Is it Income? Flashcards
(151 cards)
1
Q
How do you calculate adjusted gross income?
A
Gross Income - “Above the line” deductions
2
Q
What section is associated with gross income?
A
Section 61
3
Q
What section is associated with “above the line” deductions?
A
Section 62
4
Q
How do you calculate Taxable Income?
A
AGI - (Itemized Deductions OR Standard Deduction) - Personal Exemption
5
Q
What is vertical equity?
A
those who are more able to pay taxes should contribute more than those who are not.
6
Q
What is horizontal equity?
A
taxpayers who have the same income should pay the same amount in taxes
7
Q
What is a progressive income tax?
A
One with average tax rates that rise as income rises - like in our system
8
Q
What is a regressive income tax?
A
one where average tax rates decline with income
9
Q
What is a proportional income tax?
A
one where the tax rate stays the same despite rise or fall in income, no vertical equity
10
Q
What is one of the most important “above the line” deductions?
A
cost of producing business income
11
Q
What is “discounting to present value”?
A
the process of calculating the present value of a future amount
12
Q
What is the formula for the relationships between present and future amounts?
A
FV = PV(1+r)^n, where r is the interest rate and n is the number of years.
13
Q
What is the rule of 72?
A
that (roughly) an amount doubles within the number of years determined by dividing 72 by the interest rate. Thus, at 12 percent, compounded annually, $1 will be worth $2 in six years (72/12 = 6).
14
Q
Why might John Doe, who won the lottery, try to have his family members claim portions of the winning ticket?
A
Because it’s a progressive tax system, and taxes are higher the more money you have, so will pay less tax in aggregate if splits it up.
15
Q
What are some theoretical problems with a progressive tax system?
A
- Homeless person may value a dollar just as much Bill Gates does
- Fairness: tax one more than another
- Place more value on stuff you’ve earned than stuff you’re given (don’t pay gift taxes)
16
Q
What are the three policy concerns?
A
- Fairness
- Efficiency
- Administrability
17
Q
What are the two types of credits? Which is preferable?
A
Refundable - preferable, because you get a check for the amount not used
Nonrefundable
18
Q
What is the Eisner v. Macomber definition of income?
A
Income is gained from labor or capitol, or both.
19
Q
What is the problem with the Eisner v. Macomber version of income?
A
Horizontal equity problem; want people with similar ability to pay, to pay same or similar amounts of tax. If I found money on the street, probably wouldn’t be income.
Inefficiency (because some kinds of gain-producing activities are favored over others).
20
Q
What is the Haigs-Simon definition of income?
A
Income = C + dW
21
Q
What is the Glenshaw Glass definition of income?
A
- Undeniable Accessions to Wealth: something that makes you better off ⁃ Clearly realized: Only tax actual gains, not hypothetical ones (when you sell your house, not when it increases in value) ⁃ Complete dominion: It’s only income if someone can’t take it away from you
22
Q
What was Benaglia v. Commissioner?
A
Oh doesn’t like the holding; thinks much of this was consumption; isn’t really a perfect rule on non cash benefits
To a taxpayer employee who, solely for the convenience of his employer and as a necessary incident of the proper performance of his duty, receives food and lodging from the employer, the value thereof is not taxable income.
23
Q
Why are employers happy to provide noncash benefits to their employees in lie of income?
A
Because they can deduct it nonetheless, and might even have to spend less (post tax)
24
Q
When deciding whether something is income what is the procedure?
A
Look at 61; if it’s there, you’re done; if not, look at Glenshaw Glass factors
25
What codified the result of the Benaglia case?
Section 119: 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.
26
Are meal allowance payments excludable under Section 119?
No: In Commissioner v. Kowalski, 434 U.S. 77 (1977),
the Court, resolving a conflict among the circuits, held that meal allowance payments to state highway patrol troopers were not excludable under §119 due to failure to satisfy the "furnished" requirement. Thus, in effect, to meet the terms of the statute, the state would need to open its own version of McDonald's or Pizza Hut at various convenient points along the highway, rather than relying on the private sector to supply its troopers with fast food. However, Kowalski did not define "business premises," only "furnished."
27
In practice, how is the requisite employer's convenience most often established for the sake of Section 119?
by proof that the employee is "on call" outside of business hours.
28
What are the two main take-aways from Glenshaw Glass?
1. Punitive damages are not exempt
| 2. GG factors
29
What is the default noncash benefits rule?
That such benefits are income
30
What section deals with fringe benefits?
Section 132
31
What are the main fringe benefits (4)
1. No additional cost services
2. Qualified employee discounts
3. Working condition fringes
4. de minimis fringe
32
What are the two additional requirements for "no additional cost services" and "qualified employee discounts"?
First, in order to claim either exclusion, one must work in a line of business of the employer in which the item at issue is ordinarily offered for sale to customers (§§ 132(b) (1) and (c)(4)). Thus, if the same corporation operated both an airline and a department store, airline workers would be taxed on receiving discount department store goods, and department store workers would be taxed on receiving free airline flights.
Second, neither of these two exclusions applies to "highly compensated employees" if the employer discriminates in favor of such employees in determining to whom a given fringe benefit is available (§ 132(j)(1)).
33
Who may "no additional cost services" and "qualified employee discounts," as well as "qualified tuition reduction" be provided to?
The employee, the employee's spouse, surviving spouse, or dependent children, but not to others such as same-sex domestic partners.
34
What value is to be used if a fringe benefit is not excludable?
The basic valuation rule is that the amount to be included is "fair market value." Regs. § 1.61-21 (b).
35
What is a "cafeteria plan"?
a plan under which an employee may choose among a variety of noncash nontaxable benefits or may choose to take cash (which is, of course, taxable). In other words, an employee may in effect elect to reduce his or her taxable salary and take noncash benefits instead.
36
Why would employers provide "cafeteria plans"?
This makes it possible for an employer to provide nontaxable fringe benefits
to those employees who want them without disfavoring employees who have no need for them. For example, suppose an employer has two employees, each earning $35,000 a year. One employee has children and pays $5,000 a year to babysitters while he is at work. The other employee has no children. Under a cafeteria plan, the employer can allow the employee with children to take his compensation in the form of $30,000 worth of taxable salary and $5,000 worth of child-care payments (nontaxable under § 129). Meanwhile, the other employee can elect to take the entire $35,000 in salary; all of this is taxable, but he is no worse off than he would be if there were no cafeteria plan. The employer is allowed to deduct the full $35,000 for each employee.
37
What section expressly authorized "cafeteria plans"?
Section 125
38
What is the doctrine of constructive receipt? Does it apply to cafeteria plans?
an employee being taxed on the cash that he or she could have taken, even if a nontaxable benefit
were chosen instead.
No it doesn't; if it did, section 125 would be useless
39
What is the use-it-or-lose-it rule?
Under this rule, if, for example, an employee elects at the beginning of the year to take $5,000 worth of child-care reimbursement instead of the same amount of cash compensation or other benefits, any part of the $5,000 not used for child care will be lost to
the employee.
40
What is the issue with "frequent flyer credits"?
When an employee gets non-taxed flights for business purposes, and receives frequent flyer credits as a result. Most agree that she has income. But how much? In 2002, the IRS said it won't pursue such actions, so frequent flyer credits incurred through non-taxed business trips are not an issue.
41
What tax treatment is required by § 132 in the following situation?
1. F, a flight attendant in the employ of A, an airline company, and F's spouse decide to spend their annual vacation in Europe. A has a policy whereby any of its employees, along with members of their immediate families, may take a number of personal flights annually for a nominal charge, on a standby basis. F and F's spouse take advantage of this policy and fly to and from Europe.
Seems to be non-taxable benefit under "no additional cost services," assuming that there was no additional cost
42
What tax treatment is required by § 132 in the following situation?
2. P is the president of C, a corporation that has its executive offices situated in
New York City. P is planning a week-long business trip to Los Angeles and will
fly there and back on C's corporate jet. P's spouse intends to accompany P on the
round-trip flight for personal reasons.
Not through fringe benefit, but through business expense; however spouse doesn't get the business expense. Would wan't employer to pay for P's trip, instead of getting re-imbursed, because that way it's an above the line deduction for them, instead of a below-the-line deduction for you.
43
What tax treatment is required by § 132 in the following situation?
S, a senior vice president of D, a retail department store, purchases a
refrigerator from D's appliance department. D has a policy whereby all employees
are entitled to a 20 percent discount from the ticketed sales price of any item sold
by the store so long as the resulting sales price, on average, approximately covers
D's costs. See § 132(c), Regs. § 1.132-3(c).
This is a "qualified employee discount," which does not exceed the gross profit percentage
(c)(1)(A): 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...
44
What tax treatment is required by § 132 in the following situation?
S, a senior vice president of D, a retail department store, purchases a refrigerator from D's appliance department. D has a policy whereby all employees are entitled to a 20 percent discount from the ticketed sales price of any item sold by the store. D's profit margin on ticketed items is only 10 percent, so the resultant sales price does not cover D's costs.
This is a qualified employee discount; however, could only get 10% discount tax free.
In other words, fridge is $100 normally. He buys it for $80. Must recognize 10 of income, and can exclude the other 10.
45
What tax treatment is required by § 132 in the following situation?
S, a senior vice president of D, a retail department store, purchases a refrigerator from D's appliance department. D has a policy whereby (see below - all employees) are entitled to a 20 percent discount from the ticketed sales price of any item sold by the store. D's profit margin on ticketed items is only 10 percent, so the resultant sales price does not cover D's costs. The discount is available only to S and other officers of D.
Discrimination, so not excludable
46
What tax treatment is required by § 132 in the following situation?
A, an assistant manager in the employ of D, a department store, is occasionally required to work overtime to help mark down merchandise for special sales. On those occasional instances, D pays for the actual cost of A's evening meal. Such payment is pursuant to company policy whereby D will pay the actual, reasonable meal expense of a management-level employee when such an expense is incurred in connection with the performance of services either before or after such an employee's regular business hours.
Not furnished on business premises for 119
Probably de minimis fringe under 132
47
What tax treatment is required by § 132 in the following situation?
S, a senior partner of L, a law firm, is provided free parking by the law firm. This benefit is provided by L to all partners, associates, and other employees. The parking privilege has a value of $75 per month. See § 132 (f) (5)(E).
The IRS does not act on such facts, also 132(f)(5)(C) would allow parking for a "commuter highway vehicle" (like a Bus) or by "carpool."
48
What are examples of a working condition fringe?
the business use of a company car, or a free subscription to a magazine that relates to the employee's job (e.g., where a brokerage house buys a financial publication for its brokers
49
What was Turner v. Commissioner about?
The value of tickets received as a prize; The court decided some pretty arbitrary number to be income
50
Carla, a contestant on a game show, wins a new car. The show's producer received the car free from the manufacturer because of the advertising value of its use on the show. The ordinary dealer cost of the car is $20,000 and the "sticker" price is $25,000. Carla tries to sell the car, but the best offer she gets is $16,000 and she decides to keep it even though the value to her is more like $12,000. She hires you for professional tax advice concerning the amount, if any, that she must include as income on her federal income tax return. Her exact words to you are 'just tell me the answer." What sort of advice should you give her? How should you frame your response? In thinking about how you'll approach the situation, assume that you'll be up for partner next year at your law firm and that Carla owns a business that could provide lots of fees for the firm.
Should probably claim at least 16k, because she values it as at least that.
51
How does a working condition fringe work?
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 payment would be allowable
as a deduction under section 162 or 167.
52
If an employee receives a discounted service, what is the rule?
The term "qualified employee discount" means any
employee discount with respect to qualified property or services to the extent such discount does not exceed 20 percent of the price at which the services are being
offered by the employer to customers.
53
What about parents in the case of air transportation and no-cost-additional service?
In addition to employee, spouse, and dependents, may also include parents. Why? lobbying, randomly
54
What two tax rules does a person who borrows to invest in a personal residence rely on?
1. the nontaxation of imputed income (the rent the buyer doesn't have to pay)
2. the deductibility of the interest payment (on the loan taken out to buy the residence)
55
What is a bond?
a promise to pay
56
Imagine that you can earn $100 per hour practicing law. Assume you also need to get your house painted, and it will cost $75 an hour to pay a painter to do it. You can either spend ten hours practicing law or you can spend ten hours painting your house, but you cannot do both. Assume that you have a marginal tax rate of 30%.
Paint, by money; fifty dollar difference (700 vs. 750)
57
Consider a couple trying to figure out their family finances. One partner earns $40,000 and is the primary wage earner. The non-primary wage earner has two options: (a) working and making $10,000, or (b) not working. If the non-primary wage earner
decides to work, the couple will have to hire someone to care for their house and children. This will cost $8,000. The $10,000 that the non-primary wage earner earns would be taxed at a 30% rate.
The non-primary-wage earner is incentivized not to work, making the 8k imputed income if that person stays home to care for the children.
58
Imagine that the lawyer from question 2 finds a housepainter who needs legal services.
The lawyer and the housepainter agree that the lawyer will provide the housepainter
legal work in exchange for the housepainter painting the lawyer’s house. What are the
basic tax consequences of this transaction?
Not imputed income; has to tax fair market values
• 1.61 2(d)(1) – barter transactions do not mean imputed income even though they do
not involve cash, and are thus still taxable
“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.”
59
If I babysit your kid only if you baby sit mine, is that income?
Seems like it, but the IRS probably doesn't do it; Why not?
◦ People would get annoyed, which we want to avoid because of voluntary compliance
• Also, IRS tries to tax barter transactions, but they are hard to see
60
At its core, what is imputed income?
Income you've created by yourself
e.g., painted your own house, watched your own kids, not have to pay rent
61
If A gives B a gift of 100k, what are the tax consequences? According to what section?
A cannot deduct, but B doesn't have to include
102(a)
62
What is 102(c)?
It says, basically, there are no gifts between employer and employee.
63
What is 1041 about?
Transfers of property incident to divorce or during marriage between spouses; no gain or loss shall be recognized in those transactions (basis is exchanged and gain or loss is calculated at sale)
64
Grandma gives her Grandson a gift of $1,000. Imagine that Grandma and Grandson both have marginal tax rates of 35%. How much tax revenue is raised or lost as a result of the transaction under our tax law? Does the transaction affect tax revenue differently if, instead, we gave Grandma a deduction for the gift and required Grandson to include the gift in income?
No, nothing would change in either transaction in terms of revenue
65
Grandma gives her Grandson a gift of $1,000. Now imagine that Grandma has a marginal tax rate of 35% and Grandbaby has a marginal tax rate of 15%. Is denying Grandma a deduction under our tax law still offset by Grandbaby not having to include the gift in income?
Not quite; Grandma pays 350 instead of Grandson paying 150 (if he had to pay tax, which he doesn't)
66
What is the rationale for the gift rule?
No paperwork; don't have to keep track of gifts
Avoid income splitting to pay lower aggregate taxes
67
What was Commissioner v. Duberstein?
Gave him a car after helping him with some business contacts. Court said it was not a gift.
A gift must come from detached and disinterest generosity. It's a subjective test.
68
Are tips gifts?
No, doesn't meet Duberstein.
Ordinary tips are includable in income on the theory that they are payments for services rendered. See Regs. § 1.61-2(a) (1). The problem with tips is enforcement.
69
What are the tax consequences to the employer and employee of business gifts and business expenses?
it's deductible for the employer, and included for the employee, just like salary would be
70
What are the tax consequences of business gifts between persons not in an employer/employee relationship? What section is this?
The giver/donor gets a deduction of up to $25, and the donee may have to include based on the duberstein test
274(b)
71
Orthopedic surgeon Sandy successfully performs a difficult operation on accident victim Wendy. Therapist Teresa helps Wendy recover the full use of her damaged muscles. Wendy pays her bill and then, unexpectedly, offers both Sandy and Teresa free use of her ski condominium. Sandy and Teresa each accept Wendy's offer and each spends two weeks at the condominium. Suppose that Sandy and Teresa ask your advice on whether they must, or should, report the value of their use of the condominium as income. What do you say?
Since it's not an EE/ER, use the Duberstein test: not a social norm of giving gifts to your doctor, so prob not income
72
The facts are the same as in Question 1 except that instead of giving the use of the condominium, Wendy gives Sandy and Teresa each a check for $2,000. Are Sandy and Teresa taxable on the amounts they received? Is it important to know whether Wendy claimed a deduction for the payments as medical expenses? Suppose Wendy did deduct the payments as medical expenses, that the deduction was challenged by the IRS, and that the Tax Court, after observing that Wendy's opinion about the nature of the payments is irrelevant, upheld the IRS's denial of the deduction. Would these additional facts relating to the deduction by Wendy strengthen or weaken Sandy's and Teresa's claim that the payments were gifts?
Doesn't seem to matter whether it's cash or not; maybe it's weird social normally, so that could alter the Duberstein analysis.
If she claimed them as medical expenses, that would color them as not a gift. It's subjective to the donor, so all that matters.
73
What is gain in terms of AR and AB?
AR - AB
74
What is loss in terms of AR and AB?
AB - AR
75
Grandma bought stock for $1,000. A couple of years later, when it has appreciated in value to $2,000, she sells the stock. Does Grandma have income? Does she have a gain or loss? What is the amount realized? The basis?
Yes, 1k of income, AR is 2k, AB is 1k, gain is 1k
76
Grandma bought stock for $1,000. What if, instead of selling the stock, Grandma gifts it to Granddaughter when the stock is worth $2,000 and Granddaughter sells the stock in Year 5 when it is worth $5,000? Who has income on sale? In what amount? What is the amount realized? The basis?
Since, the item has not depreciated, Granddaughter inherits the basis, according to section, 1015(a), which is 1k, so upon sale, she recognizes 4k of income
AB is 1k
AR is 5k
77
What if the gift has depreciated in value since it was acquired? What's the donee's basis? According to what section?
FMV, 1015(a)
78
Now imagine that Grandma dies in Year 5, when the stock is worth $5,000. At that time, she gives the stock to Granddaughter via her will. Granddaughter sells the stock in Year 10 for $5,000. Who recognizes income now? In what amount? What is the amount realized? Basis?
No one recognizes income, since she gets the stepped up basis, due to section 1014(a)
Basis is 5k
AR is 5k
Gain is 0
79
What was Taft v. Bowers?
During the calendar years 1921 and 1922, the father of a donee, gave her certain shares of stock then more valuable than when acquired by him. The donee sold them during 1923 for more than their market value when the gift was made. The United States demanded an income tax reckoned upon the difference between cost to the donor and price received by the donee. The donee paid accordingly and sued to recover the portion imposed because of the advance in value while the donor owned the stock. The appellate court reversed the judgment entered in favor of the donee. The judgment was affirmed. The United States Supreme Court ruled that § 202(2) of the Revenue Act of 1921, where one who purchased shares of stock after February 28, 1913, gave them to another after December 31, 1920, when their market value had increased over the investment, and the donee afterwards sold them at a price still higher, the gain taxable to the donee was the difference between the price realized by him and the price paid by the donor. Congress had power under the Sixteenth Amendment to treat the entire increase in value, when separated from the investment by the sale, as income of the donee.
80
Suppose A purchases stock for $1,000 and gives the stock to his son, B, at a time when the fair market value of the stock is $2,500. (a) How much gain does B recognize if he sells the stock for $3,500? (b) How much gain does B recognize if he sells the stock for $1,500?
(a) gain is 2500
| (b) gain is 500
81
Suppose C purchases stock for $2,000 and gives the stock to her daughter, D, at a time when the fair market value of the stock is $1,000. What amount of gain or loss (if any) is recognized by D on a sale for the following amounts? (a) $2,500 (b) $500 (c) $1,500
her basis is 1k for loss, and 2k for gain
```
(a) gain - 500
loss - 0
(b) gain - 0
loss - 500
(c) gain - 0
loss - 0
```
82
What is important to remember when doing the 1015(a) calculations?
To use the loss basis for the loss calculation and the gain basis for the gain calculation.
83
Why don't we always use a transfer basis, instead of sometimes using FMV basis?
Don't want loss trafficking, even though that allows gain trafficking, with no clear reason why there is a preference for the latter
84
What is an example of loss trafficking? Why would you want to?
If I bought stock for x, it was x-y at time of gift, and so person would get basis of x, with the ability to get a loss when sold (of course, this isn't allowed b/c of 1015(a)).
You might want to if someone is in a higher bracket and so the loss would mean more, or maybe you don't have enough income to use the loss, or you're just being nice.
85
What is an example of gain trafficking?
mother in higher bracket and give to daughter who is in lower bracket, will pay fewer taxes on a gain
86
During the next four years, Ernesto's daughter, Ana, will require a total of $80,000 for college tuition and expenses. In each of the following settings, advise Ernesto as to the best means of transferring wealth to his daughter so
that she may go to college. Ernesto is in the maximum marginal tax bracket and Ana has no income.
(a) Ernesto has a single asset, stock with a basis of $20,000 and a fair market value of $80,000.
(b) Ernesto has a single asset, stock with a basis of $120,000 and a fair market value of $80,000.
(c) Ernesto has stock with a basis of $20,000 and a fair market value of $80,000, plus $80,000 in a savings account.
(d) Ernesto has stock with a basis of $20,000 and a fair market value of $80,000, plus stock with a basis of $120,000 and a fair market value of $80,000.
(e) The facts are the same as in (a) except that Ernesto is 88 years old and is in poor health.
In general you want to take losses, and traffic gains. If you near death, you should hold on to gains.
(a) Give it to her, because she is in a lower bracket, and taxes will be less. Might even want to sell it over time, to get the TVM.
(b) He should sell, take the loss. Take the deduction sooner, b/c of TVM.
(c) Already paid taxes on the savings, so probably want to give her the stock, so she can pay lower taxes on it, or give her the 80k from the bank.
(d) Give her the gain stock, and sell the loss stock.
(e) Hold on to it until he dies, then she'll not pay taxes on it. 1014(a)(1)
87
What was Inaja Land Co. Commissioner?
The payment of the sum of $ 50,000 to petitioner in 1939 by the city of Los Angeles in consideration of the conveyance by it to the city of a right of way and certain easements to divert foreign waters into the Owens River as it flowed through petitioner's land, and releasing the city from all claims and demands, etc., did not constitute taxable income to petitioner under section 22 (a), I. R. C.
2. Since, under the circumstances, it was practically impossible to allocate a basis to the easements granted, the net amount received, being less than the petitioner's basis for the entire property, will merely reduce that basis. Burnet v. Logan, 283 U.S. 404.
88
What kind of basis allocation was made in Inaja? What are the other types?
Basis first
Others: Pro rata, Basis last
89
Scott purchased stock several years ago for $100. Scott decides to sell all of the stock for $300. What’s his gain on sale?
gain - 200
90
Shirley purchased 100 shares of stock several years ago for $1 per share. Shirley decides to sell one share of stock. The sales price for the one share of stock is $200. What should the gain be? The basis? Do this under basis first, basis last, and pro rata.
pro rata:
basis - 1
gain - 199
basis first:
basis - 100
gain - 100
basis last:
basis - 0
gain - 200
91
Why did the court in Inaja use the basis first rule?
Because it was too hard to apportion the basis out to only a certain amount of the land, especially when it wasn't voluntary, and the land was all different.
92
What is an annuity?
Upfront payment for the promise to make a future stream of payments
93
Henry has $100k of salary income. He has won $25k playing blackjack. He has lost $50k playing the lottery. What is his income for the year? What section is this due to?
100 + (25-50 = -25 = 0) = 100k is income this year
Gambling losses can only be used against gambling gains - 165(d)
94
Raquel pays $5,000 for an annuity that will pay her $1,000 per year for the rest of her life. Raquel is expected to live for 10 years.
a. What is the exclusion ratio under 72(b)?
b. What is Raquel’s income in year 1 from the annuity?
c. What is her income in year 2 from the annuity?
d. What happens if Raquel dies on the first day of Year 3 (and therefore does not receive annuity payments after Year 2)?
e. If Raquel lives 11 years and therefore receives a 1,000 payment on the annuity in Year 11, what is the tax treatment to Raquel from receipt of this 1,000 payment?
(a) 5k/10k = 50%
(b) 500
(c) 500
(d) She can take a deduction for 4k in her final tax return.
(e) It is all taxed.
95
What is the purpose of section 101(a)?
Section 101 (a) excludes "amounts received... under a life insurance contract, if such amounts are paid by reason of the death of the insured ." This exclusion applies to all types of life insurance policies.
96
What is the rationale for not taxing proceeds from life insurance policies?
Kind of like the step-up provision of 1014(a)(1)
97
What if I buy someone's life insurance policy from them?
then, under 101(a)(2), the proceeds are no longer excludable
98
What is the advantage of annuities?
If you kept that money in a bank account, you would pay taxes on the yearly interest, but here you don't pay taxes until much later.
99
What is the structure of an annuity? i.e. an example
| What section governs an "exclusion ratio"?
I pay 100k, my life expectancy is 20 years. they will pay me some amount every year for twenty years. If I live for those twenty years, I will get some amount more than 100k in aggregate, depending on the interest rate (80k more if the r = 6.4%. The annual payment is taxed. 72(b) shows the exclusion ratio to be investment/expected return (e.g., 100k/180k = 55.55%). This ratio is applied to each payment received, with the product being the taxable income. The rest would be considered recovery of investment. If I die before I recover all of my investment, I can get a loss of that amount in my final tax return, according to 72(b)(3). If I live for more than twenty years, each of the yearly payments from then on would be fully taxed.
100
What about annuities that began before or on 12/31/1986?
If I outlive my annuity term, the exclusion ratio applies to the payments post-term, instead of them being totally taxed. (This is good for the taxpayer). But, if i I don't recover my investment before I die, no deduction is allowed in my final tax return. (this is bad for the taxpayer).
101
Aisha purchased a deferred annuity policy for 25k. At a time when the annuity policy has increased in value to 35k (because it has earned 10k of interest), Aisha takes out a 5k loan from the policy. What amount, if any, does Aisha include in income by virtue of the loan? What section governs this?
Under 72(e), a taxpayer will recognize income equal to the lesser amount of the loan or the increase in the value of the policy. Moreover, under §72(q), tax payers who are under the age of 59 generally must pay a penalty tax equal to 10 percent of the amount of the income otherwise recog nized.
So Aisha must recognize all of it (5k). He says we're not responsible for this...
102
What is the difference between an annuity and a deferred annuity?
In the former, you receive payments at some point far in the future, instead of the next year.
103
Where can you find the expected number of years a person of a certain age will live?
pg. 555
104
What was Clark v. Commissioner?
Where in the taxable year the petitioner received a sum of money from his tax counsel as recompense for an error made by the latter in preparing and filing petitioner's 1932 return, the error having caused petitioner to pay more tax than he would have owed had the correct method been employed, held, the compensatory payment is not includable in gross income.
105
Imagine that Chris’s tax lawyer caused Chris to file his tax return incorrectly, costing Chris $20,000 in extra tax liability owed. Imagine that the same thing happened to Adam and Berta. Donna hired a tax lawyer who did not make the error. As a result, Donna filed her tax return correctly and Donna was not out the $20,000 that Albert, Berta, and Chris were. Imagine that Chris’s tax lawyer feels badly about the mistake and pays Chris $20,000 to compensate Chris for the mistake. Adam’s and Berta’s tax lawyers do not compensate them for the mistake. However, Adam wins a lottery in which he receives $20,000.
a. Under Clark v. Commissioner, is Chris taxed on the payment he receives from
his lawyer?
b. If we do not tax Chris on the payment he receives from his lawyer, are we taxing him fairly relative to Adam? Relative to Berta?
c. Reverse Clark, compare Chris to Albert and Berta
d. If we do tax Chris on the payment he receives from his lawyer, are we taxing
him fairly relative to Donna?
e. What does this show about the Clark rule?
f. Would a deduction help? Is a deduction allowed is such circumstances?
Chris: 0
Berta: -20k
Adam: less than 0 (taxed on lottery winnings)
Donna: 0
a. Chris is not taxed according to Clark
b.
Relative to Adam: horizontal equity problem: same income, different taxes
Relative to Berta: vertical equity problem: people with more income should pay more taxes, but they pay the same
Makes Clark seem really unfair
c.
Chris is taxed, so he is now at less than 0
Berta is taxed, so she remains at -20k
Adam is taxed, so he remains at less than 0
Chris is taxed fairly to Berta, no vertical
Chris is taxed fairly to Adam, no horizontal
d.
Under reverse Clark, then it's unfair (Chris is taxed but Donna is not)
Under Clark, it's fair
e. Under reverse or regular Clark, there will be inequity
f. Shouldn't do this for a variety of reasons (the discussion was really unclear - Class 7 around 1hour:30min); almost because the deduction isn't allowed via 165
106
What section refers to casualty loss?
165(c)(3)
107
What are the limitations on casualty losses?
165(h)(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 arising from each casualty, or from each theft. exceeds $500 ($ 100 for taxable years beginning after December 31, 2009).
So, has to be more than 100, but can only deduct that 100.
(h)(2): Net casualty loss allowed only to the extent it exceeds 10 percent of adjusted gross income
Not in regs: Limitation on the size of deductible loss: lesser of adjusted basis and decrease in FMV (Helvering v. Owens)
Why? Because if only lose 1k on a 1mil house, only get 1k in loss, instead of 100k basis. Only allow recovery of basis or less because we don't tax on unrecognized appreciation; so, wouldn't deduct for depreciations. She wants the deduction now rather than later: TMV.
108
Maria has an adjusted gross income of $100,000. She has a house with basis of $100,000 and fair market value of $1 million. A hurricane damages the house. The house is damaged such that the fair market value is now $500,000.
a. What limitations apply to Maria’s potential casualty loss deduction under 165(h)?
b. What happens if Maria has insurance and therefore receives $500,000 in insurance proceeds as a result of the hurricane damage?
(a) Her loss deduction is limited to 89900, because 10% of her income is 10k, and then (h)(1) allows $100 more. Because she hasn't used all her basis, she'll have 10,100 of basis, when she sells the house later.
b. 165(h)(2)(B): says you have a personal casualty gain of 400k (500k insurance - 100 basis) - which uses your basis also; this is taxed at capital gain rates; act like she sold 500k of her house and kept the other 500k.
109
What happens if a company's building is destroyed by a contractor's negligence? The building has a basis of $600,000 and a fair market value of $700,000. The company sues and in the same year collects $700,000.
The company is taxable on $100k - just as if it had sold the building for $700,000." However, the tax will be deferred if the company uses the proceeds to build or buy a similar building.
110
Are recoveries for lost profits taxable? Why?
Yes, because it's like they were getting all of their income up front. Sucks for them in TMV terms.
111
Are recoveries for punitive damages taxable? Why?
Yes, GG factors are good
112
Tom is standing on the corner one day when he sees an automobile, driven by a drunk driver, strike and seriously injure his wife, Carol. Carol sues and recovers $150,000 for medical expenses, and $1,000,000 for punitive damages. She also recovers $50,000 for her emotional trauma. Tom also sues and recovers $100,000 for loss of consortium and for the emotional trauma he suffered as a result of seeing the accident and the injury to Carol, plus $10,000 for his psychiatric bills.
What amount, if any, should be reported as income by
(a) Carol and (b) Tom?
(a) Carol has to report the punitive damages, but not the medical expenses and pain and suffering (200k total). While flush language says no emotional distress, that doesn't count as long as the distress was attached to something physical.
(b) Tom should report nothing, surprisingly; kind of counter-intuitive thinks Oh; but, as long as the distress was caused by some physical injury or sickness.
113
What section governs compensation for injuries or sickness?
Section 104
114
What does Section 104 say?
Gross income does not include amount received from worker's compensation for personal injuries or sickness, and any amount of damages received on account of personal injuries or physical illness.
115
What is the rationale for excluding recovery for personal injuries or sickness?
Just making you whole
116
What does 104 cover? (3)
1. Medical expenses
2. Lost wages
3. Pain and suffering
117
What would a clever lawyer do about 104 and punitive damages?
He would try to characterize things as 104 losses, less punitive, more 104, because former is taxed, latter is not.
118
What is a recourse loan?
loans on which the borrower is personally liable
119
What is a nonrecourse loan?
the lender's only recourse in case of default is against the property pledged as security for the loan
120
Are loan proceeds includable? For both recourse and nonrecourse loans?
No; excludable for both R and NR loans
121
What is the rationale for not taxing loan proceeds?
They do not improve one's economic condition because they are offset by a corresponding liability; in other words, the loan does not increase net worth.
122
What does CODI stand for?
Cancellation of Debt Income
123
What happens with interest payments?
The payor must report them, and the payee can deduct them.
124
What are the situations where CODI happens with bank loans?
I have a loan for a rate, and the rates in the market go up, so they could offer to let me pay back my loan quicker, so they could loan out the same money at a higher rate, and make more money than I gain from the CODI. The CODI then is taxable to me.
125
What is a bond?
A bond is a debt instrument that you can assign the rights to.
126
What happened in US v. Kirby?
The trial court held that respondent taxpayer did not realize a taxable gain from the purchase of its own bonds on the open market at less than their par value, which it had received when it issued them. Upon the petition for certiorari review by the United States, the United States Supreme Court reviewed § 213(a) of the Revenue Act of November 23, 1921, and held that gross income included gains or profits and income derived from any source whatever. By the Treasury Regulations authorized by statute, if a corporation purchased and retired any such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price was income for the taxable year. The Court found no reason to disregard the regulations. There was no shrinkage of assets, and respondent made a clear gain. As a result of its dealings, respondent realized a certain sum previously offset by the obligation of bonds. Therefore, respondent realized taxable income.
127
Which section modifies US v. Kirby? i.e. all CODI is income except...
Section 108
128
What kinds of CODI are excludable? (5)
(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 residcnce indebtedness which is discharged before January 1, 2013
129
How does student loan forgiveness work?
Section 108(f)(2) excludes from income any cancellation or repayment of a student loan, provided the cancellation or repayment is contingent upon work for a charitable or educational institution.
130
What happened in Zarin v. Commissioner?
Appellant taxpayer was extended gambling credit by casino and became a compulsive gambler. The state casino control commissioner issued an emergency order making further extension of credit to the taxpayer illegal, but the casino continued to extend credit. The taxpayer ran up a debt in excess of three million dollars and the casino filed suit to collect. The taxpayer stated that the debt was unenforceable under state law, and the matter settled for $ 500,000.00. The Internal Revenue Service asserted that the forgiven portion of the contested debt was income to the taxpayer and imposed tax. The tax court agreed and the taxpayer appealed. The court reversed the tax court's decision and remanded the matter on the grounds that the taxpayer realized no income tax by reason of his settlement with a third party creditor. The gambling chips were just a debt instrument, an accounting mechanism.
131
What is the contested liability doctrine? Think Zarin
The majority in Zarin ruled for the taxpayer on the basis of a judicially created "contested liability" doctrine, under which the amount of a disputed debt is held to be the amount for which the debt is settled. In the majority's view, there was never a valid debt for $2,935,000, so there could be no relief from cancellation of indebtedness income when the debt was settled for $500,000. Central to the majority's holding in Zarin was the fact that New Jersey law cast doubt on the enforceability of debts incurred by compulsive gamblers such as Zarin.
132
Rachel loans Ben $100,000, which Ben agrees to repay in 5 years.
a. Does Ben have income on the $100,000 when he receives the loan? Why not?
Consider the Haigs-Simon definition of income.
b. When Ben pays back the $100,000 to Rachel, does he get a deduction?
(a) No, because he has to repay it. He is not net better off. In Haigs-Simon terms, his dW doesn't change.
(b) No, only deduction on interest payments.
133
Rachel loans Ben $100,000 in year 1. In year 5, Rachel decides to forgive the debt. Does Ben have income and, if so, in what amount? Why? What if Rachel is Ben’s sister?
Yes, 100k, because it was a loan and not a gift. Doesn't matter if they are related.
134
The Taxpayer purchases a truck, by agreeing to pay the seller its value in five years. As a result, the seller has loaned the taxpayer the value of the truck. Later, when it comes time for payback, the lender claims the value of the truck was 20K and the taxpayer says it is 10K. They settle at 15K, and the taxpayer pays that amount. What, if any, COD income does the taxpayer have? Under what doctrine?
None, under the contested liability doctrine
135
The Taxpayer purchases a car, by agreeing to pay the seller $20,000 in 5 years. A few months later the Taxpayer and the seller agree to settle the debt for $15,000. Is there any COD income? See 108(e)(5).
No, according to 108(e)(5), this is just a renegotiation. No CODI
136
I paint your house and you agree to pay me for this service in 3 years. Later, you say
the paint job was worth $500 and I say it was worth $1,000. We settle on $750 and
you pay that amount. Does 108(e)(5) apply? Is there COD income?
108(e)(5) does not apply because this is services, and that section only applies to property.
There is no CODI.
137
What was Diedrich v. Commissioner?
Whether a donor who makes a gift of property on condition that the donee pay the resulting gift tax receives taxable income to the extent that the gift tax paid by the donee exceeds the donor's adjusted basis in the property transferred. The USSC said the donor did realize income. Essentially, the payment of the gift tax from the payees to the payors was not a gift, and so must be taxed. The gain thus derived by the donor is the amount of the gift tax liability less the donor's adjusted basis in the entire property.
138
What are the three ways to view Diedrich with the following facts stipulated? Which does the court effectively take?
* 1000 shares
* parent's A/B = 50k (50/share)
* stock FMV = 300k (300/share)
* liability = 60k
Which of these is like that under 1011(b) for donations to charitable organizations? Why is it that way?
1. Mutual Sale (court takes this one effectively)
Parents: basis=50k, AR=60k, g=10k
Kids: basis=60k, AR=300, g=240k
2. Mutual Gift
Parents: no tax
Kids: basis=50k, AR=300, g=250k
3. Mutual Part Sale/Part Gift
Parents: basis=10k (selling 60 of the 300 stocks and gifting the rest, so only use 1/5 of 50k basis), AR=60k, g=50k
Kids: basis=60k(how much the 60 stocks cost)+40k(carryover from parents)=100k, AR=300, g = 200k
This last version is for 1011(b). It's that way so the donor pays more taxes, because the donee pays no taxes as a tax-exempt organization, and we want to conserve basis as much as we can.
139
How does basis work when you have part gift/part sale transactions? What section is this?
The basis able to be used to use against the CODI from the gift tax is the quotient of (the tax liability/AR) and the FMV multiplied by the basis of the property. E.g. Tax liability/AR = 60k, FMV = 300k, Basis of property=50k, adjusted basis = (60k/300k)*(50k) = 10k
In other words, this is asking for how much of the transaction is a sale, in this case, it was 1/5 of the transaction, so use 1/5 of the basis
From 1011(b): "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."
140
Arnie has two record players, bought each for 100, and sells one to his nephew Dave for $200, below MV (500). He sells the other to the YMCA. When Dave sells it, the record player has increased in price to $1k. Is this a pure sale? Is this a pure gift? Part sale/part gift?
Now what if he sells it to his nephew/YMCA for 50 instead of 200?
part sale/part gift b/c selling for less than the FMV, and Duberstein is satisfied.
To Dave:
so, Arnie's basis is 100, his AR is 200, so his gain is 100
and, David's basis is 200, his AR is 1000, and his gain is 800
at 50 instead of 200:
so, Arnie's basis is 100, his AR is 50, and since he can only use up to the AR in part gift/part sale transactions, his gain is 0 and his loss is 0.
and, David inherits the leftover 50 basis, on top of his own 50 basis, making his basis 100, his AR 1000, and his gain 900.
To YMCA:
1011(b) says Arnie gets to use the proportional amount of his basis that the transaction is a sale. This transaction is 200/500 or 2/5 or 40% sale and 3/5 gift, so he gets to use 40% of his 100 basis, which is $40. So Arnie's basis is 40, his AR is 200, making his gain 160.
and, YMCA doesn't pay taxes.
at 50 instead of 200: 50/500 = 1/10 is a sale, so use $10 of basis, so since AR is 50, g=40
141
What is special about part gift/part sale transactions when the payor/donor sells at a loss? Why is the law this way?
The donor/payor cannot take a loss. He can only take as much basis up to the AR.
This is because otherwise, everyone would just sell things for very cheap instead of just gifting them, so that they could take the loss (even though that screws the donee out of some part of the basis). What section this is under is unclear...
142
What is the idea of tax expenditure?
What is the argument for not doing things like 103, and instead just giving direct grants? (2)
How can politicians use this to their advantage?
Surrey says that we should tax all gain, everything away from that is a tax expenditure.
Essentially, the federal government is giving the money it would get from taxes to the state, which is just like a spending program.
In 103, part of USFG taxes disproportionately ends up in hands of high tax bracket tax payers, instead of CA, where it could just pay it directly.
Also, this way, the IRS is deciding spending allocation rather than particular agencies, like DOE, e.g., which probably know better how to use the money for its particular use.
They can spend money by cutting taxes, since those are equivalent.
143
What is the "rate of return"? Hint: a proportion
What about after tax rate return?
rate of return = amount earned/amount invested
after tax rate return = (amount earned - tax liability)/amount invested
144
Anita is planning to buy a taxable bond. It pays 10% interest (which would be taxable to Anita). Anita is in the 30% tax bracket. The State of California has tax-exempt bonds to issue. What interest rate does California have to pay Anita in order for her to buy California bonds instead of taxable bonds? What section is this? What are the implications for California and federal finances?
What about Sam in the 10% bracket? How do states do decide what interest rate to give on their bonds?
CA has to offer more than 7% interest to make Anita want CA bonds, since interest from state bonds is not taxed, according to section 103.
Before:
70 to anita
30 to USFG
State isn't using the money to invest
After 103:
70 to anita
0 to USFG
State is using the money to invest
Sam would get 90 instead of 70, so CA state bond would have to give him more than 9%. But states can't vary it like this, so they need to choose one rate that pays out a high enough interest to get enough people investing in bonds, to keep the system afloat.
145
How many tax brackets are there?
5
146
What marginal tax bracket do state bonds favor? Why?
High marginal tax bracket, because you can offer 7% interest, and they'll take it at 6.5% after-tax rate of return, where as lower brackets have higher after-tax rates of return.
147
Are deductions and exclusions worth more or less to higher marginal tax payers?
More, because there is a higher tax rate on the amount decreased for the higher marginal tax payers. As a result of this criticism, there has been more use of tax credits than there used to be.
148
A single taxpayer purchases a house for 1M and sells it for 1.5M. The taxpayer has been using the house as his principal residence for periods aggregating 3 years during the 5-year period ending on the date of the sale or exchange. What, if any, income from the sale of the house is included in the taxpayer’s gross income? What section is this under? Why did they do this?
Section 121 says if you have been living in a house for 2 years or more in the last five years, can exclude 250k if single, 500k if joint return.
500k gain - 250k = 250k taxable income
To off-set people holding on to their properties so that the basis steps up when they die.
149
What is tax arbitrage? What section disallows it? Is there a problem with this rule?
Using deduction from paying interest on non-state investments, to offset loss on using that investment's proceeds for a state-bond investment. For example, Anita (a 30% tax bracket payer) borrows 100k at 10% to buy 100k of state bonds at 8%. So every year she gets 8k from the state, but pays out 10k. However, after tax, she'll have a deduction on the interest she's paid (which is interest paid*her tax rate or 10k*.3 = 3k). So, with the deduction, she'll net 1k.
265(a)(2): can't get deduction on interest you pay on an investment you use to buy tax free bonds
Problem: cash is fungible. Just add another step: don't use the investment to buy the tax free bonds but to buy something else you would have otherwise spent cash, e.g., on, and then use that now free cash or whatever to buy the tax free bonds. E.g., Anita is sitting on 100k cash, and wants to buy a car. can functionally achieve this result without running into the rule by buying 100k in CA bonds, borrows 100k to purchase the car.
150
How do you calculate the value of a deduction?
size of the deduction * marginal tax rate
151
What if we just let tax arbitrage go?
The bond rate would decrease but the people who could invest at that smaller rate would invest way more. Of course, this would just further entrench the problem of higher marginal tax rate payers getting federal subsidies. Also, it might just not be true that those people would invest more.
