Instead, the $50K must be capitalized,
going into the basis of the trucks.
Held: There is a depreciation deduction of $10K per year. However, here, the
depreciation cannot be expensed, because it is really an investment into the asset (power
plant) and has to be capitalized into the cost of building the power plant, as a cost of
creating another long-lived asset.
Federal Personal Income Tax – Fall 2009, Joondeph
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§ 263: Congress passed to provide more clarification and ensure consistent application.
Costs incurred in creating inventory must be capitalized into an inventory account. When
sold, the expense is recognized through cost of goods sold.
 The provisions causes interest and taxes to be added to the basis of constructed
property. [CB 778]
 Broker commissions for the purchase and sale of securities must be capitalized.
This makes them ultimately a charge against capital gain at the security’s
disposition, rather than a charge against ordinary income. [CB 779].
 Investment advisor’s fees are immediately deductible, as are many other things,
merely as a matter of convention.
Exceptions:
 Research and Development costs are immediately expendable (§ 174)
 Self-generated expenses for goodwill/marketing are immediately deductible, don’t
create basis.
 § 179 creates a safe harbor for small businesses. They can exempt themselves out
of this process of tracking capital expenditures. It allows them to take immediate
deductions if their expenditures don’t reach the threshold.
§ 174. Research and experimental expenditures.
(a) Treatment as expenses.
(1) In general. A taxpayer may treat research or experimental expenditures which are
paid or incurred by him during the taxable year in connection with his trade or business
as expenses which are not chargeable to capital account. The expenditures so treated
shall be allowed as a deduction.
§ 263. Capital expenditures.
(a) General rule. No deduction shall be allowed for-(1) Any amount paid out for new buildings or for permanent improvements or
betterments made to increase the value of any property or estate. This paragraph shall
not apply to-(A) expenditures for the development of mines or deposits deductible under section
616,
(B) research and experimental expenditures deductible under section 174,
(C) soil and water conservation expenditures deductible under section 175,
(D) expenditures by farmers for fertilizer, etc., deductible under section 180,
(E) expenditures for removal of architectural and transportation barriers to the
handicapped and elderly which the taxpayer elects to deduct under section 190,
(F) expenditures for tertiary injectants with respect to which a deduction is allowed
under section 193;
(G) expenditures for which a deduction is allowed under section 179;
Federal Personal Income Tax – Fall 2009, Joondeph
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(H) expenditures for which a deduction is allowed under section 179A,
(I) expenditures for which a deduction is allowed under section 179B,
(J) expenditures for which a deduction is allowed under section 179C,
(K) expenditures for which a deduction is allowed under section 179D, or
(L) expenditures for which a deduction is allowed under section 179E.
(2) Any amount expended in restoring property or in making good the exhaustion
thereof for which an allowance is or has been made.
C.F.R. § 1.162-4 Repairs.
The cost of incidental repairs which neither materially add to the value of the property
nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition,
may be deducted as an expense, provided the cost of acquisition or production or the
gain or loss basis of the taxpayer's plant, equipment, or other property, as the case may
be, is not increased by the amount of such expenditures. Repairs in the nature of
replacements, to the extent that they arrest deterioration and appreciably prolong the life
of the property, shall either be capitalized and depreciated in accordance with section
167 or charged against the depreciation reserve if such an account is kept.
C.F.R. § 1.263(a)-1 Capital expenditures; In general.
(a) Except as otherwise provided in chapter 1 of the Code, no deduction shall be allowed
for:
(1) Any amount paid out for new buildings or for permanent improvements or
betterments made to increase the value of any property or estate, or
(2) Any amount expended in restoring property or in making good the exhaustion
thereof for which an allowance is or has been made in the form of a deduction for
depreciation, amortization, or depletion.
(b) In general, the amounts referred to in paragraph (a) of this section include amounts
paid or incurred (1) to add to the value, or substantially prolong the useful life, of
property owned by the taxpayer, such as plant or equipment, or (2) to adapt property to a
new or different use. Amounts paid or incurred for incidental repairs and maintenance of
property are not capital expenditures within the meaning of subparagraphs (1) and (2) of
this paragraph. See section 162 and § 1.162-4. See section 263A and the regulations
thereunder for cost capitalization rules which apply to amounts referred to in paragraph
(a) of this section with respect to the production of real and tangible personal property
(as defined in § 1.263A-1T(a)(5)(iii)), including films, sound recordings, video tapes,
books, or similar properties. An amount referred to in paragraph (a) of this section is a
capital expenditure that is taken into account through inclusion in inventory costs or a
charge to capital accounts or basis no earlier than the taxable year during which the
amount is incurred within the meaning of § 1.446-1(c)(1)(ii). See section 263A and the
regulations thereunder for cost capitalization rules that apply to amounts referred to in
paragraph (a) of this section with respect to the production of real and tangible personal
property (as defined in § 1.263A-2(a)(2)), including films, sound recordings, video tapes,
books, or similar properties.
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(c) The provisions of paragraph (a)(1) of this section shall not apply to expenditures
deductible under:
(1) Section 616 and §§ 1.616-1 through 1.616-3, relating to the development of mines
or deposits,
(2) Section 174 and §§ 1.174-1 through 1.174-4, relating to research and
experimentation,
(3) Section 175 and §§ 1.175-1 through 1.175-6, relating to soil and water
conservation,
(4) relating to election to expense certain depreciable business assets,
(5) relating to expenditures by farmers for fertilizer, lime, etc., and
(6)relating
to
expenditures
by
farmers
for
clearing
land.
Federal Personal Income Tax – Fall 2009, Joondeph
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Q.
Depreciation
1.
Useful life
2.
Applicable method
3.
Applicable convention
4.
Other details
Purposes for setting Rates and Methods: [CB 864-865]
 Income measurement: estimating the useful life of equipment to include this in
the cost of goods.
 Ease of administration: use standardized rates instead of allowing TPs to
calculate actual useful lives of their assets.
 Investment stimulus: faster depreciation stimulates investment in depreciable
assets.
Mechanics of depreciation
 Must be an asset used for business purposes. Primary purpose is to generate
income. Personal assets are not eligible for depreciation.
 Must be a wasting asset. Something with an indefinite life (land) would not be
subject to depreciation.
 Must know:
o Useful life of the asset.
o Date placed in service
o Method of spreading the basis. 2 parts;
 Applicable method (straight-line, double declining balance)
 Applicable convention (what do we do in the first and last year of
the asset’s use?).
 Mid Year: generally used for tangible personal property.
You get ½ of the annual depreciation amount for the first
and last month of the asset’s use.
 Mid Month: real property. If it is disposed in January, you
get 23/24s of the depreciation
 Depreciation is calculated from the perspective of each TP. If a depreciable asset
is transferred, the new owner recalculates the depreciation.
o Exception for gifts: Recipient stands in the shoes of the donor (similar to
carry-over basis)
 Adjustments to basis: all depreciation deductions reduce the asset’s basis. Even if
the TP doesn’t report the deduction on the return.
 Recapture (only applies to tangible personal property. NOT to real estate.): if a
TP sells depreciable property at a gain, to the extent the gain is a result of
depreciation deductions, that amount has to be reported as ordinary income. Any
gain above the amount of the depreciation deductions can be capital gain.
Federal Personal Income Tax – Fall 2009, Joondeph
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§ 167. Depreciation.
(a) General rule. There shall be allowed as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear (including a reasonable allowance for
obsolescence)-(1) of property used in the trade or business, or
(2) of property held for the production of income.
(c) Basis for depreciation.
(1) In general. The basis on which exhaustion, wear and tear, and obsolescence are to
be allowed in respect of any property shall be the adjusted basis provided in section
1011, for the purpose of determining the gain on the sale or other disposition of such
property.
(2) Special rule for property subject to lease. If any property is acquired subject to a
lease-(A) no portion of the adjusted basis shall be allocated to the leasehold interest, and
(B) the entire adjusted basis shall be taken into account in determining the
depreciation deduction (if any) with respect to the property subject to the lease.
§ 168. Accelerated cost recovery system. [SKIM]
(a) General rule. Except as otherwise provided in this section, the depreciation
deduction provided by section 167(a) for any tangible property shall be determined by
using-(1) the applicable depreciation method,
(2) the applicable recovery period, and
(3) the applicable convention.
(b) Applicable depreciation method. For purposes of this section-(1) In general. Except as provided in paragraphs (2) and (3), the applicable
depreciation method is-(A) the 200 percent declining balance method,
(B) switching to the straight line method for the 1st taxable year for which using the
straight line method with respect to the adjusted basis as of the beginning of such year
will yield a larger allowance.
(2) 150 percent declining balance method in certain cases. Paragraph (1) shall be
applied by substituting "150 percent" for "200 percent" in the case of-(A) any 15-year or 20-year property not referred to in paragraph (3),
(B) any property used in a farming business (within the meaning of section
263A(e)(4) [IRC Sec. 263A(e)(4)]),
(C) any property (other than property described in paragraph (3)) which is a
qualified smart electric meter or qualified smart electric grid system, or
(D) any property (other than property described in paragraph (3)) with respect to
which the taxpayer elects under paragraph (5) to have the provisions of this paragraph
apply.
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(3) Property to which straight line method applies. The applicable depreciation
method shall be the straight line method in the case of the following property:
(A) Nonresidential real property.
(B) Residential rental property.
(C) Any railroad grading or tunnel bore.
(D) Property with respect to which the taxpayer elects under paragraph (5) to have
the provisions of this paragraph apply.
(E) Property described in subsection (e)(3)(D)(ii).
(F) Water utility property described in subsection (e)(5).
(G) Qualified leasehold improvement property described in subsection (e)(6).
(H) Qualified restaurant property described in subsection (e)(7).
(I) Qualified retail improvement property described in subsection (e)(8).
(4) Salvage value treated as zero. Salvage value shall be treated as zero.
(5) Election. An election under paragraph (2)(C) or (3)(D) may be made with respect
to 1 or more classes of property for any taxable year and once made with respect to any
class shall apply to all property in such class placed in service during such taxable year.
Such an election, once made, shall be irrevocable.
(c) Applicable recovery period. For purposes of this section, the applicable recovery
period shall be determined in accordance with the following table:
The applicable
In the case of:
recovery period is:
3-year property ............... 3 years
5-year property ............... 5 years
7-year property ............... 7 years
10-year property .............. 10 years
15-year property .............. 15 years
20-year property .............. 20 years
Water utility property ........... 25 years
Residential rental property ......... 27.5 years
Nonresidential real property ........ 39 years
Any railroad grading or tunnel bore ..... 50 years
(d) Applicable convention. For purposes of this section-(1) In general. Except as otherwise provided in this subsection, the applicable
convention is the half-year convention.
(2) Real property. In the case of-(A) nonresidential real property,
(B) residential rental property, and
(C) any railroad grading or tunnel bore,
the applicable convention is the mid-month convention.
Federal Personal Income Tax – Fall 2009, Joondeph
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(3) Special rule where substantial property placed in service during last 3 months of
taxable year.
(A) In general. Except as provided in regulations, if during any taxable year-(i) the aggregate bases of property to which this section applies placed in service
during the last 3 months of the taxable year, exceed
(ii) 40 percent of the aggregate bases of property to which this section applies
placed in service during such taxable year,
the applicable convention for all property to which this section applies placed in
service during such taxable year shall be the mid-quarter convention.
(B) Certain property not taken into account. For purposes of subparagraph (A), there
shall not be taken into account-(i) any nonresidential real property, residential rental property, and railroad
grading or tunnel bore, and
(ii) any other property placed in service and disposed of during the same taxable
year.
(4) Definitions.
(A) Half-year convention. The half-year convention is a convention which treats all
property placed in service during any taxable year (or disposed of during any taxable
year) as placed in service (or disposed of) on the mid-point of such taxable year.
(B) Mid-month convention. The mid-month convention is a convention which treats
all property placed in service during any month (or disposed of during any month) as
placed in service (or disposed of) on the mid-point of such month.
(C) Mid-quarter convention. The mid-quarter convention is a convention which treats
all property placed in service during any quarter of a taxable year (or disposed of during
any quarter of a taxable year) as placed in service (or disposed of) on the mid-point of
such quarter.
(e) Classification of property. For purposes of this section-(1) In general. Except as otherwise provided in this subsection, property shall be
classified under the following table:
If such property has a class
Property shall be treated as:
life (in years) of:
3-year property ........4 or less
5-year property ........More than 4 but less than 10
7-year property ........10 or more but less than 16
10-year property .......16 or more but less than 20
15-year property .......20 or more but less than 25
20-year property .......25 or more.
(2) Residential rental or nonresidential real property.
(A) Residential rental property.
(i) Residential rental property. The term "residential rental property" means any
building or structure if 80 percent or more of the gross rental income from such building
or structure for the taxable year is rental income from dwelling units.
(ii) Definitions. For purposes of clause (i)-Federal Personal Income Tax – Fall 2009, Joondeph
Page 106
(I) the term "dwelling unit" means a house or apartment used to provide living
accommodations in a building or structure, but does not include a unit in a hotel, motel,
or other establishment more than one-half of the units in which are used on a transient
basis, and
(II) if any portion of the building or structure is occupied by the taxpayer, the
gross rental income from such building or structure shall include the rental value of the
portion so occupied.
(B) Nonresidential real property. The term "nonresidential real property" means
section 1250 property which is not-(i) residential rental property, or
(ii) property with a class life of less than 27.5 years.
(3) Classification of certain property.
(A) 3-year property. The term "3-year property" includes-(i) any race horse-(I) which is placed in service before January 1, 2014, and
(II) which is placed in service after December 31, 2013, and which is more than 2
years old at the time such horse is placed in service by such purchaser,
(ii) any horse other than a race horse which is more than 12 years old at the time it
is placed in service, and
(iii) any qualified rent-to-own property.
(B) 5-year property. The term "5-year property" includes-(i) any automobile or light general purpose truck,
(ii) any semi-conductor manufacturing equipment,
(iii) any computer-based telephone central office switching equipment,
(iv) any qualified technological equipment,
(v) any section 1245 property used in connection with research and
experimentation,
(vi) any property which-(I) is described in subparagraph (A) of section 48(a)(3) [IRC Sec. 48(a)(3)] (or
would be so described if "solar or wind energy" were substituted for "solar energy" in
clause (i) thereof and the last sentence of such section did not apply to such
subparagraph),
(II) is described in paragraph (15) of section 48(l) [IRC Sec. 48(1)] (as in effect
on the day before the date of the enactment of the Revenue Reconciliation Act of 1990
[enacted Nov. 5, 1990]) and is a qualifying small power production facility within the
meaning of section 3(17)(C) of the Federal Power Act (16 U.S.C. 796(17)(C)), as in
effect on September 1, 1986, or
(III) is described in section 48(l)(3)(A)(ix) [IRC Sec. 48(1)(3)(A)(ix)] (as in effect
on the day before the date of the enactment of the Revenue Reconciliation Act of 1990
[enacted Nov. 5, 1990]), and
(vii) any machinery or equipment (other than any grain bin, cotton ginning asset,
fence, or other land improvement) which is used in a farming business (as defined in
section 263A(e)(4) [IRC Sec. 263A(e)(4)]), the original use of which commences with the
taxpayer after December 31, 2008, and which is placed in service before January 1,
2010.
Federal Personal Income Tax – Fall 2009, Joondeph
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Nothing in any provision of law shall be construed to treat property as not being
described in clause (vi)(I) (or the corresponding provisions of prior law) by reason of
being public utility property (within the meaning of section 48(a)(3) [IRC Sec. 48(a)(3)]).
(C) 7-year property. The term "7-year property" includes-(i) any railroad track and
(ii) any motorsports entertainment complex,
(iii) any Alaska natural gas pipeline,
(iv) any natural gas gathering line the original use of which commences with the
taxpayer after April 11, 2005, and
(v) any property which-(I) does not have a class life, and
(II) is not otherwise classified under paragraph (2) or this paragraph.
(D) 10-year property. The term "10-year property" includes-(i) any single purpose agricultural or horticultural structure (within the meaning of
subsection (i)(13)),
(ii) any tree or vine bearing fruit or nuts,
(iii) any qualified smart electric meter, and
(iv) any qualified smart electric grid system.
(E) 15-year property. The term "15-year property" includes-(i) any municipal wastewater treatment plant,
(ii) any telephone distribution plant and comparable equipment used for 2-way
exchange of voice and data communications,
(iii) any section 1250 property which is a retail motor fuels outlet (whether or not
food or other convenience items are sold at the outlet),
(iv) any qualified leasehold improvement property placed in service before January
1, 2010,
(v) any qualified restaurant property placed in service before January 1, 2010,
(vi) initial clearing and grading land improvements with respect to gas utility
property,
(vii) any section 1245 property (as defined in section 1245(a)(3) [IRC Sec.
1245(a)(3)]) used in the transmission at 69 or more kilovolts of electricity for sale and
the original use of which commences with the taxpayer after April 11, 2005,
(viii) any natural gas distribution line the original use of which commences with the
taxpayer after April 11, 2005, and which is placed in service before January 1, 2011, and
(ix) any qualified retail improvement property placed in service after December 31,
2008, and before January 1, 2010.
(F) 20-year property. The term "20-year property" means initial clearing and
grading land improvements with respect to any electric utility transmission and
distribution plant.
(4) Railroad grading or tunnel bore. The term "railroad grading or tunnel bore"
means all improvements resulting from excavations (including tunneling), construction of
embankments, clearings, diversions of roads and streams, sodding of slopes, and from
similar work necessary to provide, construct, reconstruct, alter, protect, improve,
replace, or restore a roadbed or right-of-way for railroad track.
(5) Water utility property. The term "water utility property" means property--
Federal Personal Income Tax – Fall 2009, Joondeph
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(A) which is an integral part of the gathering, treatment, or commercial distribution
of water, and which, without regard to this paragraph, would be 20-year property, and
(B) any municipal sewer.
(6) Qualified leasehold improvement property. The term "qualified leasehold
improvement property" has the meaning given such term in section 168(k)(3) [IRC Sec.
168(k)(3)] except that the following special rules shall apply:
(A) Improvements made by lessor. In the case of an improvement made by the person
who was the lessor of such improvement when such improvement was placed in service,
such improvement shall be qualified leasehold improvement property (if at all) only so
long as such improvement is held by such person.
(B) Exception for changes in form of business. Property shall not cease to be
qualified leasehold improvement property under subparagraph (A) by reason of-(i) death,
(ii) a transaction to which section 381(a) [IRC Sec. 381(a)] applies,
(iii) a mere change in the form of conducting the trade or business so long as the
property is retained in such trade or business as qualified leasehold improvement
property and the taxpayer retains a substantial interest in such trade or business,
(iv) the acquisition of such property in an exchange described in section 1031,
1033, or 1038 [IRC Sec. 1031, 1033, or 1038] to the extent that the basis of such
property includes an amount representing the adjusted basis of other property owned by
the taxpayer or a related person, or
(v) the acquisition of such property by the taxpayer in a transaction described in
section 332, 351, 361, 721, or 731 [IRC Sec. 332, 351, 361, 721, or 731] (or the
acquisition of such property by the taxpayer from the transferee or acquiring corporation
in a transaction described in such section), to the extent that the basis of the property in
the hands of the taxpayer is determined by reference to its basis in the hands of the
transferor or distributor.
(7) Qualified restaurant property.
(A) In general. The term "qualified restaurant property" means any section 1250
[IRC Sec. 1250] property which is-(i) a building, if such building is placed in service after December 31, 2008, and
before January 1, 2010, or
(ii) an improvement to a building,
if more than 50 percent of the building's square footage is devoted to preparation of,
and seating for on-premises consumption of, prepared meals.
(B) Exclusion from bonus depreciation. Property described in this paragraph shall
not be considered qualified property for purposes of subsection (k).
(8) Qualified retail improvement property.
(A) In general. The term "qualified retail improvement property" means any
improvement to an interior portion of a building which is nonresidential real property if-(i) such portion is open to the general public and is used in the retail trade or
business of selling tangible personal property to the general public, and
(ii) such improvement is placed in service more than 3 years after the date the
building was first placed in service.
(B) Improvements made by owner. In the case of an improvement made by the owner
of such improvement, such improvement shall be qualified retail improvement property
Federal Personal Income Tax – Fall 2009, Joondeph
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(if at all) only so long as such improvement is held by such owner. Rules similar to the
rules under paragraph (6)(B) shall apply for purposes of the preceding sentence.
(C) Certain improvements not included. Such term shall not include any improvement
for which the expenditure is attributable to-(i) the enlargement of the building,
(ii) any elevator or escalator,
(iii) any structural component benefitting a common area, or
(iv) the internal structural framework of the building.
(D) Exclusion from bonus depreciation. Property described in this paragraph shall
not be considered qualified property for purposes of subsection (k).
(E) Termination. Such term shall not include any improvement placed in service after
December 31, 2009.
The principal effect of § 197 is to allow 15-year straight-line amortization of goodwill
and goind concern value and the like, things for which formerly no amortization was
allowed at all. [CB 860].
Excluded from § 197: [CB 859]
 Any interest in a corporation, partnership, trust, or estate
 Any interest under an existing futures contract, foreign currency K, notational
principal K, interest rate swap, or other similar financial K
 Interest in land
 Certain computer software
 Certain interests in films, sound recordings, video tapes, books, or other similar
property
 Certain right to receive tangible property or services
 Certain interests in patents and copyrights
 Any interest under an existing lease of tangible property
 Interest under existing indebtedness
 Franchise to engage in any professional sport, and any item acquired in
connection with such a franchise
 Certain transaction costs.
Included:
 Non-competition agreements entered into in connection with a business
acquisition. [CB 861]
§ 197. Amortization of goodwill and certain other intangibles.
(a) General rule. A taxpayer shall be entitled to an amortization deduction with respect
to any amortizable section 197 intangible. The amount of such deduction shall be
determined by amortizing the adjusted basis (for purposes of determining gain) of such
intangible ratably over the 15-year period beginning with the month in which such
intangible was acquired.
Federal Personal Income Tax – Fall 2009, Joondeph
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(b) No other depreciation or amortization deduction allowable. Except as provided in
subsection (a), no depreciation or amortization deduction shall be allowable with respect
to any amortizable section 197 intangible.
(c) Amortizable section 197 intangible. For purposes of this section-(1) In general. Except as otherwise provided in this section, the term "amortizable
section 197 intangible" means any section 197 intangible-(A) which is acquired by the taxpayer after the date of the enactment of this section,
and
(B) which is held in connection with the conduct of a trade or business or an activity
described in section 212.
(2) Exclusion of self-created intangibles, etc. The term "amortizable section 197
intangible" shall not include any section 197 intangible-(A) which is not described in subparagraph (D), (E), or (F) of subsection (d)(1), and
(B) which is created by the taxpayer.
This paragraph shall not apply if the intangible is created in connection with a
transaction (or series of related transactions) involving the acquisition of assets
constituting a trade or business or substantial portion thereof.
(3) Anti-churning rules.
For exclusion of intangibles acquired in certain transactions, see subsection (f)(9).
(d) Section 197 intangible. For purposes of this section-(1) In general. Except as otherwise provided in this section, the term "section 197
intangible" means-(A) goodwill,[does not apply to self-created goodwill. Only applies for goodwill
acquired in connection with the acquisition of a trade or business, which would be
depreciable (straightline over 15 years)]
(B) going concern value,
(C) any of the following intangible items:
(i) workforce in place including its composition and terms and conditions
(contractual or otherwise) of its employment,
(ii) business books and records, operating systems, or any other information base
(including lists or other information with respect to current or prospective customers),
(iii) any patent, copyright, formula, process, design, pattern, knowhow, format, or
other similar item,
(iv) any customer-based intangible,
(v) any supplier-based intangible, and
(vi) any other similar item,
(D) any license, permit, or other right granted by a governmental unit or an agency
or instrumentality thereof,
(E) any covenant not to compete (or other arrangement to the extent such
arrangement has substantially the same effect as a covenant not to compete) entered into
in connection with an acquisition (directly or indirectly) of an interest in a trade or
business or substantial portion thereof, and
(F) any franchise, trademark, or trade name.
Federal Personal Income Tax – Fall 2009, Joondeph
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§ 1016. Adjustments to basis.
(a) General rule. Proper adjustment in respect of the property shall in all cases be
made-(2) in respect of any period since February 28, 1913, for exhaustion, wear and tear,
obsolescence, amortization, and depletion, to the extent of the amount-(A) allowed as deductions in computing taxable income under this subtitle or prior
income tax laws, and
(B) resulting (by reason of the deductions so allowed) in a reduction for any taxable
year of the taxpayer's taxes under this subtitle (other than chapter 2, relating to tax on
self-employment income), or prior income, war-profits, or excess-profits tax laws,
but not less than the amount allowable under this subtitle or prior income tax laws.
Where no method has been adopted under section 167 (relating to depreciation
deduction), the amount allowable shall be determined under the straight line method.
Subparagraph (B) of this paragraph shall not apply in respect of any period since
February 28, 1913, and before January 1, 1952, unless an election has been made under
section 1020 (as in effect before the date of the enactment of the Tax Reform Act of 1976
[enacted Oct. 4, 1976]). Where for any taxable year before the taxable year 1932 the
depletion allowance was based on discovery value or a percentage of income, then the
adjustment for depletion for such year shall be based on the depletion which would have
been allowable for such year if computed without reference to discovery value or a
percentage of income;
C.F.R. § 1.167(a)–3 Intangibles.
(a) In general. If an intangible asset is known from experience or other factors to be of
use in the business or in the production of income for only a limited period, the length of
which can be estimated with reasonable accuracy, such an intangible asset may be the
subject of a depreciation allowance. Examples are patents and copyrights. An intangible
asset, the useful life of which is not limited, is not subject to the allowance for
depreciation. No allowance will be permitted merely because, in the unsupported
opinion of the taxpayer, the intangible asset has a limited useful life. No deduction for
depreciation is allowable with respect to goodwill. For rules with respect to
organizational expenditures, see section 248 and the regulations thereunder. For rules
with respect to trademark and trade name expenditures, see section 177 and the
regulations thereunder. See sections 197 and 167(f) and, to the extent applicable, §§
1.197–2 and 1.167(a)–14 for amortization of goodwill and certain other intangibles
acquired after August 10, 1993, or after July 25, 1991, if a valid retroactive election
under § 1.197–1T has been made.
(b) Safe harbor amortization for certain intangible assets--(1) Useful life. Solely for
purposes of determining the depreciation allowance referred to in paragraph (a) of this
section, a taxpayer may treat an intangible asset as having a useful life equal to 15 years
unless-(i) An amortization period or useful life for the intangible asset is specifically
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prescribed or prohibited by the Internal Revenue Code, the regulations thereunder
(other than by this paragraph (b)), or other published guidance in the Internal
Revenue Bulletin (see § 601.601(d)(2) of this chapter);
(ii) The intangible asset is described in § 1.263(a)–4(c) (relating to intangibles
acquired from another person) or § 1.263(a)–4(d)(2) (relating to created financial
interests);
(iii) The intangible asset has a useful life the length of which can be estimated with
reasonable accuracy; or
(iv) The intangible asset is described in § 1.263(a)–4(d)(8) (relating to certain
benefits arising from the provision, production, or improvement of real property), in
which case the taxpayer may treat the intangible asset as having a useful life equal to
25 years solely for purposes of determining the depreciation allowance referred to in
paragraph (a) of this section.
(2) Applicability to acquisitions of a trade or business, changes in the capital
structure of a business entity, and certain other transactions. The safe harbor useful
life provided by paragraph (b)(1) of this section does not apply to an amount required
to be capitalized by § 1.263(a)–5 (relating to amounts paid to facilitate an acquisition
of a trade or business, a change in the capital structure of a business entity, and
certain other transactions).
(3) Depreciation method. A taxpayer that determines its depreciation allowance for
an intangible asset using the 15–year useful life prescribed by paragraph (b)(1) of
this section (or the 25–year useful life in the case of an intangible asset described in §
1.263(a)–4(d)(8)) must determine the allowance by amortizing the basis of the
intangible asset (as determined under section 167(c) and without regard to salvage
value) ratably over the useful life beginning on the first day of the month in which the
intangible asset is placed in service by the taxpayer. The intangible asset is not
eligible for amortization in the month of disposition.
(4) Effective date. This paragraph (b) applies to intangible assets created on or after
December 31, 2003.
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