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Ryan Harsch Doran Tax Outline - Fall 2006

I. INTRODUCTION
A. Calculating Taxes 1. 61 - Gross Income - all income !rom "hate#er source $eri#e$% 2. 6& - Taxa'le Income 6&(a) - Itemi*ers+ ,GI - (Itemi*e$ De$uctions) - Taxa'le Income 6&(') - .on-Itemi*ers+ ,GI - (/tan$ar$ De$uction) - Taxa'le Income &. Tax Rates 0ar1inal tax rate - rate that a22lies to last $ollar earne$. 3!!ecti#e tax rate - Total tax 2ai$4Taxa'le Income 5ro1ressi#e Rate /tructure - mar1inal rates increase as income rises B. Marriage Penalty/Bonus 1. 0arria1e 5enalty - 6hen marrie$ cou2les earn a'out the same amount7 they 2ay more than they "oul$ i! they !ile$ se2arately. This is 'ecause "hen they !ile 8ointly7 they mo#e to the hi1her 'rac9et :uic9er an$ more income 1ets taxe$ at a hi1her rate. 2. 0arria1e ;onus - 6hen marrie$ cou2les earn 1rossly $i!!erent amounts7 they 2ay less than i! they !ile$ se2arately. .o"7 the one "ho earns more 1ets a hi1her 2ercenta1e o! income taxe$ at a lo"er rate. This creates an economic incenti#e !or the non-earnin1 s2ouse .OT to "or9. &. 6hy $o "e $o this< 6ant to maintain a 2ro1ressi#e rate structure This re1ime allo"s !or 'oth cou2les to 2ay the same amount o! tax. =. 0arrie$ Filin1 /e2arately% - $esi1ne$ to 2re#ent s2ouses !rom shi!tin1 income aroun$.

II. DEFININ

INCOME

A. !aig"#i$ons De%inition 1. 6hat is it< Income - >onsum2tion ? >han1e in #alue o! sa#in1s 2. 6hat@s "ron1 "ith it< This "oul$ inclu$e unreali*e$ asset 1ains7 im2ute$ income7 #alue o! 1o#@t ser#ices7 may'e e#en #alue o! leisure. B. Noncas& Bene%its 1. 0eals an$ Ao$1in1 5ro#i$e$ to 3m2loyees

Ryan Harsch Doran Tax Outline - Fall 2006 a. Benaglia v. Commissioner Facts - T5 "as the mana1er o! a hotel in Ha"aii an$ "as 2ro#i$e$ "ith !ree li#in1 accommo$ations an$ meals '4c his 8o' re:uire$ that he 'e on call.% Rule " T&e 'alue o% $eals an( lo(ging )ro'i(e( solely %or t&e con'enience o% t&e e$)loyer is NOT inco$e. Busti!ication !or this rule+ o It@s 'ein1 !orce$% on him - he is not 1ettin1 to satis!y his actual 2re!erences !or !oo$4lo$1in1. o It@s 2ersonal to him an$ can@t 'e trans!erre$ o Har$ to #alue ho" much it@s actually "orth to him 6ho 'ene!its !rom this< o 3m2loyer - has to 2ay em2loyee less in cash to 2ro#i$e the same a!ter-tax 'ene!it '4c he@s 1ettin1 the other stu!! !or !ree. Ho" much o! the 'ene!it they ca2ture $e2en$s on the mar9et an$ ho" much they can ne1otiate "ith the em2loyee. 2. * ++, " Meals an( lo(ging %urnis&e( %or con'enience o% e$)loyer 3xclu$es !rom income the #alue o! meals an$ lo$1in1 !urnishe$ to an em2loyee 'y his em2loyer 2ro#i$e$ they are !urnishe$ on the em2loyer@s 2remises an$ !or the em2loyer@s con#enience. o .ote+ 3liminates intent element - $oesn@t matter i! inten$e$ as com2ensation. &. * +-. " Rental 'alue o% )arsonage 3xclu$es !rom income !or minister o! the 1os2el the rental #alue o! the home !urnishe$ to him or rental allo"ance 2ai$ as com2ensation. o .ote+ This is $i!!erent7 'ecause it $oesn@t ha#e to 'e !or the con#enience o! the em2loyer an$ cash counts. =. Frin1e ;ene!its - 1&2 a. * +/01a2 " No"a((itional"cost ser'ice Frin1e must 'e ser#ice that the em2loyer is in the 'usiness o! 2ro#i$in1 to customers7 as lon1 as there is no su'stantial a$$itional cost. 3xam2le+ 5ro#i$in1 !ree stan$'y !li1hts to airline em2loyees. 1&2(8) - 3xclusion $oes .OT a22ly to hi1hly com2ensate$ em2loyees i! the 'ene!its are 1i#en only to them (i.e. can@t $iscriminate amon1 em2loyees). '. * +/01c2 " 3uali%ie( E$)loyee Discount >an o!!er a limite$ $iscount on :uali!ie$ 2ro2erty or ser#ices that are o!!ere$ to customers in em2loyer@s line o! 'usiness. >eilin1 !or 1oo$s - Gross 5ro!it 5ercenta1e o! the 1oo$s o (/ales 5rice - ,11re1ate >ost)4(/ales 5rice) o ,ny $iscount a'o#e this 2ercenta1e is taxa'le

Ryan Harsch Doran Tax Outline - Fall 2006 >eilin1 !or ser#ices - 20C o! the 2rice at "hich o!!ere$ 1&2(8) a22lies here too

c. * +/01(2 " 4or5ing Con(ition Fringe 3xclu$e !rom income 2ro2erty or ser#ices 1i#en to an em2loyee that the em2loyee coul$ other"ise $e$uct as a 'usiness ex2ense. 3x - 'usiness use o! a com2any car or tra$e ma1a*ine su'scri2tion $. * +/01e2 " De $ini$is Fringe 3xclu$es 'ene!its that are so small that accountin1 !or them "oul$ 'e im2ractical. 3x - use o! 2hotoco2ier7 !ree co!!ee7 etc. e. * +/01%2 " 3uali%ie( Trans)ortation Fringe (!)(1) - De!ine$ - commuter hi1h"ay trans2ortation7 transit 2ass7 :uali!ie$ 2ar9in1 exclusion (!)(=) - >an exclu$e #alue o! 2ar9in1 i! em2loyer 1i#es you a choice 'et"een !ree 2ar9in1 an$ cash. o The i$ea "as that 2eo2le "oul$ ta9e the cash tax-!ree an$ this "oul$ re$uce the num'er o! $ri#ers. o Ho"e#er7 "hat really ha22ene$ is more em2loyers starte$ 1i#in1 2ar9in1. o This illustrates the 2ro'lem "ith tryin1 to use the tax la" to 1et at a non-tax 2olicy (i.e. ener1y). C. I$)ute( Inco$e 1. O"ner-Occu2ie$ Housin1 Im2ute$ income is the amount $eri#e$ !rom the use you 1et out o! li#in1 in your house. It is the amount you coul$ 1et as rental #alue. >om2are in#estment choices+ 'on$s7 stoc97 or house. o 6hereas interest an$ $i#i$en$s are taxe$ "hen recei#e$7 the occu2ancy o! the house is ne#er taxe$. /o the house "ill 1i#e you a hi1her return a!ter tax. o This creates a 2otential $istortion that ma9es home-'uyin1 more attracti#e. >on1ress coul$ 2otentially tax this im2uter income7 'ut this "oul$ cause housin1 2rices to !all a lot. Di!!icult transition costs. 2. Im2ute$ Income From /er#ices ;ene!it o! househol$ ser#ices 2ro#i$e$ yoursel! are not inclu$e$ in income Result+ there is an economic incenti#e not to 2ro#i$e ser#ices in the mar9et2lace 'ut rather 2ro#i$e househol$ ser#ices yoursel!7 since you@re not taxe$ on it.

&

Ryan Harsch Doran Tax Outline - Fall 2006 o Remem'er exam2le - you en$ u2 "ith more net cash i! the lo"erearnin1 s2ouse $oesn@t "or9 an$ instea$ 2ro#i$es chil$ care. 5ossi'le solutions+ o Tax im2ute$ income - this is 2olitically un2o2ular. o De$uctions !or chil$ care - these are #ery ex2ensi#e to the 1o#@t. ,lso this $oesn@t 1et at other ty2es o! im2ute$ income.

D. 4in(%alls 1. 5uniti#e Dama1es a. Commissioner v. Glenshaw Glass Facts - T5 "on antitrust la"suit an$ 1ot 'oth com2ensatory an$ 2uniti#e $ama1es. D+ ,re the 2uniti#e $ama1es income 'ecause they@re not $eri#e$ !rom ca2ital or la'or< Result+ 2untiti#e $ama1es ,R3 taxa'le. o ,ccession to "ealth o#er "hich the reci2ient has com2lete $ominion.% The >ourt has 'asically 1i#en u2 on tryin1 to $e!ine income. They 8ust create a 2resum2tion that anythin1 increasin1 your "ealth is income unless you can 2oint to somethin1 in the >o$e that s2eci!ically exclu$es it. 2. General 6el!are Doctrine Go#@t assistance inten$e$ to 2romote the 1eneral "el!are (e.1. !oo$ stam2s7 T,.F) is not inclu$e$ in 1ross income. E. i%ts 1. Reci2ient /i$e a. eneral Rule6 * +-0 " i%ts an( In&eritances Gross income $oes .OT inclu$e the #alue o! 2ro2erty ac:uire$ throu1h 1i!t7 'e:uest7 $e#ise7 or inheritance. '. * +-01c2 " E$)loyee i%ts .o exclusion is allo"e$ !or 1i!ts !rom em2loyer to em2loyee 2. Taxes on /ale o! 5ro2erty a. >o$e 5ro#isions - >alculatin1 Gain4Aoss * +--+1a2 " Co$)utation o% ain or 7oss o ain/7oss 8 A$ount Reali9e( " 1A(:uste( Basis2 1001(') - ,mount Reali*e$ - 0oney recei#e$ ? F0E o! 2ro2erty recei#e$ 1011(a) - ,$8uste$ ;asis - ;asis7 as a$8uste$ 'y 1016 o 1012 - ;asis - cost o! 2ro2erty '. /ellin1 5ro2erty ,c:uire$ 'y Gi!t i. >alculatin1 Gain

Ryan Harsch Doran Tax Outline - Fall 2006 ii. * +-+;1a2 " Reci)ient<s =asis in t&e )ro)erty 8 (onor<s =asis o >arry-O#er ;asis% >alculatin1 Aoss * +-+;1a2 " Reci)ient<s =asis 8 7E##ER o%6 o Donor<s =asis> or o FM? o% t&e )ro)erty at t&e ti$e o% t&e gi%t. Reci2ient has to 2ay tax on !ull #alue o! a22reciation o! 2ro2erty "hile in $onor@s han$s7 'ut $oes .OT 1et the !ull 'ene!it o! losses. >,. shi!t 1ains7 'ut >,.@T shi!t losses. Taft v. Bowers - ma$e this >onstitutional.

c. /ellin1 5ro2erty ,c:uire$ !rom Dece$ent 'y Death * +-+@1a2 " Basis 8 FM? at ti$e o% (eat& o /te22e$-F2 ;asis% at $eath o This ma9es han$in1 $o"n 2ro2erty at $eath attracti#e. 101=(e) - .O ste22e$-u2 'asis !or a22reciate$ 2ro2erty trans!erre$ to $ece$ent "4in one year o! $eath an$ then recei#e$ 'y ori1inal $onor at $eath. $. 3xam2le - ,22reciate$ Gi!ts #toc5 FM? 8 A@; at ti$e o% gi%t. Basis 8 A;. Reci)ient sells stoc5 B&en FM? is A;-. Inter #i#os 1i!t ;e:uest Tax to $onor+ none !or 1i!t Tax to $onor+ assume none ,mount reali*e$ - GH0 ,mount reali*e$ - GH0 ,$8uste$ ;asis - GH - carryo#er 'asis ,$8uste$ ;asis - G=H - ste2-u2 in 'asis Gain - GH0 - GH - G=H Gain - GH0 - G=H - GH 1ain /toc9 a22reciate$ G=0 in $onor@s han$s ;i1 $i!!erenceI ,22reciation not taxe$ to $onor trans!er is non-reco1nition e#ent ,22reciation e#entually taxe$ to the reci2ient e. 3xam2le - Gi!t "ith ;uilt-in Aoss #toc5 FM? 8A@; at ti$e o% gi%t. Basis 8 A,-. Inter #i#os 1i!t Tax to $onor+ none !or 1i!t ,mount Reali*e$ - GH0 ,$8uste$ ;asis - GJ04G=H Gain4loss - G0 I! use GJ0 'asis - result is a loss. ;FT7 use F0E !or $eterminin1 loss. I! you use F0E7 then you ha#e a 1ain7 "hich you also can@t $o. Reci)ient sells stoc5 B&en FM? is A;-. ;e:uest Tax to $onor+ assume none ,mount Reali*e$ - GH0 ,$8uste$ ;asis - G=H - ste2-u2 in 'asis Gain - GH Trans!orme$ $onor@s loss o! =H reci2ient@s 1ain o! H ;a$ tax 2lannin1 K shoul$ not $e#ise loss 2ro2erty H

Ryan Harsch Doran Tax Outline - Fall 2006 #O No gain or loss Hi1h 'asis stoc97 "ith 'uilt in loss no 1ain4 loss7 i! 'asis is "ithin *one o Donor cannot use 'uilt in loss o Reci2ient cannot use 'uilt in loss Donor "oul$ ty2ically sell to reco1ni*e the loss &. Determinin1 6hat >onstitutes a Gi!t a. Duberstein an$ Stanton Facts - Du'erstein recei#e$ a 1i!t o! a >a$illac !rom another 'usinessman 'ecause he ma$e re!errals. He claime$ he $i$n@t "ant the 1i!t7 'ut other com2any $e$ucte$ it as a 'usiness ex2ense !or com2ensation. Facts - /tanton "as com2troller o! church real estate 1rou2. 6e "as a"ar$e$ a 1i!t at his resi1nation !or $oin1 a 1oo$ 8o'. ;ut it loo9s li9e a se#erance 2ac9a1e. Rule " 7oo5 at (onor<s intent " $ust =e a C(etac&e( an( (isintereste( generosity>D NOT co$)ensation %or ser'ices ren(ere(. Hol$in1s+ o Du'erstein - this "as com2ensation7 .OT a 1i!t o /tanton - Trial court !oun$ it "as a 1i!t 6hat $oes this mean< o ;asically the court "ill $e!er to trial court !in$in1s o! !act on the $onor@s intent o .o" 102(c) "oul$ co#er these cases. =. * 0.@1=2 " Pro&i=its De(uctions o% i%ts to In(i'i(uals First G2H o! a 1i!t 'y a com2any to an in$i#i$ual may 'e treate$ as an or$inary an$ necessary 'usiness ex2ense. L G2H7 it is counte$ as income to T5 an$ no $e$uction allo"e$ to 'usiness. /omeone has to 2ay tax - can@t allo" 'oth an exclusion an$ a $e$uction. 3ssentially7 this creates surro1ate taxation. F. Reco'ery o% Ca)ital 1. In General >a2ital Reco#ery 3xclusion - income $oes .OT inclu$e reco#ery o! ca2ital Duestion - "hen $o you reco#er 'asis as o22ose$ to recei#e income "hen there is a transaction that@s not a com2lete sale< 2. Time Ealue o! 0oney The :uestion o! reco#ery o! ca2ital #s. income is really a :uestion o! timin1 - $o you "ant to 1et taxe$ no" rather than later< Generally7 you "oul$ rather 2ay the tax later 'ecause x $ollars to$ay "ill 'e "orth more than that at some 2oint in the !uture. 6

Ryan Harsch Doran Tax Outline - Fall 2006 5E - FE4(1?r)n o 3ssentially7 this means that rather than 2ay to$ay7 you coul$ in#est a smaller amount o! money to 2ay the same amount in some !uture year.

&. Inaja Land Co. v. Commissioner Facts - T5 o"ns a 2iece o! lan$. Go#@t 'uys an easement to $um2 into his ri#er !or GH07000. o IR/ - this is taxa'le income. o T5 - thin9s this is reco#ery o! 'asis. >ourt " No tax lia=ility until entire cost o% ca)ital is reco'ere( 'ecause no a22ortionment can 'e ma$e o! the 'asis 'et"een the easement an$ all the other 2ro2erty ri1hts the T5 o"ns. o /o it@s all reco#ery o! 'asis 6hy $oes it matter< The T5 "oul$ rather reco#er 'asis !irst an$ 2ush tax lia'ility !arther into the !uture. . Annuities an( 7i%e Insurance 1. Ai!e Insurance a. Term Insurance Mou 2ay !or $eath 'ene!it 2rotection "ithin a certain 2erio$ o! time. I! you $ie $urin1 that time7 you 1et the money. I! not7 you lose it. '. >ash-Ealue Insurance Term insurance "ith a sa#in1s element. Mou 2ut extra money into the 2olicy !or the insurance com2any to in#est7 an$ you o"n the ri1ht to those earnin1s. 2. ,nnuities It@s an a1reement 'et"een com2any an$ in$i#i$ual to ma9e 2ayments o#er a 2erio$ o! time. It@s a "ay o! stretchin1 out assets - essentially insurance a1ainst not $yin1 soon enou1h. Imme$iate ,nnuity - Mou start recei#in1 2ayments imme$iately. De!erre$ ,nnuity - 5ayments start comin1 at some later $ate. &. Tax ,$#anta1es a. * .01a2 " A$ounts recei'e( un(er an annuity or li%e insurance contract are taxa=le B&en recei'e(. Tax-!ree insi$e 'uil$-u2% '. * .01=2 " I% you recei'e an a$ount o% an annuity> )art o% eac& )ay$ent Bill =e non"taxa=le return on =asis. .ontaxa'le ratio - In#estment in contract43x2ecte$ Return on contract /o7 say you in#est GH007000 !or a G1.H million annuity. Ratio - 14&. For each G=H7000 annuity 2ayment7 G1H7000 is nontaxa'le. c. * +-+1a2 " Exclu(es %ro$ inco$e li%e insurance )ay$ents )ai( =y reason o% (eat&.

Ryan Harsch Doran Tax Outline - Fall 2006 There are a lot o! in#estment earnin1s here that $on@t 1et taxe$7 so this is a 'i1 sa#in1s.

=. >or2orate Fses a. N2(u) - .o tax-!ree 'uil$-u2 !or non-natural% 2ersons. I! com2any 'uys a $e!erre$ annuity !or em2loyees7 it 1ets taxe$ on accumulation. '. >or2orate-O"ne$ Ai!e Insurance% >om2any can 'uy li!e insurance !or em2loyees an$ 1et tax-!ree 'uil$u2 an$ 'ene!it. /tates use$ to ha#e an insura'le interest re:uirement7% 'ut no" they can ta9e out 2olicies on any em2loyee. !. Annual Accounting an( its ConseEuences 1. 6hat $oes it mean< Tax lia'ility is $etermine$ 'ase$ on recei2ts an$ $e$uctions incurre$ this year. o ,lternati#e - transactional accountin1. This is an ar'itrary rule 'ecause not all 1ains an$ losses ha22en in 1 year. ,$o2te$ $ue to 2ractical necessity7 tra$e-o!! a1ainst accuracy an$ !airness. 2. Clark v. Commissioner Facts - T5@s tax la"yer 1a#e him 'a$ tax a$#ice7 "hich resulte$ in hi1her tax 2ayment in 1J&2 than he nee$e$ to ma9e. Aa"yer later $isco#ere$ the error an$ reim'urse$ him in 1J&=. >lar9 exclu$e$ this amount !rom income. >ourt - .OT income. .ot $eri#e$ !rom ca2ital or la'or7 'ut instea$ is 8ust com2ensation !or a loss or return o! ca2ital. &. Burnet v. Sanford & Brooks Facts - T5 entere$ into contract "ith F./. 1o#@t7 'ut 2ro8ect a'an$one$ an$ T5 sue$ the 1o#@t. 0ean"hile7 the com2any sustaine$ losses !or 1J1&-1J1H. Then the com2any "ins the la"suit an$ 1ets reim'urse$ in 1J20. D+ Is the reco#ery in 1J20 inclu$a'le as income< >ourt - FE# " t&e aBar( is %ully taxa=le in +,0-. Congress is not reEuire( to a(o)t a transactional accounting syste$ un(er t&e +Gt& a$en($ent. =. Rationale 6hy is this not li9e Clark< o In Clark7 there "as no tax 'ene!it !rom the loss. He only 1ets the exclusion in 1J&=. /o the tax matches u2 "ith his economic reality. o In Sanford & Brooks7 they alrea$y ha$ $e$ucte$ the loss7 so to allo" them to exclu$e the reco#ery "oul$ create a $ou'le tax 'ene!it. >ourt tries to line u2 tax treatment "ith the economics. Ho"e#er7 there "as no 1ain in 1J1&-1J16 to o!!set "ith the losses7 so $e$uctions $i$n@t really $o them any 1oo$.

Ryan Harsch Doran Tax Outline - Fall 2006 6hy not allo" re!un$s !or losses< o This mi1ht encoura1e 2eo2le to en1a1e in tax 2lannin1 that "ill 1enerate losses.

H. .et O2eratin1 Aosses * +.01c2 - .OA - Tax De$uctions - (Gross Income) * +.01a2 - .OA su!!ere$ in any year can 'e carrie$ !or"ar$ or 'ac9 an$ $e$ucte$ !rom income. * +.01=21+21A2 o (i) >arry-'ac9 !or 2 years. o (ii) >arry !or"ar$ !or 20 years. * +.01=2102 - Or$erin1 Rule - .OAs shall 'e $e$ucte$ !rom earliest 2ossi'le 2re#ious year !irst * +.01=21/2 - >an "ai#e carry-'ac9 an$ 8ust carry !or"ar$. 6. >laim o! Ri1ht a. North meri!an "il Consolidated v. Burnet Facts - >om2any o"ns lan$ an$ income 1enerate$ !rom the F./. 1o#@t in 1J16 an$ hel$ 'y a recei#er until $is2ute settle$. >ourt rules in 1J1N an$ the com2any 1ets the money. ,22eal o! the case ultimately $ismisse$ in 1J22. T5 - /houl$ 'e income in 1J16 "hen earne$ or 1J22 "hen !inal $is2osition occurs. Go#@t - It@s income "hen recei#e$ in 1J1N. >ourt - T5 must 2ay tax in 1J1N un$er claim o! ri1ht $octrine. De%inition " CI% TP recei'e( earnings un(er a Cclai$ o% rig&t>D an( B/out restriction to its (is)osition> &e &as recei'e( inco$e B&ic& &e is reEuire( to re)ort e'en t&oug& it $ay still =e clai$e( t&at &e is not entitle( to retain t&e $oney> an( e'en t&oug& &e $ay still =e a(:u(ge( lia=le to restore its eEui'alent.D o It@s income once T5 1ets the cash7 e#en i! there@s a le1al clou$ han1in1 o#er it. '. #.S. v. Lewis Facts - T5 recei#e$ 'onus !rom em2loyer in 1J==. Aater it "as $etermine$ that the 'onus "as incorrect7 so he ha$ to return 2art in 1J=6. T5 "ante$ to re-o2en his 1J== return an$ recalculate tax ('4c rates "ere hi1her in @==) Hol$in1 - ;onus "as !ull taxa'le in 1J== '4c that@s the year "hen he ha$ a claim o! ri1ht to the money. He can still $e$uct the loss in 1J=67 'ut the rates "ere lo"er7 so it@s "orth less This seems un!air to the T5 - harshness o! annual accountin1. c. * +/@+ " Clai$ o% Rig&t IF+ o (a)(1) - I! am@t "as inclu$e$ 2rior year '4c it a22eare$ that the T5 ha$ an unrestricte$ ri1ht to the incomeP ,.D

Ryan Harsch Doran Tax Outline - Fall 2006 o (a)(2) - , $e$uction is currently allo"e$ '4c it "as later $etermine$ that the T5 $i$ not ha#e an unrestricte$ ri1htP ,.D o (a)(&) - The amount is 1reater than G&7000. Then the tax shall 'e lesser o!+ o (a)(=) - the tax !or the current year "ith the $e$uctionP OR o (a)(H) - the tax !or the current year "ithout the $e$uction7 minus the amount o! tax that "oul$ ha#e 'een sa#e$ 'y claimin1 the $e$uction in the earlier year.

$. 3xam2le o! 1&=1 - Rate Decrease


0ar9 - 'onus in Mr 1 o! G10. In Mr H7 0ar9 !or!eits his 'onus a$#erse rate s"in1 Mear 1 (=0C) Mear H (2HC) Mear H "41&=1 Income 170007000 inclu$a'le (170007000) $e$ucti'le >an $e$uct or choose not to 'onus re2ayment Tax Treatment =007000 tax (2H07000) tax sa#in1s O2tion 1+ G2H07000 sa#in1s !rom $e$uction O2tion 2+ Q.o $e$uctionR K (amount o! tax !rom Mr 1) G=007000 tax sa#in1s ,ssume 270007000 O007000 other tax H007000 other tax H007000 other tax o! other income Total tax 172007000 total tax 2H07000 total tax >hoose O2tion 2+ 1007000 total tax Result6 * +/@+ sa'es Mar5 t&e A+;->--- t&at &e Boul(<'e lost %ro$ un%a'ora=le rate sBing.

e. 3xam2le o! 1&=1 - Rate Increase


/am - 'onus in Mr H o! G10. In Mr 107 /am is re:uire$ to !or!eit his 'onus !a#ora'le rate s"in1 Mear H (2HC) Mear 10 (=0C) Mear 10 "41&=1 Income 170007000 inclu$a'le (170007000) $e$ucti'le De$uct or not 'onus re2ayment Tax Treatment 2H07000 tax (=007000) tax sa#in1s O2tion 1+ =007000 sa#in1s !rom $e$uction O2tion 2+ Q.o $e$uctionR K amount o! tax 1enerate$ 'y inclusion in Mear H G2H07000 sa#in1s ,ssume 270007000 H007000 other tax O007000 other tax O007000 other tax o! other income Total tax NH07000 total tax =007000 total tax >hoose O2tion 1+ G=007000 total tax Result6 * +/@+ alloBs #a$ to 5ee) t&e Bin(%all &e gets (ue to t&e %a'ora=le rate sBing.

N. 111 - Tax ;ene!it Rule a. >o$e 5ro#isions

10

Ryan Harsch Doran Tax Outline - Fall 2006 * +++1a2 " I% you &a( a (e(uction in a )re'ious year> any later reco'ery Bill not =e inclu(e( in gross inco$e as long as it (i(n<t gi'e you a tax =ene%it 1i.e. )ai( less tax2. 111(c) - .OAs that ha#e not ex2ire$ are treate$ as a tax 'ene!it.

'. 3xam2le - GH7000 "orth o! 1oo$s stolen in Mr S7 Reco#ery in Mr M. Mear S >ase 1 >ase 2 >ase & >ase = Aoss (GH7000) (GH7000) (GH7000) (GH7000) GI "4out Aoss G2H7000 G09 G&7000 G2H7000 Gross Income G207000 (GH7000) (G27000) G207000 Mear M Reco#ery GH7000 GH7000 GH7000 G17000 Outcome in Mr 1 un$er 111 GH9 inclu$a'le in M GH9 exclu$a'le in G&9 inclu$a'le in M G19 inclu$a'le in M

>ase 1 - Got tax 'ene!it in Mr S '4c o! the $e$uction7 so no exclusion >ase 2 - Duali!y !or exclusion '4c the $e$uction $i$ no 1oo$ in Mr S >ase & - Only can exclu$e the income in Mr M to the extent it 1a#e them a 'ene!it in Mr S. /ince there "as only a G&9 tax 'ene!it in S7 that@s all that@s inclu$a'le in Mr M. >ase = - Only the amount o! the reco#ery is inclu$a'le7 so G17000.

I. Reco'ery %or Personal an( Business In:uries 1. * +-G" !ealt& Insurance Gross income o! an em2loyee $oes .OT inclu$e em2loyer-2ro#i$e$ health insurance o 3m2loyee-3m2loyer relationshi2 O.AM. o Inclu$es retirees an$ s2ouses. o .OT unmarrie$ cou2les7 same-sex cou2les. 2. * +-; " Reco'ery un(er acci(ent an( &ealt& )lans (a) - ;ene!its recei#e$ un$er 2lan "here 2remium 2ai$ 'y em2loyer are inclu$e$ in income. (') - 3xce2tion+ $oes .OT inclu$e amounts un$er 10H(a) that are 2ai$ $irectly to T5 !or reim'ursement o! me$ical ex2enses. 0any !eel that this tax su'si$y encoura1es 2eo2le to consumer more me$ical care. &. >om2ensation !or in8uries or sic9ness a. 10=(a)(2) >an exclu$e !rom 1ross income the amount o! any $ama1es recei#e$ on account o! 2ersonal in8uries or 2hysical sic9ness (asi$e !rom 2uniti#e $ama1es) This creates an incenti#e !or 5s to try to 1et structure$ settlements "ith 2erio$ic 2ayments rather than one lum2 sum.

11

Ryan Harsch Doran Tax Outline - Fall 2006 =. $ur%h& v. I'S (D.>. >ircuit) 6histle-'lo"er reco#ere$ $ama1es !or emotional $istress an$ relate$ 2hysical sym2toms an$ !or in8ury to re2utation. T5 claims that 2art o! her reco#ery is tax-exem2t un$er 10=(a)(2) '4c o! her 2hysical in8uries. o >ourt - .o. T5 claims that the tax is unconstitutional un$er the 16th amen$ment. >ourt - uses the in lieu o!% test - "hether somethin1 is income $e2en$s on i! it "as recei#e$ in lieu o! an amount that "oul$ normally 'e taxe$. o /O $ama1es !or non-2hysical in8ury are not income. o There!ore7 10=(a)(2) is unconstitutional. Is this actually true< o .O - the 2o"er to tax comes !rom ,rticle I7 not the 16th amen$ment. o The real constitutional :uestion is "hether it@s a $irect tax. Ho"e#er7 the court ne#er ans"ers that :uestion. Ho"e#er7 Gins'ur1 is ri1ht to critici*e the $istinction 'et"een 2hysical an$ non2hysical in8uries7 "hich $oesn@t ma9e much sense. H. Inco$e %ro$ Disc&arge o% In(e=te(ness 1. General Rules on ;orro"in1 Aoan 2rocee$s are .OT inclu$e$ in 1ross income7 an$ loan 2ayments are not $e$ucti'le. Interest 2ayments ,R3 income to len$er an$ $e$ucti'le 'y 'orro"er7 unless it@s !or 2ersonal consum2tion. 2. T"o Ty2es o! De't Recourse Aoan - len$er can reach 2ersonal assets .on-Recourse Aoan - len$er can attac9 only the 2ro2erty use$ as collateral &. Dischar1e o! In$e'te$ness - General Rule 4&en a (e=tor gets )art o% all o% a loan %orgi'en> t&e a$ount o% t&e %orgi'eness is inco$e to t&e (e=tor. ;FT7 i! $ischar1e o! $e't inten$e$ as a 1i!t7 .OT income. =. #.S. v. (irb& Lumber Facts - >om2any issue$ G12 million o! 'on$s an$ later 'ou1ht 'ac9 G1 million o! them at less than !ace #alue. >ourt - T&is is inco$e (ue to (isc&arge o% in(e=te(ness =ecause it %ree( u) assets %or t&e co$)any. o ;est rationale - This is a !orm o! transactional accountin1. Once you $on@t ha#e to 2ay 'ac9 all the $e't7 you ha#e an increase in "ealth. H. Diedri!h v. Commissioner

12

Ryan Harsch Doran Tax Outline - Fall 2006 Facts - 5arents 1a#e a 1i!t o! stoc9 to chil$ren on con$ition that the chil$ren 2ai$ the 1i!t tax. Duestion - Di$ the 2arents recei#e income 'y ha#in1 the $onee 2ay the tax< >ourt - 5arents ha#e income in the amount o! the $i!!erence 'et"een the 1i!t tax an$ their 'asis in the stoc9. o The court treats this as a 2art 1i!t42art sale7 at a 2rice less than F0E. o >ourt restructures the transaction so that it matches u2 "ith the economic reality o! the situation.

6. 10O - Dischar1e o! In$e'te$ness o! Insol#ent De'tors 1a21+2 " Exce)tion to general rule t&at (isc&arge o% in(e=te(ness is inco$e B&en6 o 1a21+21A2 " (isc&arge occurs in a Title ++ =an5ru)tcy case o 1a21+21B2 " (isc&arge occurs B&en TP is insol'ent ($)(1) - In$e'te$ness inclu$es 'oth recourse an$ non-recourse $e't. (a)(&) - Insol#ency exclusion is limite$ 'y the amount o! insol#ency. ($)(&) - Insol#ency - Aia'ilities - (F0E o! assets) N. )arin v. Commissioner Facts - 0an ran u2 lar1e 1am'lin1 $e't. The le1al status o! that $e't un$er .B la" "as that it@s unen!orcea'le. T5 settles $e't "ith casino !or GH007000. Issue+ Does the settlement o! a $is2ute$ lia'ility result in income !rom $ischar1e o! in$e'te$ness< >ourt - .O - Dis2ute$ De't4>onteste$ Aia'ility Doctrine - Tarin only ha$ an unen!orcea'le $e't 'e!ore the settlement. Fntil they a1ree$ on an amount in the settlement7 there "as no real $e't to 'e cancelle$. o ,nother "ay to loo9 at this+ the casino 2ro'a'ly ne#er ex2ecte$ to 'e 2ai$ 'ac97 so it "as ne#er a true loan. O. Trans!er o! 5ro2erty /u'8ect to De't a. RU7E6 I% TP =orroBs $oney to in'est in )ro)erty> you $ust inclu(e t&e a$ount o% t&e loan in your =asis an( a$ount reali9e(. '. Crane v. Commissioner Facts - T5 inherite$ a house "orth G2HH9 "ith a non-recourse mort1a1e o! that #alue. >laime$ $e2reciation $e$uction o! G2H7000 o#er 6 years7 an$ then sol$ the house !or G27H00 2lus the #alue o! the mort1a1e. T5 claime$ that house shoul$ 'e #alue$ at its e:uity (G0)7 since she "as ne#er 2ersonally lia'le !or the $e't. >ourt - .O - Tax 'ene!it "as recei#e$ throu1h the $e2reciation $e$uctions7 so no" the 1o#@t can reca2ture those 'ene!its 'y a$8ustin1 her 'asis to su'tract the $e$uctions. o De't must 'e inclu$e$ in 'oth amount reali*e$ an$ 'asis. c. Four /te2s

1&

Ryan Harsch Doran Tax Outline - Fall 2006 +2 Calculate original =asis in )ro)erty o Here7 it@s the ste22e$-u2 'asis at inheritance - G2HH9 02 Ma5e a(:ust$ents to =asis un(er * +-+G1a2102 " inclu(ing (e)reciation o G2HH9 - G2H9 ($e2reciation) - G2&09 /2 Deter$ine a$ount reali9e( =y t&e sale. Inclu(e t&e a$ount o% t&e (e=t> e'en i% non"recourse. TP got a =ene%it %ro$ so$eone else<s =orroBing. o G27H00 cash ? G2HH7000 - G2HN7H00 @2 Calculate gain un(er * +--+1a2 o G2HN7H00 - G2&07000 - G2N7H00 .ote+ this accounts !or the $e2reciation $e$uctions 2lus the cash she recei#e$.

J. Real 3state Tax /helters a. *state of +ranklin T5 2urchase$ 2ro2erty "ith non-recourse $e't "hich "as t"ice the F0E o! the 2ro2erty. This allo"e$ the T5 to ta9e lar1e $e2reciation $e$uctions. >ourt+ This is a sham transaction. 4&en t&e a$<t o% t&e (e=t su=stantially excee(s t&e FM?> t&en t&e Crane rule (oesn<t a))ly. 10. ,ufts Facts - T5 2urchase$ 2ro2erty "ith G=07000 cash an$ G1.OH million non-recourse $e't. Ta9es $e2reciation $e$uctions o! G=H070007 so a$8uste$ 'asis - G1.=Hm. F0E o! the 2ro2erty $ecrease$ to G1.=m7 "hich is less than 'asis. o 0a9es sense !or in#estor to "al9 a"ay !rom non-recourse $e't7 since it@s more ex2ensi#e than the lan$. o T5 claime$ that their amount reali*e$ coul$ 'e no more than G1.=Hm >ourt - Crane rule a))lies e'en B&en (e=t I FM? o% )ro)erty. 0F/T inclu$e $e't in 'asis an$ amount reali*e$. o Gain - G1.OHm - G1.=HHm - G&JH7000 (#alue o! $e2reciation $e$uctions minus cash 2ai$) J. Illegal Inco$e 1. Gilbert Facts - T5 "as 5res o! com2any "ho use$ com2any !un$s to ma9e his o"n mar1in calls. Ho"e#er7 he executes a 2romissory note !or com2any out o! his 2ersonal assets to 2ay the money 'ac9. Duestion - 6as this a loan or em'e**lement income< >ourt - This is a loan an$ not a reali*ation o! income. Reasons+ o T5 ex2ects "ith reasona'le certainty% to 'e a'le to re2ay the note o He 'elie#e$ the "ith$ra"als "oul$ 'e a22ro#e$ 'y the ;oar$ o He 2rom2tly assi1ne$ his assets to the com2any .ote+ 6hen em'e**le$ !un$s are counte$ as income7 the T5 has to 2ay tax 'e!ore reim'ursin1 the com2any. Thus the 1o#@t 1ets a 'ene!it !rom treatin1 it as a the!t.

1=

Ryan Harsch Doran Tax Outline - Fall 2006 2. General Rule 0oney or 2ro2erty ac:uire$ thou1h ille1al acti#ity is income. I! em'e**le$ !un$s are returne$ in the same year it@s a loan. I! em'e**le$ !un$s are re2lace$ "ith 2romissory note - it@s income.

7. Interest on #tate an( Munici)al Bon(s 1. 10& - Tax exclusion !or state an$ local 'on$s Interest )ai( on state/local =on(s is exclu(a=le %ro$ inco$e This 'ene!its local 1o#ernments '4c they can 2ay a lo"er amount o! interest an$ still o!!er com2etiti#e return to in#estors. 2. 5ro'lems It@s an ine!!icient su'si$y !rom !e$ 1o#@t to state4local 1o#ernments - 'ene!it 1ets ca2ture$ 'y hi1h-income T5s. ,s state4local 1o#@s start sellin1 'on$s to 2eo2le in lo"er tax 'rac9ets7 they en$ u2 costin1 the !e$eral 1o#ernment more money than they@re 1ettin1. o This is 'ecause as the tax rate $ecreases7 cor2orate 'on$ rate o! return increases relati#e to state4local an$ 2eo2le "on@t 'uy state4local 'on$s. o Issue o! #ertical e:uity - 2eo2le in lo"er income 'rac9ets $on@t 1et the 'ene!it o! the tax exem2tion.
Tax rate H0C 2HC 2HC 10C >or2 'on$ (10C) 10C (HC) 10C (N.HC) 10C (N.HC) 10C (JC) /4A 'on$ (HC) HC HC - "on@t 'uy N.HC (or "on@t 'uy) JC (or "on@t 'uy) >ost to Fe$ HC -02.HC or HC 1C or HC ;en to /4A HC -02.HC 1C ;en to T5 HC -02.HC =C

III. TIMIN
A. Reali9ation 1. General Rule a. Fn$er Hai1-/imons $e!inition7 i! an asset a22reciates7 this is income. Ho"e#er7 un$er the tax la"7 a reali*ation e#ent must occur to tax an a22reciation. '. Busti!ication+ Ealuation - ma9es it a$ministrati#ely easier to measure 1ains4losses Ai:ui$ity - increase in "ealth may 'e illi:ui$ Fncertainty - 1ain4loss may !luctuate in the !uture ;FT - Fn!airness - T5 is a'le to control the timin1 o! income 2. *isner v. $a!omber 1H

Ryan Harsch Doran Tax Outline - Fall 2006 Facts - T5 recei#e$ H0C stoc9 $i#i$en$ on 27200 shares7 so that no" he has &7&00 shares. T5 claims this is not taxa'le. >ourt - #toc5 (i'i(en( is NOT a reali9ation o% inco$e. Rationale+ o The $i#i$en$ $i$ not chan1e T5s economic 2osition. It 8ust increase$ his U o! shares7 'ut their #alue $i$n@t chan1e7 o 5olicy concerns (uncertainty7 li:ui$ity7 #aluation) o Fnconstitutional un$er 16th amen$ment reali*ation is a constitutional re:uirement. >ourts ha#e since retreate$ !rom this 2osition. .o"7 statutory re:uirement o! reali*ation e#ent - 1001(a)

&. De#elo2ment - Tenant Im2ro#ements a. -elvering v. Bruun Facts - T5 lease$ a 2ro2erty7 an$ lessee ma$e im2ro#ements to the 2ro2erty ('uilt ne" 'uil$in1s) that increase$ F0E o! 2ro2erty. Aessee later terminate$ lease7 an$ IR/ assesse$ 1ain on the increase in F0E. >ourt - Mes7 the lease termination is a reali*ation e#ent. There!ore7 the increase in #alue is taxa'le. o Don@t actually ha#e to recei#e cash7 8ust a #alua'le asset. o ,ssessment+ Ealue "as 9no"n7 'ut the asset "as illi:ui$ an$ the 1ain "as uncertain. '. >o$e 5ro#isions i. 10J - Im2ro#ements 'y a Aessee on Aessor@s 5ro2erty ross inco$e o% a lessor (oes not inclu(e 'alue (eri'e( %ro$ ter$ination o% a lease resulting %ro$ i$)ro'e$ents $a(e to )ro)erty =y lessee. ii. 101J - 5ro2erty on 6hich Aessee Has 0a$e Im2ro#ements 3xclu$es !rom lessor@s 'asis any 1ain4loss !rom 2ro2erty exclu$e$ un$er 10J. iii. Di!!erence 'et"een >o$e an$ Bruun Timin1 - un$er the >ourt@s a22roach7 it@s inclu$e$ in income sooner7 so it@s taxe$ earlier. =. .on-recourse 'orro"in1 in excess o! 'asis a. .oodsam v. Commissioner Facts - T5 'ou1ht 2ro2erty "ith a recourse mort1a1e7 then re!inance$ "ith non-recourse $e't su'stantially excess o! the 'asis (i.e. the ori1inal mort1a1e). T5 "ants the non-recourse $e't to 'e inclu$e$ in 'asis an$ "ants this to 'e a reali*ation e#ent '4c the /OA !or 2ayin1 taxes on it 2asse$.

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Ryan Harsch Doran Tax Outline - Fall 2006 Issue - Is this con#ersion a reali*ation e#ent7 since the T5 essentially 1ets cash "ith no $o"nsi$e '4c it@s non-recourse< >ourt - Con'ersion o% a $ortgage %ro$ recourse to non"recourse is NOT a reali9ation e'ent. o This is .OT a sale or $is2osition un$er 1001 (statutory inter2retation)7 so there@s no chan1e in o"nershi2. 3#aluation on 2olicy 1roun$s+ seems li9e a reali*ation e#ent7 'ut the test un$er the statute isn@t 'ase$ on 2olicy. o Ealuation - 9no"n o Ai:ui$ity - T5 1ot cash o Fncertainty - T5 has no $o"nsi$e on loss.

'. /ummary Non"recourse (e=t use( to =uy )ro)erty $ust =e inclu(e( in =asis an( a$<t reali9e(. Non"recourse (e=t use( a%ter t&e initial acEuisition to re%inance a $ortgage is NOT a )art o% =asis an( is t&ere%ore not a reali9ation e'ent. H. Reali*ation o! Aosses a. Cottage Savings Facts - T5 "as a sa#in1s an$ loan that hel$ 2ort!olio o! mort1a1e loans that $ecline$ su'stantially in #alue. T5 "ante$ to reco1ni*e this loss7 so it entere$ an a1reement "4 another /VA to simultaneously sell an$ 'uy similar 2ort!olios. Ho"e#er7 they $i$n@t ha#e to recor$ a loss on their 'oo9s. IR/ ar1ument - no reali*ation e#ent occurs '4c the 2ro2erties exchan1e$ are not materially $i!!erent% !rom one another. Hol$in1 - These t"o mort1a1es ,R3 materially $i!!erent. Materially (i%%erent 8 e$=o(y (istinct legal entitle$ents. For non-sale7 this is the test7 not the economic su'stance o! the transaction. o Here7 the mort1a1es ha$ $i!!erent o'li1ors an$ "ere secure$ 'y $i!!erent 2ro2erties. This means they are materially $i!!erent an$ thus there@s a reali*ation e#ent. 5ossi'le e!!ects+ o This mi1ht encoura1e T5s to en1a1es in ine!!icient transactions7 i.e. sell a 2ro2erty or hol$ on to it '4c o! the tax conse:uences. o 0i1ht encoura1e T5s to en1a1e in transactions "ith no economic su'stance merely !or the tax 'ene!it. B. Non"recognition Pro'isions 1. 1001(c) - The entire amount o! 1ain4loss reali*e$ on the sale or exchan1e o! 2ro2erty shall 'e reco1ni*e$7 unless it !alls un$er a s2eci!ic non-reco1nition rule. 2. 10&1 - 3xchan1e o! 5ro2erty Hel$ !or 5ro$ucti#e Fse or In#estment

1N

Ryan Harsch Doran Tax Outline - Fall 2006 1a21+2 " I% you exc&ange li5e 5in( =usiness )ro)erty or in'est$ent )ro)erty exc&ange( or tra(e( %or )ro(ucti'e use> no gain or loss is recogni9e( (a)(2) - 3xce2tions+ o /toc97 'on$s7 notes7 mort1a1es7 2artnershi2 interests a. Re#enue Rulin1 O2-166 o 3xchan1e o! 1ol$ 'ullion !or sil#er 'ullion is .OT a li9e 9in$ transaction &. /ordan $arsh v. Commissioner Facts - T5 o"ne$ a lar1e $e2artment store an$ sol$ its real estate !or cash7 'ut then lease$ it 'ac9 !or &0 years. T5 "ante$ to reco1ni*e its loss on the sale. 3ssentially7 T5 thin9s it@s 2 transactions - sale7 !ollo"e$ 'y a lease. Issue - 6as the transaction a sale or an exchan1e or li9e 9in$ 2ro2erty< Court " #ale/lease"=ac5 is NOT a li5e"5in( exc&ange. o T5 is 1ettin1 a $i!!erent !orm o! o"nershi2. This is the court !a#orin1 !orm o#er su'stance7 althou1h the tax la" shoul$ 'e concerne$ a'out the economic su'stance. =. Three->orner Transactions a. 10&1(') - Gain From 3xchan1es .ot /olely in 9in$ I% an exc&ange inclu(es li5e"5in( )ro)erty )lus ot&er )ro)erty 1C=ootD2> t&en recogni9e gain u) to t&e extent o% t&e FM? o% t&e =oot. '. 10&1(c) - Aoss From 3xchan1es .ot /olely in Win$ I% t&ere is C=oot>D t&en no loss Bill =e recogni9e(. c. 10&1($) - Determinin1 ;asis Basis o% recei'e( li5e"5in( )ro)erty 8 =asis o% exc&ange( )ro)erty o 7ess cas& recei'e( o Plus gain recogni9e( or $inus loss recogni9e( TP $ust allocate =asis. Basis o% =oot 8 FM? o% =oot $. 3xam2le U1 - >a2lin has 5ro2erty , "ith 'asis o! GH0 an$ F0E o! G=0. Drys$ale has 5ro2erty ;. Ti$e + U1) >a2lin exchan1es , !or Drys$ale@s ; (!m# - GJ0) Ti$e 0 1a%ter exc&ange2 GJ0 - >a2lin@s 1ain (GH0) - ,$8uste$ 'asis in 5ro2erty , G=0 - Reali*e$ Gain G0 - Reco1ni*e$ 1ain un$er 10&1(a) ;asis in ; - GH0 (su'stitute$ 'asis !rom ,) GJ0 - ,mount reali*e$ (GH0) - ,; G=0 - Reali*e$ Gain G&0 - Reco1ni*e$ 1ain un$er 10&1 (to extent o! F0E o! 'oot)

U2) >a2lin exchan1es , !or ; (!m# - G60) ? G&0 cash 'oot

1O

Ryan Harsch Doran Tax Outline - Fall 2006 U&) >a2lin exchan1es , !or ; (!m# - G&H) ? GHH cash 'oot ;asis in ; - GH0 - (G&0) ? (G&0) - GH0 (su'stitute$ 'asis cash ? 1ain) GJ0 - ,R (GH0) - ,; G=0 - Reali*e$ 1ain G=0 - Reco1ni*e$ 1ain un$er 10&1 (extent o! 'oot) ;asis in ; - GH0 - (GHH) ? G=0 - G&H

U1 - I! he sells ;7 his 'asis is GH07 so his 1ain "ill 'e G=0 an$ he@ll 'e taxe$ on the entire 1ain. U2 - I! he sells ;7 his 'asis is GH07 so his 1ain "ill 'e only G10. /o his total 1ain7 inclu$in1 the G&0 'oot7 is G=0 an$ he@s taxe$ on all G=0. U& - I! he sells ; he has no 1ain. /o "e 8ust tax him on the G=0 'oot7 "hich is his o#erall 1ain. o .ote+ Total tax is the same in all & cases.

e. 3xam2le U2 - Be!!ries has Farm , "ith 'asis o! GH00 an$ a F0E o! GO00. Doran has !arm ;.
Ti$e + U1) Be!!ries exchan1es Farm , !or Farm ; (!m# - GHH0) ? tractor (F0E - G2H0) Ti$e 0 1a%ter exc&ange2 GO00 - ,R (GH00) - ,; in Farm , G&00 - Reali*e$ Gain G2H0 - Reco1ni*e$ Gain (!m# o! 'oot) Total ;asis in Farm ; ? Tractor - GH00 - 0 ? G2H0 - GNH0 ,llocate 'asis in tractor - G2H0 ,llocate remainin1 'asis to !arm - GH00 I! /ell ; - GHH0 (F0E) - GH00 (,;) - GH0 1ain GH0 ? G2H0 'oot - G&00 - reali*e$ 1ain G&00 - Reali*e$ Gain G&00 - Reco1ni*e$ 1ain un$er 10&1 (to extent o! 'oot7 'ut can only reco1ni*e "hat@s reali*e$) Total ;asis - GH00 - (G0) ? G&00 - GO00 ,llocate 'asis in tractor - G2H0 ,llocate 'asis in co"s - G1H0 ,llocate remainin1 'asis to !arm ; - G=00 I! /ell ; - G=00 - (G=00) - G0 I! he ha$ sol$ !arm ,7 1ain - G&00 - amount reali*e$ G&00 - Reali*e$ Gain G&00 - Reco1ni*e$ 1ain Total ;asis - GH00 - (GH0) ? G&00 - GNH0 ,llocate G2H0 to tractor ,llocate G100 to co"s ,llocate remainin1 to !arm - G=00 I! sell ; - G=00 - (G=00) - G0 I! he ha$ sol$ !arm ,7 1ain - G&00 - amount reali*e$

U2) Be!!ries exchan1e$ Farm , !or Farm ; (!m# - G=00) ? tractor (!m# - G2H0) ? co"s (!m# - G1H0)

U&) Be!!ries exchan1es Farm , !or ; (!m# - G=00)7 Tractor (!m# - G2H0)7 >o"s (!m# G100)7 >ash - GH0

1J

Ryan Harsch Doran Tax Outline - Fall 2006


U=) Be!!ries exchan1es ,7 2lus tractor ('asis - G6007 !m# G200) !or ; (!m# - G17000). GO00 - ,mount Reali*e$ (GH00) - ,; G&00 - Reali*e$ Gain G0 - Reco1ni*e$ 1ain (no 'oot recei#e$7 i! li9e-9in$ 2ro2erty) G200 - ,mount reali*e$ on tractor (G600) - ,; in tractor (G=00) - Reali*e$ Aoss (G=00) - Reco1ni*e$ loss on tractor '4c no 'oot recei#e$ an$ tractor is not li9e-9in$ Total ;asis - GH00 ? 600 - G0 - (G=00) - GN00 /ince no 'oot7 allocate all to !arm ; I! sell - G1000 - (GN00) - G&00 - reali*e$ 1ain

H. Other .on-Reco1nition 5ro#isions a. 10=1 - Trans!ers 'et"een s2ouses an$ at $i#orce '. * +-// " In'oluntary con'ersion o% )ro)erty 1e.g. t&e%t> con(e$nation> (estruction2. Only gains are non"recogni9e(. 7osses are recogni9e(. (a21+2 (irect con'ersion into ot&er si$ilar )ro)erty non"recognition 1a2102 into $oney or ot&er non"si$ilar )ro)erty results in recognition> =ut can =uy a si$ilar re)lace$ent )ro)erty B/out recognition. c. 10&H - li!e insurance 2olicies an$ annuities $. 10&6 - exchan1e o! stoc9 in same com2any e. 10&N - exchan1e o! F/ Treasury o'li1ations !. 10=& - "hen an executi#e 'ranch em2loyee has to sell 2ro2erty to com2ly "ith con!lict o! interest la"s. C. Recognition o% 7osses 1. 16H - Aosses 1a2 " (e(uction alloBe( %or losses sustaine( (uring t&e taxa=le year an( not co$)ensate( %or =y insurance or ot&erBise6 o 0ust 'e e#i$ence$ 'y a close$ an$ com2lete$ transactionP o Fixe$ 'y i$enti!ia'le e#entsP an$ o ,ctually sustaine$ $urin1 the taxa'le year o 0ust 'e a 'ona !i$e loss 1c2 " De(uctions li$ite( to6 o Aosses incurre$ in a tra$e or 'usiness o Aoss incurre$ in any transaction entere$ into !or 2ro!it o Aoss o! 2ro2erty "hich arise !rom !ire7 storm7 shi2"rec97 other casualty7 the!t 2. Re#enue Rulin1 O=-1=H Facts - ,irline ha$ o2eratin1 certi!icates issue$ 'y re1ulatory 'o$y that allo"e$ them to ser#ice certain air2orts. ,!ter $ere1ulation7 certi!icates 'ecome much easier to 1et7 so there "as a su'stantial $ecline in their #alue.

20

Ryan Harsch Doran Tax Outline - Fall 2006 >ourt - .o $e$ucti'le loss un$er 16H (e#en thou1h there "as an economic loss)7 'ecause the T5 still hol$s somethin1 o! #alue. o E'en t&oug& t&ere Bas a (i$inution in 'alue> t&ere $ust =e a close( transaction to sustain a loss. o That is7 they "oul$@#e ha$ to a'an$on the certi!icates entirely.

D. O)en Transactions 1. Burnet v. Logan Facts - T5 com2any sol$ the stoc9 o! its com2any to another com2any !or cash an$ !uture 2ayments 'ase$ on the amount o! ore extracte$. o T5 "ants an o2en transaction% system - the initial cash 2ayment shoul$ count a1ainst her 'asis7 an$ the remainin1 2ayments shoul$ 'e counte$ to"ar$ 'asis '4c the #alue o! the !uture 2ayments is un9no"n. o IR/ - this is a close$-transaction% - the 2resent #alue o! the !uture 2ayments can 'e $etermine$7 so it@s taxa'le imme$iately. >ourt - T5 "ins. It<s an Co)en"transactionD =ecause t&ere is uncertainty a=out t&e reco'ery o% %uture )ay$ents. No taxa=le gain until =asis is reco'ere(. 5ro'lems "ith the close$-transaction system+ o Ai:ui$ity - you@re 'ein1 taxe$ no" on 'asis o! 2romises o! 2ayments to you in the !uture. This $oesn@t 1i#e you cash no". o Fncertainty - not clear ho" much o! the 2ayments you@ll 1et. 2. O2en #s. >lose$ >ash in 1J16 5E o! Future 5ayments ;asis in /hares ,mount inclu$a'le in 1J16 ;asis in !uture 2ayments Treatment o! !uture 2ayments O)en Transaction G1207000 G0 - uncertain (G1O07000) G0 G1O07000 - G1207000 G607000 Reco#er 'asis !irst Close( Transaction G1207000 G1007000 (G1O07000) G=07000 1ain G1007000 (taxe$ on this am@t) Reco#er 'asis 2ro rata o#er 2H yrs. G100700042H - G=70004yr

&. =H& - Installment 0etho$ =H&(') - Installment /ale - $is2osition o! 2ro2erty "here at least 1 2ayment is to 'e recei#e$ a!ter the en$ o! the taxa'le year. * @;/1c2 " Co$)ute a ratio 8 ross Pro%it/Total Contract Price. o A))ly t&is ratio to eac& )ay$ent recei'e( 8 inco$e recogni9e( =H&($) - >an o2t-out o! the installment metho$ =. 3xam2le o! the Installment 0etho$ Farm "ith ,; o! G2007000 sol$ in 200H !or G100 cash ? 2romissory note+ o .ote - G1007000 in 20067 G2007000 in 200N7 G=007000 in 200O 21

Ryan Harsch Doran Tax Outline - Fall 2006 o /o this is an installment sale. o Ratio - G6007000 (1ross 2ro!it)4GO007000 (total contract 2rice) - X 200H 5ayment 2006 5ayment 200N 5ayment 200O 5ayment Total Install$ent #ale A))roac& G1007000 Y NHC - GNH7000 1ain G1007000 Y NHC - GNH7000 1ain G2007000 Y NHC - G1H07000 1ain G=007000 Y NHC - G&007000 1ain G6007000 1ain Burnette A))roac& Re$uce 'asis !rom G2009 G1009 Re$uce 'asis !rom G1009 0 G2007000 Y NHC - G1H07000 1ain G=007000 Y NHC - G&007000 1ain G6007000

Gain is $e!erre$ un$er o2en-transaction a22roach7 "hich is #ery !a#ora'le to T5.

E. Accounting Met&o(s 1. >ash 0etho$ Inclu(e an ite$ in gross inco$e B&en recei'e(. De(uct an ite$ %ro$ gross inco$e B&en )ai(. 2. ,ccrual 0etho$ Inclu(e an ite$ in gross inco$e B&en TP &as rig&t to recei'e t&e )ay$ent or set lia=ility to $a5e a )ay$ent> e'en t&oug& t&e )ay$ent &asn<t actually =een recei'e( or $a(e. &. 3xam2le - /ay you ha#e a 'on$ "ith a maturity 2erio$ o! 1H years "ith no annual 2ayments7 #ersus a 'an9 account. Fear + G107000 GN00 G107N00 G107000 G107000 Ban5 Account Fear 0 G107N00 GN=J G117==J M Bon( G107000 G107000 Fear +; G2N7600 G2N7600

;e1innin1 ;alance Interest at NC 3n$in1 ;alance ;e1innin1 ;alance 3n$in1 ;alance

.et result is no $i!!erent economically7 'ut "ith the 'on$7 the 1ain is all $e!erre$. G0 is an accrual-metho$ T57 so they@re in$i!!erent. They can $e$uct all alon1 '4c the o'li1ation to 2ay arises7 e#en thou1h there@s no interest. Result+ mismatch 'et"een "hen you@re taxe$ on the interest an$ "hen G0 $e$ucts. Original Issue Discount - use$ !or *ero cou2on 'on$% o OID - Re(e$)tion )rice " 1Issue )rice2/7i%e o% =on( - am@t income 2ic9e$ u2 each year.

F. De%erre( Co$)ensation

22

Ryan Harsch Doran Tax Outline - Fall 2006 1. 3xecuti#e De!erre$ >om2ensation a. 6hat is it< >ontract 'et"een em2loyer an$ em2loyee to 2ay 2art or all o! em2loyee@s com2ensation at some !uture time. Fse$ only !or executi#es or hi1hly-2ai$ em2loyees7 not re1ular em2loyees. Tax-:uali!ie$ 5lan% (e.1. =01(9)) - these ha#e a tax sa#in1s 2ortion. '. 3xam2le U1 - >urrent com2 - G1007 in#est !or H yrs U2 - De!erre$ com2 - G100 !or H yrs at 6CP Gates on accrual metho$ U& - De!erre$ com2 - G1007 !or H yrs at 6C7 Gates cash metho$ U= - De!erre$ com2 - G100 "ith 2romise to 2ay 6C interest >ost to 0/ Mr 1 G100 0/ ta9es $e$uction o! G100 G100 - 0/ cannot ta9e $e$uction G111 Ealue to Gates in Mr H ,!ter-tax income - G6H7 in#est at a!ter-tax rate o! &.JC - GNJ Gates inclu$es G100 2lus earnin1s on interest7 in#este$ at &.JC - GNJ Gates has GNJ in Mr H GON

c. * @-@1a21;2 " Puts TPs all on t&e cas& $et&o( " %orces co$)any to (e%er its (e(uction an( $a5es e$)loyee in(i%%erent to current 's. (e%erre( co$). $. Tax 3xem2tion I! 0/ $i$n@t ha#e to 2ay tax on the in#estment returns7 then they can in#est a smaller amount to 1et more !or Gates. 3xam2les - charity or tax-exem2t or1ani*ationP com2any "ith .OAs7 or an o!!shore com2any =HN - >harities an$ tax-exem2t or1ani*ations are 2ut on the accrual metho$ !or $e!erre$ com2 2lans. e. He$1e Fun$s Fun$s are locate$ o!!shore are not su'8ect to F./. tax7 'ut mana1e$ 'y 2eo2le in the F./. su'8ect to F./. tax. !ere> t&ere<s still an incenti'e to (e%er tax. Manager (e%erre( A+-- %or +- years> Fun( earns 0-K> Tax 8 /;K Mr 1 5re-tax RoR ,!ter-tax RoR 5re-tax 2ayout De!erral Mr 10 Fun$ su'8ect G100 20C 1&C G100Y(1.1&)10 to F/ tax - G&=0 Fun$ not G100 20C 20C G100Y(1.20)10su'8ect to G620 F./. tax ,!ter-tax 2ayout Mr 10 G&=0Y &HC G221 G620Y &HCG=0&

2&

Ryan Harsch Doran Tax Outline - Fall 2006 2. 3conomics o! De!erre$ >om2ensation I! they@re 2ayin1 the same tax rate7 result is that com2anies 8ust ha#e to 2ay more (as in scenario =) in or$er !or the executi#e to 1et a 'ene!it. This 8ust costs the sharehol$ers money. Ho"e#er7 "hen the tax rate is lo"er or *ero7 the 1o#ernment 1ets ri22e$ o!!. &. & Doctrines to >hallen1e De!erre$ >om2ensation+ a. >onstructi#e Recei2t Cas& $et&o( TP $ust inclu(e in inco$e an un)ai( a$ount unless t&e rig&ts to t&at a$ount are su=stantially restricte(. o I! the T5 turns his 'ac9% on the income. 6as the cash there !or the ta9in1< '. O& - 3conomic ;ene!it Doctrine Cas& $et&o( TP $ust inclu(e in inco$e an un)ai( a$ount i% e$)loyer )ut t&e $oney in trust %or t&e =ene%it o% t&e TP or ot&erBise )ut it =eyon( t&e reac& o% t&e e$)loyer<s cre(itors. c. >ash-3:ui#alence Doctrine Cas& $et&o( TP $ust inclu(e in inco$e any un)ai( a$ount i% t&e TP<s rig&ts to t&at un)ai( a$ount can =e )le(ge( or assigne( %or 'alue. =. >ases Case A$en( Pulsi%er Facts /ale o! "heat in @==P 5ayment in Z=H 5ri*e money !rom lottery 2ut in trust !or chil$ren ,nnuity 'ou1ht !or em2loyee De!erre$ com2 hel$ in trust7 'uys annuities !or em2loyees Rene1otiation o! ho" rene"al commissions 1et 2ai$ 7egal Issue >onstructi#e Recei2t 3conomic 'ene!it 3conomic 'ene!it >onstructi#e recei2tP 3conomic 'ene!it /ale4exchan1eP >onstructi#e Recei2tP 3conomic ;ene!it Outco$e T5 "ins Go#@t "ins Go#@t "ins T5 "ins on 'oth Rationale .o le1al ri1ht to 2ayment in @== un$er the contract. 3#en thou1h no G no"7 the amount "as set asi$e irre#oca'ly !or T5s 'ene!it 'eyon$ reach o! cre$itors. Insurance co o'li1ation is a #este$ ri1ht !or em2loyee em2loyer can@t reach them. >R - $e!erral ma$e 'e!ore amounts recei#e$ 3; - Trust assets "ere hel$ 'y em2loyer an$ "ere reacha'le 'y cre$itors. .o#ation% - there are creatin1 all ne" contracts7 so there is no le1al entitlement.

Dresc&er Minor

Ol$stea(

T5 "ins

2=

Ryan Harsch Doran Tax Outline - Fall 2006 H. =0J, - Inclusion in GI o! De!erre$ >om2 un$er .on:uali!ie$ 5lans a. Haircut 5ro#ision% - allo"e$ executi#es to ta9e most o! the money out o! a $e!erre$ com2 2lan at any time i! they !or!eite$ 10C. '. .e" >o$e 5ro#isions 1a21@21B2 " )artici)ant in (e%erre( co$) )lan $ust $a5e initial election to (e%er =e%ore t&e close o% t&e )rior taxa=le year (a)(2)(,) - $istri'utions - must s2eci!y "hen an$ ho" 2ayment "ill 'e ma$e 1a21/2 " =ene%its cannot =e accelerate( " eli$inates C&aircutD )ro'isions 1a21@21C2 " Once co$) (e%erre(> TP can elect to re"(e%er i%6 o 3lection ma$e 12 months a!ter initial $e!erral $ecision o 0ust $e!er !or an a$$itional H yrs minimum o 3lection can@t 'e ma$e less than 12 mths 'e!ore !irst 2ayment (a)(1) - Penalties !or !ailure to !ollo" rules+ o Taxe$ on all $e!erre$ income currently o Interest is char1e$ 'ac9 to $ate o! $e!erral o 20C 2enalty tax (c) - ,nti-2reem2tion - must !ollo" re1ular $e!erre$ com2 theories . #toc5 O)tions> Restricte( Pro)erty> an( Ot&er E$)loyee Co$)ensation 1. O& - Restricte$ /toc9 - 5ro2erty Trans!erre$ In >onnection "ith 5er!ormance o! /er#ices a. * L/1a2 " eneral Rule " I% )ro)erty is trans%erre( in connection Bit& )er%or$ance o% ser'ices> TP $ust inclu(e in gross inco$e6 Taxa=le gain 8 FM? o% )ro)erty B&en no ris5 o% %or%eiture " 1A$ount )ai(2 '. * L/1c21+2 " #u=stantial ris5 o% %or%eiture - "hen 2erson@s ri1hts to !ull en8oyment o! 2ro2erty are con$itione$ u2on !uture 2er!ormance o! su'stantial ser#ices ( #estin1 re:uirement%) c. * L/1=2 " Election - >an elect to inclu$e in income at current F0E minus amount 2ai$ "hen recei#e$. $. * L/1e2 " #toc5 o)tions " * L/ (oes NOT a))ly to6 O2tion "ithout rea$ily ascertaina'le F0E Trans!ers o! 2ro2erty 2ursuant to exercise o! o2tion "ith a rea$ily ascertaina'le #alue at time o! 1rant .ote+ i! o2tions ha#e a #estin1 2erio$7 there is .O rea$ily ascertaina'le #alue at time o! 1rant. 2. LoBue 3m2loyee stoc9 o2tions are taxa'le "hen exercise$. 3m2loyee recei#es su'stantial economic an$ !inancial 'ene!it. &. Cramer 3m2loyee not re:uire$ to inclu$e o2tions in income un$er 1.O&-N 'ecause they $i$ not ha#e a rea$ily ascertaina'le !m# at time o! trans!er 2H

Ryan Harsch Doran Tax Outline - Fall 2006 =. Tres Re1. 1.O&-N - Taxation o! .on:uali!ie$ /toc9 O2tions I% e$)loyee &as o)tions Bit& no rea(ily ascertaina=le 'alue at t&e ti$e o% t&e grant> e$)loyee Bill =e taxe( B&en6 o O2tion is exercise$ Income - F0E at exercise - (O2tion 2rice 2ai$) o O2tion is sol$ H. /toc9 O2tion Tax /helter 3m2loyee "oul$ recei#e stoc9 o2tions !rom com2any. Then sells them to !amily 2artnershi27% "hich 1i#es him a &0-yr installment note "ith 2ayment at the en$. 6hen o2tions #est7 !amily exercises. 0ain i$ea+ note is not a 2ayment an$ there!ore not income. Family 2artnershi2 is not an em2loyee7 so not co#ere$ 'y O& IR/ .otice 200&-=N a$$resse$ this+ o /ale to a 2artnershi2 o! !amily mem'ers is not an arms-len1th transactionP ori1inal o"ner o! o2tion retains o"nershi2 o Installment sale $oes not :uali!y - must inclu$e #alue o! note in year 1 !. Trans%ers Inci(ent to Marriage an( Di'orce 1. #.S. v. Davis Facts - Di#orce settlement in non-community 2ro2erty state (i.e. it@s his stoc9) inclu$e$ a22reciate$ stoc9. Issue - Is the $i#ision o! 2ro2erty a taxa'le e#ent< 6hat@s his amount reali*e$< Court " Trans%er is a taxa=le e'ent an( tax calculate( as i% stoc5 sol( at FM?. o He claims this is "ron1 '4c he@s not sellin1 it. 2 2ara$i1ms+ o >ommunity 2ro2erty - no" it@s 8ust a trans!er to co-o"ner o .e#er marrie$ - 8ust a commercial sale. O$$ Result+ $i!!erent tax result $e2en$in1 on "hat state you li#e in. 2. 10=1 - Trans!ers Inci$ent to Di#orce4/e2aration 1a2 " No gain/loss recogni9e( on a trans%er o% )ro)erty to a s)ouse to a %or$er s)ouse> inci(ent to a (i'orce. 1=2 " Trans%er Bill =e treate( li5e a gi%t " assu$e t&e =asis o% t&e trans%eror. (c) - Inci$ent to $i#orce% - means "ithin 1 yr o! marria1e an$ relate$ to the cessation o! the marria1e. Does .OT a22ly+ non-resi$ent alien or same-sex cou2le. Da#is rule still a22lies. Di#orce in non-community 2ro2erty state. Hus'an$ 1i#es house to "i!e (!m# - G1m) Da'is Rule * +-@+ ;ra$ G1m - ,R G0 - ,R (treate$ as a 1i!t7 "hich is (G.Hm) - ,; exclu$a'le un$er 102) GH007000 - 1ain GH007000 - ,; un$er 10=1(')(2) 26

Ryan Harsch Doran Tax Outline - Fall 2006 Ben Ben sells house !or G1.&m G0 - ,R G1m - ,; (assume$ !rom ;ra$) G1.&m - ,R (G1m) - ,; G&007000 - taxa'le 1ain G0 reco1ni*e$ 1ain (10=1(a) is a nonreco1nition rule) G1.&m - ,R (G.Hm) - ,; GO007000 - taxa'le 1ain (same as Da#is7 8ust chan1in1 T5)

&. +arid v. Commissioner Facts - 6i!e recei#e$ stoc9 throu1h 2renu2 in exchan1e !or her relin:uishin1 marital ri1hts li9e $o"er7 alimony7 etc. Issue - "as it a 1i!t7 1i#in1 her hus'an$@s lo"er 'asis7 or "as it a sale "ith 'asis o! !m#< >ourt - Treats this as a sale7 "ith #ali$ consi$eration on 'oth si$es. o He 1a#e her the shares7 she relin:uishe$ marital ri1hts. >ourt stru11lin1 to !it this into one o! t"o 2ara$i1ms+ o Gi!t or /ale =. ,limony a. >o$e 5ro#isions * .+1a2 " TP $ust inclu(e in gross inco$e ali$ony )ay$ents * 0+;1a2 " TP can (e(uct %ro$ gross inco$e any ali$ony )ay$ents N1(') - De!inition o! alimony o 0ust 'e in cash o 0ust 'e 2ai$ un$er instrument o! $i#orce% o 0ust not ha#e a1ree$ that 2ayments are non$e$ucti'le o 0ust not li#e in same house o 5ayment cannot continue a!ter $eath o! reci2ient o 0ust not 'e chil$ su22ort N1(')(1)(;) - can o2t out o! inclu$a'ility4$e$ucti'ility '. N1(!) - Front-loa$in1 rules I! there are excess alimony 2ayments7 then in year & the 2ayor s2ouse must inclu$e in income an$ 2ayee may $e$uct. Excess ali$ony 8 su$ o% excess )ay$ents %ro$ %irst 0 yrs o Fr 0 Excess 8 Fr 0 Ali$ony " 1Fr / ali$ony " A+;>---2 o Fr + Excess 8 Fr + Ali$ony " M1Fr 0 ali$ony " Fr 0 excess N Fr / ali$ony2/0 N +;>---O 6hat is >on1ress 1ettin1 at< They@re a!rai$ o! $is1uisin1 settlement 2ayments as $e$ucti'le alimony. o Ho"e#er7 the !act that the !irst & yrs is $eterminati#e is "holly ar'itrary. ,limony Recei#e$ Result

2N

Ryan Harsch Doran Tax Outline - Fall 2006 Mear 1 Mear 2 Mear & G1007000 GNH7000 G=H7000 Mr 1 3xcess - G1007000 - Q(GNH7000 - G1H7000 ? G=H7000)42R ? G1H7000 Mr 1 3xcess - G&27H00 Mr 2 3xcess - GNH7000 - (G=H7000 ? G1H7000) - G1H7000 Mr 1 excess ? Mr 2 excess - G=N7H00 income to 2ayor4$e$uction to 2ayee

c. Die01 rguelles v. Commissioner T5 treate$ un2ai$ chil$ su22ort as $e$ucti'le 'a$ non-'usiness $e't. >ourt - .ot $e$ucti'le - /he has no 'asis in the $e't. o I! you loan someone money an$ not 2ai$ 'ac9 - then you ha#e 'asis in the $e't. ;ut i! someone #olunteers money an$ $oesn@t 2ay - no 'asis. o >ourt !eels li9e this is more li9e the latter - a 1ratuitous 2romise. /eems "ron1 - !rom an economic 2ers2ecti#e it@s the same. /he I/ out o! 2oc9et the costs o! chil$ su22ort she ha$ to 2ay. I. Consu$)tion Tax 1. 5olicy >oncerns H-/ $e!inition - Income - consum2tion ? sa#in1s >onsum2tion - Income - /a#in1s Fn$er a consum2tion tax7 sa#in1s is .OT taxe$ (unli9e un$er the current system). /ome 'elie#e that this "oul$ 'e 'ene!icial+ o Increase$ RoR !or sa#in1s - lea$s to 1reater sa#in1s Ho"e#er7 some e#i$ence sho"s that 2eo2le only sa#e !or a s2eci!ic 1oal. ,lso7 hi1her RoR on sa#in1s may lea$ to re$uce$ amounts o! sa#in1s. Duestion - shoul$ "e re2lace income tax "ith a consum2tion tax< o Other countries ha#e a little o! 'oth. Ealue ,$$e$ Tax% - tax on each sta1e o! 2ro$uction !or #alue a$$e$ 'y a 'usiness at that sta1e. 2. ,r1uments ,1ainst >han1in1 Re1imes a. !ori9ontal EEuity ;ase$ on notion that similarly situate$ 2eo2le shoul$ 'e treate$ the same. Fn$er consum2tion tax7 a'ility to 2ay is 'ase$ on consum2tion7 'ut that is not necessarily a 1oo$ measure - 2eo2le mi1ht consumer the same amount 'ut ha#e $i!!erent incomes. o Rich 2eo2le s2en$ a lo"er 2ercenta1e o! income than 2oor 2eo2le. '. ?ertical EEuity ;elie! that 2eo2le "ith 1reater a'ility to 2ay shoul$ ha#e a hi1her tax rate. Flat consum2tion tax $oes not 2ro#i$e 2ro1ressi#e rate structure. ,lso7 2eo2le at the to2 o! the income 'rac9et ten$ to sa#e more7 "hich isn@t taxe$.

2O

Ryan Harsch Doran Tax Outline - Fall 2006 o 6oul$ ha#e to im2ose a hi1h rate on hi1h-income househol$s to achie#e the same amount o! 2ro1ressi#ity. &. Transition 5ro'lems ;i1 2ro'lem+ I! you shi!t !rom a system "here sa#in1s is taxe$ to one "here it is not7 ho" $o you treat 2ro2erty that@s 'een taxe$ an$ sa#e$ at the time o! transition< Consu$)tion Tax Inco$e Tax 1;-K2 1;-K2 G100 earne$ G100 earne$YH0C - GH0 (G100) in#estment in lan$ in#est in lan$ G0 taxa'le G1H0 2rocee$s Re-in#est - G0 taxa'le >onsume - G1H0 Y .H - A.; a%ter tax GNH 2rocee$s (GH0) 'asis G2H - 1ain Y .H - G12.H0 tax AG0.;- 8 a%ter tax Inco$e tax Consu$)tion tax G100 earne$Y H0CGH0 in#este$ in lan$ GNH 2rocee$s Re-In#est - G0 taxa'le >onsume - GNH Y .H - G&N.H0 A/..;- 8 a%ter"tax

Time 1 - 3arn G1007 in#est a!ter-tax in lan$ Time 2 - /ell lan$ at F0E 1H0C

Transition Tax - a tax on ol$ ca2ital% - 2eo2le alrea$y 2ai$ tax on income "ith 'asis in in#estments. .o" the 'asis $isa22ears an$ 2eo2le 2ay tax a1ain "hen that money is s2ent. o This "oul$ $iscoura1e sa#in1s more. 6e coul$ allo" 2eo2le to 9ee2 their 'asis7 'ut this "oul$ 'e a "in$!all !or ol$ ca2ital.

I?. DEDUCTION# AND PREFERENCE#


A. De(uctions in eneral 1. Itemi*e$ De$uctions a. * G/1a2 - Inclu$es casualty loss7 me$ical ex2enses7 charita'le contri'utions7 interest7 an$ state4local taxes. '. 6N - Floor on 0iscellaneous Itemi*e$ De$uctions Miscellaneous ite$i9e( (e(uctions can only =e ta5en to t&e extent t&ey excee( a 0K %loor o% A I. 0iscellaneous itemi*e$ $e$uctions inclu$e anythin1 .OT in 6N(')+ o /o .OT interest7 taxes7 charita'le contri'utions7 casualty loss7 me$ical ex2en$itures. c. 6O - O#erall Aimitation on Itemi*e$ De$uctions I% A I excee(s A+-->--- (e(uctions =egin to )&ase"out6 o /K o% A I a=o'e t&res&ol( co$es out o U) to L-K o% ite$i9e( (e(uctions

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Ryan Harsch Doran Tax Outline - Fall 2006 2. .on-Itemi*e$ De$uctions a. * G/1=2 - I! you chose not to itemi*e7 can only ta9e $e$uctions allo"e$ in 62 ( a'o#e the line% $e$uctions) an$ stan$ar$ $e$uction. '. 62 $e$uctions - 'usiness $e$uctions7 alimony7 IR, contri'utions7 etc. c. * G/1=21+2 " #tan(ar( De(uction >an O.AM claim this i! you@re a non-itemi*er GH7000 !or sin1leP G107000 !or marrie$ /et hi1h intentionally to encoura1e 2eo2le to ta9e this rather than itemi*e

&. Itemi*er #s. .on-Itemi*er Non"Ite$i9er Gross Income (De$uctions un$er 62) A(:uste( ross Inco$e (/tan$ar$ $e$uction) (5ersonal exem2tions) 8 Taxa=le Inco$e Ite$i9er Gross Income (De$uctions un$er 62) A(:uste( ross Inco$e (Itemi*e$ $e$uctions) (5ersonal exem2tions) 8 Taxa=le Inco$e

B. Casualty 7osses 1. 16H - Aosses 16H(a) - De$uction may 'e ta9en !or any loess $urin1 taxa'le yr not com2ensate$ 'y insurance or other"ise. 16H(') - ,mount o! $e$uction $etermine$ 'y 'asis7 not F0E * +G;1c2 " AlloBa=le losses6 o Tra$e or 'usiness o ,ny transaction entere$ into !or 2ro!it o 5ro2erty loss arisin1 !rom !ire7 storm7 shi2"rec97 other casualty7 or the!t 16H(h) - Aimitations o Aoss must excee$ G1004casualty o >an only $e$uct casualty losses to extent it excee$s 10C o! ,GI 2. D&er v. Commissioner Facts - >at 'ro9e a #ase in a neurotic !it. T5 claime$ casualty loss. >ourt - This is not li9e a !ire7 storm7 shi2"rec9. >ou2le - this "as uncontrolla'le7 much li9e an ,ct o! Go$. o 5erha2s the ma1nitu$e o! the loss cuts a1ainst treatin1 this as a casualty loss.

&. Chamales v. Commissioner Facts - T5 is O.B.@s nei1h'or an$ #alue o! house $ecline$. They claim a loss an$ $isclose it on their tax return.

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Ryan Harsch Doran Tax Outline - Fall 2006 >ourt - .OT a casualty loss. o Must =e su((en - slo" $e#aluation o#er time is not a casualty. o Must =e )er$anent o Must =e )&ysical (a$age (exce2t 11th circuit)

=. Bla!kman v. Commissioner Facts - T5 char1e$ "ith arson7 althou1h he sai$ he trie$ to 2ut out the !ire 'e!ore the house 'urne$ $o"n. ,ttem2te$ to $e$uct casualty loss. >ourt - .o $e$uction+ o Gross ne1li1ence. o 6oul$ contra#ene 2u'lic 2olicy. C. Me(ical Ex)ense De(uctions 1. 21& 0+/1a2 " alloBs (e(uction %or $e(ical ex)enses o% TP> s)ouse> or (e)en(ents> not co$)ensate =y insurance to t&e extent t&at ex)enses excee( ..;K o% A I. o Hi1h threshol$ in or$er to ca2ture extraor$inary e#ents 0+/1(2 " Me(ical care - !or the $ia1nosis7 cure7 miti1ation7 treatment7 or 2re#ention o! $isease or a!!ectin1 the structure4!unction o! the 'o$y. o Does .OT inclu$e+ controlle$ su'stances7 cosmetic sur1ery (unless relate$ to illness or acci$ent)7 maternity clothes7 #et !ees. 2. "!hs v. Commissioner Facts - 6i!e@s me$ical con$ition meant that she coul$n@t 'e aroun$ her 9i$s7 so they "ere sent to a 'oar$in1 school. T5 tries to $e$uct the cost o! school. >ourt - ,mount is .OT $e$ucti'le. This is a 2ersonal !amily ex2ense. >ourt is tryin1 to $ra" the line 'et"een normal ex2enses that you can incur in li!e an$ those that are O.AM me$ical. I! she ha$ 1one to a s2a !or treatment7 then that "oul$ 'e me$ical. &. -enderson v. Commissioner Facts - T5 2arents 'ou1ht a #an an$ ma$e mo$i!ications to it in or$er to trans2ort their sic9 son. They try to $e$uct the cost 2lus ta9e $e2reciation $e$uctions. Court " Test " Is t&is so$et&ing )eo)le (o in t&eir nor$al (aily li'esP o ;uyin1 the #an - not me$ical o 0o$i!yin1 the #an - M3/7 me$ical De2reciation is not a me$ical ex2ense 2ai$% un$er the statute7 so must $e$uct !ull cost o! mo$i!ications in the !irst year. D. C&arita=le Contri=utions 1. 1N0 (a)(1) - De$uction allo"e$ !or any charita'le contri'ution (c) - De!inition o! charita'le contri'ution - !or use 'y a+

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Ryan Harsch Doran Tax Outline - Fall 2006 o Go#@t entity o Or1ani*ation+ Reli1ious7 charita'le7 scienti!ic7 literary7 or e$ucational 2ur2oses7 or !oster amateur s2orts7 or 2re#ent cruelty to chil$ren4animals. .o 2ri#ate 'ene!it. .o lo''yin1. (') Aimitations on $e$uctions+ o 1=21+21A2 " Ccore grou)s% - reli1ious7 schools4uni#ersities7 me$ical7 1o#@t entities7 classic charita'le or1@s. 7i$it u) to ;-K o% contri=ution =ase 1A I2 o 1=21+21B2 " ot&er c&arities #$aller o% /-K o% contri=ution =ase or t&e re$ain(er o% t&e ;-K not use( u) un(er )art A. ($)(1) - can carry o#er excess contri'utions an$ $e$uct !or H yrs (!)(O) - must su'stantiate any 1i!t o#er G2H0 "ith letter !rom or1

2. "ttawa Sili!a Facts - T5 minin1 com2any $onate$ lan$ to !or school an$ access roa$s. /chool 'uilt access roa$s7 "hich actually 'ene!ite$ T5 '4c it nee$e$ those roa$s to 'e a'le to $e#elo2 the 2ro2erty. T5 claims $e$uction !or $onation. >ourt - .o $e$uction 'ecause the T5 recei#e$ a su'stantial 'ene!it. Test " Di( t&e (onor get a =ene%it greater t&an t&e one t&at inures to t&e )u=licP o ;ut7 e#eryone 1ets some satis!action out o! $onatin1. Go#@t exclu$es any 2syhic 'ene!it. Rationale+ o 5ossi'le #aluation 2ro'lems "ith non-material 'ene!it. o 6ant to ma9e sure the tax su'si$y 1oes to the or1ani*ation an$ not the in$i#i$ual. I! there is a material 'ene!it7 it@s more li9ely that there@s somethin1 comin1 'ac9 to the $onor an$ the $onor is ca2turin1 the su'si$y. &. Tax-3xem2t Or1ani*ations a. H01 - General Rule 3xem2ts charita'le or1ani*ations !rom tax. De!inition trac9s that o! 1N0(c) '. Bob /ones #niversit& Facts - Fni#ersity ha$ 2olicy o! racial $iscrimination in a$missions. IR/ $eci$e$ to re#o9e tax-exem2t status '4c charity can@t act contrary to 2u'lic 2olicy. Rea1an "ants to re#o9e7 'ut >on1ress $oesn@t. >ourt - ;o' Bones is .OT tax-exem2t '4c to ha#e a charita'le 2ur2ose7 you cannot 'e #iolatin1 2u'lic 2olicy. & elements o! $ecision+ o Textual - >ourt says you ha#e to !all into one o! the O cate1ories un$er the >o$e ,.D ser#e a charita'le 2ur2ose (common la" re:uirement). &2

Ryan Harsch Doran Tax Outline - Fall 2006 Dissent - $on@t rea$ this into the statute i! it@s not there. Ho"e#er7 "e $on@t "ant to su'si$i*e or1@s "ith 'a$ 2ur2oses. o Institutional - >on1ress re!use$ to inter#ene to re#o9e the IR/ rulin17 "hich can 'e seen as en$orsement. Ho"e#er7 har$ to conclu$e that this is really "hat inaction 'y >on1ress means. o #u=si(y Analysis - Fn$er the material 'ene!it rule7 i! >on1ress 1rants the tax-exem2t status7 they 1et a su'si$y an$ "e "ant it to en$ u2 "ith the or1ani*ation. >ourt a#oi$s this analysis. They coul$@#e hel$ the "hole thin1 unconstitutional. Ho"e#er7 many reli1ious or1@s are recei#in1 the same 'ene!it7 an$ this coul$ 'e seen as an 3sta'lishment >lause #iolation. E. Interest De(uctions 1. 16& - General Rule (a) - De$uction !or all interest 2ai$ or accrue$ on in$e'te$ness in the taxa'le year (h) - Does NOT a))ly to )ersonal interest7 e.1. cre$it car$. 2. = ty2es o! $e$ucti'le interest+ o Interest alloca=le to tra(e/=usiness loans ;ut not 'usiness o! 'ein1 an em2loyee. o In'est$ent interest Aimite$ to net in#estment income. >an carry it !or"ar$ i! no earnin1s. 26H(a)(2) - no $e$uction i! $e't is to 'uy tax-exem2t 'on$s o 3uali%ie( resi(ence interest - house that T5 li#es in 2lus one a$$itional ,c:uisition in$e'te$ness - u2 to G1 million Home e:uity in$e'te$ness - u2 to G1007000 Busti!ication+ 2romotin1 home o"nershi2 o Interest relate( to e(ucational loans De$uct u2 to G27H004yr7 'ut 2hases out :uic9ly. F. Ot&er De(uctions 1. 16= - Taxes (a) De$uction allo"e$ !or state4local 2ro2erty taxes7 2ersonal 2ro2erty taxes7 income taxes. 1=21;21A2 " Can ta5e (e(uction %or state/local sales tax OR inco$e tax 2. 1H1 - 5ersonal 3xem2tions 5er 2erson $e$uctions !or T5s an$ $e2en$ents !or li#in1 ex2enses ,#aila'le to itemi*ers an$ non-itemi*ers 5hase-out - Aose 2C !or e#ery G2H00 o! ,GI a'o#e G21O7JH0 . Tax Cre(its

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Ryan Harsch Doran Tax Outline - Fall 2006 1. Generally It@s 8ust a su'traction !rom amount $ue on taxes. Gross income - (De$uctions) - Taxa'le income x (rate) - tax - (>R3DIT) - tax $ue >re$its are almost al"ays a tax 2re!erence an$ not a "ay o! 1ettin1 at income 0ay 'e re!un$a'le 6hereas $e$uctions4exclusions matter more to 2eo2le hi1her u2 the income scale7 cre$its are the same amount !or all.

2. &2 - 3arne$ Income Tax >re$it >re$it !or earne$ income7 "hether you ha#e 9i$s or not. /in1les "ith 2 chil$ren+ o /tarts at G0 0ax cre$it - G=7=00 !or G117000 earne$ income o 5hase-out 'e1ins at G1=7000 eliminate$ at G&67&00. 0arrie$ "ith 2 chil$ren+ o /tarts at G0 0ax cre$it [ G117000 o 5hase-out 'e1ins at G167=00 eliminate$ at G&N72H0 o /o marria1e 'onus $urin1 ram2-u27 'ut 2enalty $urin1 2hase-out &. 2= - >hil$ Tax >re$it Cre(it o% A+>--- %or any (e)en(ent c&il( +G yrs or younger P&ase"out " Re(uce( =y A;- %or eac& A+>--- I t&res&ol( A I o G1007000 - 8ointP GNH7000 - sin1le Re!un$a'le - not until you reach G117000 Incenti#e - 2ro'a'ly not an incenti#e to ha#e 9i$s7 'ut instea$ relie! !or 2eo2le "ho alrea$y ha#e them. Ho"e#er7 the ma8ority o! the 'ene!it 1oes to hi1her income 2eo2le7 es2ecially the mi$$le class. !. Business 's. Personal De(uctions 1. /tatutory Frame"or9 a. * 0G0 " Personal ex)enses are NOT (e(ucti=le '. * +G0 " Tra(e or =usiness ex)enses ARE (e(ucti=le I/ inclu$e$ un$er 62 - so not an itemi*e$ $e$uction UN7E## ex)enses are %or t&e =usiness o% =eing an e$)loyee c. * 0+0 " De(uction alloBe( B&en engage( in )ro(uction o% inco$e> =ut not to t&e extent o% tra(e/=usiness. Ho"e#er7 this is an itemi*e$ $e$uction. 2. Ho''y Aosses a. * +L/ " De(uction %or ex)enses o% acti'ity t&at is NOT a tra(e/=usiness an( not %or )ro(uction o% inco$e can =e (e(ucte( to t&e extent o% inco$e %ro$ t&at acti'ity. '. Ni!kerson &=

Ryan Harsch Doran Tax Outline - Fall 2006 Ty)e o% Ex)ense Tra$e4;usiness Tra$e4;usiness as em2loyee 3x2enses !or 2ro$uction o! income ,cti#ity not en1a1e$ in !or 2ro!it 5ersonal 3x2enses Facts - 5 "as an a$#ertiser "ho 'ou1ht a $airy !arm as a ne" #enture. /ustaine$ losses tryin1 to ma9e it 2ro$ucti#e7 trie$ to $e$uct. IR/ 2osition - this "as a ho''y 'ecause it "asn@t en1a1e$ in !or 2ro!it. >ourt - Pri$ary )ur)ose test - must sho" that there "as sincere 2ro!it moti#e /u'8ecti#e Test De(ucti=leP Mes Mes Mes Mes .o Ite$i9e(P .o Mes Mes Mes 7i$its on De(ucti=ilityP .one 2C !loor - 6N ,GI 2hase-out - 6O 2C !loor - 6N ,GI 2hase-out - 6O Only to extent o! acti#ity

&. Income Fnrelate$ to Tra$e or ;usiness a. .hitten Facts - T5 $e$ucte$ tra#el ex2enses !or 6heel o! Fortune as 1am'lin1 losses or as tra$e4'usiness ex2enses. >ourt - There is no $e$uction !or 1am'lin17 8ust a limit. He@s not en1a1e$ in the tra$e4'usiness o! 1am'lin17 so no $e$uction. These are 2ersonal ex2enses. o This 2uts them as 'elo" the line% $e$uctions7 so su'8ect to 6N-6O. '. -enderson T5 $e$ucte$ ex2enses !or o!!ice $ecorations an$ a 2ar9in1 s2ace as tra$e4'usiness o! 'ein1 an em2loyee. >ourt - These are 2ersonal ex2enses - not necessary !or his 8o'. This has to 'e easy - i! this stu!! isn@t 2ersonal7 "hat is< =. Home O!!ice De$uctions a. 2O0, (a) - .o $e$uction !or use o! $"ellin1 use$ 'y T5 as a resi$ence (') Threshol$ - must 'e 162 'usiness ex2enses (c) - De$uction !or 'usiness use o! home7 i! exclusi#ely on a re1ular 'asis+ o Princi)le )lace o% =usiness o Princi)le )lace use( =y custo$ers o #e)arate structure in connection to tra(e/=usiness I! em2loyee - must 'e usin1 s2ace !or the con#enience o! the em2loyer. 1c21;2 " 7i$itation6 o Inco$e %ro$ tra(e/=us use o% &o$e o 1De(. )ersonal ex)enses N Business ex)enses not relate( to &o$e2

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Ryan Harsch Doran Tax Outline - Fall 2006 (c)(H) Flush Aan1ua1e - any unuse$ $e$uction can 'e carrie$ to next year7 'ut still su'8ect to same !ormula

>hris is micro're"er - sales o! G107000P total ex2enses o! G1=7000 Ex)enses Treat$ent GO7000 - attri'uta'le to use o! home G107000 income (G&7000) - 2ersonal ex2enses (e.1. mort1a1e) (G1=7000) ex2enses (GH7000) - home o!!ice ex2enses - su'8ect to G=7000 loss 2O0,(c)(H) (e.1. utilities7 insurance7 etc) Aimitation - G107000 - (G&7000 ? G67000) - G17000 G67000 - re1ular 'usiness ex2enses (in1re$ients7 /o GH7000 - G17000 - G=7000 excess $e$uctions e:ui2ment7 etc.) not allo"e$. >an 'e carrie$ !or"ar$.

'. 2o%ov T5 musician "as usin1 her li#in1 room as 2ractice s2ace. >laims it@s exclusi#e an$ re1ular an$ it@s her 2rinci2le 2lace o! 'usiness. Soliman Test " 0")art6 o Relati'e i$)ortance o% t&e acti'ity at eac& location o Ti$e s)ent at eac& location >ourt - On im2ortance7 it@s 'asically a "ash. ;ut she s2en$s "ay more time 2racticin1 at home than 2er!ormin1 else"here. /o T5 "ins. ,lternati#es - stron1 allo"ance rule or $isallo"ance rule - "oul$ create 2ro'lems on 'oth si$es. 0ore com2lex test "oul$ inc a$min costs. o Instea$7 "e ha#e a su'8ecti#e test. c. $oller T5 use$ home to mana1e lar1e in#estments. Duestion is "hether they are in#estors or tra$ers. >ourt - They@re in#estors7 not tra$ers. Tra$ers en1a1e in many short-term transactions7 "hereas in#estors en1a1es in lon1-term in#estments. o /o it $oesn@t rise to the le#el o! a tra$e4'usiness. There!ore7 they !ail the 2O0, threshol$ an$ can@t ta9e $e$uctions. I. Tra'el/Entertain$ent 1. 'udol%h Facts - Insurance co. o!!ere$ tri2 to .M> !or T5 an$ s2ouse. T5s $e$uct costs. Pri$ary Pur)ose Test " )ersonal or =usinessP >ourt - This is mostly 2ersonal. Ho"e#er7 em2loyee has to 1o on these tri2s to a$#ance in his 8o'7 so it@s at least 2artly 'usiness. 0ore accurate result "oul$ 'e to $etermine its #alue to him7 'ut this is har$ to $o. /o it@s all or nothin1. 2. Danville 2l&wood Facts - T5 claims G1009 $e$uction !or /u2er ;o"l tri2 !or o"ner7 some em2loyees7 customers7 an$ s2ouses. >laim that it "as 'usiness-relate$ - ho"e#er7 the e#i$ence ma9es it seem li9e there only a little 'it o! 'usiness 1oin1 on. &6

Ryan Harsch Doran Tax Outline - Fall 2006 >ourt 162 re:uires that it 'e an or$inary an$ necessary% 'usiness ex2ense. Here7 there "as no reason !or the s2ouses to 'e there7 the customers "ere mostly there !or entertainment7 an$ not really 'usiness. o Ho"e#er7 i! it@s income to the em2loyees7 then "hy no $e$uction to em2loyer<

&. $oss Facts - Aa"yers lunch meetin1 case. They met at same restaurant e#ery$ay to tal9 'usiness. >laim that these are 'usiness ex2enses. >ourt - .O $e$uction. .o 'usiness nee$ to ha#e the lunches7 so not an or$inary an$ necessary ex2ense. Rationale - I! allo" $e$uction7 "oul$ su'si$i*e 2ersonal element o! meal. I! ne#er allo" $e$uctions7 then i1nore the !orce$ consum2tion% o! 'usiness com2onent. Ho"e#er7 it@s un"or9a'le to se2arate out these elements. /o Rule - 5rimary 5ur2ose Test 11J - $e$uction !or meals 2ro#i$e$ on the 2remises7 !or the con#enience o! the em2loyer% =. >o$e /ections a. 1&2($) - ;ene!it is not inclu$e$ in income i! the em2loyee "oul$@#e 'een entitle$ to a $e$uction ha$ she 2ai$ !or it hersel!. '. 2N= - Disallo"ance o! >ertain 3ntertainment 3x2enses 1a21+2 " enerally (isalloBs (e(uctions %or entertain$ent o Exce)tion6 I% TP esta=lis&es t&at t&e ex)ense Bas (irectly relate( to or (irectly )rocee(ing/%olloBing a =ona %i(e =usiness acti'ity. (a)(2)(') - 212 ex2enses are inclu$e$ alon1 "ith 162 ex2enses (m)(&) - /2ouses exclu$e$ unless also an em2loyee an$ there@s a 'ona !i$e 'usiness reason. (9) - Disallo"s extra#a1ant !oo$4'e#era1e (n) - H0C limitation on meal4entertainment ex2enses - rest is 2ersonal (c) - Forei1n Tra#el - cannot $e$uct 2ortion not alloca'le to tra$e4'usiness acti#ity. H. Co$$uting Ex)enses 1. General Rule >ommutin1 is 2ersonal an$ .OT $e$ucti'le Or$inary an$ necessary 'usiness ex2enses >,. inclu$e tra#el costs. 0eals can 'e inclu$e$ is 2ass the 2rimary 2ur2ose test. #)ecial rule6 can (e(uct costs %or Ctra'el aBay %ro$ &o$eD an( $eals C!o$eD $eans B&ere you Bor5> not B&ere you li'e CABay %ro$ !o$eD " $eans at least one nig&t aBay

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Ryan Harsch Doran Tax Outline - Fall 2006 2. +lowers T5 li#es in Bac9son an$ commutes to 0o'ile ("here 'usiness locate$) a'out &H times a year. Does some "or9 in 'oth 2laces. >ourt - .o $e$uction - treats this li9e a really lon1 commute. Aoo9 at nexus 'et"een ex2ense an$ the 'usiness. ;usiness $oes not !orce him to tra#el a"ay !rom home - it@s his o"n choice. &. -ant0is T5 is marrie$ an$ li#es in ;oston. 0o#es to .M> !or summer 8o' an$ claims li#in1 ex2enses at a $e$uction - claims she@s a"ay !rom home% on 'usiness. >ourt - Home is "here you "or97 not "here your house is. It@s your 2rinci2le 2lace o! 'usiness. There!ore7 ex2enses in .M are 2ersonal. J. C&il( Care Costs 1. Smith RU7E6 C&il( care ex)enses are NOT (e(ucti=le i% TP incurre( t&e$ to Bor5 Decision to ha#e chil$ren is 2ersonal7 so ex2enses are 2ersonal as "ell. 2. 3conomics o! >hil$ >are Distortion cause$ '4c o! !ailure to tax im2ute$ income o! chil$ care an$ not allo"in1 a chil$ care $e$uction. Remem'er exam2le - more net cash i! the lo"er-income s2ouse stays home an$ ta9es care o! the 9i$s. 6hy not allo" $e$uctions to correct $istortion< 3x2ensi#e Aine-$ra"in1 - "hy chil$ care an$ not other 2ersonal ex2enses relate$ to "or9< &. Tax Relie! !or 6or9in1 5arents a. 21 - >re$it !or >hil$ an$ De2en$ent >are 3x2enses Cre(it %or )ercentage o% c&il( care ex)ense " A/>--- %or one 5i(> AG>--%or 0N o >a22e$ at earne$ income o! T5 or s2ouse7 i! lo"er Percentage 8 /;K re(uce( =y +K %or e'ery A0>--- A I I A+;>--o >annot 'e re$uce$ to lo"er than 20C '. 12J - 3xclusion !or 3m2loyer-5ro#i$e$ De2en$ent >are 3x2enses Exclusion %ro$ gross inco$e a$ounts )ai( =y e$)loyer %or c&il( care> u) to A;>---/yr. /ince 2re-tax7 more #alua'le to hi1h-rate T5s than lo"-rate T5s. >a22e$ at earne$ income o! T5. O!!sets any 12J cre$its. ,ny exclusion here re$uces the amount o! cre$it. c. 3#aluation These mechanisms $o not come close to correctin1 the economic $istortion.

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Ryan Harsch Doran Tax Outline - Fall 2006 7. Clot&ing Ex)enses 1. 2evsner Facts - T5 "or9e$ in 'outi:ue "hich re:uire$ her to "ear 2articular ty2es o! clothes7 'ut she $i$n@t "ear them a"ay !rom "or9. /"Part Test6 o +2 Clot&ing is reEuire( as a con(ition o% e$)loy$ent o 02 Clot&ing not a(a)ta=le to general use> AND o /2 Clot&ing is not so use( =y TP. O'8ecti#e test !or $eterminin1 1eneral a$a2ta'ility (2art 2). o ,$ministrati#e necessity o Fairness - "ant to treat li9e ali9e M. E(ucation Ex)enses 1. Carroll v. Commissioner T5 "as 2olice o!!icer "ho "as 1oin1 to ni1ht school to try to 1o to la" school. Rule6 De(ucti=le e(ucation ex)enses un(er * +G0 $ust =e ex)ress reEuire$ents o% t&e e$)loyer or laB %or your :o=> or ex)enses B&ic& $aintain or i$)ro'e current :o= s5ills. >ourt - These classes ha$ no s2eci!ic relationshi2 to his current 8o'. 2. >o$e 5ro#isions a. * 0;A " !ig&er E(ucation Cre(its Ho2e - u2 to G1H004yr !or 2 yrs. >laime$ 'y stu$ent or $e2en$ent. 0ust 'e at least \ time 2ro1ram. Ai!etime Aearnin1 - u2 to G27000 !or 2ost-secon$ary !or unlimite$ years. Doesn@t ha#e to 'e a 2ro1ram7 can 8ust 'e a class. '. * 000 " De(uction %or Post"#econ(ary E(ucation Ex)enses >a22e$ at G=7000 !or sin1les ma9in1 u2 to G6H70007 marrie$ cou2les u2 to G1&07000. .o 2hase-out7 'ut a cli!!. .on-itemi*e$ $e$uction c. Co'er(ell E(ucation #a'ings Accounts Tax-!ree sa#in1s account !or anyone un$er 1O y4o ,mounts contri'ute$ not $e$ucti'le7 'ut it 1ro"s tax-!ree G270004yr contri'ution max Distri'ution o! !un$s not taxe$ i! use$ !or e$ucation ex2ense 5hase out 'et"een GJH-G1009

$. * ;0, " 3uali%ie( Tuition Progra$ ,llo" 2re-2ayment o! tuition into account7 set u2 'y state or e$ucational institution. .o income limits on contri'utions. &J

Ryan Harsch Doran Tax Outline - Fall 2006 Gro"th tax-!ree7 Distri'utions are tax-!ree i! use$ !or e$ucation ex2enses

&. 5ro'lems Eery com2licate$ >ost to 1o#ernment is lar1e7 althou1h it $oesn@t loo9 'a$ no". This is '4c the tax 'ene!its o! sa#in1s accounts are 'ac9-loa$e$. They "ill cost a lot in the !uture. ;ene!iciaries - coul$ 'e the colle1es4uni#ersities 'ecause they can char1e hi1her tuition. N. 7egal Ex)enses 1. #.S. v. Gilmore T5 $e$ucte$ le1al ex2enses o! $i#orce 2rocee$in1 '4c it "as relate$ to his 'usiness in that he "as tryin1 to 9ee2 his "i!e !rom 1ettin1 hal! o! his stoc9. o He claims un$er 212 that it@s !or the 2reser#ation o! income-2ro$ucin1 2ro2erty. Origin o% t&e Clai$ Test6 Di( t&e clai$ arise out o% =usiness acti'ities or Bas it $erely )ersonalP o >onse:uences !or your 'usiness is not enou1h. >ourt - Here the claim arose !rom 2ersonal reasons no $e$uction.

?. DEDUCTION# FOR T!E CO#T# OF EARNIN

INCOME

A. Current Ex)enses 's. Ca)ital Ex)en(itures 1. >a2ital 3x2en$itures Any ex)ense $a(e to acEuire or i$)ro'e an asset Bit& a use%ul li%e o% $ore t&an one year. .OT $e$ucte$ currently. Instea$7 the costs are a$$e$ into the 'asis o! the asset an$ reco#ere$ "hen you ma9e su'tractions !rom 'asis7 li9e throu1h $e2reciation or sale. * 0G/1a2 " No (e(uction %or cost )ai( %or neB =uil(ings or )er$anent i$)ro'e$ents to =uil(ings> or %or i$)ro'ing/restoring )ro)erty 2. 3xam2le - startin1 a "inery. Pay$ent Aan$ ;uil$in1 3:ui2ment Gra2es 6ine (stoc9s in store) Goo$"ill 3m2loyee /alaries De(uction/Ca)itali9ation >a2itali*e$ >a2itali*e$ >a2itali*e$ >a2itali*e$ (see re#enue rulin1) >a2itali*e (In#entory7 'ut must consi$er "hether $is2ose$ o! in year 1) >a2itali*e De$ucti'le7 OR >a2itali*e$ (i! ma9in1 im2ro#ements) Ti$e o% Reco'ery /ol$ De2reciation4/ol$ De2reciation4/ol$ /ol$ /ol$ ,morti*e$4/ol$

=0

Ryan Harsch Doran Tax Outline - Fall 2006 O!!ice su22lies De$ucti'le

2. *n!&!lo%edia Britanni!a Facts - T5 hire$ researcher to "rite a 'oo9 !or them. Too9 $e$uctions !or this cost e#en thou1h royalties "oul$n@t 'e earne$ until the !uture. >ourt - This manuscri2t "ill 2ro$uce income 'eyon$ one year. .ee$ to match the ex2ense an$ the income. /O it shoul$ 'e ca2ital. Faura - authors are allo"e$ to $e$uct ex2enses !rom "ritin1. >ourt - this is limite$ to "hen there is a stream o! 'oo9s7% "here the ex2enses an$ income are li9ely to match u2 re1ar$less. o It may 'e $i!!icult to allocate 2articular ex2enses to 2articular income7 'ut this $oesn@t matter. o Ho"e#er7 allo"in1 a current $e$uction as o22ose$ to ca2itali*in1 DO3/ ma9e a 'i1 $i!!erence. De$uctin1 no" is "ay more #alua'le to the T5 than $e$uctin1 "hen 2ai$. &. 26&, - Fni!orm >a2itali*ation Rules (a)(1) - 0F/T ca2itali*e+ o Direct costs o! 2ro2erty o In$irect costs alloca'le to the 2ro2erty o (') ,ny real tan1i'le 2ro2erty 2ro$uce$ 'y T5 an$ hel$ !or resale (1) - 5ro$uction - means construct7 'uil$7 install7 manu!acture7 $e#elo27 or im2ro#e o >o$i!ies 3ncyclo2e$ia ;ritannica. =. Re#enue Rulin1 OH-O2 .o $e$uction !or !armer !or cro2s alrea$y 1ro"in1 this ex2ense may 'e ta9en account o! "hen sol$. B. Re)air an( Maintenance 1. General Rule REPAIR Current (e(uction REP7ACEMENT/IMPRO?EMENT Ca)itali9e 2. Illinois $er!hants ,rust Re)air 8 anyt&ing t&at 5ee)s asset in goo( o)erating con(ition> =ut (oesn<t exten( its use%ul li%e. Not re)air 8 i% $aterially increase t&e 'alue o% )ro)erty> )rolong its li%e> increases its use%ulness or strengt&. 5ro'lem - ,ny 1oo$ re2air !ul!ills the criteria !or an im2ro#ement. /o there is not 1oo$ line to $ra" here. 2. $idland *m%ire 2a!king Co.

=1

Ryan Harsch Doran Tax Outline - Fall 2006 Facts - T5 has to oil-2roo! 'asement in or$er to 9ee2 'usiness runnin1. He $e$ucts this as a 162 ex2ense as a re2air7 'ecause it $oesn@t increase the #alue o! the 'asement relati#e to 'e!ore the oil lea9. >ourt - This is a re2air7 'ecause it@s or$inary an$ necessary !or continue$ o2eration o! the 'usiness7 not a$$in1 #alue or increasin1 li!e o! the 'usiness.

&. Norwest T5 reno#ate$ 'uil$in1 an$ remo#e$ as'estos at same time. The total cost "as GNm7 o! "hich G1.Jm "as as'estos remo#al. T5 ar1ues that as'estos remo#al "as a re2ai$ an$ is $e$ucti'le. Re#enue Rulin1 J=-&J45lain!iel$ Fnion o Re# Rulin1 - >lean-u2 costs are $e$ucti'le '4c they are restorin1 2ro2erty to its ori1inal con$ition an$ not increasin1 #alue. o 5lain!iel$ Fnion - must loo9 at the assets 'e!ore an$ a!ter the ex2en$iture an$ see i! it has 'een im2ro#e$. >ourt - T&is Bas )art o% a general )lan o% re&a=ilitation. E'en i% one )art Boul( ot&erBise =e (e(ucti=le> it all $ust =e ca)itali9e(. o Rationale - ,llocation o! costs. ,lthou1h there economies to $oin1 'oth at once7 it@s har$ to allocate sa#in1s 'et"een the t"o 2ur2oses. Annual (e)reciation (e(uctions GNm o#er &0 yrs - G2&&7000 A%ter"tax 'alue 1Q ;-K2 G11N7000 GO&7000 Present ?alue G1.Om G1.&m A%ter"tax cost GNm - G1.Om GH.2m GHm - G1.& G&.Nm G1.Hm (G&m 2re-tax)

;aseline >a2itali*e entire GNm ,lternati#e G16N7000 >a2itali*e reno#ation GHm /a#in1s !rom $oin1 8ust reha'+

>ost o! $oin1 8ust as'estos - G1.Jm /o7 sa#in1s !rom $oin1 se2arately - G&m - G1.Jm - G1.1m $ea$"ei1ht loss C. oo(Bill 1. .el!h v. -elvering Facts - T5 em2loye$ 'y com2any that "ent 'an9ru2t. He 1ot a ne" 8o' an$ 2ai$ o!! ol$ em2loyer@s $e'ts in or$er to esta'lish 1oo$"ill. 6ante$ to $e$uct. >ourt - 5ayments are .OT $e$ucti'le. This is not an or$inary an$ necessary% 'usiness ex2ense 'ecause 2ayin1 o!! someone else@s $e't is not or$inary. This "as the 2urchase o! 1oo$"ill7 "hich is use!ul L 1 yr. 2. 1JN - Goo$"ill 2urchase$ !rom someone can 'e amorti*e$ o#er 1H yrs.

=2

Ryan Harsch Doran Tax Outline - Fall 2006 D. Rent Pay$ent ?ersus Install$ent Purc&ase 1. Starr3s *state Facts - T5 lease$ a s2rin9ler system "ith 2ayments o#er H years - 2urchase 2rice. /mall nominal 2ayments a!ter that. 6ante$ to $e$uct lease 2ayments as 'usiness ex2ense. IR/ - This "as essentially a sale7 so must 'e ca2itali*e$. >ourt - This is an installment sale7 so T5 can only $e$uct interest an$ $e2reciation. o >ourt !a#ors loo9in1 at su'stance o#er !orm here. >ourt thin9s this is essentially a "ash "hen you com2are interest4$e2reciation $e$uctions to rental $e$uctions. o Ho"e#er7 this is .OT true. There is a net tax sa#in1s 'y allo"in1 the lease o2tion. For lar1er transactions7 this costs the 1o#@t a lot. E. COr(inary an( NecessaryD 1. General Rule+ 162(a) - or$inary an$ necessary% re:uirement 2. Gilliam T5 attac9e$ 2erson on a 2lane $urin1 'usiness tri2 as a result o! 2sychotic con$ition. Trie$ to $e$uct le1al !ees !rom $e!ense. Issue+ ,re these or$inary an$ necessary 'usiness ex2enses o! 'ein1 an artist< Dancer - Hel$ that T5 coul$ 1et $e$uction !or car acci$ent that occurre$ $urin1 a 'usiness tri2. >ourt - >osts .OT $e$ucti'le 'ecause not $irectly relate$ to T5@s tra$e4'usiness. o Dancer is $istin1uisha'le '4c acci$ents are a 2art o! $ri#in1. This is unrelate$ to 'ein1 an artist - assaultin1 other 2assen1ers is a 2ersonal choice. &. 162(a)(1) - Reasona'le >om2ensation Reasona'le salaries an$ other com2ensation are $e$ucti'le !or ser#ices ren$ere$. Fse$ 'y IR/ to ma9e sure com2ensation not unreasona'le in extreme cases. ,lso "ant to $istin1uish 'et"een com2ensation an$ non-$e$ucti'le $i#i$en$s.

=. * +G01$2 " Pu=lic co$)any cannot (e(uct I A+$/yr to )ay CEO an( @ &ig&est co$)ensate( o%%icers. 3xce2tion+ commissions7 2er!ormance-relate$ 'onuses. Tax 2olicy - to $iscoura1e excessi#e 2ay arran1ements !rom ;oar$ o Ho"e#er7 in 2ractice the >3Os "ill still 1et 2ai$ this amount. It 8ust "on@t 'e $e$ucti'le. o This really 8ust hurts the sharehol$ers. =. Ille1al or Fnethical ,cti#ities a. >o$e 5ro#isions 162(!) - .o $e$uction !or !ines42enalties to 1o#@t !or #iolation o! la" 162(c) - .o $e$uction !or a 'ri'e7 9ic9'ac97 or 2ayment to o!!icial

=&

Ryan Harsch Doran Tax Outline - Fall 2006 '. 162(1) - .o $e$uction !or 24& o! $ama1es !or antitrust #iolations Ao''yin1 ex2enses ,R3 $e$ucti'le i! incurre$ to in!luence le1islator on a matter o! $irect interest to T5. Ste%hens v. Comm3r Facts - T5 em'e**le$ !un$s an$ ha$ to ma9e a restitution 2ayment. >ourt - De$uction allo"e$ as transaction entere$ into !or 2ro!it. Rationale - This is not a !ine7 'ut restitution. T&e )ay$ent itsel% $ust =e illegal. Here7 the T5 alrea$y 2ai$ taxes7 !ines7 etc7 so allo"in1 the $e$uctions $oes not !rustrate 2u'lic 2olicy. o 5u'lic 2olicy exce2tions are exclusi#e.

F. De)reciation 1. General 5rinci2les 16N(a) - $e$uction !or $e2reciation7 allo"in1 !or exhaustion7 "ear7 an$ tear !or 2ro2erty use$ in tra$e4'usiness or !or 2ro$uction o! income. * +-+G1a2102 " Re(uces =asis =y a$ount o% (e)reciation (e(uction ta5en 2. 0etho$s o! ,llocation a. 3lements+ use!ul li!e7 sal#a1e #alue (usually G0)7 allocation o! cost '. '. #traig&tline Met&o( 3:ual 2ortion o! the total cost o! asset is allocate$ to each year o! use!ul li!e.

Declining Balance Met&o( (5ercenta1e Y ,4;) 4 Fse!ul Ai!e F2 to 2oint "here strai1ht-line metho$ L $eclinin1 'alance metho$7 then s"itch to strai1ht-line. This 'asically 8ust accelerates $e2reciation $e$uctions early on. &. Rules a. '. c. $. Reco#ery 5erio$ 5ersonal 5ro2erty - use $eclinin1 'alance metho$ Real 5ro2erty - use strai1ht-line metho$ Reca2ture rules 12=H - u2on sale o! $e2recia'le 2ersonal 2ro2erty7 any 1ain reali*e$ is or$inary income to the extent o! $e2reciation $e$uctions ta9en 12H0 - 1ain on sale o! real 2ro2erty is the excess o! accelerate$ $e2reciation o#er strai1ht-line $e2reciation.

?I. TAR A?OIDANCE


A. T&e Tax #&elter Pro=le$ 1. Ty2es o! /helters a. De!erral

==

Ryan Harsch Doran Tax Outline - Fall 2006 '. c. $. e. 5ushin1 income into the !uture 'y incurrin1 costs no" that are $e$ucti'le an$ recei#in1 the corres2on$in1 return in some !uture year. Ae#era1e Fse someone else@s money to !inance an in#estment that allo"s you create losses. 3.1. Fse non-recourse loan to create $e2reciation $e$uctions. >on#ersion >on#ert income into ca2ital 1ain - ta9e $e2reciation $e$uctions a1ainst or$inary income7 'ut reco1ni*e 1ain at ca2ital 1ains rates. Tax ar'itra1e Incurrin1 $e$ucti'le ex2enses in or$er to 1enerate tax-!a#ore$ income in or$er to create tax loss in excess o! economic loss. Fse o! limite$ 2artnershi2s Direct !lo"-throu1h o! $e$uctions4cre$its to 2artners. Ta9e a$#anta1e o! limite$ lia'ility to increase in#estment 'asis usin1 non-recourse loans.

B. Hu(icial Res)onse to Tax #&elters 1. *state of +ranklin Facts - 5artnershi2 2urchase$ hotel !rom the Romney@s !or GNH7000 2re2ayment o! interest (currently $e$ucti'le) ? G1.2m non-recourse note. Aease hotel 'ac9 to Romneys !or same amount as interest 2ayments. 5artnershi2 claims G607000 in $e2reciation $e$uctions !or 10 years. De!ault a!ter 10 years7 "hich is a reali*ation e#ent o! G1.2m. o G1.2m (,R) - G6007000 ,; ($e2reciation $e$uctions come out) G6007000 o 6hy $o this i! you ha#e to 2ay tax in year 10 any"ay< Timin1 - 1et current $e$uctions7 "ith tax later. >a2ital 1ains treatment on $e!ault. o /o" 1P? o% (e(uctions " P? o% tax2 " A.;>--- 1%ee to Ro$neys2 8 ain They 1et this !or essentially $oin1 nothin1. >ourt - Disallo"s 'oth $e2reciation an$ interest $e$uctions. T&is is a s&a$ transaction Bit& no econo$ic su=stance. o De2reciation re:uires e:uity in the 2ro2erty. o ,r1ua'ly it@s $e$ucti'le un$er the statute7 'ut the in!late$ 2rice ma9es it loo9 li9e a sham. Ho"e#er7 e#en i! you cut e#erythin1 in hal!7 they@re still 8ust 'uyin1 $e2reciation $e$uctions an$ aren@t intereste$ in ma9in1 money !rom the hotel. 2. (nets!h T5 'uys annuity 'on$s (2.HC interest) "ith cash an$ non-recourse loan at &.HC. He@s essentially 'uyin1 a !uture stream o! income. He then 'orro"s the amount o! insi$e 'uil$-u2 !or the !irst-year o! the annuities an$ 2ai$ the interest on the 'orro"in1. He "ants to ta9e $e$uctions !or this. The annuity is 1oin1 to 'e so small that he@s not $oin1 it !or the #alue o! them. >ourt - this is a sham transaction7 "ith no economic su'stance. =H

Ryan Harsch Doran Tax Outline - Fall 2006 o 3!!ecti#ely7 he@s 'uyin1 an in#estment 8ust to 1et the $e$uctions !rom his a'ility to 'orro" a1ainst that in#estment. &. .inn1Di4ie T5 com2any 'orro"e$ on com2any-o"ne$ li!e insurance [ 11C7 e#en thou1h economic return is lo"er. >on1ress - 26=(a)(&) - can@t $e$uct in$e'te$ness !or 'uyin1 li!e insurance. >ourt - a22lies economic su'stance test. C. Congressional Res)onse to Tax #&elters 1. =6J - 5assi#e ,cti#ity Aosses Aimite$ (a) - Disallo"s 2assi#e acti#ity% losses an$ cre$its ($)(1) - Aoss - 5assi#e acti#ity loss - (5assi#e acti#ity income) o CBas5etingD " Can use )assi'e acti'ity losses to eat u) inco$e %ro$ )assi'e acti'ity gains> =ut can<t (e(uct t&e$. (c)(1) - De!inition - >on$uct o! a tra$e4'usiness in "hich T5 $oes not materially 2artici2ate - in'ol'e$ent $ust =e regular> continuous> an( su=stantial. (') - 5assi#e acti#ity losses can 'e carrie$ !or"ar$ as 5,As 2. =6H - ,t-Ris9 Rules (a)(1) - Can only (e(uct Cat"ris5D losses %ro$ at"ris5 gains. (c)(&) - a22lies to any acti#ity en1a1e$ in !or tra$e4'us or 2ro$uction o! income (')(1) - De%inition " o A$ount o% $oney an( A/B o% )ro)erty contri=ute( =y TP to t&at acti'ity. o A$ounts =orroBe( Bit& res)ect to t&at acti'ity i% it<s a recourse loan or secure( =y )ro)erty ot&er t&an t&at use( in t&e acti'ity. (a)(2) - >an carry-!or"ar$ unuse$ at-ris9 losses. & .e" >or2orate 5enalties a. 6N00 - 5enalty o! Tax /helter 5romoters ,nyone "ho ma9es a !alse4!rau$ulent statement "4re1ar$ to a tax shelter 5enalty o! H0C o! 1ross income !rom shelter '. 6111-6112 - 0aterial ,$#isor to Re2orta'le Transaction 0aterial a$#isor - tax 2re2arer7 la"yer7 'an9er7 etc. Re2orta'le transaction - one "ith a hi1h 2otential !or tax a#oi$ance accor$in1 to the IR/ 0ust !ile $isclosure re2ort to IR/P !ul!ill list-9ee2in1 re:uirements Failure to $o these+ stee2 2enalties. =. ,ccuracy an$ Frau$ 5enalties a. >o$e 5ro#isions =6

Ryan Harsch Doran Tax Outline - Fall 2006 Reason %or Penalty .e1li1ence4Disre1ar$ o! rules4re1s /u'stantial Fn$er2ayment (GH7000 or 10C o! "hat you o"e) Fn$erstatement !rom Re2orta'le Transaction Co(e/Penalty 6662 - 20C o! un$er2ayment 6662 - 20C o! un$er2ayment De%ense Reasona'le cause an$ 1oo$ !aith 1) R> an$ GFP OR 2) /u'stantial authority (=0C chance o! "innin1)P OR &) Reasona'le 'asis (lo" threshol$) ,.D $isclosure 1) R> an$ GFP ,.D 2) DisclosureP ,.D &) /u'stantial authority+ =) Reasona'le 'elie! that more li9ely correct than not (H1C) Reasona'le cause an$ 1oo$ !aith

6662, - 20C o! un$er2aymentP &0C i! no $isclosure 666& - NHC o! un$er2ayment

Fn$er2ayment !rom Frau$

'. ,ssessment /el!-assessment+ is there enou1h incenti#e to re2ort correctly< I! you un$erstate an$ turn out to 'e "ron1+ o Only $i!!erence is the 2otential !or a 2enalty. Remem'er - R>7 GF7 an$ su'stantial authority DO.@T mean you ha#e to 1et it ri1ht. o Bust ha#e to 1et a tax la"yer to say that there@s a =0C chance o! "innin17 or ha#e some small chance an$ $isclose it. For re2orta'le transaction7 nee$ to 1et o2inion letter that she is more li9ely than not to "in. c. Role o! Aa"yers /u'8ect to IR/ ethical rules7 2lus ,;, rules /tan$ar$ !or a$#isin1 a T5+ realistic 2ossi'ility o! success on the merits% 14& chance D. Alternati'e Mini$u$ Tax 1. Ho" is it >alculate$< AMT 8 Tentati'e Min " 1Regular Tax2 Gross Income (De$uctions) Taxa=le Inco$e ? ,$8ustments un$er H6-HO - ta9es out itemi*e$ an$ stan$ar$ $e$uction7 2ersonal exem2tion (3xem2tion ,mount) Taxa=le Excess x 2HC (] G1NH7000) or 2OC (LG1NH7000) Tentati'e Mini$u$ Tax

=N

Ryan Harsch Doran Tax Outline - Fall 2006 2. 5ro'lems "ith the ,0T &. >ases a. Wlaasen '. 5rosman

?II. INCOME ATTRIBUTION


A. Bac5groun( 1. ,ssi1nment o! Income Doctrine Rules that 2rohi'it4limit a T5 !rom shi!tin1 income to another T5. Bu$icially create$ $octrine $esi1ne$ to 2rotect 2ro1ressi#e rate structure. 2. Busti!ications !or 5ro1ressi#e Rate /tructure 6ant to tax 2eo2le 'ase$ on a'ility to 2ay o ;FT7 ar1ua'ly taxin1 "ealth instea$ o! income "oul$ ca2ture a'ility to 2ay% more accurately. Declinin1 mar1inal utility o! income o >ounter - this assumes that "e can ma9e 8u$1ments a'out in$i#i$uals@ actual 2ersonal 2re!erences an$ utilities. 6or94leisure tra$e-o!! - stee2ness o! cur#e may a!!ect this at the mar1ins. B. Inco$e Fro$ #er'ices 1. Lu!as v. *arl Facts - Hus'an$ an$ "i!e entere$ 2renu2 in "hich all o! hus'an$@s income "ill 'e hel$ as 8oint tenants. They 2ay taxes se2arately on - shares o! the income. This contract "as not entere$ into !or tax 2ur2oses ('e!ore income tax institute$). >ourt - Income tax is im2ose$ on the 2erson "ho actually earns the income. >annot assi1n it to someone else throu1h a1reement. 2. 2oe v. Seaborn Facts - T5 li#e$ in community 2ro2erty state7 so "i!e ha$ le1al entitlement as coo"ner to \ all earnin1s that accrue$ to hus'an$ $urin1 the marria1e. Go#@t - hus'an$ has control7 e#en thou1h there@s 8oint o"nershi2. >ourt - T5 "ins - each "ill 1et taxe$ se2arately on their share. o Distin1uish 'et"een 2ri#ate contract an$ state la". o ?oluntariness o% t&e (i'ision seems to 'e the 9ey. &. rmantrout Facts - >om2any ma$e 2ayments to trust to 'e use$ !or colle1e e$ucation o! chil$ren o! 9ey em2loyees. There is no o2tion to $ecline this !or income - it@s 8ust extra. Wey em2loyees "ith no 9i$s $on@t 1et extra com2ensation either.

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Ryan Harsch Doran Tax Outline - Fall 2006 >ourt - These are I.>O03 to the em2loyees '4c it@s com2ensation. Ai9e Aucas7 there is an antici2atory a1reement to assi1n income7 e#en thou1h there "asn@t an a1reement here. o >ourt thin9s this is #oluntary.

=. +irst Se!urit& Bank of #tah Facts - ;an9 hol$in1 com2any has 2 su'si$iaries - 'an9 sells li!e insurance7 li!e insurance co. 1ets the 2remiums ('an9 not allo"e$ to 1et these 'y la"). Go#@t - 2art o! the 2remium that 1oes to the li!e insurance co shoul$ 1o to the 'an9. >ourt - ;an9 "ins. /ince it "as ille1al un$er la" at the time !or 'an9 to 1et commissions7 this "as 2ro2er. H. ,es!hner Facts - T5 assi1ne$ "innin1s !rom contest to $au1hter '4c only chil$ren un$er 1N coul$ "in un$er the contest rules (i.e. not his choice). >ourt - ,ttri'ution to the chil$ "as 2ro2er 'ecause 2arent ne#er ha$ a ri1ht to recei#e the "innin1s un$er the rules. 6. /ummary RU7E6 Is t&e (i'ersion 'oluntaryP I! not7 then it@s 1enerally o9. 6hy shoul$ #oluntariness matter i! it still un$ermines the rate structure< It@s an anti-a'use rule. >ourt is loo9in1 !or 'a$ actors7 'ut is only "illin1 to 1o so !ar. Case Aucas #. 3arl 5oe #. /ea'orn ,rmantrout Teschner First /ecurity Ty)e o% Inco$e /alaries an$ !ees /alary7 in#estment income >om2ensation >ontest 5ri*e Insurance commissions #ource o% Di'ersion >ontract "ith s2ouse /tate la" 3m2loyer-s2onsore$ 2lan >ontest Rules Fe$eral la" 4inner Go#ernment T5 Go#ernment T5 T5

C. Marriage Penalty an( Bonus 1. >on1ressional ,ction 5oe 1a#e an un!air a$#anta1e to marrie$ cou2les in community 2ro2erty states. 1J=O - >on1ress allo"s all marrie$ cou2les to !ile a 8oint return. Treats them as sin1les7 each "ith hal! o! the total income. o This 2ro#i$es marria1e 'onus - each 1et a start at the 'ottom o! the 2ro1ressi#e rate structure. 1J6J - >on1ress scale$ 'ac9 2enalty on 'ein1 sin1le. o Ho"e#er7 creates a 2enalty !or marrie$ cou2les "ith similar incomes.

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Ryan Harsch Doran Tax Outline - Fall 2006 2. 0arria1e 5enalty4;onus 3xam2le Re#isite$ /in1le - G0-209 [ 0CP L G209 [ 10C 0arrie$ - G0-&09 [ 0CP L G&09 [ 10C #ituation 1 /in1le ;ritney (G1007000) V We#in (G0) 2 /in1le ;ra$ (GH07000) V Ben (GH07000) & 0arrie$ ;ritney (G1009) an$ We#in (G0) = 0arrie$ ;ra$ (GH09) V Ben (GH09) 0arria1e ;onus - I! incomes are not similar. 0arria1e 5enalty - I! incomes are similar.

Current Tax GO7000 G67000 GN7000 GN7000

&. 6hy can@t "e 1et ri$ o! it< 5ro1ressi#ity V Hori*ontal e:uity To eliminate the 'onus42enalty 'ut 9ee2 tax e:ual 'et"een the marrie$ cou2les7 the tax in situation 1 - situation 2. ;FT7 can@t $o this "ith 2ro1ressi#e rate structure. D. Trans%ers o% Pro)erty an( Inco$e %ro$ Pro)erty 1. Blair v. Commissioner Facts - T5 1a#e 2art o! his interest in a trust to his 9i$s7 'ut he 9e2t 2art o! the income stream. >ourt - Treate$ this as a trans!er o! 2ro2erty7 not 8ust income. There!ore the 9i$s are taxa'le. 2. -elvering v. -orst Facts - T5 ha$ cou2on 'on$s an$ 1a#e the cou2ons to his son (at maturity can 'e tra$e$ in !or interest 2ayments). This "as a #oluntary trans!er. >ourt - This is a trans!er o! income !rom 2ro2erty7 not a trans!er o! 2ro2erty. /o income is reali*e$ 'y T5. Distin1uishes !rom Blair+ o In Blair7 the 2ro2erty 1enerates income7 "hereas the cou2on is 8ust income. Ho"e#er7 it@s har$ to see "hy the cou2on is not 2ro2erty. I! you 1i#e the 9i$s the cou2ons "hen 2urchase$7 they ha#e a !uture income stream attache$ to them. o >ourt stru11lin1 to $ra" the line 'et"een a trans!er o! 2ro2erty an$ income (reci2ient taxe$ un$er Taft v. Bowers) an$ 8ust income (trans!eror taxe$ un$er Lucas). TE#T6 Is t&ere a re'ersionary interestP o I% ga'e rig&t to t&e inco$e %ro$ )ro)erty Bit& no re'ersion " ?A7ID assign$ent o% )ro)erty. o I% ga'e rig&t to t&e inco$e %ro$ )ro)erty Bit& a re'ersion rig&t " IN?A7ID assign$ent o% inco$e TP $ust )ay tax.

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Ryan Harsch Doran Tax Outline - Fall 2006 E. #er'ices Trans%or$e( Into Pro)erty 1. -elvering v. *ubank Facts - T5 retirin1 !rom insurance com2any an$ assi1ne$ rene"al commissions (!uture income !rom 2ast ser#ices to 1et li!e insurance clients) in trust !or 9i$s. >ourt - ,ssi1nment o! !uture income streams ma$e a!ter ser#ices 2er!orme$ - still taxa'le to the 2erson "ho earne$4assi1ne$ it. o Har$ to ar1ue that this is 2ro2erty. Future earnin1s are 1uarantee$ 'y contract7 'ut they $on@t o"n the source o! the 2ayments. 2. -eim v. +it0%atri!k Facts - T5 has 2atent an$ sells to com2any !or stoc9. ;ut he 9ee2s an interest in the 2atent in the !orm o! royalty 2ayments7 "hich he assi1ns to his 9i$s. >ourt - This is a trans!er o! 2ro2erty - "hat he hel$ 'ac9 is su'stantial enou1h. He 9e2t some control. He 1a#e this to his 9i$s "ith no re#ersionary interest. o Di!!icult to $istin1uish !rom Eubank. They 'oth in#ol#e ri1ht to income !or a ser#ice that hasn@t yet 'een 2ai$. &. RU7E6 4ill eit&er =e a trans%er o% inco$e %ro$ ser'ices or inco$e )ro(ucing )ro)erty " (e)en(ing on &oB strong t&e )ro)erty interest is.

?II. CAPITA7

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A. O'er'ieB 1. 0echanics a. Aon1-Term >a2ital Gains Rate - 1HC !or T5 taxe$ [ 2HC !or or$inary income.% Rate - HC !or T5 taxe$ [ 10-1HC on or$inary income. '. /hort-term ca2ital 1ains - taxe$ at or$inary income rates c. Real estate ca2ital 1ains - max rate o! 2HC $. >ollecti'les hel$ L 1 yr - max rate o! 2OC e. Gains !rom sale o! small 'usiness stoc9 - max rate o! 2OC a!ter H0C exclusion o! 1ain !. >a2ital Aosses - .O 2re!erence. >an 'e nette$ a1ainst ca2ital 1ains. Net ca)ital loss can =e o%%set against A/>--- o% or(inary inco$e. 2. 5olicy Rationale !or >a2ital Gains Treatment Aoc9-in 3!!ect% - T5s "ith a22reciate$ assets "ill 'e reluctant to sell an$ 1enerate tax. This re$uces the !lo" o! ca2ital an$ li:ui$ity. Go#@t 'ene!its !rom this rate 'ecause it encoura1es 2eo2le to sell more assets an$ reali*e income. Ho"e#er7 loss some income 'ecause o! lo"er rate. /te2-u2 'asis at $eath exacer'ates the loc9-in e!!ect H1

Ryan Harsch Doran Tax Outline - Fall 2006 In!lation - Gains on an asset may not 'e real7 'ut 8ust the e!!ect o! in!lation Dou'le Taxation - >or2orate earnin1s are taxe$ at cor2orate le#el7 then at sharehol$er le#el. ;FT - >a2ital 1ains rate 1oes 'eyon$ sale o! stoc9 ;unchin1 o! Income >a2ital 1ains accrue o#er many years7 in "hich T5 may ha#e 'een taxe$ at a lo"er rate7 'ut "hen all 1ain is reali*e$7 it 1ets a hi1her rate. 5ro'lem - those "ith ca2ital assets ten$ to ha#e hi1hest incomes any"ay >riticism - 2re!erence !or ca2ital 1ains 'ene!its 2rimarily the "ealthy. &. 5olicy Rationale !or Dis!a#orin1 >a2ital Aosses 5re#ent 2eo2le !rom cherry-2ic9in1% losses. I$ea is that 2eo2le "ill try to reali*e losses an$ not the 1ains. T5 coul$ create he$1e% "herein i! one in#estment increases7 the other $ecreases. T5 "oul$ claim loss 'ut not 1ain7 e#en thou1h no economic chan1e. ;FT - this rule is o#er'roa$. /ome T5s ha#e nothin1 'ut unreali*e$ losses. B. Co(e Pro'isions 1. 1222 - >om2utin1 .et >a2ital Gain Net Ca)ital ain 8 Net long"ter$ C " 1net s&ort"ter$ C72 o .et lon1-term >G - lon1-term >G - (lon1-term >A) o .et short-term >A - short-term >A - (short-term >G) 7ong"ter$ ca)ital gain/loss " #ale or exc&ange o% a ca)ital asset &el( %or I + year o% ta5en into account in co$)uting gross inco$e /hort-term ca2ital 1ain4loss - /ale or exchan1e o! a ca2ital asset hel$ 1 yr or less 2. 1221 - >a2ital ,sset Pro)erty &el( =y TP B&et&er or not %or tra(e/=us> =ut NOT6 o In#entory or 2ro2erty hel$ 2rimarily !or sale to customers o De2recia'le 2ro2erty use$ in tra$e4'us o >o2yri1ht o ,ccount recei#a'le in or$inary course o! 'usiness &. 12&1 - Duali!ier * +0/+ gain/loss " ain/loss on sale or exc&ange o% )ro)erty use( in tra(e/=usiness ($e2recia'le 2ro2erty an$ R3 hel$ !or L 1 yr7 'ut not stu!! you sell to customers) I! 12&1 1ains L 12&1 losses - treat them as lon1-term 1ain I! 12&1 losses L 12&1 1ains - treat them as or$inary income =. 1211 - >a2ital Aosses In$i#i$uals can $e$uct !irst G&7000 o! net ca2ital loss a1ainst or$inary income o Remainin1 amount carrie$ !or"ar$ as /T>A or AT>A >or2orations - can only o!!set ca2ital losses a1ainst ca2ital 1ains

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Ryan Harsch Doran Tax Outline - Fall 2006 B. Calculating Ca)ital ains/7osses an( #TC7

1. #te) + " CBas5et T&e$D " #e)arate 7TC /7TC7 %ro$ #TC

2. #te) 0 " Net 4it&in t&e Bas5ets I! only 1ains - tax each at $i!!erent rates I! only losses - $e$uct G&7000 o! or$inary income an$ carry !or"ar$ losses I! 1ains in one an$ losses in the other+ &. #te) / " Net Across t&e Bas5ets I! AT>G L /T>A - tax net ca2ital 1ain at ca2ital 1ains rate I! /T>G L AT>A - tax net ca2ital 1ain as or$inary income I! /T>A L AT>G - "i2e out ca2ital 1ains7 then G&7000 o! or$inary income7 an$ carry !or"ar$ the rest I! AT>A L /T>G - "i2e out ca2ital 1ains7 then G&7000 o! or$inary income7 an$ the rest is carrie$ !or"ar$. =. 3xam2le AT>G 1 GH700 0 2 GH700 0 & G1700 0 = G1700 0 T5 "ith G2009 or$inary incomeP &&C or$inary rateP 1HC ca2ital rate AT>A .et AT /T>G /T>A .et /T Result (G17000) ? G=7000 G27000 (G&7H00) (G17H00) .et >a2ital Gain - G27H00 [ 1HC (G17000) ? G=7000 G27000 (GH00) ?G17H00 .et AT>G - G=7000 [ 1HC .et /T>G - G17H00 [ &&C (GH7000) (G=7000) G27000 (GH00) ?G17H00 .et >a2ital Aoss - G27H00 De$uct !rom or$inary income (GH7000) (G=7000) G17000 (G&7000) (G27000) .et >a2ital Aoss - G67000 De$uct G&7000 !rom or$inary income7 carry o#er G&7000

C. Pro)erty !el( CPri$arily %or #ale to Custo$ersD 1. Bielfeldt Facts - T5 ha$ lar1e losses !rom s2eculatin1 on Treasury ;on$s. He "ants to claim them as or$inary losses. Issue - Is he a $ealer% or a tra$er%< Dealers 'uy an$ sell securities !or someone else7 "hereas a tra$er $oes it !or himsel!. o I! you@re a $ealer7 than the securities he 'ou1ht are in#entory !or customers7 "hich is .OT a ca2ital asset. There!ore7 they "oul$ 'e or$inary 'usiness losses. >ourt - He@s a tra$er. He is 8ust s2eculatin1. , $ealer ma9es money o!! ser#ice !ees7 "hereas a tra$er tries to ma9e money o!! his o"n in#estments. o He $i$n@t sho" consistent acti#ity that $emonstrates he@s a tra$er.

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Ryan Harsch Doran Tax Outline - Fall 2006 2. Biedenharn T5 'ou1ht a 2lantation !or !armin1 an$ in#estment. Aater they 'e1an to im2ro#e it an$ sell the 2arcels !or resi$ential $e#elo2ment. >laims that this is li:ui$ation o! an in#estment7 so it@s a ca2ital 1ain. >ourt - They are hol$in1 the lan$ as 2art o! a tra$e4'usiness7 2rior in#estment intent a'an$one$. /o it@s or$inary income. Factors to see i% asset c&anges %ro$ ca)ital or(inary6 o Fre:uency an$ num'er o! sales (main !ocus) o /i1ni!icant im2ro#ements o /olicitation an$ a$#ertisin1 o ;ro9era1e acti#ities D. Transactions Relate( to TPs Regular Business 1. Corn 2rodu!ts Facts - T5 "as 2ro$ucer o! corn 2ro$ucts. They 'uy corn on the o2en mar9et an$ there!ore are susce2ti'le to !luctuations in 2rice. /o they 'uy corn !utures. T5 "ante$ to count 1ains on sale o! !utures contracts to 'e counte$ as ca2ital 1ains. 5ro'lem - this is a he$1in1 transaction. They "ait to see i! there@s a 1ain or loss - i! there@s a 1ain they claim ca2ital treatment. o T5 "hi2sa"s 1o#@t - he can@t lose7 'ut 1o#@t can. >ourt - Futures are or(inary inco$e =/c t&ey Bere )urc&ase( to %ul%ill an in'entory nee(. o Congress inten(e( t&at inco$e %ro$ o)eration o% a =usiness is or(inary. In#estment is se2arate !rom e#ery$ay 'usiness.% Inter2ret ca2ital asset% narro"ly. o 5ro'lem - this creates a 2otentially 'roa$er "hi2sa". ,ny in#estment "ith some relation to 'us acti#ity - T5 "ill ta9e "ait an$ see% a22roach. 2. rkansas Best Facts - T5 hol$in1 com2any hel$ in#estments in a 'an9 that su!!ere$ losses. They 'uy u2 shares to try to 2rotect the 'an97 'ut e#entually sell at a loss. T5 "ants or$inary income% treatment !or the loss. They claim that the assets "ere ac:uire$ as 2art o! e#ery$ay 'usiness (2er >orn 5ro$ucts). >ourt - T&ere is NO =usiness )ur)ose exce)tion. Inter2ret >orn 5ro$ucts narro"ly as a$$ressin1 only he$1in1 transactions to 2rotect in#entory. &. 1221(a)(N) - He$1in1 transaction is .OT a ca2ital asset i! T5 i$enti!ies it as such "hen it enters into the transaction. Once you 2ic97 can chan1e your min$. Ho"e#er7 i! choose ca2ital7 su'8ect to mar9-to-mar9et% rules7 "hich means that you@re !orce$ to 2ay tax on certain unreali*e$ 1ains4losses each year. E. #u=stitutes %or Or(inary Inco$e 1. 5ayment !or >ancellation o! a Aease a. -ort

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Ryan Harsch Doran Tax Outline - Fall 2006 T5 ac:uire$ o!!ice 'uil$in1 that ha$ a lease at an a'o#e-mar9et 2rice. Tenants later 2ay G1=07000 to cancel the lease. >laime$ a ca2ital loss !or+ o >ancellation 5ayment - (5E remainin1 rent - Fair rental #alue o! 'uil$in1) o They@#e con#erte$ a stream o! 2ayments into a lum2 sum. Court " T&is is or(inary inco$e. T&e lu$) su$ is :ust a su=stitute %or t&e rental )ay$ents> B&ic& are or(inary. o Ho"e#er7 note that there@s no 1oo$ reason to treat the sale o! the 'uil$in1 that 1enerates rents as ca2ital 'ut a sale o! the ri1ht to recei#e those rents as or$inary. ;est 8usti!ication - >ourt has to 2ic9 one or the other. I! you treat this as ca2ital7 the "hole $istinction colla2ses. ,nyone "ho is entitle$ to a stream o! 2ayments (e.1. an em2loyee) coul$ con#ert it to a lum2 sum an$ 'e entitle$ to ca2ital 1ains treatment.

2. /ale o! Interest in a Trust a. $! llister T5 o"ne$ a li!e interest in the income o! a trust an$ sol$ it o!!. T5 claime$ a ca2ital loss. >ourt - This is a ca2ital 1ain. o Remem'er ;lair - assi1nment o! income !rom a trust "as assi1nment o! 2ro2erty. Thus7 the sale o! the ri1ht to recei#e this income !ore#er is a trans!er o! 2ro2erty. RU7E6 Trans%er o% inco$e")ro(ucing )ro)erty gets ca)ital gains treat$ent unless t&e TP retains a re'ersion interest. &. Oil 5ayments a. 2.G. Lake Facts - T5 "as 5resi$ent o! oil com2any an$ recei#e$ a ri1ht to !uture oil 2ayments in return !or cancellation o! a G6007000 $e't. >ourt - This is or$inary income. Ai9e Hort7 it@s a su'stitution 2ayment usin1 !uture or$inary income. ;etter ex2lanation+ The com2any retaine$ a re#ersion interest7 so there "as no trans!er o! 2ro2erty7 8ust income. =. ;ootstra2 /ale to >harity a. Cla& Brown Facts - .on-2ro!it 'uys T5 lum'er 'usiness7 "ith a small u2-!ront 2ayment an$ the rest to 'e 2ai$ o!! !rom the 2ro!its o! the 'usiness o#er 10 yrs. Forme$ ne" com2any Fortuna7 an$ non-2ro!it lease$ the assets to it. Terms o! 2ayment "ere that the com2any 2ays O0C o! its 2ro!it to Institute7 "hich 2ai$ J0C to ;ro"n sharehol$ers. T5 claims ca2 1ains treatment. Result o! this $eal+ o ;e!ore - >lay ;ro"n earnin1s taxe$ at cor2orate rate an$ $i#i$en$s taxe$ as or$inary income. o ,!ter - They@re 1ettin1 J0C o! the rental 2ayments (sli1htly less than cor2orate earnin1s7 thou1h 2re-tax) su'8ect to lo"er tax rate. HH

Ryan Harsch Doran Tax Outline - Fall 2006 o >ourt - notes that there is no ris9 here. Hol$in1 - It@s a sale o! ca2ital assets. >ourt critici*es the su'stitution !or or$inary income% lan1ua1e o! Hort an$ 5G Aa9e. Other ex2lanation+ .o re#ersion interest here. The shares "ere sol$ an$ control "oul$ remain "ith the Institute. /o this !alls on the trans!er o! 2ro2erty% si$e o! the line.

F. Bail"Out o% Cor)orate Earnings 1. Gregor& v. -elvering Facts - T5 trans!erre$ stoc9 !rom the ol$ cor2oration to a ne" one - it@s a tax-!ree reor1ani*ation. Intent "as to sell the shares7 'ut not 'y the com2any ("hich "oul$ su'8ect her to $ou'le tax). /he then $issol#e$ the ne" com2any an$ trans!erre$ the shares to hersel!. >laims ca2 1ains treatment. >ourt - .o ca2ital 1ains treatment - in#ali$ transaction. >ourt !a#ors su'stance o#er !orm - the re-or1 here "as $one solely !or tax 2ur2oses. o RU7E6 7egiti$ate =usiness )ur)ose reEuire$ent 1in(e)en(ent o% tax consi(erations2 in or(er to get a tax"%ree reorgani9ation. . Frag$entation ?ersus Uni%ication o% Collecti'e Assets 1. .illiams v. $!Gowan Facts - T5 "as in 2artnershi2 an$ 'ou1ht out interest o! his 2artner. Aater sells the "hole thin1 an$ incurs a loss. >ourt - This is essentially the sale o! a sole 2ro2rietorshi2. The "hole 'usiness is not a ca2ital asset - nee$ to examine i! each 2iece is ca2ital or not. RU7E6 4&en selling an unincor)orate( =usiness> $ust (eter$ine i% eac& asset you sell an( (eci(e i% it<s ca)ital or or(inary. o /ale o! a 2artnershi2 interest is ca2ital. !. Correlation Bit& Prior Relate( Transaction 1. $er!hants National Bank Facts - ;an9 ha$ 'a$ notes thou1ht "orthless7 so it claime$ an or$inary loss. Mears later7 it sol$ the notes an$ claime$ ca2ital 1ain. Court " Must =e consistent in treat$ent o% relate( transactions " i.e. can<t sBitc& %ro$ or(inary to ca)ital treat$ent. o 6oul$ 'e un!air to 1et 'ene!it or or$inary loss4ca2ital 1ain on essentially the same transaction. .ote+ 111 Tax ;ene!it Rule only states that reco#ery o! $e'ts that "ere use$ !or a tax 'ene!it are taxa'le. Doesn@t tell us ho" to tax them. 2. rrowsmith Facts - T5 cor2oration ha$ li:ui$ate$ the com2any o#er a 2erio$ o! years an$ "as 1i#en ca2ital 1ains treatment. Aater7 there "as a 8u$1ment a1ainst the com2any a!ter no lon1er in existence. /harehol$ers claim or$inary loss !or 2ayment. >ourt - 0atchin1 - it@s a ca2ital loss since the !irst transaction "as a ca2ital 1ain.

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Ryan Harsch Doran Tax Outline - Fall 2006 o I! the la"suit ha$ ha22ene$ 'e!ore the li:ui$ation "as $one7 it "oul$@#e 8ust re$uce$ ca2ital 1ains. o Ho"e#er - the la"suit costs "oul$@#e 'een or$inary losses. /o i! you treat it as all ca2ital7 they@re "orse o!!. I! you treat it as all or$inary7 they@re 'etter o!!.

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