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INTRODUCTION
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FINANCIAL CALCULATIONS FOR LT
AWYERS
LECTURES INDEX
GLOSSARY
TAX CALCULATORS
PRESENT VALUE OF A SUM
FUTURE VALUE OF A SUM
SINKING FUND
AMORTIZATION WITH CHART
PRESENT VALUE OF AN ANNUITY
FUTURE VALUE OF AN ANNUITY
INTEREST CONVERSION
AMORTIZATION
SIMPLE CALCULATOR
YIELD CALCULATOR
NAVIGATION INSTRUCTIONS
SOLVING FOR INTEREST RATE
FINANCIAL CALCULATIONS FOR LAWYERS
UNITED STATES TAX CALCULATORS
This set of calculators is not available with the one-hour version of the FINANCIAL
CALCULATIONS FOR LAWYERS Course. It is, instead, part of the expanded course.
M
any – though certainly far less than a majority - of United States
Internal Revenue Code Sections are purely mechanical.
Essentially, they involve algebraic formulae. As such, one may
create a calculator which will compute the section consequences.
Arguably, Congress is ill-advised to write algebraic formulae in a
traditional English statutory manner. Doing so can be very cumbersome
as well as confusing. Arguably, such formulae should appear in
mathematical terms, with mathematical symbols. Better still, perhaps
Congress should simply enact calculators for some I.R.C. provisions,
thereby obviating the need for English words other than definitions.
Alas, because that is unlikely to come to pass, we offer some TAX
CALCULATORS. They still require the user to understand defined terms,
but that is always true of algebra. The CALCULATORS should aid a student
in understanding how the particular statutory provisions work. They
should not, however, substitute for an understanding of the Code.
The following calculators are available. Copies of the relevant statutes
are also available:
• ORIGINAL ISSUE DISCOUNT (OID) COMPUTATIONS and Section 1272.
© Steven J. Willis 2009. All Rights Reserved.
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FINANCIAL CALCULATIONS FOR LAWYERS
TAX CALCULATORS
Under sections 1272-1273, taxpayers holding OID instruments must accrue
(and then include) deferred interest on the obligation. They may then add the
accrued amount to their basis of the debt instrument. Similarly section 163(h)
allows issuers of OID instruments to accrue interest deductions consistent with
section 1272 computations. When triggered, sections 163(h) and 1272 apply
both to cash method and to accrual method taxpayers.
The section 1272 interest allocation uses a constant yield to maturity (CYM) as
the basis of the default six-month periodic interest allocations. It then uses a
modified straight-line "stair step" method for daily allocations within the relevant
six months. The stair step straight-line allocation overstates interest for three
months and then understates it – in the same amount – for three months.
Congress apparently adopted such a method believing it to be simpler than a
more consistent CYM daily allocation. Arguably, that was unwise; however, the
resulting complications are not severe and the resulting inaccuracies are not
significant.
Essentially, the OID CALCULATOR is a modified version of a SINKING FUND or
Reverse AMORTIZATION CALCULATOR.
• FRONT-LOADED ALIMONY COMPUTATIONS and Section 71.
For federal tax purposes, taxpayers must include alimony received and may
deduct alimony paid. Section 71 defines alimony for federal tax purposes.
Since 1982, it has not relied on state law definitions of alimony.
Under the federal definition, taxpayers may "elect out" of the provisions and
thereby denominate as non-alimony that which would otherwise qualify as
alimony. Otherwise, alimony involves amounts paid in cash to a spouse or
former spouse pursuant to a Court Order or other written agreement. Child
support – which also has a specific federal definition for tax purposes – is not
alimony. To qualify as alimony, periodic payments must cease on the death of
the recipient spouse (other than for past-due alimony).
Under the federal definition, amounts paid in cash to a former spouse to satisfy
an obligation to equitably distribute property or to satisfy a community property
allocation may indeed qualify as alimony. To so qualify, the recipient must
waive the right to any payments which may accrue following her death;
however, that risk is often less significant than it might otherwise appear. For
one thing, she would be dead, so why would she care? Second, in many
cases, the unpaid amounts which remain with her ex-husband will flow – in time
– to their children. Also, she may purchase life insurance on herself which will
equal the waived payments.
The ultimate result can be very favorable to taxpayers in some cases. Such
cases involve one high-bracket taxpayer and one low-bracket taxpayer – not an
© Steven J. Willis 2009. All Rights Reserved.
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FINANCIAL CALCULATIONS FOR LAWYERS
TAX CALCULATORS
unrealistic possibility. If that is the case, the parties may legally disguise
property distribution payments as deductible (and includible) alimony payments.
Thereby, they would arbitrage the bracket differential. For example, if the payor
were in a 50% bracket (do not forget about state taxes) and the recipient in a
20% bracket, Uncle Sam would effectively contribute a 30% savings, which the
parties could then share as part of the marital settlement negotiations.
Congress clearly made this possible under the statute.
However, Congress also included a statutory catch for those who attempt the
above arbitrage. Under section 71(f), in the third post separation year, the
alimony payor must include the amount of alimony "front-loaded" alimony into
the first and second post-separation years. The recipient may deduct the same
amount.
• DEPRECIATION COMPUTATIONS and Section 168.
Tax depreciation is purely mechanical, albeit a bit convoluted. It requires
knowledge of an arbitrarily assigned life, an arbitrary convention, and several
depreciation "methods."
Some additional math plays a part, but the
computations are not difficult – they are just tedious.
The DEPRECIATION CALCULATORS perform the tedious work. Students must still
understand the definitions and the economic impact of the deductions.
• PRE-PAID RENT ALLOCATIONS and Section 467(f).
Absent the application of sub-section 467(f), recipients of pre-paid rent must
include the amount received in the year of receipt. This is always true of cash
method taxpayers who include income items upon receipt. It is almost always
true of accrual method taxpayers who must generally include income items as
of the earliest of the date they are due, paid, or earned. See, Schlude v.
Commissioner, 372 U.S. 128 (1963).
Similarly, absent the application of sub-section 467(f), payors of pre-paid rent
must capitalize the amount paid under section 263 and then may amortize it on
a straight-line basis over the appropriate term.
Sub-section 467(f) – if operative – would place both taxpayers (the payor and
the payee) on the accrual method for purposes of the rent deduction or rent
income. It would also impute the appropriate interest income and deduction,
using a statutorily defined interest rate and a constant yield to maturity
computation method. Essentially, the sub-section treats pre-paid rent as a loan
repaid - both interest and principal - with the use of property.
© Steven J. Willis 2009. All Rights Reserved.
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FINANCIAL CALCULATIONS FOR LAWYERS
TAX CALCULATORS
The resulting computations – which involve a modified SINKING FUND
CALCULATOR – appear as an upward-sloping curve. In contrast, more
traditional amortization of intangibles appears as a straight line with zero slope.
Accelerated Depreciation – as computed in the DEPRECIATION CALCULATOR –
appears as a downward-sloping curve.
Because the sub-section 467(f) allocation method rests on the economic reality
of the transaction (subject to the statutorily defined interest rate), it is
economically neutral: it neither subsidizes nor penalizes pre-paid rent
situations. Other cost allocation methods – such as accelerated depreciation
with its downward curve and intangible amortization with its zero sloped line –
subsidize or penalize their inherent transactions, depending on the viewpoint of
the party.
Unfortunately for taxpayers, the Treasury has yet to issue regulations
implementing section 467(f). Without such operative regulations, the section is
arguably inapplicable. Enacted in 1986, the sub-section has been nonoperative for over two decades.
• DEFERRED RENT ALLOCATIONS and Section 467(a).
Absent the application of sub-section 467(a), accrual method recipients of
deferred rent must include the amounts in the years earned, but without any
consideration of an interest component. In contrast, cash method taxpayers
would include such income items upon receipt; hence, they would defer
recognition.
Similarly, absent the application of sub-section 467(a), accrual method payors
of deferred rent deduct the amount accrued under section 461(h), but without
any consideration of unstated interest. Cash method payors would deduct
nothing until the year of payment.
Sub-section 467(a) places both taxpayers (the payor and the payee) on the
accrual method for purposes of the rent deduction or rent income. It also
imputes the appropriate interest income and deduction, using a statutorily
defined interest rate and a constant yield to maturity computation method.
Essentially, the sub-section treats deferred rent as a loan - both for interest and
principal The principal of the loan is the annual rental amount; then, the subsection imputes interest on the deferral.
The resulting computations – which involve a modified AMORTIZATION
CALCULATOR – appear as an upward-sloping curve. In contrast, more
traditional amortization of intangibles appears as a straight line with zero slope.
Accelerated Depreciation – as computed in the DEPRECIATION CALCULATOR –
appears as a downward-sloping curve.
© Steven J. Willis 2009. All Rights Reserved.
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FINANCIAL CALCULATIONS FOR LAWYERS
TAX CALCULATORS
Because the sub-section 467(a) allocation method rests on the economic reality
of the transaction (subject to the statutorily defined interest rate), it is
economically neutral: it neither subsidizes nor penalizes deferred rent
situations. Other cost allocation methods – such as accelerated depreciation
with its downward curve and intangible amortization with its zero sloped line –
subsidize or penalize their inherent transactions, depending on the viewpoint of
the party.
• STRIPPED COUPON BONDS and Section 1286.
One of the most famous United States tax cases involved stripped coupon
bonds: Helvering v. Horst, 311 U.S. 112 (1940). The decision helped create
the ASSIGNMENT OF INCOME DOCTRINE, particularly in its application to income
from property. Under the doctrine, when a taxpayer stripped the coupons from
a bond and gave them to another, the taxpayer/donor remained liable for
reporting the income resulting from redemption of the coupons.
Section 1286 does not change the Assignment of Income Doctrine; however, it
changes the measurement of the income attributable to stripped coupons. It
also moots the specific holding of Horst with regard to coupon bonds. It says
nothing, however, about the application of Horst to assignments of income from
property other than coupon bonds.
Another famous tax case is Commissioner v. P.G. Lake, Inc., 356 U.S. 260
(1958). Lake involved the ACCELERATION OF INCOME DOCTRINE – a tax doctrine
related to but distinguishable from the ASSIGNMENT OF INCOME DOCTRINE
discussed in Horst. Lake applies to a taxpayer who sells an income right from
property and who retains ownership of the underlying property. Under Lake,
the owner/seller taxpayer must currently recognize ordinary equal to the sale
proceeds unreduced by any basis. The taxpayer must allocate the property's
entire basis to the retained interest and none to the income interest.
Section 1286 changes the Lake result as it applies to stripped coupons from a
coupon bond. It says nothing, however, about stripped income rights from any
other type of property.
Section 1286 requires a taxpayer who strips coupons from a bond to apportion
his basis, by relative fair market values, to the various component parts of the
bond. As a result, each coupon would receive a basis, as would the underlying
bond itself, which represents the principal invested.
The STRIPPED COUPON BOND CALCULATOR uses both a PRESENT VALUE OF A
SUM CALCULATOR and a modified AMORTIZATION CALCULATOR to apportion the
bond's basis.
• ACQUISITION PREMIUM ALLOCATIONS and Section 1272.
© Steven J. Willis 2009. All Rights Reserved.
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FINANCIAL CALCULATIONS FOR LAWYERS
TAX CALCULATORS
Acquisition Premium is the opposite of Market Discount. Both result because of
market interest rate changes with regard to a particular instrument. If interest
rates fall, an instrument with a fixed rate will rise in price, resulting in an
Acquisition Premium on sale. If, instead, interest rates rise, an instrument with
a fixed rate will fall in price, resulting in Market Discount on sale.
Section 1272(a)(7) provides one method for allocating Acquisition Premium
over the taxpayer's remaining ownership period in the instrument. This method
divides the premium by the un-accrued original issue discount. It then
subtracts that portion of future OID accruals. The method is relatively simple to
use and does not require a re-computation of interest allocations: the OID
computations would already appear with the instrument, as computed by the
issuer.
Treasury Regulation section 1.1272-2 provides an alternate method of dealing
with Acquisition Premium. Essentially, it re-applies the OID Calculator as if the
instrument were re-issued. As such, it correctly allocates the premium based
on a constant yield to maturity assumption. In contrast, the arguably simpler
arithmetic Code method understates the holder's income in the early years
following a premium purchase and then overstates income in the later years.
In 1982, when Section 1272 first appeared in its present form, the Code
section method was clearly simpler to use because it involved simple arithmetic
rather than algebra, which the regulation method requires. The regulation
method is more accurate, but not sufficiently so to justify the added
complication in 1982. The widespread use of Financial Calculators – and the
ease of creating an OID CALCULATOR and an AP CALCULATOR – may justify a
statutory amendment forcing use of the algebraic regulation method. Until such
an amendment occurs, however, most taxpayers will use the Code method
because it defers income: in most cases income deferral is desirable.
• MARKET DISCOUNT INTEREST ALLOCATIONS and Sections 1275-76.
Market Discount is the opposite of Acquisition Premium. Both result because of
market interest rate changes with regard to a particular instrument. If interest
rates rise, an instrument with a fixed rate will fall in price, resulting in Market
Discount on sale. If, instead, interest rates fall, an instrument with a fixed rate
will rise in price, resulting in an Acquisition Premium on sale.
• LIKE-KIND EXCHANGE GAIN/LOSS/BASIS COMPUTATIONS and Section
1031.
• HOTCH-POT AND FIRE-POT COMPUTATIONS and Section 1231.
© Steven J. Willis 2009. All Rights Reserved.
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FINANCIAL CALCULATIONS FOR LAWYERS
TAX CALCULATORS
• ANTI-SCHLUDE CALCULATOR for Pre-paid Services Deferral.
• DEPRECIABLE PERSONAL PROPERTY
CALCULATOR and Section 1245.
• CAPITAL GAINS
1211-12.
AND
GAIN
CHARACTERIZATION
LOSS CARRYOVER CALCULATOR and Sections
© Steven J. Willis 2009. All Rights Reserved.
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